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Bright Horizons Family Solutions (NYSE:BFAM)

Q1 2013 Earnings Call

May 9, 2013 05:00 PM ET

Executives

David Lissy - CEO

Elizabeth Boland - CFO

Analyst

Gary Bisbee - Barclays Capital

Jeffery Volshteyn - JPMorgan

Ang Syng - Credit Suisse

Jeff Silber - BMO Capital Markets

Bob Craig - Stifel Nicolaus

Tim Carl - William Blair

Brian Zimmerman - Goldman Sachs

Jeff Meuler - Baird

Operator

Greetings and welcome to the Bright Horizons’ Family Solutions First Quarter 2013 Conference Call. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Lissy, CEO of Bright Horizons’ Family Solutions. Thank you Mr. Lissy, you may begin.

David Lissy

Thank you, Roya and greetings from Watertown and hello to everybody on our call today. Joining me as usual is Elizabeth Boland, our Chief Financial Officer and she has been waiting all day to go through our Safe Harbor Statements. So, let me turn it over first to Elizabeth. Elizabeth?

Elizabeth Boland

Thank you, Dave. Hi, everybody. Our earnings release did go out today after the close of the market and it’s available on our website under the investor relations section at brighthorizons.com. This call has been recorded and it’s also being webcast and so a complete replay is available in either medium. The phone replay number is 877-870-5176 or for an international caller it’s 858-384-5571 with conference ID number 413218. The webcast will be available at our website under the Investor Relations section also.

In accordance with Regulation FD, 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 expectations for future performance. We adhere to restrictions on selective disclosure and limit our comments to items previously discussed in these types of calls.

We also discussed certain non-GAAP measures on this call and detailed disclosures relative to these measures are included in our press release as well as the Investor Relations section of our website.

The risks and uncertainties that might cause our future operating results to vary from what we describe in our forward-looking statements made during this call include our ability to successfully implement our growth strategies, including executing contracts for new client commitments, enrolling children in our childcare centers, retaining client contracts and operating profitably in the U.S. and abroad. Secondly, our ability to identify complete and successfully integrate acquisitions and to realize the attending operating synergies, third, decisions around capital investment and employee benefit to employers that we are making, fourth, our ability to hire and retain qualified teachers and other key employees and management. Fifth, our substantial indebtedness and terms of such indebtedness, and lastly, the other risk factors which are set forth in our SEC filings. So back to Dave to summarize our results and give you all our business update.

David Lissy

Thanks Elizabeth and hello again to everybody on our call. It’s been a busy couple of months since we last spoke to you about our fourth quarter results and as usual I will kick things off of the broad overview and Elizabeth will follow up with a more detailed review of the numbers and our outlook before we open it up for Q&A.

First, let me recap the headline numbers for the quarter. Revenue of $280 million was up 9% over prior year. An adjusted EBITDA of $49 million was up 17%. Adjusted net income of $16 million was up 85% over the first quarter of 2012, which yielded adjusted earnings per share of $0.25, up from $0.16 in last year’s first quarter. We started off 2013 strong as we continued to execute in our long term plan to grow our core center business while expanding or newer services and growing our footprint outside the United States.

We added 11 new centers in the quarter and increased our full service center capacity by just over 5%. Some of these highlights in the first three months for new centers were St. Jude’s Children Research Hospital, Marion Regional Medical Center as well as our third Center for the University of California at San Francisco.

Our back up in educational advisory services also continued to grow this quarter with new client additions that included limited brands, (inaudible) price and Ingersoll-Rand, just to name a few. We continued to be very optimistic about the cross selling opportunity that exist for us to expand our relationships with existing and new clients through these valuable service channels.

Once again this quarter we have continued to deliver on our long term plans to improve our gross margins which expanded a 100 basis points to 23.5%. The main drivers of the improvement this quarter were first tuition increases that averaged 3% to 4% and were paced modestly ahead of our cost increases in our full service care segment. Second, enrollment growth in our mature and ramp-up class of centers. Third, the new centers added in 2012 and in the first quarter of 2013. Fourth continued growth and improvement in our backup business. And lastly, growth and the associated benefits of scale in our UK operations.

Speaking of the U.K., I also wanted to talk with you today about a recently completed acquisition of Kidsunlimited which closed on April 10th. Kidsunlimited operates 64 centers throughout the U.K. with concentrations of centers in Greater London as well as in and around Manchester. The purchase price for this deal was GBP45 million. On an annual basis Kidsunlimited generates GBP45 million worth of revenue. This is a group that we have known and respected for a long time, and one of the most exciting aspects of this deal is that it fit with our existing U.K. business as this combination aligns us with the other major provider of employer sponsored center in the U.K. kids managed centers on behalf of the University of Oxford, Cambridge University of Hospitals and WH Smith to name a few and the consortium lease models provide high quality care to working families in geographic locations that complement our existing footprint. Their centers average 88 capacity and achieve gross margins and maturity that are consistent with our existing business in the UK.

Another attractive feature in our decision to acquire Kids was their recent growth of new organic centers over the past two years as well as a pipeline of centers in various stages of development as a result their portfolio included several centers that are still ramping up and will become mature contributors under our ownership as such we expect to be able to expand our current operating performance over the next 12 to 18 months which today is somewhat diluted by the immature class of ramping centers.

Lastly we are excited about the opportunity to cross sell backup services into this expanded portfolio which will further leverage our investment we have already begun the integration process which is proceeding well first and foremost I want to make sure employees families and clients understand our deep commitment to quality in all that we do over the next 12 months we will combine our support functions given the overlap with our current back office structure.

As a result we expect to realize significant back office overhead synergies similar to what we did in our last two acquisitions in the UK once this integration period is complete. We project that the business will generate EBITDA of just over £7 million on an annual basis. Let me give you a little context about how this fits into our existing growth plan for 2013. As we previously discussed given our consistent track record of executing on acquisitions each year we had expected in our 2013 plan to achieve approximately 30% of our new center growth from acquisitions. So the Kids acquisition is not all incremental to our previous outlook that we gave you for this year. The size of this transaction does fill that place older however when you consider the ramping phase of the newer centers deal costs and the time it will take us to achieve our targeted synergies we are not expecting to realize the full earnings impact until 2014. Therefore while this addition will improve our revenue growth for 2013. It won’t change our earnings outlooks for this year.

now let me update you on our view for the remainder of 2013 our view now contemplates the addition of 100 to 105 new centers, 75 to 80 net of expected closures. This is inclusive of our organic growth and the newly acquired centers. The organic new center growth will be achieved in large part due to the strength of our pipeline of centers currently under development. Broadly speaking the mix of centers in our pipeline is representative in geography, industry verticals and operating models as our existing base. Consistent with our last discussion we continue to see good momentum within higher education, technology, healthcare and the energy sectors with both new clients and new centers for existing clients in our pipeline. As we typically do each year we'll augment our new center openings in the year with transitions of management of center that are either self-managed by an employer client or managed by a competitor.

Moving to the acquisition side our pipeline of prospects remains robust in each country in which we operate. While we've satisfied our initial targets that we set for ourselves in 2013, we continue to be encouraged by the opportunity that we see to continue to add strategic value in this area. Another important part of our story in 2013 and beyond will be the growth of our newer lines of business led by the growth of our backup to pending care services. Backup care will continue to contribute to our margin expansion once again this year. Although still our smaller sector our educational advisory services grew almost 20% again this past quarter as interest in our EdAssist tuition advisory business continues to expand.

These services allow us to offer a broader value proposition to employer clients serving employee populations through more key life stages and in more locations than we ever could in the past. On the pricing side consistent with our historical experience we expect to realize 3-4% tuition increases on average once again this year, and this will outpace our expected cost increases by approximately 1%. We also expect to continue the positive trend in enrollment growth in our mature class of P&L centers that have been steadily regaining enrollment for the past 2 plus years which is also contributing to gross margin expansion. As we talked about before we’re always working to enhance the key drivers of quality in our centers.

Two important areas of focus this area are on the enhancement of our pre-K curriculum focused on school readiness and on the wellbeing of the children and families we serve through a comprehensive set of priorities around healthy eating, movement and wellness that make up our commitment as part of the partnership for a healthier America. Overall we raising our outlook for revenue growth for 2013 to a range that approximates 10-13% over 2012 levels. The components of this topline growth as follows, organic growth - which includes the estimated 3-4% price increases. One to three percent in enrollment in our mature and ramping centers, 1 to 2% from new organic full service center additions and 1 to 2% growth from back up and educational advisory services. In addition, acquisitions were approximately 5% including the lobbying effect of the acquisitions completed last year.

Offsetting these increases are the effects of centers closing and variations in costs plus revenue which together approximate 2%. As a reminder, costs plus center revenue is somewhat harder for us to gauge particularly early in the year and movements in revenue in this class have no effect on earnings.

For example, in the first quarter this group was approximately $3 million than we had previously anticipated in our plan but given the fix nature of this group, there are no economics on it either way. Overall, we anticipate that this growth will allow us to leverage gross margins, 60-90 basis points in 2013 which will in turn drive adjusted EBITDA to a range of 206-212 million and adjusted net income to 76-79 million.

Thus our guidance for earnings per share for the full year 2013 is a range of a $1.16 to a $1.21. With that, let me turn it over to Elizabeth to dive into the numbers in more detail and I will be back with you during Q&A. Elizabeth?

Elizabeth Boland

So my comments on our operating results will focus on revenue, gross margins and certain adjusted metrics, including adjusted EBITDA and adjusted net income and EPS. As a reminder, the earnings release includes tables that re-council our US GAAP reported numbers to these additional metrics including one time charges of 7.5 million to terminate our sponsor management agreement with (inaudible) 5 million associated with divesting of performance based options upon completion of the IPO and 1.5 million of deal costs in connection with our acquisition of Kidsunlimited.

So, into this sort of detailed line items on the P&L; top line revenue growth with 22 million as Dave mentioned in Q1, with the full service center business increase in 18 million or back up division increase in 3 million and advisory services increasing 1 million.

Revenue on our full service segment increased to the rate increases and enrollment gains of approximately 1% in our material class of P&L centers as well as through growth from new centers. Our revenue growth in this segment will dampen somewhat this quarter by lower than planned operating subsidies from our class of cost split centers.

As Dave mentioned earlier, movements in revenue in costs plus contracts have no effect on our earnings given the fix nature of our management fees. This short volume estimated 3 million in the quarter. When additional offsetting effect to revenue growth this quarter was approximately 1 million from foreign exchange impact.

Gross profits increased $7.8 million to $66 million in the quarter and were 23.5% of revenue compared to 22.5% in 2012. The largest contributor to this was in the full service segment which grew more than 6 million as the margins there expanded over a 100 basis points. Excluding the one-time costs and SG&A related to the IPO and the acquisition of Kidsunlimited, overhead in the quarter was 29.5 million and increased to 10.5% revenue from 9.8% in 2012. The primary driver of this increase is ongoing staff compensation expanse which was 1.7 million in 2013 compared to 225,000 in 2012. This added 60 basis points to the overhead rate in the first quarter of ’13. Our European operations continued to perform well despite continued general economic challenges.

We’ve completed the integration of the Casterbridge centers and have realized the expected the synergies in our overhead spending such that overhead levels in Europe continued to lever down toward U.S. levels. In connection with debt refinancing we completed on January 31, 2013, we reported a net loss on the extinguishment of our previous debt arrangements for 63.7 million the first quarter of ’13. Net interest expense was 13.3 million for the quarter compared to 19.9 million in 2012.

This year interest expense includes approximately one month of interest under our older arrangements and two months under the new 790 million term loan which I’ll talk about a bit more in detail in a minute. In summary, adjusted net income 15.5 million translates to adjusted EPS of $0.25 a share in the quarter up from $0.16 a share in 2012.

We generated operating cash flow of 52 million in the quarter compared to 38 million last year and after deducting maintenance CapEx our free cash flow in the quarter totaled 43 million in 2013 compared to 30 million last year. The main drivers of this $13 million increase are the improved operating performance and consistent networking capital offset by incremental maintenance capital spending. We ended the quarter with approximately 97 million in cash.

Now, let me recap a few operating statistics for the quarter end at March 31st we operated 773 centers with total capacity of 88,100 an increase of 5.2% from 83,700 at March 31st of ’12. We operate approximately 70% of our contracts into profit and loss arrangements and 30% under cost plus contracts and our average full service center capacity as a 137 in the U.S. and 71 in Europe.

As Dave previewed before, our updated top line projects for the full year of 2013 anticipates revenue growth of 10% to 13% over 2012 levels inclusive of Kidsunlimited from April 10th forward the gross margin improvement as Dave previewed of 60 to 90 basis points will in turn generate adjusted income from operations improvement of 25 to 50 basis points after overhead. To be clear projected adjusted operating income excludes the Q1 2013 cost to complete the IPO as well as the acquisition cost for Kidsunlimited.

In addition, it excludes the onetime expenses for stock comp and IPO related expenses totaling 16.9 million in 2012. With this translates to as adjusted operating income margins for the full year of approximately 10.75% to 11% compared to 10.5% for 2012.

Including the estimate of purchased press allocation for Kidsunlimited, we expect amortization expense to approximate 28.5 million for the year, including 20 million related our May of 2008 LBO and depreciation expense to approximate 44 million to 45 million. We estimate stock compensation expense of 11 million, including the $5 million IPO related charge in Q1 of ’13. Interest expense, which includes the amortization of deferred financing fees and OID on the debt we issued in January of ‘13, is projected to approximate 40.5 million for the year including the impact of the previous credit arrangements through January 30, which added approximately 4.5 million to the reported interest for Q1.

With borrowing rates at approximately 4% our term loan carries an L+300, 1% floor rate. We expect our ongoing interest expense to approximate 9 million per quarter. We estimate that the effective re-structural tax rate will approximate 37% of our adjusted pretax income in 2013, similar to that that we illustrated in our results for 2012.

For our GAAP reported results we are estimating an effective tax rate of approximately 20% for full year of ’13. The combination of top line growth and margin leverage leads us to project adjusted EBITDA of 206 million to 212 million for 2013, which is an increase of 14% to 17% over the 181 million we reported in 2011 and adjusted net income for 2013 in the range of 76 million to 79 million.

With respect to share count, we currently have approximately 66.5 million fully diluted shares outstanding.

For Q1 weighted average shares, they were 62.75 million including the IPO shares weighted average for the issuance dates and assuming the conversion of the Class L shares as of January 1, 2013. We, therefore, estimate that for the full year weighted average shares will approximate 65.5 million to 66 million. Based on this share count, we estimate that our adjusted pro forma earnings per share will range from $1.16 to $1.21 in 2013.

Lastly, for the full year, we project that we will generate a 145 million to 155 million of cash flow from operations or 120 million to 130 million of free cash flow, net of projected maintenance capital spending of 25 million to 30 million. This compares to a 107 million of cash flow from operations in 2012 and 66 million of free cash flow, net of 41 million of maintenance CapEx.

Based on the centers in development and slated to open in 2013 or early 2014, we expect to invest 40 million to 45 million in new center capital compare to $28.5 million in 2012.

On the acquisitions front as mentioned, we spend approximately$70 million for the Kidsunlimited acquisition in April which we funded out of cash from operations.

Looking specifically to the second quarter of 2013, we are estimating revenue growth of 12% to 13% and adjusted EBITDA of $54 to $56 million. Using the 37% effective structural tax rate on the adjusted income before tax, we are projecting adjusted net income in the range of 21 million to 22 million and with 66.5 million diluted shares outstanding in the quarter EPS would approximate $0.32 to $0.34 of share for Q2 of ’13.

So with that, that’s the end of our prepared remarks and (inaudible) we would be ready to go to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Sara Gubins with Bank of America Merrill Lynch. Please proceed with your question.

Unidentified Analyst

This is David for Sara Gubins. Can you just go over the cost plus situation a little bit more detail, why it was late for the quarter.

David Lissy

Yes, David, I will take that, so for some of you who follow the company for a long time, you know that in the cost plus class of centers the revenue component is made up in part by what parents pay us in those contracts in tuitions, and in part from what clients subsidize, and what ends up happening is we set budgets for that classes at the beginning of the year, for a variety of expenses and if subsidy spending which is good in the eyes of the client as you know running a little less, it turns into a slightly lower spend for them, a little less revenue for us, but doesn’t change our fee since the management fee is a fixed fee. So essentially what we were seeing in Q1, the numbers move around a little bit but directionally it’s not different. It really has not effect in our view in the underlying fundamentals of the business and has not effect on earnings.

Unidentified Analyst

Okay, that’s helpful and one more from me. What kind of economic expectations are embedded in your 2013 forecast, I am just trying to get a sense of, do you expect the job (inaudible) to improve and which could suggest improved capacity utilization?

David Lissy

I think our view David is we are not banking on any additional economic movement in our plan. I feel like we have been operating in a somewhat schizophrenic recovery period for a while now. I am hopeful that in time that will change, but for now our plan banks on sort of the experience we have had over the past year, a year and a half, to two years of whatever you want to call the recovery period we have been in, continuing at a pace similar to what we have seen in the second part of this year in the first quarter of this year and so. We are really not banking on any uptick in economic activity.

Operator

Our next question comes from the line of Gary Bisbee with Barclays Capital, please proceed with your question.

Gary Bisbee - Barclays Capital

If I can just ask about the revenue growth in both backup and educational advisory, the growth rates decelerated somewhat from the recent trend, anything in particular you would point to?

David Lissy

No, it’s just timing more than anything else. I think there is no change in our view of the fundamentals, in those areas Gary. Quarterly growth rates may move a little bit based on the timing of leasing of contracts and things like that, but. No real change in the fundamentals.

Gary Bisbee - Barclays Capital

Okay and are there reasons to believe both of those that the year-to-year growth rate would accelerate based on the contracted activity, and what not, as we move throughout the year?

Elizabeth Boland

Yes, so over the course of the rest of the year, there is a little bit of seasonality in the advisory business in particular so both the timing of the growth and then newer contracts in that area we would expect to see it moving up as the year goes along and the backup business has a bit of that seasonality as well and what we have in the plan for the rest of the year is openings we would see that tick up somewhat as well so that the rate you are seeing in Q1 is the lightest quarter of the year.

Gary Bisbee - Barclays Capital

And then just on the acquisition it sounds like a rogue deal the 7 million of EBITDA once you have achieved the overhead savings is that a good number to plug-in for 2014 or is that, could that get better as you see their recent start-up facilities mature?

David Lissy

Yes Gary we are not yet in a position to give definitive guidance for 2014 so we wanted to provide you with a number that is a rational basis on which we looked at this deal and we believe that on an annualized basis that it will generate the GBP7 million of EBITDA. It is fair to say that in that number includes some of the ramp up within their centers sort of a realistic view of what that can be over the course of the next 12 months. also it includes a what I will call realistic view of overhead synergy opportunities that exist and it is also fair to say like in any acquisition there is risks and opportunities and we will be working hard to try and see if we can get the opportunities to play off and achieve upside but I think GBP7 million is a fair kind of annualized number and I think it also directionally helps you to understand the value that we saw in it in what we paid for it we believe is pretty much in our wheel house in terms of fair valuation of the deals we like.

Gary Bisbee - Barclays Capital

And then just one last cleanup question, the 1.5 million this quarter in deal charges are there going to be one-time stuff in the second quarter or was the fee paid ahead of the…?

Elizabeth Boland

No there is some expectation of the final charges that we will have to complete some of the work that is necessary with our SEC filings Gary. So there will be a little bit more coming out of that scale but we would to expect another up to three quarters of a million probably in Q2 that we would just isolate as well.

Operator

Our next question comes from the line of Jeffery Volshteyn with JPMorgan. Please proceed with your question.

Jeffery Volshteyn - JPMorgan

In the second quarter I appreciate the additional guidance can you help us think through the acquired revenue piece. I know the prior acquisition kind of rolls off and the new one comes in like what is the percentage of acquired revenues in the second quarter?

Elizabeth Boland

Let me just take that. After maybe I can circle back, I don't know if you have another question Jeff that I can better diagnose that.

Jeffrey Volshteyn - JPMorgan

Sure. International markets outside of US and the UK, can you comment on those what's going on there? I know they are much smaller.

David Lissy

Do you mean Jeff the ones we're currently in?

Jeffrey Volshteyn - JPMorgan

Yes and potentially where you are potentially looking.

David Lissy

As you know and I think it's early days and relatively small scale for us both in Netherlands and in India. I think in both places there are continued sort of challenges but also I think in those challenges we see opportunity. In the Netherlands for example we see, when we got into that market we anticipated some ultimate contraction in the market that we’re starting to see but we also saw an opportunity particularly around the major cities of Amsterdam, Rotterdam and The Hague and so we are growing in those areas and opening new centers this year in those markets. With respect to India its early days for us, we're still in the process of thinking through the right strategy, we only operate a cost plus center there and we'll continue to comment over time as we look at what the right growth vehicle should be for us in that market which is a big market but nonetheless you know as I've talked about before we want to take sort of a cautious approach to be sure we find the right platform for us to grow, with respect to other markets around the world there's a lot of activity in the world around child care and related services and obviously we have been the recipient of lots of interest both historically and now post IPO. I would say it's fair to say that we're interested in continuing to look at opportunities both in Europe and Asia and other places around the world but we're going to take a cautious approach there's nothing on our radar today that will suggest well we see something that we're going to jump off on, but we're going to keep our eyes open and I'm confident over the long run we'll find other markets where Bright Horizons can add value.

Jeffrey Volshteyn - JPMorgan

Great. Thank you. And just one follow-up on the one-time adjustments in the second quarter. So outside if you have the $0.75 million for the deal, will there be any other one-time adjustments in the second quarter?

Elizabeth Boland

In the second quarter? Not anticipating anything else in the second quarter, no.

Jeffrey Volshteyn - JPMorgan

And we can follow up on that.

David Lissy

We'll circle back on your other question, Jeff.

Operator

Thank you, our next question comes from the line of Ang Syng with Credit Suisse, please proceed with your question.

Ang Syng - Credit Suisse

So my first question is just regarding the gross margin improvement that you saw in the quarter. Could you delve a little deeper into the drivers, specifically the enrollment gains? Are those proceeding in line? Are they exceeding your expectations? And also what sort of cost management efforts might be contributing to the increase?

David Lissy

I would say that the enrollment gains that we're seeing in our mature and our ramp up class are right in line with what we had planned for. So that's really contributing as we had expected. There are no additional sort of outside of our normal discipline around costs, there are no unique costs cutting efforts that are contributing to our results in the quarter; we have an ongoing discipline to be sure that we are managing costs wisely and step with enrollment. But we are leveraging again another big driver we are leveraging the tuition increases slightly ahead of our average increases in our other costs which are mainly driven by wages and benefits and so we continue to provide increases to our team and our managing to get some arbitrage between that and price. But I would say it's right in the gross margin expansion; overall that we had in the quarter is the drivers of it are all pretty much in line with what we had planned. There were no extraordinary events that were driving that in the quarter.

Ang Syng - Credit Suisse

And also could you related to that question, could you comment on what utilization was like for this current quarter or for Q1?

Elizabeth Boland

I think what our goal here is to try to give you some context around enrollment improvement year-over-year so it's a quarter of the year. We may take an annual view at utilization but not a quarterly update on that so as we mentioned in the prepared remarks enrollments up in the mature class around 1% and our mature and ramping class we're looking to 1-3% improvement so we're on track with that but from a utilization level there is not a ton of change since December.

Ang Syng - Credit Suisse

And then also just regarding the international opportunity that you touched upon, what is the scope for the backup and advisory businesses; the opportunity for those businesses internationally; if you could just talk a little bit about that?

David Lissy

Yes, we are operational today with our back-up business in both the US and the UK. And the UK is a little bit behind in US in terms of its maturity and time we have been selling so we don’t think the UK has a good back-up opportunity going forward and that will continue to play out and add to the overall whole. We're still evaluating how and if back up care in the Netherlands will employers will jump on board to that and so that is sort of to be decided question and we are not operational in our educational advisory services today outside the United States although we serve our client with EPACT-related educational advising services but that’s really generated through the American client, but we’ll be exploring that as we go forward.

Ang Syng - Credit Suisse

And one final one if I could. You had indicated that the organic growth strategy would mature for Kidsunlimited under bright horizons; can we expect the same type of ramp up period of two to three years for those centers mature?

David Lissy

We respect the Kidsunlimited management team, they are good group and I think they know the business well and we competed in the market for a while. so I suspect we’ll have learn more specifically when we get in there that their dynamics around ramp up won’t differ too much from what we see in our mix.

Operator

Thank you. Our next question comes from the line of Jeff Silber with BMO Capital Markets. Please proceed with your question.

Jeff Silber - BMO Capital Markets

Thanks so much. Just want to follow up I think was from Gary’s question about added advisory and backup care. I know revenues were, we saw the growth rate slow a little bit but margins were down year-over-year, is anything that we need read into?

Elizabeth Boland

No, I think that is just the timing particularly in the advisory business as we scale that in the investment that we have and systems coming on online that nothing other than investment in the growth of business. I think on the backup side its timing of utilizations and where that the services are rendered and so we’re not seeing any weakness or change in the overall margin for year consistent with what we were able to realize last year, so we feel good about the overall annual performance just as you said it’s a little light this quarter.

Jeff Silber - BMO Capital Markets

And on the Kidsunlimited acquisition a pretty sizable deal, did it change your appetite in terms of the types of companies you might be acquiring over the next year or so?

David Lissy

No, Jeff, actually you know we have as I commented earlier we have pretty robust pipeline of potential acquisitions that we’re engaged within in every country in which operate. I think the dynamics of what’s available size wise in each country defer a little bit and specifically in the UK the Kids is one of handful of companies in and around their size range that are still there in the market, so we have an appetite for deals that did with us with all the same sort of attributes we look for in a small 5 -10 center operator, if we can find one that’s 50 or 60 centers that the same criteria fits and we think we can add value, we’re certainly interested in moving forward. So, I think you’ll see over the longer term other deals that sort of potentially could happen in that size range and then you’ll see us continue with our sort of bread and butter smaller center type deals.

Jeff Silber - BMO Capital Markets

If I could just one more and I apologies in events for asking this but I bet some folks ask this question. With the tragedy that happened in Boston especially what occurred around Watertown, was there any impact on your business, were you able to get into your offices et cetera?

David Lissy

Yes. I know it was obviously a horrible tragedy and anybody who’s watching CNN, you saw our office in the background. So we were in sort of ground zero for the media and for the law enforcement during that horrible Friday.

Fortunately our office was locked down for one day on Friday and then we were back up and running over the weekend and back full board on Monday. Our centers in the Boston area rose to the occasion. We think while our employees are not first responders they are supporting those that are, they are the people caring for the children of the fireman and the policeman and the FBI agents in the hospital, doctors and nurses that were all sort of engaged in the tragedy and really proud of the way stepped up and obviously tough time for them try to getting home but they stepped up and did some incredible things.

We saw no impact financially in our business.

Operator

Thank you. Our next question comes from the line of Bob Craig with Stifel Nicolaus. Please proceed with your question.

Bob Craig - Stifel Nicolaus

Dave, I know you’re no longer quantifying or breaking out the number of centers in the development pipeline, you can if you want by the way. But could you just offer some commentary there is that you find it growing with I guess what everybody tells us is an economic tailwind when we don’t see it in our coverage universe but that’s what the pundits are saying.

David Lissy

I think it’s consistent with everything we’ve said in the past, I wouldn’t tell you that that things are much different than they were when we talked a couple months ago when I said that we continue to add to it with things that are largely in line with where we’ve been before. I mean in the sectors that I talked about before are the ones that are, if I were to pick a few out the energy sector, healthcare, higher end the technology are the ones that sort of seen to stand out, not just for centers but also in the back up and educational advising area. So, we think it’s consistent and as I said in my comment to whomever asked before, we are not sort of banking on any kind of recovery, I view the time we have been as sort of a bit all over the place and as I said earlier schizophrenic in terms of the recovery itself so it’s steady and we continue to be confident in what’s in the pipeline as it relates to the projections we are giving you for center growth.

Bob Craig - Stifel Nicolaus

Okay and the overall sale cycle is staying fairly flat taken them?

David Lissy

Yes.

Bob Craig - Stifel Nicolaus

We have taken a step at this but give us any idea in terms of your numbers which I am sure better than ours of the profitability, profit sensitivity or impact of improving capacity utilization in your business, the incremental margin of that additional kid?

Elizabeth Boland

Obviously it’s in my nature to caviar almost anything, you know with of course each situation has its own new ones and it depends on the ages of the children and when you have the step, sort of the step variability of a classroom that needs to be staffed when you reach a ratio threshold of one to five or one to eight where you need to open it in the classroom but in general crossing enrolment, a general class of enrolment if our typical margins are in the 20% range the marginal improvement when you pass breakeven it’s going to more like 40%, a doubling ratio and on any one child there can be more than that but in generally you really do have to look at collectively because of the nature of the incremental staffing in those step variable threshold.

Bob Craig - Stifel Nicolaus

Last one from me, David I have seen some articles about the potential changes to childcare ratios in UK any thoughts on that.

David Lissy

The discussions that I have read, Bob, really it relate to trying to ease if you will some of the restrictions in their view to may be try to make it more affordable for families. I have mixed views on that, obviously if that would happen one could argue that gives us some opportunity financially. Obviously we are used to operating at the high end of quality and while there may be some of those opportunities depending on where you are in the UK and how we would run the things, I would say that that probably won’t have much of effect on our business just because we tend to already operate at ratios that we think are appropriate to drive the level of quality that we stand for.

Operator

Our next question comes from the line of Tim Carl with William Blair; please proceed with your question.

Tim Carl - William Blair

So in the UK it looks like you are sort of neck-in-neck for your number one, number two overall market share. What about in the employer’s concept market? Do you have any sense of what’s your share is within that segment?

David Lissy

Yes, I would say, and I would have to calculate the numbers, so like Elizabeth just cavy out something, I am going to caveat out mine, by saying I am going to give you an anecdotal answer. But with the combination of us and Kidsunlimited, you know it is like the U.S. very fragmented in that there are lot of small providers that have contracts, we are by far and away the largest provider of scale and I would guess our market share is probably two thirds at this point.

Tim Carl - William Blair

And then do you think over time you can get the margins in the UK up to U.S. levels; I believe they are a little bit lower right now.

David Lissy

I think that the longer term opportunity in the U.K. will be to continue to scale the overhead structure there to be in line with the U.S. Now it’s not fairly necessary to compare exact apples-to-apples because in the U.S. overhead structure, we have other businesses in there so you would have to kind of isolate the center business only for service center business. The backup business in U.K. is really relatively small compared to the U.S. So overall I think we still have little bit of room with respect to levering our overhead structure to have operating margins, get closer or meet the U.S. Yes, there is still some opportunity there over time.

Elizabeth Boland

I mean, I think, what I would add to that from a color standpoint is of course the addition of a group like Kidsunlimited and Casterbridge last year, adds centers of slightly larger size and so to the extent that we are able to do that, and so grow the average unit size, we have more opportunity to keep leveraging to that consistent level.

Tim Carl - William Blair

Okay thanks and then someone touched on it earlier, but the margins and back up, how far along do you think you are in in terms of getting the scale necessary in that business then and what are the scale opportunities in that business. Do you have significant opportunities in back up care.

David Lissy

I think our view on back up is that we will continue to maintain the margins that we had achieved last year in back up in 2013. We are not banking in our plan on expansion of the backup margin if you would isolate that on its own but obviously we are banking on backup continuing to grow at rates that are slightly faster than the core center business so that it is contributing to overall margin expansion in the year. But we think that when you look at the gross margins on backup they are strong and the overhead level necessary for that is slightly more on a percentage of revenue than it takes to manage the full service business of scale. But there may be overtime some smaller technology advances that help us on the sort of contact center staffing side but right now on the current view it is to maintain the ultimate operating margins of backup and then increase it through volume on the revenue side increase…

Tim Carl - William Blair

Okay and final one for me, maybe you already said this the net new center growth expectations for this year what are those now including Kidsunlimited I think last quarter you had gone through a breakout on that. I just wanted to confirm that if you had a new estimate for that?

David Lissy

Yes we are estimating 100 to 105 total new centers 75 to 80 net of closures.

Operator

(Operator Instructions) Our next question comes from the line of Brian Zimmerman with Goldman Sachs. Please proceed with your question.

Brian Zimmerman - Goldman Sachs

You have talked in the past about government sector opportunities and with government spending cuts coming sequestration have you seen any impact in Q1 from this on your part of the business exposed to government jobs and how are you thinking about this going forward for the remainder of the year?

David Lissy

Yes Brian we have a pretty small exposure to government revenue we do operate some centers for the GSA we have a few for the military the defense logistics authority but overall it is a relatively small amount comparatively to the whole. So the exposure in general really is not that large. And the way those centers are funded there is no ongoing funding coming to us from the government. The only exposure we could potentially have is if people who are enrolled there lose their job and then they obviously would not, it could impact enrollment I guess potentially but to answer your directly no impact in the first quarter.

Brian Zimmerman - Goldman Sachs

And then can you give us a bit more detail on the investments you have made in IT and marketing in the quarter and how should we think about these costs going forward?

Elizabeth Boland

I am not really answering so much in the quarter because it's been a process that we've been going through in terms of our IT spending, so with respect to the backup services it is a matter of some investment in both the specific software that allows us to handle calls from such a wide variety of both clients and parents and placed families into the backup care that they need on eve of the emergency or short term time frame so to be able to question and solicit space available and respond back to the parents.

On the full service side we have also invested in updating our systems there, it's center operations management systems and advisory business of course these are newer nescient businesses and so we have invested in, these are mainly software applications and the attendant business drivers that go with been able to utilize both automated processing and automated service delivery.

David Lissy

And I would just add Brian that we're not breaking out specific line items by quarter like IT and marketing that everything Elizabeth just said is baked into our 2013 plan. So there's been no extraordinary expense beyond that.

Operator

Our next question comes from the line of Jeff Meuler with Baird. Please proceed with your question.

Jeff Meuler - Baird

I wanted to ask about the enrollment growth at existing mature centers. I think you said it was up 1% in Q1, and the guidance for the full year is 1% to 3%. I guess, what would have to happen to accelerate towards the middle or upper end of the guidance on a full-year basis, and are you seeing any sort of leading indicator signs that that is starting to occur or anything around registration rates or anything like that?

Elizabeth Boland

I'm glad you asked the question Jeff, because I want to make sure that I'm clear on the distinction between those two statistics. So the 1% year-over-year growth in the mature class is what we would typically be referring to as the same center or same stores kind of growth, in the group of centers that has been open for more than 2 years. So, we've got centers that are in a mature class that are growing 1% year-over-year. This is the class where we have the most opportunity over the next several years. This is a long-term trajectory that we're going to recover the enrollment that we saw under so much pressure in 2009-2010 and that we've been gaining back 1% or 2% a year. So we're continuing with that in '13, 1% growth in that mature class. The 1% to 3%, so immediately it includes the one on the lower end, so probably is closer to the 1.5% - 2% to 3% that's including centers that are ramping it's obviously a smaller group with centers that are mature class but the one, two, three is ramping and mature centers are gaining enrollment year-over-year. So not a real shift in our thinking or catalyst or a change in the rate of enrollment growth over the course of the year but really just reiterating that we are seeing good growth in our ramping centers. We have been very pleased with the centers we have opened over the last couple of years that have been doing very well in ramping quickly and then our mature class is also gaining year-over-year.

Jeff Meuler - Baird

And then did you say Kidsunlimited is going to in 2013 be net neutral on an EPS basis or with an EPS and EBITDA?

David Lissy

Yes, I think we said that it was going to be not net neutral to the guidance that we had previously given to be clear about it on both levels; both on EBITDA basis and on the EPS basis. So the point that I made earlier Jeff was that we've already have something in our plans for the year, for acquisitions so it's not that the deal itself overall was net neutral; it was net neutral to the guidance we previously gave.

Operator

Our next question comes from the line of Gary Bisbee with Barclays Capital. Please proceed with your question.

Gary Bisbee - Barclays Capital

It is one quick follow-up, can you give us a sense with the annualized amortization expense from the Kidsunlimited will be?

Elizabeth Boland

We have not really done the detailed purchase accounting Gary but the estimate is in the range of 1.5 million or so. Let me actually clarify, that's 1.5 million pounds or dollars because that have the same important so.

Operator

Mr. Lissy there are no further question at this time. I would like to turn the floor back over to you for closing comments.

David Lissy

Thanks so much. Thanks for everybody for being on our call today and as usual we'll be here with follow up questions and look forward to talking to you next quarter and seeing you on the road in between.

Operator

This concludes today's tele conference. You may disconnect your lines at this time and thank you for your participation.

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