ITEM 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
The Company is a leading provider of analytics and insights that facilitate measurement and improvement of the patient and employee experience while also increasing patient engagement and customer loyalty for healthcare providers, payers and other healthcare organizations. The Company’s solutions enable its clients to understand the voice of the customer with greater clarity, immediacy and depth. NRC Health’s heritage, proprietary methods, and holistic approach enable our partners to better understand the people they care for and design experiences that inspire loyalty and trust, while also facilitating regulatory compliance and the shift to population-based health management. The Company’s ability to measure what matters most and systematically capture, analyze and deliver insights based on self-reported information from patients, families and consumers is critical in today’s healthcare market. NRC Health believes that access to and analysis of its extensive consumer-driven information is becoming more valuable as healthcare providers increasingly need to more deeply understand and engage patients and consumers in an effort towards effective population-based health management.
The Company’s portfolio of subscription-based solutions provide actionable information and analysis to healthcare organizations and payers across a range of mission-critical, constituent-related elements, including patient experience and satisfaction, community population health risks, workforce engagement, community perceptions, and physician engagement. NRC Health partners with clients across the continuum of healthcare services. The Company’s clients range from integrated health systems and post-acute providers, such as home health, long term care and hospice, to numerous payer organizations. The Company believes this cross-continuum positioning is a unique and an increasingly important capability as evolving payment models drive healthcare providers and payers towards a more collaborative and integrated service model.
Results of Operations
The following table and graphs set forth, for the periods indicated, select financial information derived from the Company’s condensed consolidated financial statements expressed as a percentage of total revenue. The trends illustrated may not necessarily be indicative of future results. The discussion that follows the table should be read in conjunction with the condensed consolidated financial statements.
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Direct
|
|
|
41.6
|
|
|
|
41.3
|
|
Selling, general and administrative
|
|
|
25.4
|
|
|
|
22.1
|
|
Depreciation and amortization
|
|
|
4.1
|
|
|
|
3.7
|
|
Total operating expenses
|
|
|
71.1
|
|
|
|
67.1
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
28.9
|
%
|
|
|
32.9
|
%
|
Three Months Ended
March 31, 2018
, Compared to Three Months Ended
March 31, 2017
Revenue
. Revenue for the three-month period ended March 31, 2018, increased 2.4% to $31.0 million, compared to $30.3 million in the three-month period ended March 31, 2017. The increase was primarily due to new customer sales, as well as increases in sales to the existing client base.
Direct expenses
. Direct expenses increased 3.3% to $12.9 million for the three-month period ended March 31, 2018, compared to $12.5 million in the same period in 2017. This was due to an increase of fixed expenses of $407,000. Fixed expenses increased primarily as a result of increased salary and benefit costs and contracted services in the customer service and information technology areas. Direct expenses as a percentage of revenue were 41.6% in the three-month periods ended March 31, 2018 and 41.3% for the same period in 2017.
Selling, general and administrative expenses
. Selling, general and administrative expenses increased 17.7% to $7.9 million for the three-month period ended March 31, 2018, compared to $6.7 million for the same period in 2017, primarily due higher costs associated with the Recapitalization of $292,000, higher salaries and related payroll taxes of $242,000, increased legal and accounting services primarily related to the Tax Act and adoption of ASC 606 of $131,000, increased software and platform hosting expenses of $369,000, higher contracted services of $135,000 and increased bad debt expense of $95,000. The net effect of deferring commissions and incentive due to the adoption of ASC 606 decreased expenses by $168,000 in the three-month period ended March 31, 2018. Selling, general and administrative expenses as a percentage of revenue were 25.4% in the three-month periods ended March 31, 2018 and 22.1% for the same period in 2017.
Depreciation and amortization.
Depreciation and amortization increased 16.0% to $1.3 million for the three-month period ended March 31, 2018, compared to $1.1 million for the same period in 2017 mainly due to increased amortization from additional computer software investments. Depreciation and amortization expenses as a percentage of revenue was 4.1% for the three-month period ended March 31, 2018, and 3.7% for the same period in 2017.
Provision for income taxes.
Provision for income taxes was $1.7 million (18.5% effective tax rate) for the three-month period ended March 31, 2018, compared to $3.5 million (34.7% effective tax rate) for the same period in 2017. The effective tax rate for the three-month period ended March 31, 2018, was lower mainly due to the reduction in the corporate tax rate from 35% to 21% due to the Tax Act that was enacted on December 22, 2017. In addition, the Company had increased tax benefits of $350,000 from the exercise of options and dividends paid to non-vested shareholders partially offset by $67,000 additional tax expense from non-deductible recapitalization expenses.
Liquidity and Capital Resources
The Company believes that its existing sources of liquidity, including cash and cash equivalents, borrowing availability under existing and new credit facilities obtained in April 2018, and operating cash flows will be sufficient to meet its projected capital and debt maturity needs, including the Recapitalization in April 2018, and the dividend policy for the foreseeable future.
As of March 31, 2018, our principal sources of liquidity included $35.5 million of cash and cash equivalents and up to $12 million of unused borrowings under our revolving credit note. The amount of unused borrowings actually available under the revolving credit note varies in accordance with the terms of the agreement. Of this cash, $13.3 million was held in Canada.
Working Capital
The Company's working capital was $22.4 million and $19.9 million on March 31, 2018 and December 31, 2017, respectively. The change was primarily due to decreases in current portion of notes payable of $1.1 million, decreases in accrued wages, bonus, and profit sharing of $3.1million and increases in cash and cash equivalents of $745,000. This was partially offset by increases in income taxes payable of $865,000, increases in accrued expenses and accounts payable of $346,000, and decreases in income taxes receivable of $307,000. Trade accounts receivable deceased due to the timing of billings and collections on new and renewal contracts, as well as the inclusion of unbilled revenue amounts. Accrued wages, bonus and profit sharing decreased due to the payment of 2017 annual bonuses in the three-month period ended March 31,2018. Income taxes payable and receivable changed due to the timing of income tax payments. Current portion of notes payable decreased due to the payoff of the term note. The Company’s working capital is significantly impacted by its large deferred revenue balances which will vary based on the timing and frequency of billings on annual agreements. The deferred revenue balances as of March 31, 2018 and December 31, 2017 were $17.0 million and $16.9 million, respectively.
Deferred revenue is recognized when we invoice clients in advance of performing the related services under the terms of a contract and is recognized as revenue when we have satisfied the related performance obligation. The Company typically invoices clients for performance tracking services and custom research projects before they have been completed. In addition, when work is performed in advance of billing, the Company records this work as unbilled revenue. Substantially all deferred revenue and all unbilled revenue will be earned and billed respectively, within 12 months of the respective period ends.
Cash Flow Analysis
A summary of operating, investing, and financing activities is shown in the following table:
|
|
Three Months Ended March 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
(In thousands)
|
|
Provided by operating activities
|
|
$
|
8,228
|
|
|
$
|
8,143
|
|
Used in investing activities
|
|
|
(1,298
|
)
|
|
|
(1,425
|
)
|
Used in financing activities
|
|
|
(5,851
|
)
|
|
|
(5,161
|
)
|
Effect of exchange rate change on cash
|
|
|
(334
|
)
|
|
|
86
|
|
Net change in cash and cash equivalents
|
|
|
745
|
|
|
|
1,643
|
|
Cash and cash equivalents at end of period
|
|
$
|
35,478
|
|
|
$
|
34,664
|
|
Cash Flows from Operating Activities
Cash flows from operating activities consist of net income adjusted for non-cash items including depreciation and amortization, deferred taxes, share-based compensation and related taxes, reserve for uncertain tax positions and the effect of working capital changes.
Net cash provided by operating activities was $8.2 million for the three months ended March 31, 2018, which included net income of $7.3 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, reserve for uncertain tax positions, totaling $2.1 million. Net changes in assets and liabilities decreased cash flows from operating activities by $1.2 million, primarily due to decreases accrued wages, bonus and profit sharing and increases in deferred contract costs partially offset by income taxes receivable and payable which fluctuate with the timing of income tax payments.
Net cash provided by operating activities was $8.1 million for the three months ended March 31, 2017, which included net income of $6.5 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, reserve for uncertain tax positions and non-cash stock compensation totaling $2.0 million. Changes in working capital decreased cash flows from operating activities by $381,000, primarily due to increases in trade accounts receivables and unbilled revenue, net of increases in deferred revenue, which fluctuate due to the timing and frequency of billings on new and renewal contracts. The timing of payments related to prepaid expenses and accrued expenses, wages, bonus and profit sharing also decreased operating cash flows. These decreases to cash flows were partially offset by decreases to the timing of payments related to income taxes receivable and payable, and accounts payable.
Cash Flows from Investing Activities
Net cash of $1.3 million and $1.4 million was used for investing activities in the three months ended March 31, 2018 and 2017, respectively. These expenditures consisted mainly of computer software classified in property and equipment. The Company expects similar capital expenditure purchases for the remainder of 2018 consisting primarily of computer software and hardware and other equipment to be funded through cash generated from operations.
Cash Flows from Financing Activities
Net cash used in financing activities was $5.9 million in the three months ended March 31, 2018. Cash was used to repay borrowings under the term note totaling $1.1 million and for capital lease obligations of $28,000. Cash was also used to pay $4.2 million of dividends on common stock, and to pay payroll tax withholdings related to share-based compensation of $535,000.
Net cash used in financing activities was $5.2 million in the three months ended March 31, 2017. Cash was used to repay borrowings under the term note totaling $816,000 and for capital lease obligations of $27,000. Cash was also used to pay $4.2 million of dividends on common stock, and to pay payroll tax withholdings related to share-based compensation of $105,000.
The effect of changes in foreign exchange rates decreased cash and cash equivalents by $334,000 in the three months ended March 31, 2018 and increased it by $86,000 in the three months ended March 31, 2017.
Capital Expenditures
Cash paid for capital expenditures was $1.3 million for the three months ended March 31, 2018. These expenditures consisted mainly of computer software classified in property and equipment. The Company expects similar capital expenditure purchases for the remainder of 2017 consisting primarily of computer software and hardware and other equipment to be funded through cash generated from operations.
Debt and Equity
The balance on the Company’s term note was paid in full in March 2018.
As of March 31, 2018, the Company also had a revolving credit note with a maturity date of June 30, 2018. The maximum aggregate amount available under the revolving credit note was $12.0 million. Borrowings under the revolving credit note bore interest at a variable annual rate, with three rate options at the discretion of management as follows: (1) 2.1% plus the one-month London Interbank Offered Rate (“LIBOR”) or (2) 2.1% plus the one-, two- or three- month LIBOR rate, or (3) the bank’s one-, two, three, six, or twelve month Money Market Loan Rate. As of March 31, 2018, the revolving credit note did not have a balance. The Company had the capacity to borrow $12.0 million as of March 31, 2018. The revolving credit note was terminated in April 2018 when the Company entered into a new credit agreement (see below).
The term note and revolving credit note were secured by certain of the Company’s assets, including the Company’s land, building, trade accounts receivable and intangible assets. The term note and revolving credit note contained various restrictions and covenants applicable to the Company, including requirements that the Company maintain certain financial ratios at prescribed levels and restrictions on the ability of the Company to consolidate or merge, create liens, incur additional indebtedness or dispose of assets. As of March 31, 2018, the Company was in compliance with its financial covenants.
The Company has capital leases for computer equipment, office equipment, printing and inserting equipment. The balance of the capital leases as of March 31, 2018 was $130,000.
Shareholders’ equity increased $5.3 million to $95.4 million at March 31, 2018, from $90.0 million at December 31, 2017. The increase was mainly due to net income of $7.3 million, revenue transition adjustments associates with adoption of ASC 606 of $2.7 million, and share-based compensation of $454,000. This was partially offset by dividends declared of $4.2 million, share repurchases exceeding the cost of stock options exercised of $534,000 and changes in the cumulative translation adjustment of $414,000.
On April 16, 2018, the shareholders of the Company approved the Recapitalization pursuant to which each share of the Company’s class B common stock will be exchanged for one share of the Company’s class A common stock plus $19.59 in cash, without interest. On April 17, 2018, the Company filed an amendment to its Articles effecting the Recapitalization and then a further amendment and restatement of the Company’s Articles which resulted in the elimination of the Company’s class B common stock and the reclassification of the Company’s class A common stock as a share of Common Stock. The Common Stock continues to trade on The NASDAQ Global Market under the revised symbol “NRC.”
In connection with the Recapitalization, on April 18, 2018, the Company entered into the Credit Agreement with FNB, providing for (i) a $15,000,000 Line of Credit, (ii) a $40,000,000 Term Loan and (iii) a $15,000,000 Delayed Draw Term Loan. The Company (A) used the Term Loan to fund, in part, the cash portion paid to holders of class B common stock in connection with the Recapitalization and the accompanying exchange of outstanding equity awards tied to the class B common stock, as well as for the costs of the Recapitalization, (B) may use the Delayed Draw Term Loan to fund any permitted future business acquisitions or repurchasing of the Company’s Common Stock and (C) will use the Line of Credit to fund ongoing working capital needs and for other general corporate purposes, including to pay the fees and expenses incurred in connection with the Recapitalization and the Credit Agreement.
Principal amounts outstanding under the Line of Credit are due and payable in full at maturity, which is April 18, 2021. The Line of Credit will bear interest (which shall accrue and be due on a monthly basis during the term of the Line of Credit) at a floating rate equal to the thirty (30) day LIBOR index, plus 225 basis points (4.15% at April 18, 2018).
Principal and accrued interest amounts outstanding under the Term Loan are due and payable monthly during the term of the Term Loan, which expires on April 18, 2023. The Term Loan bears interest at a fixed rate per annum equal to 5%.
In the event that the Delayed Draw Term Loan is used, interest-only payments will be due through the calendar year in which the Delayed Draw Term Loan is drawn upon. After that, amortization will occur at the then current Term Loan rate and schedule with principal and accrued interest amounts outstanding under the Delayed Draw Term Loan due and payable monthly during the term of the Delayed Draw Term Loan, which expires on April 18, 2023. The Delayed Draw Term Loan (if drawn upon) will bear interest at a floating rate equal to the thirty (30) day LIBOR index, plus 225 basis points (4.15% at April 18, 2018).
In addition to paying interest on outstanding principal under the Credit Facilities, the Company was required to pay at the closing of the Credit Facilities a one-time fee equal to 0.25% of the amount borrowed under the Term Loan. The Company is also obligated to pay ongoing unused commitment fees quarterly in arrears pursuant to the Line of Credit and the Delayed Draw Term Loan facility at a rate of 0.20% per annum based on the actual daily unused portions of the Line of Credit and the Delayed Draw Term Loan facility, respectively.
All obligations under the Credit Facilities are to be guaranteed by each of the Company’s direct and indirect wholly owned domestic subsidiaries, if any, and, to the extent required by the Credit Agreement, direct and indirect wholly owned foreign subsidiaries (each, a “guarantor”).
The Credit Facilities are secured, subject to permitted liens and other agreed upon exceptions, by a first-priority lien on and perfected security interest in substantially all of the Company’s and the guarantors’ present and future assets (including, without limitation, fee-owned real property, and limited, in the case of the equity interests of foreign subsidiaries, to 65% of the outstanding equity interests of such subsidiaries).
The Credit Agreement contains customary representations, warranties, affirmative and negative covenants (including financial covenants) and events of default. The negative covenants include, among other things, restrictions regarding the incurrence of indebtedness and liens, repurchases of the Company’s Common Stock and acquisitions, subject in each case to certain exceptions. The Credit Agreement also contains certain financial covenants with respect to minimum fixed charge coverage ratio and maximum cash flow leverage ratio. Pursuant to the Credit Agreement, the Company is required to maintain a minimum fixed charge coverage ratio of 1.10x for all testing periods throughout the terms of the Credit Facilities. The Company is also required to maintain a cash flow leverage ratio of 3.00x or less for all testing periods throughout the terms of the Credit Facilities.
Contractual Obligations
The Company had contractual obligations to make payments in the following amounts in the future as of March 31, 2018:
Contractual Obligations
(1)
|
|
Total
Payments
|
|
|
Remainder
of 2017
|
|
|
One to
Three Years
|
|
|
Three to
Five Years
|
|
|
After
Five Years
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating leases
|
|
$
|
2,750
|
|
|
$
|
492
|
|
|
$
|
1,164
|
|
|
$
|
567
|
|
|
$
|
527
|
|
Capital leases
|
|
|
142
|
|
|
|
50
|
|
|
|
84
|
|
|
|
8
|
|
|
|
--
|
|
Uncertain tax positions
(2)
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
Total
|
|
$
|
2,892
|
|
|
$
|
542
|
|
|
$
|
1,248
|
|
|
$
|
575
|
|
|
$
|
527
|
|
|
(1)
|
Amounts are inclusive of interest payments, where applicable.
|
|
(2)
|
We have $900,000 in liabilities associated with uncertain tax positions. We are unable to reasonably estimate the expected cash settlement dates of these uncertain tax positions with the taxing authorities.
|
Stock Repurchase Program
The Board of Directors of the Company authorized the repurchase of up to 2,250,000 class A and 375,000 class B shares of common stock in the open market or in privately negotiated transactions under a stock repurchase program that was originally approved in February 2006 and subsequently amended in May 2013. As of March 31, 2018, the remaining number of common stock shares that could be purchased under this authorization was 280,491 class A shares and 69,491 class B shares. In connection with the Recapitalization in April 2018, the Board of Directors amended the stock repurchase program to eliminate the repurchase of the former class B common stock.
Critical Accounting Estimates
Except as set forth below in connection with the adoption of ASC 606, there have been no changes to the Company’s critical accounting estimates described in the Annual Report on Form 10-K for the year ended December 31, 2017 that have a material impact on the Company’s Condensed Consolidated Financial Statements and the related Notes.
Revenue Recognition
The Company derives a majority of its revenue from annually renewable subscription-based service agreements with its customers. Refer to Note 1 to the accompanying Condensed Consolidated Financial Statements for a description of the Company’s revenue recognition policies.
The Company’s revenue arrangements with a client may include combinations of more than one service offering which may be executed at the same time, or within close proximity of one another. The Company combines contracts with the same customer into a single contract for accounting purposes when the contract is entered into at or near the same time and the contracts are negotiated as a single performance obligation. For contracts that contain more than one separately identifiable performance obligation, the total transaction price is allocated to the identified performance obligations based upon the relative stand-alone selling prices of the performance obligations. The stand-alone selling prices are based on an observable price for services sold to other comparable customers, when available, or an estimated selling price using a cost plus margin or residual approach. The Company estimates the total contract consideration it expects to receive for variable arrangements based on the most likely amount it expects to earn from the arrangement based on the expected quantities of services it expects to provide and the contractual pricing based on those quantities. The Company only includes some or a portion of variable consideration in the transaction price when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. The Company considers the sensitivity of the estimate, its relationship and experience with the client and variable services being performed, the range of possible revenue amounts and the magnitude of the variable consideration to the overall arrangement.
The Company’s fixed, non-subscription arrangements typically require the Company to perform an unspecified amount of services for a fixed price during a fixed period of time. Revenues are recognized over time based upon the costs incurred to date in relation to the total estimated contract costs. In determining cost estimates, management uses historical and forecasted cost information which is based on estimated volumes, external and internal costs and other factors necessary in estimating the total costs over the term of the contract. Changes in estimates are accounted for using a cumulative catch up adjustment which could impact the amount and timing of revenue for any period.
If management made different judgments and estimates, then the amount and timing of revenue for any period could differ from the reported revenue.