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NATIONAL RESEARCH CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 8, 2014

Overview

The Company is a leading provider of analytics and insights that facilitate revenue growth, patient, employee and customer retention and patient engagement for healthcare providers, payers and other healthcare organizations. The Company's solutions support the improvement of business and clinical outcomes, while facilitating regulatory compliance and the shift to population-based health management for its clients. The Company's ability to systematically capture, analyze and deliver to its client's self-reported information from patients, families and consumers is critical in today's healthcare market. NRC believes that access to and analysis of its extensive consumer-driven information will become even more valuable in the future as healthcare providers increasingly need to more deeply understand and engage patients and consumers in an effort towards effective population-based health management. The Company's portfolio of subscription-based solutions provide actionable information and analysis to healthcare organizations and payers across a range of mission-critical, constituent-related elements, including patient experience and satisfaction, community population health risks, workforce engagement, community perceptions, and physician engagement. NRC partners with clients across the continuum of healthcare services. The Company's clients range from acute care hospitals 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 interactive healthcare system. Results of Operations The following table sets forth for the periods indicated, select financial information derived from the Company's condensed consolidated financial statements expressed as a percentage of total revenue. The trends illustrated may not necessarily be indicative of future results. The discussion that follows the table should be read in conjunction with the condensed consolidated financial statements. Three months ended March 31, 2014 2013 Revenue: 100.0 % 100.0 % Operating expenses: Direct 39.7 41.1 Selling, general and administrative 24.4 26.1 Depreciation and amortization 3.6 3.8 Total operating expenses 67.7 71.0 Operating income 32.3 % 29.0 % -15-

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Three Months Ended March 31, 2014, Compared to Three Months Ended March 31, 2013

Revenue. Revenue for the three-month period ended March 31, 2014, increased 4.5% to $26.0 million, compared to $24.9 million in the three-month period ended March 31, 2013. The increase was due to new customer sales, as well as increases in sales to the existing client base. Direct expenses. Direct expenses increased 0.8% to $10.3 million for the three-month period ended March 31, 2014, compared to $10.2 million in the same period during 2013. This was mainly due to increased vendor services in technology and survey related costs of $165,000 offset by lower variable costs of $49,000. Direct expenses decreased as a percentage of revenue to 39.7% in the three-month period ended March 31, 2014, compared to 41.1% during the same period of 2013 as a result of lower mailing volumes on subscription agreements, as well as per unit cost reductions for certain contracted survey related costs. Selling, general and administrative expenses. Selling, general and administrative expenses decreased 2.0% to $6.4 million for the three-month period ended March 31, 2014, compared to $6.5 million for the same period in 2013 due to a decrease in legal and accounting fees of $335,000 that were associated with the 2013 recapitalization transaction and a decrease in non-cash share based compensation expense of $345,000 primarily associated with the forfeitures of certain stock options and restricted share awards, partially offset by increased expenses for sales, product development, and marketing resources and building and equipment leases. Selling, general, and administrative expenses decreased as a percentage of revenue to 24.4% for the three-month period ended March 31, 2014, from 26.1% for the same period in 2013. Depreciation and amortization. Depreciation and amortization expenses decreased to $935,000 for the three-month period ended March 31, 2014, compared to $950,000 for the same period in 2013 primarily due to less intangible asset amortization. Depreciation and amortization expenses as a percentage of revenue decreased to 3.6% for the three-month period ended March 31, 2014, from 3.8% during the same period in 2013. Provision for income taxes. Provision for income taxes was $2.9 million (34.6% effective tax rate) for the three-month period ended March 31, 2014, compared to $2.7 million (37.3% effective tax rate) for the same period in 2013. The effective tax rate for the three-month period ended March 31, 2014, is lower than the rate in the same period of 2013 mainly due to lower projected state tax rates due to legislative changes.



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. The Company will make capital contributions up to $2.5 million on an as-needed basis as determined by the Board of Directors of Connect. As of March 31, 2014 the Company had contributed $1.7 million. Additionally, the Company has a future obligation to purchase the other equity units in Connect when certain targeted events have been achieved. If, at any time, Connect has at least $12.5 million of annual recurring contract value, including the NRC contracts being serviced, and the members have approved a financial statement showing a pro forma minimum 35% EBITDA margin for revenue on a going-forward basis, then within 90 days thereafter NRC is required to purchase from the other members, and the other members shall be required to sell to NRC, all of their equity units not owned by NRC. As of March 31, 2014, the price at which the other members had the obligation to sell their equity units to NRC was $0. The Company had cash and cash equivalents of $26.5 million at March 31, 2014, of which $7.4 million was held in Canada. All of the amounts held in Canada are intended to be indefinitely reinvested in foreign operations. The amounts held outside of the U.S. are eligible for repatriation, but under current law, would be subject to U.S. federal income taxes, less applicable foreign tax credits. It is impractical to determine the additional income tax liability, if any, associated with such repatriation. -16-

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Working Capital The Company had a working capital balance of $18.3 million as of March 31, 2014, compared to a working capital balance of $12.8 million as of December 31, 2013. The change was primarily due to increases in cash and cash equivalents of $4.4 million and reductions in accrued wages, bonus and profit sharing of $953,000. The Company's working capital is significantly impacted by its large deferred revenue balances. The deferred revenue balances as of March 31, 2014 and December 31, 2013 were $14.7 million and $13.9 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 performance tracking services and custom research projects before they have been completed. Billed amounts are recorded as billings in excess of revenue earned, or deferred revenue, on the Company's condensed 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 revenue earned in excess of billings, or unbilled revenue. Substantially all deferred revenue and all unbilled revenue will be earned and billed respectively, within 12 months of when the respective period ends. Cash Flow Analysis A summary of operating, investing, and financing activities is shown in the following table: Three Months Ended March 31, 2014 2013 (In thousands) Provided by operating activities $ 5,163 $



3,101

Used in investing activities (605 ) (416 ) Provided by (used) in financing activities 40 (1,600 ) Effect of exchange rate change on cash (237 ) (137 ) Net increase in cash and cash equivalents 4,361



948

Cash and cash equivalents at end of period $ 26,453$ 9,234

Cash Flows from Operating Activities

Cash flows from operating activities consist of net income adjusted for non-cash items including depreciation and amortization, gain or loss on sale of property and equipment, deferred taxes, share-based compensation and related taxes, and the effect of working capital changes. Net cash provided by operating activities was $5.2 million for the three months ended March 31, 2014, which included net income of $5.5 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, and non-cash stock compensation totaling $991,000. Changes in working capital reduced 2014 cash flows from operating activities by $1.3 million, primarily due to timing of billings and collections on new or renewal contracts, annual prepaid commitments, and payments of annual bonuses. These changes were partially offset by increasing cash flows from increases in deferred revenue due to timing of billing and revenue recognition on new or renewal contracts. Net cash provided by operating activities was $3.1 million for the three months ended March 31, 2013, which included net income of $4.5 million, plus non-cash charges (benefits) for deferred tax expense, depreciation and amortization, and non-cash stock compensation totaling $1.2 million. Changes in working capital reduced 2013 cash flows from operating activities by $2.6 million, primarily due to the timing of initial billings on new or renewal contracts, annual prepaid commitments, and payments of annual bonuses. These changes were partially offset by increasing cash flows from the timing of estimated tax payments. -17-

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Cash Flows from Investing Activities

Net cash of $605,000 and $416,000 was used for investing activities in the three months ended March 31, 2014 and 2013, respectively, for purchases of property and equipment.



Cash Flows from Financing Activities

Net cash provided by financing activities was $40,000 in the three months ended March 31, 2014. Proceeds from the exercise of stock options and the excess tax benefit of share-based compensation provided cash of $408,000 and $528,000, respectively. Cash was used to pay payroll taxes on vested restricted shares of $309,000, capital lease obligations of $29,000 and to repay borrowings under the term notes totaling $558,000. Net cash used in financing activities was $1.6 million in the three months ended March 31, 2013. Proceeds from the exercise of stock options and the excess tax benefit of share-based compensation provided cash of $375,000 and $575,000, respectively. Cash was used to pay dividends of $2.1 million, payroll taxes on vested restricted shares of $55,000, capital lease obligations of $27,000 and to repay borrowings under the term notes totaling $326,000.



The effect of changes in foreign exchange rates decreased cash and cash equivalents by $237,000 in the three months ended March 31, 2014 and by $137,000 for the three months ended March 31, 2013.

Capital Expenditures Cash paid for capital expenditures was $605,000 for the three-month period ended March 31, 2014. These expenditures consisted mainly of computer software, computer hardware, furniture and other equipment. The Company expects similar capital expenditure purchases for the remainder of 2014 consisting primarily of computer software and hardware and other equipment to be funded through cash generated from operations. Debt and Equity The Company had two term notes, which were used to partially finance acquisitions in 2008 and 2010. Borrowings under the term notes bore interest at an annual rate of 3.79%. The Company refinanced these two term notes on May 9, 2013, and combined them into one new term note. Borrowings under the new term note bear interest at an annual rate of 3.12%. The outstanding balance of the new term note at March 31, 2014, was $9.8 million. For additional information on the new term loan, see Note 4 above. The Company also has a revolving credit note that was renewed in May 2013 to extend the term to June 30, 2014. This revolving credit note provides for the maximum aggregate borrowings of $6.5 million, subject to a borrowing base equal to 75.0% of the Company's eligible accounts receivable. Borrowings under the revolving credit note bear interest at a variable annual rate, with three rate options at the discretion of management as follows: (1) 2.5% plus the daily reset one-month LIBOR rate, or (2) 2.2% plus the one-, two-, or three-month LIBOR rate, or (3) the bank's one-, two-, three-, six- or twelve-month Money Market Loan Rate. As of March 31, 2014, the revolving credit note did not have a balance. According to the borrowing base requirements, the Company had the capacity to borrow $6.5 million as of March 31, 2014. The Company expects to renew the revolving credit note prior to June 30, 2014. If, however, the revolving credit note cannot be renewed, the Company believes it has adequate cash from operations to meet its debt and capital needs. -18-

-------------------------------------------------------------------------------- The term note and revolving credit note are secured by certain of the Company's assets, including the Company's land, building, trade accounts receivable and intangible assets. The term note and revolving credit note contain various restrictions and covenants applicable to the Company, including requirements that the Company maintain certain financial ratios at prescribed levels and restrictions on the ability of the Company to consolidate or merge, create liens, incur additional indebtedness or dispose of assets. As of March 31, 2014, the Company was in compliance with these restrictions and covenants. The Company has capital leases for computer equipment, office equipment, and inserting equipment. The balance of the capital leases as of March 31, 2014 was $193,000. Shareholders' equity increased $5.6 million to $77.3 million at March 31, 2014, from $71.8 million at December 31, 2013. The increase was primarily due to net income of $5.5 million and $1.4 million related to share-based compensation, partially offset by share repurchases of $907,000 and foreign currency translation adjustment of $405,000. Contractual Obligations



The Company had contractual obligations to make payments in the following amounts in the future as of March 31, 2014:

Total Remainder One to Three to After



Contractual Obligations(1) Payments of 2014 Three Years

Five Years Five Years

(In thousands) Operating leases $ 2,382$ 592$ 1,256$ 520 $ 14 Capital leases 226 95 131 -- -- Uncertain tax positions(2) 193 -- -- -- -- Long-term debt 10,424 1,912 5,099 3,413 -- Total $ 13,225$ 2,599$ 6,486$ 3,933 $ 14



(1) Amounts are inclusive of interest payments, where applicable.

(2) We have $193,000 in liabilities associated with uncertain tax positions. We are unable to reasonably estimate the expected cash settlement dates of these uncertain tax positions with certain taxing authorities. Stock Repurchase Program The Board of Directors of the Company authorized the repurchase of 2,250,000 class A and 375,000 class B shares of common stock in the open market or in privately negotiated transactions under a stock repurchase program that was originally approved in February 2006 and subsequently amended in May 2013. As of March 31, 2014, the remaining number of common stock shares that could be purchased under this authorization was 418,749 class A shares and 69,791 class B shares.


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Source: Edgar Glimpses


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