NRC Health: Form 10-Q for the period ended Sep 30, 2023

The following discussion of our results of operations and financial conditions should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q.

Our purpose is to humanize healthcare and support organizations in their understanding of each unique individual. Our commitment to Human Understanding® helps leading healthcare systems get to know each person they serve not as point-in-time insights, but as an ongoing relationship. Our end-to-end solutions enable our clients to understand what matters most to each person they serve – before, during, after, and beyond clinical encounters – to gain a longitudinal understanding of how life and health intersect, with the goal of developing lasting, trusting relationships. 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 access to and analysis of our extensive consumer-driven information is increasingly valuable as healthcare providers need to better understand and engage the people they serve to create long-term relationships and build 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, employee engagement, reputation management, and brand loyalty. We partner with clients across the continuum of healthcare services and 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 tables set forth, for the periods indicated, selected financial information derived from our condensed consolidated financial statements and the percentage change in such items versus the prior comparable period, as well as other key financial metrics. The discussion that follows the information should be read in conjunction with our condensed consolidated financial statements.

Three Months Ended September 30, 2023, Compared to Three Months Ended September 30, 2022

Revenue. Revenue in the 2023 period increased compared to the 2022 period with increased US revenue of $255,000. US recurring revenue in our existing client base increased $331,000. US recurring revenue from new customer sales decreased $282,000 and increased for non-recurring revenues of $205,000.

Direct expenses. Variable expenses increased $392,000 in the 2023 period compared to the 2022 period primarily from higher survey and other subscription services, as well as increased conference expenses mainly due to higher expenses per conference. Variable expenses as a percentage of revenue were 16.3% and 15.3% in the 2023 and 2022 periods, respectively. Fixed expenses decreased $283,000 primarily due to decreased salary and benefit costs from workforce reduction and automation partially offset by increased contracted services to support our Human Understanding solutions, increased sales tax expense from state tax incentive plan changes, and higher travel costs.

Selling, general and administrative expenses. Selling, general and administrative expenses increased in the 2023 period compared to the 2022 period primarily due to growth in marketing initiative expenses of $343,000 to expand brand recognition and support sales development, increased salary and benefit costs of $304,000 in sales and client support, increased legal fees of $241,000, and additional cyber security and various software services of $242,000.

Depreciation and amortization. Depreciation and amortization expenses increased in the 2023 period compared to the 2022 period primarily due to shortening the estimated useful lives of certain building assets and increased software investment amortization.

Operating income and margin. Operating income and margin decreased in the 2023 period compared to the 2022 period primarily due to growth in marketing initiative expenses and other costs exceeding growth in revenue.

Total other income (expense). Total other income (expense) increased in the 2023 period compared to the 2022 period primarily due to higher interest income of $241,000 from additional money market funds investments and lower interest expense from the declining balance on our term loan of $128,000. In future periods we expect total other income (expense) to decrease due to an expected decrease in interest income resulting from reduced money market fund investments and increased interest expense due to borrowings on our line of credit.

Provision for income taxes and effective tax rate. Provision for income taxes decreased in the 2023 period compared to the 2022 period primarily due to decreased taxable income. The effective tax rate decreased primarily due to lower state income taxes of $313,000 which fluctuate based on various apportionment factors and rates for the states we operate in partially offset by decreased tax benefits of $138,000 from the exercise of share-based compensation awards.

Nine Months Ended September 30, 2023, Compared to Nine Months Ended September 30, 2022

Revenue. Revenue in the 2023 period decreased compared to the 2022 period with reductions in US revenue of $2.1 million and Canadian revenue of $793,000 due to the closure of our Canadian office. US recurring revenue in our existing client base decreased $1.1 million which included $439,000 attributed to elimination of a non-core solution. US recurring revenue from new customer sales decreased $1.2 million and increased for non-recurring revenues of $225,000. We do not expect Canadian revenues in the future due to the closure of the Canadian office.

Direct expenses. Variable expenses increased $243,000 in the 2023 period compared to the 2022 period primarily from higher survey and other subscription services partially offset by lower conference expenses due to one less large conference being held. Variable expenses as a percentage of revenue were 15.0% and 14.4% in the 2023 and 2022 periods, respectively. Fixed expenses decreased $1.1 million primarily due to decreased salary and benefit costs from workforce reduction and automation partially offset by increased contracted services to support our Human Understanding solutions and higher travel costs.

Selling, general and administrative expenses. Selling, general and administrative expenses increased in the 2023 period compared to the 2022 period primarily due to growth in marketing initiative expenses of $2.6 million to expand brand recognition and support sales development, increased salary and benefit costs of $1.4 million in sales and client support, increased travel costs of $425,000, additional cyber security and various software services of $570,000 partially offset by a reduction in innovation investments of $941,000 and decreased building demolition costs of $605,000 related to the remodel of our headquarters.

Depreciation and amortization. Depreciation and amortization expenses increased in the 2023 period compared to the 2022 period primarily due to additional depreciation expense from shortening the estimated useful lives of certain building assets and increased software investment amortization.

Operating income and margin. Operating income and margin decreased in the 2023 period compared to the 2022 period primarily due to a decline in revenue and growth in marketing initiatives and other costs.

Total other income (expense). Total other income (expense) increased in the 2023 period compared to the 2022 period primarily due to higher interest income of $745,000 from additional money market funds investments and lower interest expense from the declining balance on our term loan of $330,000. In future periods we expect total other income (expense) to decrease due to an expected decrease in interest income resulting from reduced money market fund investments and increased interest expense due to borrowings on our line of credit.

Provision for income taxes and effective tax rate. Provision for income taxes decreased in the 2023 period compared to the 2022 period primarily due to decreased taxable income. The effective tax rate decreased primarily due to lower state income taxes of approximately $572,000 which fluctuate based on various apportionment factors and rates for the states we operate in and increased tax benefits of $110,000 from the exercise of share-based compensation awards.

Recurring Contract Value. Recurring contract value declined in 2023 compared to 2022 primarily from our strategy to focus on our core digital solutions and a decline in new client sales. Our recurring contract value metric represents the total revenue projected under all renewable contracts for their respective next annual renewal periods, assuming no upsells, downsells, price increases, or cancellations, measured as of the most recent quarter end.

Liquidity and Capital Resources

Our Board of Directors has established priorities for capital allocation, which prioritize funding of innovation and growth investments, including merger and acquisition activity as well as internal projects. The secondary priority is capital allocation for quarterly dividends and share repurchases. 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 for the foreseeable future.

As of September 30, 2023, our principal sources of liquidity included $3.8 million of cash and cash equivalents, up to $25 million of unused borrowings under our line of credit and up to $75 million on our delayed draw term note. Of this cash, $189,000 was held in Canada. The delayed draw term note can only be used to fund permitted future business acquisitions or repurchasing our common stock.

Our 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 and the effect of working capital changes. Cash provided by operating activities decreased mainly due to decreased net income net of non-cash items. Cash provided by operating activities also decreased due to working capital changes, mainly consisting of changes in prepaid expenses and other current assets primarily due to the timing of our annual business insurance payment and other annual service agreements, partially offset by changes in trade accounts receivable and deferred revenue primarily due to timing of initial billings on new and renewal contracts and changes in accounts payable due to timing of payments.

See the Condensed Consolidated Statements of Cash Flows included in this report for the detail of our operating cash flows.

We had a working capital deficit of $16.1 million and surplus of $10.3 million on September 30, 2023 and December 31, 2022, respectively. The change was primarily due to decreases in cash and cash equivalents and other current assets and increases in the line of credit, accrued expenses, and deferred revenue, partially offset by increases in prepaid expenses. Cash and cash equivalents decreased and the line of credit increased mainly due to dividends paid and repurchases of shares of our common stock for treasury. Other current assets decreased due to state tax incentive adjustments and receipts received. Accrued expenses and prepaid expenses fluctuated due to the timing of 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.

Cash used in investing activities primarily consisted of purchases of property and equipment including computer software and hardware, building improvements and furniture and equipment partially offset by the proceeds from the sale of property and equipment.

Cash used in financing activities consisted of payments for borrowings under the term note and finance lease obligations. We also used cash to repurchase shares of our common stock for treasury and to pay dividends on common stock. This was partially offset by cash provided from the proceeds from the exercise of share-based awards and borrowings on the line of credit.

Our material cash requirements include the following contractual and other obligations:

Dividends

Cash dividends of $33.4 million were paid in the nine months ended September 30, 2023, including $24.6 million related to a special dividend of $1.00 per share declared and paid during September 2023. Dividends of $2.9 million were declared in the three months ended September 30, 2023 and paid in October 2023. The dividends were paid from cash on hand and borrowings on the line of credit. Our board of directors considers whether to declare a dividend and the amount of any dividends declared on a quarterly basis.

Capital Expenditures

We paid cash of $12.0 million for capital expenditures in the nine months ended September 30, 2023. These expenditures consisted mainly of computer software development for our Human Understanding solutions and building renovations to our headquarters. We estimate future costs related to our headquarters building renovations to be $2.6 million and $12.3 million in 2023 and 2024, respectively, which we expect to fund through operating cash flows and borrowings on the line of credit.

Debt

Our amended and restated credit agreement (the “Credit Agreement”) with First National Bank of Omaha (“FNB”) includes (i) a $30,000,000 revolving credit facility (the “Line of Credit”), (ii) a $23,412,383 term loan (the “Term Loan”) and (iii) a $75,000,000 delayed draw-down term facility (the “Delayed Draw Term Loan” and, together with the Line of Credit and the Term Loan, the “Credit Facilities”). We may use the Delayed Draw Term Loan to fund any permitted future business acquisitions or repurchases of our common stock and the Line of Credit to fund ongoing working capital needs and for other general corporate purposes.

The Term Loan has an outstanding balance of $18.9 million and is payable in monthly installments of $462,988 through May 2027. 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 Secured Overnight Financing Rate (“SOFR”) plus 235 basis points (7.66% at September 30, 2023). 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 May 2025. As of September 30, 2023, we had $5,000,000 of borrowings outstanding and the availability to borrow $25,000,000 on the Line of Credit. The weighted average borrowings on the Line of Credit for the three and nine-month periods ended September 30, 2023 was $543,000 and $183,000, respectively. The weighted average interest rate on borrowings on the Line of Credit for the three and nine-month periods ended September 30, 2023 was 7.68%. There have been no borrowings on the Delayed Draw Term Loan since origination.

We are 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.

The Credit Agreement is collateralized by substantially all of our assets, subject to permitted liens and other agreed exceptions, and 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. In June 2023, the Credit Agreement was amended to exclude our costs associated with our building renovation from or after January 1, 2023 from the fixed charge coverage ratio calculation. Pursuant to the amended Credit Agreement, we are required to maintain a minimum fixed charge coverage ratio of 1.10x for all testing periods throughout the term(s) of the Credit Facilities, which calculation excludes, unless our liquidity falls below a specified threshold, (i) any cash dividend in a fiscal quarter that, together with all other cash dividends paid or declared during such fiscal quarter, exceeds $5,500,000 in total cash dividends paid or declared, (ii) the portion of the purchase price for any permitted share repurchase of our shares paid with cash on hand, (iii) the portion of any acquisition consideration for a permitted acquisition paid with cash on hand, and (iv) up to $25 million of costs associated with our building renovation from or after January 1, 2023 . We are also required to maintain a cash flow leverage ratio of 3.00x or less for all testing periods throughout the term(s) of the Credit Facilities. 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. As of September 30, 2023, we were in compliance with our financial covenants.

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 our 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).

Leases

We have lease arrangements for certain computer, office, printing and inserting equipment as well as office and data center space. As of September 30, 2023, we had fixed lease payments of $598,000 and $32,000 for operating and finance leases, respectively payable within 12 months.

Taxes

The liability for gross unrecognized tax benefits related to uncertain tax positions was $1.8 million as of September 30, 2023. See Note 3, "Income Taxes", to the Condensed Consolidated Financial Statements contained in this report for income tax related information.

As of September 30, 2023, the balance of the deemed repatriation tax payable imposed by the U.S. Tax Cuts and Jobs Act of 2017 was $10,000, which we expect to pay in early 2024. Withholding tax of $72,000 was paid in the nine-month period ended September 30, 2023, due to the deemed dividend and return of capital processed in 2022.

Stock Repurchase Program

In May 2022, our Board of Directors authorized the repurchase of 2,500,000 shares of common stock (the “2022 Program”). Under the 2022 Program we are authorized to repurchase from time-to-time shares of our outstanding common stock on the open market or in privately negotiated transactions. The timing and amount of stock repurchases will depend on a variety of factors, including market conditions as well as corporate and regulatory considerations. The 2022 Program may be suspended, modified, or discontinued at any time and we have no obligation to repurchase any amount of common stock in connection with the 2022 Program. The 2022 Program has no set expiration date.

During the three months ended September 30, 2023, we repurchased 7,384 shares of our common stock under the 2022 Program for an aggregate of $310,000. As of September 30, 2023, the remaining number of shares of common stock that could be purchased under the 2022 Program was 1,824,041 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, 2022 that have a material impact on our Condensed Consolidated Financial Statements and the related Notes.

There are no material changes to the disclosures regarding our market risk exposures made in its Annual Report on Form 10-K for the year ended December 31, 2022.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report, and our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, even effective internal control over financial reporting can only provide reasonable assurance of achieving its control objectives.

We have confidence in our internal controls and procedures. Nevertheless, our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure procedures and controls or our internal controls will prevent all errors or intentional fraud. An internal control system, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of such internal controls are met. Further, the design of an internal control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. As a result of the inherent limitations in all internal control systems, no evaluation of controls can provide absolute assurance that all our control issues and instances of fraud, if any, have been detected.

There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that occurred during the quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The significant risk factors known to us that could materially adversely affect our business, financial condition, or operating results are described in Part I, Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2022.