Business context and reporting period
National Research Corporation (NRC) provides analytics and insights to healthcare organizations, including solutions for patient experience, retention, engagement and population health. This Form 10-Q covers the quarter and nine months ended September 30, 2014; financial amounts below are in U.S. dollars. During the quarter, NRC changed its internal reporting structure from two operating segments to three—U.S. NRC, NRC Canada and Customer-Connect LLC (Connect)—but aggregates them as one reportable segment.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $23.7 million | $22.4 million | $73.7 million | $69.7 million |
| Operating income | $7.2 million | $6.0 million | $21.9 million | $18.8 million |
| Operating margin | 30.2% | 26.9% | 29.7% | 27.0% |
| Net income | $4.6 million | $3.8 million | $14.1 million | $11.7 million |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $20.6 million | $15.3 million |
Q3 diluted EPS was $0.11 for Class A and $0.64 for Class B, versus $0.09 and $0.54, respectively, a year earlier. Nine-month diluted EPS was $0.33 for Class A and $1.99 for Class B, compared with $0.28 and $1.67. The classes have different contractual participation rights in earnings.
Liquidity, debt and cash flow
At September 30, 2014, NRC had $39.1 million in cash and cash equivalents, including $9.5 million held in Canada, and working capital of $26.2 million, versus $12.8 million at December 31, 2013. The increase in working capital primarily reflected higher cash, partly offset by deferred revenue. Current deferred revenue was $17.0 million; the company says it primarily reflects advance billing and is generally recognized within 12 months.
Nine-month operating cash flow rose to $20.6 million from $15.3 million, including a $3.0 million cash benefit from increased deferred revenue. Investing activities used $2.1 million, mainly for property and equipment; financing activities used $1.2 million, including $1.7 million of term-debt repayments. Cash increased $17.0 million during the period.
Term debt outstanding was $8.6 million, with a 3.12% interest rate; capital lease obligations were $354,000. NRC had no borrowings on its $6.5 million revolving credit facility, which was renewed through June 30, 2015, and reported capacity to borrow the full $6.5 million. The company was in compliance with its debt covenants. Its term and revolving facilities are secured by specified assets.
Changes, outlook, risks and unusual items
- Revenue increased 5.7% in Q3 and 5.8% for the nine-month period, which management attributed to new customers and increased sales to existing clients. Q3 operating margin improved 3.3 percentage points; SG&A declined as a share of revenue, while direct costs were broadly stable as a share of nine-month revenue.
- Nine-month net income rose 20.0% year over year. The nine-month effective tax rate fell to 35.3% from 36.8%, primarily due to lower projected state tax rates and prior-year recapitalization fees; the Q3 rate was approximately unchanged at 36.0% versus 35.9%.
- Connect, in which NRC owns 49% but consolidates as primary beneficiary, recorded operating losses of $1.1 million for the first nine months of 2014, compared with $471,000 in the prior-year period. NRC has contributed $2.5 million. NRC may be required to buy the other members’ interests if Connect reaches at least $12.5 million in annual recurring contract value and a pro forma minimum 35% EBITDA margin is approved; the stated purchase price as of September 30 was $0.
- After quarter-end, NRC invested $2.2 million to purchase a healthcare technology platform and made an $800,000 seed investment in a talent-matching partner, with an option to purchase that target for $4.1 million. Both products were expected to launch in 2015; the purchase price allocation for the platform had not been completed.
- Management stated that existing cash, borrowing availability and operating cash flows should meet projected capital and debt needs and its dividend policy for the foreseeable future. The filing gives no quantified earnings or revenue guidance. NRC expected capital expenditures for the remainder of 2014 to be similar to the first nine months.
- Key disclosed risks include client non-renewals and concentration, competition and price pressure, healthcare-industry consolidation and regulatory changes, economic downturns, and retaining key clients and personnel. Management reported no material change to previously disclosed risk factors. Foreign-currency translation reduced comprehensive income by $590,000 in Q3 and $533,000 over nine months.
- NRC reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It was evaluating the impact and adoption method of the forthcoming revenue-recognition standard.
Important facts for investors to verify
- Whether revenue growth and improved operating margins continue, and how much cash-flow growth depends on advance billings and deferred revenue.
- Connect’s operating losses, progress toward its buyout thresholds, and potential future cash commitment.
- The realized returns and integration costs of the two October strategic investments, including the partner-company purchase option.
- Liquidity and debt-service capacity, including the June 2015 revolving-credit renewal date, covenant compliance and restrictions on secured assets.
- Potential tax effects of repatriating cash held in Canada, which NRC intended to keep invested abroad and for which it did not quantify a potential U.S. tax liability.