NRC Health (National Research Corporation) — Q3 2017 Form 10-Q
Business and period: NRC Health provides analytics and insights focused on patient and employee experience, engagement and loyalty for healthcare organizations in the U.S. and Canada. This unaudited filing covers the quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Revenue | $29.0m | $27.0m | $87.7m | $81.0m |
| Operating income | $7.1m | $7.3m | $25.6m | $22.4m |
| Operating margin | 24.6% | 27.2% | 29.2% | 27.6% |
| Net income | $4.2m | $4.7m | $16.4m | $14.8m |
| Operating cash flow | Not reported separately | Not reported separately | $21.5m | $18.0m |
- Q3 revenue rose 7.1%, attributed to new customers and higher sales to existing clients. Operating income declined 3.0%, and net income declined 12.2%.
- For the first nine months, revenue increased 8.2%, operating income 14.3%, and net income 11.0%. Net margin was approximately 18.7%, versus 18.3% in 2016.
- Q3 diluted EPS was $0.09 for Class A and $0.57 for Class B, compared with $0.11 and $0.66, respectively. Nine-month diluted EPS was $0.38 and $2.28, compared with $0.35 and $2.08.
- Q3 direct expense was 42.4% of revenue in both years. SG&A rose to 29.1% of revenue from 26.4%, primarily reflecting recapitalization costs and higher recruiting and software-related expenses. Nine-month SG&A declined to 25.1% of revenue from 26.9%.
Cash, debt and liquidity
- At September 30, cash and cash equivalents were $35.8m, current assets $53.8m, current liabilities $34.2m, and working capital $19.7m. Cash increased $2.7m from year-end 2016; working capital was $15.6m at year-end.
- Nine-month operating cash flow was $21.5m; investing cash outflow was $4.9m, including $3.3m of capital expenditures and a $1.3m strategic investment; financing cash outflow was $14.7m, including $12.6m of dividends and $1.8m of debt repayment.
- Term-note debt was $1.7m; the existing $12.0m revolving facility was undrawn. Capital lease obligations were $0.2m. The company reported compliance with debt covenants. Cash held in Canada was $12.8m and was intended to remain invested abroad.
- Deferred revenue increased to $18.5m from $15.5m, mainly reflecting billing timing on new and renewed contracts. Management stated that existing liquidity, borrowing availability and operating cash flow should meet projected needs and its dividend policy for the foreseeable future.
Material changes, outlook and risks
- Proposed recapitalization: The board approved a transaction involving a reverse and forward split of Class B shares to cash out holders other than the founder and CEO, at $53.44 per share. It requires financing and shareholder approvals. A bank commitment letter contemplated a $70m senior secured term loan, a $20m delayed-draw term loan and a $10m revolving facility; the letter expired December 29, 2017. The proposed transaction would substantially increase borrowing if completed. NRC incurred $1.1m of related expenses in the first nine months, including $0.975m in Q3; these also contributed to higher tax expense.
- Strategic investment and related-party matters: NRC invested $1.3m for approximately 15.7% of privately held PracticingExcellence.com and has a board seat. It also reported $0.454m of nine-month reseller revenue from PX and paid $0.250m for content licenses. CEO Michael Hays was reimbursed approximately $0.538m for strategic-alternatives-related fees and expenses.
- Operating outlook: The filing provides no specific revenue or earnings guidance. Management expected capital expenditures for the rest of 2017 to be similar to the first nine months, primarily for software, hardware and equipment, funded from operating cash flow.
- Accounting and other risks: NRC planned to adopt the new revenue standard on January 1, 2018 using a cumulative-effect adjustment; anticipated changes include deferring commissions over the estimated client relationship and estimating variable consideration at contract inception. It disclosed $1.8m of operating lease commitments. Management reported no material change to previously disclosed risk factors; identified risks include client nonrenewal, competition and price pressure, healthcare-sector consolidation and regulatory change, personnel retention, and cybersecurity or intellectual-property threats.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether recapitalization financing and required shareholder approvals were obtained, the transaction closed, and final debt terms differed from the commitment letter.
- Whether revenue growth from new and existing clients continued and whether direct costs and Q3 SG&A pressure affected subsequent operating margins.
- Cash generation, receivables and deferred-revenue trends, and the effect of Canadian cash balances and any repatriation taxes.
- The outcome and accounting impact of the PX investment and commercial relationship, and the extent of related-party reimbursements.
- The realized effects of adopting the revenue-recognition standard and any subsequent changes to capital spending, dividends or liquidity.