ITEM 2.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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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 provides 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.
As described in Note 2, the Company completed a Recapitalization effective April 17, 2018. Pursuant to the Recapitalization, each share of the Company’s then-existing class B common stock was exchanged for one share of the Company’s then-existing class A common stock plus $19.59 in cash, without interest. All class B common stock were subsequently eliminated, and the Company’s class A common stock was reclassified as Common Stock. The Company issued 3,617,615 shares of Common Stock and paid $72.4 million in exchange for all class B shares outstanding and to settle outstanding share-based awards for class B common stock. In connection with the Recapitalization, the Company entered into a credit agreement with FNB as described in Note 5.
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.
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Three months ended
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Nine months ended
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September 30,
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September 30,
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2018
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2017
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2018
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2017
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|
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|
|
|
|
|
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|
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Revenue:
|
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100.0
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%
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|
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100.0
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%
|
|
|
100.0
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%
|
|
|
100.0
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%
|
|
|
|
|
|
|
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Operating expenses:
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Direct
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39.3
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|
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42.4
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40.1
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41.9
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Selling, general and administrative
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25.6
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29.1
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26.4
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25.1
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Depreciation and amortization
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4.6
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3.9
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4.4
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3.8
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Total operating expenses
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69.5
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75.4
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70.9
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70.8
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Operating income
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30.5
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%
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24.6
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%
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29.1
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%
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|
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29.2
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%
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Three Months Ended
September
30, 2018, Compared to Three Months Ended
September
30, 2017
Revenue
. Revenue for the three-month period ended September 30, 2018, increased 3.7% to $30.0 million, compared to $29.0 million in the three-month period ended September 30, 2017. This was primarily due to new customer sales, as well as increases in sales to the existing client base and the adoption of ASC 606.
Direct expenses
. Direct expenses decreased 4.0% to $11.8 million for the three-month period ended September 30, 2018, compared to $12.3 million in the same period in 2017. This was primarily due to a decrease in variable expenses of $587,000, partially offset by an increase in fixed expenses of $100,000. Variable expenses decreased due to less postage, printing and paper costs due to lower volumes and changes in survey methodologies, partially offset by increased conference expenses. Fixed expenses increased primarily due to higher salary and benefit costs in the customer service and information technology areas, partially offset by lower contracted services. Direct expenses as a percentage of revenue were 39.3% in the three-month periods ended September 30, 2018 and 42.4% for the same period in 2017 as direct expenses decreased by 4.0% while revenue increased by 3.7%.
Selling, general and administrative expenses
. Selling, general and administrative expenses decreased 8.9% to $7.7 million for the three-month period ended September 30, 2018, compared to $8.4 million for the same period in 2017, primarily due to lower legal and accounting expenses associated with the Recapitalization of $958,000, less recruiting expense of $331,000, lower salaries and benefit costs of $145,000, and decreased bad debt expense of $95,000. These were partially offset by increased software and platform hosting expenses of $483,000 and increased contracted services of $333,000. Selling, general and administrative expenses as a percentage of revenue were 25.6% in the three-month periods ended September 30, 2018 and 29.1% for the same period in 2017 as selling, general and administrative expenses decreased by 8.9% while revenues increased by 3.7%.
Depreciation and amortization.
Depreciation and amortization increased 22.6% to $1.4 million for the three-month period ended September 30, 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 4.6% for the three-month period ended September 30, 2018, and 3.9% for the same period in 2017.
Other income (expense).
Other expense, net was $783,000 for the three-month period ended September 30, 2018, compared to other income, net of $51,000 for the same period in 2017. This increase in expenses is primarily due to increased interest expense and other expense. Interest expense increased to $544,000 due to the interest related to the borrowings on the new Term Loan originated in April 2018. Other expense increased to $242,000 primarily due to revaluation on intercompany transactions due to changes in the foreign exchange rate.
Provision for income taxes.
Provision for income taxes was $1.4 million (16.6% effective tax rate) for the three-month period ended September 30, 2018, compared to $3.0 million (42.1% effective tax rate) for the same period in 2017. The effective tax rate for the three-month period ended September 30, 2018, was lower mainly due a reduction in the corporate tax rate from 35% to 21% due to the Tax Act that was enacted on December 22, 2017, a tax depreciation method change election for software development costs creating an income tax benefit of $308,000, decreased non-deductible Recapitalization expenses of $384,000 and other state tax and uncertain tax position adjustments decreasing tax by $179,000 over the same period last year. In addition, the Company had increased tax benefits of $161,000 from the exercise of options and dividends paid to non-vested shareholders.
Nine
Months Ended
September
30, 2018, Compared to
Nine
Months Ended
September
30, 2017
Revenue
. Revenue for the nine-month period ended September 30, 2018, increased 1.6% to $89.0 million, compared to $87.7 million in the nine-month period ended September 30, 2017. The increase was due to new customer sales and increases in sales to the existing client base, as well as adoption of ASC 606.
Direct expenses
. Direct expenses decreased 2.8% to $35.7 million for the nine-month period ended September 30, 2018, compared to $36.7 million in the same period in 2017. This was due to a decrease in variable expenses of $1.5 million, partially offset by an increase in fixed expenses of $487,000. Variable expenses decreased mainly due to less postage, printing and paper costs due to lower volumes and changes in survey methodologies. Fixed expenses increased primarily as a result of increased salary and benefit costs in the customer service and information technology areas. Direct expenses decreased as a percentage of revenue to 40.1% in the nine-month period ended September 30, 2018, compared to 41.9% during the same period of 2017 as expenses decreased by 2.8% while revenue for the same period increased by 1.6%.
Selling, general and administrative expenses
. Selling, general and administrative expenses increased 6.7% to $23.5 million for the nine-month period ended September 30, 2018, compared to $22.0 million for the same period in 2017, primarily due to increased software and platform hosting expenses of $1.3 million, higher salary and benefit costs of $616,000, including acceleration of shared based compensation expense from the vesting of restricted stock and settlement of stock options associated with the Recapitalization of $331,000, and increased contracted services of $411,000. These were partially offset by lower recruiting expenses of $ 485,000, decreased legal and accounting expenses primarily associated with the Recapitalization of $270,000, and lower marketing expenses of $235,000. Selling, general, and administrative expenses increased as a percentage of revenue to 26.4% for the nine-month period ended September 30, 2018, from 25.1% for the same period in 2017 as expenses increased by 6.7% while revenue for the same period increased by 1.6%.
Depreciation and amortization.
Depreciation and amortization expenses increased to $4.0 million for the nine-month period ended September 30, 2018, compared to $3.4 million for the same period in 2017 due to increased amortization from additional computer software investments. Depreciation and amortization expenses as a percentage of revenue was 4.4% for the nine-month periods ended September 30, 2018 and 3.8% for the same period in 2017.
Other income (expense).
Other expense, net was $711,000 for the nine-month period ended September 30, 2018, compared to other income, net of $66,000 for the same period in 2017. This increase in expenses was primarily due to increased interest expense, offset by other income. Interest expense increased to $990,000 due to the interest related to the borrowings on the new Term Loan originated in April 2018. Other income increased to $222,000 primarily due to revaluation on intercompany transactions due to changes in the foreign exchange rate.
Provision for income taxes.
Provision for income taxes was $2.9 million (11.6% effective tax rate) for the nine-month period ended September 30, 2018, compared to $9.2 million (35.9% effective tax rate) for the same period in 2017. The effective tax rate was lower mainly due to income tax benefits from the Recapitalization, due to accelerated vesting of restricted stock and settlement of options of $1.1 million and the reduction in the corporate tax rate from 35% to 21% due to the Tax Act. In addition, the Company had increased tax benefits of $1.7 million from the exercise of options and dividends paid to non-vested shareholders, a tax depreciation method change election for software development costs creating an income tax benefit of $308,000, decreased non-deductible Recapitalization expenses of $247,000, and other state tax and uncertain tax position adjustments decreasing taxes by $179,000 over the same period last year.
Liquidity and Capital Resources
The Company believes that its existing sources of liquidity, including cash and cash equivalents, borrowing availability under the Company’s existing Credit Facilities, and operating cash flows will be sufficient to meet its projected capital and debt maturity needs and the dividend policy for the foreseeable future.
As of September 30, 2018, our principal sources of liquidity included $7.3 million of cash and cash equivalents, up to $15 million of unused borrowings under our Line of Credit and up to $15 million available under our Delayed Draw Down Term Loan. The Delayed Draw Down Term Loan can only be used to fund permitted future business acquisitions or repurchasing the Company’s common stock. Of this cash, $1.2 million was held in Canada.
Working Capital
The Company had a working capital deficit of $6.7 million and a working capital surplus of $19.9 million on September 30, 2018 and December 31, 2017, respectively. The change was primarily due to decreases in cash and cash equivalents of $27.5 million and increases in current portion of notes payable of $2.6 million mainly due to the Recapitalization (see Note 2), increases in deferred revenue of $1.8 million, and increases in accrued expenses and accounts payable of $630,000 due to timing of payments. These were partially offset by increases in trade accounts receivable of $1.7 million due to timing of billing and collections on new and renewal contracts, increases in prepaid expenses of $1.4 million, decreases in accrued wages, bonus and profit sharing of $2.0 million, and increases in income taxes receivable of $626,000. 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 receivable changed due to the timing of income tax payments and prepaid expenses changed due to the timing of pre-payment for services. 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 September 30, 2018 and December 31, 2017 were $18.6 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:
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Nine Months Ended September 30,
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|
|
2018
|
|
|
2017
|
|
|
|
(In thousands)
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|
Provided by operating activities
|
|
$
|
25,936
|
|
|
$
|
21,480
|
|
Used in investing activities
|
|
|
(4,858
|
)
|
|
|
(4,897
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)
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Used in financing activities
|
|
|
(48,193
|
)
|
|
|
(14,682
|
)
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Effect of exchange rate change on cash
|
|
|
(345
|
)
|
|
|
828
|
|
Net change in cash and cash equivalents
|
|
|
(27,460
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)
|
|
|
2,729
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|
Cash and cash equivalents at end of period
|
|
$
|
7,273
|
|
|
$
|
35,750
|
|
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 $25.9 million for the nine months ended September 30, 2018, which included net income of $22.2 million, plus non-cash charges (benefits) for deferred income taxes, depreciation and amortization, reserve for uncertain tax positions, stock compensation and loss on disposal of property and equipment, totaling $6.9 million. Net changes in assets and liabilities decreased cash flows from operating activities by $3.2 million, primarily due to decreases in accrued wages, bonus and profit sharing, increases in prepaid expenses and other current assets, by increases in trade accounts receivable and deferred revenue which fluctuate due to timing and frequency of billings on new and renewal contract, and increases in income taxes receivable which fluctuate with the timing of income tax payments partially offset decreases in accounts payable.
Net cash provided by operating activities was $21.5 million for the nine months ended September 30, 2017, which included net income of $16.4 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, reserve for uncertain tax positions and non-cash stock compensation totaling $4.9 million. Changes in working capital increased cash flows from operating activities by $109,000, primarily due to increases in deferred revenue, which fluctuate due to the timing and frequency of billings on new and renewal contracts, and increases in income taxes payable which fluctuate with the timing of income tax payments. These were partially offset by increases in trade accounts receivable and increases in prepaid expenses.
Cash Flows from Investing Activities
Net cash of $4.9 million was used for investing activities in each of the nine months ended September 30, 2018 and 2017. 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 $48.2 million in the nine months ended September 30, 2018. Cash was used for the Recapitalization of $72.4 million (see Note 2), to repay borrowings under the term notes totaling $2.2 million, to repay borrowings on the line of credit of $2.5 million, to pay loan origination fees on the Credit Agreement of $187,000 and for capital lease obligations of $103,000. Cash was also used to pay $12.7 million of dividends on common stock, and to pay payroll tax withholdings related to share-based compensation of $712,000. Cash was provided from proceeds of the new Term Loan of $40 million and the new Line of Credit for $2.5 million.
Net cash used in financing activities was $14.7 million in the nine months ended September 30, 2017. Cash was used to repay borrowings under the term note totaling $1.8 million and for capital lease obligations of $81,000. Cash was also used to pay $12.6 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) increased cash and cash equivalents by $(345,000) in the nine months ended September 30, 2018 and $828,000 in the nine months ended September 30, 2017.
Capital Expenditures
Cash paid for capital expenditures was $4.9 million for the nine months ended September 30, 2018. 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.
Debt and Equity
The balance on the Company’s former term note with US Bank was paid in full in March 2018.
On April 18, 2018, in connection with the Recapitalization, the Company entered into a credit agreement (the “Credit Agreement”) with FNB providing for (i) a $15,000,000 revolving credit facility (the “Line of Credit”), (ii) a $40,000,000 term loan (the “Term Loan”) and (iii) a $15,000,000 delayed draw-dawn term facility (the “Delayed Draw Term Loan” and, together with the Line of Credit and the Term Loan, the “Credit Facilities”). The Company used the Term Loan to fund, in part, the cash portion paid to holders of the Company’s then-existing 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. The Delayed Draw Term Loan may be used to fund any permitted future business acquisitions or repurchasing of the Company’s Common Stock and the Line of Credit will be used to fund ongoing working capital needs and other general corporate purposes, including to pay the fees and expenses incurred in connection with the Recapitalization and the Credit Agreement.
The Term Loan is payable in monthly installments of $462,988 through April 2020 and $526,362 thereafter, with a balloon payment due at maturity in April 2023. The Term Loan bears interest at a fixed rate of 5%.
Borrowings under the Line of Credit and the Delayed Draw Term Loan, if any, bear interest at a floating rate equal to the 30 day London Interbank Offered Rate plus 225 basis points (4.36% at September 30, 2018). Interest on the Line of Credit accrues and is payable monthly. Principal amounts outstanding under the Line of Credit are due and payable in full at maturity, in April 2021. As of September 30, 2018, the Line of Credit did not have a balance. The weighted average borrowings on the Line of Credit for the three and nine months ended September 30, 2018 was $587,000 and $486,000 respectively. The weighted average interest on borrowings on the Line of Credit for the three and nine months ended September 30, 2018 was 4.35 and 4.25%, respectively.
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. There have been no borrowings on the Delayed Draw Term Loan since origination.
The Company paid a one-time fee equal to 0.25% of the amount borrowed under the Term Loan at the closing of the Credit Facilities. 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. As of September 30, 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 September 30, 2018 was $933,000.
Shareholders’ equity decreased $59.9 million to $30.1 million at September 30, 2018, from $90.0 million at December 31, 2017. The decrease was due to the effect of the Recapitalization of $72.4 million (see Note 2), dividends declared of $12.6 million, changes in the cumulative translation adjustment of $418,000 and share repurchases exceeding the cost of stock options exercised of $712,000. This was partially offset by net income of $22.2 million, revenue transition adjustments associated with adoption of ASC 606 of $2.7 million, and share-based compensation of $1.3 million, including accelerated share-based compensation expense due to the Recapitalization of $331,000.
Contractual Obligations
The Company had contractual obligations to make payments in the following amounts in the future as of September 30, 2018:
Contractual Obligations
(1)
|
|
Total
Payments
|
|
|
Remainder
of 2018
|
|
|
One to
Three
Years
|
|
|
Three to
Five Years
|
|
|
After
Five Years
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
$
|
45,783
|
|
|
$
|
1,389
|
|
|
$
|
11,619
|
|
|
$
|
12,633
|
|
|
$
|
20,142
|
|
Operating leases
|
|
$
|
3,032
|
|
|
$
|
178
|
|
|
$
|
1,430
|
|
|
$
|
813
|
|
|
$
|
611
|
|
Capital leases
|
|
|
1,029
|
|
|
|
47
|
|
|
|
498
|
|
|
|
386
|
|
|
|
98
|
|
Uncertain tax positions
(2)
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
Total
|
|
$
|
49,844
|
|
|
$
|
1,614
|
|
|
$
|
13,547
|
|
|
$
|
13,832
|
|
|
$
|
20,851
|
|
(1)
|
Amounts are inclusive of interest payments, where applicable.
|
(2)
|
We have $550,000 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 then-existing class A shares and 375,000 then-existing 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. In connection with the Recapitalization in April 2018, the Board of Directors further amended the stock repurchase program to eliminate the repurchase of the former class B common stock. As of September 30, 2018, the remaining number of shares that could be purchased under this authorization was 280,491 shares of Common Stock.
Critical Accounting Policies and 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 policies and 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.