10-K 1 nrc_10k-123112.htm FORM 10-K nrc_10k-123112.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-K
 
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the fiscal year ended December 31, 2012
 
or
 
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the transition period from                                to _______________
 
Commission file number:  0-29466
 
  National Research Corporation  
 
(Exact name of registrant as specified in its charter)
 
 
 
Wisconsin
 
47-0634000
 
 
(State or other jurisdiction
 
(I.R.S. Employer
 
 
of incorporation or organization)
 
Identification No.)
 
         
 
1245 Q Street
     
 
Lincoln, Nebraska
 
68508
 
 
(Address of principal executive offices)
 
(Zip code)
 

Registrant’s telephone number, including area code:  (402) 475-2525
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
Title of Class     Name of Each Exchange on Which Registered
Common Stock, $.001 par value   The NASDAQ Stock Market
 
Securities registered pursuant to Section 12(g) of the Act:  None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes  £    No  T
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes  £    No  T
 
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   T   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   T   No  £
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  £
 
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  T                                            Non-accelerated filer £ 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  T
 
Aggregate market value of the voting stock held by nonaffiliates of the registrant at June 30, 2012:  $131,966,864.
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, $0.001 par value, outstanding as of February 20, 2013: 6,910,928 shares
 
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2013 Annual Meeting of Shareholders are incorporated by reference into Part III.
 
 
 

 
 
TABLE OF CONTENTS
 
   
Page
 
PART I
 
     
Item 1.
Business
1
Item 1A.
Risk Factors
8
Item 1B.
Unresolved Staff Comments
13
Item 2.
Properties
13
Item 3.
Legal Proceedings
13
Item 4.
Mine Safety Disclosures
13
     
 
PART II
 
     
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
14
Item 6.
Selected Financial Data
16
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
Item 7A.
Quantitative and Qualitative Disclosure About Market Risk
27
Item 8.
Financial Statements and Supplementary Data
28
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
55
Item 9A.
Controls and Procedures
55
Item 9B.
Other Information
55
     
 
PART III
 
     
Item 10.
Directors and Executive Officers of the Registrant
57
Item 11.
Executive Compensation
57
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
57
Item 13.
Certain Relationships and Related Transactions
58
Item 14.
Principal Accountant Fees and Services
58
     
 
PART IV
 
     
Item 15.
Exhibits and Financial Statement Schedules
59
Signatures
 
62
 
 
i

 
 
PART I
 
Item 1.            Business
 
Special Note Regarding Forward-Looking Statements
 
Certain matters discussed in this Annual Report on Form 10-K 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:
 
 
·
The possibility of non-renewal of the Company’s client service contracts;
 
 
·
The Company’s ability to compete in its markets, which are highly competitive, and the possibility of increased price pressure and expenses;
 
 
·
The effects of an economic downturn;
 
 
·
The possibility of consolidation in the healthcare industry;
 
 
·
The impact of federal healthcare reform legislation or other regulatory changes;
 
 
·
The Company’s ability to retain its limited number of key clients;
 
 
·
The Company’s ability to attract and retain key managers and other personnel;
 
 
·
The possibility that the Company’s intellectual property and other proprietary information technology could be copied or independently developed by its competitors;
 
 
·
Regulatory developments; and
 
 
·
The factors set forth under the caption “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
 
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 Annual Report on Form 10-K and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.
 
General
 
The Company is a leading provider of analytics and insights that facilitate revenue growth, patient, employee and customer retention and patient engagement for healthcare providers, payers and other healthcare organizations.  The Company’s solutions support the improvement of business and clinical outcomes, while facilitating regulatory compliance and the shift to population-based health management for its clients.  The Company’s ability to 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 will become even more valuable in the future as healthcare providers increasingly need to more deeply understand and engage patients and consumers in an effort towards effective population-based health management.
 
 
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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, and physician engagement.  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 a more collaborative and interactive healthcare system.
 
NRC’s expertise includes the efficient capture, interpretation, transmittal and benchmarking of critical data elements from millions of healthcare consumers.  Using its portfolio of solutions through internet-based business intelligence tools, the Company’s clients gain insights into best practices to drive improvements across key performance metrics.  The Company’s clients are also able to access networking groups, on-line education and an extensive library of performance improvement material that can be tailored to each of their unique needs.
 
NRC has achieved a market leadership position through its more than 31 years of industry innovation and experience, as well as its long-term, recurring revenue relationships (solutions that are used or required by a client each year) with many of the healthcare industry’s largest organizations.  Since its founding in 1981, the Company has focused on meeting the evolving information needs of the healthcare industry through internal product development, as well as select acquisitions. The Company is a Wisconsin corporation headquartered in Lincoln, Nebraska.
 
Industry and Market Opportunity
 
According to the Kaiser Foundation, health expenditures in the United States were approximately $2.6 trillion in 2010, over ten times the $256 billion spent in 1980.  In total, health spending accounted for 17.9% of the nation’s Gross Domestic Product in 2010.  Addressing this growing expenditure burden continues to be a major policy priority at both federal and state levels.  In addition, continued high unemployment rates and lower incomes for many Americans coupled with increased co-pays and deductibles in employer-sponsored plans have focused even more consumer attention on health spending and affordability. In the public sector, Medicare provides health coverage for individuals aged 65 and older, while Medicaid provides coverage for low income families and other individuals in need.  Both programs are administered by the Centers for Medicare & Medicaid Services (“CMS”).  With the aging of the U.S. population, Medicare enrollment has increased significantly.  In addition, longer life spans and greater prevalence of chronic illnesses among both the Medicare and Medicaid populations have placed tremendous demands on the health care system.
 
Driven by escalating costs and a growing recognition of the challenges of chronic care and unnecessary hospitalizations, Medicare reimbursement for healthcare providers is shifting from a volume-based approach (fees paid for each element of service rendered, independent of outcome) to a more value-based model, where reimbursement is based on the value (or quality) of the healthcare service delivered.  This shift has been enabled, in part, by the establishment of standardized quality-focused datasets and the requirement that providers capture and transmit these data to CMS.
 
 
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An increasing percentage of Medicare reimbursement (and, in all likelihood, reimbursement from commercial payers as well) will be at risk for hospitals, based on factors such as patient readmission rates and provider adherence to certain quality-related protocols.  At the same time, many hospitals and other providers are creating new models of care delivery and reimbursement to reduce cost and enable more effective delivery of care.  These new models are based on sharing financial risk and managing the health and behaviors of large populations of patients and consumers.  Certain of these new models are known as accountable care organizations, or ACOs, and medical homes, in which multiple provider organizations are coordinated in providing care and bearing shared financial risk in serving a defined patient population.  This transformation towards population-based health management, value-based purchasing, and an increased engagement of healthcare consumers is resulting in a greater need for providers to deliver more customer-centric healthcare.
 
NRC believes that its current portfolio of solutions is aligned to address this evolving market opportunity.  The Company provides tools and solutions to capture, interpret and improve the data required by CMS as well as enhanced capabilities that capture insights about patient health risks, behaviors and perspectives.  The information and analytics provided through these solutions enable payers and providers to better tailor offerings to the populations they serve.  Meanwhile, the Company’s portfolio of engagement solutions helps providers address and impact the types of behaviors that could result in reduced hospital re-admission rates—resulting in a direct and measurable impact on providers’ revenue.
 
Finally, the Company believes that its ability to offer these insights across the entire care continuum is particularly relevant as new reimbursement models force collaboration amongst different types of providers.  Bundled payments, medical home, ACOs and other models of reimbursement for population-based health management all require an understanding of healthcare both within and outside of the traditional acute care setting.
 
NRC’s Solutions
 
NRC’s portfolio of solutions address specific market needs around growth, retention, engagement and thought leadership for healthcare providers, payers and other healthcare organizations.  While each distinct solution provides discernible value on a stand-alone basis, the Company believes that in combination, its solutions provide a comprehensive view of healthcare consumers both within healthcare settings and outside of those settings—creating a differentiated solution set to address the emerging needs for population-based health management.
 
Growth Solutions - NRC’s growth solutions are subscription-based services that include measurement of community perception (Market Insights), brand tracking (BrandArc) and advertising testing (Advoice).  Market Insights is the largest online U.S. healthcare survey, measuring the opinions and behaviors of 270,000 healthcare consumers in the top 250 metropolitan areas annually.   Market Insights is a syndicated survey that provides clients with an independent third-party source of information that is used to understand consumer preferences and optimize marketing strategies.  BrandArc is a solution that enables clients to measure brand value and build brand equity in their markets.  AdVoice is a solution that helps NRC’s clients evaluate and optimize advertising efficiency and consumer recall.  The Company’s growth solutions have historically been marketed under the Healthcare Market Guide and Ticker brands.
 
Retention Solutions - NRC’s retention solutions include patient and resident experience, physician engagement and employee experience measurement and improvement tools. These solutions enable clients to comply with regulatory requirements and to improve their reimbursement under value-based purchasing models.  Additionally, clients use these applications to positively impact patient experience through utilization of the Company’s prescriptive analytics to enable improvement planning and implementation of best practices.  Finally, with a growing body of research linking employee and physician satisfaction levels to provider quality and patient experience, NRC’s retention solutions also measure satisfaction from those constituents and integrate that data into prescriptive analytics for improvement.
 
 
3

 
 
The Company’s retention solutions are marketed under the NRC Picker, My InnerView (“MIV”), and NRC Picker Canada brands and are provided on a subscription basis via a cross-continuum platform that collects and measures data and then delivers business intelligence that the Company’s clients utilize to improve retention, experience and reimbursement.  NRC provides these performance results and prescriptive analytics to its clients via the Company’s Catalyst improvement planning and business intelligence portal.  In addition, clients have an option of more immediate feedback via the Company’s real-time mobile data collection platform.
 
Engagement Solutions - NRC’s engagement solutions include its health risk assessments (Payer Solutions), patient outreach and discharge call program (Illuminate) and post-acute analytics (Outcome Concept Systems, or OCS).  These solutions enable the Company’s clients to understand the health risks associated with populations of patients, analyze and address readmission risks and efficiently reach out to patients to impact their behaviors outside of the healthcare provider settings.  The Company’s health risk assessment solutions enable its clients to effectively stratify and manage care for those who are most at-risk, engage individuals, increase preventative care and manage wellness programs to improve patient experience and outcomes.  NRC’s patient outreach and discharge call solutions are provided to healthcare organizations on a subscription basis.  These solutions provide real-time, immediate feedback to its clients to enable improvement of patient experience and rate of avoidable readmissions. NRC’s post-acute analytics solutions provide business intelligence for home health and hospice providers that enable the improvement of patient experience, operational performance and clinical outcomes.
 
The key proprietary components of NRC’s engagement solutions include a real-time electronic medical records integration platform; a portfolio of risk assessments for individual patient populations and care settings; and post-acute predictive models and algorithms based on proprietary datasets.
 
Thought Leadership Solutions – NRC’s  thought leadership solutions include national conferences, publications and an on-line portal, and are integrated at various levels into NRC’s growth, retention and engagement solutions.  NRC also offers a specific thought leadership service branded as The Governance Institute (“TGI”). TGI is a membership organization that offers subscription-based governance information solutions and educational conferences designed to improve the effectiveness of hospital and healthcare systems by continually strengthening their boards, medical leadership and management performance.  TGI conducts conferences, produces publications, videos, white papers and research studies, and tracks industry trends showcasing emerging healthcare trends and best practice solutions of healthcare boards across the country.
 
NRC’s Competitive Strengths
 
The Company believes that its competitive strengths include the following:
 
A leading provider of patient experience solutions for healthcare providers, payers and other healthcare organizations. The Company’s history is based capturing the voice of the consumer in healthcare markets.  With survey solutions that span the healthcare continuum, in 2012 the Company was recognized by Modern Healthcare as one of the nation’s largest patient experience survey providers.  Its solutions build on the “Eight Dimensions of Patient-Centered Care,” a philosophy developed by noted patient advocate Harvey Picker, who believed patients’ experiences are integral to quality healthcare. NRC has extended this philosophy to include families, caregivers, employees and other stakeholders.
 
Premier client portfolio across the care continuum. NRC’s client portfolio encompasses leading healthcare organizations across the healthcare continuum, from acute care hospitals and post-acute providers to healthcare payers.  The Company’s client base is diverse, with its top ten clients representing approximately 22% of total revenue for the year ended December 31, 2012 and no single client representing more than 5% of the Company’s revenue.
 
 
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Highly scalable and visible revenue model.  The Company’s solutions are offered to healthcare providers, payers and other healthcare organizations primarily through subscription-based service agreements.  The solutions NRC provides are also recurring in nature, which enables an ongoing relationship with its clients.  This combination of subscription-based revenue, a base of ongoing client renewals and automated platforms creates a highly visible and scalable revenue model for the Company.

Comprehensive portfolio of solutions.  Since NRC offers solutions encompassing growth, retention, engagement and thought leadership, its clients can engage with the Company at multiple levels and, over time, increase their commitment and spend.

Exclusive focus on healthcare. The Company focuses exclusively on healthcare and serving the unique needs of healthcare organizations across the continuum, which NRC believe gives it a distinct competitive advantage compared to other survey and analytics software providers. The Company’s platform includes features and capabilities built specifically for healthcare providers, including a library of performance improvement content which can be tailored to the provider based on their specific customer feedback profile.
 
Experienced senior management team led by NRC’s founder.  NRC’s senior management team has extensive industry and leadership experience.  Michael D. Hays, the Company’s Chairman and Chief Executive Officer, founded NRC in 1981.  Prior to launching the Company, Mike served as Vice President and as a Director of SRI Research Center, Inc. (now known as the Gallup Organization).  The Chief Financial Officer, Kevin Karas, CPA, has extensive financial experience having served as CFO at two previous companies, along with healthcare experience at Rehab Designs of America, Inc. and NovaCare, Inc.  NRC’s President and Chief Operating Officer, Susan Henricks, has extensive leadership experience in high volume data and analytics businesses, having served as President of Financial Institution Services for First Data Corporation, the largest processor of credit card, debit card, and merchant transactions in the U.S. She also served as President for printing and marketing services organizations, in addition to various other leadership positions.
 
 
Competition
 
The healthcare information and market research services industry is highly competitive.  The Company has traditionally competed with healthcare organizations’ internal marketing, market research and/or quality improvement departments which create their own performance measurement tools, and with relatively small specialty research firms which provide survey-based healthcare market research and/or performance assessment.  The Company’s primary competitors among such specialty firms include Press Ganey, which NRC believes has significantly higher annual revenue than the Company, and three or four other firms that NRC believes have less annual revenue than the Company.  The Company, to a certain degree, currently competes with, and anticipates that in the future it may increasingly compete with, (1) traditional market research firms which are significant providers of survey-based, general market research and (2) firms which provide services or products that complement healthcare performance assessments such as healthcare software or information systems.  Although only a few of these competitors have offered specific services that compete directly with the Company’s solutions, many of these competitors have substantially greater financial, information gathering, and marketing resources than the Company and could decide to increase their resource commitments to the Company’s market.  There are relatively few barriers to entry into the Company’s market, and the Company expects increased competition in its market which could adversely affect the Company’s operating results through pricing pressure, increased marketing expenditures, and market share losses, among other factors.  There can be no assurance that the Company will continue to compete successfully against existing or new competitors.
 
 
5

 
 
The Company believes the primary competitive factors within its market include quality of service, timeliness of delivery, unique service capabilities, credibility of provider, industry experience, and price.  NRC believes that its industry leadership position, exclusive focus on the healthcare industry, cross-continuum presence, comprehensive portfolio of solutions and relationships with leading healthcare payers and providers position the Company to compete in this market.
 
Growth Strategy
 
NRC believes that the value proposition of its current solutions, combined with the favorable alignment of its solutions with emerging market demand, positions the Company to benefit from multiple growth opportunities.  The Company believes that it can accelerate its growth through (1) increasing sales of its existing solutions to its existing clients (or  cross-selling), (2) winning additional new clients through market share growth in existing market segments, (3) developing and introducing new solutions to new and existing clients, and (4) pursuing acquisitions of, or investments in, firms providing products, solutions or technologies which complement those of the Company.
 
Selling additional solutions to existing clients.  Less than 20% of the Company’s existing clients purchase more than one of its solutions.  NRC’s sales organization actively identifies and pursues these cross-sell opportunities in order to accelerate the growth of the Company.
 
Adding new clients.  NRC believes that there is an opportunity to add new clients in each of the acute care, post-acute care and health plan market segments.  For example, in the acute care segment, the Company has client relationships with approximately 50% of the facilities in the U.S., leaving half of the market as an available growth opportunity.  The Company’s sales organization is actively identifying and engaging new client prospects in each of the segments noted above, with a focus on featuring its comprehensive cross continuum portfolio of solutions.
 
Adding new solutions.  The need for growth, retention and engagement solutions in the market segments that NRC serves is evolving to align with emerging healthcare regulatory and reimbursement trends.  The evolving market creates an opportunity for the Company to introduce new solutions that leverage its existing core competencies.  The Company believes that there is an opportunity to drive sales growth with both existing and new clients, across all of the market segments that it serves, through the introduction of new solutions.  Two examples of solutions the Company recently developed and introduced are the Care Transition and Point-of-Care offerings that were successfully piloted over the past year.
 
Pursue Strategic Acquisitions.  The Company has historically complemented its organic growth with strategic acquisitions, having completed six such transactions over the past twelve years.  These transactions have added new capabilities and access to market segments that are adjacent and complementary to the Company’s existing solutions and market segments.  NRC believes that additional strategic acquisition opportunities exist for the Company to complement its organic growth by further expanding its service capabilities, technology offerings and end markets.
 
Sales and Marketing
 
The Company generates the majority of its revenue from the renewal of subscription-based client service agreements, supplemented by sales of  other solutions to existing clients and the addition of new clients.  NRC sales activities are carried out by a direct sales organization staffed with professional, trained sales associates.  As compared to the typical industry practice of compensating sales associates with relatively high base pay and a relatively small sales commission, NRC compensates its sales staff with relatively low base pay and a relatively high commission component.  The Company believes this compensation structure provides incentives to its sales associates to surpass sales goals and increases the Company’s ability to attract top-quality sales associates.
 
 
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In addition to prospect leads generated by direct sales associates, the Company’s integrated marketing activities facilitate its ongoing receipt of prospect request-for-proposals.  NRC uses lead generation mechanisms to add generated leads to its database of current and potential client contacts.  The Company also maintains an active public relations program which includes (1) an ongoing presence in leading industry trade press and in the mainstream press, (2) public speaking at strategic industry conferences, (3) fostering relationships with key industry constituencies, and (4) the annual Consumer Choice Award program recognizing top-ranking healthcare organizations.
 
Clients
 
NRC’s clients include many of the nation’s largest healthcare systems.  The Company serves over 2,500 acute care facilities, including over 75% of the Thomson “Top 100 Hospitals.”  It also provides solutions to over 100 payer organizations and 9,500 post-acute facilities.  These clients utilize NRC’s reporting platforms that capture, self-reported customer data from over 15 million unique healthcare episodes annually.
 
The Company’s ten largest clients accounted for 22%, 20%, and 19% of the Company’s total revenue in 2012, 2011 and 2010, respectively.  Approximately 8% of the Company’s revenue was derived from foreign customers in 2012, 2011, and 2010.
 
For financial information by geographic area, see Note 12 to the Company’s consolidated financial statements.
 
Intellectual Property and Other Proprietary Rights
 
The Company’s success depends in part upon its data collection processes, research methods, data analysis techniques and internal systems, and procedures that it has developed specifically to serve clients in the healthcare industry.  The Company has no patents.  Consequently, it relies on a combination of copyright and trade secret laws and associate nondisclosure agreements to protect its systems, survey instruments and procedures.  There can be no assurance that the steps taken by the Company to protect its rights will be adequate to prevent misappropriation of such rights or that third parties will not independently develop functionally equivalent or superior systems or procedures.  The Company believes that its systems and procedures and other proprietary rights do not infringe upon the proprietary rights of third parties.  There can be no assurance, however, that third parties will not assert infringement claims against the Company in the future or that any such claims will not result in protracted and costly litigation, regardless of the merits of such claims or whether the Company is ultimately successful in defending against such claims.
 
Associates
 
As of December 31, 2012, the Company employed a total of 348 persons on a full-time basis.  In addition, as of such date, the Company had 35 part-time associates primarily in its survey operations, representing approximately 18 full-time equivalent associates.  None of the Company’s associates are represented by a collective bargaining unit.  The Company considers its relationship with its associates to be good.
 
Executive Officers of the Company
 
The following table sets forth certain information as of February 1, 2013, regarding the executive officers of the Company:
 
Name
Age
Position
     
Michael D. Hays
58
Chief Executive Officer
     
Susan L. Henricks
62
President and Chief Operating Officer
     
Kevin R. Karas
55
Senior Vice President Finance, Chief Financial Officer, Treasurer and Secretary
 
 
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Michael D. Hays has served as Chief Executive Officer and a director since he founded the Company in 1981.  He also served as President of the Company from 1981 to 2004 and from July 2008 to July 2011.  Prior to founding the Company, Mr. Hays served for seven years as a Vice President and a director of SRI Research Center, Inc. (n/k/a the Gallup Organization).
 
Susan L. Henricks has served as President and Chief Operating Officer of the Company since she joined the Company in July 2011.  From 2008 until joining the Company, she served as Managing Partner and Co-Founder of Arbor Capital, LLC, a private equity firm focused primarily on companies in the marketing and information services, payments technology and business process outsourcing sectors.  Prior to starting Arbor Capital, Ms. Henricks served as President of the Financial Institution Services business of First Data Corporation, the largest processor of credit card, debit card and merchant transactions in the U.S., from 2006 to 2008, President of RRD Direct and then the directories business of RR Donnelley, a global leader in printing and print services, from 2000 to 2006, President of Donnelley Marketing, a direct marketing services company, from 1999 to 2000, and President of First Data Enterprises, the credit card issuing business of First Data Corporation, from 1997 to 1999.  Ms. Henricks also held various leadership positions with Metromail Corporation, a direct marketing services company, from 1985 to 1997, including President and CEO from 1993 to 1997.

Kevin R. Karas has served as Chief Financial Officer, Treasurer and Secretary of the Company since September 2011, and as Senior Vice President Finance since he joined the Company in December 2010.  From 2005 to 2010, he served as Vice President of Finance for Lifetouch Portrait Studios, Inc., a national retail photography company.  Mr. Karas also previously served as Chief Financial Officer at CARSTAR, Inc., an automobile collision repair franchise business, from 2000 to 2005, Chief Financial Officer at Rehab Designs of America, Inc., a provider of orthotic and prosthetic services, from 1993 to 2000, and as a regional Vice President of Finance and Vice President of Operations at Novacare, Inc., a provider of physical rehabilitation services, from 1988 to 1993.  He began his career as a Certified Public Accountant at Ernst & Young.

Executive officers of the Company are elected by and serve at the discretion of the Company’s Board of Directors.  There are no family relationships between any directors or executive officers of NRC.
 
Available Information
 
More information regarding NRC is available on the Company's website at www.nationalresearch.com.  NRC is not including the information contained on or available through its website as part of, or incorporating such information by reference into, this Annual Report on Form 10-K.  The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports are made available to the public at no charge through a link appearing on the Company's website.  NRC provides access to such materials through its website as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the Securities and Exchange Commission.  Reports and amendments posted on the Company’s website do not include access to exhibits and supplemental schedules electronically filed with the reports or amendments.

 
Item 1A.         Risk Factors
 
You should carefully consider each of the risks described below, together with all of the other information contained in this Annual Report on Form 10-K, before making an investment decision with respect to our securities.  If any of the following risks develop into actual events, our business, financial condition or results of operations could be materially and adversely affected and you may lose all or part of your investment.
 
 
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We depend on contract renewals for a large share of our revenue and our operating results could be adversely affected.
 
We expect that a substantial portion of our revenue for the foreseeable future will continue to be derived from renewable service contracts.  Substantially all contracts are renewable annually at the option of our clients, although a client generally has no minimum purchase commitment under a contract and the contracts are generally cancelable on short or no notice without penalty.  To the extent that clients fail to renew or defer their renewals, we anticipate our results may be materially adversely affected.  Our ability to secure renewals depends on, among other things, our ability to gather and analyze performance data in a consistent, high-quality, and timely fashion.  In addition, the service needs of our clients are affected by accreditation requirements, enrollment in managed care plans, the level of use of satisfaction measures in healthcare organizations’ overall management and compensation programs, the size of operating budgets, clients’ operating performance, industry and economic conditions, and changes in management or ownership.  As these factors are beyond our control, we cannot ensure that we will be able to maintain our renewal rates.  Any material decline in renewal rates from existing levels would have an adverse effect on our revenue and a corresponding effect on our operating and net income.
 
Our operating results may fluctuate and this may cause our stock price to decline.
 
Our overall operating results may fluctuate as a result of a variety of factors, including the size and timing of orders from clients, client demand for our services (which, in turn, is affected by factors such as accreditation requirements, enrollment in managed care plans, operating budgets and clients’ operating performance), the hiring and training of additional staff, expense increases, and industry and general economic conditions.  Because a significant portion of our overhead is fixed in the short-term, particularly some costs associated with owning and occupying our building and full-time personnel expenses, our results of operations may be materially adversely affected in any particular period if revenue falls below our expectations.  These factors, among others, make it possible that in some future period our operating results may be below the expectations of securities analysts and investors which would have a material adverse effect on the market price of our common stock.
 
We operate in a highly competitive market and could experience increased price pressure and expenses as a result.
 
The healthcare information and market research services industry is highly competitive.  We have traditionally competed with healthcare organizations’ internal marketing, market research and/or quality improvement departments that create their own performance measurement tools, and with relatively small specialty research firms that provide survey-based healthcare market research and/or performance assessment.  The Company’s primary competitors among such specialty firms include Press Ganey, which we believe has significantly higher annual revenue than us, and three or four other firms that we believe have lower annual revenue than us.  To a certain degree, we currently compete with, and anticipate that in the future we may increasingly compete with, (1) traditional market research firms which are significant providers of survey-based, general market research, and (2) firms which provide services or products that complement healthcare performance assessments, such as healthcare software or information systems.  Although only a few of these competitors have offered specific services that compete directly with our services, many of these competitors have substantially greater financial, information gathering, and marketing resources than the Company and could decide to increase their resource commitments to our market.  There are relatively few barriers to entry into the Company’s market, and we expect increased competition in our market which could adversely affect our operating results through pricing pressure, increased marketing expenditures, and market share losses, among other factors.  There can be no assurance that the Company will continue to compete successfully against existing or new competitors.
 
 
9

 
 
Because our clients are concentrated in the healthcare industry, our revenue and operating results may be adversely affected by changes in regulations, a business downturn or consolidation with respect to the healthcare industry.
 
Substantially all of our revenue is derived from clients in the healthcare industry.  As a result, our business, financial condition and results of operations are influenced by conditions affecting this industry, including changing political, economic, competitive and regulatory influences that may affect the procurement practices and operation of healthcare providers and payers.  The 2010 Federal comprehensive healthcare reform plan, which includes provisions to control healthcare costs, improve healthcare quality and expand access to affordable health insurance,  could result in lower reimbursement rates and otherwise change the environment in which providers and payers operate.  In addition, large private purchasers of healthcare services are placing increasing cost pressure on providers.  Healthcare providers may react to these cost pressures and other uncertainties by curtailing or deferring purchases, including purchases of our services.  Moreover, there has been consolidation of companies in the healthcare industry, a trend which we believe will continue to grow.  Consolidation in this industry, including the potential acquisition of certain of our clients, could adversely affect aggregate client budgets for our services or could result in the termination of a client’s relationship with us.  The impact of these developments on the healthcare industry is difficult to predict and could have an adverse effect on our revenue and a corresponding effect on our operating and net income.
 
In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.  The legislation makes extensive changes to the current system of healthcare insurance and benefits that will include changes in Medicare and Medicaid payment policies and other healthcare delivery reforms aimed at improving quality and decreasing costs, comparative effectiveness research, and independent payment advisory boards, among other provisions.  These provisions could negatively impact our health care clients and could impact the services we provide our clients, the demand for the services we provide and the Company’s business.  At this time, it is difficult to estimate the impact of this legislation on the Company but there can be no assurances that health care reform will not adversely impact either our operating results or the manner in which we operate our business.
 
We rely on a limited number of key clients and a loss of one or more of these key clients will adversely affect our operating results.
 
We rely on a limited number of key clients for a substantial portion of our revenue.  The Company’s ten largest clients accounted for 22%, 20%, and 19% of the Company’s total revenue in 2012, 2011, and 2010, respectively.
 
We cannot assure you that we will maintain our existing client base, maintain or increase the level of revenue or profits generated by our existing clients, or be able to attract new clients.  Furthermore, the healthcare industry continues to undergo consolidation and we cannot assure you that such consolidation will not cause us to lose clients.  The loss of one or more of our large clients or a significant reduction in business from such clients, regardless of the reason, may have a negative effect on our revenue and a corresponding effect on our operating and net income.  See “Risk Factors Because our clients are concentrated in the healthcare industry, our revenue and operating results may be adversely affected by changes in regulations, a business downturn or consolidation with respect to the healthcare industry.”
 
 
10

 
 
We face several risks relating to our ability to collect the data on which our business relies.
 
Our ability to provide timely and accurate performance measurement and improvement services to our clients depends on our ability to collect large quantities of high-quality data through surveys and interviews.  If receptivity to our survey and interview methods by respondents declines, or, for some other reason, their willingness to complete and return surveys declines, or if we, for any reason, cannot rely on the integrity of the data we receive, then our revenue could be adversely affected with a corresponding effect on our operating and net income.  We also rely on third-party panels of pre-recruited consumer households to produce Ticker in a timely manner.  If we are not able to continue to use these panels, or the time period in which we use these panels is altered and we cannot find alternative panels on a timely, cost-competitive basis, we could face an increase in our costs or an inability to effectively produce Ticker.  In either case, our operating and net income could be negatively affected.
 
Our principal shareholder effectively controls our company.
 
Michael D. Hays, our Chief Executive Officer, beneficially owned approximately 58% of our outstanding common stock as of February 20, 2013.  As a result, Mr. Hays can control matters requiring shareholder approval, including the election of directors and the approval of significant corporate matters such as change of control transactions.  The effects of such influence could be to delay or prevent a change of control of our company unless the terms are approved by Mr. Hays.
 
Our business and operating results could be adversely affected if we are unable to attract or retain key managers and other personnel.
 
Our future performance may depend, to a significant extent, upon the efforts and ability of our key personnel who have expertise in gathering, interpreting and marketing survey-based performance information for healthcare markets.  Although client relationships are managed at many levels within our company, the loss of the services of Michael D. Hays, our Chief Executive Officer, or one or more of our other senior managers, could have a material adverse effect, at least in the short to medium term, on most significant aspects of our business, including strategic planning, product development, and sales and customer relations.  As of December 31, 2012, we maintained $500,000 of key officer life insurance on Mr. Hays.  Our success will also depend on our ability to hire, train and retain skilled personnel in all areas of our business.  Currently, we do not have employment agreements with our officers or our other key personnel.  Competition for qualified personnel in our industry is intense, and many of the companies that compete with us for qualified personnel have substantially greater financial and other resources than us.  Furthermore, we expect competition for qualified personnel to become more intense as competition in our industry increases.  We cannot assure you that we will be able to recruit, retain and motivate a sufficient number of qualified personnel to compete successfully.
 
If intellectual property and other proprietary information technology were copied or independently developed by our competitors, our operating results could be negatively affected.
 
Our success depends in part upon our data collection process, research methods, data analysis techniques, and internal systems and procedures that we have developed specifically to serve clients in the healthcare industry.  We have no patents.  Consequently, we rely on a combination of copyright, trade secret laws and associate nondisclosure agreements to protect our systems, survey instruments and procedures.  We cannot assure you that the steps we have taken to protect our rights will be adequate to prevent misappropriation of such rights, or that third parties will not independently develop functionally equivalent or superior systems or procedures.  We believe that our systems and procedures and other proprietary rights do not infringe upon the proprietary rights of third parties.  We cannot assure you, however, that third parties will not assert infringement claims against us in the future, or that any such claims will not result in protracted and costly litigation, regardless of the merits of such claims, or whether we are ultimately successful in defending against such claims.
 
 
11

 
 
Our business and operating results could be adversely affected if we experience business interruptions or failure of our information technology and communication systems.
 
Our ability to provide timely and accurate performance measurement and improvement services to our clients depends on the efficient and uninterrupted operation of our information technology and communication systems, and those of our external service providers.  Our systems and those of our external service providers, could be exposed to damage or interruption from fire, natural disasters, energy loss, telecommunication failure, security breach and computer viruses.  An operational failure or outage in our information technology and communication systems or those of our external service providers, could result in loss of customers, damage to customer relationships, reduced revenue and profits, refunds of customer charges and damage our reputation and may result in additional expense to repair or replace damaged equipment and recover data loss resulting from the interruption.  Although we have taken steps to prevent system failures and have back-up systems and procedures to prevent or reduce disruptions, such steps may not prevent an interruption of services and our disaster recovery planning may not account for all contingencies.  Additionally, our insurance may not adequately compensate us for all losses or failures that may occur.  Any one of the above situations could have a material adverse effect on our business, financial condition, results of operations and reputation.
 
Security breaches or computer viruses could harm our business.
 
In connection with our client services, we receive, process, store and transmit sensitive business information electronically over the Internet.  Computer viruses could spread throughout our systems and disrupt operations and service delivery.  Unauthorized access to our computer systems or databases could result in the theft or publication of confidential information or the deletion or modification of records or could otherwise cause interruption in our operations.  We cannot be certain that the technology protecting our networks and information will successfully prevent computer viruses, data thefts, release of confidential information or security breaches.  A compromise in our data security systems that results in inappropriate disclosure of our associates', customers' or vendors' confidential information, could harm our reputation and expose us to regulatory action and claims.  Changes in privacy and information security laws and standards may require we incur significant expense to ensure compliance due to increased technology investment and operational procedures.  An inability to prevent security breaches or computer viruses or failure to comply with privacy and information security laws could result in litigation and regulatory risk, loss of customers, damage to customer relationships, reduced revenue and profits, refunds of customer charges and damage our reputation, which could adversely affect our business, financial condition, results of operations and reputation.
 
Our growth strategy includes future acquisitions which involve inherent risk.
 
In order to expand services or technologies to existing clients and increase our client base, we may make strategic business acquisitions that we believe complement our business.  Acquisitions have inherent risks which may have a material adverse effect on our business, financial condition, or results of operations, including, among other things:  (1) failure to successfully integrate the purchased operations, technologies, products or services and maintain uniform standard controls, policies and procedures; (2) substantial unanticipated integration costs; (3) loss of key associates including those of the acquired business; (4) diversion of management’s attention from other operations; (5) failure to retain the customers of the acquired business; (6) failure to achieve any projected synergies and performance targets; (7) additional debt and/or assumption of known or unknown liabilities; (8) dilutive issuances of equity securities; and (9) a write-off of goodwill, software development costs, client lists, other intangibles and amortization of expenses.  If we fail to successfully complete acquisitions or integrate acquired businesses, we may not achieve projected results and there may be a material adverse effect on our business, financial condition and results of operations.
 
 
12

 

Item 1B.          Unresolved Staff Comments
 
The Company has no unresolved staff comments to report pursuant to this item.
 
Item 2.             Properties
 
The Company’s headquarters is located in an owned office building in Lincoln, Nebraska, of which 62,000 square feet are used for the Company’s operations.  This facility houses all the capabilities necessary for NRC’s survey programming, printing and distribution, data processing, analysis and report generation, marketing, and corporate administration.  The Company’s term notes are secured by this property, among other things.
 
The Company is leasing 2,600 square feet of office space in Markham, Ontario, 5,100 square feet of office space in San Diego, California and 8,100 square feet of office space in Seattle, Washington.
 
Item 3.             Legal Proceedings
 
The Company is not subject to any material pending litigation.
 
Item 4.             Mine Safety Disclosures
 
Not applicable.
 
 
13

 
 
PART II
 
Item 5.            Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
The Company’s Common Stock, $0.001 par value (“Common Stock”), is traded on the NASDAQ Global Market under the symbol “NRCI.”  The following table sets forth the range of high and low sales prices for, and dividends declared on, the Common Stock for the period from January 1, 2011, through
December 31, 2012:
 
   
High
   
Low
   
Dividends Declared Per Common Share
 
2011 Quarter Ended:
                 
March 31
  $ 34.25     $ 29.01     $ 0.22  
June 30
  $ 36.89     $ 33.63     $ 0.22  
September 30
  $ 44.44     $ 30.96     $ 0.22  
December 31
  $ 38.96     $ 28.00     $ 0.22  
                         
2012 Quarter Ended:
                       
March 31
  $ 43.98     $ 36.58     $ 0.26  
June 30
  $ 53.00     $ 41.00     $ 0.26  
September 30
  $ 52.71     $ 46.19     $ 0.26  
December 31
  $ 58.23     $ 49.51     $ 1.76  
 
Cash dividends of $17.4 million and $5.9 million in the aggregate were declared and paid during the twelve-month periods ended December 31, 2012 and 2011, respectively.  The payment and amount of future dividends is at the discretion of the Company’s Board of Directors and will depend on the Company’s future earnings, financial condition, general business conditions and other factors.
 
On February 20, 2013, there were approximately 17 shareholders of record and approximately 1,200 beneficial owners of the Common Stock.
 
In February 2006, the Board of Directors of the Company authorized the repurchase of 750,000 shares of common stock in the open market or in privately negotiated transactions.  As of February 20, 2013, 610,417 shares have been purchased under this authorization.
 
The table below summarizes stock repurchases during the three-month period ended December 31, 2012.

Period
 
Total Number of Shares Purchased
   
Average Price
Paid per Share
   
Total Number of Shares Purchased as Part of Publicly Announced
Plans or Programs
   
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
 
                         
October 1 – October 31, 2012
    28,194     $ 50.32       28,194       162,668  
November 1 – November 30, 2012
    --       --       --       162,668  
December 1 – December 31, 2012
    19,270     $ 53.88       19,270       143,398  

 
14

 

The following graph compares the cumulative 5-year total return provided shareholders on National Research Corporation's common stock relative to the cumulative total returns of the NASDAQ Composite Index and the Russell 2000 Index.  An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock and in each of the indexes on December 31, 2007, and its relative performance is tracked through December 31, 2012.
 
 
 
 

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN DATA
The stock price performance included in this graph is not necessarily indicative of future stock price performance.
 
      12/07       12/08       12/09       12/10       12/11       12/12  
                                                 
                                                 
National Research Corporation
    100.00       109.39       80.36       136.99       159.37       234.23  
NASDAQ Composite
    100.00       59.03       82.25       97.32       98.63       110.78  
Russell 2000
    100.00       66.21       84.20       106.82       102.36       119.09  

 
15

 

Item 6.            Selected Financial Data
 
The selected statement of income data for the years ended December 31, 2012, 2011, and 2010, and the selected balance sheet data at December 31, 2012, and 2011, are derived from, and are qualified by reference to, the audited consolidated financial statements of the Company included elsewhere in this Annual Report on Form 10-K.  The selected statement of income data for the years ended December 31, 2009, and 2008, and the balance sheet data at December 31, 2010, 2009, and 2008, are derived from audited consolidated financial statements not included herein.  The Company acquired OCS on August 3, 2010, MIV on December 19, 2009, and customer contracts of SQ Strategies on April 1, 2008.  See Note 2 to the Company's consolidated financial statements.
 
   
Year Ended December 31,
   
2012
   
2011
   
2010
   
2009
   
2008
   
(In thousands, except per share data)
Statement of Income Data:
                       
Revenue
  $ 86,421     $ 75,767     $ 63,398     $ 57,692     $ 51,013  
Operating expenses:
                                       
Direct
    35,461       28,667       24,635       24,148       23,611  
Selling, general and administrative
    23,542       23,300       20,202       16,016       12,728  
Depreciation and amortization
    4,699       5,065       4,704       3,831       2,685  
Total operating expenses
    63,702       57,032       49,541       43,995       39,024  
Operating income
    22,719       18,735       13,857       13,697       11,989  
Other expense
    (512 )     (575 )     (542 )     (580 )     (6 )
Income before income taxes
    22,207       18,160       13,315       13,117       11,983  
Provision for income taxes
    7,139       6,596       4,816       4,626       4,538  
Net income
  $ 15,068     $ 11,564     $ 8,499     $ 8,491     $ 7,445  
                                         
Net income per share - basic
  $ 2.22     $ 1.73     $ 1.28     $ 1.28     $ 1.11  
Net income per share - diluted
  $ 2.17     $ 1.69     $ 1.26     $ 1.26     $ 1.09  
Dividends per share
  $ 2.54     $ 0.88     $ 0.76     $ 0.64     $ 0.56  
Weighted average shares outstanding – basic
    6,775       6,672       6,637       6,637       6,685  
Weighted average shares outstanding – diluted
    6,951       6,842       6,735       6,723       6,831  
 
 
 
 
December 31,
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
   
(In thousands)
 
Balance Sheet Data:
                             
Working capital deficiency
  $ (11,483 )   $ (2,262 )   $ (8,809 )   $ (4,432 )   $ (10,650 )
Total assets
    100,046       100,676       95,770       72,499       72,145  
Total debt and capital lease obligations, including current portion
    12,763       14,912       16,599       7,719       12,954  
Total shareholders’ equity
  $ 56,742     $ 55,554     $ 48,584     $ 44,171     $ 38,598  

 
16

 
 
Item 7.            Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
 
The Company is a leading provider of analytics and insights that facilitate revenue growth, patient, employee and customer retention and patient engagement for healthcare providers, payers and other healthcare organizations.  The Company’s solutions support the improvement of business and clinical outcomes, while facilitating regulatory compliance and the shift to population-based health management for its clients.  The Company’s ability to 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 will become even more valuable in the future 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, and physician engagement.  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 a more collaborative and interactive healthcare system.
 
Acquisitions
 
On August 3, 2010, the Company acquired all of the issued and outstanding shares of stock and stock rights of OCS, a provider of clinical, financial and operational benchmarks and analytics to home care and hospice providers.  The acquisition provides the Company with an entry in the home health and hospice markets through OCS’s customer relationships with home healthcare and hospice providers and expands the Company's service offerings across the continuum of care.  Goodwill related to the acquisition of OCS primarily relates to intangible assets that do not qualify for separate recognition, including the depth and knowledge of management.  The all-cash consideration paid at closing was $15.3 million, net of $1.0 million cash received.
 
Critical Accounting Policies and Estimates
 
The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein.  The most significant of these areas involving difficult or complex judgments made by management with respect to the preparation of the Company’s consolidated financial statements for fiscal year 2012 include:
 
 
Revenue recognition;
 
 
Valuation of goodwill and identifiable intangible assets; and
 
 
Income taxes.
 
 
17

 
 
Revenue Recognition
 
The Company derives a majority of its operating revenue from its annually renewable services, which include performance measurement and improvement services, healthcare analytics and governance education services.  The Company provides these services to its clients under annual client service contracts, although such contracts are generally cancelable on short or no notice without penalty.  The Company also derives some revenue from its custom and other research projects.
 
Services are provided under subscription-based service agreements.  The Company recognizes subscription-based service revenue over the period of time the service is provided.  Generally, the subscription periods are for twelve months and revenue is recognized equally over the subscription period.
 
Certain contracts are fixed-fee arrangements with a portion of the project fee billed in advance and the remainder billed periodically over the duration of the project.  Revenue and direct expenses for services provided under these contracts are recognized under the proportional performance method.  Under the proportional performance method, the Company recognizes revenue based on output measures or key milestones such as survey set-up, survey mailings, survey returns and reporting.  The Company measures its progress based on the level of completion of these output measures and recognizes revenue accordingly.  Management judgments and estimates must be made and used in connection with revenue recognized using the proportional performance method.  If management made different judgments and estimates, then the amount and timing of revenue for any period could differ materially from the reported revenue.
 
The Company also derives revenue from hosting arrangements where our propriety software is offered as a service to our customers through our data processing facilities.  The Company’s revenue also includes software-related revenue for software license revenue, installation services, post-contract support (maintenance) and training.  Software-related revenue is recognized in accordance with the provisions of Accounting Standards Codification (“ASC”) 985-605, Software-Revenue Recognition.
 
Hosting arrangements to provide customers with access to the Company’s propriety software are marketed under long-term arrangements, generally over periods of one to three years.  Under these arrangements, the customer is not provided the contractual right to take possession of the licensed software at any time during the hosting period without significant penalty, and the customer is not provided the right to run the software on their own hardware or contract with another party unrelated to us to host the software.  Upfront fees for set-up services are typically billed for our hosting arrangements.  However, these arrangements do not qualify for separation from the ongoing hosting services due to the absence of standalone value for the set-up services.  Therefore, we account for these arrangements as service contracts and recognize revenue ratably over the hosting service period when all other conditions to revenue are met.  Other conditions that must be met before the commencement of revenue recognition include achieving evidence of an arrangement, determining that the collection of the revenue is probable, and determining that fees are fixed and determinable.
 
The Company’s software arrangements typically involve the sale of a time-based license bundled with installation services, post-contract support (“PCS”) and training.  License terms range from one year to three years and require an annual fee for bundled elements of the arrangement.  PCS is also contractually provided for a period that is co-terminus with the term of the time-based license.  The Company’s installation services are not considered to be essential to the functionality of the software license.  The Company does not achieve vendor-specific objective evidence (“VSOE”) of the fair value of the undelivered elements of its software arrangements (primarily PCS) and, therefore, these arrangements are accounted for as a single unit of accounting with revenue recognized ratably over the minimum bundled PCS period.
 
 
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The Company’s revenue arrangements (not involving software elements) may include multiple elements.   In assessing the separation of revenue for elements of such arrangements, we first determine whether each delivered element has standalone value based on whether we or other vendors sell the services separately.   We also consider whether there is sufficient evidence of the fair value of the elements in allocating the fees in the arrangement to each element.  Revenue allocated to an element is limited to revenue that is not subject to refund or otherwise represents contingent revenue.
 
On January 1, 2011, the Company prospectively adopted Accounting Standard Update (“ASU”) 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (ASU 2009-13).  For arrangements entered into or materially modified beginning January 1, 2011, we allocated revenue to arrangements with multiple elements based on relative selling price using a selling price hierarchy.  The selling price for a deliverable is based on its VSOE if it exists, otherwise third-party evidence of selling price.  If neither exists for a deliverable, the best estimate of the selling price is used for that deliverable based on list price, representing a component of management’s market strategy, and an analysis of historical prices for bundled and standalone arrangements.

Valuation of Goodwill and Identifiable Intangible Assets
 
Intangible assets include customer relationships, trade names, non-compete agreements and goodwill.  Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.  The Company reviews intangible assets with indefinite lives for impairment annually as of October 1 and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.
 
When performing the impairment assessment, the Company first assesses qualitative factors to determine whether it is necessary to recalculate the fair value of our intangible assets with indefinite lives.  If the Company believes, as a result of the qualitative assessment, that it is more likely than not that the fair value of the indefinite-lived intangibles is less than their carrying amount, the Company calculates the fair value using a market approach.  If the carrying value of an intangible asset with an indefinite life exceeds its fair value, then the intangible asset is written-down to their fair values.  The Company did not recognize any impairments related to our long-lived assets during 2012, 2011, or 2010.
 
Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.  All of the Company’s goodwill is allocated to its reporting units, which are the same as its operating segments.  Goodwill is reviewed for impairment at least annually as of October 1 and whenever events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable.
 
The Company reviews for goodwill impairment by first assessing qualitative factors to determine whether any impairment may exist.  If we believe, as a result of the qualitative assessment that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative two-step test is required; otherwise, no further testing is required.  Under the first step of the quantitative test, the fair value of the reporting unit is compared with its carrying value (including goodwill).  If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed.  If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the entity must perform step two of the impairment test (measurement).  Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the fair value of that goodwill.  The fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the fair value of the reporting unit goodwill.
 
 
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In instances when a step two is required, the fair value of the reporting unit is determined using an income approach and comparable market multiples.  Under the income approach, there are a number of inputs used to calculate the fair value using a discounted cash flow model, including operating results, business plans, projected cash flows and a discount rate.  Discount rates, growth rates and cash flow projections are the most sensitive and susceptible to change as they require significant management judgment.  Discount rates are determined by using a weighted average cost of capital, which considers market and industry data.  Operational management develops growth rates and cash flow projections for each reporting unit considering industry and Company-specific historical and projected information.  Terminal value rate determination follows common methodology of capturing the present value of perpetual cash flow estimates beyond the last projected period assuming a constant weighted average cost of capital and low long-term growth rates.  Under the market approach, the Company considers its market capitalization, comparisons to other public companies’ data, and recent transactions of similar businesses within the Company’s industry.
 
No impairments were recorded during the years ended December 31, 2012, 2011 or 2010.  The most recent quantitative analysis was performed as of October 1, 2011.  That analysis indicated that the fair value of our reporting units, including goodwill, was significantly in excess of their carrying values.  The Company performed a qualitative analysis as of October 1, 2012, which did not indicate that it was more likely than not that the carrying values of the reporting units exceeded fair value.
 
Income Taxes
 
The Company uses the asset and liability method of accounting for income taxes.  Under that method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases using enacted tax rates.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  Valuation allowances, if any, are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized.  The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained.  Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized.  Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.  Management judgment is required to determine the provision for income taxes and to determine whether deferred income taxes will be realized in full or in part.  Such judgments include, but are not limited to, the likelihood we would realize the benefits of net operating loss carryforwards, the adequacy of valuation allowances, the election to capitalize or expense costs incurred, and the probability of outcomes of uncertain tax positions.  It is possible that the various taxing authorities could challenge those judgments or positions and reach conclusions that would cause us to incur tax liabilities in excess of, or realize benefits less than, those currently recorded.  In addition, changes in the geographical mix or estimated amount of annual pretax income could impact our overall effective tax rate.
 
Results of Operations
 
The following table sets forth, for the periods indicated, selected financial information derived from the Company’s consolidated financial statements, expressed as a percentage of total revenue and the percentage change in such items versus the prior comparable period (please note that all columns may not add up to 100% due to rounding).  The trends illustrated in the following table may not necessarily be indicative of future results.  The discussion that follows the table should be read in conjunction with the Company’s consolidated financial statements.
 
 
20

 
 
   
Percentage of Total Revenue
Year Ended December 31,
   
Percentage
Increase (Decrease)
 
   
2012
   
2011
   
2010
   
2012 over 2011
   
2011 over 2010
 
                               
Revenue
    100.0 %     100.0 %     100.0 %     14.1 %     19.5 %
Operating expenses:
                                       
Direct
    41.0       37.8       38.8       23.7       16.4  
Selling, general and administrative
    27.2       30.8       31.9       1.0       15.3  
Depreciation and amortization
    5.4       6.7       7.4       (7.2 )     7.7  
Total operating expenses
    73.7       75.3       78.1       11.7       15.1  
Operating income
    26.3 %     24.7 %     21.9 %     21.3 %     35.2 %

Year Ended December 31, 2012, Compared to Year Ended December 31, 2011
 
Revenue.  Revenue increased 14.1% in 2012 to $86.4 million from $75.8 million in 2011.  The increase was due to market share growth and vertical growth in the existing client base.  Revenue from subscription-based agreements comprised 76.0% of the total revenue for the year ended December 31, 2012 compared to 63.0% of the total revenue for the year ended December 31, 2011.

Direct expenses.  Direct expenses increased 23.7% to $35.5 million in 2012 from $28.7 million in 2011.  Direct variable expenses are costs that vary with volumes and consist mainly of printing, postage, hourly labor, and contracted survey work.  Direct fixed expenses consist mainly of salaries and benefits, and contracted services for client service, analytical, research, and information technology development functions.  The increase in variable expenses of $4.1 million included increased postage, labor costs, contracted survey-related costs to service the higher volume of business and conference-related expenses.  The increase in fixed expenses of $2.7 million was due to additional staffing and related expenses in information technology development and client service functions.  Direct expenses increased as a percentage of revenue to 41.0% in the year ended December 31, 2012, from 37.8% during the same period of 2011.  Variable expenses as percentage of revenue were 2.2% of the change due to higher survey volumes for the subscription-based products, and fixed expenses were 1.0% of the change due to investments in technology, research and service resources.  The Company expects this percentage to continue at a similar rate for 2013.

Selling, general and administrative expenses.  Selling, general and administrative expenses increased 1.0% to $23.5 million in 2012 from $23.3 million in 2011. Selling, general, and administrative expenses decreased as a percentage of revenue to 27.2% for the year ended December 31, 2012, from 30.8% for the same period in 2011 due to the leveraging of selling, general and administrative expenses against increased revenue.  This percentage is projected to continue at a similar rate in 2013.

Depreciation and amortization.  Depreciation and amortization expenses decreased 7.2% to $4.7 million in 2012 from $5.1 million in 2011. This decrease was attributed to declining intangible asset amortization expenses. Depreciation and amortization expenses as a percentage of revenue decreased to 5.4% in 2012 from 6.7% in 2011.  The Company projects depreciation expense in 2013 to approximate 4.0% of revenue.
 
Provision for income taxes.  The provision for income taxes totaled $7.1 million (32.1% effective tax rate) for 2012, compared to $6.6 million (36.3% effective tax rate) for 2011.  The effective tax rate for the year ended December 31, 2012, is lower than the rate in the same period of 2011 primarily due to an adjustment to income taxes of $661,000 for decreases in deferred state tax rates resulting from legislative changes.  The Company also recorded federal tax credits of $198,000, and recognized an additional $73,000 in tax benefits over the same period in 2011 due to the expiration of the U.S. federal statute of limitations associated with certain tax positions.
 
 
21

 

Year Ended December 31, 2011, Compared to Year Ended December 31, 2010
 
Revenue.  Revenue increased 19.5% in 2011 to $75.8 million from $63.4 million in 2010.  This increase was due to the addition of OCS (increasing revenue by $4.5 million), market share growth, increased pricing from enhanced offerings, and vertical growth in the existing client base from successful cross-selling activities.

Direct expenses.  Direct expenses increased 16.4% to $28.7 million in 2011 from $24.6 million in 2010.  Direct variable expenses are costs that vary with volumes and consist mainly of printing, postage, hourly labor, and contracted survey work.  Direct fixed expenses consist mainly of salaries and benefits and contracted services for client service, analytical, research, and information technology development functions.  The primary reason for the increase in direct expenses was due to an increase in variable expenses of $2.4 million, including postage of $1.1 million and contracted survey related costs of $1.1 million to service the higher volume of business, and an increase in fixed expenses of $675,000 from additional staffing and related expenses in information technology development and client service functions.  The addition of OCS also increased variable expenses by $106,000 and fixed expenses by $809,000.  Direct expenses decreased as a percentage of revenue to 37.8% in 2011 from 38.8% during 2010, mainly due to leveraging revenue growth and expanded use of more cost-efficient survey methodologies.

Selling, general and administrative expenses.  Selling, general and administrative expenses increased $3.1 million or 15.3%, to $23.3 million in 2011 from $20.2 million in 2010.  Of the increase, $2.0 million was primarily due to the expansion of the sales force, increased sales commissions, and the addition of several executives in various leadership roles.  The addition of OCS accounted for the remaining $1.1 million of the increase.  Selling, general, and administrative expenses decreased as a percentage of revenue to 30.8% for 2011 from 31.9% for 2010, primarily due to 2011 sales and revenue growth from the sales expansion in 2010, decreases in acquisition and transition-related expenses for OCS and the consolidation of MIV sales and operations activities into the Lincoln location incurred in 2010 compared to 2011.
 
Depreciation and amortization.  Depreciation and amortization expenses increased 7.7% to $5.1 million in 2011 from $4.7 million in 2010, primarily due to the addition of OCS in 2010.  Depreciation and amortization expenses as a percentage of revenue decreased to 6.7% in 2011 from 7.4% in 2010.

Provision for income taxes.  The provision for income taxes totaled $6.6 million (36.3% effective tax rate) for 2011 compared to $4.8 million (36.2% effective tax rate) for 2010.  The increase in the effective tax rate was due to higher state taxes, partially offset by increased research and development credits and a decrease in unrecognized tax benefits.

Inflation and Changing Prices
 
Inflation and changing prices have not had a material impact on revenue or net income in the last three years.
 
Liquidity and Capital Resources
 
As of December 31, 2012, our principal sources of liquidity included $8.3 million of cash and cash equivalents and up to $6.5 million of unused borrowings under our revolving credit note.  Of this cash, $5.6 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, 2012, that an additional tax liability of $732,000 would become due if repatriation of undistributed earnings would occur.  The amount of unused borrowings actually available under the revolving credit note varies in accordance with the terms of the agreement.  The Company believes that our existing sources of liquidity, including cash and cash equivalents, borrowing availability, and operating cash flow will be sufficient to meet its projected capital and debt maturity needs and dividend policy for the foreseeable future.
 
 
22

 
 
Working Capital
 
The Company had a working capital deficiency of $11.5 million on December 31, 2012, compared to a $2.3 million working capital deficiency on December 31, 2011.  The change in the working capital balance was primarily due to an increase in the current portion of notes payable of $10.6 million.  The increase in the current portion of notes payable is due to the balloon payments on the term notes due in July 2013.  The Company’s working capital is also significantly impacted by its large deferred revenue balances.  The deferred revenue balances as of December 31, 2012 and December 31, 2011, were $15.8 million and $16.5 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 performance tracking services and custom research projects before they have been completed.  Billed amounts are recorded as billings in excess of revenue earned, or deferred revenue, on the Company’s 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 the respective period ends.
 
Cash Flow Analysis
 
A summary of operating, investing, and financing activities are shown in the following table:
 
   
For the Year Ended December 31,
 
   
2012
   
2011
   
2010
 
   
(In thousands)
 
Provided by operating activities
  $ 19,132     $ 18,481     $ 14,603  
                         
Used in investing activities
    (2,348 )     (6,927 )     (16,980 )
                         
(Used in) provided by financing activities
    (16,687 )     (6,886 )     3,254  
                         
Effect of exchange rate changes on cash
    107       (105 )     130  
                         
Net increase in cash and cash equivalents
    204       4,563       1,007  
                         
Cash and cash equivalents at end of period
  $ 8,286     $ 8,082     $ 3,519  

Cash Flows from Operating Activities
 
Cash flows from operating activities consist of net income adjusted for non-cash items including depreciation and amortization, deferred taxes, and the effect of working capital changes.
 
Net cash provided by operating activities was $19.1 million for the year ended December 31, 2012, which included net income of $15.1 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, tax benefit from exercise of stock options, and non-cash stock compensation totaling $5.3 million.  Changes in working capital decreased 2012 cash flows from operating activities by $1.2 million, primarily due to timing of initial billings on new or renewal contracts decreasing cash flows provided from trade accounts receivable and deferred revenue and timing of payments on accounts payable and prepaid expenses, partially offset by increases and timing in payments of accrued expenses, wages, and bonus and profit sharing.
 
 
23

 
 
Net cash provided by operating activities was $18.5 million for the year ended December 31, 2011, which included net income of $11.6 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, tax benefit from exercise of stock options and non-cash stock compensation totaling $7.2 million.  Changes in working capital decreased 2011 cash flows from operating activities by $273,000, primarily due to timing of initial billings on new or renewal contracts decreasing cash flows provided from trade accounts receivable and deferred revenue, partially offset by timing of payments on accrued expenses and income taxes.
 
Net cash provided by operating activities was $14.6 million for the year ended December 31, 2010, which included net income of $8.5 million, plus non cash charges (benefits) for deferred tax expense, depreciation and amortization and non-cash stock compensation totaling $6.1 million.
 
Cash Flows from Investing Activities
 
Net cash of $2.3 million was used for investing activities in the year ended December 31, 2012.  Purchases of property and equipment totaled the $2.3 million.
 
Net cash of $6.9 million was used for investing activities in the year ended December 31, 2011.  Earn-out payments related to the MIV acquisition approximated $4.1 million, and purchases of property and equipment totaled $2.8 million.
 
Net cash of $17.0 million was used for investing activities in the year ended December 31, 2010.  Cash of $15.3 million was used for the acquisition of OCS and $172,000 was paid under the earn-out related to the MIV acquisition.  Cash of $1.5 million was used for the purchase of property and equipment.
 
Cash Flows from Financing Activities
 
Net cash used in financing activities was $16.7 million in the year ended December 31, 2012.  Proceeds from the exercise of stock options and the excess tax benefit of share-based compensation provided cash of $1.3 million and $2.1 million, respectively, partially offset by repurchases of shares for payroll tax withholdings related to share-based compensation of $527,000.  Cash was used to pay dividends of $17.4 million, including a special dividend of $10.3 million in the fourth quarter of 2012.  Cash was also used to repay borrowings under the term note totaling $2.1 million and capital lease obligations of $109,000.
 
Net cash used in financing activities was $6.9 million in the year ended December 31, 2011.  Cash was generated from borrowings under the Company’s term note and revolving credit note totaling $4.5 million.  Proceeds from the exercise of stock options and the excess tax benefit of share-based compensation provided cash of $568,000 and $407,000, respectively, partially offset by repurchases of shares for payroll tax withholdings related to share-based compensation of $146,000.  Cash was used to pay dividends of $5.9 million, repay borrowings under the term note and revolving credit note totaling $6.2 million, and repay capital lease obligations of $130,000.
 
Net cash provided by financing activities was $3.3 million in the year ended December 31, 2010.  Cash was generated from borrowings under the term note and revolving credit note totaling $11.3 million.  Proceeds from the exercise of stock options provided cash of $274,000.  Cash was used to pay dividends of $5.1 million, repay borrowings under the term note and revolving credit note totaling $2.8 million, and repurchases of the Company’s common stock for $399,000.
 
 
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The effect of changes in foreign exchange rates increased (decreased) cash and cash equivalents by $107,000, ($105,000), and $130,000 in the years ended December 31, 2012, 2011, and 2010, respectively.
 
Capital Expenditures
 
Capital expenditures for the year ended December 31, 2012, were $2.3 million.  These expenditures consisted mainly of computer software, computer hardware, furniture and other equipment.  The Company expects similar capital expenditure purchases in 2013 consisting primarily of computer software and hardware and other equipment, to be funded through cash generated from operations.
 
Debt and Equity
 
On December 19, 2008, the Company borrowed $9.0 million under a term note to partially finance the acquisition of MIV.  In July 2010, the Company refinanced the existing term loan with a $6.9 million fixed-rate term loan.  The new term loan is payable in 35 monthly installments of $80,104, with a balloon payment for the remaining principal balance and interest due on July 31, 2013.  Borrowings under the term note bear interest at an annual rate of 3.79%.  The outstanding balance of the term note at December 31, 2012, was $5.1 million.
 
On July 31, 2010, the Company borrowed $10.0 million under a fixed-rate term note to partially finance the acquisition of OCS.  The term loan is payable in 35 monthly installments of $121,190 with a balloon payment for the remaining principal balance and interest due on July 31, 2013.  Borrowings under the term note bear interest at an annual rate of 3.79%.  The outstanding balance of the term note at December 31, 2012, was $7.3 million.
 
The Company expects to refinance the term notes prior to July 31, 2013.  If, however, the notes cannot be extended, the Company believes it has adequate cash flows from operations to meet its debt and capital needs.
 
The Company entered into a revolving credit note in 2006.  The maximum aggregate amount available under the revolving credit note following an addendum to the note in March 2008, is $6.5 million.  The revolving credit note was renewed in June 2012 to extend the term to June 30, 2013.  The Company may borrow, repay and re-borrow amounts under the revolving credit note from time to time until its maturity on June 30, 2013.  The Company expects to extend the term of the revolving credit note for at least one year beyond the maturity date.  If, however, the note cannot be extended, the Company believes it has adequate cash flows from operations to meet its debt and capital needs. 
 
The term notes and revolving line of credit are secured by certain of the Company’s assets, including the Company’s land, building, accounts receivable and intangible assets.  The term notes and the 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 December 31, 2012, the Company was in compliance with these restrictions and covenants.
 
The maximum aggregate amount available under the revolving credit note of $6.5 million is subject to a borrowing base equal to 75.0% of the Company’s eligible accounts receivable.  Borrowings under the renewed 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 London Interbank Offered Rate (“LIBOR”) rate, or (2) 2.2% plus the one-, two-, three-, six- or twelve-month LIBOR rate, or (3) the bank’s Money Market Loan Rate.  The rate at December 31, 2012, was 2.71%.  As of December 31, 2012, the revolving credit note did not have a balance.  According to borrowing base requirements, the Company had the capacity to borrow $6.5 million as of December 31, 2012.
 
 
25

 
 
Contractual Obligations

The Company had contractual obligations to make payments in the following amounts in the future as of December 31, 2012:
 
Contractual Obligations(1)
 
Total
Payments
   
Less than
One Year
   
One to
Three Years
   
Three to
Five Years
   
After
Five Years
 
(In thousands)
                             
Operating leases
  $ 2,554     $ 687     $ 1,176     $ 573     $ 118  
Capital leases
    380       135       237       8       --  
Uncertain tax positions(2)
    224       --       --       --       --  
Long-term debt
    12,703       12,703       --       --       --  
Total
  $ 15,861     $ 13,525     $ 1,413     $ 581     $ 118  
 
 
(1) 
Amounts are inclusive of interest payments, where applicable
 
(2)
We have $224,000 in liabilities associated with uncertain tax positions. We are unable to reasonably estimate the expected cash settlement dates of these uncertain tax positions with the taxing authorities.
 
The Company generally does not make unconditional, non-cancelable purchase commitments.  The Company enters into purchase orders in the normal course of business, but these purchase obligations do not exceed one year.

Shareholders’ equity increased $1.2 million to $56.7 million in 2012, from $55.6 million in 2011.  The increase was primarily due to net income of $15.1 million and $8.2 million of related share-based compensation, partially offset by dividends paid of $17.4 million and stock re-purchases of $5.2 million.  Dividends paid in 2012 include $10.3 million for a special dividend paid in the fourth quarter of 2012.
 
Stock Repurchase Program
 
In February 2006, the Board of Directors of the Company authorized the repurchase of 750,000 shares of common stock in the open market or in privately negotiated transactions.  As of December 31, 2012, the remaining number of shares that could be purchased under this authorization was 143,398.
 
Off-Balance Sheet Obligations
 
The Company has no significant off-balance sheet obligations other than the operating lease commitments disclosed in “Liquidity and Capital Resources.”
 
Adoption of New Accounting Pronouncements
 
In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income, which amends ASC 220, Comprehensive Income, by requiring all non-owner changes in shareholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The guidance was effective retrospectively for fiscal years and interim periods within those years beginning after December 15, 2011.  In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers certain portions of ASU No. 2011-05 indefinitely and will be further deliberated by the FASB at a future date.  The Company adopted the requirements of ASU 2011-05 and ASU 2011-12 by presenting a Consolidated Statement of Comprehensive Income immediately following the Consolidated Statement of Income.  There was no other impact on the Company’s consolidated financial statements.
 
 
26

 
 
In September 2011, the FASB issued ASU No. 2011-08, Intangibles — Goodwill and Other.  ASU No. 2011-08 allows entities to first assess qualitatively whether it is necessary to perform the two-step goodwill impairment test.  If an entity believes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative two-step goodwill impairment test is required.  An entity has the unconditional option to bypass the qualitative assessment and proceed directly to performing the quantitative goodwill impairment test.  The Company adopted the requirements of ASU 2011-08 and performed a qualitative assessment when performing the annual goodwill assessment in the fourth quarter of 2012.  The adoption of this standard did not have a material effect on the Company’s consolidated financial statements.
 
In July 2012, the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment.  Similar to the guidance in ASU 2011-08 for goodwill, ASU No. 2012-02 allows entities to first perform a qualitative assessment of its indefinite-lived intangible assets.  The Company is not required to perform further analysis, unless, based on the qualitative assessment, the Company concludes that it is more likely than not that the indefinite-lived intangible assets are impaired.  The Company has the option to bypass the qualitative assessment and perform the quantitative assessment.  The Company adopted the requirements of ASU No. 2012-02 and performed a qualitative assessment when performing its annual assessment of indefinite-lived intangible assets in the fourth quarter of 2012.  The adoption of this standard did not have a material effect on the Company’s consolidated financial statements.
 
Item 7A.          Quantitative and Qualitative Disclosure About Market Risk
 
The Company’s primary market risk exposure is changes in foreign currency exchange rates and interest rates.
 
The Company’s Canadian subsidiary uses as its functional currency the local currency of the country in which it operates.  It translates its assets and liabilities into U.S. dollars at the exchange rate in effect at the balance sheet date.  It translates its revenue and expenses at the average exchange rate during the period.  The Company includes translation gains and losses in accumulated other comprehensive income (loss), a component of shareholders’ equity.  Foreign currency translation gains (losses) were $217,000, ($201,000), and $339,000 in 2012, 2011, and 2010, respectively.  Gains and losses related to transactions denominated in a currency other than the functional currency of the countries in which the Company operates and short-term intercompany accounts are included in other income (expense) in the consolidated statements of income.
 
We are exposed to interest rate risk with both our fixed-rate term debt and variable rate revolving line of credit facility.  Interest rate changes for borrowings under our fixed-rate term debt would impact the fair value of such debt, but do not impact earnings or cash flow.  At December 31, 2012, our fixed-rate term debt totaled $12.4 million.  Based on a sensitivity analysis, a one percent change in market interest rates as of December 31, 2012, would not have a material effect on the estimated fair value of our fixed-rate debt outstanding at December 31, 2012.

Borrowings under our revolving line of credit bear interest at a variable annual rate, with three rate options at the discretion of management.  Borrowings under the revolving line of credit may not exceed the lesser of a calculated borrowing base or $6.5 million.  There were no borrowings outstanding under our revolving credit facility at December 31, 2012, or at any time during 2012.  A sensitivity analysis assuming a hypothetical 100 basis point movement in interest rates applied to the average daily borrowings and the maximum borrowings available under the revolving line of credit facility indicated that such a movement would not have a material impact on our consolidated financial position, results of operations or cash flows.

 
27

 
 
Item 8.             Financial Statements and Supplementary Data
 
Quarterly Financial Data (Unaudited)
 
The following table sets forth selected financial information for each of the eight quarters in the two-year period ended December 31, 2012.  This unaudited information has been prepared by the Company on the same basis as the consolidated financial statements and includes all normal recurring adjustments necessary to present fairly this information when read in conjunction with the Company’s audited consolidated financial statements and the notes thereto.
 
   
(In thousands, except per share data)
 
   
Quarter Ended
 
   
Dec. 31, 2012
   
Sept 30, 2012
   
June 30, 2012
   
Mar. 31, 2012
   
Dec. 31, 2011
   
Sept 30, 2011
   
June 30, 2011
   
Mar. 31, 2011
 
                                                 
Revenue
  $ 21,996     $ 21,386     $ 20,632     $ 22,407     $ 19,111     $ 18,549     $ 18,316     $ 19,791  
Direct expenses
    9,128       8,769       8,633       8,931       7,178       7,471       7,260       6,758  
Selling, general and administrative expenses
    6,001       5,821       5,569       6,151       5,648       5,572       5,990       6,090  
Depreciation and amortization
    1,093       1,149       1,214       1,243       1,275       1,312       1,235       1,243  
Operating income
    5,774       5,647       5,216       6,082       5,010       4,194       3,831       5,700  
Other expense
    (100 )     (155 )     (105 )     (152 )     (158 )     (77 )     (144 )     (196 )
Provision for income taxes
    1,971       1,915       1,172       2,081       1,720       1,470       1,358       2,048  
Net income
  $ 3,703     $ 3,577     $ 3,939     $ 3,849     $ 3,132     $ 2,647     $ 2,329     $ 3,456  
Net income per share – basic
  $ 0.54     $ 0.53     $ 0.58     $ 0.57     $ 0.47     $ 0.40     $ 0.35     $ 0.52  
Net income per share – diluted
  $ 0.53     $ 0.51     $ 0.57     $ 0.56     $ 0.46     $ 0.39     $ 0.34     $ 0.51  
Weighted average shares outstanding – basic
    6,838       6,791       6,751       6,719       6,691       6,679       6,665       6,654  
Weighted average shares outstanding – diluted
    6,986       6,961       6,943       6,907       6,847       6,850       6,855       6,809  

 
28

 
 
Report of Independent Registered Public Accounting Firm


The Board of Directors and Shareholders
National Research Corporation:
 
We have audited the accompanying consolidated balance sheets of National Research Corporation and subsidiary (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2012. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed in Item 15(2) of this Form 10-K. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Research Corporation and subsidiary as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 1, 2013 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
 
 
/s/ KPMG LLP
 
Lincoln, Nebraska
March 1, 2013
 

 
29

 
 
NATIONAL RESEARCH CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)

Assets
 
2012
   
2011
 
Current assets:
           
Cash and cash equivalents
  $ 8,286     $ 8,082  
Trade accounts receivable, less allowance for doubtful accounts of $244 and $289, respectively
    12,119       11,187  
Unbilled revenue
    932       913  
Prepaid expenses
    1,269       768  
Income taxes receivable
    158       -  
Deferred income taxes
    547       789  
Other current assets
    504       398  
Total current assets
    23,815       22,137  
                 
Net property and equipment
    12,493       13,613  
Intangible assets, net
    5,794       7,073  
Goodwill
    57,799       57,730  
Other
    145       123  
                 
Total assets
  $ 100,046     $ 100,676  
                 
Liabilities and Shareholders’ Equity
               
Current liabilities:
               
Current portion of notes payable
  $ 12,436     $ 1,861  
Accounts payable
    291       783  
Accrued wages, bonus and profit sharing
    4,392       3,591  
Accrued expenses
    2,265       1,418  
Income taxes payable
    -       145  
Current portion of capital lease obligations
    102       101  
Deferred revenue
    15,812       16,500  
Total current liabilities
    35,298       24,399  
                 
Notes payable, net of current portion
    -       12,625  
Deferred income taxes
    7,527       7,588  
Deferred revenue
    254       185  
Capital lease obligations, net of current portion
    225       325  
Total liabilities
    43,304       45,122  
                 
Shareholders’ equity:
               
Common stock, $0.001 par value; authorized 20,000,000 shares, issued 8,376,592 in 2012 and 8,117,849 in 2011, outstanding 6,874,992 in 2012 and 6,724,280 in 2011
    8       8  
Additional paid-in capital
    39,514       31,080  
Retained earnings
    44,700       46,995  
Accumulated other comprehensive income, foreign currency translation adjustment
    1,124       907  
Treasury stock, at cost; 1,501,600 shares in 2012 and 1,393,569 shares in 2011
    (28,604 )     (23,436 )
Total shareholders’ equity
    56,742       55,554  
                 
Total liabilities and shareholders’ equity
  $ 100,046     $ 100,676  

See accompanying notes to consolidated financial statements.
 
 
30

 
 
NATIONAL RESEARCH CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except for per share amounts)

 
   
2012
   
2011
   
2010
 
                   
Revenue
  $ 86,421     $ 75,767     $ 63,398  
                         
Operating expenses:
                       
Direct
    35,461       28,667       24,635  
Selling, general and administrative
    23,542       23,300       20,202  
Depreciation and amortization
    4,699       5,065       4,704  
Total operating expenses
    63,702       57,032       49,541  
                         
Operating income
    22,719       18,735       13,857  
                         
Other income (expense):
                       
Interest income
    32       13       6  
Interest expense
    (541 )     (629 )     (491 )
Other, net
    (3 )     41       (57 )
                         
Total other expense
    (512 )     (575 )     (542 )
                         
Income before income taxes
    22,207       18,160       13,315  
                         
Provision for income taxes
    7,139       6,596       4,816  
                         
Net income
  $ 15,068     $ 11,564     $ 8,499  
                         
Net income per share - basic
  $ 2.22     $ 1.73     $ 1.28  
Net income per share - diluted
  $ 2.17     $ 1.69     $ 1.26  
                         
Weighted average shares and shares equivalent outstanding - basic
    6,775       6,672       6,637  
Weighted average shares and shares equivalent outstanding - diluted
    6,951       6,842       6,736  
 
See accompanying notes to consolidated financial statements.
 
 
31

 
 
NATIONAL RESEARCH CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)

 
   
2012
   
2011
   
2010
 
                   
Net Income
  $ 15,068     $ 11,564     $ 8,499  
                         
Other comprehensive income (loss):
                       
Cumulative translation adjustment
  $ 217     $ (201 )   $ 339  
Other comprehensive income (loss)
  $ 217     $ (201 )   $ 339  
Comprehensive Income
  $ 15,285     $ 11,363     $ 8,838  
 
See accompanying notes to consolidated financial statements.
 
 
32

 
 
NATIONAL RESEARCH CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands except share and per share amounts)

 
   
Common
Stock
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income
   
Treasury
Stock
   
Total
 
Balances at December 31, 2009
  $ 8     $ 27,871     $ 37,905     $ 769     $ (22,382 )   $ 44,171  
Purchase of 20,349 shares of treasury stock
    --       --       --       --       (463 )     (463 )
Issuance of 17,573 common shares for the exercise of stock options
    --       274       --       --       --       274  
Tax benefit from the exercise of options and vested restricted stock
    --       46       --       --       --       46  
Issuance of 9,238 restricted common shares
    --       --       --       --       --       --  
Non-cash stock compensation expense
    --       779       --       --       --       779  
Dividends declared of $0.76 per common share
    --       --       (5,061 )     --       --       (5,061 )
Other comprehensive income (loss), foreign currency translation adjustment
    --       --       --       339       --       339  
Net income
    --       --       8,499       --       --       8,499  
Balances at December 31, 2010
  $ 8     $ 28,970     $ 41,343     $ 1,108     $ (22,845 )   $ 48,584  
Purchase of 17,288 shares of treasury stock
    --       --       --       --       (591 )     (591 )
Issuance of 58,671 common shares for the exercise of stock options
    --       940       --       --       --       940  
Tax benefit from the exercise of options and vested restricted stock
    --       407       --       --       --       407  
Issuance of 14,323 restricted common shares, net of forfeitures
    --       --       --       --       --       --  
Non-cash stock compensation expense
    --       763       --       --       --       763  
Dividends declared of $0.88 per common share
    --       --       (5,912 )     --       --       (5,912 )
Other comprehensive income (loss), foreign currency translation adjustment
    --       --       --       (201 )     --       (201 )
Net income
    --       --       11,564       --       --       11,564  
Balances at December 31, 2011
  $ 8     $ 31,080     $ 46,995     $ 907     $ (23,436 )   $ 55,554  
Purchase of 108,031 shares of treasury stock
    --       --       --       --       (5,168 )     (5,168 )
Issuance of 262,101 common shares for the exercise of stock options
    --       5,968       --       --       --       5,968  
Tax benefit from the exercise of options and vested restricted stock
    --       2,078       --       --       --       2,078  
Issuance of restricted common shares, net of forfeitures (3,358)
    --       --       --       --       --       --  
Non-cash stock compensation expense
    --       388       --       --       --       388  
Dividends declared of $2.54 per common share
    --       --       (17,363 )     --       --       (17,363 )
Other comprehensive income (loss), foreign currency translation adjustment
    --       --       --       217       --       217  
Net income
    --       --       15,068       --       --       15,068  
Balances at December 31, 2012
  $ 8     $ 39,514     $ 44,700     $ 1,124     $ (28,604 )   $ 56,742  
 
See accompanying notes to consolidated financial statements.
 
 
33

 
 
NATIONAL RESEARCH CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
   
2012
   
2011
   
2010
 
Cash flows from operating activities:
                 
Net income
  $ 15,068     $ 11,564     $ 8,499  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization
    4,699       5,065       4,704  
Deferred income taxes
    (421 )     1,297       614  
(Gain) Loss on sale of property and equipment
    4       (1 )     1  
Tax benefit from exercise of stock options
    601       66       33  
Non-cash stock compensation expense
    388       763       779  
Change in assets and liabilities, net of effect of acquisitions:
                       
Trade accounts receivable
    (879 )     (2,064 )     (2,489 )
Unbilled revenue
    (11 )     194       91  
Prepaid expenses
    (357 )     253       1425  
Other current assets
    (106 )     (121 )     429  
Accounts payable
    (516 )     52       (1,391 )
Accrued expenses, wages, bonus and profit sharing
    1,602       1,176       113  
Income taxes payable and recoverable
    (303 )     1,420       (442 )
Deferred revenue
    (637 )     (1,183 )     2,237  
Net cash provided by operating activities
    19,132       18,481       14,603  
                         
Cash flows from investing activities:
                       
Purchases of property and equipment
    (2,348 )     (2,812 )     (1,539 )
Acquisitions, net of cash acquired and earn-out on acquisitions
    --       (4,115 )     (15,441 )
Net cash used in investing activities
    (2,348 )     (6,927 )     (16,980 )
                         
Cash flows from financing activities:
                       
Proceeds from notes payable
    --       4,545       11,300  
Payments on notes payable
    (2,050 )     (6,218 )     (2,799 )
Payments on capital lease obligations
    (108 )     (130 )     (43 )
Proceeds from exercise of stock options
    1,283       568       274  
Excess tax benefit from share-based compensation
    2,078       407       46  
Purchase of treasury stock
    --       --       (399 )
Repurchase of shares for payroll tax withholdings related to share-based compensation
    (527 )     (146 )     (64 )
Payment of dividends on common stock
    (17,363 )     (5,912 )     (5,061 )
Net cash (used in) provided by financing activities
    (16,687 )     (6,886 )     3,254  
                         
Effect of exchange rate changes on cash
    107       (105 )     130  
                         
Net increase in cash and cash equivalents
    204       4,563       1,007  
                         
Cash and cash equivalents at beginning of period
    8,082       3,519       2,512  
                         
Cash and cash equivalents at end of period
  $ 8,286     $ 8,082     $ 3,519  
                         
Supplemental disclosure of cash paid for:
                       
Interest expense, net of capitalized amounts
  $ 554     $ 542     $ 497  
Income taxes
  $ 5,108     $ 3,383     $ 4,549  

Supplemental disclosures of non-cash investing and financing activities:

Capital lease obligations for property and equipment originating during the years ended December 31, 2012, 2011 and 2010 was $9,000, $115,000 and $389,000, respectively.

In connection with the Company’s equity incentive plans, certain optionees tendered to the Company previously owned shares to pay for the option strike price.  The total non-cash stock options exercised was $4.6 million, $445,000 and $-0- for the years ended December 31, 2012, 2011, and 2010, respectively.

See accompanying notes to consolidated financial statements.
 
 
34

 
 
NATIONAL RESEARCH CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(1)           Summary of Significant Accounting Policies
 
Description of Business and Basis of Presentation
 
National Research Corporation (“NRC” or the “Company”) is a leading provider of analytics and insights that facilitate revenue growth, patient, employee and customer retention and patient engagement for healthcare providers, payers and other healthcare organizations.  The Company’s ten largest clients accounted for 22%, 20%, and 19% of the Company’s total revenue in 2012, 2011, and 2010, respectively.
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of the Company and its subsidiary.  All significant intercompany transactions and balances have been eliminated in consolidation.
 
Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.
 
Translation of Foreign Currencies
 
The Company’s Canadian subsidiary uses as its functional currency the local currency of the country in which it operates.  It translates its assets and liabilities into U.S. dollars at the exchange rate in effect at the balance sheet date.  It translates its revenue and expenses at the average exchange rate during the period.  The Company includes translation gains and losses in accumulated other comprehensive income (loss), a component of shareholders’ equity.  Gains and losses related to transactions denominated in a currency other than the functional currency of the countries in which the Company operates and short-term intercompany accounts are included in other income (expense) in the consolidated statements of income.  Since the undistributed earnings of the Company’s foreign subsidiaries are considered to be indefinitely reinvested, the components of accumulated other comprehensive income (loss) have not been tax effected.
 
Revenue Recognition
 
The Company derives a majority of its operating revenue from its annually renewable services, which include performance measurement and improvement services, healthcare analytics and governance education services.  The Company provides these services to its clients under annual client service contracts, although such contracts are generally cancelable on short or no notice without penalty.  The Company also derives some revenue from its custom and other research projects.
 
Services are provided under subscription-based service agreements.  The Company recognizes subscription-based service revenue over the period of time the service is provided.  Generally, the subscription periods are for twelve months and revenue is recognized equally over the subscription period.
 
 
35

 
 
Certain contracts are fixed-fee arrangements with a portion of the project fee billed in advance and the remainder billed periodically over the duration of the project.  Revenue and direct expenses for services provided under these contracts are recognized under the proportional performance method.   Under the proportional performance method, the Company recognizes revenue based on output measures or key milestones such as survey set-up, survey mailings, survey returns and reporting.  The Company measures its progress based on the level of completion of these output measures and recognizes revenue accordingly.  Management judgments and estimates must be made and used in connection with revenue recognized using the proportional performance method.  If management made different judgments and estimates, then the amount and timing of revenue for any period could differ materially from the reported revenue.
 
The Company also derives revenue from hosting arrangements where our propriety software is offered as a service to our customers through our data processing facilities.  The Company’s revenue also includes software-related revenue for software license revenue, installation services, post-contract support (maintenance) and training.  Software-related revenue is recognized in accordance with the provisions of Accounting Standards Codification (“ASC”) 985-605, Software-Revenue Recognition.
 
Hosting arrangements to provide customers with access to the Company’s propriety software are marketed under long-term arrangements generally over periods of one to three years.  Under these arrangements, the customer is not provided the contractual right to take possession of the licensed software at any time during the hosting period without significant penalty, and the customer is not provided the right to run the software on their own hardware or contract with another party unrelated to us to host the software.  Upfront fees for setup services are typically billed for our hosting arrangements,  however, these arrangements do not qualify for separation from the ongoing hosting services due to the absence of standalone value for the set-up services.  Therefore, we account for these arrangements as service contracts and recognize revenue ratably over the hosting service period when all other conditions to revenue are met.  Other conditions that must be met before the commencement of revenue recognition include achieving evidence of an arrangement, determining that the collection of the revenue is probable, and determining that fees are fixed and determinable.
 
The Company’s software arrangements typically involve the sale of a time-based license bundled with installation services, post-contract support (“PCS”) and training.  License terms range from one year to three years, and require an annual fee for bundled elements of the arrangement.  PCS is also contractually provided for a period that is co-terminus with the term of the time-based license.  The Company’s installation services are not considered to be essential to the functionality of the software license.  The Company does not achieve vendor-specific objective evidence (“VSOE”) of the fair value of the undelivered elements of its software arrangements (primarily PCS) and, therefore, these arrangements are accounted for as a single unit of accounting with revenue recognized ratably over the minimum bundled PCS period.
 
The Company’s revenue arrangements (not involving software elements) may include multiple elements.  In assessing the separation of revenue for elements of such arrangements, we first determine whether each delivered element has standalone value based on whether we, or other vendors, sell the services separately.  We also consider whether there is sufficient evidence of the fair value of the elements in allocating the fees in the arrangement to each element.  Revenue allocated to an element is limited to revenue that is not subject to refund or otherwise represent contingent revenue.
 
On January 1, 2011, the Company prospectively adopted Accounting Standard Update (“ASU”) 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (ASU 2009-13).  For arrangements entered into or materially modified beginning January 1, 2011, we allocated revenue to arrangements with multiple elements based on relative selling price using a selling price hierarchy.  The selling price for a deliverable is based on its VSOE if it exists, otherwise third-party evidence of selling price.  If neither exists for a deliverable, the best estimate of the selling price is used for that deliverable based on list price, representing a component of management’s market strategy, and an analysis of historical prices for bundled and standalone arrangements.
 
 
36

 
 
Trade Accounts Receivable
 
Trade accounts receivable are recorded at the invoiced amount.  The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable.  The Company determines the allowance based on specific account analysis and on the Company’s historical write-off experience.  The Company reviews the allowance for doubtful accounts monthly.  Past due balances over 90 days and over a specified amount are reviewed individually for collectability and provisions are made for accounts not specifically reviewed.  Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
 
Property and Equipment
 
Property and equipment is stated at cost.  Major expenditures to purchase property or to substantially increase useful lives of property are capitalized.  Maintenance, repairs and minor renewals are expensed as incurred.  When assets are retired or otherwise disposed of, their costs and related accumulated depreciation are removed from the accounts and resulting gains or losses are included in income.
 
For costs of software developed for internal use, the Company expenses computer software costs as incurred in the preliminary project stage, which involves the conceptual formulation, evaluation and selection of technology alternatives.  Costs incurred related to the design, coding, installation and testing of software during the application project stage are capitalized.  Costs for training and application maintenance are expensed as incurred.  The Company has capitalized approximately $636,000, $840,000 and $900,000, of internal and external costs incurred for the development of internal-use software for the years ended December 31, 2012, 2011, and 2010, respectively, with such costs classified as property and equipment.
 
The Company provides for depreciation and amortization of property and equipment using annual rates which are sufficient to amortize the cost of depreciable assets over their estimated useful lives.  The Company uses the straight-line method of depreciation and amortization over estimated useful lives of three to ten years for furniture and equipment, three to five years for computer equipment, three to five years for capitalized software, and seven to forty years for the Company’s office building and related improvements.
 
Leases are categorized as operating or capital at the inception of the lease.  Assets under capital lease obligations are reported at the lower of fair value or the present value of the aggregate future minimum lease payments at the beginning of the lease term.  The Company depreciates capital lease assets without transfer-of-ownership or bargain-purchase-options using the straight-line method over the lease terms, excluding any lease renewals, unless the lease renewals are reasonably assured.  Capital lease assets with transfer-of-ownership or bargain-purchase-options are depreciated using the straight-line method over the assets’ estimated useful lives.
 
Impairment of Long-Lived Assets
 
Long-lived assets, such as property and equipment and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  If circumstances require a long-lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by that asset or asset group to its carrying value.  If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value.  Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.  No impairments were recorded during the years ended December 31, 2012, 2011, or 2010.
 
 
37

 
 
Among others, management believes the following circumstances are important indicators of potential impairment of such assets and as a result may trigger an impairment review:
 
 
Significant underperformance in comparison to historical or projected operating results;
 
 
Significant changes in the manner or use of acquired assets or the Company’s overall strategy;
 
 
Significant negative trends in the Company’s industry or the overall economy;
 
 
A significant decline in the market price for the Company’s common stock for a sustained period; and
 
 
The Company’s market capitalization falling below the book value of the Company’s net assets.
 
Goodwill and Intangible Assets
 
Intangible assets include customer relationships, trade names, non-compete agreements and goodwill.   Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.  The Company reviews intangible assets with indefinite lives for impairment annually as of October 1 and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.
 
When performing the impairment assessment, the Company will first assess qualitative factors to determine whether it is necessary to recalculate the fair value of the intangible assets with indefinite lives.  If the Company believes, as a result of the qualitative assessment, that it is more likely than not that the fair value of the indefinite-lived intangibles is less than their carrying amount, the Company calculates the fair value using a market approach.  If the carrying value of intangible assets with indefinite lives exceeds their fair value, then the intangible assets are written-down to their fair values.  The Company did not recognize any impairments related to long-lived assets during 2012, 2011, or 2010.
 
Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.  All of the Company’s goodwill is allocated to its reporting units, which are the same as its operating segments.  Goodwill is reviewed for impairment at least annually, as of October 1, and whenever events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable.
 
The Company reviews for goodwill impairment by first assessing qualitative factors to determine whether any impairment may exist.  If the Company believes, as a result of the qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative two-step test is required; otherwise, no further testing is required.  Under the first step of the quantitative test, the fair value of the reporting unit is compared with its carrying value (including goodwill).  If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed.  If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the entity must perform step two of the impairment test (measurement).  Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the fair value of that goodwill.  The fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the fair value of the reporting unit goodwill.
 
 
38

 
 
In instances when a step two is required, the fair value of the reporting unit is determined using an income approach and comparable market multiples.  Under the income approach, there are a number of inputs used to calculate the fair value using a discounted cash flow model, including operating results, business plans, projected cash flows and a discount rate.  Discount rates, growth rates and cash flow projections are the most sensitive and susceptible to change as they require significant management judgment.  Discount rates are determined by using a weighted average cost of capital, which considers market and industry data.  Operational management develops growth rates and cash flow projections for each reporting unit considering industry and Company-specific historical and projected information.  Terminal value rate determination follows common methodology of capturing the present value of perpetual cash flow estimates beyond the last projected period assuming a constant weighted average cost of capital and low long-term growth rates.  Under the market approach, the Company considers its market capitalization, comparisons to other public companies’ data, and recent transactions of similar businesses within the Company’s industry.
 
No impairments were recorded during the years ended December 31, 2012, 2011 or 2010.  The most recent quantitative analysis was performed as of October 1, 2011.  That analysis indicated that the fair value of our reporting units, including goodwill, was significantly in excess of their carrying values.  The Company performed a qualitative analysis as of October 1, 2012 which did not indicate that it was more likely than not that the carrying values of the reporting units exceeded fair value.
 
Income Taxes
 
The Company uses the asset and liability method of accounting for income taxes.  Under that method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis using enacted tax rates.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  Valuation allowances, if any, are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized.  The Company uses the deferral method of accounting for its investment tax credits related to state tax incentives.  During the years ended December 31, 2012, 2011 and 2010, the Company recorded income tax benefits relating to these tax credits of $289,000, $229,000, and $251,000, respectively.
 
The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained.  Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized.  Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
 
The Company had an unrecognized tax benefit at December 31, 2012, and 2011, of $224,000 and $266,000, respectively, excluding interest of $11,000 and $43,000, respectively, and no penalties.  Of this amount, $224,000 and $266,000 at December 31, 2012 and 2011, respectively, represents the net unrecognized tax benefits that, if recognized, would favorably impact the effective income tax rate.  The Company accrues interest and penalties related to uncertain tax position in the statements of income as income tax expense.  The Company is not subject to tax examinations for years prior to 2009 in the U.S. and 2008 in Canada.
 
 
39

 

Share-Based Compensation
 
The Company measures and recognizes compensation expense for all share-based payments.  The compensation expense is recognized based on the grant-date fair value of those awards.  All of the Company’s existing stock option awards and non-vested stock awards have been determined to be equity-classified awards.
 
Amounts recognized in the financial statements with respect to these plans:
 
   
2012
   
2011
   
2010
 
   
(In thousands)
 
Amounts charged against income, before income tax benefit
  $ 388     $ 763     $ 779  
Amount of related income tax benefit
    153       302       309  
Total net income impact
  $ 235     $ 461     $ 470  
 
Cash and Cash Equivalents
 
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.  Cash equivalents were $7.5 million and $7.9 million as of December 31, 2012, and 2011, respectively, consisting primarily of money market accounts and funds invested in commercial paper.  At certain times, cash equivalent balances may exceed federally insured limits.
 
Fair Value Measurements
 
The Company’s valuation techniques are based on maximizing observable inputs and minimizing the use of unobservable inputs when measuring fair value.  Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions.  The inputs are then classified into the following hierarchy: (1) Level 1 Inputs—quoted prices in active markets for identical assets and liabilities; (2) Level 2 Inputs—observable market-based inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities in active markets, quoted prices for similar or identical assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data; (3) Level 3 Inputs—unobservable inputs.

The following details the Company’s financial assets and liabilities within the fair value hierarchy at December 31, 2012 and 2011:
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(In thousands)
 
As of December 31, 2012
                       
Money Market Funds
  $ 5,245     $ --     $ --     $ 5,245  
Commercial Paper
  $ 2,242     $ --     $ --     $ 2,242  
Total
  $ 7,487     $ --     $ --     $ 7,487  
As of December 31, 2011
                               
Money Market Funds
  $ 3,243     $ --     $ --     $ 3,243  
Commercial Paper
  $ 4,659     $ --     $ --     $ 4,659  
Total
  $ 7,902     $ --     $ --     $ 7,902  
 
 
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The Company's long-term debt is recorded at historical cost.  The fair value of long-term debt is classified in Level 2 of the fair value hierarchy and was estimated based primarily on estimated current rates available for debt of the same remaining duration and adjusted for nonperformance and credit.  The following are the carrying amount and estimated fair values of long-term debt:
 
   
December 31, 2012
   
December 31, 2011
 
   
(In thousands)
 
Total carrying amount of long-term debt
  $ 12,436     $ 14,486  
Estimated fair value of long-term debt
  $ 12,490     $ 14,498  

The Company believes that the carrying amounts of accounts receivable, accounts payable, and accrued expenses approximate their fair value.  All non-financial assets that are not recognized or disclosed at fair value in the financial statements on a recurring basis, which includes goodwill and non-financial long-lived assets, are measured at fair value in certain circumstances (for example, when there is evidence of impairment).  As of December 31, 2012 and 2011, there was no impairment related to property and equipment, goodwill and other intangible assets.
 
Contingencies
 
From time to time, the Company is involved in certain claims and litigation arising in the normal course of business.  Management assesses the probability of loss for such contingencies and recognizes a liability when a loss is probable and estimable.  At December 31, 2012, the Company was not engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material effect on the Company.
 
Earnings Per Share
 
Net income per share has been calculated and presented for “basic” and “diluted” per share data.  Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding.  Diluted income per share is computed by dividing net income by the weighted average number of common shares adjusted for the dilutive effects of options and restricted stock.  At December 31, 2012, 2011, and 2010, the Company had 30,820, 119,569 and 384,652 options, respectively, which have been excluded from the diluted net income per share computation because the exercise price exceeds the fair market value.
 
The weighted average shares outstanding were calculated as follows:
 
   
2012
   
2011
   
2010
 
   
(In thousands)
 
Common stock
    6,775       6,672       6,637  
Dilutive effect of options
    164       158       87  
Dilutive effect of restricted stock
    12       12       12  
Weighted average shares used for dilutive per share information
    6,951       6,842       6,736  
 
There are no reconciling items between the Company’s reported net income and net income used in the computation of basic and diluted income per share.
 
 
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Segment Information

The Company has eight operating segments that are aggregated into one reporting segment because they have similar economic characteristics and meet the other aggregation criteria from the Financial Accounting Standards Board (“FASB”) guidance on segment disclosure.  The eight operating segments are as follows: NRC Picker U.S. and NRC Picker Canada, which each offer renewable performance tracking and improvement services, custom research, subscription-based educational services and a renewable syndicated service; Ticker, which offers stand-alone market information as well as a comparative performance database to allow the Company’s clients to assess their performance relative to the industry, to access best practice examples, and to utilize competitive information for marketing purposes; Payer Solutions, which offers functional disease-specific and health status measurement tools; The Governance Institute (“TGI”), which offers subscription-based governance information and educational conferences designed to improve the effectiveness of hospital and healthcare systems by continually strengthening their healthcare boards, medical leadership and management performance in the United States; My InnerView (“MIV”), which provides quality and performance improvement solutions to the senior care industry; Outcome Concept Systems, Inc. (“OCS”), a provider of clinical, financial and operational benchmarks and analytics to home care and hospice providers; and Illuminate, a patient outreach and discharge program designed to facilitate service and clinical recovery within the critical hours after a patient is discharged from a healthcare setting within the acute care, skilled nursing, physician and home health environments.
 
Adoption of New Accounting Pronouncements
 
In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income, which amends ASC 220, Comprehensive Income, by requiring all non-owner changes in shareholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance was effective retrospectively for fiscal years and interim periods within those years beginning after December 15, 2011.  In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers certain portions of ASU No. 2011-05 indefinitely and will be further deliberated by the FASB at a future date.  The Company adopted the requirements of ASU 2011-05 and ASU 2011-12 by presenting a Consolidated Statement of Comprehensive Income immediately following the Consolidated Statement of Income.  There was no other impact on the Company’s consolidated financial statements.
 
In September 2011, the FASB issued ASU No. 2011-08, Intangibles — Goodwill and Other. ASU No. 2011-08 allows entities to first assess qualitatively whether it is necessary to perform the two-step goodwill impairment test.  If an entity believes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative two-step goodwill impairment test is required.  An entity has the unconditional option to bypass the qualitative assessment and proceed directly to performing the quantitative goodwill impairment test.  The Company adopted the requirements of ASU 2011-08 and performed the qualitative assessment when performing the annual goodwill assessment in the fourth quarter of 2012.  The adoption of this standard did not have a material effect on the Company’s consolidated financial statements.
 
 
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In July 2012, the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment.  Similar to the guidance in ASU 2011-08 for goodwill, ASU No. 2012-02 allows entities to first perform a qualitative assessment of its indefinite-lived intangible assets.  The Company is not required to perform further analysis, unless, based on the qualitative assessment, the Company concludes that it is more likely than not that the indefinite-lived intangible assets are impaired.  The Company has the option to bypass the qualitative assessment and perform the quantitative assessment.  The Company adopted the requirements of ASU No. 2012-02 and performed the qualitative assessment when performing its annual assessment of indefinite-lived intangible assets in the fourth quarter of 2012.  The adoption of this standard did not have a material effect on the Company’s consolidated financial statements.
 
(2)           Acquisitions
 
On August 3, 2010, the Company acquired all of the issued and outstanding shares of stock and stock rights of OCS, a provider of clinical, financial and operational benchmarks and analytics to home care and hospice providers.  The acquisition provides the Company with an entry in the home health and hospice markets through OCS’s customer relationships with home healthcare and hospice providers and expands the Company's service offerings across the continuum of care.  Goodwill related to the acquisition of OCS primarily relates to intangible assets that do not qualify for separate recognition including the depth and knowledge of management.  Cash consideration paid at closing was $15.3 million, net of $1.0 million cash received.  The following table summarizes the purchase allocation of fair value of the assets acquired and liabilities assumed at the acquisition date.
 
Amount of Identified Assets Acquired and Liabilities Assumed

(In thousands)
 
   
Weighted-Average Life
(years)
       
Current Assets
        $ 3,615  
Property and equipment
          1,632  
Customer relationships
    10       2,330  
Trade name
    5       330  
Non-compete Agreements
    3       430  
Goodwill
            13,502  
Total acquired assets
            21,839  
                 
Current liabilities
            6,310  
Long-term liabilities
            260  
Total liabilities assumed
            6,570  
                 
Net assets acquired
          $ 15,269  

The identifiable intangible assets are being amortized over their estimated useful lives and have a total weighted average amortization period of 8.5 years.  The excess of purchase price over the fair value of net assets acquired was recorded as goodwill.  The goodwill and identifiable intangible assets are non-deductible for tax purposes.  No residual value was estimated for intangible assets.

The consolidated financial statements as of December 31, 2012, 2011 and 2010, and for the years then ended, include amounts acquired from, as well as the results of operations of, OCS from August 3, 2010, forward.  Results of operations for the year ended December 31, 2010, include revenue of $3.0 million and operating income of $221,000 attributable to OCS since its acquisition.  Acquisition-related costs included in selling, general and administrative expenses for the year ended December 31, 2010, approximated $312,000.  The following unaudited pro forma information for the Company has been prepared as if the acquisition of OCS had occurred on January 1, 2009.  The information is based on the historical results of the separate companies and may not necessarily be indicative of the results that could have been achieved or of results that may occur in the future.  The pro forma adjustments include the impact of depreciation and amortization of property and equipment and intangible assets acquired, interest expense on the acquisition debt and income tax benefits for tax effects of the foregoing adjustments to depreciation, amortization and interest expense.
 
 
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December 31,
2010
 
   
(in thousands)
 
Revenue
  $ 67,341  
         
Net income
  $ 7,664  
         
Net income per share – basic
  $ 1.15  
         
Net income per share – diluted
  $ 1.14  

(3)           Property and Equipment
 
At December 31, 2012, and 2011, property and equipment consisted of the following:
 
   
2012
   
2011
 
   
(In thousands)
 
Furniture and equipment
  $ 3,797     $ 3,667  
Computer equipment and software
    17,647       15,866  
Building
    9,322       9,271  
Land
    425       425  
      31,191       29,229  
Less accumulated depreciation and amortization
    18,698       15,616  
Net property and equipment
  $ 12,493     $ 13,613  
 
Depreciation and amortization expense related to property and equipment, including assets under capital lease, for the years ended December 31, 2012, 2011, and 2010 was $3.4 million, $3.5 million, and $3.4 million, respectively.
 
Property and equipment included the following amounts under capital lease:
 
   
2012
   
2011
 
   
(In thousands)
 
Furniture and equipment
  $ 514     $ 527  
Computer equipment and software
    47       47  
      561       574  
Less accumulated amortization
    196       117  
Net assets under capital lease
  $ 365     $ 457  
 
 
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(4)            Goodwill and Intangible Assets
 
Goodwill and intangible assets consisted of the following at December 31, 2012:
 
   
Useful Life
   
Gross
   
Accumulated Amortization
   
Net
 
    (In years)           (In thousands)        
Goodwill
        $ 57,799           $ 57,799  
Non-amortizing intangible assets:
                           
Indefinite trade name
          1,191             1,191  
Amortizing intangible assets:
                           
Customer related
  5 - 15       10,521       6,709       3,812  
Non-competes
    3         430       346       84  
Trade names
  5 - 10       1,902       1,195       707  
Total amortizing intangibles
              12,853       8,250       4,603  
Total intangible assets other than goodwill
            $ 14,044     $ 8,250     $ 5,794  
 
Goodwill and intangible assets consisted of the following at December 31, 2011:
 
   
Useful Life
   
Gross
   
Accumulated Amortization
   
Net
 
    (In years)           (In thousands)        
Goodwill
        $ 57,730           $ 57,730  
Non-amortizing intangible assets:
                           
Indefinite trade name
          1,191             1,191  
Amortizing intangible assets:
                           
Customer related
  5 - 15       10,513       5,789       4,724  
Non-competes
    3         430       203       227  
Trade names
  5 - 10       1,902       971       931  
Total amortizing intangibles
              12,845       6,963       5,882  
Total intangible assets other than goodwill
            $ 14,036     $ 6,963     $ 7,073  

The following represents a summary of changes in the Company’s carrying amount of goodwill for the years ended December 31, 2012, and 2011 (in thousands):
 
Balance as of December 31, 2010
  $ 55,133  
MIV contingent consideration earned
    2,550  
OCS correcting entries
    106  
Foreign currency translation
    (59 )
Balance as of December 31, 2011
  $ 57,730  
Foreign currency translation
    69  
Balance as of December 31, 2012
  $ 57,799  

 
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Correcting entries related to the OCS acquisition were made in 2011 for adjustments needed in the purchase price allocation.  Those entries decreased accrued expenses by $49,000, increased the valuation allowance for deferred tax asset by $155,000, and increased goodwill by $106,000.  The effects of these errors were not material to any previously reported periods.

The agreement under which the Company acquired MIV in 2008 provided for contingent earn-out payments over three years based on growth in revenue and earnings.  The 2010 and 2009 earn-out payments paid in February 2011 and 2010 were $1.6 million and $172,000, respectively, net of closing valuation adjustments, and were recorded as additions to goodwill.  In April 2011, the Company reached an agreement which limited the final earn-out payment associated with the MIV acquisition at approximately $2.6 million.  Of this amount, $2.4 million was paid during April 2011 and a final payment of $117,000 was paid in September 2011, which were recorded as additions to goodwill.
 
 
Aggregate amortization expense for customer related intangibles, trade names and non-competes for the years ended December 31, 2012, 2011 and 2010 was $1.3 million, $1.6 million, and $1.3 million, respectively.  Estimated amortization expense for the next five years is: 2013—$954,000; 2014—$842,000; 2015—$789,000; 2016—$597,000; 2017—$531,000: thereafter $890,000.
 
(5)           Income Taxes
 
For the years ended December 31, 2012, 2011, and 2010, income before income taxes consists of the following:
 
   
2012
   
2011
   
2010
 
U.S. Operations
  $ 19,836     $ 16,017     $ 11,353  
Foreign Operations
    2,371       2,143