NRC

Business Context and Reporting Period

Company: National Research Corporation (NRC Health)

Filing Type: Form 10-K (Annual Report)

Period Ended: December 31, 2008

NRC Health is a leading provider of survey-based performance measurement, improvement services, and governance education to the healthcare industry in the United States and Canada. The company serves hospitals, health systems, and payers with tools to measure patient experience and health status. In December 2008, NRC acquired My InnerView, Inc. (MIV), a provider of quality improvement solutions for the senior care market, to expand its service offerings.

Key Financial Metrics

Dividends: $3.8 million paid in 2008 ($0.56 per share).

Stock Repurchases: The company repurchased approximately 101,872 shares in Q4 2008 alone, with a total of 395,558 shares repurchased during the full year.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 4.3% driven by expanded scope of work with existing clients and new client additions. The acquisition of MIV contributed to growth but was closed late in the year (Dec 19, 2008).
• Expense Reallocation: Direct expenses increased 8.3% (to 46.3% of revenue) while Selling, General, and Administrative (SG&A) expenses decreased 3.4% (to 25.0% of revenue). This shift was due to a change in the business model where sales staff focused on servicing current clients were reclassified from SG&A to Direct Expenses.
• Debt Increase: Total debt surged from $3.0 million to $13.0 million. This was primarily due to a $9.0 million term note borrowed in December 2008 to finance the MIV acquisition.
• Working Capital Deficiency: The working capital deficiency widened to $10.7 million from $2.4 million. This was caused by increased billings in excess of revenue earned (deferred revenue), decreased unbilled revenue, and the new debt incurred for the acquisition.
• Market Guide Accounting Change: Starting in May 2008, the Market Guide product shifted from annual delivery to monthly subscription-based delivery. Consequently, revenue recognition changed from lump-sum recognition (typically Q3) to ratable recognition over 12 months, and related costs began being expensed monthly rather than deferred.

Guidance, Outlook, and Risks

Management Commentary: Management believes the company has adequate capital resources to meet projected needs. The company expects to extend its revolving credit facility beyond its July 2009 maturity. Capital expenditures for 2009 are budgeted at approximately $2.0 million.

Key Risks:

• Client Concentration: The ten largest clients accounted for 24% of 2008 revenue. The U.S. Department of Veterans Affairs alone accounted for 7%.
• Renewal Dependency: A substantial portion of revenue comes from annually renewable contracts that are cancelable on short notice without penalty.
• Competition: The market is highly competitive, with Press Ganey identified as a significantly larger competitor. Increased competition could lead to pricing pressure.
• Key Personnel: The company relies heavily on CEO Michael D. Hays, who beneficially owns 72.7% of the outstanding common stock and controls significant corporate matters.
• Regulatory Changes: Changes in healthcare reimbursement rates or the implementation of government-mandated surveys (e.g., HCAHPS) could impact demand for NRC's services.

Investor Verification Checklist

• Debt Covenants: Verify compliance with the new $9.0 million term note covenants, which include maintaining specific financial ratios.
• Renewal Rates: Monitor client renewal rates for performance tracking services, as these contracts are cancelable without penalty.
• Market Guide Transition: Assess the long-term impact of the shift from annual to monthly revenue recognition on quarterly earnings volatility.
• Integration of MIV: Track the integration progress and financial performance of the My InnerView acquisition in 2009.
• CEO Concentration: Consider the implications of the CEO's 72.7% ownership stake on corporate governance and potential change-of-control scenarios.