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 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 the people they serve to build customer loyalty.
The Company’s portfolio of subscription-based solutions provides actionable information and analysis to healthcare organizations across a range of mission-critical, constituent-related elements, including patient experience, service recovery, care transitions, health risk assessments, employee engagement, reputation management, and brand loyalty. NRC Health partners with clients across the continuum of healthcare services. The Company’s clients include integrated health systems, post-acute providers and 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.
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Three months ended
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March 31,
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2019
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2018
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Revenue:
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100.0
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%
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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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37.0
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41.6
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Selling, general and administrative
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24.5
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25.4
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Depreciation and amortization
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4.5
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4.1
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Total operating expenses
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66.0
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71.1
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Operating income
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34.0
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%
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28.9
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%
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Three Months Ended March 31, 2019, Compared to Three Months Ended March 31, 2018
Revenue
. Revenue for the three-month period ended March 31, 2019, increased 1.5% to $31.5 million, compared to $31.0 million in the three-month period ended March 31, 2018. The increase was primarily due to new customer sales, as well as increases in sales to the existing client base.
Direct expenses
. Direct expenses decreased 9.7% to $11.7 million for the three-month period ended March 31, 2019, compared to $12.9 million in the same period in 2018. This was due to a decrease of variable expenses of $1.5 million and an increase in fixed expenses of $222,000. Variable expenses decreased due to less postage, printing and paper costs resulting from changes in survey methodologies and lower conference expenses due to timing of conferences. Fixed expenses increased primarily as a result of increased salary and benefit costs partially offset by decreased contracted services in the customer service and information technology areas. Direct expenses as a percentage of revenue were 37.0% in the three-month periods ended March 31, 2019 and 41.6% for the same period in 2018.
Selling, general and administrative expenses
. Selling, general and administrative expenses decreased 2.0% to $7.7 million for the three-month period ended March 31, 2019, compared to $7.9 million for the same period in 2018, primarily due to a reduction in legal and accounting costs of $488,000 mainly associated with the Recapitalization, the Tax Cut and Jobs Act and adoption of the new revenue standard in 2018, reduced bad debt expense of $150,000 and decreased contracted services of $103,000. These were partially offset by increased software and platform hosting expenses of $305,000, higher salary and benefit costs of $211,000 and increased business insurance costs of $71,000. Selling, general and administrative expenses as a percentage of revenue were 24.5% in the three-month periods ended March 31, 2019 and 25.4% for the same period in 2018.
Depreciation and amortization
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Depreciation and amortization increased 10.3% to $1.4 million for the three-month period ended March 31, 2019, compared to $1.3 million for the same period in 2018 mainly due to increased amortization from additional computer software investments partially offset by an intangible asset that has been fully amortized. Depreciation and amortization expenses as a percentage of revenue was 4.5% for the three-month period ended March 31, 2019, and 4.1% for the same period in 2018.
Other income (expense)
. Other income (expense) decreased to other expense of $844,000 for the three-month period ended March 31, 2019, compared to other income of $9,000 for the same period in 2018, primarily due to increased interest expense and foreign exchange rate changes. Interest expense increased to $570,000 in 2019 from $8,000 for the same period in 2018 due to interest related to the new term loan originated in April 2018. Other expense increased to $280,000 in 2019 compared to $28,000 for the same period of 2018 primarily due to revaluation on intercompany transactions due to changes in the foreign exchange rate.
Provision for income taxes
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Provision for income taxes was $1.7 million (16.9% effective tax rate) for the three-month period ended March 31, 2019, compared to $1.7 million (18.5% effective tax rate) for the same period in 2018. The effective tax rate for the three-month period ended March 31, 2019, was lower mainly due to an insurance reimbursement of Recapitalization expenses creating a tax benefit of $26,000 in 2019 compared to additional tax of expense of $67,000 from the non-deductible Recapitalization expenses in 2018. In addition, the Company had increased tax benefits of $87,000 from the exercise of options and dividends paid to non-vested shareholders.
Liquidity and Capital Resources
The Company believes that its existing sources of liquidity, including cash and cash equivalents, borrowing availability, and operating cash flows will be sufficient to meet its projected capital and debt maturity needs and dividend policy for the foreseeable future.
As of March 31, 2019, our principal sources of liquidity included $2.6 million of cash and cash equivalents, up to $13.2 million of unused borrowings under our line of credit and up to $15 million on our delayed draw term note. Of this cash, $1.6 million was held in Canada. The delayed draw term note can only be used to fund permitted future business acquisitions or repurchasing the Company’s Common Stock.
Working Capital
The Company had a working capital deficit of $16.4 million and $18.7 million on March 31, 2019 and December 31, 2018, respectively.
The change was primarily due to a decrease in dividends payable of $12.4 million, a decrease in accrued wages, bonus and profit sharing of $1.8 million, an increase in trade accounts receivable of $4.0 million and an increase in prepaid expenses of $681,000. These were partially offset by a decrease in cash and cash equivalents of $10.4 million, a $2.0 million increase in deferred revenue, an increase in borrowings on the line of credit of $1.8 million due to the special dividends paid in 2018, an increase in income taxes payable of $1.1 million, an increase in accounts payable of $917,000 (due to timing of payments) and an increase in other current liabilities of $724,000 (mainly due to the adoption of the new leases standard). Dividends payable decreased due to a special dividend, in addition to a quarterly dividend declaration, that was declared in 2018 and paid in January 2019. Trade accounts receivable increased due to the timing of billings and collections on new and renewal contracts. Prepaid expenses and accounts payable changed due to the timing of payment for services and supplies. Accrued wages, bonus and profit sharing decreased due to the payment of 2018 annual bonuses in the three-month period ended March 31, 2019. Income taxes payable changed due to the timing of income tax payments. 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, 2019 and December 31, 2018, was $18.2 million and $16.2 million, respectively.
The deferred revenue balance is primarily due to timing of initial billings on new and renewal contracts. The Company typically invoices clients for services before they have been completed. Billed amounts are recorded as deferred revenue on the Company’s consolidated financial statements and are recognized as income when earned. In addition, when work is performed in advance of billing, the Company records this work as contract assets or unbilled revenue. Substantially all deferred revenue and all unbilled revenue will be earned and billed respectively, within 12 months of the respective period ends.
Cash Flow Analysis
A summary of operating, investing, and financing activities is shown in the following table:
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Three Months Ended March 31,
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2019
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2018
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(In thousands)
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Provided by operating activities
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$
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7,300
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$
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8,228
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Used in investing activities
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(1,134
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)
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(1,298
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)
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Used in financing activities
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(16,820
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)
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(5,851
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)
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Effect of exchange rate change on cash
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304
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(334
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)
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Net change in cash and cash equivalents
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(10,350
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)
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745
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Cash and cash equivalents at end of period
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$
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2,641
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$
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35,478
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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 $7.3 million for the three-month period ended March 31, 2019, which included net income of $8.2 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, reserve for uncertain tax positions, totaling $1.7 million. Net changes in assets and liabilities decreased cash flows from operating activities by $2.6 million, primarily due to increases in trade accounts receivable and prepaid and other current assets, and decreases in accrued expense, wages, bonus and profit sharing, partially offset by increases in accounts payable, deferred revenue and income taxes payable and receivable which fluctuate with the timing of income tax payments.
Net cash provided by operating activities was $8.2 million for the three-month period 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.
Cash Flows from Investing Activities
Net cash of $1.1 million and $1.3 million was used for investing activities in the three months ended March 31, 2019 and 2018, respectively. These expenditures consisted mainly of computer software classified in property and equipment. The Company expects similar capital expenditure purchases for the remainder of 2019 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 $16.8 million in the three months ended March 31, 2019. Cash was used to repay borrowings on the line of credit of $6.8 million, repay borrowings under the note payable totaling $918,000, and for finance lease obligations of $57,000. Cash was also used to pay $17.1 million of dividends on common stock, and to pay payroll tax withholdings related to share-based compensation of $483,000. Cash was provided from proceeds of the line of credit of $8.5 million.
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 finance 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.
The effect of changes in foreign exchange rates increased cash and cash equivalents by $304,000 in the three months ended March 31, 2019 and decreased it by $334,000 in the three months ended March 31, 2018.
Capital Expenditures
Cash paid for capital expenditures was $1.1 million for the three months ended March 31, 2019. These expenditures consisted mainly of computer software classified in property and equipment. The Company expects similar capital expenditure purchases for the remainder of 2019 consisting primarily of computer software and hardware and other equipment to be funded through cash generated from operations.
Debt and Equity
The Company’s credit agreement (the “Credit Agreement”) with First National Bank of Omaha (“FNB”) provides 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-down term facility (the “Delayed Draw Term Loan” and, together with the Line of Credit and the Term Loan, the “Credit Facilities”). 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.
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 (“LIBOR”) plus 225 basis points (4.73% at March 31, 2019). 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. At March 31, 2019, the Line of Credit had an outstanding balance of $1.8 million. The weighted average borrowings on the Line of Credit for three-month period ended March 31, 2019 was $5.7 million. The weighted average interest on borrowings on the Line of Credit for the three-month period ended March 31, 2019 was 4.75%. 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.
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.
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 March 31, 2019, the Company was in compliance with its financial covenants.
LIBOR is currently expected to be phased out in 2021. We are required to pay interest on borrowings under our Line of Credit and Delayed Draw Term Loan at floating rates based on LIBOR. Future debt that we may incur may also require that we pay interest based upon LIBOR. Under the terms of our Credit Agreement with FNB, if LIBOR becomes unavailable during the term of the agreement, FNB may, in its reasonable discretion and in a manner consistent with market practice, designate a substitute index. We currently expect that the determination of interest under our Credit Agreement would be revised as to provide for an interest rate that approximates the existing interest rate as calculated in accordance with LIBOR. Despite our current expectations, we cannot be sure that if LIBOR is phased out or transitioned, the changes to the determination of interest under our agreements would approximate the current calculation in accordance with LIBOR. We do not know what standard, if any, will replace LIBOR if it is phased out or transitioned.
The Company has finance leases for computer equipment, office equipment, printing and inserting equipment. The balance of the finance leases as of March 31, 2019 was $848,000.
Shareholders’ equity increased $3.7 million to $22.7 million at March 31, 2019, from $19.1 million at December 31, 2018. The increase was mainly due to net income of $8.2 million, share-based compensation of $302,000 and changes in the cumulative translation adjustment of $365,000. This was partially offset by dividends declared of $4.7 million, share repurchases exceeding the cost of stock options exercised of $483,000.
Contractual Obligations
The Company had contractual obligations to make payments in the following amounts in the future as of March 31, 2019:
Contractual Obligations
(1)
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Total
Payments
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Remainder
of 2019
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One to
Three Years
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Three to
Five Years
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After
Five Years
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(In thousands)
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Operating leases
(3)
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$
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2,431
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$
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601
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$
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1,040
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$
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470
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$
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320
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Finance leases
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924
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200
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471
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253
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--
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Uncertain tax positions
(2)
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--
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--
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--
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--
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--
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Line of credit
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1,750
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1,750
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Long term debt
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43,005
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4,167
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12,379
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26,459
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--
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Total
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$
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48,110
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$
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6,718
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$
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13,890
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|
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$
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27,182
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$
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320
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(1)
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Amounts are inclusive of interest payments, where applicable.
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(2)
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We have $579,000 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.
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(3)
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Excludes variable costs such as taxes, insurance, and maintenance which vary from year to year.
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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 March 31, 2019, the remaining number of shares of Common Stock that could be purchased under this authorization was 280,491 shares.
Critical Accounting Estimates
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, 2018 that have a material impact on the Company’s Condensed Consolidated Financial Statements and the related Notes.