NATIONAL RESEARCH CORP - Quarter Report: 2019 September (Form 10-Q)

 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2019

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 001-35929

 

         National Research Corporation         

(Exact name of Registrant as specified in its charter)

 

Wisconsin		47-0634000
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

 

	1245 Q Street, Lincoln, Nebraska          68508
	(Address of principal executive offices) (Zip Code)

 

	(402) 475-2525
	(Registrant’s telephone number, including area code)

 

Securities registered pursuant to 12(b) of the Act:

Title of Each Class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $.001 par value	NRC	The NASDAQ stock market

 

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 every Interactive Data File required to be submitted 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 such files). Yes  ☒  No ☐

 

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

 

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes ☐    No  ☒ 

 

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

 

Common Stock, $.001 par value, outstanding as of October 25, 2019: 24,920,050

 

 

 

NATIONAL RESEARCH CORPORATION

 

FORM 10-Q INDEX

 

For the Quarter Ended September 30, 2019

 

			Page No.
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets	3
		Condensed Consolidated Statements of Income	4
		Condensed Consolidated Statements of Comprehensive Income	5
		Condensed Consolidated Statements of Shareholders' Equity	6-8
		Condensed Consolidated Statements of Cash Flows	9
		Notes to Condensed Consolidated Financial Statements	10-23
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24-30
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
	Item 4.	Controls and Procedures	30
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	31
	Item 1A.	Risk Factors	31
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
	Item 6.	Exhibits	32
	Signatures		33

 

 

 

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		September 30, 2019				December 31, 2018
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	8,358			$	12,991
Trade accounts receivable, less allowance for doubtful accounts of $138 and $175, respectively			15,308				11,922
Prepaid expenses			2,000				2,925
Income taxes receivable			556				348
Other current assets			348				224
Total current assets			26,570				28,410
Net property and equipment			13,696				14,153
Intangible assets, net			1,822				2,102
Goodwill			57,896				57,831
Deferred contract costs, net			3,993				3,484
Operating lease right-of-use assets			1,805				--
Other assets			1,867				2,052
Total assets		$	107,649			$	108,032
Liabilities and Shareholders’ Equity
Current liabilities:
Current portion of notes payable, net of unamortized debt issuance costs		$	4,133			$	3,667
Accounts payable			777				613
Accrued wages, bonus and profit sharing			5,192				5,798
Accrued expenses			3,504				2,834
Income taxes payable			14				636
Dividends payable			4,735				17,113
Deferred revenue			19,133				16,244
Other current liabilities			824				204
Total current liabilities			38,312				47,109
Notes payable, net of current portion			30,977				34,176
Deferred income taxes			7,210				6,276
Other long-term liabilities			2,175				1,388
Total liabilities			78,674				88,949
Shareholders’ equity:
Preferred stock, $0.01 par value, authorized 2,000,000 shares, none issued			--				--
Common stock, $0.001 par value; authorized 60,000,000 shares, issued 30,100,762 in 2019 and 29,917,667 in 2018, outstanding 24,920,050 in 2019 and 24,800,796 in 2018			30				30
Additional paid-in capital			160,524				157,312
Retained earnings (accumulated deficit)			(96,817	)			(106,339	)
Accumulated other comprehensive loss, foreign currency translation adjustment			(2,442	)			(2,916	)
Treasury stock, at cost; 5,180,712 Common shares in 2019 and 5,116,871 shares in 2018			(32,320	)			(29,004	)
Total shareholders’ equity			28,975				19,083
Total liabilities and shareholders’ equity		$	107,649			$	108,032

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		Three months ended September 30,								Nine months ended September 30,
		2019				2018				2019				2018
Revenue		$	32,465			$	30,013			$	95,359			$	89,047
Operating expenses:
Direct, exclusive of depreciation and amortization			12,109				11,780				35,269				35,685
Selling, general and administrative, exclusive of depreciation and amortization			8,706				7,679				24,732				23,486
Depreciation and amortization			1,430				1,388				4,285				3,996
Total operating expenses			22,245				20,847				64,286				63,167
Operating income			10,220				9,166				31,073				25,880
Other income (expense):
Interest income			10				3				24				57
Interest expense			(510	)			(544	)			(1,613	)			(990	)
Other, net			89				(242	)			(330	)			222
Total other (expense) income			(411	)			(783	)			(1,919	)			(711	)
Income before income taxes			9,809				8,383				29,154				25,169
Provision for income taxes			1,690				1,391				5,446				2,923
Net income		$	8,119			$	6,992			$	23,708			$	22,246
Earnings Per Share of Common Stock:
Basic Earnings Per Share:
Common (formerly Class A)		$	0.33			$	0.28			$	0.95			$	0.76
Class B		$	--			$	--			$	--			$	1.31
Diluted Earnings Per Share:
Common (formerly Class A)		$	0.31			$	0.27			$	0.92			$	0.73
Class B		$	--			$	--			$	--			$	1.27
Weighted average shares and share equivalents outstanding:
Common (formerly Class A) – basic			24,827				24,671				24,794				23,184
Class B – basic			--				--				--				3,527
Common (formerly Class A) – diluted			25,741				25,526				25,624				24,083
Class B – diluted			--				--				--				3,628

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		Three months ended September 30,								Nine months ended September 30,
		2019				2018				2019				2018
Net income		$	8,119			$	6,992			$	23,708			$	22,246
Other comprehensive income:
Foreign currency translation adjustment			(146	)			280				474				(418	)
Other comprehensive income		$	(146	)		$	280			$	474			$	(418	)
Comprehensive Income		$	7,973			$	7,272			$	24,182			$	21,828

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		Common Stock (formerly Class A)				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Total
Balances at December 31, 2018		$	30			$	157,312			$	(106,339	)		$	(2,916	)		$	(29,004	)		$	19,083
Purchase of 28,657 shares treasury stock			--				--				--				--				(1,116	)			(1,116	)
Issuance of 86,247 common shares for the exercise of stock options			--				633				--				--				--				633
Issuance of 6,005 restricted common shares			--				--				--				--				--				--
Non-cash stock compensation expense			--				302				--				--				--				302
Dividends declared of $0.19 per common share			--				--				(4,724	)			--				--				(4,724	)
Other comprehensive income, foreign currency translation adjustment			--				--				--				365				--				365
Net income			--				--				8,196				--				--				8,196
Balances at March 31, 2019		$	30			$	158,247			$	(102,867	)		$	(2,551	)		$	(30,120	)		$	22,739
Purchase of 2,977 shares treasury stock			--				--				--				--				(137	)			(137	)
Issuance of 18,000 common shares for the exercise of stock options			--				137				--				--				--				137
Non-cash stock compensation expense			--				307				--				--				--				307
Dividends declared of $0.19 per common share			--				--				(4,727	)			--				--				(4,727	)
Other comprehensive income, foreign currency translation adjustment			--				--				--				255				--				255
Net income			--				--				7,393				--				--				7,393
Balances at June 30, 2019		$	30			$	158,691			$	(100,201	)		$	(2,296	)		$	(30,257	)		$	25,967
Purchase of 32,207 shares treasury stock			--				--				--				--				(2,063	)			(2,063	)
Issuance of 72,843 common shares for the exercise of stock options			--				1,525				--				--				--				1,525
Non-cash stock compensation expense			--				308				--				--				--				308
Dividends declared of $0.19 per common share			--				--				(4,735	)			--				--				(4,735	)
Other comprehensive income, foreign currency translation adjustment			--				--				--				(146	)			--				(146	)
Net income			--				--				8,119				--				--				8,119
Balances at September 30, 2019		$	30			$	160,524			$	(96,817	)		$	(2,442	)		$	(32,320	)		$	28,975

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		Common Stock (formerly Class A)				Class B Common Stock				Additional Paid-in Capital				Retained Earnings				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 30,180 shares of class A and 3,677 shares of class B treasury stock			--				--				--				--				--				(1,272	)			(1,272	)
Issuance of 74,769 class A and 9,296 class B common shares for the exercise of stock options			--				--				737				--				--				--				737
Issuance of 6,793 class A restricted common shares			--				--				--				--				--				--				--
Non-cash stock compensation expense			--				--				454				--				--				--				454
Dividends declared of $0.10 per class A and $0.60 per class B common share			--				--				--				(4,223	)			--				--				(4,223	)
Cumulative effect adjustment for adoption of ASC 606, net of income tax			--				--				--				2,735				--				--				2,735
Other comprehensive income, foreign currency translation adjustment			--				--				--				--				(414	)			--				(414	)
Net income			--				--				--				7,306				--				--				7,306
Balances at March 31, 2018		$	26			$	4			$	52,216			$	83,392			$	(2,049	)		$	(38,225	)		$	95,364
Purchase of 126,617 shares of class A treasury stock			--				--				--				--				--				(4,358	)			(4,358	)
Issuance of 270,189 class A common shares for the exercise of stock options			--				--				4,182				--				--				--				4,182
Forfeitures of (10,289) class A restricted common shares			--				--				--				--				--				--				--
Non-cash stock compensation expense			--				--				541				--				--				--				541
Settlement of class B 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 4,328,552 class B common shares in connection with Recapitalization			--				(4	)			(17,112	)			(186,944	)			--				204,060				--
Dividends declared of $0.17 per class A common share			--				--				--				(4,206	)			--				--				(4,206	)
Other comprehensive income, foreign currency translation adjustment			--				--				--				--				(284	)			--				(284	)
Net income			--				--				--				7,948				--				--				7,948
Balances at June 30, 2018		$	30			$	--			$	155,614			$	(99,810	)		$	(2,333	)		$	(26,684	)		$	26,817

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		Common Stock (formerly Class A)				Class B Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Total
Balances at June 30, 2018		$	30			$	--			$	155,614			$	(99,810	)		$	(2,333	)		$	(26,684	)		$	26,817
Purchase of 12,771 shares of class A shares of treasury stock			--				--				--				--				--				(511	)			(511	)
Issuance of 36,000 class A common shares for the exercise of stock options			--				--				510				--				--				--				510
Non-cash stock compensation expense			--				--				260				--				--				--				260
Dividends declared of $0.17 per class A common share			--				--				--				(4,209	)			--				--				(4,209	)
Other comprehensive income, foreign currency translation adjustment			--				--				--				--				280				--				280
Net income			--				--				--				6,992				--				--				6,992
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,
		2019				2018
Cash flows from operating activities:
Net income		$	23,708			$	22,246
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			4,285				3,996
Deferred income taxes			919				1,775
Reserve for uncertain tax positions			(262	)			(297	)
Non-cash share-based compensation expense			917				1,255
Loss on disposal of property and equipment			40				212
Net changes in assets and liabilities:
Trade accounts receivable			(3,343	)			(1,842	)
Prepaid expenses and other current assets			978				(1,632	)
Deferred contract costs, net			(508	)			1
Operating lease assets and liability, net			(10	)			--
Accounts payable			69				147
Accrued expenses, wages, bonuses and profit sharing			138				(1,310	)
Income taxes receivable and payable			(829	)			(554	)
Deferred revenue			2,872				1,939
Net cash provided by operating activities			28,974				25,936
Cash flows from investing activities:
Purchases of property and equipment			(3,429	)			(4,858	)
Net cash used in investing activities			(3,429	)			(4,858	)
Cash flows from financing activities:
Payments related to Recapitalization			--				(72,370	)
Proceeds from issuance of note payable			--				40,000
Borrowings on line of credit			21,000				2,500
Payments on line of credit			(21,000	)			(2,500	)
Payment of debt issuance costs			--				(187	)
Payments on notes payable			(2,767	)			(2,170	)
Payments on finance lease obligations			(223	)			(104	)
Payment of employee payroll tax withholdings on share-based awards exercised			(1,021	)			(712	)
Payment of dividends on common stock			(26,564	)			(12,650	)
Net cash used in financing activities			(30,575	)			(48,193	)
Effect of exchange rate changes on cash			397				(345	)
Change in cash and cash equivalents			(4,633	)			(27,460	)
Cash and cash equivalents at beginning of period			12,991				34,733
Cash and cash equivalents at end of period		$	8,358			$	7,273
Supplemental disclosure of cash paid for:
Interest, net of capitalized amounts		$	1,558			$	767
Income taxes		$	5,607			$	2,017
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
Finance lease obligations originated for property and equipment		$	206			$	879
Stock tendered to the Company for cashless exercise of stock options in connection with equity incentive plans		$	2,295			$	5,429

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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 organizations in the United States and Canada. Our portfolio of solutions represent a unique set of capabilities that individually and collectively provide value to our clients. The solutions are offered at an enterprise level through the Voice of the Customer ("VoC") platform, The Governance Institute, and legacy Experience solutions.

 

Our six operating segments are aggregated into one reporting segment because they have similar economic characteristics and meet 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, 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.

 

Our condensed consolidated balance sheet at December 31, 2018 was derived from our 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) that we consider 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 our Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission (the “SEC”) on March 8, 2019.

 

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.

 

Our 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. We include 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 we operate and short-term intercompany accounts are included in other income (expense) in the consolidated statements of income. 

 

 

Revenue Recognition

 

We derive a majority of our revenues from our annually renewable subscription-based service agreements with our 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 our contracts with customers. We account for revenue using the following steps:

 

	●	Identify the contract, or contracts, with a customer
	●	Identify the performance obligations in the contract
	●	Determine the transaction price
	●	Allocate the transaction price to the identified performance obligations; and
	●	Recognize revenue when, or as, we satisfy the performance obligations.

 

Our 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. We combine 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. We estimate the amount of total contract consideration we expect to receive for variable arrangements based on the most likely amount we expect to earn from the arrangement based on the expected quantities of services we expect to provide and the contractual pricing based on those quantities. We only include 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. We consider the sensitivity of the estimate, our 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. Our revenue arrangements do not contain any significant financing element due to the contract terms and the timing between when consideration is received and when the service is provided.

 

Our 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 us to perform a specific one-time service in a particular month. We are entitled to a fixed payment upon completion of the service. Under these arrangements, we recognize revenue at the point in time we complete the service and it is accepted by the customer.

 

Fixed, non-subscription services – These arrangements typically require us 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.

 

Unit-price services – These arrangements typically require us 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.

 

 

We recognize 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 we have 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.  

 

Deferred Contract Costs

 

Deferred contract costs, net is stated at gross deferred costs less accumulated amortization. We defer 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 we expect to receive net of the expected future costs directly related to providing those services.  We deferred incremental costs of obtaining a contract of $1.0 million and $616,000 in the three-month periods ended September 30, 2019 and 2018, respectively. We deferred incremental costs of obtaining a contract of $2.6 million and $1.8 million in the nine-month periods ended September 30, 2019 and 2018, respectively. Total amortization by expense classification for the three and nine month-periods ended September 30, 2019 and 2018 was as follows:

 

 

 

Additional expense included in selling, general and administrative expenses for impairment of costs capitalized due to lost clients was $1,000 and $12,000 for the three months ended September 30, 2019 and 2018, respectively and $22,000 and $31,000 in the nine months ended September 30, 2019 and 2018, respectively. We have elected the practical expedient to expense contract costs when incurred for any nonrenewable contracts with a term of one year or less.

 

Leases

 

We adopted Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) (“Topic 842” or the “New Leases Standard”) effective January 1, 2019 using a modified retrospective transition, with the cumulative-effect adjustment recorded to retained earnings as of the effective date. As a result, the financial results for periods prior to 2019 have not been restated. We elected practical expedients related to existing leases at transition to not reassess whether contracts are or contain leases, to not reassess lease classification, initial direct costs, or lease terms. Additionally, we elected the practical expedient to account for lease and non-lease components as a single lease component for all asset classifications. We have also made a policy election to not record short-term leases with a duration of 12 months or less on the balance sheet.

 

Topic 842 requires lessees to recognize a lease liability and a right-of-use (“ROU”) asset on the balance sheet for operating leases. We recorded $2.3 million of ROU assets and $2.4 million of lease liabilities related to operating leases at the date of transition. The ROU assets recorded were net of $43,000 of accrued liabilities and prepaid expenses representing previously deferred (prepaid) rent. There was no significant impact to the unaudited condensed consolidated statements of income, comprehensive income, shareholders’ equity or cash flows. Accounting for finance leases is substantially unchanged.

 

We determine whether a lease is included in an agreement at inception. Operating lease ROU assets are included in operating lease right-of-use assets in our consolidated balance sheet. Finance lease assets are included in property and equipment. Operating and finance lease liabilities are included in other current liabilities and other long term liabilities. Certain lease arrangements may include options to extend or terminate the lease. We include these provisions in the ROU and lease liabilities only when it is reasonably certain that we will exercise that option. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term and is included in direct expenses and selling, general and administrative expenses. Our lease agreements do not contain any residual value guarantees.

 

 

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments during the lease term. ROU assets and lease liabilities are recorded at lease commencement based on the estimated present value of lease payments. Because the rate of interest implicit in each lease is not readily determinable, we use our estimated incremental collateralized borrowing rate at lease commencement, to calculate the present value of lease payments. When determining the appropriate incremental borrowing rate, we consider our available credit facilities, recently issued debt and public interest rate information.

 

Fair Value Measurements

 

Our 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 our market assumptions. The inputs are then classified into the following hierarchy: (1) Level 1 Inputs—quoted prices in active markets for identical assets and liabilities; (2) Level 2 Inputs—observable market-based inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities in active markets, quoted prices for similar or identical assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data; (3) Level 3 Inputs—unobservable inputs.

 

The following details our financial assets within the fair value hierarchy at September 30, 2019 and December 31, 2018:

 

 

There were no transfers between levels during the three and nine-month periods ended September 30, 2019.

 

Our long-term debt described in Note 5 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 carrying amounts of accounts receivable, accounts payable, and accrued expenses approximate their fair value. All non-financial assets that are not recognized or disclosed at fair value in the financial statements on a recurring basis, which includes ROU assets, 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, 2019 and December 31, 2018, there was no indication of impairment related to these assets.

 

Contingencies

From time to time, we are 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. Legal fees, net of estimated insurance recoveries, are expensed as incurred.

 

 

Recent Accounting Pronouncements Not Yet Adopted

 

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 years beginning after December 15, 2019 and interim periods within those fiscal years. We believe our adoption will not significantly impact our 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 to be applied either retrospectively or prospectively and is effective for annual reporting periods beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the method of adoption and impact that this guidance will have upon our results of operations and financial position and have not yet determined whether early adoption will be elected.

 

 

(2)	RECAPITALIZATION

 

On April 16, 2018, our shareholders approved, among other things, an amendment to our Amended and Restated Articles of Incorporation (the “Articles”) to effect a recapitalization (the “Recapitalization”) pursuant to which each share of our then-existing class B common stock was exchanged for one share of the our then-existing Class A common stock plus $19.59 in cash, without interest. On April 17, 2018, we filed an amendment to our Articles effecting the Recapitalization, followed by an amendment and restatement of our Articles, which resulted in the elimination of our class B common stock and the reclassification of our class A common stock as a share of Common Stock, par value $0.001 per share (“Common Stock”). We 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.

 

 

(3)	CONTRACTS WITH CUSTOMERS

 

The following table disaggregates revenue based on timing of revenue recognition (In thousands):

 

 

Our solutions within the digital VoC platform accounted for 63.8% and 51.2% of total revenue, in the three-month periods ending September 30, 2019 and 2018, respectively, and 61.3% and 48.7% of total revenue in the nine-month periods ending September 30, 2019 and 2018, respectively. The remaining revenue consists of legacy Experience and Governance Solutions.  

 

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

 

 

 

Significant changes in contract assets and contract liabilities during the nine months ended September 30, 2019 and 2018 are as follows (in thousands):

 

 

We have 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, 2019 approximated $1,252,000, of which $308,000, $889,000 and $55,000 will be recognized during the remainder of 2019, 2020 and 2021, respectively.

 

 

 

(4)	INCOME TAXES

 

The effective tax rate for the three-month period ended September 30, 2019 increased to 17.2% compared to 16.6% for the same period in 2018 primarily due to a tax depreciation method change election for software development costs creating an income tax benefit of $308,000 in 2018, additional withholding on unrepatriated Canadian earnings of $90,000 and higher projected state taxes. These were partially offset by increased tax benefits from the exercise of options and dividends paid to non-vested shareholders of $459,000. The effective tax rate for the nine-month period ended September 30, 2019 increased to 18.7% compared to 11.6% for the same period in 2018. The effective tax rate for the nine-month period ended September 30, 2019, was higher mainly due to income tax benefits from the Recapitalization due to accelerated vesting of restricted stock and settlement of stock options of $1.1 million, a tax depreciation method change election for software development costs creating an income tax benefit of $308,000 in 2018 and a $247,000 reduction in tax benefits from the exercise of options and dividends paid to non-vested shareholders compared to 2018. In addition, there was additional withholding on unrepatriated Canadian earnings of $90,000. This was partially offset by less non-deductible fees of $154,000 primarily related to the Recapitalization.

 

 

 

(5)	NOTES PAYABLE

 

Our long-term debt consists of the following (In thousands):  

 

 

 

Our credit agreement (the “Credit Agreement”) with First National Bank of Omaha, includes (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”). The Term Loan was used to fund, in part, the cash payment to the holders of the class B common stock in connection with the Recapitalization and certain costs of the Recapitalization. The Delayed Draw Term Loan may be used to fund any permitted future business acquisitions or repurchases of our Common Stock and the Line of Credit is used to fund ongoing working capital needs and for other general corporate purposes.

 

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 per annum 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 (4.33% at September 30, 2019). 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, 2019, there were no borrowings outstanding under the Line of Credit and we had the availability to borrow $15.0 million. There were no borrowings outstanding under the Line of Credit at December 31, 2018. The weighted average interest rate on borrowings on the Line of Credit for the three and nine-month periods ended September 30, 2019 was 4.62% and 4.72%, respectively. There have been no borrowings on the Delayed Draw Term Loan since origination.

  

The Credit Agreement is collateralized by substantially all of our assets, subject to permitted liens and other agreed exceptions, 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 our 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. The special dividend paid on January 15, 2019, is excluded from the calculation of the fixed charge coverage ratio pursuant to a consent received from the lender. As of September 30, 2019, we were in compliance with these financial covenants. 

 

 

 

(6)	SHARE-BASED COMPENSATION

 

We measure and recognize compensation expense for all share-based payments based on the grant-date fair value of those awards. All of our existing stock option awards and unvested stock awards have been determined to be equity-classified awards. We account for forfeitures as they occur. We completed a Recapitalization in April 2018 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, we accelerated vesting of all outstanding class B share based awards, resulting in accelerated share-based compensation of $331,000 in the nine-month period ended September 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, less the exercise price, if any, which approximated the awards’ intrinsic values.

 

The 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 our former class A common stock and 300,000 shares of our 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. Due to the expiration of the 2001 Equity Incentive Plan, at December 31, 2015, there were no shares of stock available for future grants.

 

The 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 3,000,000 shares of the our Common Stock and, prior to the Recapitalization, 500,000 shares of our former class B common stock. The 2004 Director Plan provides for grants of nonqualified stock options to each of our non-employee directors. Beginning in 2018, on the date of each annual meeting of our shareholders, 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 each 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 2006 Equity Incentive Plan (the “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 our 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. 

 

 

We granted options to purchase 100,615 and 116,276 shares of our Common Stock during the nine-month periods ended September 30, 2019 and 2018, respectively. 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 our 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 we estimate that options will be outstanding. We consider groups of associates that have similar historical exercise behavior separately for valuation purposes.

 

The following table summarizes stock option activity under the 2001 and 2006 Equity Incentive Plans and the 2004 Director Plan for the nine-month period ended September 30, 2019:

 

 

As of September 30, 2019, the total unrecognized compensation cost related to non-vested stock option awards was approximately $1.7 million which was expected to be recognized over a weighted average period of 2.98 years.

 

The following table summarizes information regarding non-vested stock granted to associates under the 2006 Equity Incentive Plan for the nine-month period ended September 30, 2019:

 

 

As of September 30, 2019, the total unrecognized compensation cost related to non-vested stock awards was approximately $484,000 and is expected to be recognized over a weighted average period of 3.03 years. 

 

 

 

(7)	GOODWILL AND OTHER INTANGIBLE ASSETS

 

The following represents a summary of changes in our carrying amount of goodwill for the nine months ended September 30, 2019:

 

 

 

 Intangible assets consisted of the following:

 

 

 

 

 

(8)	PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following:

 

 

 

 

(9)	EARNINGS PER SHARE

 

Prior to the Recapitalization, net income per share of our former class A common stock and former class B common stock was computed using the two-class method. Basic net income per share was 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 was 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 our 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 (1/6^th) of the amount of any such dividend or other distribution payable on each share of former class B common stock. As a result, the undistributed earnings for each period were allocated based on the contractual participation rights of the former class A and former class B common stock as if the earnings for the year had been distributed.

 

As described in Note 2, we completed a Recapitalization in April 2018, resulting in the elimination of the class B common stock and settlement of all then-existing outstanding class B share-based awards and reclassification of all 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 stock using the two-class method through April 16, 2018, and fully allocated to the Common Stock (formerly class A) following the Recapitalization.

 

We had 27,284 and 107,512 options of Common Stock (former class A shares) for the three-month periods ended September 30, 2019 and 2018, respectively which have been excluded from the diluted net income per share computation because their inclusion would be anti-dilutive.

 

 

 

We had 12,493 and 88,572 options of Common Stock (former class A shares) for the nine-month periods ended September 30, 2019 and 2018, respectively which have been excluded from the diluted net income per share computation because their inclusion would be anti-dilutive

 

 

 

 

(10)

LEASES

 

We lease printing equipment in the United States, and office space in Canada, California, Georgia, Washington, and Tennessee. The leases remaining terms as of September 30, 2019 range from less than one year to 5.9 years.

 

Certain equipment and office lease agreements include provisions for periodic adjustments to rates and charges. The rates and charges are adjusted based on actual usage or actual costs for internet, common area maintenance, taxes or insurance, as determined by the lessor and are considered variable lease costs.

 

The components of lease expense for the three and nine-month periods ended September 30, 2019 included:

 

 

 

 

Supplemental balance sheet information related to leases (in thousands):     

 

 

(1) Represents the December 31, 2018 balance recorded at implementation of Topic 842

 

 

Supplemental cash flow and other information related to leases was as follows (in thousands):

 

 

 

Undiscounted payments under non-cancelable operating leases and finance leases at September 30, 2019 are as follows (in thousands):

 

 

Undiscounted payments under non-cancelable operating leases and finance leases at December 31, 2018 were as follows (in thousands):

 

 

 

 

(11)	RELATED PARTY

 

One of our directors also serves as an officer and board member of Ameritas Life Insurance Corp. (“Ameritas”). In connection with our regular assessment of our insurance-based associate benefits, which is conducted by an independent insurance broker, and the costs associated therewith, we purchase dental and vision insurance for certain of our associates from Ameritas. The total value of these purchases was $61,000 and $54,000 in the three-month periods ended September 30, 2019 and 2018, respectively, and $187,000 and $148,000 in the nine-month periods ended September 30, 2019 and 2018, respectively.

 

During 2017, we 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.  We also have an agreement with PX which commenced in 2016 under which we act as a reseller of PX services and receive a portion of the revenues. Our total revenue earned from the PX reseller agreement was $170,000 and $87,000 agreement in the three-month periods ended September 30, 2019 and 2018, respectively, and $493,000 and $195,000 in nine-month periods ended September 30, 2019 and 2018, respectively.

 

 

 

(12)	SEGMENT INFORMATION

 

Our 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 our assets, after elimination of intercompany balances by geographic area:

 

  

 

 

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