NATIONAL RESEARCH CORP - Quarter Report: 2019 June (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 June 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 July 26, 2019: 24,879,414

 

 

 

NATIONAL RESEARCH CORPORATION

 

FORM 10-Q INDEX

 

For the Quarter Ended June 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	6-7
		Condensed Consolidated Statements of Cash Flows	8
		Notes to Condensed Consolidated Financial Statements	9-21
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22-28
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
	Item 4.	Controls and Procedures	28
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	29
	Item 1A.	Risk Factors	29
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29
	Item 6.	Exhibits	30
	Signatures		31

 

 

 

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		June 30, 2019				December 31, 2018
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	4,020			$	12,991
Trade accounts receivable, less allowance for doubtful accounts of $124 and $175, respectively			15,087				11,922
Prepaid expenses			2,696				2,925
Income taxes receivable			637				348
Other current assets			448				224
Total current assets			22,888				28,410
Net property and equipment			13,872				14,153
Intangible assets, net			1,915				2,102
Goodwill			57,922				57,831
Deferred contract costs, net			3,743				3,484
Operating lease right-of-use assets			1,985				--
Other assets			1,950				2,052
Total assets		$	104,275			$	108,032
Liabilities and Shareholders’ Equity
Current liabilities:
Current portion of notes payable, net of unamortized debt issuance costs		$	3,890			$	3,667
Line of credit			1,000				--
Accounts payable			1,186				613
Accrued wages, bonus and profit sharing			5,535				5,798
Accrued expenses			2,813				2,834
Income taxes payable			43				636
Dividends payable			4,727				17,113
Deferred revenue			16,988				16,244
Other current liabilities			894				204
Total current liabilities			37,076				47,109
Notes payable, net of current portion			32,139				34,176
Deferred income taxes			6,768				6,276
Other long term liabilities			2,325				1,388
Total liabilities			78,308				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 30,027,919 in 2019 and 29,917,667 in 2018, outstanding 24,879,414 in 2019 and 24,800,796 in 2018			30				30
Additional paid-in capital			158,691				157,312
Retained earnings (accumulated deficit)			(100,201	)			(106,339	)
Accumulated other comprehensive loss, foreign currency translation adjustment			(2,296	)			(2,916	)
Treasury stock, at cost; 5,148,505 Common shares in 2019 and 5,116,871 shares in 2018			(30,257	)			(29,004	)
Total shareholders’ equity			25,967				19,083
Total liabilities and shareholders’ equity		$	104,275			$	108,032

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		Three months ended June 30,								Six months ended June 30,
		2019				2018				2019				2018
Revenue		$	31,414			$	28,017			$	62,894			$	59,034
Operating expenses:
Direct			11,506				10,996				23,160				23,904
Selling, general and administrative			8,319				7,940				16,026				15,808
Depreciation and amortization			1,440				1,325				2,855				2,608
Total operating expenses			21,265				20,261				42,041				42,320
Operating income			10,149				7,756				20,853				16,714
Other income (expense):
Interest income			8				9				14				54
Interest expense			(533	)			(439	)			(1,103	)			(447	)
Other, net			(139	)			493				(419	)			464
Total other income (expense)			(664	)			63				(1,508	)			71
Income before income taxes			9,485				7,819				19,345				16,785
Provision (benefit) for income taxes			2,092				(129	)			3,756				1,531
Net income		$	7,393			$	7,948			$	15,589			$	15,254
Earnings Per Share of Common Stock:
Basic Earnings Per Share:
Common (formerly Class A)		$	0.30			$	0.29			$	0.63			$	0.47
Class B		$	--			$	0.27			$	--			$	1.31
Diluted Earnings Per Share:
Common (formerly Class A)		$	0.29			$	0.28			$	0.61			$	0.45
Class B		$	--			$	0.26			$	--			$	1.27
Weighted average shares and share equivalents outstanding:
Common (formerly Class A) – basic			24,789				23,957				24,777				22,429
Class B – basic			--				3,527				--				3,527
Common (formerly Class A) – diluted			25,586				24,846				25,549				23,350
Class B – diluted			--				3,620				--				3,628

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		Three months ended June 30,								Six months ended June 30,
		2019				2018				2019				2018
Net income		$	7,393			$	7,948			$	15,589			$	15,254
Other comprehensive income:
Foreign currency translation adjustment			255				(284	)			620				(698	)
Other comprehensive income		$	255			$	(284	)		$	620			$	(698	)
Comprehensive Income		$	7,648			$	7,664			$	16,209			$	14,556

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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

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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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		Six months ended
		June 30,
		2019				2018
Cash flows from operating activities:
Net income		$	15,589			$	15,254
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			2,855				2,608
Deferred income taxes			472				996
Reserve for uncertain tax positions			(251	)			92
Non-cash share-based compensation expense			609				995
Loss on disposal of property and equipment			40				2
Net changes in assets and liabilities:
Trade accounts receivable			(3,088	)			3,955
Prepaid expenses and other current assets			118				(2,393	)
Deferred contract costs, net			(259	)			2
Operating lease assets and liabilities, net			(4	)			--
Accounts payable			432				481
Accrued expenses, wages, bonuses and profit sharing			(222	)			(2,371	)
Income taxes receivable and payable			(881	)			(1,235	)
Deferred revenue			696				5
Net cash provided by operating activities			16,106				18,391
Cash flows from investing activities:
Purchases of property and equipment			(2,280	)			(2,773	)
Net cash used in investing activities			(2,280	)			(2,773	)
Cash flows from financing activities:
Payments related to Recapitalization			--				(72,370	)
Proceeds from issuance of note payable			--				40,000
Borrowings on line of credit			16,500				1,000
Payments on line of credit			(15,500	)			(1,000	)
Payment of debt issuance costs			--				(187	)
Payments on notes payable			(1,837	)			(1,286	)
Payments on finance lease obligations			(161	)			(58	)
Payment of employee payroll tax withholdings on share-based awards exercised			(483	)			(712	)
Payment of dividends on common stock			(21,837	)			(8,445	)
Net cash used in financing activities			(23,318	)			(43,058	)
Effect of exchange rate changes on cash			521				(595	)
Change in cash and cash equivalents			(8,971	)			(28,035	)
Cash and cash equivalents at beginning of period			12,991				34,733
Cash and cash equivalents at end of period		$	4,020			$	6,698
Supplemental disclosure of cash paid for:
Interest, net of capitalized amounts		$	1,066			$	256
Income taxes		$	4,404			$	1,703
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		$	167			$	210
Stock tendered to the Company for cashless exercise of stock options in connection with equity incentive plans		$	770			$	4,919

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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. NRC Health’s portfolio of solutions represent a unique set of capabilities that individually and collectively provide value to its clients. The solutions are offered at an enterprise level through the Voice of the Customer ("VoC") platform, The Governance Institute, and legacy Experience solutions.

 

The Company’s 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.

 

The condensed consolidated balance sheet of the Company at December 31, 2018 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, 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.

 

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

 

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. The Company accounts 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
	●	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. The Company’s 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.

 

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.

 

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.  

 

 

Deferred Contract Costs

 

Deferred contract costs, net is stated at gross deferred costs less accumulated amortization. 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 $741,000 and $445,000 in the three-month periods ended June 30, 2019 and 2018, respectively. The Company deferred incremental costs of obtaining a contract of $1.6 million and $1.3 million in the six-month periods ended June 30, 2019 and 2018, respectively. Total amortization by expense classification for the three and six month-periods ended June 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 $7,000 for the three months ended June 30, 2019 and 2018, respectively and $21,000 and $19,000 in the six months ended June 30, 2019 and 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.

 

Leases

 

The Company 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. The Company 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, the Company has elected the practical expedient to account for lease and non-lease components as a single lease component for all asset classifications. The Company has 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. The Company 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. The Company includes these provisions in the ROU and lease liabilities only when it is reasonably certain that the Company 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. The Company’s 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, the Company uses its estimated incremental collateralized borrowing rate at lease commencement, to calculate the present value of lease payments. When determining the appropriate incremental borrowing rate, the Company considers its available credit facilities, recently issued debt and public interest rate information.

 

 

Fair Value Measurements

 

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

 

The following details the Company’s financial assets within the fair value hierarchy at June 30, 2019 and December 31, 2018:

 

 

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

 

The Company's 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 June 30, 2019 and December 31, 2018, 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. 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. 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 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. The Company is currently evaluating the method of adoption and 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 a recapitalization (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.

 

 

 

(3)	CONTRACTS WITH CUSTOMERS

 

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

 

 

The Company’s solutions within the digital VoC platform accounted for 62.1% and 50.4% of total revenue, in the three-month periods ending June 30, 2019 and 2018, respectively, and 60.0% and 47.4% of total revenue in the six-month periods ending June 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 six months ended June 30, 2019 and 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 June 30, 2019 approximated $513,000, of which $303,000, $180,000 and $30,000 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 June 30, 2019 increased to 22.1% compared to (1.7)% for the same period in 2018 due to income tax benefits from the Recapitalization as a result of accelerated vesting of restricted stock and settlement of stock options of $1.1 million, as well as additional tax benefits from the exercise of options and dividends paid to non-vested shareholders of $800,000 in 2018. The effective tax rate for the six-month period ended June 30, 2019 increased to 19.4% compared to 9.1% for the same period in 2018. The effective tax rate was higher mainly due to income tax benefits from the Recapitalization as a result of accelerated vesting of restricted stock and settlement of stock options of $1.1 million, as well as additional tax benefits from the exercise of options and dividends paid to non-vested shareholders of $700,000 in 2018. This was partially offset by less non-deductible expenses of $154,000 primarily related to the Recapitalization.

 

 

 

(5)	NOTES PAYABLE

 

The Company’s long-term debt consists of the following (In thousands):  

 

 

The Company’s 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 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 is used to fund ongoing working capital needs and 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 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 (4.68% at June 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 June 30, 2019, borrowings outstanding under the Line of Credit were $1.0 million and the Company had the availability to borrow an additional $14.0 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 six-month periods ended June 30, 2019 was 4.74% and 4.75%, respectively. There have been no borrowings on the Delayed Draw Term Loan since origination.

  

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 June 30, 2019, the Company was in compliance with its financial covenants. 

 

 

 

(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. The Company accounts for forfeitures as they occur. The Company 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, 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, less the exercise price, if any, which approximated the awards’ intrinsic values.

 

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. 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 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 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 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 Company’s 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 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 100,615 and 116,276 shares of the Company’s Common Stock during the six-month periods ended June 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 the Company’s 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 2001 and 2006 Equity Incentive Plans and the 2004 Director Plan for the six-month period ended June 30, 2019:

 

 

As of June 30, 2019, the total unrecognized compensation cost related to non-vested stock option awards was approximately $2.0 million which was expected to be recognized over a weighted average period of 3.10 years.

 

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

 

 

As of June 30, 2019, the total unrecognized compensation cost related to non-vested stock awards was approximately $556,000 and is expected to be recognized over a weighted average period of 3.11 years. 

 

 

 

(7)	GOODWILL AND OTHER INTANGIBLE ASSETS

 

The following represents a summary of changes in the Company’s carrying amount of goodwill for the three-month period ended June 30, 2019 (In thousands):

 

 

 

Intangible assets consisted of the following:

 

 

 

 

(8)	PROPERTY AND EQUIPMENT

 

 

 

 

(9)	EARNINGS PER SHARE

 

Prior to the Recapitalization, 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 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 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 (1/6^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, the Company completed a Recapitalization in April 2018 which settled all then-existing outstanding class B share-based awards, resulting 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 stock using the two-class method through April 16, 2018, and fully allocated to the Common Stock (formerly class A) following the Recapitalization.

 

The Company had 83,225 and 84,963 options of Common Stock (former class A shares) for the three-month periods ended June 30, 2019 and 2018, respectively which have been excluded from the diluted net income per share computation because their inclusion would be anti-dilutive.

 

 

 

The Company had 143,247 and 78,945 options of Common Stock (former class A shares) for the six-month periods ended June 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

 

The Company leases printing equipment in the United States, and office space in Canada, California, Georgia, Washington, and Tennessee. The leases remaining terms as of June 30, 2019 range from less than one year to 6.2 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 six-month periods ended June 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 June 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

 

A director of the Company also 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 $67,000 and $53,000 in the three-month periods ended June 30, 2019 and 2018, respectively, and $127,000 and $94,000 in the six-month periods ended June 30, 2019 and 2018, 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 was $170,000 and $66,000 agreement in the three-month periods ended June 30, 2019 and 2018, respectively, and $323,000 and $109,000 in six-month periods ended June 30, 2019 and 2018, respectively.

 

 

 

(12)	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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