NRC

Business Context and Reporting Period

Company: National Research Corporation (NRC Health)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
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 8.7% in the quarter and 2.7% for the nine-month period compared to the prior year. The nine-month growth was tempered by lower revenues from U.S. federal government contracts in Q1 2005, offset by new client additions.
• Expense Trends:
  • Direct Expenses: Decreased 3.8% (quarter) and 3.4% (nine months) due to a mix of business and data collection methodology changes, including reduced printing/postage and fieldwork costs.
  • Selling, General & Administrative (SG&A): Increased 27.8% (quarter) and 18.4% (nine months) driven by sales and marketing expansion initiatives, specifically higher salary, benefits, and travel expenses.
• Profitability: Operating income increased 19.5% for the quarter and 1.7% for the nine-month period. The effective tax rate increased to 39.8% in 2005 from 38.6% in 2004 due to state income tax differences.
• Acquisition: On September 16, 2005, the company acquired Geriatric Health Systems, LLC (GHS) for approximately $4.0 million in cash. This acquisition is expected to expand the company's presence in the commercial health plan market.

Guidance, Outlook, and Risks

• Outlook: Management expects operating cash flows to remain sufficient for working capital and capital expenditures. Growth is anticipated to be driven by increased demand for performance measurement products due to public reporting programs.
• Dividends: The company initiated a quarterly cash dividend in March 2005, paying $1.7 million in the first nine months of 2005. Future dividends are at the Board's discretion.
• Stock Repurchases: The company has an active stock repurchase program. As of November 8, 2005, 328,211 shares had been repurchased under the 500,000 share authorization. No shares were repurchased in Q3 2005.
• Accounting Changes: The company is evaluating the impact of adopting SFAS No. 123(R) regarding share-based payments, effective January 1, 2006. This will require recognizing compensation costs based on fair value, which may reduce reported net income.
• Liquidity: Cash and cash equivalents decreased to $1.0 million from $3.6 million at year-end 2004, primarily due to the GHS acquisition, treasury stock purchases, and dividend payments.

Investor Verification Checklist

• Acquisition Integration: Verify the financial contribution of the Geriatric Health Systems (GHS) acquisition to future quarters and the status of the $500,000 escrow account.
• Government Contract Exposure: Assess the impact of reduced U.S. federal government contract revenues in Q1 2005 on future revenue stability.
• SG&A Sustainability: Monitor whether the significant increase in SG&A expenses (driven by marketing expansion) yields proportional revenue growth in subsequent periods.
• Dividend Policy: Confirm the sustainability of the new quarterly dividend policy given the reduction in cash reserves and increased capital outflows.
• Stock-Based Compensation Impact: Review the projected impact of SFAS No. 123(R) adoption in 2006 on future net income and EPS.