NATIONAL RESEARCH CORP - Quarter Report: 2018 September (Form 10-Q)

 

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		September 30, 2018				December 31, 2017
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	7,273			$	34,733
Trade accounts receivable, less allowance for doubtful accounts of $197 and $200, respectively			16,544				14,806
Prepaid expenses			3,674				2,310
Income taxes receivable			1,001				375
Other current assets			278				35
Total current assets			28,770				52,259
Net property and equipment			14,269				12,359
Intangible assets, net			2,260				2,764
Goodwill			57,955				58,021
Deferred contract costs, net			3,371				--
Other			2,092				1,913
Total assets		$	108,717			$	127,316
Liabilities and Shareholders’ Equity
Current liabilities:
Current portion of notes payable		$	3,623			$	1,067
Accounts payable			839				593
Accrued wages, bonus and profit sharing			4,586				6,597
Accrued expenses			3,266				2,882
Current portion of capital lease obligations			202				71
Income taxes payable			70				--
Dividends payable			4,209				4,222
Deferred revenue			18,642				16,878
Total current liabilities			35,437				32,310
Notes payable, net of current portion			35,109				-
Deferred income taxes			6,599				4,030
Other long term liabilities			1,433				935
Total liabilities			78,578				37,275
Shareholders’ equity:
Preferred stock, $0.01 par value, authorized 2,000,000 shares, none issued			--				--
Common Stock (formerly Class A), $0.001 par value; authorized 60,000,000 shares, issued 29,830,307 in 2018 and 25,835,230 in 2017, outstanding 24,762,212 in 2018 and 20,936,703 in 2017			30				26
Class B Common stock, $0.001 par value; 4,319,256 issued and 3,535,238 outstanding in 2017			--				4
Additional paid-in capital			156,384				51,025
Retained earnings (accumulated deficit)			(97,027	)			77,574
Accumulated other comprehensive (loss) income			(2,053	)			(1,635	)
Treasury stock, at cost; 5,068,095 Common (formerly Class A) shares in 2018 and 4,898,527 in 2017 and 784,018 Class B shares in 2017			(27,195	)			(36,953	)
Total shareholders’ equity			30,139				90,041
Total liabilities and shareholders’ equity		$	108,717			$	127,316

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		Three months ended September 30,								Nine months ended September 30,
		2018				2017				2018				2017
Revenue		$	30,013			$	28,951			$	89,047			$	87,661
Operating expenses:
Direct			11,780				12,267				35,685				36,706
Selling, general and administrative			7,679				8,430				23,486				22,021
Depreciation and amortization			1,388				1,132				3,996				3,376
Total operating expenses			20,847				21,829				63,167				62,103
Operating income			9,166				7,122				25,880				25,558
Other income (expense):
Interest income			3				29				57				58
Interest expense			(544	)			(18	)			(990	)			(68	)
Other, net			(242	)			40				222				76
Total other (expense) income			(783	)			51				(711	)			66
Income before income taxes			8,383				7,173				25,169				25,624
Provision for income taxes			1,391				3,020				2,923				9,198
Net income		$	6,992			$	4,153			$	22,246			$	16,426
Earnings Per Share of Common Stock:
Basic Earnings Per Share:
Common (formerly Class A)		$	0.28			$	0.10			$	0.76			$	0.39
Class B		$	--			$	0.59			$	1.31			$	2.34
Diluted Earnings Per Share:
Common (formerly Class A)		$	0.27			$	0.09			$	0.73			$	0.38
Class B		$	--			$	0.57			$	1.27			$	2.28
Dividends Per Share of Common Stock:
Common (formerly Class A)		$	0.17			$	0.10			$	0.44			$	0.30
Class B		$	--			$	0.60			$	0.60			$	1.80
Weighted average shares and share equivalents outstanding:
Common (formerly Class A) – basic			24,671				20,788				23,184				20,759
Class B – basic			--				3,514				3,527				3,514
Common (formerly Class A) – diluted			25,526				21,740				24,083				21,537
Class B – diluted			--				3,620				3,628				3,595

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		Three months ended September 30,								Nine months ended September 30,
		2018				2017				2018				2017
Net income		$	6,992			$	4,153			$	22,246			$	16,426
Other comprehensive income:
Foreign currency translation adjustment			280				599				(418	)			1,098
Other comprehensive income		$	280			$	599			$	(418	)		$	1,098
Comprehensive Income		$	7,272			$	4,752			$	21,828			$	17,524

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		Common Stock (formerly Class A)				Class B Common Stock				Additional Paid-in Capital				Retained Earnings (Accumulated deficit)				Accumulated Other Comprehensive Income(Loss)				Treasury Stock				Total
Balances at December 31, 2017		$	26			$	4			$	51,025			$	77,574			$	(1,635	)		$	(36,953	)		$	90,041
Purchase of 169,568 shares of class A and 3,677 shares of class B treasury stock			--				--				--				--				--				(6,141	)			(6,141	)
Issuance of 380,958 class A common shares and 9,296 class B common shares for the exercise of stock options			--				--				5,429				--				--				--				5,429
Issuance of restricted common shares, net of forfeitures (3,496 class A shares)			--				--				--				--				--				--				--
Non-cash stock compensation expense			--				--				1,255				--				--				--				1,255
Settlement of restricted common shares and stock options in connection with Recapitalization for cash of $3,271 and 90,369 class A common shares			-				--				(2,548	)			--				--				(723	)			(3,271	)
Settlement of class B common shares in connection with Recapitalization (3,527,246 class B common shares exchanged for $69,099 cash and 3,527,246 class A common shares)			4				--				118,335				--				--				(187,438	)			(69,099	)
Retirement of class B common shares in connection with Recapitalization (retirement of 4,328,552 class B common shares)			--				(4	)			(17,112	)			(186,944	)			--				204,060				--
Dividends declared of $0.44 and $0.60 per A and B common share, respectively			--				--				--				(12,638	)			--				--				(12,638	)
Cumulative effect adjustment for adoption of ASC 606			--				--				--				2,735				--				--				2,735
Other comprehensive income, foreign currency translation adjustment			--				--				--				--				(418	)			--				(418	)
Net income			--				--				--				22,246				--				--				22,246
Balances at September 30, 2018		$	30			$	--			$	156,384			$	(97,027	)		$	(2,053	)		$	(27,195	)		$	30,139

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		Nine months ended
		September 30,
		2018				2017
Cash flows from operating activities:
Net income		$	22,246			$	16,426
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			3,996				3,376
Deferred income taxes			1,775				184
Reserve for uncertain tax positions			(297	)			112
Non-cash share-based compensation expense			1,255				1,273
Loss on disposal of property and equipment			212				--
Net changes in assets and liabilities:
Trade accounts receivable			(1,842	)			(2,298	)
Prepaid expenses and other current assets			(1,632	)			(1,274	)
Deferred contract costs, net			1				--
Accounts payable			147				(108	)
Accrued expenses, wages, bonuses and profit sharing			(1,310	)			(293	)
Income taxes receivable and payable			(554	)			1,157
Deferred revenue			1,939				2,925
Net cash provided by operating activities			25,936				21,480
Cash flows from investing activities:
Purchases of equity investment			--				(1,300	)
Purchases of intangible Content License			--				(250	)
Purchases of property and equipment			(4,858	)			(3,347	)
Net cash used in investing activities			(4,858	)			(4,897	)
Cash flows from financing activities:
Payments related to Recapitalization			(72,370	)			--
Proceeds from issuance of note payable			40,000				--
Borrowings on line of credit			2,500				--
Payments on line of credit			(2,500	)			--
Payment of debt issuance costs			(187	)			--
Payments on notes payable			(2,170	)			(1,847	)
Payments on capital lease obligations			(104	)			(81	)
Payment of employee payroll tax withholdings on share-based awards exercised			(712	)			(105	)
Payment of dividends on common stock			(12,650	)			(12,649	)
Net cash used in financing activities			(48,193	)			(14,682	)
Effect of exchange rate changes on cash			(345	)			828
Change in cash and cash equivalents			(27,460	)			2,729
Cash and cash equivalents at beginning of period			34,733				33,021
Cash and cash equivalents at end of period		$	7,273			$	35,750
Supplemental disclosure of cash paid for:
Interest, net of capitalized amounts		$	767			$	65
Income taxes		$	2,017			$	7,749
Supplemental disclosure of non-cash investing and financing activities:
Common stock (formerly class A) issued in the Recapitalization in exchange for then-existing class B shares and options.		$	121,371			$	--
Capital lease obligations originated for property and equipment		$	879			$	74
Stock tendered to the Company for cashless exercise of stock options in connection with equity incentive plans		$	5,429			$	2,123

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1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Description of business and basis of presentation

 

National Research Corporation, doing business as NRC Health (“NRC Health,” the “Company,” “we,” “our,” “us” or similar terms), is a leading provider of analytics and insights that facilitate measurement and improvement of the patient and employee experience while also increasing patient engagement and customer loyalty for healthcare providers, payers and other healthcare organizations in the United States and Canada.

 

The Company’s six operating segments are aggregated into one reporting segment because they have similar economic characteristics and meet the other aggregation criteria from the Financial Accounting Standards Board (“FASB”) guidance on segment disclosure. The six operating segments are Experience, The Governance Institute, Market Insights, Transparency, NRC Health Canada and Transitions (formerly Connect), which offer a portfolio of solutions that address specific needs around market insight, experience, transparency and governance for healthcare providers, payers and other healthcare organizations.

 

The condensed consolidated balance sheet of the Company at December 31, 2017 was derived from the Company’s audited consolidated balance sheet as of that date. All other financial statements contained herein are unaudited and, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) the Company considers necessary for a fair presentation of financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States.

 

Information and footnote disclosures included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto that are included in the Company’s Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission (the “SEC”) on March 14, 2018.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, National Research Corporation Canada, doing business as NRC Health Canada. All significant intercompany transactions and balances have been eliminated.

 

The Company’s Canadian subsidiary uses as its functional currency the local currency of the country in which it operates. It translates its assets and liabilities into U.S. dollars at the exchange rate in effect at the balance sheet date. It translates its revenue and expenses at the average exchange rate during the period. The Company includes translation gains and losses in accumulated other comprehensive income (loss), a component of shareholders’ equity. Gains and losses related to transactions denominated in a currency other than the functional currency of the country in which the Company operates and short-term intercompany accounts are included in other income (expense) in the consolidated statements of income. 

Revenue Recognition

 

On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09, Revenue- Revenue from Contracts with Customers and all related amendments (“ASC 606” or “new revenue standard”) using the modified retrospective method for all incomplete contracts as of the date of adoption. The Company applied the practical expedient to reflect the total of all contract modifications occurring before January 1, 2018 in the transaction price and performance obligations at transition rather than accounting for each modification separately. Results for reporting periods beginning on or after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. As discussed in more detail below and under “Deferred Contract Costs”, the largest impact of implementing the new revenue standard was the deferral and amortization of direct and incremental costs of obtaining contracts. In addition, there were other revisions to the revenue recognition primarily related to performance obligation determinations and estimating variable consideration. The Company recorded a transition adjustment of approximately $2.7 million, net of $814,000 of tax, to the opening balance of retained earnings.

 

 

The Company derives a majority of its revenues from its annually renewable subscription-based service agreements with its customers, which include performance measurement and improvement services, healthcare analytics and governance education services. Such agreements are generally cancelable on short or no notice without penalty. See Note 3 for further information about the Company's contracts with customers. Under ASC 606, the Company accounts for revenue using the following steps:

 

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Identify the contract, or contracts, with a customer

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Identify the performance obligations in the contract

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Determine the transaction price

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Allocate the transaction price to the identified performance obligations

●

Recognize revenue when, or as, the Company satisfies the performance obligations.

 

The Company’s revenue arrangements with a client may include combinations of more than one service offering which may be executed at the same time, or within close proximity of one another. The Company combines contracts with the same customer into a single contract for accounting purposes when the contract is entered into at or near the same time and the contracts are negotiated together. For contracts that contain more than one separately identifiable performance obligation, the total transaction price is allocated to the identified performance obligations based upon the relative stand-alone selling prices of the performance obligations. The stand-alone selling prices are based on an observable price for services sold to other comparable customers, when available, or an estimated selling price using a cost-plus margin or residual approach. The Company estimates the amount of total contract consideration it expects to receive for variable arrangements based on the most likely amount it expects to earn from the arrangement based on the expected quantities of services it expects to provide and the contractual pricing based on those quantities. The Company only includes some or a portion of variable consideration in the transaction price when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. The Company considers the sensitivity of the estimate, its relationship and experience with the client and variable services being performed, the range of possible revenue amounts and the magnitude of the variable consideration to the overall arrangement.

 

Prior to 2018, total contract consideration was allocated to each separate unit of accounting that was separately sold by the Company or a competitor, based on relative selling price using a selling price hierarchy: vendor-specific objective evidence (“VSOE”), if available, third-party evidence (“TPE”) if VSOE was not available, or estimated selling price if VSOE nor TPE was available. VSOE was established based on the services normal selling prices and discounts for the specific services when sold separately. TPE was established by evaluating similar competitor services in standalone arrangements. If neither existed for a deliverable, the best estimate of the selling price (“ESP”) was 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 was limited to revenue that was not subject to refund or otherwise represented contingent revenue.

 

The Company’s arrangements with customers consist principally of four different types of arrangements: 1) subscription-based service agreements; 2) one-time specified services performed at a single point in time; 3) fixed, non-subscription service agreements; and 4) unit-priced service agreements.

 

Subscription-based services - Services that are provided under subscription-based service agreements are usually for a twelve month period and represent a single promise to stand ready to provide reporting, tools and services throughout the subscription period as requested by the customer. These agreements are renewable at the option of the customer at the completion of the initial contract term for an agreed upon price increase each year. These agreements represent a series of distinct monthly services that are substantially the same, with the same pattern of transfer to the customer as the customer receives and consumes the benefits throughout the contract period. Accordingly, subscription services are recognized ratably over the subscription period. Subscription services are typically billed annually in advance but may also be billed on a quarterly and monthly basis.

 

One-time services – These agreements typically require the Company to perform a specific one-time service in a particular month. The Company is entitled to fixed payment upon completion of the service. Under these arrangements, the Company recognizes revenue at the point in time the service is completed by the Company and accepted by the customer.

 

Fixed, non-subscription services – These arrangements typically require the Company to perform an unspecified amount of services for a fixed price during a fixed period of time. Revenues are recognized over time based upon the costs incurred to date in relation to the total estimated contract costs. In determining cost estimates, management uses historical and forecasted cost information which is based on estimated volumes, external and internal costs and other factors necessary in estimating the total costs over the term of the contract. Changes in estimates are accounted for using a cumulative catch up adjustment which could impact the amount and timing of revenue for any period. Prior to 2018, these arrangements were recognized under the proportional performance method based on cost inputs, output measures or key milestones such as survey set-up, survey mailings, survey returns and reporting.

 

 

Unit-price services – These arrangements typically require the Company to perform certain services on a periodic basis as requested by the customer for a per-unit amount which is typically billed in the month following the performance of the service. Revenue under these arrangements is recognized over the time the services are performed at the per-unit amount.

 

The Company recognizes contract assets or unbilled receivables related to revenue recognized for services completed but not invoiced to the clients. Unbilled receivables are classified as receivables when the Company has an unconditional right to contract consideration. A contract liability is recognized as deferred revenue when we invoice clients in advance of performing the related services under the terms of a contract. Deferred revenue is recognized as revenue when we have satisfied the related performance obligation.

 

The following tables summarize the impact the adoption of ASC 606 had on the Company’s consolidated financial statements (in thousands, except per share data):

 

Consolidated balance sheet:

 

 

Consolidated statement of income:

 

 

 

Consolidated statement of comprehensive income:

 

 

Consolidated statement of cash flows:

 

 

 

Deferred Contract Costs

 

Deferred contract costs, net is stated at gross deferred costs less accumulated amortization. Beginning January 1, 2018, with the adoption of the new revenue standard, the Company defers commissions and incentives, including payroll taxes, if they are incremental and recoverable costs of obtaining a renewable customer contract. Deferred contract costs are amortized over the estimated term of the contract, including renewals, which generally ranges from three to five years. The contract term was estimated by considering factors such as historical customer attrition rates and product life. The amortization period is adjusted for significant changes in the estimated remaining term of a contract.  An impairment of deferred contract costs is recognized when the unamortized balance of deferred contract costs exceeds the remaining amount of consideration the Company expects to receive less than the expected future costs directly related to providing those services.  The Company deferred incremental costs of obtaining a contract of $616,000 and $1.9 million in the three and nine months ended September 30, 2018, respectively. Total amortization was $614,000 and $1.9 million for the three and nine months ended September 30, 2018, respectively. Amortization of deferred contract costs included in direct expenses was $13,000 and $73,000 for the three and nine months ended September 30, 2018, respectively. Amortization of deferred contract costs included in selling, general and administrative expenses was $601,000 and $1.8 million for the three and nine months ended September 30, 2018, respectively. Additional expense included in selling, general and administrative expenses for impairment of costs capitalized due to lost clients was $12,000 and $31,000 in the three and nine months ended September 30, 2018, respectively. The Company has elected the practical expedient to expense contract costs when incurred for any nonrenewable contracts with a term of one year or less. Prior to 2018, all commissions and incentives were expensed as incurred. The Company recorded a transition adjustment on January 1, 2018 as an increase to retained earnings of $2.6 million, net of $776,000 of tax, to reflect $3.4 million of commissions and incentives related to contracts that began prior to 2018, net of accumulated amortization.

 

 

Fair Value Measurements

 

The Company’s valuation techniques are based on maximizing observable inputs and minimizing the use of unobservable inputs when measuring fair value. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. The inputs are then classified into the following hierarchy: (1) Level 1 Inputs—quoted prices in active markets for identical assets and liabilities; (2) Level 2 Inputs—observable market-based inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities in active markets, quoted prices for similar or identical assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data; and (3) Level 3 Inputs—unobservable inputs.

 

Commercial paper and Eurodollar deposits are included in cash equivalents and are valued at amortized cost, which approximates fair value due to their short-term nature. Eurodollar deposits are United States dollars deposited in a foreign bank branch of a United States bank and have daily liquidity. Both of these are included as a Level 2 measurement in the table below.

 

The following details the Company’s financial assets and liabilities within the fair value hierarchy at September 30, 2018 and December 31, 2017: 

 

Fair Values Measured on a Recurring Basis

 

 

There were no transfers between levels during the three month period ended September 30, 2018.

 

 

The Company's long-term debt is recorded at historical cost. The fair value of long-term debt is classified in Level 2 of the fair value hierarchy and was estimated based primarily on estimated current rates available for debt of the same remaining duration and adjusted for nonperformance and credit. The following are the carrying amount and estimated fair values of long-term debt:

 

 

The Company believes that the carrying amounts of trade accounts receivable, accounts payable and accrued expenses approximate their fair value due to the short maturity of those instruments. Long-lived assets that are not recognized or disclosed at fair value in the financial statements on a recurring basis, which includes property and equipment, goodwill, intangibles, and cost method investments are measured at fair value in certain circumstances (for example, when there is evidence of impairment). As of September 30, 2018, and December 31, 2017, there was no indication of impairment related to these assets.

 

Contingencies

From time to time, the Company is involved in certain claims and litigation arising in the normal course of business. Management assesses the probability of loss for such contingencies and recognizes a liability when a loss is probable and estimable.

 

Since the September 2017 announcement of the original proposed recapitalization plan (“Original Transaction”) (see Note 2), three purported class action and/or derivative complaints have been filed in state or federal courts by three individuals claiming to be shareholders of the Company. All of the complaints name as defendants the Company and the individual directors of the Company. Two of these lawsuits were filed in the United States District Court for the District of Nebraska— a putative class action lawsuit captioned Gennaro v. National Research Corporation, et al., which was filed on November 15, 2017, and a putative class and derivative action lawsuit captioned Gerson v. Hays, et al., which was filed on November 16, 2017. These lawsuits were consolidated by order of the federal court under the caption In re National Research Corporation Shareholder Litigation. A third lawsuit was filed in the Circuit Court for Milwaukee County, Wisconsin—a putative class action lawsuit captioned Apfel v. Hays, et al., which was filed on December 1, 2017. The allegations in all of the lawsuits were very similar. The plaintiffs alleged, among other things, that the defendants breached their fiduciary duties in connection with the allegedly unfair proposed transaction, at an allegedly unfair price, conducted in an allegedly unfair and conflicted process and in alleged violation of Wisconsin law and the Company’s Articles of Incorporation. The plaintiffs in these lawsuits sought, among other things, an injunction enjoining the defendants from consummating the Original Transaction, damages, equitable relief and an award of attorneys’ fees and costs of litigation. After the announcement of a revised proposed recapitalization plan (the “Recapitalization”), the plaintiffs abandoned their efforts to enjoin the transaction. However, the plaintiffs in In re National Research Corporation Shareholder Litigation in Nebraska filed an Amended Complaint on March 23, 2018 seeking damages for alleged breach of fiduciary duties in connection with the Original Transaction and alleged omission of material facts in the proxy statement relating to the Recapitalization. The plaintiffs in the Apfel case in Wisconsin filed an amended complaint on April 4, 2018 seeking damages for alleged breach of fiduciary duties in connection with the Original Transaction and the Recapitalization. The Company and its directors will defend themselves against these lawsuits vigorously, and have moved to dismiss both lawsuits. On September 9, 2018, the Wisconsin Circuit Court granted the defendants’ motion to dismiss, but judgment has not yet been entered. On October 9, 2018, the federal court in Nebraska granted the defendants’ motion to dismiss and entered judgment in the case the same day. As of September 30, 2018, no losses have been accrued as the Company does not believe the losses are probable or estimable.

 

Recent Accounting Pronouncements Not Yet Adopted

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 changes certain recognition, measurement, presentation and disclosure aspects related to financial instruments. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is not permitted. The Company believes its adoption will not significantly impact the Company’s results of operations and financial position. 

 

The FASB issued ASU 2016-02, Leases (Topic 842) in February 2016 and ASU 2018-11, Leases – Targeted Improvements in July 2018. ASU 2016-02 requires lessees to recognize a lease liability and a right-to-use asset for all leases, including operating leases, with a term greater than twelve months on its balance sheet. The guidance is effective in fiscal years beginning after December 15, 2018, with early adoption permitted. Originally, a modified retrospective transition method was required, but ASU 2018-11 added the additional transition method to adopt the new guidance as of the adoption date and recognize a cumulative-effect adjustment to the beginning balance of retained earnings in the period of adoption. As of September 30, 2018, the Company had approximately $3.0 million of operating lease commitments which would be recorded on the balance sheet under the new guidance. However, the Company is currently in the process of further evaluating the impact that this new guidance will have on its consolidated financial statements and does not plan to elect early adoption. The Company plans to adopt ASU 2016-02 using the optional transitional method by recording a cumulative-effect adjustment as of January 1, 2019 and expects to utilize the optional practical expedients to not reassess whether expired or existing contracts contain leases, not reassess the lease classification for expired or existing leases and reassess initial direct costs for existing leases.

 

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326):  Measurement of Credit Losses on Financial Instruments.  This ASU will require the measurement of all expected credit losses for financial assets, including trade receivables, held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The guidance is effective for annual reporting periods beginning after December 15, 2019 and interim periods within those fiscal years. The Company believes its adoption will not significantly impact the Company’s results of operations and financial position.  

 

In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40). This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The guidance is effective for annual reporting periods beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact that this guidance will have upon the Company’s results of operations and financial position and has not yet determined whether early adoption will be elected.

 

 

 

2.	RECAPITALIZATION

 

On April 16, 2018, the shareholders of the Company approved, among other things, an amendment to the Company’s Amended and Restated Articles of Incorporation (the "Articles") to effect the Recapitalization pursuant to which each share of the Company’s then-existing class B common stock was exchanged for one share of the Company’s then-existing class A common stock plus $19.59 in cash, without interest. On April 17, 2018, the Company filed an amendment to its Articles effecting the Recapitalization and then a further amendment and restatement of the Company’s Articles which resulted in the elimination of the Company’s class B common stock and the reclassification of the Company’s class A common stock as a share of Common Stock, par value $0.001 per share (“Common Stock”). The Company issued 3,617,615 shares of Common Stock and paid $72.4 million in exchange for all class B shares outstanding and to settle outstanding share based awards for class B common stock. The Common Stock continues to trade on The NASDAQ Global Market under the revised symbol “NRC.”

 

In connection with the Recapitalization, on April 18, 2018, the Company entered into a credit agreement with First National Bank of Omaha, a national banking association (“FNB”), as described in Note 5. 

 

 

3.	CONTRACTS WITH CUSTOMERS

 

The following table disaggregates revenue for the three and nine month periods ending September 30, 2018 based on timing of revenue recognition (In thousands):

 

 

 The following table provides information about receivables, contract assets, and contract liabilities from contracts with customers (In thousands):

 

(1)  Represents the December 31, 2017 balance adjusted for the ASC 606 transition adjustments.

 

 

Significant changes in contract assets and contract liabilities during 2018 are as follows (in thousands):

 

The Company has elected to apply the practical expedient to not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less. Total remaining contract revenue for contracts with original duration of greater than one year expected to be recognized in the future related to performance obligations that are unsatisfied at September 30, 2018 approximated $578,000, of which $144,000, $370,000 and $64,000 will be recognized during the remainder of 2018, 2019 and 2020, respectively.

 

 

4.	INCOME TAXES

 

The effective tax rate for the three-month period ended September 30, 2018 decreased to 16.6% compared to 42.1% for the same period in 2017 mainly due to a reduction in the corporate tax rate from 35% to 21% due to the Tax Cut and Jobs Act (the “Tax Act”) that was enacted on December 22, 2017, a tax depreciation method change election for software development creating an income tax benefit of $308,000, decreased non-deductible Recapitalization expenses of $384,000 and other state tax and uncertain tax position adjustments decreasing tax by $179,000 over the same period last year. In addition, the Company had increased tax benefits of $161,000 from the exercise of options and dividends paid to non-vested shareholders. The effective tax rate for the nine-month period ended September 30, 2018 decreased to 11.6% compared to 35.9% for the same period in 2017. The effective tax rate was lower mainly due to income tax benefits from the Recapitalization, due to accelerated vesting of restricted stock and settlement of options of $1.1 million and the reduction in the corporate tax rate from 35% to 21% due to the Tax Act. In addition, the Company had increased tax benefits of $1.7 million from the exercise of options and dividends paid to non-vested shareholders, a tax depreciation method change election for software development costs creating an income tax benefit of $308,000, decreased non-deductible Recapitalization expenses of $247,000, and other state tax and uncertain tax position adjustments decreasing taxes by $179,000 over the same period last year.  

 

As permitted by Staff Accounting Bulletin No. 118, the Company made reasonable estimates and recorded a provisional net tax benefit of $1.9 million as of December 31, 2017 related to the following elements of the Tax Act:

 

●

Reduction in the U.S. Federal Corporate Tax Rate: The Tax Act reduces the corporate tax rate to 21%, effective January 1, 2018. Recorded a decrease related to deferred tax assets and liabilities with a corresponding net adjustment to deferred income tax benefit for the year ended December 31, 2017.

●

Availability of 100% bonus depreciation on assets placed in service after September 27, 2017

●

Certain stock compensation plans potentially subject to limitations as to deductibility

 

The above items were final as of September 30, 2018, and no material adjustments were made to the provisional amounts recorded as of December 31, 2017.  Under the Tax Act, the Company was also subject to a one-time mandatory deemed repatriation tax on accumulated non-U.S. earnings.  The estimates booked as of December 31, 2017 have been finalized and no material adjustments were made to the financials.

 

 

5.	NOTES PAYABLE

 

The Company’s long term debt consists of the following:

 

 

The balance on the Company’s former term note with US Bank was paid in full in March 2018.

 

 

On April 18, 2018, in connection with the Recapitalization, the Company entered into a credit agreement (the “Credit Agreement”) with FNB providing for (i) a $15,000,000 revolving credit facility (the “Line of Credit”), (ii) a $40,000,000 term loan (the “Term Loan”) and (iii) a $15,000,000 delayed draw-dawn term facility (the “Delayed Draw Term Loan” and, together with the Line of Credit and the Term Loan, the “Credit Facilities”). The Company used the Term Loan to fund, in part, the cash portion paid to holders of the Company’s then-existing class B common stock in connection with the Recapitalization and the accompanying exchange of outstanding equity awards tied to the class B common stock, as well as for the costs of the Recapitalization. The Delayed Draw Term Loan may be used to fund any permitted future business acquisitions or repurchasing of the Company’s Common Stock and the Line of Credit will be used to fund ongoing working capital needs and other general corporate purposes, including to pay the fees and expenses incurred in connection with the Recapitalization and the Credit Agreement.

 

The Term Loan is payable in monthly installments of $462,988 through April 2020 and $526,362 thereafter, with a balloon payment due at maturity in April 2023. The Term Loan bears interest at a fixed rate of 5%.

 

Borrowings under the Line of Credit and the Delayed Draw Term Loan, if any, bear interest at a floating rate equal to the 30-day London Interbank Offered Rate plus 225 basis points (4.36% at September 30, 2018). Interest on the Line of Credit accrues and is payable monthly. Principal amounts outstanding under the Line of Credit are due and payable in full at maturity, in April 2021. As of September 30, 2018, the Line of Credit did not have a balance. The weighted average borrowings on the Line of Credit for the three and nine months ended September 30, 2018 was $587,000 and $486,000 respectively. The weighted average interest on borrowings on the Line of Credit for the three and nine months ended September 30, 2018 was 4.35% and 4.25%, respectively. There have been no borrowings on the Delayed Draw Term Loan since origination.

  

The Company paid a one-time fee equal to 0.25% of the amount borrowed under the Term Loan at the closing of the Credit Facilities. The Company is also obligated to pay ongoing unused commitment fees quarterly in arrears pursuant to the Line of Credit and the Delayed Draw Term Loan facility at a rate of 0.20% per annum based on the actual daily unused portions of the Line of Credit and the Delayed Draw Term Loan facility, respectively.

  

 The Credit Agreement is collateralized by substantially all of the Company’s assets and contains customary representations, warranties, affirmative and negative covenants (including financial covenants) and events of default. The negative covenants include, among other things, restrictions regarding the incurrence of indebtedness and liens, repurchases of the Company’s Common Stock and acquisitions, subject in each case to certain exceptions. The Credit Agreement also contains certain financial covenants with respect to a minimum fixed charge coverage ratio of 1.10x and a maximum cash flow leverage ratio of 3.00x or less. As of September 30, 2018, the Company was in compliance with its financial covenants. 

 

Scheduled maturities of notes payable at September 30, 2018 are as follows:

 

 

 

6.	SHARE-BASED COMPENSATION

 

The Company measures and recognizes compensation expense for all share-based payments based on the grant-date fair value of those awards. All of the Company’s existing stock option awards and unvested stock awards have been determined to be equity-classified awards.  As described in Note 2, the Company completed a Recapitalization in April which, among other things, settled all then-existing outstanding class B share-based awards and resulted in the elimination of the class B common stock. As a result, the Company accelerated vesting of all outstanding class B share based awards, resulting in accelerated share-based compensation of $331,000 in the three and six month periods ended June 30, 2018. All outstanding class B share based awards were then settled for the same stock to cash proportion of the class B common stock described in Note 2, less the exercise price, if any, which approximated the awards’ intrinsic value.

 

The Company’s 2001 Equity Incentive Plan provided for the granting of stock options, stock appreciation rights, restricted stock, performance shares and other share-based awards and benefits up to an aggregate of 1,800,000 shares of the Company's former class A common stock and 300,000 shares of the Company's former class B common stock. Stock options granted could have been either nonqualified or incentive stock options. Stock options vest over one to five years following the date of grant and option terms are generally five to ten years following the date of grant.

  

 

The Company’s 2004 Non-Employee Director Stock Plan, as amended (the “2004 Director Plan”), is a nonqualified plan that provides for the granting of options with respect to an aggregate of 3,000,000 shares of the Company's Common Stock and, prior to the Recapitalization, 500,000 shares of the Company's former class B common stock. The 2004 Director Plan provides for grants of nonqualified stock options to each director of the Company who is not employed by the Company. Beginning in 2018, on the date of each annual meeting of shareholders of the Company, options to purchase shares of Common Stock equal to an aggregate grant date fair value of $100,000 are granted to each non-employee director that is elected or retained as a director at such meeting. Stock options vest approximately one year following the date of grant and option terms are generally ten years following the date of grant, or three years in the case of termination of the outside director’s service.

 

The Company’s 2006 Equity Incentive Plan, as amended, provides for the granting of stock options, stock appreciation rights, restricted stock, performance shares and other share-based awards and benefits up to an aggregate of 1,800,000 shares of Common Stock and, prior to the Recapitalization, 300,000 shares of the Company’s former class B common stock. Stock options granted may be either incentive stock options or nonqualified stock options. Vesting terms vary with each grant and option terms are generally five to ten years following the date of grant.

 

The Company granted options to purchase 116,276 shares of the Company’s Common Stock during the nine-month period ended September 30, 2018. Options to purchase shares of common stock were granted with exercise prices equal to the fair value of the common stock on the date of grant. The fair value of the stock options granted was estimated using a Black-Scholes valuation model with the following weighted average assumptions: 

 

 

 

The risk-free interest rate assumptions were based on the U.S. Treasury yield curve in effect at the time of the grant. The expected volatility was based on historical monthly price changes of the Company’s common stock based on the expected life of the options at the date of grant. The expected life of options is the average number of years the Company estimates that options will be outstanding. The Company considers groups of associates that have similar historical exercise behavior separately for valuation purposes.

 

The following table summarizes stock option activity under the Company’s 2001 and 2006 Equity Incentive Plans and the 2004 Director Plan for the nine months ended September 30, 2018: 

 

 

 

As of September 30, 2018 the total unrecognized compensation cost related to non-vested stock option awards was approximately $1.4 million and is expected to be recognized over a weighted average period of 2.94 years.

 

The following table summarizes information for the nine months ended September 30, 2018, regarding non-vested stock granted to associates under the 2001 and 2006 Equity Incentive Plans:

 

 

As of September 30, 2018, the total unrecognized compensation cost related to non-vested stock awards was approximately $532,000 and is expected to be recognized over a weighted average period of 2.74 years.

 

 

7.	GOODWILL AND OTHER INTANGIBLE ASSETS

 

The following represents a summary of changes in the Company’s carrying amount of goodwill for the nine months ended September 30, 2018:

 

 

 

 Intangible assets consisted of the following:

 

 

 

 

8.	PROPERTY AND EQUIPMENT

 

 

 

 

9.	EARNINGS PER SHARE

 

Net income per share of the Company's former class A common stock and former class B common stock was computed using the two-class method. Basic net income per share is computed by allocating undistributed earnings to common shares and using the weighted-average number of common shares outstanding during the period.

 

Diluted net income per share is computed using the weighted-average number of common shares and, if dilutive, the potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options and vesting of restricted stock. The dilutive effect of outstanding stock options is reflected in diluted earnings per share by application of the treasury stock method.

 

The liquidation rights and the rights upon the consummation of an extraordinary transaction were the same for the holders of the Company's former class A common stock and former class B common stock. Other than share distributions and liquidation rights, the amount of any dividend or other distribution payable on each share of former class A common stock was equal to one-sixth (1/6th) of the amount of any such dividend or other distribution payable on each share of former class B common stock until the Recapitalization. As a result, the undistributed earnings for each period are allocated based on the contractual participation rights of the former class A and former class B common stock as if the earnings for the period had been distributed.

 

As described in Note 2, the Company completed a Recapitalization in April 2018 which settled all then-existing outstanding class B share-based awards, resulted in the elimination of the class B common stock and reclassified class A common stock to Common Stock. The Recapitalization was effective on April 17, 2018. Therefore, income was allocated between the former class A and class B common stock using the two-class method through April 16, 2018, and fully allocated to the Common Stock (formerly class A) following the Recapitalization.

 

For the three months ended September 30, 2018, 107,512 options of former class A shares have been excluded from the diluted net income per share computation because the exercise or grant price exceeded the fair market value.

 

 

 

 

 

For the nine months ended September 30, 2018 and 2017, the Company had 36,231 and 91,385 options of former class A shares, respectively, and for the nine months ended September 30, 2017 15,231 options of class B shares, which have been excluded from the diluted net income per share computation because the exercise or grant price exceeded the fair market value. For the nine months ended September 30, an additional 52,341 options of former class A shares were excluded, as their inclusion would be anti-dilutive.

 

 

 

 

 

10.	RELATED PARTY

 

A director of the Company serves as an officer of Ameritas Life Insurance Corp. (“Ameritas”). In connection with the Company’s regular assessment of its insurance-based associate benefits, which is conducted by an independent insurance broker, and the costs associated therewith, the Company purchases dental and vision insurance for certain of its associates from Ameritas. The total value of these purchases was $54,000 and $63,000 for the three-month periods ended September 30, 2018 and 2017, respectively, and $148,000 and $183,000 for the nine-month periods ended September 30, 2018 and 2017, respectively. 

 

During 2017, the Company acquired a cost method investment in convertible preferred stock of Practicing Excellence.com, Inc., a privately-held Delaware corporation (“PX”), which is included in other non-current assets and is carried at cost, adjusted for changes resulting from observable price changes in orderly transactions of the same investment in PX, if any.  The Company also has an agreement with PX which commenced in 2016 under which the Company acts as a reseller of PX services and receives a portion of the revenues. The total revenue earned from the PX reseller agreement in the three-month periods ended September 30, 2018 and 2017, were $87,000 and $159,000, respectively, and in nine-month periods ended September 30, 2018 and 2017, were $195,000 and $454,000, respectively.

 

 

 

11.	SEGMENT INFORMATION

 

The Company’s six operating segments are aggregated into one reporting segment because they have similar economic characteristics and meet the other aggregation criteria from the FASB guidance on segment disclosure. The six operating segments are Experience, The Governance Institute, Market Insights, Transparency, National Research Corporation Canada and Transitions, which offer a portfolio of solutions that address specific needs around market insight, experience, transparency and governance for healthcare providers, payers and other healthcare organizations. The table below presents entity-wide information regarding the Company’s assets, after elimination of intercompany balances by geographic area:

 

  

 

 

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