NRC Health — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. National Research Corporation, doing business as NRC Health, provides analytics and insights focused on patient and employee experience, engagement, and healthcare market research. Figures below are in U.S. dollars; financial statement amounts are rounded to millions unless stated otherwise.
Key financial results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $28.0m | $28.4m | $59.0m | $58.7m |
| Operating income | $7.8m | $8.5m | $16.7m | $18.4m |
| Operating margin | 27.7% | 29.7% | 28.3% | 31.4% |
| Net income | $7.9m | $5.8m | $15.3m | $12.3m |
| Diluted EPS, Common Stock formerly Class A | $0.28 | $0.13 | $0.45 | $0.28 |
| Operating cash flow | Not separately stated | Not separately stated | $18.4m | $10.6m |
- Q2 revenue declined 1.5%; management attributed the decrease primarily to ASC 606 adoption, conference timing, and minimal contract value growth. First-half revenue increased 0.6%, reflecting new customer sales and growth among existing clients.
- Q2 operating income fell 8.2%, while net income rose, primarily reflecting a tax benefit. The Q2 tax provision was a benefit of $0.1m, versus tax expense of $2.7m a year earlier. First-half effective tax rate was 9.1%, compared with 33.5%.
- Direct expense decreased 7.9% in Q2 and 2.2% in the first half, helped by lower postage, printing, paper, and conference costs. SG&A rose 15.0% in Q2 and 16.3% in the first half; drivers included compensation, software and platform hosting, and Recapitalization-related costs. Depreciation and amortization also increased, mainly due to software investment.
- First-half investing cash use was $2.8m, primarily for software and equipment. Cash and equivalents declined $28.0m to $6.7m, largely reflecting the Recapitalization and dividends; financing activities used $43.1m.
Financial position, debt, and liquidity
- At June 30, cash was $6.7m, current assets $23.6m, current liabilities $32.9m, and the working capital deficit $9.1m. Deferred revenue was $16.7m.
- Notes payable totaled $39.8m, including a $40m term loan originated in April. The term loan bears fixed interest at 5%, amortizes monthly, and matures in April 2023. The $15m revolving facility and $15m delayed-draw term facility had no outstanding balance at quarter-end; the delayed-draw facility is restricted to permitted acquisitions or share repurchases.
- The credit agreement is secured by substantially all company assets and includes minimum fixed-charge coverage and maximum cash-flow leverage covenants. NRC Health reported compliance at June 30. Management stated cash, operating cash flows, and available credit were expected to meet projected capital and debt needs and support the dividend policy for the foreseeable future.
Material changes, outlook, and risks
- Recapitalization: Effective April 17, 2018, each former Class B share was exchanged for one Common Stock share plus $19.59 cash. The company issued about 3.6m shares and paid $72.4m, funded in part by the new term loan. Class B shares were eliminated and former Class A shares reclassified as Common Stock.
- Accounting change: NRC Health adopted ASC 606 on January 1, 2018 using the modified retrospective method, recording a $2.7m after-tax increase to opening retained earnings. Prior-year results were not restated. The new standard primarily changed accounting for contract-acquisition costs, which are now deferred and amortized over estimated customer contract lives; reported Q2 revenue was $0.1m lower than it would have been without ASC 606.
- Management commentary: The company expected capital spending to remain similar for the rest of 2018, mainly for software, hardware, and equipment. No formal earnings or revenue guidance is provided in the filing.
- Contingencies: Two shareholder lawsuits remained pending, alleging fiduciary-duty breaches related to the proposed transaction and Recapitalization disclosures. The company moved to dismiss and said it would defend the matters; no loss was accrued because management considered loss not probable or estimable.
- Other risks: Client contract renewal and retention, competition and price pressure, healthcare-industry consolidation and regulation, personnel retention, cybersecurity, and protection of proprietary technology. Subscription agreements are generally cancelable on short or no notice without penalty. The filing reported no material change to previously disclosed risk factors.
- Market exposure: The company disclosed foreign-exchange and interest-rate exposure and no foreign-currency hedging. It reported $16.9m of intercompany loans from its Canadian subsidiary to the U.S. parent, denominated in Canadian dollars.
Important facts for investors to verify
- How revenue growth and client retention develop after a quarter affected by ASC 606 and conference timing.
- Whether higher SG&A and software/platform hosting costs translate into durable revenue growth and operating-margin recovery.
- Cash generation, working-capital trends, and the capacity to service debt and maintain dividends after the $72.4m Recapitalization payment.
- Future covenant headroom and the terms or permitted uses of available revolving and delayed-draw facilities.
- Resolution and potential financial impact of the shareholder litigation; no liability was recorded at June 30, 2018.
- Effects of ASC 606 estimates, including contract duration and deferred commission amortization, on period-to-period comparability.