NRC 10-Q Quarter ended Sept. 30, 2016

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2016

or

For the transition period from ________ to ________

Commission File Number 0-29466

National Research Corporation

(Exact name of Registrant as specified in its charter)

1245 Q Street, Lincoln, Nebraska          68508

(Address of principal executive offices) (Zip Code)

(402) 475-2525

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐        Accelerated filer ☒        Non-accelerated filer ☐      Smaller reporting company ☐

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)

Yes ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

Class A Common Stock, $.001 par value, outstanding as October 28, 2016: 20,900,082 shares

Class B Common Stock, $.001 par value, outstanding as of October 28, 2016: 3,541,433 shares

NATIONAL RESEARCH CORPORATION

FORM 10-Q INDEX

For the Quarter Ended September 30, 2016

Special Note Regarding Forward-Looking Statements

Certain matters discussed in this Quarterly Report on Form 10-Q are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements can generally be identified as such because the context of the statement includes phrases such as National Research Corporation (“NRC,” the “Company,” “we,” “our,” “us,” or similar terms) “believes,” “expects,” or other words of similar import. Similarly, statements that describe the Company’s future plans, objectives or goals are also forward-looking statements. Such forward-looking statements are subject to certain risks and uncertainties which could cause actual results or outcomes to differ materially from those currently anticipated. Factors that could affect actual results or outcomes include, without limitation, the following factors:

Shareholders, potential investors and other readers are urged to consider these and other factors in evaluating the forward-looking statements, and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included are only made as of the date of this Quarterly Report on Form 10-Q and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.

NATIONAL RESEARCH CORPORATION AND SUBSIDIARY

(In thousands, except share amounts and par value)

See accompanying notes to condensed consolidated financial statements

NATIONAL RESEARCH CORPORATION AND SUBSIDIARY

(In thousands, except for per share amounts, unaudited)

See accompanying notes to condensed consolidated financial statements

NATIONAL RESEARCH CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands, unaudited)

See accompanying notes to condensed consolidated financial statements.

NATIONAL RESEARCH CORPORATION AND SUBSIDIARY

(In thousands, unaudited)

See accompanying notes to condensed consolidated financial statements.

NATIONAL RESEARCH CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company is a leading provider of analytics and insights that facilitate measurement and improvement of the patient and employee experience while also increasing patient engagement and loyalty for healthcare providers, payers and other healthcare organizations. The Company’s solutions enable its clients to provide customer-centric healthcare through understanding the voice of the customer to improve patient experience, engagement and loyalty, while also facilitating regulatory compliance and the shift to population-based health management for its clients. The Company’s ability to measure what matters most and systematically capture, analyze and deliver to its clients self-reported information from patients, families and consumers is critical in today’s healthcare market. NRC believes that access to and analysis of its extensive consumer-driven information is becoming more valuable as healthcare providers increasingly need to more deeply understand and engage patients and consumers in an effort towards effective population-based health management.

The Company’s portfolio of subscription-based solutions provide actionable information and analysis to healthcare organizations and payers across a range of mission-critical, constituent-related elements, including patient experience and satisfaction, community population health risks, workforce engagement, community perceptions, physician engagement and transparency. NRC partners with clients across the continuum of healthcare services. The Company’s clients range from acute care hospitals and post-acute providers, such as home health, long-term care and hospice, to numerous payer organizations. The Company believes this cross-continuum positioning is a unique and an increasingly important capability as evolving payment models drive healthcare providers and payers towards more collaborative and integrated healthcare systems.

Results of Operations

The following table sets forth for the periods indicated, select financial information derived from the Company’s condensed consolidated financial statements expressed as a percentage of total revenue. The trends illustrated may not necessarily be indicative of future results. The discussion that follows the table should be read in conjunction with the condensed consolidated financial statements.

Three Months Ended September 30, 2016, Compared to Three Months Ended September 30, 2015

Revenue . Revenue for the three-month period ended September 30, 2016, increased 7.1% to $27.0 million, compared to $25.2 million in the three-month period ended September 30, 2015. The increase was due to new customer sales, as well as increases in sales to the existing client base.

Direct expenses . Direct expenses increased 4.2% to $11.5 million for the three-month period ended September 30, 2016, compared to $11.0 million in the same period during 2015. This was mainly due to an increase in fixed expenses of $477,000 partially offset by a decrease in variable costs of $16,000. Fixed expenses increased primarily as a result of increased salary and benefit costs in the customer service area. Variable costs decreased due to a reduction in postage fees and changes in survey methodologies. Direct expenses decreased as a percentage of revenue to 42.4% in the three-month period ended September 30, 2016, compared to 43.6% during the same period of 2015 as expenses increased by 4.2% while revenue for the same period increased by 7.1%.

Selling, general and administrative expenses. Selling, general and administrative expenses increased 7.8% to $7.1 million for the three-month period ended September 30, 2016, compared to $6.6 million for the same period in 2015, as a result of increased salary and benefit costs of $220,000 and increased marketing expenses of $239,000. Selling, general, and administrative expenses increased as a percentage of revenue to 26.4% for the three-month period ended September 30, 2016, from 26.2% for the same period in 2015 as expenses increased 7.8% while revenue for the same period increased by 7.1%.

Depreciation and amortization. Depreciation and amortization expenses remained at $1.1 million for the three-month periods ended September 30, 2016 and 2015 primarily due to increased depreciation and amortization from increased computer software investments and computer software license expense being included in depreciation and amortization in 2016, resulting from the adoption of ASU 2015-05 . These increases were offset by decreased amortization as a result of the sale of the clinical workflow product of the former Predictive Analytics operating segment in 2015 and other intangibles becoming fully amortized. Depreciation and amortization expenses as a percentage of revenue was 4.0% for the three-month period ended September 30, 2016, and 4.2% for the same period in 2015.

Provision for income taxes. Provision for income taxes was $2.6 million (35.3% effective tax rate) for the three-month period ended September 30, 2016, compared to $2.3 million (36.2% effective tax rate) for the same period in 2015. The effective tax rate for the three-month period ended September 30, 2016, was lower than the rate in the same period of 2015 mainly due to lower state tax expenses of $57,000 and a $38,000 reduction of income taxes for the excess tax benefit from the exercise of stock options and dividends paid to non-vested shareholders in the three-month period ended September 30, 2016.

Nine Months Ended September 30, 2016, Compared to Nine Months Ended September 30, 2015

Revenue . Revenue for the nine-month period ended September 30, 2016, increased 6.6% to $81.0 million, compared to $76.0 million in the nine-month period ended September 30, 2015. The increase was due to new customer sales, as well as increases in sales to the existing client base.

Direct expenses . Direct expenses increased 1.5% to $33.7 million for the nine-month period ended September 30, 2016, compared to $33.2 million in the same period during 2015. Variable expenses increased $34,000 due to increased contracted survey costs, partially offset by decreased postage and internal labor costs due to a reduction in postage fees and changes in survey methodologies. Fixed expenses increased $462,000 as a result of higher salary and benefit costs in the customer service area, increased travel expenses and increased software license amortization. Direct expenses decreased as a percentage of revenue to 41.6% in the nine-month period ended September 30, 2016, compared to 43.7% during the same period of 2015 as expenses increased by 1.5% while revenue for the same period increased by 6.6%.

Selling, general and administrative expenses. Selling, general and administrative expenses increased 4.2% to $21.8 million for the nine-month period ended September 30, 2016, compared to $20.9 million for the same period in 2015 primarily due to increased salary and benefits of $1.1 million mainly from increased incentives and share based compensation expense, increased marketing expenses of $514,000 and higher bad debt expense of $118,000. These were partially offset by decreased legal and accounting costs of $469,000, less repairs and maintenance on the Company’s headquarters building of $241,000, and less computer equipment supplies and software license fees of $169,000. Legal and accounting costs decreased by $469,000 primarily due to a purchase option write off of $657,000 in 2015, partially offset by SEC registration fees expensed in 2016 of $177,000. Selling, general, and administrative expenses decreased as a percentage of revenue to 26.9% for the nine-month period ended September 30, 2016, from 27.5% for the same period in 2015 as expenses increased by 4.2% while revenue increased by 6.6% during the same period.

Depreciation and amortization. Depreciation and amortization expenses remained at $3.1 million for the nine-month periods ended September 30, 2016 and 2015 primarily due to increased depreciation and amortization from increased computer software investments and computer software license expense being included in depreciation and amortization in 2016, resulting from the adoption of ASU 2015-05 . These increases were offset by decreased amortization as a result of the sale of the clinical workflow product of the former Predictive Analytics operating segment in 2015 and other intangibles becoming fully amortized. Depreciation and amortization expenses as a percentage of revenue decreased to 3.9% for the nine-month period ended September 30, 2016, from 4.1% during the same period in 2015.

Provision for income taxes. Provision for income taxes was $7.6 million (33.8% effective tax rate) for the nine-month period ended September 30, 2016, compared to $6.9 million (37.2% effective tax rate) for the same period in 2015. The decrease in the effective tax rate was mainly due to the establishment of a $300,000 capital loss valuation allowance due to the write-off of a purchase option in 2015, the adoption of ASU 2016-09 which reduced tax expense by $447,000, and United States federal tax examination adjustments, net of interest and penalties, and state tax return adjustments decreasing tax expense by $105,000 in 2016.

Liquidity and Capital Resources

The Company believes that its existing sources of liquidity, including cash and cash equivalents, borrowing availability, and operating cash flows will be sufficient to meet its projected capital and debt maturity needs and dividend policy for the foreseeable future.

On March 7, 2016, the Company elected to exercise its first option to acquire one-third of the outstanding non-controlling interest of Customer-Connect LLC for $1.0 million. Subsequently, on March 28, 2016, an agreement was reached with Illuminate Health whereby the Company acquired the remaining interest held by Illuminate Health for $1,000,000. As of March 31, 2016, the Company owned 100% of Customer-Connect LLC and dissolved this subsidiary on June 30, 2016.

The Company had cash and cash equivalents of $28.9 million at September 30, 2016, of which $10.7 million was held in Canada. All of the amounts held in Canada are intended to be indefinitely reinvested in foreign operations. The amounts held outside of the U.S. are eligible for repatriation, but under current law, would be subject to U.S. federal income taxes, less applicable foreign tax credits. The Company estimated at December 31, 2015, that an additional tax liability of $534,000 would become due if repatriation of undistributed earnings would occur.

Working Capital

The Company had a working capital balance of $14.8 million as of September 30, 2016, compared to a working capital balance of $10.9 million as of December 31, 2015. The change was primarily due to decreases in dividends payable of $15.1 million and income taxes payable of $622,000, and increases in trade accounts receivable of $4.3 million. This was partially offset by decreases in cash and cash equivalents of $13.3 million and increases in deferred revenue of $2.6 million. Dividends payable and cash and cash equivalents changed mainly due to the payment of $18.4 million in dividends in 2016 that were declared in 2015. Trade accounts receivable increased due to the timing of billings and collections on new and renewal contracts. Income tax payables changed due to the timing of income tax payments. The Company’s working capital is significantly impacted by its large deferred revenue balances which will vary based on the timing and frequency of billings on annual agreements. The current deferred revenue balances as of September 30, 2016 and December 31, 2015 were $17.4 million and $14.8 million, respectively.

The deferred revenue balance is primarily due to timing of initial billings on new and renewal contracts. The Company typically invoices clients for services before they have been completed. Billed amounts are recorded as billings in excess of revenue earned, or deferred revenue, on the Company’s condensed consolidated financial statements, and are recognized as income when earned. In addition, when work is performed in advance of billing, the Company records this work as revenue earned in excess of billings, or unbilled revenue. Substantially all deferred revenue and all unbilled revenue will be earned and billed respectively, within 12 months of when the respective period ends.

Cash Flow Analysis

A summary of operating, investing, and financing activities is shown in the following table:

Cash Flows from Operating Activities

Cash flows from operating activities consist of net income adjusted for non-cash items such as depreciation and amortization, deferred taxes, share-based compensation and related taxes, and the effect of working capital changes.

Net cash provided by operating activities was $18.0 million for the nine months ended September 30, 2016, which included net income of $14.8 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, provision for uncertain tax positions and non-cash stock compensation totaling $5.6 million. Changes in working capital decreased 2016 cash flows from operating activities by $2.3 million, primarily due to increases in trade accounts receivable and prepaids and a decrease in income taxes payable, net of increases in deferred revenue due to the timing of billing, collections and revenue recognition on new or renewal contracts. The Company adopted ASU 2016-09 in 2016 prospectively and did not retrospectively adjust prior periods. Therefore, the excess tax benefit of share-based compensation is included in cash flows from operating activities in 2016 and from financing activities in 2015.

Net cash provided by operating activities was $14.8 million for the nine months ended September 30, 2015, which included net income of $11.7 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, purchase option write-off, provision for uncertain tax positions and non-cash stock compensation totaling $4.2 million. Changes in working capital decreased 2015 cash flows from operating activities by $1.1 million, primarily due to increases in trade accounts receivable, net of increases in deferred revenue due to the timing of billing, collections and revenue recognition on new or renewal contracts.

Net cash provided by operating activities increased $3.2 million for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015. The increase was mainly due to an increase in net income of $3.1 million. Net cash provided by operating activities also increased by $1.4 million from non-cash charges, primarily attributable to increased share-based compensation. These increases were partially offset by a decrease of $1.2 million from changes in working capital, primarily attributable to a decrease in the change in accrued expenses, wages bonuses and profit sharing.

Cash Flows from Investing Activities

Net cash of $3.1 million and $2.2 million was used for investing activities in the nine months ended September 30, 2016 and 2015, respectively, for purchases of property and equipment.

Cash Flows from Financing Activities

Net cash used in financing activities was $28.7 million in the nine months ended September 30, 2016. The exercise of stock options provided cash of $491,000. Cash was used to pay payroll taxes on vested restricted shares of $147,000, to pay capital lease obligations of $73,000, to repay borrowings under the term note totaling $1.8 million, to pay dividends on common stock of $25.2 million, and to pay $2.0 million for Customer-Connect LLC non-controlling interests.

Net cash used in financing activities was $13.8 million in the nine months ended September 30, 2015. The excess tax benefit of share-based compensation provided cash of $107,000. Cash was used to pay payroll taxes on vested restricted shares of $92,000, to pay capital lease obligations of $148,000, to repay borrowings under the term note totaling $1.7 million, to pay dividends on common stock of $7.5 million, to pay $2.8 million for Customer-Connect LLC interests and for the purchase of treasury stock of $1.6 million.

The effect of changes in foreign exchange rates increased cash and cash equivalents by $484,000 in the nine months ended September 30, 2016 and decreased cash and cash equivalents by $1.2 million for the nine months ended September 30, 2015.

Capital Expenditures

Cash paid for capital expenditures was $3.1 million for the nine-month period ended September 30, 2016. These expenditures consisted mainly of computer software classified in property and equipment. The Company expects similar capital expenditure purchases for the remainder of 2016 consisting primarily of computer software and hardware and other equipment to be funded through cash generated from operations.

Debt and Equity

The Company’s term note is payable in 60 monthly installments of $212,468. Borrowings under the term note bears interest at an annual rate of 3.12%. The outstanding balance of the term note at September 30, 2016 was $3.9 million.

The Company also has a revolving credit note that was renewed in June 2016 to extend the term to June 30, 2017. This revolving credit note provides for the maximum aggregate borrowings of $6.5 million, subject to a borrowing base equal to 75.0% of the Company’s eligible accounts receivable. Borrowings under the revolving credit note bear interest at a variable annual rate, with three rate options at the discretion of management as follows: (1) 2.5% plus the daily reset one-month LIBOR rate, or (2) 2.2% plus the one-, two-, or three-month LIBOR rate, or (3) the bank’s one-, two-, three-, six- or twelve-month Money Market Loan Rate. As of September 30, 2016, and throughout the first nine months of 2016, the revolving credit note did not have a balance. According to the borrowing base requirements, the Company had the capacity to borrow $6.5 million as of September 30, 2016.

The term note and revolving credit note are secured by certain of the Company’s assets, including the Company’s land, building, trade accounts receivable and intangible assets. The term note and revolving credit note contain various restrictions and covenants applicable to the Company, including requirements that the Company maintain certain financial ratios at prescribed levels and restrictions on the ability of the Company to consolidate or merge, create liens, incur additional indebtedness or dispose of assets. As of September 30, 2016, the Company was in compliance with these restrictions and covenants.

The Company has capital leases for computer equipment, office equipment, and inserting equipment. The balance of the capital leases as of September 30, 2016 was $214,000.

Shareholders’ equity increased $7.0 million to $81.2 million at September 30, 2016, from $74.2 million at December 31, 2015. The increase was mainly due to net income of $14.8 million, changes in the cumulative translation adjustment of $680,000, share-based compensation of $1.5 million and $945,000 from the exercise of stock options. This was partially offset by dividends declared of $10.1 million, the acquisition of Customer-Connect LLC non-controlling interests of a net $252,000, and share repurchases of $601,000. The Customer-Connect LLC non-controlling interests net amounts consists of $2.0 million paid for the controlling interest, offset by the addition of a $1.7 million deferred tax asset from the purchase of these remaining interests, which resulted in an increase to additional paid-in capital.

Contractual Obligations

The Company had contractual obligations to make payments in the following amounts in the future as of September 30, 2016:

⁽¹⁾ Amounts are inclusive of interest payments, where applicable.

⁽²⁾ We have $418,000 in liabilities associated with uncertain tax positions. We are unable to reasonably estimate the expected cash settlement dates of these uncertain tax positions with certain taxing authorities.

Stock Repurchase Program

The Board of Directors of the Company authorized the repurchase of 2,250,000 class A and 375,000 class B shares of common stock in the open market or in privately negotiated transactions under a stock repurchase program that was originally approved in February 2006 and subsequently amended in May 2013. As of September 30, 2016 the remaining number of common stock shares that could be purchased under this authorization was 280,491 class A shares and 69,491 class B shares.

There are no material changes to the disclosures regarding the Company’s market risk exposures made in its Annual Report on Form 10-K for the year ended December 31, 2015.

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report, and has concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.

There have been no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that occurred during the quarter ended September 30, 2016, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

There have been no material changes to the risk factors relating to the Company set forth in Part I, Item 1A of its Annual Report on Form 10-K for the year ended December 31, 2015.

The Board of Directors of the Company authorized the repurchase of 2,250,000 class A and 375,000 class B shares of common stock in the open market or in privately negotiated transactions under a stock repurchase program that was originally approved in February 2006 and subsequently amended in May 2013. Unless terminated earlier by resolution of the Company’s Board of Directors, the repurchase program will expire when the Company has repurchased all shares authorized for repurchase thereunder. As of October 28, 2016, 1,969,509 shares of class A common stock and 305,509 shares of class B common stock have been repurchased under that authorization. No stock was repurchased under the program during the three-month period ended September 30, 2016.

The exhibits listed in the accompanying index of exhibits are filed as part of this Quarterly Report on Form 10-Q.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

NATIONAL RESEARCH CORPORATION

EXHIBIT INDEX TO QUARTERLY REPORT ON FORM 10-Q

For the Quarterly Period ended September 30, 2016

Exhibit

* In accordance with Rule 406T of Regulation S-T, the information in these exhibits shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.

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