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BFAM > SEC Filings for BFAM > Form 10-K on 26-Mar-2013All Recent SEC Filings

Show all filings for BRIGHT HORIZONS FAMILY SOLUTIONS INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for BRIGHT HORIZONS FAMILY SOLUTIONS INC.


26-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the "Selected Financial Data" and the audited consolidated financial statements and related notes appearing elsewhere in this annual report on Form 10-K. This discussion contains forward-looking statements and involves numerous risks and uncertainties. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and generally contain words such as "believes," expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates," "anticipates" or similar expressions. Our forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those projected or implied by the forward-looking statement.
Forward-looking statements are based on current expectations and assumptions and currently available data and are neither predictions nor guarantees of future events or performance. You should not place undue reliance on forward-looking statements, which speak only as of the date hereof. See "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements" for a discussion of factors that could cause our actual results to differ from those expressed or implied by forward-looking statements.

Overview

We are a leading provider of high-quality child care and early education as well as other services that are designed to help employers and families better address the challenges of work and life. We provide services primarily under multi-year contracts with employers who offer child care and other dependent care solutions as part of their employee benefits packages to improve their employee engagement, productivity, recruitment and retention. As of December 31, 2012, we had more than 850 client relationships with employers across a diverse array of industries, including more than 130 Fortune 500 companies and more than 75 of Working Mother magazine's 2012 "100 Best Companies for Working Mothers."

At December 31, 2012, we operated 765 child care and early education centers, consisting of 596 centers in North America and 169 centers in Europe and India. We have the capacity to serve approximately 87,100 children in 42 states, the District of Columbia, the United Kingdom, Puerto Rico, Canada, Ireland, the Netherlands and India. We seek to cluster centers in geographic areas to enhance operating efficiencies and to create a leading market presence. Our North American child care and early education centers have an average capacity of 126 children per location, while the centers in Europe and India have an average capacity of 70 children per location.


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We operate centers for a diverse group of clients. At December 31, 2012, we managed child care centers on behalf of single employers in the following industries and also manage lease/consortium locations in approximately the following proportions:

                                                 Percentage of Centers
          Classification                     North America          Europe
          Single employer locations:
          Consumer                                      7.5 %           2.5 %
          Financial Services                           15.0             2.5
          Government                                    7.5            10.0
          Higher Education                              5.0             2.5
          Healthcare and Pharmaceuticals               17.5             5.0
          Industrial/Manufacturing                      5.0             2.5
          Professional Services and Other               7.5              -
          Technology                                    5.0              -

                                                       70.0            25.0
          Lease/consortium locations                   30.0            75.0

                                                      100.0 %         100.0 %

Segments

Our primary reporting segments are full service center-based care services and back-up dependent care services. Full service center-based care includes child care and early education, preschool and elementary education. Back-up dependent care includes center-based back-up child care, in-home well child care, in home mildly ill child care and in home adult/elder care. Our remaining business services are included in the other educational advisory services segment, which includes our college preparation and admissions counseling services as well as tuition reimbursement management and educational counseling services.

Center Models

We operate our centers under two principal business models, which we refer to as profit & loss ("P&L") and cost-plus. Approximately 70% of our centers operate under the P&L model. Under this model, we retain financial risk for child care and early education centers and are therefore subject to variability in financial performance due to fluctuation in enrollment levels. The P&L model is further classified into two subcategories: (i) the sponsor model and (ii) the lease/consortium model. Under the sponsor model, we provide child care and early education services on a priority enrollment basis for employees of an employer sponsor, and the employer sponsor generally pays facility, pre-opening and start-up capital equipment and maintenance costs. Our operating contracts typically have initial terms ranging from three to ten years. Under the lease/consortium model, the child care center is typically located in an office building or office park in a property that we lease, and we provide these services to the employees of multiple employers. We typically negotiate initial lease terms of 10 to 15 years for these centers, often with renewal options.

When we open a new P&L center, it generally takes two to three years for the center to ramp up to a steady state level of enrollment, as a center will typically enroll younger children at the outset and children age into the older (preschool) classrooms over time. We refer to centers that have been open for three years or less as "ramping centers." A center will typically achieve breakeven operating performance between 12 to 24 months and will typically achieve a steady state level of enrollment that supports our average center operating profit by the end of three years, although the period needed to reach a steady state level of enrollment may be longer or shorter. Centers that have been open more than three years are referred to as "mature centers."

Approximately 30% of our centers operate under the cost-plus business model. Under this model, we receive a management fee from the employer sponsor and an additional operating subsidy from the employer to


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supplement tuition paid by parents of children in the center. Under this model, the employer sponsor typically pays facility, pre-opening and start-up capital equipment and maintenance costs, and the center is profitable from the outset. Our cost-plus contracts typically have initial terms ranging from three to five years. For additional information about the way we operate our centers, see "Business-Our Business Models."

Performance and Growth Factors

We believe that 2012 was a successful year for the Company. We grew our income from operations by 9.9%, from $86.8 million to $95.5 million. In addition, we added 50 child care and early education centers with a total capacity of approximately 5,900 children, including 27 centers through the acquisition of Casterbridge. In 2012, we closed 28 centers, resulting in a net increase of 22 centers for the year. We expect to add approximately 35-40 net new centers in 2013.

Our year-over-year improvement in operating income can be attributed to enrollment gains in ramping and mature centers, disciplined pricing strategies aimed at covering anticipated cost increases with tuition increases, contributions from back-up dependent care services and contributions from mature centers obtained through acquisitions and added through transitions of management.

General economic conditions and the business climate in which individual clients operate remain some of the largest variables in terms of our future performance. These variables impact client capital and operating spending budgets, industry specific sales leads and the overall sales cycle, enrollment levels, as well as labor markets and wage rates as competition for human capital fluctuates.

Our ability to increase operating income will depend upon our ability to sustain the following characteristics of our business:

maintenance and incremental growth of enrollment in our mature and ramping centers, and cost management in response to changes in enrollment in our centers,

effective pricing strategies, including typical annual tuition increases of 3% to 4%, consistent with typical annual increases in personnel costs, including wages and benefits,

additional growth in expanded service offerings to clients,

successful integration of acquisitions and transitions of management of centers, and

successful management and improvement of underperforming centers.

Cost Factors

Our most significant expense is cost of services. Cost of services consists of direct expenses associated with the operation of our centers, direct expenses to provide back-up dependent care services (including fees to back-up dependent care providers) and direct expenses to provide educational advisory services. Direct expenses consist primarily of staff salaries, taxes and benefits, food costs, program supplies and materials, parent marketing and facilities costs, including occupancy costs and depreciation. Personnel costs are the largest component of a center's operating costs, and, on a weighted average basis, comprise approximately 75% of a center's operating expenses. We are typically responsible for additional costs in a P&L model center as compared to a cost-plus model center. As a result, personnel costs in centers operating under the P&L model will typically represent a smaller proportion of overall costs when compared to the centers operating under the cost-plus model.

We are highly leveraged. As of December 31, 2012, consolidated total debt was $928.3 million, which we refinanced into a $790.0 million senior secured term loan on January 30, 2013. Historically, a large portion of our cash flows from operations has been used to make interest payments on our indebtedness.


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Seasonality

Our business is subject to seasonal and quarterly fluctuations. Demand for child care and early education and elementary school services has historically decreased during the summer months when school is not in session, at which time families are often on vacation or have alternative child care arrangements. In addition, our enrollment declines as older children transition to elementary schools. Demand for our services generally increases in September and October coinciding with the beginning of the new school year and remains relatively stable throughout the rest of the school year. In addition, use of our back-up dependent care services tends to be higher when schools are not in session and during holiday periods, which can increase the operating costs of the program and impact the results of operations. Results of operations may also fluctuate from quarter to quarter as a result of, among other things, the performance of existing centers, including enrollment and staffing fluctuations, the number and timing of new center openings, acquisitions and management transitions, the length of time required for new centers to achieve profitability, center closings, refurbishment or relocation, the contract model mix (P&L versus cost-plus) of new and existing centers, the timing and level of sponsorship payments, competitive factors and general economic conditions.


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Results of Operations

The following table sets forth statement of operations data as a percentage of revenue for the three years ended December 31, 2012, (in thousands, except percentages).

                                                                 Years Ended December 31,
                                             2010                         2011                          2012
Revenue                             $ 878,159        100.0 %     $ 973,701        100.0 %     $ 1,070,938        100.0 %
Cost of services (1)                  698,264         79.5 %       766,500         78.7 %         825,168         77.1 %

Gross profit                          179,895         20.5 %       207,201         21.3 %         245,770         22.9 %
Selling, general and
administrative expenses (2)            83,601          9.5 %        92,938          9.5 %         123,373         11.5 %
Amortization                           27,631          3.2 %        27,427          2.9 %          26,933          2.5 %

Income from operations                 68,663          7.8 %        86,836          8.9 %          95,464          8.9 %
Net interest expense and other         88,971         10.1 %        81,249          8.3 %          83,712          7.8 %

Income (loss) before tax              (20,308 )       (2.3 )%        5,587          0.6 %          11,752          1.1 %
Income tax (expense) benefit           10,314          1.2 %          (825 )       (0.1 )%         (3,243 )       (0.3 )%

Net income (loss)                   $  (9,994 )       (1.1 )%    $   4,762          0.5 %     $     8,509          0.8 %

(1) Cost of services consists of direct expenses associated with the operation of child care centers, and direct expenses to provide back-up dependent care services, including fees to back-up care providers, and educational advisory services. Direct expenses consist primarily of salaries, taxes and benefits for personnel, food costs, program supplies and materials, parent marketing and facilities costs, which include occupancy costs and depreciation.

(2) Selling, general and administrative ("SGA") expenses consist primarily of salaries, payroll taxes and benefits (including stock compensation costs) for corporate, regional and business development personnel. Other overhead costs include information technology, occupancy costs for corporate and regional personnel, professional services fees, including accounting and legal services, and other general corporate expenses.

Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011

Revenue. Revenue increased $97.2 million, or 9.9%, to $1.07 billion for the year ended December 31, 2012 from $973.7 million for the prior year. Revenue growth is primarily attributable to contributions from new and ramping child care and early education centers, expanded sales of our back-up dependent care services and typical annual tuition increases of 3% to 4%. Revenue generated by full service center-based care services in the year ended December 31, 2012 increased by $77.6 million, or 9.2%, when compared to 2011. Revenue generated by back-up dependent care services in the year ended December 31, 2012 increased by $15.6 million, or 13.6%, when compared to the same period in 2011. Additionally, revenue generated by other educational advisory services in the year ended December 31, 2012 increased by $4.0 million, or 27.7%, when compared to 2011.

Our acquisition of the 27 Casterbridge centers in the United Kingdom on May 23, 2012 contributed approximately $26.3 million of revenue in the year ended December 31, 2012 from the date of the acquisition. The acquisition of a majority interest in 20 centers in the Netherlands on July 20, 2011, contributed approximately $25.4 million of revenue in the year ended December 31, 2012 compared to $10.9 million in the year ended December 31, 2011 from the date of acquisition. At December 31, 2012, we operated 765 child care and early education centers compared to 743 centers at December 31, 2011.

Cost of Services. Cost of services increased $58.7 million, or 7.7%, to $825.2 million for the year ended December 31, 2012 when compared to the prior year. Cost of services in the full service centers segment increased $52.1 million, or 7.6%, to $740.1 million in 2012. Personnel costs typically represent approximately 75% of total cost of services for this segment, and personnel costs increased 7.1% as a result of a 6.2% increase in overall enrollment and routine wage increases. In addition, program supplies, materials, food and facilities costs increased 6.9% in connection with the enrollment growth and the incremental occupancy costs associated


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with centers that have been added in 2011 and 2012. Cost of services in the back-up dependent care segment increased $5.6 million, or 8.0%, to $75.4 million in 2012, primarily for personnel costs and for increased care provider fees associated with the higher levels of back-up services provided. Cost of services in the other educational advisory services segment increased by $1.0 million, or 11.8%, to $9.7 million in 2012, as we realized economies of scale with existing personnel on the incremental sales of these services.

Gross Profit. Gross profit increased $38.6 million, or 18.6%, to $245.8 million for the year ended December 31, 2012 when compared to the prior year, and as a percentage of revenue, increased to 22.9% in the year ended December 31, 2012 from 21.3% in the year ended December 31, 2011. The increase is primarily due to the new and ramping P&L centers, which achieve proportionately lower levels of operating costs in relation to revenue as they ramp up enrollment to steady state levels, increased enrollment in our mature P&L centers and expanded back-up services revenue with proportionately lower direct cost of services.

Selling, General and Administrative Expenses. SGA increased $30.4 million, or 32.7%, to $123.4 million for the year ended December 31, 2012 compared to $92.9 million for the same period in the prior year, and as a percentage of revenue increased to 11.5% from 9.5% in the same period in the prior year. The increase in SGA was primarily due to an increase in stock compensation expense. Stock compensation expense increased $16.4 million, from $1.2 million in the year ended December 31, 2011 to $17.6 million in the year ended December 31, 2012. The increase primarily relates to our option exchange transaction that was completed on May 2, 2012. The increase was also due to the award of additional options to purchase a combination of shares of our Class A common stock and Class L common stock in the second quarter of 2012. The modification of the previously existing awards resulted in incremental stock compensation expense of $12.7 million, and the new option awards resulted in total incremental stock compensation expense of $2.5 million, for a combined incremental charge of $15.2 million in the quarter ended June 30, 2012 related to the requisite service period already fulfilled.

Excluding the incremental stock compensation expense totaling $15.2 million in 2012, SGA increased by $15.2 million, or 16.4%, for the year ended December 31, 2012 compared to the same period in 2011. The additional increase in SGA is related to investments in technology and marketing, incremental overhead associated with acquisitions, including $3.3 million for our Netherlands operations acquired in July 2011 and $2.3 million for the 27 Casterbridge centers acquired on May 23, 2012, and routine increases in costs compared to the prior year, including annual wage increases. In addition, we incurred approximately $1.8 million in accounting and legal fees associated with preparing for the Offering and refinancing of our debt that were completed in January 2013.

Upon the completion of the Offering on January 30, 2013, we recognized approximately $5.0 million in stock compensation expense, related to certain performance-based stock options which vested upon completion of the Offering.

Amortization. Amortization expense on intangible assets totaled $26.9 million for the year ended December 31, 2012, compared to $27.4 million for the year ended December 31, 2011. The decrease relates to certain intangible assets becoming fully amortized, partially offset by additional amortization for acquisitions completed in 2012. We do not expect any significant change in amortization expense in 2013.

Income from Operations. Income from operations increased by $8.6 million, or 9.9%, to $95.5 million for the year ended December 31, 2012 when compared to the same period in 2011. Income from operations was 8.9% of revenue for the year ended December 31, 2012, consistent with the prior year. Excluding the impact of the incremental stock compensation charge of $15.2 million in the second quarter of 2012 described above, income from operations would have been $110.7 million, or 10.3% of revenue, an increase of $23.8 million, or 27.4%, from $86.8 million in the year ended December 31, 2011.

In the full service center-based care segment, income from operations increased $1.2 million for the year ended December 31, 2012, including a proportionate share of the incremental stock compensation expense of approximately $11.2 million that was included in SGA in the year ended December 31, 2012. Excluding this charge, the $12.7 million increase in 2012 reflects price increases and enrollment gains over the prior year as well as contributions from new centers that have been added in 2012. The back-up dependent care segment added $5.2 million in the year ended December 31, 2012. Excluding the proportionate share of the incremental stock


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compensation for this segment of $2.8 million, the back-up dependent care segment added $7.7 million in income from operations in the year ended December 31, 2012 due to the expanding revenue base and efficiencies of service delivery across a wider revenue base. Income from operations in the other educational advisory services segment increased $2.2 million for the year ended December 31, 2012 compared to the same period in 2011, and increased $3.4 million excluding this segment's proportionate share of the incremental stock compensation. This increase reflects the higher sales volume in the 2012 period.

Interest Expense. At December 31, 2012, we had total borrowings outstanding of $928.3 million of term loans, senior subordinated notes and senior notes, including $85.0 million term loan used in May 2012 in connection with the Casterbridge acquisition, and we had access to an additional $75.0 million revolving line of credit. Interest expense for the year ended December 31, 2012 totaled $83.9 million compared to $82.9 million for the same period in 2011. The increase in interest expense is primarily related to the additional borrowings in May 2012, offset by a reduction in the interest rate attributable to the term loans as a result of the expiration of the interest rate floors on our Base and Euro rates on May 28, 2011.

On January 30, 2013, we completed a refinancing of our existing debt with $890.0 million senior secured credit facilities which included a $790.0 million senior secured term loan facility and a $100.0 million revolving credit facility. We used the net proceeds of our initial public offering and certain proceeds from the issuance of the $790.0 million secured term loan to redeem our senior notes in full for $213.3 million. We used the remainder of the $790.0 million secured term loan to repay all of the existing indebtedness under the senior subordinated notes as well as existing indebtedness outstanding under the Tranche B term loans and Series C new term loans. Accordingly, we will recognize a loss on extinguishment of debt of approximately $63.0 million, including redemption premiums on the senior notes, the senior subordinated notes and the Series C new term loans, and the write-off of deferred financing costs associated with this indebtedness, in the first quarter of 2013. Based upon borrowings outstanding of $790.0 million after the refinancing and borrowings available to us under the $100.0 million revolving line of credit, we expect interest expense to decrease significantly in 2013 compared to 2012.

Income Tax Expense. We had income tax expense of $3.2 million for the year ended December 31, 2012 on pre-tax income of $11.8 million, or a 27.6% effective rate, which includes the benefit of permanent items, a reduction to the statutory tax rate in the United Kingdom and a decrease to the reserves for uncertain tax positions. Income tax expense of $0.8 million in 2011, or an effective tax rate of 14.8% was lower due primarily to the reversal of a valuation allowance in the United Kingdom.

Net Income Attributable to Non-controlling Interest. Net income attributable to the non-controlling interest in our Netherlands subsidiary, which reduces net income attributable to Bright Horizons Family Solutions Inc., increased to $0.3 million for the year ended December 31, 2012 from less than $0.1 million in the prior year due to improved center performance in the Netherlands.

Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010

Revenue. Revenue increased $95.5 million, or 10.9%, to $973.7 million for the year ended December 31, 2011 from $878.2 million in the prior year. Revenue growth is primarily attributable to contributions from new and ramping full service child care centers, expanded sales of our back-up dependent care services and typical annual tuition increases of 3% to 4%. Revenue generated by full service center-based care services in the year ended December 31, 2011 increased by approximately $75.2 million, or 9.8%, when compared to 2010. Revenue generated by back-up dependent care services in the year ended December 31, 2011 increased by approximately $15.5 million, or 15.7%, when compared to 2010. Additionally, revenue generated by other educational advisory services increased by $4.8 million, or 48.4%, when compared to 2010.

Our acquisition of 20 centers in the United States on March 14, 2011 contributed approximately $17.1 million of revenue in 2011 from the date of the acquisition. The acquisition of a majority interest in 20 centers in the Netherlands on July 20, 2011 contributed approximately $10.9 million of revenue from the date of the acquisition. At December 31, 2011, we operated 743 child care and early education centers compared to 705 centers at December 31, 2010.


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Cost of Services. Cost of services increased $68.2 million, or 9.8%, to $766.5 million for the year ended 2011 from $698.3 million in the prior year. Cost of services in the full service centers segment increased $58.3 million, or 9.3%, to $688.1 million in 2011. Personnel costs increased 7.9% as a result of a 7.5% increase in overall enrollment and routine wage increases. In addition, program supplies, materials, food and facilities costs increased 14.1% in connection with the enrollment growth and the incremental occupancy costs associated with centers that have been added in 2010 and 2011, including the 40 centers acquired in 2011. Cost of services in the back-up dependent care segment increased $6.1 . . .

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