10-K 1 nrci20131231_10k.htm FORM 10-K nrci20131231_10k.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, 2013     

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                   

(State or other jurisdiction

of incorporation or organization)

     47-0634000     

(I.R.S. Employer

Identification No.)

 

1245 Q Street

                 Lincoln, Nebraska                 

(Address of principal executive offices)

 

   68508   

(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

Class A Common Stock, $.001 par value

The NASDAQ Stock Market 

Class B 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  ☒ 

 

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  ☒ 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ☒  No ☐

 

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

 

Indicate by check mark 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 ☒     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  ☒ 

 

Aggregate market value of the class A common stock and the class B common stock held by non-affiliates of the registrant at June 28, 2013: $201,088,365.

 

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

Class A Common Stock, $0.001 par value, outstanding as of February 21, 2014: 20,795,772 shares

Class B Common Stock, $0.001 par value, outstanding as of February 21, 2014: 3,478,128 shares

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2014 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

9

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 impact 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 32 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 healthcare 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.

 

 
2

 

 

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 markets across the country 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 provide 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 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 (Connect Transitions) 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. Through preference-based communications and real time alerts, these solutions enable organizations to identify and manage high risk patients to reduce readmissions, increase patient satisfaction and support safe care transitions. 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 Connect Transitions solution is provided by Customer-Connect LLC (doing business as Connect). Connect was formed in June 2013 to develop and provide patient outreach and discharge call solutions. NRC has a 49% ownership interest in Connect, NG Customer-Connect, LLC holds 25% interest and the remaining 26% is held by Illuminate Health, LLC.

 

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 2013 and 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.

  

 
4

 

 

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 19% of total revenue for the year ended December 31, 2013 and no single client representing more than 5% of the Company’s revenue.

  

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 believes 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 Chief Executive Officer, founded NRC in 1981. Prior to launching the Company, Mr. Hays 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.

 

 
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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 25% 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. 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.

 

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 2,400 acute care facilities. It also provides solutions to over 80 payer health plans and 7,700 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 19%, 22%, and 20% of the Company’s total revenue in 2013, 2012 and 2011, respectively. Approximately 7% of the Company’s revenue was derived from foreign customers in 2013, and 8% in 2012 and 2011.

 

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, 2013, the Company employed a total of 352 persons on a full-time basis. In addition, as of such date, the Company had 36 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.

  

 
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Executive Officers of the Company

 

The following table sets forth certain information as of February 1, 2014, regarding the executive officers of the Company:

   

Name

 

Age

 

Position

           

Michael D. Hays

    59  

Chief Executive Officer

           

Susan L. Henricks

    63  

President and Chief Operating Officer

           

Kevin R. Karas

    56  

Senior Vice President Finance, Chief Financial Officer, Treasurer and Secretary

 

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 Reports 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.

  

 
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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.

 

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 class A common stock and/or our class B 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 includes 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 19%, 22%, and 20% of the Company’s total revenue in 2013, 2012, and 2011, 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 Market Insights (formerly Ticker). In either case, our operating and net income could be negatively affected.

 

Our principal shareholder effectively controls the Company, and holders of class A common stock are not able to independently elect directors of NRC or control any of the Company's management policies or business decisions because the holders of class A common stock have substantially less voting power than the holders of the Company's class B common stock, a majority of which is beneficially owned by our principal shareholder.

 

The Company's outstanding stock is divided into two classes of common stock: class A common stock and class B common stock. The class B common stock has one vote per share on all matters and the class A common stock has one-one-hundredth (1/100th) of one vote per share. As of February 21, 2014, the class B common stock constitutes approximately 94% of NRC's total voting power. As a result, holders of class B common stock are able to exercise a controlling influence over the Company's business, have the power to elect its directors and indirectly control decisions such as whether to issue additional shares, declare and pay dividends or enter into significant corporate transactions. A majority of the class B common stock is owned by Michael D. Hays, our Chief Executive Officer.

 

As of February 21, 2014, approximately 54% of the outstanding class B common stock and approximately 26% of the outstanding class A common stock was beneficially owned by Mr. Hays, and that collectively constitutes approximately 52% of the Company's total voting power. 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 the 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, 2013, 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.

  

 
11

 

 

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.

 

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.

  

 
12

 

 

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.

 

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 note is secured by this property, among other things.

 

The Company is leasing 4,000 square feet of office space in Markham, Ontario, 5,100 square feet of office space in San Diego, California, 3,300 square feet of office space in Lincoln, Nebraska, 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

 

In May 2013, the Company consummated a recapitalization (the “May 2013 Recapitalization”) pursuant to which the Company established two classes of common stock (class A common stock and class B common stock), issued a dividend of three shares of class A common stock for each share of the Company’s then existing common stock and reclassified each then existing share of common stock as one-half of one share of class B common stock. Following the May 2013 Recapitalization, the Company’s class A common stock and the Company’s class B common stock are traded on the NASDAQ Global Market under the symbols “NRCIA” and “NRCIB,” respectively.

 

The following table sets forth the range of high and low sales prices for, and dividends declared on, the Company’s pre-May 2013 Recapitalization common stock and the post-May 2013 Recapitalization class A common stock and class B common stock for the period from January 1, 2012, through December 31, 2013:

 

Pre –May 2013 Recapitalization (a):

 

High

   

Low

   

Dividends Declared Per Prior Common Share

 

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  

2013 Quarter Ended:

                       

March 31

  $ 61.58     $ 50.00     $ 0.31  

April 1 to May 22

  $ 64.36     $ 53.45       --  

 

        Class A     Class B  

Post –May 2013 Recapitalization:

 

High

   

Low

   

Dividends

Declared Per 

 Common Share

   

High

   

Low

   

Dividends

Declared Per

Common Share

 

2013 Quarter Ended:

                                               

May 23 to June 30

  $ 21.31     $ 12.36       --     $ 46.52     $ 18.24       --  

September 30

  $ 18.84     $ 15.36       --     $ 42.48     $ 26.61       --  

December 31

  $ 19.00     $ 15.69       --     $ 36.88     $ 27.25       --  

 

(a) Sales prices and dividends have not been adjusted to give effect to the May 2013 Recapitalization described above.


Cash dividends of $2.1 million and $17.4 million in the aggregate were declared and paid during the twelve-month periods ended December 31, 2013 and 2012, respectively. In August 2013, the Company’s Board of Directors decided to suspend the payment of cash dividends through the year 2014. The payment and amount of future dividends, if any, 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, alternative uses of the Company’s earnings and other factors.

 

On February 21, 2014, there were approximately 25 shareholders of record and approximately 1,015 beneficial owners of the class A common stock and approximately 17 shareholders of record and approximately 1,197 beneficial owners of the class B common stock.

 

In February 2006, the Board of Directors of the Company authorized the repurchase of 2,250,000 shares of class A common stock and 375,000 shares of class B common stock (on a post-May 2013 Recapitalization basis) in the open market or in privately negotiated transactions. Unless terminated earlier by resolution of the Company’s Board of Directors, the repurchase program will expire when the Company has repurchased all shares authorized for repurchase thereunder. As of February 21, 2014, 610,417 shares of the Company’s prior common stock (now equivalent to 1,831,251 shares of class A common stock and 305,208 shares of class B common stock) have been repurchased under that authorization. No stock was repurchased during the three-month period ended December 31, 2013.

 

 
14

 

 

The following graph compares the cumulative 5-year total return provided shareholders on the Company’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, 2008 (or on May 23, 2013 for our class A common stock which was the first day it was traded), and its relative performance is tracked through December 31, 2013. In accordance with Securities and Exchange Commission guidance, in calculating the cumulative 5-year total return on our class B common stock, we gave retroactive effect to the May 2013 Recapitalization (i.e., as if it had occurred on December 31, 2008).

 

 

 

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.

 

   

12/08

   

12/09

   

12/10

   

12/11

   

12/12

   

5/23/2013

   

12/13

 
                                                         

National Research Corporation- Class A

    ---       ---       ---       ---       ---       100.00       94.10  

National Research Corporation- Class B

    100.00       73.46       125.23       145.69       214.12       ---       250.71  

NASDAQ Composite

    100.00       144.88       170.58       171.30       199.99       ---       283.39  

Russell 2000

    100.00       127.17       161.32       154.59       179.86       ---       249.69  

 

 
15

 

  

Item 6.     Selected Financial Data

 

The selected statement of income data for the years ended December 31, 2013, 2012, and 2011, and the selected balance sheet data at December 31, 2013 and 2012, 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 year ended December 31, 2010 and 2009, and the balance sheet data at December 31, 2011, 2010 and 2009, are derived from audited consolidated financial statements not included herein. The Company acquired Outcome Concept Systems on August 3, 2010, and My InnerView (“MIV”) on December 19, 2009.

 

   

Year Ended December 31, (a)

 
   

2013

   

2012

   

2011

   

2010

   

2009

 
   

(In thousands, except per share data)

 

Statement of Income Data:

                                       

Revenue

  $ 92,590     $ 86,421     $ 75,767     $ 63,398     $ 57,692  

Operating expenses:

                                       

Direct

    38,844       35,461       28,667       24,635       24,148  

Selling, general and administrative

    25,208       23,542       23,300       20,202       16,016  

Depreciation and amortization

    3,732       4,699       5,065       4,704       3,831  

Total operating expenses

    67,784       63,702       57,032       49,541       43,995  

Operating income

    24,806       22,719       18,735       13,857       13,697  

Other expense

    (318 )     (512 )     (575 )     (542 )     (580 )

Income before income taxes

    24,488       22,207       18,160       13,315       13,117  

Provision for income taxes

    9,004       7,139       6,596       4,816       4,626  

Net income

  $ 15,484     $ 15,068     $ 11,564     $ 8,499     $ 8,491  

Earnings per share common stock:

                                       

Basic Earnings per share:

                                       

Class A

  $ 0.37     $ 0.37     $ 0.29     $ 0.21     $ 0.21  

Class B

  $ 2.25     $ 2.22     $ 1.73     $ 1.28     $ 1.28  

Diluted Earnings per share:

                                       

Class A

  $ 0.37     $ 0.36     $ 0.28     $ 0.21     $ 0.21  

Class B

  $ 2.20     $ 2.17     $ 1.69     $ 1.26     $ 1.26  
                                         
Weighted average share and share equivalents outstanding:                                        

Class A - basic

    20,677       20,325       20,016       19,912       19,910  

Class B - basic

    3,447       3,388       3,336       3,319       3,318  

Class A - diluted

    21,099       20,854       20,526       20,207       20,170  

Class B - diluted

    3,514       3,476       3,421       3,368       3,362  

 

    December 31,  
   

2013

   

2012

   

2011

   

2010

   

2009

 
   

(In thousands)

 

Balance Sheet Data:

                                       

Working capital surplus (deficiency)

  $ 12,784     $ (11,483 )   $ (2,262 )   $ (8,809 )   $ (4,432 )

Total assets

    110,996       100,046       100,676       95,770       72,499  

Total debt and capital lease obligations, including current portion

    10,546       12,763       14,912       16,599       7,719  

Total shareholders’ equity

  $ 71,755     $ 56,742     $ 55,554     $ 48,584     $ 44,171  

 

 

 

(a)

All share and per share data have been retroactively adjusted to give effect to the May 2013 Recapitalization as further described in Note 1 to the accompanying consolidated financial statements.

  

 
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.

 

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 2013 include:

 

 

● 

Revenue recognition;

 

 

Valuation of goodwill and identifiable intangible assets; and

 

 

Income taxes.

 

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.

  

 
17

 

  

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) with a client may include combinations of performance measurement and improvement services, healthcare analytics or governance education services which may be executed at the same time, or within close proximity of one another (referred to as a multiple-element arrangement). Each element of a multiple-element arrangement is accounted for as a separate unit of accounting provided each delivered element is sold separately by the Company or another vendor; and for an arrangement that includes a general right of return relative to the undelivered elements, delivery or performance of the undelivered services are considered probable and substantially in the control of the Company. The Company’s arrangements generally do not include a general right of return related to the delivered services. If these criteria are not met, the arrangement is accounted for as a single unit of accounting with revenue generally recognized equally over the subscription period or recognized under the proportional performance method.

 
Revenue is allocated to each separate unit of accounting based on relative selling price using a selling price hierarchy: VSOE, if available, third-party evidence (“TPE”) if VSOE is not available, or estimated selling price if VSOE nor TPE is available. VSOE is established based on the services normal selling price and discounts for the specific services when sold separately. TPE is established by evaluating similar competitor services in standalone arrangements. If neither exists for a deliverable, the best estimate of the selling price (“ESP”) 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. Revenue allocated to an element is limited to revenue that is not subject to refund or otherwise represents contingent revenue. VSOE, TPE, and ESP are periodically adjusted to reflect current market conditions. These adjustments are not expected to differ significantly from historical results.

  

 
18

 

 

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 impairment related to our indefinite-lived intangible assets during 2013, 2012, or 2011.

 

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 is not 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 Company performs 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.

 

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. 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.

  

 
19

 

 

The Company performed a qualitative analysis as of October 1, 2013, which did not indicate that it was more likely than not that the carrying values of the reporting units exceeded fair value. No impairments were recorded during the years ended December 31, 2013, 2012 or 2011.

 

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)

 
   

2013

   

2012

   

2011

   

2013 over 2012

   

2012 over 2011

 
                                         

Revenue

    100.0 %     100.0 %     100.0 %     7.1 %     14.1 %

Operating expenses:

                                       

Direct

    42.0       41.0       37.8       9.5       23.7  

Selling, general and administrative

    27.2       27.2       30.8       7.1       1.0  

Depreciation and amortization

    4.0       5.4       6.7       (20.6 )     (7.2 )

Total operating expenses

    73.2       73.7       75.3       6.4       11.7  

Operating income

    26.8 %     26.3 %     24.7 %     9.2 %     21.3 %

 

Year Ended December 31, 2013, Compared to Year Ended December 31, 2012

 

Revenue. Revenue increased 7.1% in 2013 to $92.6 million from $86.4 million in 2012 which was driven by a combination of continued gains in market share and vertical growth in our existing client base. Revenue from subscription-based agreements comprised 81.9% of the total revenue for the year ended December 31, 2013 compared to 76.0% of the total revenue for the year ended December 31, 2012.

 

Direct expenses. Direct expenses increased 9.5% to $38.8 million in 2013 from $35.5 million in 2012. 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 included postage and contracted survey-related costs to service the higher volume of business, and an increase in fixed expenses of $1.8 million from additional investments in technology, research and service resources. Direct expenses increased as a percentage of revenue to 42.0% in the year ended December 31, 2013, from 41.0% during the same period of 2012. Variable expenses as percentage of revenue were 0.2% of the change due to higher survey volumes for the subscription-based products, and fixed expenses were 0.8% of the change due to investments in technology, research and service resources. The Company expects this percentage to continue at a similar rate for 2014.

 

Selling, general and administrative expenses. Selling, general and administrative expenses increased 7.1% to $25.2 million in 2013 from $23.5 million in 2012 mainly due to additional expense in share based compensation, increases in annual software license fees and costs from the May 2013 Recapitalization, which were partially offset by decreased incentive payments and marketing costs. Selling, general, and administrative expenses remained constant as a percentage of revenue at 27.2% for each of the years ended December 31, 2013 and 2012 due to the leveraging of selling, general and administrative expenses against increased revenue. This percentage is projected to be approximately 26% of revenue in 2014.

 

Depreciation and amortization. Depreciation and amortization expenses decreased 20.6% to $3.7 million in 2013 from $4.7 million in 2012. This decrease was a result of a large software development project becoming fully depreciated and intangibles associated with an acquisition becoming fully amortized. Depreciation and amortization expenses as a percentage of revenue decreased to 4.0% in 2013 from 5.4% in 2012. The Company expects this percentage to continue at a similar rate for 2014.

 

Provision for income taxes. The provision for income taxes totaled $9.0 million (36.8% effective tax rate) for 2013, compared to $7.1 million (32.1% effective tax rate) for 2012. The effective tax rate for the year ended December 31, 2013, is higher than the rate in the same period of 2012 primarily due to an adjustment to income taxes of $575,000 for decreases in deferred state tax rates resulting from legislative changes in 2012 and nondeductible fees associated with the May 2013 Recapitalization that are part of the annualized effective rate.

  

 
21

 

 

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.

 

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.

 

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.

 

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.

 

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

 

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

 

 
22

 

 

The Company will make capital contributions up to $2.5 million on an as-needed basis as determined by the Board of Directors of Connect. Additionally, the Company has a future obligation to purchase the other equity units in Connect when certain targeted events have been achieved. If, at any time, Connect has at least $12.5 million of annual recurring contract value, including the NRC contracts being serviced, and the members have approved a financial statement showing a pro forma minimum 35% EBITDA margin for revenue on a going-forward basis, then within 90 days thereafter NRC is required to purchase from the other members, and the other members shall be required to sell to NRC, all of their equity units not owned by NRC. As of December 31, 2013, the price at which the other members had the obligation to sell their equity units to NRC was $0.

 

As of December 31, 2013, our principal sources of liquidity included $22.1 million of cash and cash equivalents and up to $6.5 million of unused borrowings under our revolving credit note. Of this cash, $7.5 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, 2013, that an additional tax liability of $705,000 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.

 

Working Capital

 

The Company had a working capital surplus of $12.8 million on December 31, 2013, compared to a $11.5 million working capital deficiency on December 31, 2012. The change in the working capital balance was primarily due to the refinancing of the Company’s term notes in May 2013, which now have the final term note payments in April 2018. Additionally, the Company has not declared cash dividends since March 2013, and has temporarily suspended dividend payments in order maximize cash for possible investment opportunities. One such investment was made in Connect in June 2013. The deferred revenue balances as of December 31, 2013 and December 31, 2012, were $13.9 million and $15.8 million, respectively.

 

The deferred revenue balance is primarily due to timing of initial billings on new and renewal contracts. The Company typically invoices clients for 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,

 
   

2013

   

2012

   

2011

 
   

(In thousands)

 

Provided by operating activities

  $ 19,315     $ 19,132     $ 18,481  

Used in investing activities

    (2,188 )     (2,348 )     (6,927 )

Used in financing activities

    (2,824 )     (16,687 )     (6,886 )

Effect of exchange rate changes on cash

    (497 )     107       (105 )

Net increase in cash and cash equivalents

    13,806       204       4,563  

Cash and cash equivalents at end of period

  $ 22,092     $ 8,286     $ 8,082  

  

 
23

 

  

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 $19.3 million for the year ended December 31, 2013, which included net income of $15.5 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 $4.8 million. Changes in working capital decreased 2013 cash flows from operating activities by $1.0 million, primarily due to timing of billings on new or renewal contracts decreasing cash flows provided from deferred revenue and unbilled revenue offset by increases in trade accounts receivable. The cash flows decrease was partially offset by timing of payments on accounts payable and accrued expenses, wages, bonus and profit sharing.

 

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.

 

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.

 

Cash Flows from Investing Activities

 

Net cash of $2.2 million was used for investing activities in the year ended December 31, 2013. Purchases of property and equipment totaled the $2.2 million.

 

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.

 

Cash Flows from Financing Activities

 

Net cash used in financing activities was $2.8 million in the year ended December 31, 2013. Proceeds from the exercise of stock options and the excess tax benefit of share-based compensation provided cash of $840,000 and $755,000, respectively, partially offset by repurchases of shares for payroll tax withholdings related to share-based compensation of $55,000. Cash was used to pay dividends of $2.1 million. Cash was also used to repay borrowings under the term note totaling $2.1 million and capital lease obligations of $110,000.

  

 
24

 

 

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 $108,000.

 

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.

 

The effect of changes in foreign exchange rates increased (decreased) cash and cash equivalents by ($497,000), $107,000, and ($105,000) in the years ended December 31, 2013, 2012, and 2011, respectively.

 

Capital Expenditures

 

Capital expenditures for the year ended December 31, 2013, were $2.2 million. These expenditures consisted mainly of computer software, computer hardware, furniture and other equipment. The Company expects similar capital expenditure purchases in 2014 consisting primarily of computer software and hardware and other equipment, to be funded through cash generated from operations.

 

Debt and Equity

 

The Company had two term notes, which were used to partially finance acquisitions in 2008 and 2010. Borrowings under the term notes bore interest at an annual rate of 3.79%. The Company refinanced these two term notes on May 9, 2013, and combined them into one new term note. The new term note is payable in 60 monthly installments of $212,468. Borrowings under the new term note bear interest at an annual rate of 3.12%. The outstanding balance of the new term note at December 31, 2013, was $10.3 million.

 

The Company also has a revolving credit note that was renewed in May 2013 to extend the term to June 30, 2014. The Company may borrow, repay and re-borrow amounts under the revolving credit note from time to time until its maturity on June 30, 2014. This revolving credit note provides for the maximum aggregate borrowings of $6.5 million, subject to a borrowing base equal to 75.0% of the Company’s eligible accounts receivable. Borrowings under the 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”) or (2) 2.2% plus the one-, two-, three-, six- or twelve-month LIBOR rate, or (3) the bank’s one-, two-, three-, six- or twelve-month Money Market Loan Rate. The rate at December 31, 2013 was 2.67%. As of December 31, 2013, 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, 2013. The Company expects to renew the revolving credit note prior to June 30, 2014. If, however, the revolving credit note cannot be renewed, the Company believes it has adequate cash from operations to meet its debt and capital needs.

 

The term note and revolving credit note are secured by certain of the Company’s assets, including the Company’s land, building, accounts receivable and intangible assets. The term note 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, 2013, the Company was in compliance with these restrictions and covenants.

  

 
25

 

 

The Company has capital leases for computer equipment, office equipment, and inserting equipment. The balance of the capital leases as of December 31, 2013 was $222,000.

 

Contractual Obligations

 

The Company had contractual obligations to make payments in the following amounts in the future as of December 31, 2013:

 

Contractual Obligations(1)

 

Total

Payments

   

Less than

One Year

   

One to

Three Years

   

Three to

Five Years

   

After

Five Years

 

(In thousands)

                                       

Operating leases

  $ 2,582     $ 782     $ 1,260     $ 526     $ 14  

Capital leases

    250       137       113       --       --  

Uncertain tax positions(2)

    --       --       --       --       --  

Long-term debt

    11,017       2,505       7,649       863       --  

Total

  $ 13,849     $ 3,424     $ 9,022     $ 1,389     $ 14  

 

(1) Amounts are inclusive of interest payments, where applicable.
(2) We have $193,000 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 $15.0 million to $71.8 million in 2013, from $56.7 million in 2012. The increase was primarily due to net income of $15.5 million, $1.7 million of related share-based compensation, and $1.0 million from the exercise of options partially offset by dividends paid of $2.1 million.

 

Stock Repurchase Program

 

In February 2006, the Board of Directors of the Company authorized the repurchase of 2,250,000 shares of class A common stock and 375,000 shares of class B common stock (on a post-May 2013 Recapitalization basis) in the open market or in privately negotiated transactions. As of December 31, 2013, the remaining number of shares that could be purchased under this authorization was 418,749 shares of class A common stock and 69,791 shares of class B common stock.

 

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.”

 

Recent Accounting Pronouncements

 

There have been no new accounting pronouncements not yet effective or adopted that have significance or potential significance to the consolidated financial statements at December 31, 2013. 

  

 
26

 

 

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 ($822,000), $217,000, and ($201,000) in 2013, 2012, and 2011, 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. A portion of our cash in our Canadian subsidiary is denominated in foreign currencies, where fluctuations in exchange rates will impact our cash balances in U.S. dollar terms. A sensitivity analysis assuming a hypothetical 100 basis point movement in the value of the U.S. dollar would impact our reported cash balance by approximately $0.8 million. We have not entered into any foreign currency hedging transactions. We do not purchase or hold any derivative financial instruments for the purpose of speculation or arbitrage.

 

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, 2013, our fixed-rate term debt totaled $10.3 million. Based on a sensitivity analysis, a one percent change in market interest rates as of December 31, 2013, would not have a material effect on the estimated fair value of our fixed-rate debt outstanding at December 31, 2013.

 

Borrowings under our revolving credit note bear interest at a variable annual rate, with three rate options at the discretion of management. Borrowings under the revolving credit note may not exceed the lesser of a calculated borrowing base or $6.5 million. There were no borrowings outstanding under our revolving credit note at December 31, 2013, or at any time during 2013. 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 credit note 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, 2013. 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) (1)

 
   

Quarter Ended

 
   

Dec. 31, 2013

   

Sept 30, 2013

   

June 30, 2013

   

Mar. 31, 2013

   

Dec. 31, 2012

   

Sept 30, 2012

   

June 30, 2012

   

Mar. 31, 2012

 
                                                                 

Revenue

  $ 22,923     $ 22,407     $ 22,354     $ 24,906     $ 21,996     $ 21,386     $ 20,632     $ 22,407  

Direct expenses

    9,648       9,452       9,498       10,246       9,128       8,769       8,633       8,931  

Selling, general and administrative expenses

    6,305       6,019       6,391       6,493       6,001       5,821       5,569       6,151  

Depreciation and amortization

    944       907       931       950       1,093       1,149       1,214       1,243  

Operating income

    6,026       6,029       5,534       7,217       5,774       5,647       5,216       6,082  

Other expense

    (82 )     (81 )     (71 )     (84 )     (100 )     (155 )     (105 )     (152 )

Provision for income taxes

    2,177       2,135       2,029       2,663       1,971       1,915       1,172       2,081  

Net income

  $ 3,767     $ 3,813     $ 3,434     $ 4,470     $ 3,703     $ 3,577     $ 3,939     $ 3,849  

Earnings per share of common stock:

                                                               

Basic earnings per share

                                                               

Class A

  $ 0.09     $ 0.09     $ 0.08     $ 0.11     $ 0.09     $ 0.09     $ 0.10     $ 0.10  

Class B

  $ 0.55     $ 0.55     $ 0.50     $ 0.65     $ 0.54     $ 0.53     $ 0.58     $ 0.57  

Dilutive earnings per share

                                                               

Class A

  $ 0.09     $ 0.09     $ 0.08     $ 0.11     $ 0.09     $ 0.09     $ 0.09     $ 0.09  

Class B

  $ 0.54     $ 0.54     $ 0.49     $ 0.64     $ 0.53     $ 0.51     $ 0.57     $ 0.56  

Weighted average shares outstanding – basic

                                                               

Class A

    20,692       20,672       20,672       20,669       20,513       20,373       20,254       20,157  

Class B

    3,452       3,445       3,445       3,445       3,419       3,395       3,376       3,360  

Weighted average shares outstanding - diluted

                                                               

Class A

    21,137       21,111       21,085       21,063       20,959       20,883       20,829       20,721  

Class B

    3,514       3,514       3,516       3,511       3,493       3,480       3,471       3,454  

 

 

(1)

All share and per share data have been retroactively adjusted to give effect to the May 2013 Recapitalization as further described in Note 1 to the accompanying consolidated financial statements.

  

 
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, 2013 and 2012, 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, 2013. In connection with our audits of the consolidated financial statements, we also have audited 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, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, 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, 2013, based on criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 4, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

 

/s/ KPMG LLP

 

Lincoln, Nebraska
March 4, 2014

  

 
29

 

  

NATIONAL RESEARCH CORPORATION AND SUBSIDIARY

Consolidated Balance Sheets
(In thousands, except share amounts)

 

Assets

 

2013

   

2012

 

Current assets:

               

Cash and cash equivalents

  $ 22,092     $ 8,286  

Trade accounts receivable, less allowance for doubtful accounts of $183 and $244, respectively

    11,043       12,119  

Unbilled revenue

    1,282       932  

Prepaid expenses

    1,310       1,269  

Income taxes receivable

    265       158  

Deferred income taxes

    53       547  

Other current assets

    429       504  

Total current assets

    36,474       23,815  
                 

Net property and equipment

    11,898       12,493  

Intangible assets, net

    4,840       5,794  

Goodwill

    57,593       57,799  

Other

    191       145  
                 

Total assets

  $ 110,996     $ 100,046  
                 

Liabilities and Shareholders’ Equity

               

Current liabilities:

               

Current portion of notes payable

  $ 2,256     $ 12,436  

Accounts payable

    654       291  

Accrued wages, bonus and profit sharing

    4,319       4,392  

Accrued expenses

    2,462       2,265  

Current portion of capital lease obligations

    114       102  

Deferred revenue

    13,885       15,812  

Total current liabilities

    23,690       35,298  
                 

Notes payable, net of current portion

    8,068       -  

Deferred income taxes

    7,132       7,527  

Deferred revenue

    243       254  

Capital lease obligations, net of current portion

    108       225  

Total liabilities

    39,241       43,304  
                 

Shareholders’ equity:

               

Preferred stock, $0.01 par value, authorized 2,000,000 shares, none issued

    --       --  

Class A Common stock, $0.001 par value; authorized 60,000,000 shares, issued 25,285,029 in 2013 and 25,129,776 in 2012, outstanding 20,768,784 in 2013 and 20,624,976 in 2012

    25       25  

Class B Common stock, $0.001 par value; authorized 80,000,000 shares, issued 4,220,117 in 2013 and 4,188,296 in 2012, outstanding 3,467,410 in 2013 and 3,437,496 in 2012

    4       4  

Additional paid-in capital

    42,192       39,493  

Retained earnings

    58,042       44,700  

Accumulated other comprehensive income, foreign currency translation adjustment

    302       1,124  

Treasury stock, at cost; 4,516,245 Class A shares, 752,707 Class B shares in 2013 and 4,504,800 Class A shares, 750,800 Class B shares in 2012

    (28,810 )     (28,604 )

Total shareholders’ equity

    71,755       56,742  
                 

Total liabilities and shareholders’ equity

  $ 110,996     $ 100,046  

 

See accompanying notes to consolidated financial statements.

 

 
30

 

 

NATIONAL RESEARCH CORPORATION AND SUBSIDIARY

Consolidated Statements of Income
(In thousands, except for per share amounts)

 

   

2013

   

2012

   

2011

 
                         

Revenue

  $ 92,590     $ 86,421     $ 75,767  
                         

Operating expenses:

                       

Direct

    38,844       35,461       28,667  

Selling, general and administrative

    25,208       23,542       23,300  

Depreciation and amortization

    3,732       4,699       5,065  

Total operating expenses

    67,784       63,702       57,032  
                         

Operating income

    24,806       22,719       18,735  
                         

Other income (expense):

                       

Interest income

    63       32       13  

Interest expense

    (397 )     (541 )     (629 )

Other, net

    16       (3 )     41  
                         

Total other expense

    (318 )     (512 )     (575 )
                         

Income before income taxes

    24,488       22,207       18,160  
                         

Provision for income taxes

    9,004       7,139       6,596  
                         

Net income

  $ 15,484     $ 15,068     $ 11,564  
                         

Earnings per share of common stock:

                       
Basic earnings per share:                        

Class A

  $ 0.37     $ 0.37     $ 0.29  

Class B

  $ 2.25     $ 2.22     $ 1.73  

Diluted earnings per share:

                       
Class A   0.37     0.36     0.28  

Class B

  $ 2.20     $ 2.17     $ 1.69  
                         

Weighted average shares and share equivalents outstanding

                       
Class A - basic     20,677       20,325       20,016  

Class B - basic

    3,447       3,388       3,336  

Class A - diluted

    21,099       20,854       20,526  

Class B - diluted

    3,514       3,476       3,421  

  

See accompanying notes to consolidated financial statements.

 

 
31

 

 

NATIONAL RESEARCH CORPORATION AND SUBSIDIARY

Consolidated Statements of comprehensive income
(In thousands)

 

   

2013

   

2012

   

2011

 
                         

Net Income

  $ 15,484     $ 15,068     $ 11,564  
                         

Other comprehensive income (loss):

                       

Cumulative translation adjustment

  $ (822 )   $ 217     $ (201 )

Other comprehensive income (loss)

  $ (822 )   $ 217     $ (201 )
                         

Comprehensive Income

  $ 14,662     $ 15,285     $ 11,363  

 

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 A
 
    Common
Stock B
    Additional
Paid-in
Capital
    Retained
 Earnings
   

Accumulated

Other
Comprehensive
   Income

   

Treasury

Stock

    Total  
                                                         

Balances at December 31, 2010

  $ 24     $ 4     $ 28,950     $ 41,343     $ 1,108     $ (22,845 )   $ 48,584  

Purchase of 51,864 A and 8,644 B shares of treasury stock

    --       --       --       --       --       (591 )     (591 )

Issuance of 176,013 A and 29,336 B 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 42,969 A and 7,162 B restricted common shares, net of forfeitures

    --       --       --       --       --       --       --  

Non-cash stock compensation expense

    --       --       763       --       --       --       763  

Dividends declared of $0.15 and $.0.88 per A and B common share, respectively

    --       --       --       (5,912 )     --       --       (5,912 )

Other comprehensive loss, foreign currency translation adjustment

    --       --       --       --       (201 )     --       (201 )

Net income

    --       --       --       11,564       --       --       11,564  

Balances at December 31, 2011

  $ 24     $ 4     $ 31,060     $ 46,995     $ 907     $ (23,436 )   $ 55,554  

Purchase of 324,093 A and 54,015 B shares of treasury stock

    --       --       --       --       --       (5,168 )     (5,168 )

Issuance of 786,303 class A common shares and 131,051 class B shares for the exercise of stock options

    1       --       5,967       --       --       --       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 (10,074 class A and 1,679 class B)

    --       --       --       --       --       --       --  

Non-cash stock compensation expense

    --       --       388       --       --       --       388  

Dividends declared of $0.42 and $2.54 per A and B common share, respectively

    --       --       --       (17,363 )     --       --       (17,363 )