NATIONAL RESEARCH CORP - Quarter Report: 2020 March (Form 10-Q)

 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended March 31, 2020

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 April 24, 2020: 25,183,851

 

 

 

NATIONAL RESEARCH CORPORATION

 

FORM 10-Q INDEX

 

For the Quarter Ended March 31, 2020

 

			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	22-27
	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	30
	Item 6.	Exhibits	31
	Signatures		32

 

 

 

 

 

		March 31, 2020				December 31, 2019
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	10,021			$	13,517
Trade accounts receivable, less allowance for doubtful accounts of $143 and $144, respectively			17,403				11,639
Prepaid expenses			2,608				2,038
Income taxes receivable			580				69
Insurance receivable			2,771				--
Other current assets			1,556				1,894
Total current assets			34,939				29,157
Net property and equipment			12,655				13,530
Intangible assets, net			1,635				1,728
Goodwill			57,746				57,935
Deferred contract costs, net			4,896				4,204
Operating lease right-of-use assets			1,460				1,628
Other			2,524				2,503
Total assets		$	115,855			$	110,685
Liabilities and Shareholders’ Equity
Current liabilities:
Current portion of notes payable		$	4,631			$	4,378
Accounts payable			655				1,279
Accrued wages, bonus and profit sharing			4,913				6,086
Accrued expenses			4,292				3,408
Income taxes payable			--				366
Dividends payable			5,278				5,239
Deferred revenue			19,111				16,354
Other current liabilities			999				1,045
Total current liabilities			39,879				38,155
Notes payable, net of current portion and unamortized debt issuance costs			28,593				29,795
Deferred income taxes			7,704				7,399
Other long term liabilities			2,382				2,444
Total liabilities			78,558				77,793
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 30,412,055 in 2020 and 30,151,574 in 2019, outstanding 25,132,001 in 2020 and 24,947,500 in 2019			30				30
Additional paid-in capital			165,631				162,154
Retained earnings (accumulated deficit)			(86,880	)			(93,357	)
Accumulated other comprehensive loss, foreign currency translation adjustment			(3,333	)			(2,209	)
Treasury stock, at cost; 5,280,054 Common shares in 2020 and 5,204,074 shares in 2019			(38,151	)			(33,726	)
Total shareholders’ equity			37,297				32,892
Total liabilities and shareholders’ equity		$	115,855			$	110,685

 

		Three months ended March 31,
		2020				2019
Revenue		$	33,860			$	31,480
Operating expenses:
Direct, exclusive of depreciation and amortization			12,546				11,654
Selling, general and administrative, exclusive of depreciation and amortization			8,749				7,707
Depreciation and amortization			1,371				1,415
Total operating expenses			22,666				20,776
Operating income			11,194				10,704
Other income (expense):
Interest income			11				6
Interest expense			(465	)			(570	)
Other, net			630				(280	)
Total other income (expense)			176				(844	)
Income before income taxes			11,370				9,860
Income tax provision (benefit)			(385	)			1,664
Net income		$	11,755			$	8,196
Earnings Per Share of Common Stock:
Basic Earnings Per Share		$	0.47			$	0.33
Diluted Earnings Per Share		$	0.46			$	0.32
Weighted average shares and share equivalents outstanding:
Basic			24,972				24,766
Diluted			25,725				25,509

 

		Three months ended March 31,
		2020				2019
Net income		$	11,755			$	8,196
Other comprehensive income (loss):
Foreign currency translation adjustment		$	(1,124	)		$	365
Other comprehensive income (loss)		$	(1,124	)		$	365
Comprehensive income		$	10,631			$	8,561

 

		Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Total
Balances at December 31, 2019		$	30			$	162,154			$	(93,357	)		$	(2,209	)		$	(33,726	)		$	32,892
Purchase of 75,980 shares treasury stock			--				--				--				--				(4,425	)			(4,425	)
Issuance of 260,481 common shares for the exercise of stock options			--				3,145				--				--				--				3,145
Non-cash stock compensation expense			--				332				--				--				--				332
Dividends declared of $0.21 per common share			--				--				(5,278	)			--				--				(5,278	)
Other comprehensive income, foreign currency translation adjustment			--				--				--				(1,124	)			--				(1,124	)
Net income			--				--				11,755				--				--				11,755
Balances at March 31, 2020		$	30			$	165,631			$	(86,880	)		$	(3,333	)		$	(38,151	)		$	37,297

		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, net of (forfeitures)			--				--				--				--				--				--
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

 

		Three months ended
		March 31,
		2020				2019
Cash flows from operating activities:
Net income		$	11,755			$	8,196
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			1,371				1,415
Deferred income taxes			348				(25	)
Reserve for uncertain tax positions			80				20
Non-cash share-based compensation expense			332				302
Net changes in assets and liabilities:
Trade accounts receivable			(5,886	)			(3,934	)
Prepaid expenses and other current assets			(165	)			(1,004	)
Insurance receivable			(2,771	)			--
Deferred contract costs, net			(693	)			(158	)
Operating lease assets and liabilities, net			(4	)			3
Accounts payable			(623	)			807
Accrued expenses, wages, bonuses and profit sharing			(139	)			(1,840	)
Income taxes receivable and payable			(886	)			1,531
Deferred revenue			2,804				1,987
Net cash provided by operating activities			5,523				7,300
Cash flows from investing activities:
Purchases of property and equipment			(590	)			(1,134	)
Net cash used in investing activities			(590	)			(1,134	)
Cash flows from financing activities:
Borrowings on line of credit			--				8,500
Payments on line of credit			--				(6,750	)
Payments on notes payable			(959	)			(918	)
Payments on finance lease obligations			(58	)			(57	)
Payment of employee payroll tax withholdings on share-based awards exercised			(1,280	)			(483	)
Payment of dividends on common stock			(5,239	)			(17,112	)
Net cash used in financing activities			(7,536	)			(16,820	)
Effect of exchange rate changes on cash			(893	)			304
Change in cash and cash equivalents			(3,496	)			(10,350	)
Cash and cash equivalents at beginning of period			13,517				12,991
Cash and cash equivalents at end of period		$	10,021			$	2,641
Supplemental disclosure of cash paid for:
Interest, net of capitalized amounts		$	445			$	520
Income taxes		$	70			$	147
Supplemental disclosure of non-cash investing and financing activities:
Finance lease obligations originated for property and equipment		$	--			$	25
Stock tendered to the Company for cashless exercise of stock options in connection with equity incentive plans		$	3,145			$	633

 

(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 represents 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, 2019 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, 2019, filed with the Securities and Exchange Commission (the “SEC”) on March 6, 2020.

 

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 consolidated financial statements include the accounts of the Company and our wholly-owned subsidiary, National Research Corporation 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 2 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.

 

Revenue is presented net of any sales tax charged to our clients that we are required to remit to taxing authorities. 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 have elected the practical expedient to expense contract costs when incurred for any nonrenewable contracts with a term of one year or less. We deferred incremental costs of obtaining a contract of $1.6 million and $868,000 in the three months ended March 31, 2020 and 2019, respectively. Deferred contract costs, net of accumulated amortization was $4.9 million and $4.2 million at March 31, 2020 and December 31, 2019, respectively. Total amortization by expense classification for the three months ended March 31, 2020 and 2019 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 $21,000 for the three months ended March 31, 2020 and 2019, respectively.

 

Trade Accounts Receivable

 

Trade accounts receivable are recorded at the invoiced amount. Effective January 1, 2020, we adopted Accounting Standards Update (“ASU”) 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU requires 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 adoption of this standard did not impact on our condensed consolidated financial statements. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable, determined based on our historical write-off experience, current economic conditions and reasonable and supportable forecasts about the future. We review the allowance for doubtful accounts monthly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

 

The following table provides the activity in the allowance for doubtful accounts for the three months ended March 31, 2020 and 2019 (In thousands):

 

 

Leases

 

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.

 

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.

 

 Implementation Costs of Hosting Arrangements

 

When a software license is included in a cloud computing arrangement and we have the ability and feasibility to download the software, it is accounted for as software, included in property and equipment, and amortized. If a software license is not included or we do not have the ability or feasibility to download software included in a cloud computing arrangement, it is accounted for as a service contract, which is expensed to direct expenses or selling, general and administrative expenses during the service period. Effective January 1, 2020, we prospectively adopted 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 adoption did not significantly impact our results of operations and financial position.

 

 

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 March 31, 2020 and December 31, 2019:

 

 

There were no transfers between levels during the three-month period ended March 31, 2020.

 

Our long-term debt described in Note 4 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 March 31, 2020, and December 31, 2019, there was no indication of impairment related to these assets.

 

Annually, we consider whether the recorded goodwill and indefinite lived intangibles have been impaired. However, goodwill and intangibles must be tested between annual tests if an event occurs or circumstances change to indicate that it is more likely than not that an impairment loss has been incurred (“triggering event”). We considered the current and expected future economic and market conditions, including the impact of the COVID-19 pandemic on each of our reporting units. We also assessed our current market capitalization compared to book value, forecasts and margins in our last quantitative impairment testing. We concluded that a triggering event has not occurred which would require an interim impairment test to be performed as it is not more likely than not that an impairment loss has been incurred at March 31, 2020.

 

Our Canadian reporting unit generates service revenue from a relatively small number of customers with approximately 56.5% of its annual revenue concentrated in one customer contract which currently expires in March 2021. While historically we have been successful in renewing or retaining contracts with our customers, should we be unable to or choose not to renew a significant contract, it would likely result in an impairment of goodwill at this reporting unit. The carrying amount of goodwill related to our Canadian reporting unit at March 31, 2020 was $2.0 million.

 

 

Commitments and 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. There were no outstanding claims at March 31, 2020.

 

A sales tax accrual of $775,000 was recorded in 2019 after we became aware that a state sales tax liability was both probable and estimable as of December 31, 2019, due to sales taxes that should have been collected from customers in 2019 and certain previous years. We are working through voluntary disclosure agreements with certain states and will have procedures in place to start collecting and remitting sales tax in June or July of 2020. State and local jurisdictions have differing rules and regulations governing sales, use, and other taxes and these rules and regulations can be complex and subject to varying interpretations that may change over time. As a result, we could face the possibility of tax assessment and audits, and our liability for these taxes and associated interest and penalties could exceed our original estimates. In addition, we incurred additional sales tax expense in the first quarter of 2020 of $50,000 and will incur additional expense in the second quarter of 2020, since we will not start collecting sales tax from customers until June or July of 2020.

 

Recent Accounting Pronouncements Not Yet Adopted

 

In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes (Topic 740). Among other clarifications and simplifications related to income tax accounting, this ASU simplifies the accounting for income taxes by eliminating certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, hybrid taxes and the recognition of deferred tax liabilities for outside basis differences.  The guidance is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years.  Early adoption is permitted in interim or annual periods with any adjustments reflected as of the beginning of the annual period that includes that interim period.  Additionally, entities that elect early adoption must adopt all the amendments in the same period.  Amendments are to be applied prospectively, except for certain amendments that are to be applied either retrospectively or with a modified retrospective approach through a cumulative effect adjustment recorded to retained earnings.  We are currently in the process of further evaluating the impact that this new guidance will have on our consolidated financial statements.

 

In March 2020, FASB issued ASU No. 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting", which provides optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments are effective for all entities as of March 12, 2020 through December 31, 2022. We expect to apply the optional expedient for contract modification to account for the change in the reference rate on impacted credit facilities prospectively by adjusting the effective interest rate.

 

(2)	CONTRACTS WITH CUSTOMERS

 

The following table disaggregates revenue for the three-month periods ending March 31, 2020 and 2019 based on timing of revenue recognition (in thousands):

 

 

Our solutions within the digital VoC platform in the three-month periods ending March 31, 2020 and 2019 accounted for 69.1% and 57.8% of total revenue, 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 (In thousands):

 

 

 

Significant changes in contract assets and contract liabilities during the three months ended March 31, 2019 and 2018 are as follows (in thousands):

 

We applied 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 March 31, 2020 approximated $759,000, of which $671,000 and $88,000 are expected to be recognized during 2020 and 2021, respectively.

 

(3)	INCOME TAXES

 

The effective tax rate for the three-month period ended March 31, 2020 decreased to a (3.4)% benefit compared to 16.9% expense for the same period in 2019 mainly due to increased tax benefits of $2.6 million from the exercise and vesting of share-based compensation awards partially offset by higher state income taxes due to the requirements to file in more states.  

 

In March 27, 2020, the U.S. federal government enacted the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act is an emergency economic stimulus package in response to the coronavirus outbreak which, among other things, contains numerous income tax provisions. While we continue to evaluate the impact of the CARES Act, we don’t currently believe it will have a material impact on our consolidated financial statements or related disclosures.

 

(4)	NOTES PAYABLE

 

Our long-term debt consists of the following:  

 

 

Our credit agreement (the “Credit Agreement”) with First National Bank of Omaha (“FNB”) 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” and, together with the Line of Credit and the Term Loan, the “Credit Facilities”). 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 can be 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 (3.61% at March 31, 2020). 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 March 31, 2020, and December 31, 2019, the Line of Credit did not have a balance. There were no borrowings on the Line of Credit for three months ended March 31, 2020. There have been no borrowings on the Delayed Draw Term Loan since origination.

 

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

 

The Credit Agreement is collateralized by substantially all of 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. As of March 31, 2020, we were in compliance with our financial covenants.

 

 

 

(5)	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.

 

Our 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 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.

 

Our 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 our Common Stock. The 2004 Director Plan provides for grants of nonqualified stock options to each of our directors who we do not employ. Beginning in 2018, on the date of each annual meeting of 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 the earlier of ten years following the date of grant, or three years from the termination of the outside director’s service.

 

Our 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 our 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.

 

During the three months ended March 31, 2020 and 2019, we granted options to purchase 48,934 and 73,331 shares of Common Stock, respectively. Options to purchase shares of common stock are typically granted with exercise prices equal to the fair value of the common stock on the date of grant. We do, in certain limited situations, grant options with exercise prices that exceed the fair value of the common shares on the date of grant. The fair value of 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 three-month period ended March 31, 2020:

 

 

As of March 31, 2020, the total unrecognized compensation cost related to non-vested stock option awards was approximately $2.2 million which was expected to be recognized over a weighted average period of 3.59 years.

 

There was no cash received from stock options exercised for the three months ended March 31, 2020 and 2019. We recognized $282,000 and $230,000 of non-cash compensation for three months ended March 31, 2020 and 2019, respectively, related to options, which is included in direct fixed and selling, general and administrative expenses.

 

During the three months ended March 31, 2019, we granted 6,005 non-vested shares of Common Stock under the 2006 Equity Incentive Plan. No shares were granted during the three months ended March 31, 2020. As of March 31, 2020, we had 49,554 non-vested shares of Common Stock outstanding under the 2006 Equity Incentive Plan. These shares vest over five years following the date of grant and holders thereof are entitled to receive dividends from the date of grant, whether or not vested. The fair value of the awards is calculated as the fair market value of the shares on the date of grant. We recognized $50,000 and $73,000 of non-cash compensation for the three months ended March 31, 2020 and 2019, respectively, related to this non-vested stock, which is included in direct fixed and selling, general and administrative expenses. During the three months ended March 31, 2020, 34,622 shares vested.

 

The following table summarizes information regarding non-vested stock granted to associates under the 2006 Equity Incentive Plan for the three-month period ended March 31, 2020:

 

 

As of March 31, 2020, the total unrecognized compensation cost related to non-vested stock awards was approximately $361,000 and is expected to be recognized over a weighted average period of 2.91 years.

 

 

 

(6)	GOODWILL AND OTHER INTANGIBLE ASSETS

 

The following represents a summary of changes in the carrying amount of goodwill for the three-month period ended March 31, 2020:
 

 

Intangible assets consisted of the following:

 

 

(7)	PROPERTY AND EQUIPMENT

 

 

 

 

(8)	EARNINGS PER SHARE

 

Basic net income per share was computed 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.

 

We had 47,859 and 137,453 options of Common Stock for the three-month periods ended March 31, 2020 and 2019, respectively which have been excluded from the diluted net income per share computation because their inclusion would be anti-dilutive.

 

 

(9)

LEASES

 

We lease printing, computer, other equipment and office space in the United States and Canada. The leases remaining terms as of December 31, 2020 range from less than one year to 5.4 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-month period ended March 31, 2020 and 2019 included (in thousands):

 

 

 

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

 

 

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 March 31, 2020 are as follows (in thousands):

 

 

Undiscounted payments under non-cancelable operating leases and finance leases at December 31, 2019 were as follows (in thousands): 

 

 

(10)	CYBER-ATTACK

 

We were the target of an external ransomware attack in February 2020 which resulted in a temporary suspension of our services to clients. Since then, we have fully restored our services. 

 

We recorded an insurance receivable of $2.8 million for incremental costs related to the cyber-attack that our insurer has confirmed as reimbursable. We are expecting reimbursement of $2.4 million of this amount in the quarter ending June 30, 2020. We expect the remaining $400,000 of costs to be paid directly by the insurer to our vendors. This $400,000 is also recorded in accrued expenses, since we are the primary obligor of these costs. Due to the attack in the three-month period ended March 31, 2020, we also recognized revenue adjustments decreasing revenue by approximately $280,000 for our estimate of variable consideration related to subscription-based services that could not be performed. In addition, we incurred other expenses related to the incident including but not limited to professional fees and information technology costs amounting to approximately $285,000. These revenue adjustments and costs will be further evaluated and submitted as a loss claim to the insurer. We will record any insurance recovery when it is probable of collection. Due to insurance recoverability, we do not believe the cyber-attack will have a significant impact on our consolidated financial statements.   

 

 

 

(11)	RELATED PARTY

 

Until January 2020, one of our directors served as an officer and director of Ameritas Life Insurance Corp. (“Ameritas”) and continues to serve on the board of directors. 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 $72,000 and $59,000 in the three-month periods ended March 31, 2020 and 2019, respectively.

 

One of our directors serves as a board member of IMA Financial Group. In connection with our regular assessment of our liability coverage, during 2020 we began purchasing directors and officers and employment practices liability insurance through IMA Financial Group. These purchases totaled $478,000 in the three-month period ended March 31, 2020.

 

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 receives a portion of the revenues. The total revenue earned from the PX reseller agreement in the three-month periods ended March 31, 2020 and 2019, were $83,000 and $153,000, respectively. We will no longer earn revenue under this agreement after December 31, 2020.