ITEM 2.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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We are 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. Our solutions enable our clients to understand the voice of the customer with greater clarity, immediacy and depth. Our 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. Our 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. We believe that access to and analysis of our 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.
Our 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. We partner with clients across the continuum of healthcare services. Our clients include integrated health systems, post-acute providers and payer organizations. We believe 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 our 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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2019
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2018
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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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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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37.3
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39.3
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37.0
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40.1
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Selling, general and administrative
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26.8
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25.6
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25.9
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26.4
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Depreciation and amortization
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4.4
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4.6
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4.5
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4.4
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Total operating expenses
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68.5
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69.5
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67.4
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70.9
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Operating income
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31.5
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%
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30.5
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%
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32.6
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%
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29.1
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%
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Three Months Ended September 30, 2019, Compared to Three Months Ended September 30, 2018
Revenue. Revenue for the three-month period ended September 30, 2019, increased 8.2% to $32.5 million, compared to $30.0 million in the three-month period ended September 30, 2018. This was primarily due to new customer sales, as well as increases in sales to the existing client base.
Direct expenses. Direct expenses, which represent direct costs of fulfilling our performance obligations, increased 2.8% to $12.1 million for the three-month period ended September 30, 2019, compared to $11.8 million in the same period in 2018. This was primarily due to an increase in fixed expenses of $744,000 partially offset by a decrease in variable expenses of $416,000. Variable expenses decreased due to less postage, printing and paper costs due to lower volumes and increased use of digital survey methodologies. Fixed expenses increased primarily due to higher salary and benefit costs in the customer service and information technology areas and higher company incentive event costs. Direct expenses as a percentage of revenue were 37.3% in the three-month periods ended September 30, 2019 and 39.3% for the same period in 2018 as direct expenses increased by 2.8% while revenue increased by 8.2%.
Selling, general and administrative expenses. Selling, general and administrative expenses increased 13.4% to $8.7 million for the three-month period ended September 30, 2019, compared to $7.7 million for the same period in 2018, primarily due to higher salary and benefit costs of $488,000, increased legal and accounting expenses of $293,000, higher increased software license fees and platform hosting expenses of $221,000, additional marketing program costs of $133,000, higher insurance costs of $71,000 and additional travel costs of $56,000. These were partially offset by lower contracted services of $334,000. Selling, general and administrative expenses as a percentage of revenue were 26.8% in the three-month period ended September 30, 2019 and 25.6% for the same period in 2018 as selling, general and administrative expenses increased by 13.4% while revenues increased by 8.2%.
Depreciation and amortization. Depreciation and amortization increased 3.0% to $1.4 million for the three-month period ended September 30, 2019 due to increased amortization from additional computer software investments, partially offset by an intangible asset that was fully amortized prior to the 2019 period. Depreciation and amortization expenses as a percentage of revenue was 4.4% for the three-month period ended September 30, 2019, and 4.6% for the same period in 2018.
Other income (expense). Other expense, net was $411,000 for the three-month period ended September 30, 2019, compared to $783,000 for the same period in 2018. This decrease in other expense was primarily due to revaluation on intercompany transactions due to changes in the foreign exchange rate.
Provision for income taxes. Provision for income taxes was $1.7 million (17.2% effective tax rate) for the three-month period ended September 30, 2019, compared to $1.4 million (16.6% effective tax rate) for the same period in 2018. The effective tax rate for the three-month period ended September 30, 2019, was higher mainly due to a tax depreciation method change election for software development costs creating an income tax benefit of $308,000 in the 2018 period, additional withholding on unrepatriated Canadian earnings of $90,000 in the 2019 period, and higher projected state taxes in the 2019 period. These were partially offset by increased tax benefits from the exercise of options and dividends paid to non-vested shareholders of $459,000.
Nine Months Ended September 30, 2019, Compared to Nine Months Ended September 30, 2018
Revenue. Revenue for the nine-month period ended September 30, 2019, increased 7.1% to $95.4 million, compared to $89.0 million in the nine-month period ended September 30, 2018. The increase was due to new customer sales and increases in sales to the existing client base.
Direct expenses. Direct expenses, which represent direct costs of fulfilling our performance obligations, decreased 1.2% to $35.3 million for the nine-month period ended September 30, 2019, compared to $35.7 million in the same period in 2018. This was due to a decrease in variable expenses of $2.0 million, partially offset by an increase in fixed expenses of $1.6 million. Variable expenses decreased mainly due to less postage, printing and paper costs due to lower volumes and increased use of digital survey methodologies. Fixed expenses increased primarily as a result of increased salary and benefit costs in the customer service and information technology areas partially offset by lower contracted services. Direct expenses decreased as a percentage of revenue to 37.0% in the nine-month period ended September 30, 2019, compared to 40.1% during the same period of 2018 as expenses decreased by 1.2% while revenue for the same period increased by 7.1%.
Selling, general and administrative expenses. Selling, general and administrative expenses increased 5.3% to $24.7 million for the nine-month period ended September 30, 2019, compared to $23.5 million for the same period in 2018 primarily due to increased salary and benefit costs of $750,000, higher software license fees and platform hosting expenses of $772,000, additional travel costs of $204,000, increased marketing program expenses of $143,000 and higher insurance costs of $214,000. These were partially offset by a reduction in legal and accounting costs of $410,000 mainly associated with the Recapitalization in the 2018 period, the Tax Cut and Jobs Act and adoption of ASC 606 in the 2018 period, as well as decreased contracted services of $327,000, lower bad debt expense of $55,000 and decreased repairs and maintenance costs of $40,000 in the 2019 period. Selling, general and administrative expenses as a percentage of revenue were 25.9% in the nine-month periods ended September 30, 2019 and 26.4% for the same period in 2018 as selling, general and administrative expenses increased by 5.3% while revenues increased by 7.1%.
Depreciation and amortization. Depreciation and amortization expenses increased 7.2% to $4.3 million for the nine-month period ended September 30, 2019, compared to $4.0 million for the same period in 2018 due to increased amortization from additional computer software investments, partially offset by an intangible asset that was fully amortized prior to the 2019 period. Depreciation and amortization expenses as a percentage of revenue was 4.5% and 4.4% for the nine-month periods ended September 30, 2019 and 2018, respectively.
Other income (expense). Other expense, net was $1.9 million for the nine-month period ended September 30, 2019, compared to $711,000 for the same period in 2018. Interest expense increased $623,000 due to additional interest related to the term loan originated in April 2018 and borrowings on the line of credit. Other expense, net increased $552,000 primarily due to revaluation of intercompany transactions for changes in the foreign exchange rates
Provision for income taxes. Provision for income taxes was $5.4 million (18.7% effective tax rate) for the nine-month period ended September 30, 2019, compared to $2.9 million (11.6% effective tax rate) for the same period in 2018. The effective tax rate for the nine-month period ended September 30, 2019, was higher mainly due to income tax benefits from the Recapitalization due to accelerated vesting of restricted stock and settlement of stock options of $1.1 million, a tax depreciation method change election for software development costs creating an income tax benefit of $308,000 in 2018 and a $247,000 reduction in tax benefits from the exercise of options and dividends paid to non-vested shareholders compared to 2018. In addition, there was additional withholding on unrepatriated Canadian earnings of $90,000 in the 2019 period. This was partially offset by less non-deductible fees of $154,000 primarily related to the Recapitalization in the 2018 period.
Liquidity and Capital Resources
We believe that our existing sources of liquidity, including cash and cash equivalents, borrowing availability, and operating cash flows will be sufficient to meet our projected capital and debt maturity needs and dividend policy for the foreseeable future, and therefore we feel that our working capital deficit has little impact on our liquidity. Requirements for working capital, capital expenditures, and debt maturities will continue to be funded by operations and our borrowing arrangements.
As of September 30, 2019, our principal sources of liquidity included $8.4 million of cash and cash equivalents, up to $15.0 million of unused borrowings under our line of credit and up to $15.0 million on our delayed draw term note. Of this cash, $3.0 million was held in Canada. The delayed draw term note can only be used to fund permitted future business acquisitions or repurchasing our Common Stock.
Working Capital
We had a working capital deficit of $11.7 million and $18.7 million on September 30, 2019 and December 31, 2018, respectively.
The change was primarily due to a decrease in dividends payable of $12.4 million, an increase in trade accounts receivable of $3.4 million, a decrease in income taxes payable of $622,000 and a decrease in accrued wages, bonus and profit sharing of $606,000 million. These were partially offset by a decrease in cash and cash equivalents of $4.6 million, a $2.9 million increase in deferred revenue, an increase in accrued expenses of $670,000 and an increase in the current portion of operating lease liability included in other current liabilities of $589,000 (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. Accrued expenses 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. Our working capital is significantly impacted by our 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, 2019 and December 31, 2018, were $19.1 million and $16.2 million, respectively.
The deferred revenue balance is primarily due to timing of initial billings on new and renewal contracts. We typically invoice clients for services before they have been completed. Billed amounts are recorded as deferred revenue in our consolidated financial statements and are recognized as income when earned. In addition, when work is performed in advance of billing, we record this work as contract assets or unbilled revenue. Substantially all deferred revenue and all unbilled revenue will be earned and billed respectively, within 12 months of the respective period ends.
Cash Flow Analysis
A summary of operating, investing, and financing activities is shown in the following table:
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Nine Months Ended September 30,
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2019
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2018
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(In thousands)
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Provided by operating activities
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$
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28,974
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$
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25,936
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Used in investing activities
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(3,429
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)
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(4,858
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)
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Used in financing activities
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(30,575
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)
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(48,193
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)
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Effect of exchange rate change on cash
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397
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(345
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)
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Net change in cash and cash equivalents
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(4,633
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)
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(27,460
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Cash and cash equivalents at end of period
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$
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8,358
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$
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7,273
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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 income taxes, share-based compensation and related taxes, reserve for uncertain tax positions, loss on disposal of property and equipment and the effect of working capital changes.
Net cash provided by operating activities was $29.0 million for the nine-month period ended September 30, 2019, which included net income of $23.7 million, plus non-cash charges (benefits) for deferred income taxes, depreciation and amortization, reserve for uncertain tax positions, non-cash share-based compensation expense, and loss on disposal of property and equipment totaling $5.9 million. Net changes in assets and liabilities decreased cash flows from operating activities by $633,000, primarily due to increases in trade accounts receivable, deferred contract costs, net, and income taxes receivable and payable. These were partially offset by increases in deferred revenue and decreases in prepaid expenses and other current assets.
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 and increases in trade accounts receivable, prepaid expenses and other current assets, and income taxes receivable and payable, which fluctuate with the timing of income tax payments. These were partially offset by a decrease in deferred revenue which fluctuates due to timing and frequency of billings on new and renewal contract.
Cash Flows from Investing Activities
Net cash of $3.4 million and $4.9 million was used for investing activities in each of the nine months ended September 30, 2019 and 2018, respectively. These expenditures consisted mainly of computer software classified in property and equipment. We expect 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 $30.6 million in the nine months ended September 30, 2019. Cash was used to repay borrowings on the line of credit of $21.0 million, repay borrowings under the note payable totaling $2.8 million, and for finance lease obligations of $223,000. Cash was also used to pay $26.6 million of dividends on common stock, and to pay payroll tax withholdings related to share-based compensation of $1.0 million. Cash was provided from proceeds of the line of credit of $21.0 million.
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 $104,000. 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 line of credit for $2.5 million.
The effect of changes in foreign exchange rates (decreased) increased cash and cash equivalents by $397,000 in the nine months ended September 30, 2019 and $(345,000) in the nine months ended September 30, 2018.
Capital Expenditures
Cash paid for capital expenditures was $3.4 million for the nine months ended September 30, 2019. These expenditures consisted mainly of computer software classified in property and equipment. We expect 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
Our 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 Term Loan was used to fund, in part, the cash payment to the holders of the class B common stock in connection with the Recapitalization and certain costs of the Recapitalization. The Delayed Draw Term Loan may be used to fund any permitted future business acquisitions or repurchases of our Common Stock and the Line of Credit is used to fund ongoing working capital needs and for 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 per annum 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 (4.33% at September 30, 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 September 30, 2019, the Line of Credit did not have an outstanding balance. The weighted average borrowings on the Line of Credit for the nine-month period ended September 30, 2019 was $4.9 million. The weighted average interest rate on borrowings on the Line of Credit for the nine-month period ended September 30, 2019 was 4.72%. We are 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 our 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 our 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 our 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, we are required to maintain a minimum fixed charge coverage ratio of 1.10x for all testing periods throughout the terms of the Credit Facilities. The special dividend paid on January 15, 2019, is excluded from the calculation of the fixed charge coverage ratio pursuant to a consent received from the lender. We are also required to comply with a maximum cash flow leverage ratio of 3.00x for all testing periods throughout the terms of the Credit Facilities. As of September 30, 2019, we were in compliance with these 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.
We have finance leases for computer equipment, office equipment, printing and inserting equipment. The balance of the finance leases as of September 30, 2019 was $863,000.
Shareholders’ equity increased $9.9 million to $29.0 million at September 30, 2019, from $19.1 million at December 31, 2018. The increase was mainly due to net income of $23.7 million, share-based compensation of $917,000 and changes in the cumulative currency translation adjustment of $474,000. This was partially offset by dividends declared of $14.2 million, and share repurchases exceeding the cost of stock options exercised of $1.0 million.
Contractual Obligations
We had contractual obligations to make payments in the following amounts in the future as of September 30, 2019:
Contractual Obligations(1)
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Total
Payments
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Remainder
of 2019
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One to
Three Years
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Three to
Five Years
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After
Five Years
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(In thousands)
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Operating leases(2)
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$
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2,032
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|
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$
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191
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|
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$
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1,049
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|
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$
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471
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|
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$
|
321
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|
Finance leases
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|
|
936
|
|
|
|
70
|
|
|
|
520
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|
|
|
333
|
|
|
|
13
|
|
Uncertain tax positions(3)
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|
|
--
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|
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--
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|
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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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|
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--
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|
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--
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|
|
|
|
|
|
|
|
|
|
|
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Long term debt
|
|
|
40,226
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|
|
|
1,389
|
|
|
|
12,379
|
|
|
|
26,458
|
|
|
|
--
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|
Total
|
|
$
|
43,194
|
|
|
$
|
1,650
|
|
|
$
|
13,948
|
|
|
$
|
27,262
|
|
|
$
|
334
|
|
|
(1)
|
Amounts are inclusive of interest payments, where applicable.
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|
(2)
|
Excludes variable costs such as taxes, insurance, and maintenance which vary from year to year.
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|
(3)
|
We have $298,000 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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Stock Repurchase Program
Our Board of Directors 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, 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 our 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 our Condensed Consolidated Financial Statements and the related Notes.