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Executives

Michael D. Hays - Founder, Chief Executive Officer and Director

Kevin R. Karas - Chief Financial Officer, Principal Accounting Officer, Senior Vice President of Finance, Treasurer and Secretary

Analysts

Ryan Daniels - William Blair & Company L.L.C., Research Division

Frank Sparacino - First Analysis Securities Corporation, Research Division

National Research (NRCI) Q1 2013 Earnings Call May 8, 2013 11:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the First Quarter 2013 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 8, 2013. I would now like to turn the conference over to Michael Hays, Chief Executive Officer. Please go ahead, sir.

Michael D. Hays

Thank you, Matt, and welcome, everyone, to National Research Corporation's 2013 First Quarter Conference Call. My name is Michael Hays, the company's CEO, and joining me on the call today is Susan Henricks, President, Chief Operating Officer; as well as Kevin Karas, our Chief Financial Officer. Before we continue, I'd ask Kevin to review conditions related to any forward-looking statements that may be made as part of today's call. Kevin?

Kevin R. Karas

Thank you, Mike. This conference call includes forward-looking statements related to the company that involve risks and uncertainties that could cause actual results or outcomes to differ materially from those currently anticipated. These forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. For further information about the facts that could affect the company's future results, please see the company's filings with the Securities and Exchange Commission.

With that, I'll turn it back to you, Mike.

Michael D. Hays

Thank you, Kevin, and again, welcome, everyone. On the call today, I would like to share with you several product updates, not the least of which is a review of the great first quarter in which we experienced increased traction across almost our entire product portfolio. Leading that path was strong growth with CG-CAHPS and Illuminate, our discharge call program.

First off, however, let me turn it back to Kevin and have him provide a detailed review of our financial performance for the first quarter.

Kevin R. Karas

Thank you, Mike. Net new sales of $4.6 million were added in the first quarter of 2013 compared with $3.9 million in the same quarter last year, representing a 17% increase. Ending total contract value for the first quarter was $96.4 million. Our subscription-based agreements represented 80% of contract value at the end of quarter compared to 75% contract value at the end of the same quarter last year. Subscription agreements generated 74% of total revenue for the first quarter of 2013 compared to 68% of revenue for the same quarter last year.

Our revenue for the first quarter was $24.9 million, an increase of 11% over the first quarter of 2012. Revenue growth for the quarter is comprised entirely from organic growth, which was driven by a combination of continued gains in market share and vertical growth from cross-selling and increasing contract value in our existing client base.

Along with our positive revenue growth trend, we continue to successfully manage our expenses to expand operating margins. Operating income for the first quarter of 2013 was $7.2 million or 29% of revenue compared to $6.1 million or 27% of revenue for the same period last year.

Total operating expenses for the first quarter increased by 8% from $16.3 million in 2012 to $17.7 million in 2013.

Of that, direct expenses increased $10.2 million for the first quarter compared to $8.9 million for the same period in 2012. This increase is a result of increased variable costs related to the revenue growth and higher survey volumes for subscription-based products. Direct expenses as percent of revenue were 41% for the first quarter, and we expect direct expenses as a percent of revenue to average 41% for the full year in 2013.

Selling, general and administrative expenses increased by 6% to $6.5 million for the quarter compared to $6.2 million for the same period in 2012.

The SG&A expenses decreased as a percentage of revenue to 26% for the quarter from 27% for the same period last year due to leveraging the SG&A expenses against our increased revenue. We expect SG&A expenses to average 27% of revenue for the full year in 2013.

Depreciation and amortization expense for the first quarter was $950,000 compared to $1.2 million for the first quarter of 2012, with the decrease attributed to declining intangible asset amortization expense. Depreciation and amortization expense was 4% of revenue for the first quarter and is also expected to average 4% of revenue for the full year in 2013.

The provision for income taxes totaled $2.7 million for the 3-month period ending March 31, 2013, compared to $2.1 million for the same period in 2012. For the quarter, the effective tax rate was 37.3% and is expected to average at 37.5% for the full year in 2013.

Finally, net income for the first quarter increased by 16% to $4.5 million compared to $3.8 million in 2012. Diluted earnings per share for the first quarter increased by 14% to $0.64 a share compared to $0.56 for the same period last year.

With that, I'll turn the call back to Mike.

Michael D. Hays

Thank you, Kevin. As Kevin just reported, our consolidated 11% revenue growth for the quarter was positive, yet lower than our historical 15% plus top line growth and was directly a result of our post-acute care group's weak performance stemming from last year. Late last year and earlier this year, we provided the post-acute group more resources and added leadership with laser focus, and I'm pleased to report these changes are paying off.

New sales for the post-acute product bundle, which primarily serves home health and skilled nursing facilities, achieved new sales in excess of each of the last 6 quarters and they also recorded a material increase in its sales pipeline.

As revenue is recognized from these first quarter sales and from harvesting the pipeline, post-acute will return to its historical growth contribution. As that happens, post-acute products will join a very robust growth story.

On the acute care and medical group side of our business, we continue to see increasing growth across NRC's diverse product portfolio. Illuminate recorded the greatest percentage increase in the quarter, albeit on a small base. With hospitals now at risk for avoidable readmission penalties, the pain is tangible and solutions such as Illuminate are receiving strong acceptance. CG-CAHPS, the government's standardized measurement of a patient's experience with his or her physician, continues to contribute material revenue and sales growth for the company, and the addressable market remains very large.

In the first quarter, Illuminate and CG-CAHPS, 2 of our newer offerings, collectively surpassed 10% of total contract value. Personally, I'm not aware of any other set of products having achieved this level of financial materiality this quickly. Our plan is to pour more and more gas on CG-CAHPS in terms of sales resource and product value, as will also be the case with Illuminate.

Our basic bread-and-butter product, patient experience patient measurement for hospitals, suggested by some to be a mature product, registered a 24% increase this past quarter, clearly establishing the fact this runway is alive and well. The uniqueness of our offering stands out at point of sale when we continue to win share. The attractiveness of our patient experience product offering does not stop at the U.S. border. NRC Canada also finished the quarter with a 24% revenue growth quarter-over-quarter by winning new logos and increasing spend among current client organizations.

Also experienced great growth in the first quarter was Ticker with a 25% growth rate. Ticker, as you're aware, measures the attitudes, behaviors and needs of consumers in each of the 300 largest markets in the United States. Ticker, now in its 26th year, has the largest and longest provider-specific comparable database of its type in the country. This barrier to entry essentially enables Ticker to maintain pricing power and the resulting attractive margins.

As the importance of the voice of the customer and brand equity increases, it's likely Ticker will maintain its very attractive growth rate and margin contribution to the company.

Proceeding through the balance of our product portfolio, our health risk assessment, largely used by Medicare Advantage health plans, was short on its revenue plan. However, contract value was up 10% from new logo wins and more client spend. We're also beginning to see an expanded number of plans back in the market given the more attractive Medicare Advantage rates recently announced.

As well, expanded use cases are emerging for HRA offerings, especially among state Medicaid programs where we have recently won 2 state-wide contracts so far.

Rounding out this brief review of our product portfolio. The Governance Institute now counts over 1,000 organizations as members. TGI is a very profitable product and has a great strategic value by allowing NRC access to 20% of the nation's hospital boardrooms for other product offerings, clearly an advantage no other competitor, for any of our products, enjoys.

For example, the board portal, which is part of TGI membership, creates an interesting opportunity to have a systematic informational conduit created between our products and our member boards. Our newest product, Point of Care rounding solution, announced during our last earnings call, is now beginning its adoption journey with 28 new organizations opting in this last quarter, including Banner and National Institutes of Health.

Additional products are in the new product pipeline, the most exciting to me is Customer Connect, which we've reviewed in our last conference call. Customer Connect is all about providing our clients with a deep understanding of every individual as a patient, not only when they receive care but also of their attitudes, behaviors, preferences and activities of daily living outside the 4 walls of a traditional care setting. We will be sharing progress reports as Customer Connect goes to market, which is a product, I believe, will emerge as the most important growth engine of NRC for the next decade.

Before I open the call to questions, I'd like to touch on the relaunch of the Picker Institute. In May of 2001, NRC acquired the commercial patient experience measurement business from the Picker Institute and left on its own the educational side of the institute.

NRC is now taking on the Picker Institute and will relaunch to become the home of all things improvement. With unparalleled pedigree, having written a book and coined the phrase, patient-centered care, we believe the Picker Institute will be the go-to place for advanced learning on how to improve the patient experience.

Matt, with that, I'd like to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Ryan Daniels with William Blair.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Let me start a little bit on the revenue growth this quarter in the forward outlook. Michael, you discussed the quarter-over-quarter strength in the acute care side and I know that's being dragged down by weakness from last year's sales in the post-acute. But given that the pipeline's improving in post-acute and given the kind of best sales in 6 quarters, how quickly might we see that turnaround from a revenue drag to actually contributing to revenue growth? Will that be something that appears in the second quarter? Or is it going to be more back-half weighted?

Michael D. Hays

Good question. Don't have an exact -- the answer forecast on the sales for Q2 are at record levels as well. We hope that, that actually gets booked as forecasted. That clearly will help accelerate along the annual timetable sooner versus later. But I would look towards our historical 15% plus annual growth rate on top line being a year-ended net rather than any particular quarter.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Okay, that's helpful color. And then you mentioned the relaunch of the Picker Institute and I'm curious what the revenue model will look like behind that. Is that something similar to TGI where you subscribe to the institute and then participate in conferences and get research -- best practices, things of that nature? Just some color there will be good.

Michael D. Hays

Happy to do so, and you're exactly right. The Picker Institute, over the last series of years, has been a, for lack of a better word, a not-for-profit organization that has incredible insights on improving the patient experience but lacked a business model. Through different conversations and premeditated agreements we had with them, there was a time-certain date for us to take that back over and relaunch it. That time is now. The model we will use is exactly to TGI. It's an annual membership price separate and distinct from any of the other products and services that we offer that had a combination of deliverables, including conferences, best practices, facilitation, networking. And that will be sold to acute care hospitals or post-acute organizations that would enjoy increasing their HCAHP and other type of like home health care CAHPS scores. So look at TGI as the template that we will lift and lay over on top of Picker Institute.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Okay. And did you have to pay anything to acquire those rights? Or was that kind of a free transition for you?

Michael D. Hays

Well, it's essentially part and parcel of the agreement back in May of 2001. Harvey Picker was alive at that point in time. We made a gentleman's agreement that he would be able to do what he wanted to do on the educational side under that umbrella. And there was a time-certain period post his death that it was agreed that we would then reconstitute it. And that time has come. So no purchase consideration.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Okay, perfect. And then maybe a couple of macro questions for you. This has been an interesting quarter, I think, in the health care space. The hospitals saw weakening volumes and mix and then got the 2% rate cut starting in the second quarter. And a lot of other companies have commented on seeing some sales weakness in the acute care side manifest due to some budget freezes, maybe more in the CapEx side but some OpEx, too. And I'm curious if you've got any feedback from the sales force about seeing more hesitation in the client base to sign new contracts or any hospitals you're seeing kind of freeze their budgets or not giving renewals because of those trends. Any color there?

Michael D. Hays

We hear that every quarter. And health care, for the last 30-odd years that I've been associated here, has always had reimbursement issues. Very rarely has it an increase. It's usually always a decrease. And the industry has always worked itself through that. And quite frankly, looking retrospectively, every time we've been faced with a reimbursement pressure, cost pressures from our clients that just increases the opportunity for us to bring value to the party, things like avoiding readmission penalties. So yes, we see it but I don't know that it's any more severe in these past quarters than it has been forever. And it's just not an excuse we allow our sales group to go to the bank on.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Okay, that's helpful. And then last question and I'll hop off. Just any color on the size of the sales force today and maybe what your plans are for 2013 given all the opportunities and then a lot of new product launches here?

Michael D. Hays

The sales staff today is, I think, right at -- Kevin, what was it at year end? Is that true?

Kevin R. Karas

Yes, we're still around that 68 number that we are running at the last half of last year.

Michael D. Hays

And our plan is to add to that specifically in the area of post-acute and CG-CAHPS.

Operator

[Operator Instructions] Our next question comes from the line of Frank Sparacino with First Analysis.

Frank Sparacino - First Analysis Securities Corporation, Research Division

I was hoping you could give some additional color as it relates to CG-CAHPS and even Illuminate, just to give us a better sense of kind of the momentum relative to maybe the last quarter a year ago in terms of the contribution.

Michael D. Hays

I'd be happy to and Kevin, feel free to weigh in as well. CG-CAHPS seems to be increasing at an increasing rate, not only quarter-over-quarter, but even on a sequential basis. The pipeline is significantly larger each and every quarter. I think we have our presentation deck well oiled and have leveraged points-of-sale differentiation. So we are aggressively going after not only acute care hospitals and our own client portfolio that have medical groups as part of their enterprise now, but also using it as a foot in the door, a way to get our nose under the tent in terms of acute care hospitals. They have medical groups that we don't do their, for example, inpatient experience. We have not as aggressively as we probably will in the future focused on the independent medical groups, of which there's perhaps a hundred of significant size. So we have a fairly clear prioritization on which ones we're going after first, second and third. I don't believe we have a large enough sales group feet on the street in order to cover all of those different sectors or segments parallel. So most of it is sequential, so I'd like to see where we can broaden the bandwidth and kind of take the growth trajectory up another notch or 2. So hopefully, that helps. Kevin, is there anything that...

Kevin R. Karas

No. I think you're absolutely right. Both of those products, the trend line quarter-over-quarter-over-quarter the past 6 to 8 quarters has been a very steady growth trend growing every quarter.

Frank Sparacino - First Analysis Securities Corporation, Research Division

And as it relates to the patient experience side of things being up 24% year-over-year, can you tell us what was that growth rate in 2012?

Kevin R. Karas

I do not have that in front of me, so I do not know. I think part of the advantage we have now is the bundling we're doing with a variety of different measurement products and services and adding additional value to that particular portfolio. So when we walk in to make a presentation at any prospect, we're always up against an incumbent, and I think our group is doing a good job, or an increasingly better job, showcasing value and differentiation, oftentimes at a slightly higher cost than perhaps what the current spend is in that organization. So as our sales group matures and gets better at their pitch, I think we're finding the message to resonate. So most all of the growth, in fact all of the growth, of that particular group is coming from market share wins or increasing spend among current clients.

Operator

[Operator Instructions] Mr. Hays, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Michael D. Hays

Thank you, Matt, and thank you, everyone, for joining us today. As always, Kevin, Susan and I look forward to sharing progress during our upcoming conference call for next quarter. Thank you for your time.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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