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National Research (NASDAQ:NRCIB)

Q4 2013 Earnings Call

February 12, 2014 11:00 am ET

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

Jeffrey Garro - William Blair & Company L.L.C., Research Division

Frank Sparacino - First Analysis Securities Corporation, Research Division

Peter Van Roden

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the -- our [ph] 2013 fourth quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, February 12, 2014.

I would now like to turn the conference over to Mr. Michael Hays, Chief Executive Officer. Please go ahead, sir.

Michael D. Hays

Thank you, Matthew, and welcome, everyone, to the National Research Corporation's 2013 Fourth Quarter and Year End Conference Call. My name is Mike Hays, the company's CEO, and joining me on the call today is Susan Henricks, President and Chief Operating Officer; along with Kevin Karas, our CFO.

Before we continue, I'd ask Kevin to review the 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 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. As referenced in the earnings release last evening, we set a record in the fourth quarter of 2013 for new sales, which came in at $6.4 million, and that was on the heels of a record third quarter of $6.2 million for the third quarter, again, in 2013. The last half of the year has really set us up nicely for the year 2014. And I want to return and dive into some of the momentum we have on the sales side, but let me have Kevin review the financial performance first. Kevin?

Kevin R. Karas

Thank you, Mike. As Mike mentioned, our net new sales of $6.4 million that were added in the fourth quarter helped increase total contract value for the year to $102.3 million. Subscription-based agreements now represent 85% of our total return contract value and were also representing 85% of total revenue for the fourth quarter. Also, fourth quarter total contract value includes approximately $657,000 of contract value from new Customer Connect agreements, 100% of which were subscription based.

Revenue for the fourth quarter of 2013 was $22.9 million, an increase of 4% over the fourth quarter of 2012. Revenue growth for the quarter was comprised entirely from organic growth, which is driven by a combination of continued gains of market share and vertical growth from cross-selling and increasing contract value in our existing client base.

Fourth quarter revenue results also include $91,000 of revenue from Customer Connect.

The consolidated operating income for the fourth quarter of 2013 was $6.0 million or 26% of revenue compared to $5.8 million, also 26% of revenue, for the same period last year. The 2013 fourth quarter consolidated operating income does include $366,000 in operating losses from Customer Connect.

Operating income for the fourth quarter 2013 without Customer Connect as a result was $6.4 million, which represents a 28% operating income margin and an increase in operating income of 11% over the fourth quarter of 2012. The total operating expenses for the fourth quarter increased by 4%, from $16.2 million in 2012 to $16.9 million in 2013.

Direct expenses increased to $9.6 million for the fourth quarter compared to $9.1 million for the same period in 2012. This is a result of increased variable costs related to revenue growth and higher survey volumes for subscription-based products. Direct expenses as a percent of revenue were 42% for the fourth quarter of 2013. Direct expenses are also expected to continue at 42% of revenue for the full year in 2014.

Selling, general and administrative expenses increased to $6.3 million or 28% of revenue for the 3-month period ended December 31, 2013, compared to $6.0 million or 27% of revenue for the same period in 2012. The SG&A expense for the fourth quarter of 2013 without Customer Connect was $6.0 million or 26% of revenue.

So going into 2014, including the incremental expenses that are projected to be incurred next year for Customer Connect resources, the consolidated SG&A expense is expected to be at 26% of revenue for the full year in 2014. Our depreciation and amortization expense for the fourth quarter of 2013 was $944,000 compared to $1.1 million in the fourth quarter of 2012. The decrease is attributed to declining intangible asset amortization expenses. Depreciation and amortization expense was 4% of revenue for the fourth quarter and is also expected to continue to be 4% of revenue for the full year in 2014.

Our provision for income taxes totaled $2.2 million for the fourth quarter of 2013 compared to $2.0 million for the same quarter in 2012. The effective tax rate was 36.6% for fourth quarter of 2013 compared to effective tax rate of 34.8% for the same period last year.

Going forward, the effective tax rate is expected to decrease to an average effective rate of 35% for the full year in 2014 as a result of reduced expense from state income taxes. Our net income for the fourth quarter of 2013 increased by 2% to $3.8 million compared to $3.7 million in 2012.

For the fourth quarter of 2013, our combined non-GAAP diluted earnings per share remained consistent with the fourth quarter of 2012 at $0.15.

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

Michael D. Hays

Thank you, Kevin. At the opening of the call today, I mentioned our strong sales in the last half of the year 2013, which were up 36% over the first half of the year. All of this, of course, is great for top line growth going into 2014, but clearly was too little too late for 2013, and we ended the year with a bleak 7% top line revenue growth. The drivers of sales in the last half of the year and resulting growth in recurring contract value coming into 2014 was the Picker patient experience product portfolio across the entire continuum. From physician office, CG-CAHPS, as well as ambulatory visits to emergency departments, as well as hospital inpatient increased volumes and post-acute care settings all contributed to the revenue growth -- or excuse me, sales growth.

The Picker brand is the strongest in the business bar any competitor, and we have simply failed to capitalize on this asset, but when we do, the results are compelling. In addition, Customer Connect contributed sales growth in the last half of the year and is likely to increase its sales growth trajectory in the year 2014 as it staffs up its salesforce. In fact, Connect is now the largest database of discharged patients in the United States, which is building higher barriers to entry with each new client.

In closing and prior to the questions, I'd like just to mention that in addition to Connect, our resources and focus for 2014 is all about the Picker Institute, its patient experience measurement improvement products across the continuum in the United States and Canada.

Matthew, I'd like to now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Jeff Garro with William Blair.

Jeffrey Garro - William Blair & Company L.L.C., Research Division

I wanted to ask about the trends in the post-acute segment. Last quarter, you had said that a negative trend had reversed, so I want to get an update after this quarter.

Kevin R. Karas

Sure, Jeff. This is Kevin. And for the fourth quarter, this was the first quarter during the year where we actually saw a positive revenue growth in the post-acute business. So after 3 quarters of not contributing, that segment is now contributing. Albeit modest positive revenue growth, they did return to contributing in the fourth quarter.

Operator

Our next question comes from the line of Frank Sparacino with First Analysis.

Frank Sparacino - First Analysis Securities Corporation, Research Division

I was wondering if you could just talk a little bit about what the road map looks like for Connect in 2014, just in terms of building up a product as well as the sales channel.

Michael D. Hays

Frank, this is Mike. Let me give you a little bit of insight on that. But first, let me preface that Connect is starting to take off, and I think we've been a little too robust in our communication with the marketplace on where we're at on the product roadmap. So we're putting it undercover for a little bit, so I don't want to be as -- I won't be as descriptive as we historically have been. But we are ramping up the salesforce. It clearly is a white-space market to which market share grab is actively going on as we speak. The product roadmap is ahead of plan. We have products and services -- or excuse me, features and functions within the offering today that is probably a quarter ahead of where we originally anticipated, and we think that, that will help capture share on a go-forward basis. But we are dumping a lot of energy and a lot of effort around it. We'll accelerate the roadmap, and we'll accelerate the staffing on sales.

Frank Sparacino - First Analysis Securities Corporation, Research Division

Is it fair to say, Mike or Kevin, just relative to sort of 90 days ago, in terms of your planned spend and expectations in terms of 2014, there's no changes that relates to Connect?

Michael D. Hays

Total spend will be the same as previously [indiscernible].

Frank Sparacino - First Analysis Securities Corporation, Research Division

And then just as it relates to the patient experience side in Picker, just curious, anything meaningful in terms of the marketplace you see in 2014? Obviously, CG-CAHPS, I assume, will continue to build momentum throughout 2014 as well. But anything from a sort of regulatory or even hospital-specific standpoint that you've seen or heard from customers?

Michael D. Hays

From a regulatory standpoint, there probably will be some additional CAHPS-type regulation become more standardized, maybe even on the post-acute side. CG-CAHPS will become more refined in terms of exactly what the requirement will be. So I think we'll just get more visibility through the course of 2014 as it relates to regulatory issues on measuring the patient experience. So we could probably look forward to that. Relative to where the market share gains and revenue growth is coming from, it still resides on the CG-CAHPS side of the business, followed by the ambulatory, emergency and the hospital inpatient. As Kevin suggested, the post-acute turned around this quarter, contributing positively to revenue, which is a follow-on from last quarter turning positive from a sales growth standpoint. So I think across the entire continuum, we're seeing more activity and more wins relative to our products and services.

Frank Sparacino - First Analysis Securities Corporation, Research Division

And maybe lastly for me, guys. Just in terms of -- obviously, 2013 was a weaker year than expected from a revenue standpoint. But based on the current product portfolio, what should we expect in terms of a top line growth rate for the company, perhaps exiting 2014 or in the coming years?

Michael D. Hays

Well, we got to get back to mid to high double-digit growth. I mean, 7% top line growth is nothing to write home about, and that was largely in and around a slow first half of 2013 in terms of sales. And we had some backdoor loss relative to HRA that was disproportionate to what we historically had seen. So all of those came together to produce a pretty weak top line growth in 2013. But if we can continue the momentum on sales and have less backdoor loss or less uniqueness relative to the mix of backdoor loss, then we ought to be at mid-teens towards the end of 2014.

Frank Sparacino - First Analysis Securities Corporation, Research Division

Okay. And just following up on that comment, Mike, in terms of the backdoor loss, could you just be more specific there? And also, I assume it's not just combined to HRA, but obviously, given we're in a seasonal period with the HRA business, any comments around that business in Q1?

Michael D. Hays

It is the HRA, so Medicare Advantage reimbursement is not nearly as attractive under the current paradigm of health care coverage as it was, and we're seeing some of the larger clients cut back. I don't know what -- so there was a $2.9 million loss in HRAs in terms of total contract value, which, by any previous estimation, that would be significantly higher. Whether or not that continues into the year, I don't know. We're seeing some plans have higher membership enrollment for members that we interview here in Q1, and we've seen others have less. So I think it's going to be a fairly weak, hard-to-predict product line for the first half of 2014. I mean, it's really episodic business. It's not very high quality.

Operator

Our next question comes from the line of Peter Van Roden with Spitfire Capital.

Peter Van Roden

Just a quick question. I guess this year was the first year that sales in the following year weren't as high as the contract value that you had in the year ending before. So you had $95 million of contract value ending the year 2012, and you ended the year kind of at $93 million in total revenue. And so can you just sort of talk about the relationship between those 2 generally, and then sort of how much of the contract value you guys currently have you expect to ship in the current year?

Kevin R. Karas

Peter, this is Kevin. The -- it's a good question. Typically, if you go back, you would see that our beginning contract value each year would be a proxy for revenue the following year, and we would typically end up at somewhere between 100% to 103% of beginning contract value for revenue. 2013 was unusual in that we actually ended with revenue lower than beginning contract value, and the reason is essentially the timing of losses, contract value reductions and new sales and upsells or contract value increases. So as Mike mentioned, when you look at the combination of weak new sales in the first half of the year, which then failed to generate a large amount of revenue from those agreements, when you bring in new agreements the last half of the year under a subscription model, we are only able to realize a fraction of that revenue in the current year. At the same time, we experienced a disproportionately higher percentage of contract value reductions in the first half of the year, and particularly in the HRA segment that Mike referred to because that is the -- part of the 15% of our contract value that's nonsubscription. When those contract value losses are incurred, 100% of that revenue is also lost in the current fiscal year. So it's really a combination of the type of losses, the timing of losses and the delay in new sales, which were heavier in the back half of the year.

Peter Van Roden

Okay. And then just how much of the current contract value do you expect to be attributable to 2014?

Kevin R. Karas

Well, we're not really giving revenue guidance, so I'm not able to specifically answer that question. I think Mike -- I would probably refer back to Mike's comment earlier regarding what we would expect as far as some of the growth rate trends going into 2014, where we -- our goal is to grow back from 7% this year to be back in the mid-teens by the end of next year from a revenue standpoint.

Peter Van Roden

Got it. Okay. And then just on margins, you guys -- is the Customer Connect cost in your gross margin and SG&A guidance for the year?

Kevin R. Karas

Yes. Yes, all of those costs are incorporated into the margin estimates that I pointed out for 2014.

Peter Van Roden

Okay. And then -- and just in terms of what happened for the quarter, you guys gave kind of guidance around direct costs being 41.5% of sales in Q4, and it ended up being in the 42% range. What drove the difference between -- I know it's small, but I'm just trying to get a sense of the trend.

Kevin R. Karas

Well, it's a good question. No one item in particular. I think a combination of -- to some degree, slightly lower revenue than we expected. So when you look at our direct expense of 42% or 41.5%, it's comprised of 2 components: one is the variable cost component that will vary directly with revenue; but also, within that, there's a direct fixed component, and when our revenue -- we're not able to leverage that when we come in lower than anticipated from a revenue standpoint. So I think probably, as much as anything, it was a product of slightly lower revenue than we had initially expected in Q4.

Operator

[Operator Instructions] Our next question is a follow-up from the line of Jeff Garro with William Blair.

Jeffrey Garro - William Blair & Company L.L.C., Research Division

Just a couple of more quick follow-ups. I know you guys started to sell memberships to the Picker Institute at the beginning of the year, so I wanted to see if there have been any progress made there?

Michael D. Hays

We are standing up Picker Institute, but we have not started selling memberships yet. We will through the course of this year. But as of today, we have not commenced that.

Jeffrey Garro - William Blair & Company L.L.C., Research Division

Okay. And then on the Customer Connect investment, you had given a number last quarter and then you had said we should expect that to -- it hasn't changed. So I did want to ask, though, should we expect that investment to be more heavily weighted to the front half of the year?

Michael D. Hays

Kevin, what's the rhythm of the...

Kevin R. Karas

So the estimate for 2014 is to invest from an operating loss standpoint, if you will, so net operating loss of $1.5 million is the impact for 2014. And that will be just in terms of the cadence of the business, where they'll be growing their revenues and ramping up revenues as the year progresses. We would expect to see a higher percentage of that $1.5 million in the first half of the year. So I don't have the actual breakout with me, but we will see that operating loss be higher, obviously, in month 1 and reduce in successive months as we progress through the year.

Jeffrey Garro - William Blair & Company L.L.C., Research Division

Got it. That makes sense. And then my last question is, you talked about some increased staffing for sales staff, and I want to see if we could get an update on where we are today in terms of number of quota-carrying sales personnel and any kind of split between Customer Connect and the rest of the business?

Kevin R. Karas

Total sales count is around 70, maybe a little bit shy of that in terms of our sales force, and just a handful of those are on the Connect side as of today. But we'll be adding significantly more to the Connect side over the course of Q1.

Operator

[Operator Instructions] And Mr. Hays, it appears we have no further questions at this time. I'll now turn the call back to you.

Michael D. Hays

Thank you, Matthew, and thank you, everyone, for joining us on the call today. And we look forward to reporting progress next quarter. Thanks again.

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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