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Bright Horizons Family Solution Inc. (NYSE:BFAM)

Q4 2013 Earnings Conference Call

March 13, 2014 5.00 PM ET

Executives

David H. Lissy – Chief Executive Officer

Elizabeth J. Boland – Chief Financial Officer and Investor Relations Contact

Analysts

Dan Dolev – Jefferies LLC

Timo Connor – William Blair & Co. LLC

Sara Rebecca Gubins – Bank of America Merrill Lynch

Anjaneya K. Singh – Credit Suisse Securities LLC

Manav Shiv Patnaik – Barclays Capital, Inc.

Trace A. Urdan – Wells Fargo Securities LLC

Jeff P. Meuler – Robert W. Baird & Co., Inc.

Jeffrey Y. Volshteyn – JPMorgan Securities LLC

Gary E. Bisbee – RBC Capital Markets LLC

Jeff M. Silber – BMO Capital Markets

Operator

Greetings, ladies and gentlemen, and welcome to the Bright Horizons Family Solution’s Fourth Quarter 2013 Earnings Conference. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Mr. David Lissy, Chief Executive Officer. Please go ahead, sir.

David H. Lissy

Thank you, Jenn, and hello to everybody, greetings from chilly Boston. Joining me on the call today is Elizabeth Boland, our CFO, and as usual before I begin my formal remarks Elizabeth will go through the administrative matters. Elizabeth?

Elizabeth J. Boland

Thank you. So our earnings release went out just about an hour ago after the close of the market and it’s available on our website under the Investor Relations section at brighthorizons.com. As mentioned, this call is recorded and it’s being webcast, and a complete replay is available either way. The phone replay number is 877-870-5176, or for international callers it’s 858-384-5517. The conference ID number, 13576700. The webcast will be available at our website also under the Investor Relations section.

In accordance with Reg FD, we use these conference calls and other similar public forums to provide the public and the investing community with timely information about our recent business operations and our financial performance, along with forward-looking statements regarding our current expectations for the future.

Forward-looking statements inherently involve risks and uncertainties that may cause the actual operating and financial results to differ materially from those described in our forward-looking statements made during this call. These risks and uncertainties include; one, our ability to successfully implement our growth strategies, including executing contracts for new clients, enrolling children in our childcare centers, retaining client contracts, and operating profitably in the U.S. and abroad; second, our ability to identify, complete and successfully integrate acquisitions and to realize attendant operating synergies; third, our decisions around capital investment and employee benefits that employers are making; fourth, our ability to hire and retain qualified teachers and other key employees and management; fifth, our substantial indebtedness and the terms of that indebtedness; and lastly, the variety of other risk factors that are set forth in our SEC filings.

We’ll also discuss certain non-GAAP financial measures on this call and the detailed disclosures and reconciliations related to these measures are included in our press release, which is, as I mentioned, in the Investor Relations section of our website.

Let me turn it back over to Dave to kick off the call.

David H. Lissy

Thanks, Elizabeth, and hello everybody again. We’re pleased to be talking with you today. Let me start with the review of Q4 and the full year 2013’s operating results. And then I’ll share updated outlook and our plans for 2014. As usual, Elizabeth will follow me with a more detailed review of the numbers and then we’ll both be together for Q&A afterwards.

First, let me recap the quarter’s headline numbers for you. Revenue of $317 million was up 17% over the prior year and adjusted EBITDA at $53 million was up 13%. Adjusted net income more than doubled to $21 million, which yielded adjusted earnings per share of $0.32, up from $0.17 in last year’s fourth quarter.

For the full year 2013, revenue totaled $1.2 billion, a 14% increase over 2012. Adjusted EBITDA of $209 million was up $28 million, or 15% over last year and increased 20 basis points to 17.1% of revenue. Adjusted net income more than doubled to $78 million for the full year in 2013, and adjusted earnings per share for 2013 was $1.19 compared to $0.71 for 2012.

During this past year we continue to deliver on our long-term plan to grow our core center business both here in North America and in Europe, while at the same time expanding our newer lines of business.

This past quarter we added nine new centers and overall for the year we added 148 centers, which increased our full service capacity by 14%. Here in the U.S., we solidified our position as a leader in high-quality employer-sponsored childcare with the acquisition of Children’s Choice back in July.

Looking back at the year, we added new centers for new clients across a variety of industry sectors, which were led by healthcare and biotech, higher education and energy. Some highlights for you for new center opening this past year, included Biogen Idec, Weill Cornell Medical Center, The University of Virginia Medical Center, two sites for the University of Chicago, three sites for Anova Healthcare Services, and two locations for Wellstar Health System.

We also continue to expand our relationships with existing clients, opening additional centers for clients such as the University of California System, MIT here in Cambridge, and the University of Pittsburgh Medical Center.

Our strategy of developing new consortium locations continue to play out as well this past year, with the addition of 17 new centers that opened across our network. We continue to execute on our strategy of expansion and market leadership in Europe as well, in the U.K. with the acquisition of kidsunlimited, a 64 center group in April, and in the Netherlands with the opening of five new organic centers.

Our back-up business also continued to show strength, having grown 11% over the prior year with the addition of 43 new clients adopting this valuable service. Educational advising, our newest and smallest segment, grew 31% over the prior year, as both existing Bright Horizons’ clients and new clients became convinced of the strong value proposition and the cost efficiencies we bring about toward the considerable investments companies make in tuition reimbursement for their employees.

We’re also continue to close centers in 2013, just over 3% of total centers, which is roughly in line with our anticipated plan for the year and roughly in line with the same percentage we’ve experienced over the past few years. As a reminder, the primary sources of our center closings this past year were: one, client mergers and acquisitions or internal reorganizations in the resulting consolidation of workforce locations; two, centers that were part of an acquired group that did not meet our performance thresholds, including three, we closed this past quarter that were associated with the acquisitions we did this past year; and three, our usual discipline around pruning underperformers; and lastly, opportunistic relocations are consolidations of lease/consortium centers at least renewal in order to maximize future results.

On the margin side, we continued our long-term track record to improve recurring income from operations again this past year, generating a 13% increase to $127 million in 2013. As we have previewed on our third quarter call, gross margins this past quarter were impacted by the headwinds from the acquisitions we completed earlier in the year, as well as the incremental losses from the larger class of lease/consortium centers that we opened in 2013, which in total was roughly $6 million more than we experienced in that same class in 2012.

Even after the impact of these factors, we grew gross margins approximately 20 basis points to 23.1%. perhaps the best news here is how well we’re positioned for 2014 and beyond, as we expect to leverage our investment in the larger classes of lease/consortium centers and also realize the full value of the acquisitions we made this past year. I’ll touch on that more later when we discuss our guidance for 2014.

In total, for last year the key factors in our gross margin performance included: first, tuition rate increases averaging 3% to 4% in our full service segment; second, enrollment growth in our mature group, which continued at 1% to 2% above prior year levels, as well as the ramp up of our class of newer centers; third, new centers we added in 2013; and lastly, continued growth and margin improvement in our back-up business.

And I’ve just discussed before, offsetting these positive contributors in 2013 were center closings, the losses associated with the larger class of consortium models and the impact on the integration of the two larger acquisitions we did this past year.

We also continue to remain very focused on closely managing and leveraging down our core SG&A spending. To that end, we achieved results slightly ahead of our plan and have leveraged overhead, excluding transaction related costs, by approximately 40 basis points in the fourth quarter. We’re very pleased with the progress to date integrating our 2013 acquisitions and remain on track to complete that process in the first half of this year.

Speaking of this year, let me turn to 2014. Our plan for this year contemplates the addition of 50 to 55 new centers, approximately 13 net of expected closures, including new organic centers and some small tuck-in acquisitions. The organic new center growth will be achieved largely on the strength of our pipeline of centers, currently under development and as typical each year transitions of management of centers that are either self managed by the employer or managed by a competitor.

Broadly speaking, the mix of centers in the pipeline is representative in size, geography and operating model of our existing base. With respect to industry mix, we continue to see good representation within higher education, technology, healthcare and energy with both new clients and new centers for existing clients in the pipeline.

In terms of our acquisition pipeline, we continue to review and evaluate a fairly steady stream of opportunities and expected our track record of adding value in this area will continue in 2014.

Our current outlook does not contemplate any larger scale acquisitions like those we completed this past year, but rather considers that for 2014 and beyond, roughly a third of our new center growth will continue to come through the acquisition of smaller groups of high-quality centers and providers, both here in the U.S. and in Europe.

Another important piece of our story in 2014 and beyond will be the growth of our newer lines of business led by our back-up dependent care services, which we expect to grow and contribute to our margin expansion once again this year. One brief note on this segment as you look at this past quarter’s growth rate, we’re comping in this past quarter against a few unusual factors that incurred in the fourth of 2012, the most significant of which was Hurricane Sandy, which produced a significant uplift in our back-up revenue that was non-recurring as clients listed our help to provide some incremental services during that period of crisis.

Thus the year-over-year growth rate we experienced in the fourth quarter is not our typical trend and we expect that going forward our growth rate in this segment will return to our typical low teens pace. We now serve more than 500 clients through our Back-up Care Advantage program and continue to invest in the systems and operating structure that position us well to maintain our leadership in this market.

We also remain encouraged by the interest in our educational advising services. New client additions in 2013 in this area included Liberty Mutual, Northwestern Memorial Hospital, Shell and T. Rowe Price and we now serve more than 110 clients, of which 40% also buy another Bright Horizons service.

The pipeline of new opportunities for this service remains robust and we anticipate that this segment will begin to contribute margins and approximate our back-up segment as it achieved scale in the coming years. Overall, we’re excited about the opportunities that lie ahead for us in 2014 and beyond. Our base business remains in very good shape, while our newer lines of business and our markets outside the U.S. continue to have strong growth potential.

Our enrollment in our legacy class of profit and loss centers continues to show positive year-over-year trends as capacity utilization continues to recover toward the pre-downturn levels. The visibility in our pricing remains solid in the 3% to 4% range compared with more modest projected cost increases.

Lastly, I believe that we’ll began to realize the full value of the investments we made this past year in new lease/consortium centers and in acquisitions as we achieved the synergies we planned.

So, all in, our current outlook for 2014 is for revenue growth that approximates 10% to 12% over 2013 levels. We anticipate growing our adjusted EBITDA in the mid-to-high teens in the range of $240 million to $245 million. This will in turn drive adjusted net income for 2014 in the range of $96 million to $99 million, and adjusted earnings per share growth north of 20% to a range of $1.42 to $1.46 in 2014.

Before I turn it over to Elizabeth, I wanted to quickly acknowledge a critical aspect of our long-term strategy. The unwavering commitment we’ve made over the years to being the employer of choice in our field, and our intense focus on our culture and work environment is a key reason why our turnover rates remain less than half the industry average. We’re proud once again this January to be recognized by FORTUNE Magazine as one of the 100 best places to work for in America for the 15th time.

We’re similarly recognized in the U.K., Ireland and the Netherlands this past year. I want to take a moment to congratulate and thank the great group of people across the Bright Horizons Family who make this all possible.

With that, I’ll hand it over to Elizabeth, who will review the numbers in more detail and I’ll be back here with Q&A. Elizabeth?

Elizabeth J. Boland

Thank you, Dave. So, as we’ve done on previous conference calls given the various constant charges we have in our results this year arising from the IPO and refinancing and secondary offerings and acquisitions we’ve done, I will discuss our reported results as well as certain metrics that help isolate those unusual and non-recurring charges.

I’ll refer you to the earnings release, which includes the tables that reconcile the U.S. GAAP reported numbers to these additional metrics. Specifically for adjusted EBITDA, adjusted operating income, adjusted net income and then adjusted EPS, and specifically we’ll be quantifying the one-time charges, as I mentioned, for the IPO and the deal cost et cetera.

So top line growth for the quarter was $46 million or 17%, as Dave mentioned, with the full service center business generating $42 million of that gain. From rate increases that averaged 3% to 4%, enrollment gains at just under 2% and our mature class of P&L centers and from new organic and acquired centers.

Gross profit increased $8 million or 13% to $71.2 million in the quarter, again with the full service segment adding the lion share of that or $7 million. The gross margin for the quarter was 22.3%, compared to 23.1% in 2012. As Dave mentioned, there are a couple of factors that are affecting the full service margins resulting in a slight decrease year-over-year.

First, is the larger class of lease/conversion centers, their development in 2013 or 2017 compared to the four that we added in 2012. These new centers generate losses during their ramp up period and we incurred approximately $1 million more in such ramp losses in fourth quarter of 2013 compared to 2012, as well as the total of about $6 million more for the full year in 2013.

In addition, the kidsunlimited centers and Children’s Choice centers have operated at gross margins ranging from 15% to 20% and both of them came to us also with a class of newer centers. They are ramping and therefore are not at their own mature operating contribution level.

The incremental $29 million of revenue from these two larger groups, and therefore contributing slightly lower gross profit than the overall full service margin, which approximate 20%.

On back-up side, overall contributions continue to be strong in the fourth quarter of 2013 with 30% operating income, compared to 29.3% in Q4 of 2012. That trend is consistent with the full year growth as well.

Dave discussed in our non-recurring factors affecting the revenue growth compared then in Q4 2013 versus 2012. The revenue growth for the full-year of 11% in this segment, broadly reflects our outlook on the longer term trend, their opportunity for back-up growth in the low-teen. The quarterly trend in revenue can vary based on the timing and scale of new client launches as well as seasonal trends and utilization.

Excluding the one-time transaction cost for Children’s Choice and the secondary offering that was pending at year-end, totaling $1.2 million, overhead in the fourth quarter was $31.6 million and decreased to 9.9% of revenue from 10.3% in 2012. As we gained scale across all of our segments and geographies, we are realizing the overhead leverage that we’ve targeted as a long-term goal.

One other factor in 2013 and in the first three to six months of 2014 was the incremental cost that we were incurring as we complete the integration of the kids and Children’s Choice centers. For reference, we have approximately $4 million in integration related costs in 2013.

Subsequent to the debt refinancing that we completed back in January of 2013, we’ve reduced our interest expense this year and it was $9.2 million in the fourth quarter of 2013, compared to more than $22 million last year. Amortization expense of $8 million increased $1.4 million in the fourth quarter of 2013 in connection with the acquisitions that we’ve been talking about at kidsunlimited and Children’s Choice.

So, in summary, adjusted net income of $21.2 million translates to adjusted EPS of $0.32 a share in the quarter, up from $0.17 a share in 2012. We generated operating cash flow of $160 million in 2013, which compares to $107 million last year.

After deducting our maintenance CapEx of $30 million, free cash flow in 2013 nearly doubled to $130 million, from the $66 million that we generated in 2012. The main drivers of this increase are the improved operating performance, lower cash interest expense, which is $17 million for the full year. As well as higher networking capital of about $8 million. We ended the quarter with approximately $30 million in cash and no borrowings outstanding under our revolver.

I’m going to recap the operating stats before I get into the recap of the outlook. So at the end of 2013, we operated 880 centers with total capacity of 99,700 which is an increase of 14% since 12/31 of 2012. We operated approximately 75% of our contracts under profit & loss arrangements and 25% under costs plus arrangements. And our average full center capacity is now 137 in the U.S., 75 in Europe.

As Dave previewed our updated outlook for the 2014 now anticipates revenue growth approximating 10% to 12% over 2013 levels. The components of this top line growth are as follows, organic growth approximating a total of 7% to 9%, which includes the estimated 3% to 4% price increase, 1% to 2% growth 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 advising services. In addition to this, acquisitions add approximately 5% to revenue in 2014, inclusive of the lapping effect of the deals we completed in 2013.

As always, offsetting these increases by approximately 2% is the impact we estimate from center closings, which includes both legacy organic and in some cases, acquired centers.

We expect that income from operations in 2014 will approximate 11% of revenue. Therefore, expanding by 60 to 75 basis points from the 10.4% adjusted income from operations we generated in 2013. This includes the effect of approximately 20 to 40 basis points of gross margin improvement, plus overhead leverage, as we realize the synergies associated with completing the integration of kids and Children’s Choice, and as we continue to scale our overall operations.

We expect the amortization expense to approximate $30 million for the full year, including $20 million related to our May of 2008 LVO and depreciation expense to approximate $51 million to $53 million.

Stock compensation expense is projected to be $9 million and interest expense will approximate $34 million to $35 million for the year, assuming continued borrowing rates at approximately 4% on our term loans. We are not expecting to have outstanding borrowings under the line of credit during 2014, based on our current projections but we’ll generate an operating cash flow and our capital on acquisition spending plans for the year.

We estimate that the effective tax rate, both GAAP and the structural tax rate, now that we don’t have the anomalies of this year in the results. We will approximate 37% to 37.5%, which is slightly higher than the structural rate for 2013 due to the projected higher mix of pretax income generated in the U.S., which has the overall highest marginal tax rate.

Combination of top line growth and margin leverage leads us to project adjusted EBITDA of $240 million to $245 million for 2014, which is an increase of 15% to 17%, over the $209 million we reported for this year and adjusted net income for 2014 in the range of $96 million to $99 million.

With respect to share count, we currently have $67 million fully diluted shares outstanding and project this to rise approximately 200,000 shares per quarter in 2014, yielding weighted average shares of approximately $67.5 million for the full year. So based on the share counts, we estimate that adjusted EPS will therefore range from $1.42 to $1.46 for the full year.

Lastly, we project that we’ll generate approximately $170 million of cash flow from operations or $140 million of free cash flow, net of projected maintenance capital spending of approximately $30 million. This compares to the $160 million of cash flow and $130 million of free cash flow that I mentioned before for 2013.

The relatively modest increase is primarily attributable to the higher projection of cash taxes that we expect to pay in 2014, compared to this past year, which benefitted from the deductible cost for the IPO and refinancing that we completed at the beginning of the year. Based on the centers in development and slated to open this year, we expect to invest approximately $45 million in new center capital, compared to the $39 million we invested this year.

Looking specifically to the first quarter of 2014, therefore we are estimating revenue growth in the range of 15% to 17%, adjusted EBITDA of $55 million and $66 million, adjusted net income in the range of $21 million to $22 million, and EPS of approximately $0.32 to $0.33 a share.

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

Question-and-Answer Session

Operator

Thank you (Operator instructions) Our first question comes from the line of Dan Dolev with Jefferies and Company. Please proceed with your question.

David H. Lissy

Jen, we might want to go ahead that it sound like we?

Dan Dolev – Jefferies LLC

Can you hear me?

David H. Lissy

Dan, we can hear you now.

Dan Dolev – Jefferies LLC

Yes, sorry about that sorry, about that. Thanks for taking my question. So, just the obvious question on the guidance, it seems to have tick down a 1% on the lower end of the guidance from 11% to 12% to 10% to 12%. Is there anything to read into that or what are the sort of the explanation behind that?

David H. Lissy

Yes, I think there is really nothing to read into it, Dan I think we feel pretty similar to when we gave the broad based view last time. It’s just the only thing that has the potential to move it around, has to deal with timing of when some centers will open in the year, and we will just try to give ourselves a little room with respect to particularly the timing of when things will happen within the year.

Dan Dolev – Jefferies LLC

Okay, great and then one follow-up question, if I may in terms of the accounts receivable and deferred revenue, it seems like accounts receivable has been going very – is going very fast and so deferred revenues. Is there anything it’s been going ahead of revenue, if can – if I could calculate correctly. Is there anything to see there or any explanation for that or what could it be?

Elizabeth J. Boland

Yes, so that’s a good question. The timing of when we bill just as a matter of reference, when we bill our back-up clients, the majority of those are billed in advance of the start of the year, and we had very strong consistent billing ahead of time. So that’s where the deferred revenue comes into play, and it’s tied into the receivable.

So we don’t recognize the revenue until the period of service being rendered. So if you are seeing it deferred revenue balance is comprised of the tuitions that we bill and/or collect from parents in advance, and it’s any kind of client contractual billing that occurs prior to the service being rendered. So, that’s arising from primarily from the higher back-up billings that we did just timing wise in 2014 versus for 2013.

Dan Dolev – Jefferies LLC

Got it. Thank you very much.

Elizabeth J. Boland

Yes.

David H. Lissy

Thanks. Thanks Dan.

Operator

Thank you. Our next question comes from the line of Tim Connor with William Blair. Please proceed with your question.

Timo Connor – William Blair & Co. LLC

Thank you very much. The higher mix of pre-tax income in the U.S. is the U.K. business particularly Kidsunlimited progressing, as you thought it would and both from a top line and bottom line perspective?

David H. Lissy

Yes, I think broadly the business is, when we thought it was when we bought it in, I think that there are a couple of moving parts to just add a little color to; one is that the centers that we acquired that were ramping – are ramping broadly in line with what we had hoped, when we brought them on. And we did, as we talked about before, there are a couple of underperformers that were on and that were – that we either close or thinking about closing within that group. And then – but the bigger opportunity I think with that specific acquisition is the overhead – the overhead leverage or overhead synergy that we expect to get, much – some of which we got slightly ahead of plan in Q4. And then the rest of which will continue to get – we’re getting now and expect to get through the first half of this year.

So I would say on the – above the sort of revenue line, things were pretty much in line with what we had hoped or thought, and then below that there is slightly ahead with respect to where we’d hope to be and our goal of getting through the overhead synergy, really for this one and for the Children’s Choice acquisition, it is on plan to happen by the middle of this year.

Timo Connor – William Blair & Co. LLC

Okay.

Elizabeth J. Boland

I think let me just answer that the question on the pretax income, because that might not be clear in what I said, which is because we carried a debt here in the U.S, we incurred all of the costs of the refinancing and IPO related costs in the U.S. results. So the U.S pretax income was artificially lower this year.

Timo Connor – William Blair & Co. LLC

All right.

Elizabeth J. Boland

So just in terms of the adjusted structural rate, we will just have a proportionately, slightly higher fulfillment next year.

Timo Connor – William Blair & Co. LLC

So from a gross margin perspective, it seems like the progress internationally is going along if you thought it would?

Elizabeth J. Boland

Yes, very much so.

Timo Connor – William Blair & Co. LLC

Okay. And then final one from me, it sounds like mature center enrollment is trending closer to 2% than 1%, where at least maybe, above where you were seeing earlier in 2013. I guess when do you expect to get back to closer to peak capacities additional levels and then what could that do for margins.

David H. Lissy

Yes, I think as we had talked in previous calls, obviously that's an area of pretty strong focus for us, and you’re right. We get experience within the range of 1% to 2%. We experienced growth as we had hoped in this past year and the trends continue to play out in that direction for 2014.

So we believe me, we have roughly 5 to 6 percentage points of occupancy left to go to cover back to the levels we were pre the downtown times. Obviously, as we’ve also talked before, we’re somewhat gated by the realities of capacity being the lowest in our youngest aged groups and graduating classes of children every year in the preschool area. So, it takes a couple of years for us to really absorb the increase through the system, and have it actually get back to where we were in the past.

Obviously, the margins associated with that are strong. Broadly across the system there the incremental margins, probably twice the gross margin in our core business. So more in the neighborhood of 40% range, but getting there we need to get our preschools back full to the levels they were in the downturn, and that’s going to take us a couple of years. But the progress is good. It’s right on track with what we had hoped. The efforts that we have in place to continue to be share our centers, show really well and have a good strong reputation locally and all the marketing efforts that we do there are really positive and we’re pleased with the direction and we expect that 2014 will yield a similar result to 2013 in that regard.

Timo Connor – William Blair & Co. LLC

Thank you very much.

David H. Lissy

Yes.

Elizabeth J. Boland

Thank you.

Operator

Thank you. Our next question comes from the line of Sara Gubins with Bank of America Merrill Lynch. Please proceed with your questions.

Sara Rebecca Gubins – Bank of America Merrill Lynch

Hi, thank you.

David H. Lissy

Hi, Sara.

Sara Rebecca Gubins – Bank of America Merrill Lynch

I know it’s small, but education advisory saw nice pickup in the past two quarters. Is there anything particular here to note and do you see that as a good run rate in 2014?

Elizabeth J. Boland

So I think that you’re right, it’s a very new business and so the opportunity there has been good. I think as Dave stated in his prepared remarks and he may add here, but we know are serving more than 110 clients there. So we’ve had good interest and feel like it’s got a lot of momentum going into next year, and we are investing in the business too. So, I think there is still a little bit of that step cost to absorb, but we’re well on our way, I think to building the pipeline and new opportunities.

David H. Lissy

And we think it’s got, Sara we continue to be sure that and prove really the value proposition in the marketplace, that we can drive our strong return on investment, in that area that’s really that we can demonstrate employer-by-employer, and we believe that the more data that we can bring to bear in that area the better the opportunity will continue to be to spread the word

That service is a bit of a missionary service, it feels like when we first started doing [indiscernible] childcare years ago there, where we have to really take time to explain the concept, because we’re typically not replacing somebody else, it’s a new idea that we’re bringing to bear and one that we think has good legs.

Sara Rebecca Gubins – Bank of America Merrill Lynch

Okay, great. And then as we think about that the types of centers and sort of how that will play out over the next couple of years. Do you think we’ll see a higher skew of these consortium centers overtime?

David H. Lissy

I would say you’re going to see more lease consortium centers, it’s not as a cohort, because we believe that there is really good opportunity to leverage the footprint of clients we have around major metropolitan markets across the country. I think the trend that really supports the continued growth of consortium centers is twofold.

One, it’s the fact that employer, we become a much broader and deeper provider solutions to our clients and our clients expect us to bring solutions to there in more locations than ever for them. So they can serve as much as of their workforce as possible. So to the degree that we can actually continue to have our leverage to footprint of where our clients are, we think that's a good use of, to invest in centers, particularly centers where we’ve proven we can drive really strong margins over time.

And then secondly, we also believe that the continued development of this network directly supports the back-up growth, because we’re able to then have a much bigger footprint of really quality center-based back-up options that exist within the Bright Horizons network, in particular in areas where the supply may not be as robust. So we think the strategy is solid.

I think we’ll still continue to grow our other types of centers too. But we do expect that, you saw the numbers this year we opened 17 versus four. We probably won’t have that kind of growth year-over-year going forward. But we’re still very interested in maintaining the numbers that we did this year for the foreseeable future.

Sara Rebecca Gubins – Bank of America Merrill Lynch

Okay. Thank you.

David H. Lissy

Yes.

Elizabeth J. Boland

Thanks Sara.

Operator

Thank you. Our next question comes from the line of Anjaneya Singh from Credit Suisse Group. Please proceed with your question.

Anjaneya K. Singh – Credit Suisse Securities LLC

Hi, there.

David H. Lissy

Hi, Anjaneya.

Anjaneya K. Singh – Credit Suisse Securities LLC

Hey. Thanks for taking my questions. So, first off, just building on the last question that was asked. Do you guys anticipate the impact from the larger cohort of lease/consortium centers to dissipate at any point in 2014? Or do you expect that impact to sort of be on going, but perhaps at a lesser rate as those centers are just larger in number due to that opportunity you have?

Elizabeth J. Boland

Yes, so I think broadly what we would see is the cohorts that we opened in 2013 continues to ramp up. There will be a little bit of, it will layer in a little bit of cost or loss in 2014 and then new class that opens in 2014 will also have a similar level of loss as the group we have this year.

So there will be a slight headwind in 2014 about that, but by the end of the year as when we would start to see the class that we’re opening in 2013, really making more significant contribution. So, we do have one more year. I qualified as Dave, talking about the size of the classes that we would be looking to and planning to open. Probably have one more year in 2014 where we’re incurring a relatively high level of lease/consortium ramp up loses, but it won’t be materially significantly different from this year, a couple million maybe. And then it will be embedded in the base. And so our growth against that will – it will start to comp in a more positive way. I don’t know if I answered that clearly enough, but I was…

Anjaneya K. Singh – Credit Suisse Securities LLC

No, that’s super helpful. I appreciate it. And then another question. How much did a healthcare and pharmaceuticals comprise of your total revenue for 2013 and which segments by end market didn’t grow that well for you guys?

Elizabeth J. Boland

So healthcare and pharmaceutical, I think we can talk broadly about it. I don’t have a revenue number for that group, although the number of centers that we operate for healthcare and pharmaceutical is now; it’s around 20% of the total group. It kicked up slightly in the quarter. So it’s pretty consistent.

David H. Lissy

Yes. And I think broadly speaking, as I’d mentioned earlier Anj, I think we see the most momentum in the areas of healthcare and biotech, and less of the traditional pharmaceutical companies, mostly because they are already clients. And so the new – the new business in that area is mostly with the biotech companies, and then healthcare systems. And then higher education continues to be a bright spot for us and then energy and technology are the other areas.

I would say that overall, areas of, again, traditional pharmaceuticals, financial services in which we have a lot of already embedded depth in terms of clients grew at rates slightly less last year than maybe, we had in prior years. First of the other sectors that I just talked about.

Anjaneya K. Singh – Credit Suisse Securities LLC

Okay, thank you, and then one final one. I guess on the other educational services, the educational advisory services, why were margins so much weaker than they were last year? Are you making any concessions on pricing to drive adoption there higher? Or is that coming off from the investments that you make there?

David H. Lissy

Yes. It’s really coming at the overhead line and not at – it’s not pricing concessions, and it’s not – it’s really coming from the investments we’re making in increased sales and support people in trying to perfect the back-end of the service, which we’re trying to invest in technology to make it less labor intensive. And we expected it with scale over time that we can achieve operating margins that look more like the back-up business than the full service business. But we just think we need some more time to build scale.

Anjaneya K. Singh – Credit Suisse Securities LLC

Okay, great. Thank you so much.

Elizabeth J. Boland

Thanks.

Operator

Thank you. Our next question comes from the line of Manav Patnaik, Barclays Capital. Please proceed with your question.

Manav Shiv Patnaik – Barclays Capital, Inc.

Yeah, hi, good evening.

David H. Lissy

Hi, Manav.

Manav Shiv Patnaik – Barclays Capital, Inc.

Hi, how are you doing? The first question just on the back-up services. Is there any way to quantify that how I can time the impact from last year sort of normalize what that growth rate would have been? And if there was any season aspect to just a normal fourth quarter that we should consider?

David H. Lissy

Well, I think that with respect to Q3 versus Q4 in general we would expect to see slightly – a tick down slightly because the Q3 is particularly higher utilization months, generally speaking – quarter for back-up care than what we would see typically in Q4. But I think that between – to be clear about it, Hurricane Sandy accounted for quite a bit of it and there were a handful of clients back at the end of 2012 that were on contractual arrangements that were sort of the way we used to do it that required the year-end sort of true-ups associated with overuse.

They have been sort of since redone to contemplate it on a more regular basis. So the quarter was also – was part oversized in Q4 2012 by Hurricane Sandy and the other part by a handful of these larger clients since then contractual changes have been changed.

But I think have they not been there, those two factors, you would have seen a more normalized growth rate in the 10%-ish or 11%-ish range this quarter, and that's what we expect to see going forward. There’s always going to be some quarterly fluctuation in this. Some of it also have to do going forward with when we sign up new business and when that happens timing wise and a year versus prior year, that can affect things. But on a more normalized basis, we see low teens growth rate returning in 2014 and that’s where we are trending towards thus far this year.

Manav Shiv Patnaik – Barclays Capital, Inc.

Got it, helpful. And then it sounds like obviously the integration of these two acquisitions are going may be even ahead of plan, just out of curiosity, the 5% acquisition contribution that you have for 2014. How much of that like as the bulk of that basically those two acquisitions and how much is the sort of one-off smaller ones that you guys plan on acquiring?

Elizabeth J. Boland

So I mean in a normalized year, I think if you look at our long-term growth rate construct you would see typically 1% to 2% coming from a typical class of acquisition so that order of magnitude the difference 5 versus 1 to 2.

Manav Shiv Patnaik – Barclays Capital, Inc.

Okay, fine. And then just one last one just in light of this Care.com, IPO just wondering if you could explain sort of your relationship with Sittercity that you have I think you have a JV with them and how that adds to your service offering to the employers?

David H. Lissy

Well, we obviously, we have been working at ensuring that our service the back-up care suite of service that we offer clients the most breadth and depth of any back-up care offering in the market, and I think over time the care sites like Care and Sittercity and others have come to market, it’s not a new thing, it’s been out there for a while. And I think there is a certain segment of the population within our client companies who want to use those offerings and the value that they bring.

So our desire with the Sittercity was to form a partnership whereby all of our back-up clients can have Sittercity packaged into our service, and thus again continues to make the Bright Horizons care advantage program the most the deepest and the broadest service available in the market with everything – we already had to offer plus the addition of that.

Frankly from other than, if you remove marketing and a lot of things the caregivers that exists on these sites are pretty much the same and so the idea would be for people, who are looking for – interested in having care arrangements going in that area. We thought Sittercity was a great option and they’re great partner and we’ll just make that round off the service as I just talked about before.

Manav Shiv Patnaik – Barclays Capital, Inc.

Okay. Thanks a lot.

David H. Lissy

Yes.

Elizabeth J. Boland

Thanks.

Operator

Thank you. Our next question comes from the line of Trace Urdan with Wells Fargo. Please proceed with your question.

Trace A. Urdan – Wells Fargo Securities LLC

Thanks very much. I wanted to go back once again to lease/consortium centers if I couldn’t and maybe ask you to just comment on what you see as the drivers of growth, because it sounded like from your answer to Sara’s question that a lot of that is from your own prospecting internally with your existing client. So, I want you talk to that and maybe kind of what level you can sustain in terms of growth in that, if that is a major source or may be if not?

David H. Lissy

Yes, I think, Trace, to be clear about it, it’s largely driven to leverage the footprint of where our clients are, but also those centers have to be able to exist, if you will, in places that we think that for the rest of the spaces that can’t be used by clients or used for back-up that there is a good strong demand in the area of parents, who desire our type of service and they can afford it.

And so, our focus in this area has been in and around major metropolitan areas like the New York and Chicago and San Francisco and other – sort of Seattle, other select cities, where we think that can happen and also following the trend that obviously many young professional families are choosing to live closer in or in cities, those are making the mad dash with the suburbs as soon as the child is born.

So, I think all of these trends sort of working in our favor and produce we think a good runway for this area for us. And not just in the United States, it’s true in places like London and Amsterdam and other places that we operate in. We think we have a good runway or visibility to continue to do order of magnitude the number of sites globally that we achieved this year for the foreseeable future.

Trace A. Urdan – Wells Fargo Securities LLC

So David, how do you identify opportunities in that segment and how do you think about forecasting. I mean is there a pipeline, it strikes me that the pipeline will be pretty different from the pipeline for corporate sponsored centers. Can you just talk to that?

David H. Lissy

Yes, I mean the pipeline is derived through the combination of a real-estate team that’s actually, actively looking at sites combined with our sales team, and our client management team, which is actively managing both the interest of new clients and existing clients to where they would be interested. And then it’s the sort of collision of those two efforts that produces the best site prospects for us. And then obviously the real-estate team goes and executes on them.

So, some of that it is a pipeline of prospects that exists out there and then obviously once we sign a lease on something like that, we then consider that in our pipeline of centers under development and then obviously it opens with pretty similar characteristics to the timeline a corporate sponsored center would open.

Trace A. Urdan – Wells Fargo Securities LLC

Okay and then last question. Since the last time you guys had a call, we had a lot of discussion of universal childcare. The President talked about in the State of the Union New York managed [indiscernible], who has got that as high priority. Can you speak to that phenomenon to what extent do you see it is any kind of a threat in terms of peeling off four year olds from your new centers, if you do or maybe conversely to what extend could it be a future opportunity for you?

David H. Lissy

Yes, I mean I think first off, I think good discussion about the value of quality early education, is good for all of us, who have believed in this for a long time and all providers I believe. I think that the reality of course where this all will go, come down to the physical realities that states and cities have and how they open and choose to take whatever finite resources, they have and execute.

Most of the Universal Pre-K efforts that were currently used to like those that we see in Georgia and in Florida represent a partial day offering for four years olds, that doesn’t fully meet the needs of working families. And those systems do allow for us and other providers, private providers to participate, and I would anticipate that in most places around the country, whatever Universal Pre-K legislation is conceived of that can be afforded, first resources will go to those most in need and after that which is it really our market.

But after to the degree it becomes universal, it will probably represents some portion of what we provide, and that we could wrap around that like we do in Georgia and Florida. So in those cases we actually take the state funding for part of that – part of the few days a week for the children that participate in that, and then our programs sort of wrapped around it, because the parents we are serving need a full-day option. I can’t go with just a partial day, couple of days a week. And that’s broadly speaking the same way we operate in London and in the Netherlands too.

So that’s my view on it. I think I’m a little skeptical that there will be enough places that I will have enough money to fully execute on it. But where that does happen, I feel good about our opportunity to participate in whatever system happens.

Trace A. Urdan – Wells Fargo Securities LLC

Great. Thanks for that.

David H. Lissy

Yes.

Elizabeth J. Boland

Thanks.

Operator

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

Jeff P. Meuler – Robert W. Baird & Co., Inc.

[indiscernible] consortium centers, can you remind us what percentage of full service enrollment at the lease/consortium centers come to through an employer, one of the employer partners?

David H. Lissy

Yes, we don’t. I’m not sure, Jeff, we have that stat across the board to give you today. Broadly those centers though are real combination. If you look at it across the system you have those that are fully, on each end you have those that are fully sort of enrolled through sponsorship or back-up care, all the way to the other side, with this just a mild bit of back-up use and many of the spaces are enrolled through the community to what I’ll call a more usual situation, where you would have centers that are sponsored with quarter to half the spaces and the rest in the community plus back-up on top of that. So, it’s really a broad spectrum. We can probably do some work on that in the future, but I’m not sure we have the stack you’re looking for today.

Jeff P. Meuler – Robert W. Baird & Co., Inc.

[Indiscernible]

David H. Lissy

Jeff, we’re having trouble hearing you.

Jeff P. Meuler – Robert W. Baird & Co., Inc.

Sorry. Can you hear me now?

Elizabeth J. Boland

A little better.

Jeff P. Meuler – Robert W. Baird & Co., Inc.

The full service, can you just give us a sense of the organic revenue growth on that?

Elizabeth J. Boland

So, full service centers in the – allow me just see if I can pull that back-up because I mean our organic growth in the year, we outlined briefly.

Jeff P. Meuler – Robert W. Baird & Co., Inc.

What I’m wondering is the step-up in the growth rate in Q4?

Elizabeth J. Boland

Right. Yes, there is a bit of that part of the momentum behind the additional enrollment, and on a gross basis, the organic growth is around 7% and net of closures, the effect of closers is around 5%. So, we did see a bit of an uptick in Q4 for that.

Jeff P. Meuler – Robert W. Baird & Co., Inc.

Okay. And then just finally, there was a fairly sizable debt to cash flow that was characterized as other. What is that?

Elizabeth J. Boland

Sorry let me get over to this. So, that the changes in assets and liabilities, so that’s primarily the change arising from deferred revenue that was – that Dan Dolev asked about earlier. So, we have fairly significant – you can see the uptick in receivables as well and deferred revenue due to the billing – primarily the billing and back-up care.

Jeff P. Meuler – Robert W. Baird & Co., Inc.

Got it. Thanks, stay warm I emphasize.

Elizabeth J. Boland

Great.

David H. Lissy

Thanks Jeff.

Operator

Thank you. Our next question comes from the line of Jeff Volshteyn with JPMorgan Chase. Please proceed with your question.

Jeffrey Y. Volshteyn – JPMorgan Securities LLC

Thank you for taking my question.

David H. Lissy

Hi, Jeff.

Jeffrey Y. Volshteyn – JPMorgan Securities LLC

Hi. I wanted to ask on the international side. What are the dynamics presenters in Netherlands, you mentioned five new centers, how do they compare to the ones in the U.K or U.S. and perhaps, can you update us a newer methodology for looking at other international markets?

David H. Lissy

Yes. So, Jeff the metrics that we would use to evaluate a center in the Netherlands far closer to what the way we’d look at a consortium center here in the U.S. or the U.K. The Netherlands has a funding scheme as we’ve talked about in the past, where an individual’s funding comes partially through the government and partially through a fund that employers contribute to, such that the amount that parents pay is, pretty subsidized there.

So, in effect, what we’re doing in Netherlands is finding the best possible locations, both located near employment generators and also near good communities that can support our growth, our type of parent and looking for the right location that can return the returns that we would look for in a consortium model.

Generally speaking, when we’re investing our capital in a consortium model, we’re looking through IRRs north of 20% and that metric is a metric that we use here in the U.S., in the Netherlands and in the UK with respect to investing our capital in these sites. Did I get your question?

Jeffrey Y. Volshteyn – JPMorgan Securities LLC

That’s perfect. That’s very helpful. And just a couple of model questions. Elizabeth, in the past, you’ve just given us for the current – for the fourth quarter – for the fourth quarter, contribution from acquired revenues, kind of asking another way where Jeff was asking before in dollar terms.

Elizabeth J. Boland

Yes, in dollar terms. So it was $29 million, I think I said that in the prepared remarks, $29 million from the acquisitions in the fourth quarter.

Jeffrey Y. Volshteyn – JPMorgan Securities LLC

Great. And just to clarify better than your 2014 guidance, what are the dynamics for segment margins?

Elizabeth J. Boland

So, from a forward-looking view, I think on balance, we would be seeing some expansion in the full service business for the various reasons we cited on where we have leveraged with tuition, tuition ahead of costs, enrollment, ramp, and our ramping centers, as well as in the mature class, and then offset by the effect of some lease consortium center impacts.

So there’s margin expansion in full service. There’s stable margins in the back-up business, and that’s really a growth story and it’s a more mature sort of business compared to, for example, the ed advisory business, which is still very much a nascent, and developing business where we would expect to see the margins expanding. we have some step cost investment there, but on balance, as we add clients we’re leveraging both at the gross margin and at the operating margin level.

Jeffrey Y. Volshteyn – JPMorgan Securities LLC

Perfect. thank you very much.

Elizabeth J. Boland

Thank you.

David H. Lissy

Thanks, Jeff.

Operator

Thank you. Our next question comes from the line of Jerry Herman with Stifel. Please proceed with your question.

Jerry R. Herman – Stifel, Nicolaus & Co., Inc.

Thanks guys, I’ll be quick, and I was late. just sort of a follow-up on that, you guys indicated in your guidance that you’re expecting 3% to 4% price increases. Just wondering what you’re seeing on the cost side, given some discussion about minimum wage increases and strengthening job markets, if you’re starting to see any signs on the cost side for wage pressure?

David H. Lissy

Yes. we still believe, Jerry that the cost increases will average about 1% less than our average pricing increases based on what we see this year. We feel good about the sort of compensation packages that we have in place. I think we’ve talked about this in the past, combining our wage rate with the benefits package that Bright Horizons offers. We feel obviously, we feel good about that, overall, obviously everybody follows the minimum wage to-date, we don’t believe – while it will have some mild impact, it’s not a real big impact at all, and that’s given where our wage tends to sit in the centers that we operate.

Jerry R. Herman – Stifel, Nicolaus & Co., Inc.

And there is one real quick follow-up. Dave, I missed the date when you gave some metrics on the pipeline. I know you can’t give any numbers, but can you just talk conceptually about the trends and your feelings in the pipeline?

David H. Lissy

Yes, I mean like I said in the remarks, Jerry, I feel like the pipeline is representative of the industries, slightly higher, representative of the industries that I’ve talked about before healthcare, technology, energy, the higher education. and I think that we obviously have in the pipeline, some new lease/consortium models that we feel good about that are taking advantage of some of the client relationships that I talked about earlier when previous questions were asked. So we think that the pipeline continues to give us visibility that the center targets that we have for 2014 are in line.

Jerry R. Herman – Stifel, Nicolaus & Co., Inc.

Thanks very much, I appreciate it.

David H. Lissy

Yes.

Elizabeth J. Boland

Thanks.

Operator

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

Gary E. Bisbee – RBC Capital Markets LLC

Hey, good afternoon.

David H. Lissy

Hey, Gary.

Gary E. Bisbee – RBC Capital Markets LLC

I guess let me just first follow up on two – quickly on two questions that were asked earlier, and probably too many people are asking about the lease/consortiums. But if you continue to grow that as a percent of the mix, at some point in the future, this makes the business at all more volatile like if the economy turns down, given the seats aren’t all accounted for, or is that really you’re not expecting that much different than the rest of the mature days?

David H. Lissy

I think Gary to a degree, I mean obviously, the place where we’re more vulnerable in a downturn, when you look at the sort of overall portfolio of the business is the centers in which we have P&L responsibility for and that’s what we experienced in 2008, 2009, 2010 timeframe in that class. I think that the key for us is that the centers obviously, combine both community, back-up and corporate sponsorship in them.

So we’re not --, we still remain, I think, with this model, less exposed than sort of a straight retail model would, because of the corporate sponsorship and because of the back-up business. And again, I think we’ll continue to grow other models too. So maybe, on the margin slightly, but I still think, many of the – I would still anticipate that overall the way the company performed during the last downturn is probably indicative of what we might expect should we experience something similar in the future.

Gary E. Bisbee – RBC Capital Markets LLC

Okay, great. And then on the whole universal Pre-K concept, you talked about Georgia and Florida. Can you just give us a commentary? are your margins the same despite, again, it’s probably getting the lower state fees for part of the week as they are in the rest of the business?

David H. Lissy

I think our margins are in line in those states with the rest of the business. I think again, the key there is, that we are wrapping around, whatever the reimbursement is in those places in order to complete essentially a view of what our tuitions would average in those areas, when you take there what’s paid for, we sort of what subsidize, what the parents would have to pay to wrap around for care for whatever hours they’re going to wrap around.

Gary E. Bisbee – RBC Capital Markets LLC

Okay. And then just a last one on, any updated thoughts on leverage and the leverage target. I know you brought the leverage down a lot with the IPO, it hasn’t come down a lot since then, obviously with you investing all of the – all of your cash flows through the M&A and the internal investment. Would you be comfortable just having a leverage come down going forward just from the growth of your cash flow and continue to invest all of excess cash flow, or any thoughts on how we might think about it over the next couple of years?

David H. Lissy

Yes, I’ll let Elizabeth in a second, Gary comment on the specifics of kind of what we see on that, and what we expect in 2014. But I would say broadly that we believe the first and foremost to the degree we can find acquisitions and our new center growth opportunities that meet our investment thresholds, or return thresholds that’s probably the best way we can drive value for everybody with the cash that we generate in the business.

To the degree that we’re in a situation in the future, and that’s what happened this year, we’re able to do that essentially deploy all of our cash and with a little bit of cash, but not much and not really have any thing on the revolver. And we did see some modest deleveraging just with growth. We’ll continue to see that as Elizabeth can add color to.

But I think going forward if we find ourselves with a sort of high class problem of -- having too much cash that we generate more so than we can invest with good investments back in the business. Then I think we would look at the three options that would exist there, whether that would be a dividend, a buyback plan or paying down some debt. The caveat on paying down the debt as we feel very good, it’s a 4% rate that we have now that that’s a pretty – it’s sufficient for us at that level. so if it’s staying that way going forward, it would be more likely that our choice would be either buyback or dividend.

Elizabeth J. Boland

Yes. I agree and I think that we’re ending the year at under 4 or 3.75, without even considering the full year contribution that we will get from the acquisitions have done in midyear. so by the end of this year, we’ll be close to three turns on our adjusted EBITDA, and we feel like that’s very comfortable to just continue to grow into it with our natural deleveraging that occurs there for the short foreseeable future.

Gary E. Bisbee – RBC Capital Markets LLC

Great, thank you.

Elizabeth J. Boland

Thanks.

Operator

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

Jeff M. Silber – BMO Capital Markets

Thank you so much. just a real quick one, Elizabeth the $29 million you mentioned in the acquired revenues, was that all of the full service center segment?

Elizabeth J. Boland

Yes, it is.

Jeff M. Silber – BMO Capital Markets

Okay, great. Thank you so much.

Elizabeth J. Boland

And I just would clarify a question that came through earlier. so our back-up and ed advisory growth in the quarter was a neighborhood of 1.5. And so full service organic growth is just over 7% growth, and then there’s closures against that that bring it down to around 5%. So that was just the full service business, not the other organic growth. So I think that we’re out of time.

David H. Lissy

Yes. Appreciate everybody’s time and thanks for the questions and we’ll be talking to you, I’m sure, in the near future. Have a good night.

Operator

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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