NRC

Business Context and Reporting Period

Company: National Research Corporation (NRC Health)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2006
Business Overview: NRC Health provides survey-based performance measurement, analysis, and educational services to the healthcare industry in the U.S. and Canada. The company helps healthcare organizations comply with regulatory standards and improve business practices through performance tracking, custom research, and educational services.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 43.7% to $9.5 million, driven by expanded scope of work with existing clients, new client additions, and $880,000 in revenue from the Geriatric Health Systems (GHS) acquisition.
• Profitability: Net income rose 62.7% to $1.2 million. Operating margin improved to 20.0% from 18.8%.
• Expense Increases:
  • Direct Expenses: Increased 49.1% to $4.1 million due to higher printing, postage, salaries, and fieldwork costs associated with increased business volume. As a percentage of revenue, this rose to 43.3% from 41.7%.
  • Selling, General & Administrative (SG&A): Increased 37.6% to $3.0 million, primarily due to sales/marketing expansion and new share-based compensation expenses under SFAS No. 123R. As a percentage of revenue, this decreased to 31.7% from 33.1%.
• Cash Flow: Net cash provided by operating activities decreased 49.4% to $1.2 million. This decline was attributed to a $771,000 increase in customer-related accounts (receivables and unbilled revenues) and decreases in accrued expenses and accounts payable, partially offset by higher net income.
• Debt Reduction: The company made significant principal payments on bank debt, reducing the current portion of notes payable from $1.47 million to $200,000.

Guidance, Outlook, and Risks

• Expense Outlook: Management expects direct expenses to remain within 43% to 45% of total revenues for the remainder of 2006. SG&A expenses are expected to be on the upper end of the 23% to 25% model due to continued sales and marketing expansion.
• Accounting Changes: The company adopted SFAS No. 123R (Share-Based Payment) effective January 1, 2006. This resulted in $215,000 of compensation expense for the quarter. Management estimates the impact of this standard to be approximately $0.05 to $0.07 per share for the full year 2006.
• Stock Repurchase: In February 2006, the Board authorized the repurchase of an additional 750,000 shares. No shares were repurchased under this plan during the quarter ended March 31, 2006.
• Risk Factors: No material changes to risk factors were reported since the previous 10-K filing. The company notes that its principal source of funds is cash flow from operations, which it expects to remain sufficient for working capital and capital expenditures.

Investor Verification Checklist

• Revenue Quality: Verify the sustainability of the 43.7% revenue growth, specifically the contribution from the GHS acquisition ($880,000) versus organic growth.
• Cash Conversion: Investigate the reasons for the significant drop in operating cash flow despite a 62% increase in net income, focusing on the $771,000 increase in receivables and unbilled revenues.
• Expense Ratios: Monitor if SG&A expenses remain within the projected 23-25% range as sales and marketing efforts expand.
• Debt Servicing: Confirm the status of the remaining long-term debt obligations following the $1.27 million principal payment made in the quarter.
• Share-Based Compensation: Track the actual impact of SFAS No. 123R on future earnings per share against the management estimate of $0.05-$0.07.