Bright Horizons Family Solutions Inc (BFAM) 2007 Q4 法說會逐字稿

Good day, everyone, and welcome to the Bright Horizons Family Solutions fourth quarter earnings release conference call. Today's conference is being recorded. For opening remarks and introductions, I would like to turn the call over to Mr. David Lissy. Please go ahead, sir.

Thanks, Sarah, and hello to everybody who's joined us on the call today. Joining me is Elizabeth Boland, our Chief Financial Officer, and before I begin with my comments I'll have Elizabeth go through some administrative matters. Elizabeth?

Hi, everyone. As you know, our earnings release went out over the wire after the close of the market today and its also available on our web site, brighthorizons.com. As just announced, the call is being recorded and is being webcast as well and a complete replay will be available in either medium.

For anyone wishing to access the phone replay you can call 913-312-0414 and use pin code 4858257. The webcast will be available at our web site under the Investor Relations section.

In accordance with Reg FD, as you know, we use these conference calls and other similar public forums to provide the public and the investing community with timely information about our business operations and financial performance along with our current expectations for the future.

We adhere to restrictions on selective disclosure and limit our comments to items previously discussed in these forums. Certain non-GAAP measures may be discussed during the call and detailed disclosures relative to these measures are included in our press release, as well as the Investor Relations section of our web site.

The risks and uncertainties that may cause future operating results to vary from those we describe in our forward-looking statements made during this conference call include our ability to execute contracts for new client commitments, to enroll children and to retain client contracts, as well as to operate profitably abroad.

It depends on our ability to successfully integrate acquisitions. The risks include capital investment and employee benefit decisions that employers are making, the effect of governmental tax and fiscal policies on employers considering work site child care, as well as the timing and completion of our previously announced merger agreement to be acquired by an affiliate of Bain Capital, LLC..

Lastly, you can see other risk factors that are set forth in our SEC filings, including our Annual Report on Form 10-K. The 2007 10-K will be filed at the end of this month.

Thanks, Elizabeth, and, hi, to everybody, again, on the call. As you all know, last month we announced that Bright Horizons has entered into a definitive agreement to be acquired by Bain Capital, and that transaction is expected to close sometime in the second calendar quarter of 2008.

So today's conference call is to provide investors with information about our recent operating and financial performance in the fourth quarter of 2007 and provide our current outlook as we head into 2008. As such, we'll not discuss or take any questions regarding the transaction and refer any such questions that you may have to the information that's already publicly available on our web site or in our SEC filings.

So let me begin today with a review of our fourth quarter operating results. I'll then finish up my remarks with a look ahead at our expectations for 2008. And as usual, Elizabeth will follow me with a more detailed review of the quarter's numbers and our outlook and then I'll come back and join her for Q&A.

First let me recap the numbers for the quarter. Revenue of $194 million was in line with our forecast and up 7% over last year's fourth quarter. Let me point out to you up front that during the quarter we recognized approximately $7 million in expenses associated with our transaction. So for the purposes of providing you with comparable numbers, today I'll discuss our earnings results excluding those expenses.

As such, operating margin of $20.5 million in the quarter expanded 30 basis points over last year's fourth quarter and generated net income of $12 million resulting in earnings per share of $0.44 versus $11 million and $0.41 respectively in last year's fourth quarter. Now let me give you some more color on our operating performance in the quarter. We added five new centers. Additions included new centers for Yale University, the Securities and Exchange Commission, Truman Medical Center in Kansas City, a second center for Valley Baptist Medical Center in Texas, and a consortium center in Dublin, Ireland.

We had previously planned on the Lipton acquisition, which as you know, closed on January 11 to have closed in the fourth quarter which accounts for the difference in new center openings in the quarter versus our prior forecast. We closed three centers in the quarter for a total of 14 routine center closings in 2007. That is after you exclude the 26 closures from the UAW/Ford network of child care and family centers.

To that end, let me remind you this is the second full quarter without the UAW/Ford centers which had the effect of reducing our revenue by approximately $7.5 million in the quarter compared to last year's fourth quarter and reducing operating contribution by a little more than $1 million. This translates to just under $0.03 a share.

Despite the UAW/Ford closures, we continued to improve our operating contribution again this quarter to 10.6% from 10.3% in 2006. The three main drivers of this performance were, first, our tuition rate increases of 4% to 5% offsetting labor cost increases of approximately 3% to 4%. Second, modest enrollment growth from our ramping and mature centers, and slightly improved performance 35 underperforming centers that we discussed with you last quarter.

We've implemented our action plan in those centers and have seen the results essentially reflect our forecast. Our actions have included, as we previously talked to you about, enhanced marketing support, properly enrolling and pricing part-time care, reviewing and adjusting staffing patterns, and adjusting general execution and leadership issues on a center-by-center basis. We knew that the rebuilding process would take us some time and we're pleased with the progress that's been made thus far. We expect to continue to see improvement throughout 2008.

The third factor in our margin improvement was the contribution from our suite of back-up services and College Coach.

Now let me look ahead and touch on our outlook for the remainder of 2008. Our pipeline of centers under development at the end of the quarter remains solid with more than 60 centers under development and scheduled to open now through 2009. For 2007, we added 35 organic centers and four through acquisition.

As I've mentioned on prior calls, the timing of acquisitions is quite variable, unlike the pipeline for organic growth which builds more steadily over time. While we make it a practice not to comment on deal specifics, the quality of our acquisition prospects is very good, and over time we expect that roughly a third of our growth will continue to come through the acquisition of high quality centers and providers. A great example of this is our recent announcement that the nine Lipton Corporate Child Care Centers joined the Bright Horizons family on January 11 expanding our network of dedicated back-up centers to more than 80.

Among Lipton's diverse list of leading clients are Bloomberg, CIP Group, and Jones Apparel. Bright Horizons and Lipton also shared many clients including Morgan Lewis, Pepsi, and Gap. Looking forward, we have several other smaller acquisition prospects at a stage where we'd expect them to be completed in 2008.

Our two newest service offerings, Back-up Care Advantage and College Coach, also finished off the year with good performance. Having generated just over $6 million in revenue in its first full year in operating the Back-up Care Advantage program, we're excited by the level of client interest and now serve more than 110 clients.

College Coach grew 30% over their last fiscal year with revenues of $7 million and we're encouraged by several early successes in cross marketing this service to our larger base of clients. As these services continue to ramp up we're making the necessary overhead investments to ensure that they have the specific marketing resources and solid delivery platforms needed to realize their growth potential.

As they grow and further leverage the investments we make we expect them to continue to return operating margins significantly above those in our center-based business. On the pricing side we believe that the 4% to 5% tuition increases in 2007 will continue in 2008 and we expect they will track ahead of our budgeted labor cost increases by approximately 1%.

We continue to work very hard in a field plagued with annual turnover rates north of 70% to enhance our culture and work environment which helps us to create our long-term competitive advantage. It's our goal to be the employer of choice in our field and we're very encouraged to see our annual turnover rate decline once again this year to approximately 20%.

Our efforts in this area are once again nationally recognized with our designation by Fortune Magazine as one of the 100 best companies to work for in America for the ninth time. We remain confident that our business is well positioned for solid growth and financial performance. The work we've been doing to improve performance in the centers that fell short in the third quarter is bearing fruit. And although they are not yet back to desired levels, we expect further improvement in 2008.

Our current outlook for 2008 is for revenue growth of approximately 10% over 2007 levels with higher growth rates in the second half of the year after we get past the comparative quarters that include the UAW/Ford centers. We also expect to once again improve operating margins in the range of 40 to 70 basis points over 2007 levels, and to generate earnings per share in the range of $1.94 to $1.99 for the year.

So with that, I'll hand it back over to Elizabeth to get into the numbers in more detail and I'll speak to you again during the Q&A. Elizabeth?

Thanks, Dave. So Dave just went through the top level results for quarter and I will just go through some details underlying those results. As Dave did, I'll caveat my remarks by clarifying that the figures I will be comparing also exclude the $7 million in acquisition-related costs that have been recorded in 2007. The pro forma effect of that is reflected in the attachments to the press release.

Reported net income, operating income and EPS are all affected by these transaction expenses. First, looking at top line growth. The sources of the $12 million of revenue growth in the quarter over the last year remain consistent -- new center capacity and program additions, enrollment gains and rate increases. We added five centers in the fourth quarter and a total of 39 for the full year.

Revenue also increased from the ongoing ramp up of enrollment in the centers we've opened in 2005 and 2006 as well as from the newer service that Dave referenced, especially Back-up Care and College Coach. Lastly, rate increases of 4% to 5% are the primary source of increased revenue in our mature center group, which is approximately 80% of our revenue base.

Offsetting these increases were lower operating subsidies in our cost-plus group of centers totaling approximately $500,000 as well as the effect of the closed UAW/Ford centers which, as Dave mentioned, generated approximately $7.5 million less in revenue in Q4 '07 than in Q4 '06. Center gross margins increased $4.2 million to $41 million in the quarter and were 21.1% of revenue compared to 20.3% in Q4 of '06.

The primary factors in improved gross margin contribution include basically the solid execution in the majority of the core business, contributions from centers acquired and transitions in management, and contributions from our higher margin services such as Back-up and College Admissions Counseling. We have seen steady improvement in most of the group of 35 community-based centers that fell short of our expectations in the third quarter.

A few centers in this group continue to lag targets in the fourth quarter. But these shortfalls were offset by other centers' outperformance. As we've discussed in the past, the gross margin is also burdened by pre-opening and early stage operating losses from newer P&L centers that we've opened, a total of 25 since the beginning of 2006. Overall in '07, we incurred approximately $4 million in pre-opening and ramp-up losses for this class of centers, which is an increase of $900,000 over 2006 levels.

However, the good news is that in the fourth quarter the comparative losses are lower than last year, approximately $1.1 million in Q4 '07 compared to $1.3 million in Q4 '06 due to the continued ramp of those that opened in early '06 which are now beginning to contribute. SG&A as a percentage of revenue increased 9.9% in the fourth quarter from 9.4% in the same 2006 period. The modest leverage that we've achieved in overhead spending in the U.K. has been offset by incremental overhead associated with the newer lines of business that we've mentioned, Back-up Care and College Coach.

In addition, as we absorbed the closure of the 26 UAW/Ford locations in 2007 we also absorbed the overhead team that had supported these locations which essentially resulted in spending slightly ahead of our growth. All this said, our rate of overhead spend on the core business mirrors past periods, and with continued vigilance on cost management paired with prudent investments to support our growth, we expect to leverage the overhead rate to appropriately align the costs with the top line growth rate in the second half of '08.

Amortization expense totaled approximately $1.2 million in the fourth quarter of '07 similar to '06 levels and was $4.7 million for the full year. Net interest expense was $100,000 for the quarter compared to $436,000 last year. We have reduced our borrowings outstanding under the line from $35 million in December of '06 to just under $12 million at the end of December '07.

So our financial performance so far this year, for the full year that is, drove a 15% increase in EBITDA to $104 million for the year while capital spending totaled $42 million. We ended the year with approximately $9 million in cash and weighted average shares outstanding stayed relatively even at $26.9 million for the quarter and the year.

Now let me recap our usual operating statistics. At December 31, we operated 641 centers with 71,000 total capacity. We now operate approximately 65% of our contracts under profit and loss arrangements, and 35% under cost-plus contracts. This shift results from the closure of the UAW/Ford cost-plus contract programs.

For full service centers, the average capacity per center is now 134 in the U.S. and remains at 59 in Europe. To give a little more detail behind the guidance for '08 let me first isolate the impact of the UAW/Ford contract. For first half of 2008, these closures will have the effect of reducing year-over-year revenue by approximately $19 million with more weighting in Q2. About $11 million of the $19 million will hit in Q2, and operating income by approximately $2.1 million split relatively evenly between the quarters. This translates to approximately $0.05 a share also split evenly between the first and second quarter.

Now turning to the full year view, our top line projection for '08 anticipates revenue growth of approximately 10% over 2006 levels or just over $850 million for the full year. We expect to add roughly 50 net new centers in '08.

Considering the mix of centers opened at the end of '07 and then planned for '08, as well as the variables that impact margin which include enrollment levels, labor management, personnel cost trends, the mix of contracts, our pricing power, and the timing of new center openings, we believe we'll generate 40 to 70 basis points of operating margin improvement in '08.

This translates to operating margins for the full year of approximately 10.7% to 11%. We expect amortization expense to approximate $5 million for the year and to have an effective tax rate of 42%. The combination of top line growth and margin leverage leads us to project EPS in the range of $1.94 to $1.99 for the full year, and looking specifically to the first quarter of '08 we're estimating EPS at $0.44 to $0.45.

So with that, Sarah, we are ready to go to Q&A.

Thank you. The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) We'll pause for a moment to assemble our queue. And we'll take our first question from Amy Junker with Robert Baird. Please go ahead.

Good afternoon. I was hoping you might be able to comment, and I don't know if it's too early to tell this, Elizabeth or David. Have you noticed any pullbacks from some of your more major financial services clients at this point just given the turmoil that's happening with a lot of the bigger banks? Is that something that they talk to you about or given you any sort of confidence that they're not going to be pulling back any of their centers at this point, and specifically think, I guess, JPMorgan, Bank of America, Citigroup?

Yes, Amy, this is Dave. I'll answer that. I think we have relationships with lots -- with the folks you've just mentioned and others throughout the financial services industry and have for many, many years. I think what we have going on it really is client-by-client.

In some cases we're actually expanding relationships, opening some centers as recently as in 2008 already, which we'll talk about when we talk about the first quarter. In other cases, we expect 2008 to be more of a we'll just hang on to what we have and it won't be an opportunity for expansion.

Our experience in the past has been as we've gone through different economic cycles with many of these clients who have been with us for years is we don't see a pullback, but rather we see certain clients go into times where they are not interested in talking about expansion. So to date, we haven't had any worries with respect to pullbacks.

And just to make sure I understand, I believe most of those clients, aren't they cost-plus clients of yours? So for instance, some of the layoffs they've been doing might mean that there's fewer people using the centers. That risk falls on them? Or am I wrong about that?

I think it's fair to say that many of them are cost-plus clients, but some of them are also P&L where we have the P&L. But I would say, if I had to look at that class as a group they're more heavily weighted towards cost-plus and you're correct in your thoughts around the fact that when enrollment fluctuates either way, we're not at risk in a cost-plus arrangement.

Great. I'll pass it on. Thank you.

Yes.

Thanks, Amy.

Thank you, and we'll take our next question from Jeff Silber with BMO Capital Markets. Please go ahead.

Thanks so much. I was wondering if we could get a little bit more color underlying your first quarter '08 guidance?

More color --

Either in terms of revenue growth, margins, et cetera, just to help us model.

Well, the first half, just to maybe expand on what I was alluding to on the Ford contract. The revenue growth that we're seeing in Q4 is likely to be pretty consistent in the first half of the year where the 10% that we see for all of '08 would manifest by higher growth in the back half.

And then from, otherwise from a training standpoint, because that is relatively ratable in the earnings side, the margin trends would be similar to prior years on an operating margin level and then the overhead piece of it is comparable as well in terms of [trends].

Okay. I know you asked us not to ask any acquisition related questions, but I'm going to try anyhow. What milestones should we be looking for between now and when the deal is going to be closing? What announcements, et cetera?

Jeff, I'm going to have to just give you the boilerplate. We can't comment.

All right. Let me try another one then. In terms of your relationships with your clients since you have announced the acquisition, have you seen any meaningful changes?

No.

Okay. That's good. And then just a quick numbers question, you have the stock-based compensation in the quarter?

In the quarter the stock-based comp is about -- it's just over $1 million dollars.

Great. I'll let somebody else jump on. Thanks.

I was just going to say it was a total of just about 5 -- sorry, just over $4.5 million for the year.

Thank you. And we'll take our next question from Bob Craig with Stifel Nicolaus. Please go ahead.

We're going to miss dealing with you guys by the way.

Oh, thanks.

A couple of questions for you. I know with your end market and geographic diversity you're not terribly affected by cycles. But could you review the timing of any cyclical influence on front-end sales activity, inquiry activity? I seem to recall, I think, you mentioning, Dave, that after 2001 was a pretty decent lag between that downturn and the time where you really started to see a pickup in that front end activity?

I think there are a couple factors that go on, Bob, as you know following us for so long. You can go through different economic cycles. The one place we do see some sensitivity to the economy is in the cyclical kinds of prospects, financial services, tech, consumer goods, and the sales cycle does get a little more elongated when the economy is softer in those areas.

That's counterbalanced, for us anyway, by our sort of [acyclical] clients, hospitals, universities, others, and also we do see a little bit more of a robust opportunity in the acquisition area when the economy is a little softer because of buyers being less bullish about the foreseeable future, I mean, sellers, excuse me, being a little less bullish. We're not really seeing yet, Bob, any differences in our sales cycle, our average sales cycle.

As I said in my comments to Amy, I think with respect to, even in the cyclical sectors, I think financial services, tech, we're still getting new commitments from prospects in those sectors and the time it's taking us to get them really isn't any different than it has been in the past year or two.

That would be something that we'd look out for. If we saw that that would be a signal. We just haven't seen any changes with respect to the sales cycle like we saw after 2001.

Okay, that's helpful. I guess, as long as we've covered you, we haven't lived through a consumer-led recession with you folks. Any outlook there? Seeing any impact? Parents pulling back at all on the service?

No. I think that when you sort of take out the effects of what we saw in that group of 35 centers in the third quarter which, again, to think that they're isolated in certain geographies and they're not, indicative of any sort of pervasive issues that we're seeing.

If you were to isolate and take them out, I think our enrollment trends, the rebound in the fourth quarter and the progression that we're seeing in the Q1 is pretty consistent with what we've seen in prior year trends. That would be the area, of course, where if anything was to change we would see it.

So disengagement levels are normal?

Right.

Okay. Could you provide some metrics on Lipton? If you did so I missed it and I apologize.

There's nine centers. They're back-up centers that are pretty similar in size of our overall base. So have revenue in the range of $500,000 to $800,000 or $900,000 as a sort of bandwidth of size. The capacities are similar. They're geographically based along the Eastern seaboard, D.C, New York, New Jersey area.

In terms of overlap, they don't really overlap much with centers that we already have. Except for those few clients that Dave mentioned that we have in common, there's a nice tuck-in to the footprint there from a back-up care opportunity standpoint, as well as the extensive full-service centers that we have in that same area. So it allows us to get a cross sell entree there.

Relatively, I mean there are other performances similar to our back-up centers as well. I think we see some opportunity there principally from future sales and growth. But what they're doing in the $500,000 to $800,000 is similar to the gross margin level around 20%.

Okay. And last question, Dave, you alluded to the acquisition pipeline. Can you give us characterization of that pipeline between domestic, international, back-up versus full-service or any other add-on services that you're looking to?

I think mostly what we're looking at now are the services we currently provide. I don't think you'll see us at this point in time -- we're kind of in digestion mode on the back-up (inaudible) services and on College Coach and we need to prove those businesses out.

So I think what we're mostly talking about in our pipeline, Bob, are core business opportunities, kind of what we consider to be our bread and butter which is more of the smaller operators, three to 15 center-type operators, both here and in Europe, in the U.K. and Ireland where we operate.

Great, I'll turn it over. Thanks.

Thank you. (OPERATOR INSTRUCTIONS) And we'll take our next question from Jeff Lee with Signal Hill. Please go ahead.

Hi, good afternoon. You said that College Coach had grown 30% in 2007. Are you expecting a similar growth rate for 2008?

Yes, we are expecting the growth to approximate that same level in 2008.

Okay. Great. And then what are your expectations for back-up care center business?

Well, the back-up -- we run 72 back-up centers at the end of '07 and then we added the Lipton centers. So we've got two tracks of growth in the back-up suite.

There's a few centers in the pipeline that will be dedicated back-up centers that are planned to open in 2008 that would be additive like the Lipton centers are additive. And then there's additional sales of memberships throughout the rest of the Bright Horizons network of through the Back-Up Care Advantage services.

We have, as we mentioned, Back-Up Care Advantage generated about $6 million in revenue this year. That was its first year out of the gate.

I'd say we're expecting growth there that's certainly in the range like you've seen with College Coach in the 30% plus rate for '08 and we're optimistic about its prospects. The rest of the back-up group we would see growing similar to our full-service business in terms of new center adds and regular performance growth.

Right. Thank you very much.

Sure.

And we'll take our next question from Amanda Miller with [Austock.] Please go ahead.

Good morning. Firstly, I'd just like to wish you good luck with everything that lies ahead. I was wondering if you are seeing any changes in the competitive environment at all?

Thanks, Amanda, first, for your good wishes. From our point of view, the competitive environment is pretty similar to what we would have talked to the group about when we spoke in October and through the quarters last year.

We still see our principal competitors for corporate-sponsored centers as the other two larger chains that operate here that we've competed with on a kind of client by client basis in certain geographies for many years. And we still see them out there.

And then wherever we are locally within the U.S. or the U.K., we're also competing with smaller operators, regional operators, local operators for contracts. So I think that same landscape still exists today.

Thank you.

Thank you. (OPERATOR INSTRUCTIONS) And we'll take our next question from Michael [Elhadge], a private investor. Please go ahead.

Good afternoon. Thank you for taking my question. I was wondering if you could help address two related questions.

The first is, notwithstanding the swoon inn stock price at your Company since your Q3 results, can you articulate some of the specific merits of your proposed go-private transaction since I can't seem to find anything that addresses such benefits clearly in any of your regulatory filings or press releases?

I think you'll see those in the preliminary proxy when it's filed, and that will be on file shortly, all the description of the rationale will be included there.

Okay, and will that also cover some of the reasons why the board felt a go-private transaction with such high leverage would be better done by an outside buyer as opposed to something that the Company would pursue on its own while still retaining its public listed status?

Again, Michael, our intent today was to talk about our results for the fourth quarter and not to comment on the transaction.

I think, as Elizabeth said, you'll find all of our rationale on file in the proxy, preliminary proxy which should be filed shortly.

Okay. Thank you very much.

Okay.

Thank you.

And it appears we have no further questions at this time. I'd like to turn the call back over to Mr. David Lissy for any closing remarks.

Okay. Just thank you everybody for joining us and for all your support throughout the years. For many of you it's been a long time and we appreciate your support as the Company has grown and hope to talk to you again soon.

Thanks, everyone.

Thank you. That concludes today's conference. We appreciate your participation. You may now disconnect.