NRC

Business Context and Reporting Period

Company: National Research Corporation (NRC Health)

Filing Type: Form 10-K (Annual Report)

Reporting Period: Fiscal year ended December 31, 2006

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's primary services include renewable performance tracking, custom research, subscription-based governance information, and the syndicated NRC Healthcare Market Guide. In 2006, the company significantly expanded its operations through the acquisition of The Governance Institute (TGI) for $19.8 million and continued to integrate Geriatric Health Systems (GHS), acquired in late 2005.

Key Financial Metrics

Liquidity Note: The company moved from a positive working capital position of $8.1 million in 2005 to a deficit of $1.5 million in 2006. This shift was primarily driven by the reduction of marketable securities and an increase in notes payable to fund the TGI acquisition.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased by $11.3 million (34.9%) year-over-year. This growth was driven by expanded scope of work with existing clients and new business from acquisitions. TGI contributed approximately $3.5 million and GHS contributed $4.0 million in revenue during 2006.
• Expense Increases:
  • Direct Expenses: Rose 42.5% to $19.4 million, increasing as a percentage of revenue from 42.1% to 44.4%. This was due to higher costs associated with servicing new business and specific health plan projects with higher direct cost structures.
  • Selling, General & Administrative (SG&A): Increased 41.1% to $12.2 million, driven by sales/marketing expansion, acquisition-related costs, and the adoption of SFAS No. 123R (share-based compensation).
  • Depreciation & Amortization: Increased 28.3% to $2.3 million due to amortization of intangibles from the GHS and TGI acquisitions.
• Debt Structure: Total debt surged from $1.5 million to $11.1 million. The company entered a new credit facility in May 2006, borrowing $9.0 million in term notes and $3.5 million in revolving credit to finance the TGI acquisition. The previous $1.4 million note was paid off.
• Goodwill: Net goodwill increased from $11.5 million to $30.0 million following the TGI acquisition.

Guidance, Outlook, and Risks

Management Outlook:

• 2007 Expense Guidance: Management expects direct expenses to be in the upper end of their 43% to 45% revenue model. SG&A expenses are also expected to be in the upper end of their 23% to 25% model. Depreciation and amortization are expected to remain within the 4.5% to 6.0% revenue model.
• Capital Expenditures: Budgeted at approximately $1.0 million for 2007, primarily for hardware, software, and production equipment.

Key Risks and Contingencies:

• Client Concentration: The ten largest clients accounted for 32% of 2006 revenues. The U.S. Department of Veterans Affairs alone accounted for 8%. Loss of key clients could materially impact results.
• Renewal Dependency: A substantial portion of revenue comes from annually renewable contracts that are generally cancelable on short notice without penalty.
• Seasonality: Operating results fluctuate quarterly, particularly due to the timing of the Market Guide delivery (typically Q3), which concentrates revenue recognition.
• Competition: The market is highly competitive, with Press Ganey identified as a significantly larger competitor. Increased competition could lead to pricing pressure.
• Regulatory Changes: The introduction of the HCAHPS survey program by the Centers for Medicare and Medicaid Services may increase competition and pricing pressure.

Investor Verification Checklist

• Acquisition Integration: Verify the revenue contribution and integration progress of The Governance Institute (TGI) and Geriatric Health Systems (GHS) to ensure they meet projected performance targets.
• Client Retention Rates: Monitor renewal rates for the top 10 clients, which represent nearly one-third of total revenue, to assess revenue stability.
• Debt Covenants: Review compliance with the new credit facility covenants, specifically financial ratio requirements, given the significant increase in leverage.
• Working Capital Trends: Track the working capital deficit to ensure it does not widen further and that cash flow from operations remains sufficient to service debt and fund operations.
• Market Guide Timing: Confirm the delivery schedule for the annual Market Guide, as delays could materially impact quarterly revenue recognition.