NRC HEALTH (NRC)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis provides a summary of significant factors relevant to our financial performance and condition. It should be read in conjunction with the consolidated financial statements and accompanying notes included in Part II, Item 8 of this Form 10-K. This section of this Form 10-K generally discusses 2024 and 2023 items and year-to-year comparisons between 2024 and 2023. Discussions of 2022 items and year-to-year comparisons between 2023 and 2022 are not included in this Form 10-K and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

Overview

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.

On February 26, 2025, our Board of Directors appointed Trent Green as our Chief Executive Officer and to serve as a director, both effective June 1, 2025. Mr. Green brings more than 25 years of healthcare leadership experience, most recently serving as Chief Executive Officer of Amazon One Medical and previously as Chief Operating Officer of Legacy Health. Upon the effectiveness of Mr. Green’s appointment as Chief Executive Officer, Mr. Hays will transition to the role of Chairman.

Critical Accounting Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. The following areas are considered critical accounting estimates because they involve significant judgments or assumptions, involve complex or uncertain matters or they are susceptible to change and the impact could be material to our financial condition or operating results:

Revenue Recognition

We derive a majority of our revenue from annually renewable subscription-based service agreements with our customers. Such agreements are generally cancelable on short or no notice without penalty. We also derive revenue from fixed, non-subscription arrangements. Our revenue recognition policy requires management to estimate, among other factors, the future contract consideration we expect to receive under variable consideration subscription arrangements as well as future total estimated contract costs over the contract term with respect to fixed, non-subscription arrangements. If management made different judgments and estimates, then the amount and timing of revenue for any period could differ from the reported revenue. See Notes 1 and 3 to our consolidated financial statements for a description of our revenue recognition policies.

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Valuation of Goodwill and Identifiable Intangible Assets

Intangible assets include customer relationships, trade names, technology, and goodwill. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment with other long-lived assets in the related asset group whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. We review intangible assets with indefinite lives for impairment annually as of October 1 and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. This review requires management to assess qualitative factors to determine whether an impairment may have occurred, which inherently involves management’s judgment. This assessment also requires a determination of the fair value of the asset, which often includes several significant estimates and assumptions, including future cash flow estimates, determination of appropriate discount rates, and other assumptions that management believed reasonable under the circumstances. Changes in these estimates and assumptions could materially affect the determination of fair value and/or impairment of goodwill or other intangible assets. See Notes 1 and 6 to our consolidated financial statements for a description of our goodwill and intangible asset valuation and impairment policies and associated impacts for the reported periods. At December 31, 2024, we assessed our current market capitalization compared to book value, forecasts and margins in our last quantitative impairment testing. We concluded that it is not more likely than not that an impairment loss had been incurred at December 31, 2024.

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Key Financial Metrics and Results of Operations

The following table sets forth, for the periods indicated, selected financial information derived from our 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 consolidated financial statements.

Revenue. Revenue in 2024 decreased compared to 2023 by $5.5 million. This was mainly from decreased recurring revenue in our existing client base. Of this decrease, 34% was from our non-core solutions. We view total Recurring Contract Value, or TRCV, a measure of revenue under all renewable contracts for their respective annual renewal periods, as a leading indicator of revenue expectations. TRCV declined for several quarters prior to the fourth quarter of 2024, when it increased slightly. We believe the expansion of our product and services portfolio during 2024, along with a broader sales effort, led to improved sales and retention in the fourth quarter compared with the prior several quarters. There is a lag between changes in TRCV (next twelve months) and revenue (trailing twelve months). Generally, if we are able to sustain growth in TRCV, we would expect revenue growth to follow within the next few quarters (and vice versa). However, intervening events may affect this general expectation.

Direct expenses. Variable expenses increased $23,000 in the 2024 period compared to the 2023 period primarily from higher conference expenses partially offset by decreased hourly labor and data collection expenses. Variable expenses as a percentage of revenue were 16% and 15% in the 2024 and 2023 periods, respectively. Fixed expenses increased $895,000 primarily due to higher contracted services to support investments in our Human Understanding solutions partially offset by decreased salary and benefit costs from workforce changes and automation and state tax incentive adjustments. During the fourth quarter of 2024, we reduced our workforce to align with lower revenue, which is expected to lower these fixed expenses in future periods. We expect to continue to invest in providing innovative solutions to our clients, which could cause direct expenses to fluctuate as a percentage of revenue.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased in the 2024 period compared to the 2023 period primarily due to decreases in marketing expenses of $2.0 million, web hosting and other software services of $287,000, consulting fees of $304,000, professional development and training of $200,000, and bad debt expense of $175,000 partially offset by increased salary and benefit costs of $1.2 million from investments in strategic leadership, product development and sales teams and increased recruiting expenses of $255,000. While we continue to invest in product development and sales, our goal is to drive efficiencies and savings in overall costs to offset such investments. We expect a substantial portion of the benefits of our lower expense run rate for the fourth quarter of 2024 to continue into 2025, partially offset by increased compensation expense of our new CEO, including an expected charge during the second quarter of 2025, of approximately $4.9 million (based on the price of our common stock at February 28, 2025) for Mr. Green's signing bonus and quarterly non-cash charges of approximately $608,000 (based on the price of our common stock on February 28, 2025) for Mr. Green's equity grant beginning in June 2025 and continuing through the third anniversary of the grant. In light of Mr. Green's hiring and compensation, we expect to terminate the existing long-term incentive program for our executive leadership team with the consent of the impacted participants and adopt a new incentive program during the second quarter of 2025, which could result in additional expenses.

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Depreciation, amortization and impairment. Depreciation, amortization and impairment expenses increased in 2024 compared to the 2023 period due to increased software investment amortization and intangible amortization from the Nobl acquisition partially offset by less building, furniture and computer equipment depreciation. We expect our depreciation and amortization to increase slightly given continued software and intangible amortization, as well as depreciation on the building renovations when completed in 2025.

Operating income and margin. Operating income and margin decreased in 2024 compared to 2023 primarily due to the decline in revenue while direct expenses and depreciation and amortization increased. In the near term, we expect operating income and margin to increase due to revenue and cost initiatives, excluding the impact of the compensation charge described above.

Total other income (expense). Total other expense increased in the 2024 period compared to the 2023 period primarily due to higher interest expense of $1.7 million mainly from borrowings on our Line of Credit and Delayed Draw Term Loan, as well as the increased interest rate on our Term Loan, and lower interest income of $695,000 from decreased money market funds investments. Other expense is expected to increase in future periods due to additional borrowings on our Delayed Draw Term Loan. Additionally, starting in August 2024 the Term Note changed from a fixed interest rate of 5% per annum to a floating rate. All borrowings currently bear interest at a floating rate, which is currently equal to the one-month Term SOFR plus a percentage per annum determined by our cash flow leverage ratio, ranging from 2.25% to 2.75%.

Provision for income taxes and effective tax rate. Provision for income taxes decreased in 2024 compared to 2023 primarily due to decreased taxable income. The effective tax rate increased primarily due to an increase in the effective rate related to state income taxes which fluctuates based on various apportionment factors and rates for the states we operate in, increased provision for uncertain tax positions and decreased tax benefits from the share-based compensation awards. See Note 7, “Income Taxes,” to our Consolidated Financial Statements contained in this report for additional information on the change in the effective tax rates.

Recurring Contact Value. Recurring contract value declined in 2024 compared to 2023 primarily due to the lack of growth in new contracts to replace losses. Our retention rate decreased 4% in 2024 compared to 2023. 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.

As of December 31, 2024, our principal sources of liquidity included $4.2 million of cash and cash equivalents, up to $30 million of unused borrowings under our Line of Credit and an additional $24 million on our Delayed Draw Term Loan.

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, change in fair value of contingent consideration, loss on disposal of property and equipment and the effect of working capital changes. Cash provided by operating activities decreased primarily due to decreased net income net of non-cash items, partially offset by working capital changes. Working capital changes mainly consisted of changes in deferred contract costs primarily due to the timing of commissions and incentives and related amortization and changes in prepaid expenses and other current and noncurrent assets primarily due to the timing of our annual business insurance and other service agreements.

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

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We had a working capital deficit of $16.3 million and $11.8 million on December 31, 2024 and December 31, 2023, respectively. The change was primarily due to decreases in cash and cash equivalents and trade accounts receivable, and prepaid expenses due to the timing of our annual business insurance payment and other service agreements and increases in accrued wages, accrued expenses and deferred revenue. These changes were partially offset by the decrease in the current portion of notes payable due to the amendment of our credit agreement in 2024. Cash and cash equivalents decreased mainly due to the repurchase of shares of our common stock for treasury and cash paid to fund the Nobl acquisition, which was also funded by borrowings on our Line of Credit and Delayed Draw Term Loan. Trade accounts receivable decreased due to timing of billing and collections, as well as decreases in our overall recurring contract value. Accrued expenses and accrued wages and bonuses increased primarily due to the accrual of annual incentives and 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. Notwithstanding our working capital deficit on December 31, 2024, 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.

Cash used in investing activities primarily consisted of payments for the acquisition of Nobl Health and purchases of property and equipment including computer software and hardware, building improvements, and furniture and equipment.

Cash used in financing activities consisted of payments for borrowings under the Term Loan, Delayed Draw Term Loan, Line of Credit and finance lease obligations. We also used cash to repurchase shares of our common stock for treasury, to pay dividends on common stock and for payment of payroll tax withholdings on options exercised. This was partially offset by cash provided from borrowings on the Line of Credit and Delayed Draw Down Term loan.

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

Dividends

Cash dividends in the aggregate amount of $11.3 million, $36.3 million and $20.9 million were declared in 2024, 2023 and 2022 respectively. Dividends were paid from cash on hand and borrowings on our line of credit. The payment and amount of future dividends, if any, is at the discretion of our Board of Directors and will depend on our future earnings, financial condition, general business conditions, alternative uses of our earnings and cash and other factors.

Capital Expenditures

We paid cash of $15.4 million for capital expenditures in the year ended December 31, 2024. 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 $5.8 million in 2025, which we expect to fund through operating cash flows and borrowings on the Line of Credit and Delayed Draw Term Loan.

Debt

As of December 31, 2024, our amended and restated credit agreement (the “Credit Agreement”) with First National Bank of Omaha (“FNB”) included (i) a $30.0 million revolving credit facility (the “Line of Credit”), (ii) a $23.4 million term loan (the “Term Loan”) and (iii) a $75.0 million delayed draw-down term facility (the “Delayed Draw Term Loan” and, together with the Line of Credit and the Term Loan, the “Credit Facilities”). As of December 31, 2024, we could use the Delayed Draw Term Loan to fund dividends, any permitted future business acquisitions, capital expenditures or repurchases of our common stock. As of December 31, 2024, the Line of Credit was available to fund ongoing working capital needs and for other general corporate purposes.

As of December 31, 2024, borrowings on the Term Loan, Delayed Draw Term Loan and Line of Credit, accrued interest at a floating rate equal to the SOFR plus 235 basis points (6.9% at December 31, 2024), which is payable monthly.

The outstanding balance on the Term Loan was $14.3 million at December 31, 2024. As of December 31, 2024, principal payments were due in monthly installments of $92,800 through May 2027 and a balloon payment for the remaining balance of $11.6 million was due May 28, 2027.

The outstanding balance on the Delayed Draw Term Loan was $48.5 million at December 31, 2024. As of December 31, 2024, principal payments were due on the Delayed Draw Term Loan in monthly installments of $318,790 through May 2027 and a balloon payment for the remaining balance of $39.4 million was due in May 28, 2027. We had the availability to borrow an additional $24 million on the Delayed Draw Term Loan at December 31, 2024.

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As of December 31, 2024, principal amounts outstanding under the Line of Credit were due and payable in full, at maturity, in May 2027. As of December 31, 2024, we had no borrowings outstanding and the availability to borrow $30.0 million on the Line of Credit. The weighted average borrowings on the Line of Credit for the years ended December 31, 2024 and 2023 were $8.5 million and $1.7 million, respectively. The weighted average interest rate on borrowings on the Line of Credit during the years ended December 31, 2024 and 2023 were 7.52% and 7.67%, respectively.

As of December 31, 2024, we were obligated to pay ongoing unused commitment fees quarterly in arrears 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.

Pursuant to the Credit Agreement, we were 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 excluded, unless our liquidity fell below a specified threshold, (i) any cash dividends in a fiscal quarter that, together with all other cash dividends paid or declared during such fiscal quarter, exceeded $5.5 million 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 $27.5 million of costs associated with our building renovation from or after January 1, 2023. We were 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. As of December 31, 2024, we were in compliance with our financial covenants.

The Credit Facilities were 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).

In February 2025, we entered a new credit agreement (the “New Credit Agreement”) with a group of lenders and FNB that amends and restates the terms of our existing Credit Facility, as amended. The New Credit Agreement provides for (i) a $30,000,000 revolving credit facility (the “Revolving Loan”) and (ii) a $110,000,000 delayed draw-down term facility (“the “New Delayed Draw Term Loan” and, together with the Revolving Loan, the “New Credit Facilities”). The New Delayed Draw Term Loan includes an accordion feature that, so long as no event of default exists or would exist after giving effect to such increase, allows us to request an increase in the New Delayed Draw Term Loan of up to the lesser of (x) $25,000,000 and (y) our EBITDA as of the preceding four fiscal quarters, exercisable in increments of $10,000,000 (or the remaining available amount of the accordion, if less).

Interest accrues and is payable monthly on the New Delayed Draw Term Loan and the Revolving Loan at a floating rate equal to the one-month Term SOFR plus a percentage per annum determined by our cash flow leverage ratio, ranging from 2.25% to 2.75%. Principal amounts outstanding under the Revolving Loan are due and payable in full at maturity at February 6, 2028. Principal amounts outstanding under the New Delayed Draw Term Loan are due and payable monthly during the term of the New Delayed Draw Term Loan, in equal monthly installments to amortize the aggregate outstanding principal balance by (i) 5% during each of the first three years and (ii) 7.5% during each of the fourth and fifth years following the date of such loan. All outstanding principal and interest on the New Delayed Draw Term Loan are due and payable in full at the maturity date, February 6, 2030. The Delayed Draw Term Loan can only be used to refinance certain existing term indebtedness, fund dividends, capital expenditures, permitted future business acquisitions, or repurchasing our common stock.

We are obligated to pay ongoing unused commitment fees quarterly in arrears at a percentage per annum determined by our cash flow leverage ratio, ranging from 0.15% to 0.30%, based on the actual daily unused portions of the Revolving Loan and the New Delayed Draw Term Loan, respectively.

The New 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 present and future assets (including, without limitation, fee-owned real property).

The New 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 New Credit Agreement also contains certain financial covenants with respect to minimum fixed charge coverage ratio and maximum cash flow leverage ratio. We are required to maintain a minimum fixed charge coverage ratio of 1.10x for all testing periods throughout the terms of the New Credit Facilities, which calculation excludes certain specified items, unless our liquidity falls below a specified threshold. We are also required to maintain a cash flow leverage ratio of 3.50x or less for all testing periods throughout the terms of the New Credit Facilities.

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Leases

We have lease arrangements for certain computer, office, printing and inserting equipment as well as office and data center space. As of December 31, 2024, we had fixed lease payments of $624,000 and $10,000 for operating and finance leases, respectively payable within 12 months. A summary of our operating and finance lease obligations as of December 31, 2024 can be found in Note 10, "Leases", to the Consolidated Financial Statements contained in this report.

Taxes

The liability for gross unrecognized tax benefits related to uncertain tax positions was $2.2 million as of December 31, 2024. See Note 7, "Income Taxes", to the Consolidated Financial Statements contained in this report for income tax related information.

Purchase Commitments

We generally do not make unconditional, non-cancelable purchase commitments. We enter into purchase orders in the normal course of business, but these purchase obligations do not exceed one year.

Stock Repurchase Program

In May 2022, our Board of Directors approved the 2022 Program with a repurchase authorization of 2,500,000 shares of common stock. 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 2024, we repurchased 1,154,595 shares of our common stock for an aggregate of $30.8 million under the 2022 Program. As of December 31, 2024, the remaining number of shares of common stock that could be purchased under the 2022 Program was 307,709 shares.

Recent Accounting Pronouncements

There are no recently issued accounting pronouncements we believe will have a material impact on our financial position, results of operations or cash flows.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis provides a summary of significant factors relevant to our financial performance and condition. It should be read in conjunction with the consolidated financial statements and accompanying notes included in Part II, Item 8 of this Form 10-K. This section of this Form 10-K generally discusses 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussions of 2021 items and year-to-year comparisons between 2022 and 2021 are not included in this Form 10-K and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Overview

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.

Critical Accounting Policies and Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. The following areas are considered critical accounting estimates because they involve significant judgments or assumptions, involve complex or uncertain matters or they are susceptible to change and the impact could be material to our financial condition or operating results:

Revenue Recognition

We derive a majority of our revenue from annually renewable subscription-based service agreements with our customers. Such agreements are generally cancelable on short or no notice without penalty. We also derive revenue from fixed, non-subscription arrangements. Our revenue recognition policy requires management to estimate, among other factors, the future contract consideration we expect to receive under variable consideration subscription arrangements as well as future total estimated contract costs over the contract term with respect to fixed, non-subscription arrangements. If management made different judgments and estimates, then the amount and timing of revenue for any period could differ from the reported revenue. See Notes 1 and 3 to our consolidated financial statements for a description of our revenue recognition policies.

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Valuation of Goodwill and Identifiable Intangible Assets

Intangible assets include customer relationships, trade names, technology, and goodwill. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment with other long-lived assets in the related asset group whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. We review intangible assets with indefinite lives for impairment annually as of October 1 and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. This review requires management to assess qualitative factors to determine whether an impairment may have occurred, which inherently involves management’s judgment. This assessment also requires a determination of the fair value of the asset, which often includes several significant estimates and assumptions, including future cash flow estimates, determination of appropriate discount rates, and other assumptions that management believed reasonable under the circumstances. Changes in these estimates and assumptions could materially affect the determination of fair value and/or impairment of goodwill or other intangible assets. See Notes 1 and 6 to our consolidated financial statements for a description of our goodwill and intangible asset valuation and impairment policies and associated impacts for the reported periods. At December 31, 2023, we assessed our current market capitalization compared to book value, forecasts and margins in our last quantitative impairment testing. We concluded that a triggering event had not occurred which would require an additional interim impairment test to be performed as it is not more likely than not that an impairment loss had been incurred at December 31, 2023.

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Key Financial Metrics and Results of Operations

The following table sets forth, for the periods indicated, selected financial information derived from our 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 consolidated financial statements.

Revenue. Revenue in 2023 decreased compared to 2022 with reductions in US revenue of $2.2 million and Canadian revenue of $793,000 due to the closure of our Canadian office. US recurring revenue in our existing client base decreased $819,000 which included $439,000 attributed to elimination of a non-core solution. US recurring revenue decreased from new customer sales by $1.4 million and from non-recurring revenues by $4,000. We do not expect Canadian revenues in the future due to the closure of the Canadian office.

Direct expenses. Variable expenses increased $906,000 in 2023 compared to 2022 primarily from higher data collection expenses. Variable expenses as a percentage of revenue were 15% and 14% in 2023 and 2022, respectively. Fixed expenses decreased $1.9 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 2023 compared to 2022 primarily due to growth in marketing initiative expenses of $2.8 million to expand brand recognition and support sales development, increased salary and benefit costs of $1.5 million in sales and client support, increased travel costs of $512,000, additional technology services of $736,000 partially offset by a reduction in innovation investments of $1.1 million and decreased building demolition costs of $384,000 related to the remodel of our headquarters. We expect salary and benefit costs to increase in 2024 due to our new executive officer positions and changes to our commission structure, although we hope to have meaningful offsets from ongoing efficiency and cost controls.

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Depreciation, amortization and impairment. Depreciation, amortization and impairment expenses increased in 2023 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 2023 compared to 2022 primarily due to a decline in revenue and growth in marketing and technology investments and higher data collection expenses.

Total other income (expense). Total other expense decreased in 2023 compared to 2022 primarily due to the reclassification of the cumulative foreign currency translation adjustment of $2.6 million to other expense as a result of the substantial liquidation of our Canadian subsidiary in December 2022. Interest income increased $652,000 from additional money market funds investments and interest expense decreased $347,000 from the declining balance on our term loan partially offset from interest expense due to drawing on the line of credit. In future periods we expect total other expense to increase 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 and delayed draw term loan.

Provision for income taxes and effective tax rate. Provision for income taxes decreased in 2023 compared to 2022 primarily due to decreased taxable income. The effective tax rate decreased primarily due to lower state income taxes of approximately $864,000 which fluctuate based on various apportionment factors and rates for the states we operate in, the non-deductible reclassification of the cumulative foreign currency translation adjustment of $539,000 in 2022 and increased tax benefits of $250,000 from the share-based compensation awards. See Note 7, “Income Taxes,” to our Consolidated Financial Statements contained in this report for additional information on the change in the effective tax rates.

Recurring Contact Value. Recurring contract value declined in 2023 compared to 2022 primarily from our strategy to focus on our core digital solutions and lower net sales, although the trend improved later in 2023. 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.

As of December 31, 2023, our principal sources of liquidity included $6.7 million of cash and cash equivalents, up to $30 million of unused borrowings under our line of credit and an additional $56 million on our delayed draw term note. Of this cash, $155,000 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, amortization, and impairments, reclassification of cumulative foreign currency translation adjustment into earnings, 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. Cash provided by operating activities increased primarily due to working capital changes, mainly consisting of changes in deferred revenue and trade accounts receivable primarily due to timing of initial billings and collections for new and renewal contracts, changes in accrued expenses, wages and bonuses mainly due to decreased bonuses and reductions in accruals for paid time off due to a new unlimited plan, partially offset by changes in prepaid expenses and other current assets primarily due to the timing of our annual business insurance payment and growth in operating lease assets and liabilities due to changes in our leases and a reassessment. Cash provided by operating activities was also partially offset by decreased net income net of non-cash items.

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

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We had a working capital deficit of $11.8 million and surplus of $10.3 million on December 31, 2023 and 2022, respectively. The change was primarily due to decreases in cash and cash equivalents and trade accounts receivable and an increase in the current portion of notes payable. These were partially offset by increases in prepaid expenses primarily due to the timing of our annual business insurance payment. Cash and cash equivalents decreased mainly due to the repurchase of shares of our common stock for treasury. We also borrowed on our delayed draw term loan to fund the share repurchases which increased the current portion of notes payable. Trade accounts receivable decreased due to timing of billing and collections, as well decreases in our overall recurring contract value. 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. Notwithstanding our working capital deficit on December 31, 2023, 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.

Cash used in investing activities primarily consisted of purchases of property and equipment including computer software and hardware, building improvements, and furniture and equipment.

Cash used in financing activities consisted of payments for borrowings under the term note, line of credit 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, borrowings on the line of credit and delayed draw term loan.

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

Dividends

Cash dividends in the aggregate amount of $36.3 million, $20.9 million and $12.2 million were declared in 2023, 2022 and 2021 respectively. Dividends were paid from cash on hand and borrowings on our line of credit. The payment and amount of future dividends, if any, is at the discretion of our Board of Directors and will depend on our future earnings, financial condition, general business conditions, alternative uses of our earnings and cash and other factors.

Capital Expenditures

We paid cash of $15.8 million for capital expenditures in the year ended December 31, 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 $11.6 million in 2024 and $1.4 million in 2025, 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 outstanding balance on the Term Loan was $17.8 million at December 31, 2023 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 Delayed Draw Term Loan and Line of Credit, if any, bear interest at a floating rate equal to the 30-day Secured Overnight Financing Rate (“SOFR”) plus 235 basis points (7.68% at December 31, 2023). Interest on the Line of Credit and Delayed Draw Term Loan accrues and is payable monthly.

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Principal amounts outstanding under the Line of Credit are due and payable in full at maturity, in May 2025. The Line of Credit did not have a balance at December 31, 2023 and we had the availability to borrow $30,000,000. The weighted average borrowings on the Line of Credit for year ended December 31, 2023 was $1.7 million. The weighted average interest rate on borrowings on the Line of Credit during the year ended December 31, 2023 was 7.67%.

The outstanding balance on the Delayed Draw Term Loan was $19.0 million at December 31, 2023. Principal payments are due in monthly installments of $226,190 through April 2027 and a balloon payment for the remaining balance of $10.2 million is due in May 2027. We had the availability to borrow an additional $56.0 million on the Delayed Draw Term Loan at December 31, 2023.

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.

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. 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 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 $5.5 million 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 December 31, 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 December 31, 2023, we had fixed lease payments of $678,000 and $23,000 for operating and finance leases, respectively payable within 12 months. A summary of our operating and finance lease obligations as of December 31, 2023 can be found in Note 10, "Leases", to the Consolidated Financial Statements contained in this report.

Taxes

The liability for gross unrecognized tax benefits related to uncertain tax positions was $2.0 million as of December 31, 2023. See Note 7, "Income Taxes", to the Consolidated Financial Statements contained in this report for income tax related information.

We generally do not make unconditional, non-cancelable purchase commitments. We enter into purchase orders in the normal course of business, but these purchase obligations do not exceed one year.

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Stock Repurchase Program

In May 2022, our Board of Directors approved the 2022 Program with a repurchase authorization of 2,500,000 shares of common stock. 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 2023, we repurchased 462,140 shares of our common stock for an aggregate of $19.1 million under the 2022 Program. As of December 31, 2023, the remaining number of shares of common stock that could be purchased under the 2022 Program was 1,462,304 shares.

Recent Accounting Pronouncements

There are no recently issued accounting pronouncements we believe will have a material impact on our financial position, results of operations or cash flows.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis provides a summary of significant factors relevant to our financial performance and condition. It should be read in conjunction with the consolidated financial statements and accompanying notes included in Part II, Item 8 of this Form 10-K. This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 are not included in this Form 10-K, and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

Overview

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.

The outbreak of COVID-19, and the associated responses, have impacted our business in a variety of ways. Many businesses, including many of our clients, have de-emphasized external business opportunities and restricted in-person meetings while shifting their attention toward addressing COVID-19 planning, business disruptions, higher costs, and revenue shortfalls. The on-going impacts of the COVID-19 pandemic and associated impacts on our business, including the impact on our revenue, expenses, and cash flows, cannot be predicted at this time.

Critical Accounting Policies and Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. The following areas are considered critical accounting estimates because they involve significant judgments or assumptions, involve complex or uncertain matters or they are susceptible to change and the impact could be material to our financial condition or operating results:

Revenue Recognition

We derive a majority of our revenue from annually renewable subscription-based service agreements with our customers. Such agreements are generally cancelable on short or no notice without penalty.  We also derive revenue from fixed, non-subscription arrangements.  Our revenue recognition policy requires management to estimate, among other factors, the future contract consideration we expect to receive under variable consideration subscription arrangements as well as future total estimated contract costs over the contract term with respect to fixed, non-subscription arrangements. If management made different judgments and estimates, then the amount and timing of revenue for any period could differ from the reported revenue.  See Notes 1 and 3 to our consolidated financial statements for a description of our revenue recognition policies.

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Valuation of Goodwill and Identifiable Intangible Assets

Intangible assets include customer relationships, trade names, technology, and goodwill. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment with other long-lived assets in the related asset group whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. We review intangible assets with indefinite lives for impairment annually as of October 1 and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.  This review requires management to assess qualitative factors to determine whether an impairment may have occurred, which inherently involves management’s judgment.  This assessment also requires a determination of the fair value of the asset, which often includes several significant estimates and assumptions, including future cash flow estimates, determination of appropriate discount rates, and other assumptions that management believed reasonable under the circumstances.  Changes in these estimates and assumptions could materially affect the determination of fair value and/or impairment of goodwill or other intangible assets.  See Notes 1 and 6 to our consolidated financial statements for a description of our goodwill and intangible asset valuation and impairment policies and associated impacts for the reported periods.

In March 2021, we changed our operating segments from six to one to reflect a change in the way we operated and managed our business, including changes to our corporate reporting structure to the Company’s Chief Executive Officer and chief operating decision maker. In connection with the revision to our operating segments, we performed an interim qualitative analysis immediately before and after the reorganization and concluded that the fair value of our reporting units likely exceeded the carrying values and no impairments were recorded. Following the reorganization, we considered the current and expected future economic and market conditions, including the impact of the COVID-19 pandemic, on our reporting unit. We also assessed our current market capitalization compared to book value, forecasts and margins in our last quantitative impairment testing. We concluded that a triggering event had not occurred which would require an additional interim impairment test to be performed as it is not more likely than not that an impairment loss had been incurred at December 31, 2022.

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Key Financial Metrics and Results of Operations

The following table sets forth, for the periods indicated, selected financial information derived from our 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 consolidated financial statements.

Due to changes in our corporate reporting structure in 2021, certain associates moved between departments. As a result, the related salaries and benefits and company incentive expenses are included in Selling, general and administrative expenses in the 2022 and 2021 periods instead of Direct as in the 2020 periods. The total amount of the reclassified expenses approximates $1.9 million in 2021.

Revenue. Revenue in 2022 increased compared to 2021 due to an increase in US revenue of $5.8 million partially offset by decreased Canadian revenue of $2.2 million due to the closure of the Canadian office in 2022. US revenue increased due to growth in recurring revenue in our existing client base of $13.1 million partially offset by decreases in US recurring revenue from new customer sales of $6.8 million and non-recurring revenues of $557,000.  We do not expect Canadian revenues in the future due to the closure of the Canadian office.

Direct expenses. Variable expenses increased $584,000 in 2022 compared to 2021 primarily due to growth in conference expenses of $1.3 million due to additional conferences being held in 2022 compared to 2021 and the shift to allow live or virtual attendance at conferences partially offset by lower survey and other subscription services of $801,000. Variable expenses as a percentage of revenue were 14.4% in 2022 and 2021. Fixed expenses increased $4.1 million primarily as a result of increased salary and benefit costs to attract and retain associates of $3.3 million, contracted services to support our Human Understanding Solutions of $547,000 and increased travel costs of $376,000 due to COVID travel restrictions being lifted.

Selling, general and administrative expenses. Selling, general and administrative expenses increased in 2022 compared to 2021 primarily due to innovation investments to support further development of our Human Understanding Solutions of $1.5 million, new marketing initiatives of $2.3 million, increased travel costs of $645,000 due to COVID travel restrictions being lifted, and new associate coaching benefit expense of $561,000, as well as increased business insurance costs of $405,000, partially offset by decreases in public company and other legal and accounting costs of $861,000.

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Depreciation, amortization and impairment. Depreciation, amortization and impairment expenses decreased in 2022 compared to 2021 primarily due to a decrease in building depreciation expense of $352,000 resulting from shortening the estimated useful lives of certain building assets, incurring a right-of-use asset impairment of $324,000 from subleasing a remote office location in 2021 and a decrease of $460,000 due to certain software development and intangible assets being fully amortized after 2021.

Operating income and margin. Operating income and margin decreased in 2022 compared to 2021 primarily due to growth in salary and benefit costs to attract and retain associates including a new associate benefit, as well as additional investments in our Human Understanding Solutions and marketing initiatives outpacing our revenue growth.

Total other income (expense). Total other expense increased in 2022 compared to 2021 primarily due the reclassification of the cumulative foreign currency translation adjustment of $2.6 million to other expense as a result of the substantial liquidation of our investment in our Canadian subsidiary in December 2022. Any future currency changes related to our Canadian subsidiary will be recognized in Other income (expense), net in our Consolidated Statements of Income. This expense was partially offset by a $458,000 decrease in interest expense due to the declining balance on our term loan.

Provision for income taxes and effective tax rate. Provision for income taxes decreased in 2022 compared to 2021 primarily due to decreased taxable income. The effective tax rate increased in 2022 compared to 2021 mainly due to decreased tax benefits from share-based compensation awards of $540,000, the non-deductible reclassification of cumulative foreign currency translation adjustment into earnings of $539,000 and $383,000 in higher state income taxes. See Note 7, “Income Taxes,” to our Consolidated Financial Statements contained in this report for additional information on the change in the effective tax rates.

Recurring Contact Value. Recurring contract value declined in 2022 compared to 2021 primarily from a decrease in new client sales as well as a 2.0% decrease in our client retention rate partially due to our strategy to focus on our core digital solutions. The recurring contract value of our core digital solutions declined 1.1% at December 31, 2022 compared to December 31, 2021. 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 December 31, 2022, our principal sources of liquidity included $25.0 million of cash and cash equivalents, up to $30 million of unused borrowings under our line of credit and up to $75 million on our delayed draw term note. Of this cash, $78,000 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, amortization, and impairments, reclassification of cumulative foreign currency translation adjustment into earnings, 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. 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 deferred revenue primarily due to timing of initial billings on new and renewal contracts and decreased overall recurring contract value and changes in accrued expenses, wages and bonuses mainly due to decreased bonuses, partially offset by changes in prepaid expenses and other current assets primarily due to the timing of our annual business insurance payment.

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

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We had a working capital surplus of $10.3 million and $33.3 million on December 31, 2022 and 2021, respectively. The change was primarily due to decreases in cash and cash equivalents and prepaid expenses partially offset by decreases in accrued wages and bonuses, accrued expenses and deferred revenue. Cash and cash equivalents decreased mainly due to repurchase of shares of our Common Stock for treasury. Prepaid expenses decreased primarily due to the timing of our annual business insurance payment. Accrued expenses decreased due to timing of payment for services and supplies. Accrued wages and bonuses decreased due to less bonuses being earned in 2022 and the final payment of employer social security taxes that were deferred due to the Coronavirus Aid, Relief, and Economic Security Act. 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 consisted of purchases of property and equipment including computer software and hardware, building improvements and furniture and equipment.

Cash used in financing activities consisted of payments for borrowings under the term note, finance lease obligations and debt issuance costs. We also used cash to pay deferred acquisition consideration related to our 2021 acquisition of PatientWisdom, repurchase shares of our Common Stock for treasury, to pay dividends on Common Stock and to pay employee payroll tax withholdings on share-based awards exercised.

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

Dividends

Cash dividends in the aggregate amount of $20.9 million, $12.2 million and $5.3 million were declared in 2022, 2021 and 2020 respectively. All dividends were paid from cash on hand. The payment and amount of future dividends, if any, is at the discretion of our Board of Directors and will depend on our future earnings, financial condition, general business conditions, alternative uses of our earnings and cash and other factors.

Acquisition Consideration

On January 4, 2021, we acquired substantially all assets and assumed certain liabilities of PatientWisdom, Inc., a company with a health engagement solution that will further our purpose of operationalizing human understanding through tangible and actionable insights. $3.0 million of the total $5.0 million all-cash consideration was paid at closing. We paid the remaining $2.0 million in January 2022. All payments were made with cash on hand.

Capital Expenditures

We paid cash of $9.8 million for capital expenditures in the year ended December 31, 2022. These expenditures consisted mainly of computer software development for our Human Understanding solutions and building renovations to our headquarters of $3.6 million and $5.1 million, respectively We estimate future costs related to our headquarters building renovations to be $16.1 million and $2.9 million in 2023 and 2024, respectively, which we expect to fund through operating cash flows.

Debt

Our amended and restated credit agreement (the “Credit Agreement”) with First National Bank of Omaha (“FNB”) was amended and restated on September 30, 2022 and 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 $22.3 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 (6.10% at December 31, 2022). 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 December 31, 2022, the Line of Credit did not have a balance. There were no borrowings on the Line of Credit during the years ended December 31, 2022 or 2021. There have been no borrowings on the Delayed Draw Term Loan since origination.

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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 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. 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 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, and (iii) the portion of any acquisition consideration for a permitted acquisition paid with cash on hand. 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 wholly owned domestic subsidiaries, if any, and, to the extent required by the Credit Agreement, direct and indirect wholly owned foreign subsidiaries. As of December 31, 2022, 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 December 31, 2022, we had fixed lease payments of $547,000 and $315,000 for operating and finance leases, respectively payable within 12 months. A summary of our operating and finance lease obligations as of December 31, 2022 can be found in Note 10, "Leases", to the Consolidated Financial Statements contained in this report.

Taxes

The liability for gross unrecognized tax benefits related to uncertain tax positions was $1.6 million as of December 31, 2022. See Note 7, "Income Taxes", to the Consolidated Financial Statements contained in this report for income tax related information.

As of December 31, 2022, the balance of the deemed repatriation tax payable imposed by the U.S. Tax Cuts and Jobs Act of 2017 was $82,000, which we expect to pay in the next year.

We generally do not make unconditional, non-cancelable purchase commitments. We enter into purchase orders in the normal course of business, but these purchase obligations do not exceed one year.

Stock Repurchase Program

In February 2006 and subsequently amended in May 2013, our Board of Directors authorized the repurchase of up to 2,250,000 shares of Common Stock in the open market or in privately negotiated transactions under a stock repurchase program under the 2006 Program. In 2022, we repurchased all the remaining shares authorized for repurchase under the 2006 Program. In May 2022, our Board of Directors approved the 2022 Program with a repurchase authorization of 2,500,000 shares of Common Stock. 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 2022, we repurchased 744,499 shares of our Common Stock for an aggregate of $27.6 million, of which 168,943 shares were repurchased under the 2006 Program and 575,556 shares were repurchased under the 2022 Program. As of December 31, 2022, the remaining number of shares of Common Stock that could be purchased under the 2022 Program was 1,924,444 shares.

Recent Accounting Pronouncements

There are no recently issued accounting pronouncements we believe will have a material impact on our financial position, results of operations or cash flows.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis provides a summary of significant factors relevant to our financial performance and condition. It should be read in conjunction with the consolidated financial statements and accompanying notes included in Part II, Item 8 of this Form 10-K. This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 are not included in this Form 10-K, and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

Overview

Our purpose is to establish human understanding by enabling our clients to understand what matters most to each person they serve. We are a leading provider of analytics and insights that facilitate measurement and improvement of patient engagement and customer loyalty for healthcare organizations. 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. 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.

The outbreak of COVID-19, and the associated responses, have impacted our business in a variety of ways. Governments have implemented business and travel restrictions and recommended social distancing and other guidelines. Many businesses, including many of our clients, have de-emphasized external business opportunities and restricted in-person meetings while shifting their attention toward addressing COVID-19 planning, business disruptions, higher costs, and revenue shortfalls. At NRC, the vast majority of our associates are working remotely, and to date we have been capable of providing our services without significant disruption. We have made our facilities available for associates to return to work effective July 1, 2021 at their discretion. Historically, we have relied on national travel as part of our sales efforts, but as a result of the pandemic we had placed a temporary hold on all company related travel. We modified our travel policy and limited travel did resume in the third quarter of 2021. The duration and severity of the COVID-19 pandemic and associated impacts on our business, including the impact on our revenue, expenses, and cash flows, cannot be predicted at this time. Like many other companies, we experienced higher attrition rates in 2021. We may incur higher costs to attract, train and retain these associates. Attrition in our sales and service areas can also impact our ability to retain and attract new business. Based on the foregoing, we do not expect our recent revenue and earnings growth to be indicative of future expectations. We do, however, expect to have adequate sources of liquidity to meet our current and expected needs for the foreseeable future.

Critical Accounting Policies and Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. The following areas are considered critical accounting estimates because they involve significant judgments or assumptions, involve complex or uncertain matters or they are susceptible to change and the impact could be material to our financial condition or operating results:

Revenue Recognition

We derive a majority of our revenue from annually renewable subscription-based service agreements with our customers. Such agreements are generally cancelable on short or no notice without penalty.  We also derive revenue from fixed, non-subscription arrangements.  Our revenue recognition policy requires management to estimate, among other factors, the future contract consideration we expect to receive under variable consideration subscription arrangements as well as future total estimated contract costs over the contract term with respect to fixed, non-subscription arrangements. If management made different judgments and estimates, then the amount and timing of revenue for any period could differ from the reported revenue.  See Notes 1 and 3 to our consolidated financial statements for a description of our revenue recognition policies.

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Valuation of Goodwill and Identifiable Intangible Assets

Intangible assets include customer relationships, trade names, technology, and goodwill. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment with other long-lived assets in the related asset group whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. We review intangible assets with indefinite lives for impairment annually as of October 1 and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.  This review requires management to assess qualitative factors to determine whether an impairment may have occurred, which inherently involves management’s judgment.  This assessment also requires a determination of the fair value of the asset, which often includes several significant estimates and assumptions, including future cash flow estimates, determination of appropriate discount rates, and other assumptions that management believed reasonable under the circumstances.  Changes in these estimates and assumptions could materially affect the determination of fair value and/or impairment of goodwill or other intangible assets.  See Notes 1 and 6 to our consolidated financial statements for a description of our goodwill and intangible asset valuation and impairment policies and associated impacts for the reported periods.

In March 2021, we changed our operating segments from six to one to reflect a change in corporate reporting structure to the Company’s Chief Executive Officer and chief operating decision maker. In connection with the revision to our operating segments, we performed an interim qualitative analysis immediately before and after the reorganization and concluded that the fair value of our reporting units likely exceeded the carrying values and no impairments were recorded. Following the reorganization, we considered the current and expected future economic and market conditions, including the impact of the COVID-19 pandemic, on our reporting unit. We also assessed our current market capitalization compared to book value, forecasts and margins in our last quantitative impairment testing. We concluded that a triggering event has not occurred which would require an additional interim impairment test to be performed as it is not more likely than not that an impairment loss had been incurred at December 31, 2021.

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Key Financial Metrics and Results of Operations

The following table sets forth, for the periods indicated, selected financial information derived from our 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 consolidated financial statements.

Due to changes in our corporate reporting structure in 2021, certain associates moved between departments. As a result, the related salaries and benefits and company incentive expenses are included in Selling, general and administrative expenses in the 2021 periods instead of Direct as in the 2020 periods. The total amount of the reclassified expenses approximates $1.9 million in 2021.

Revenue. Revenue in 2021 increased compared to 2020, primarily due to new customer sales, as well as increases in sales to the existing client base. During 2020, we also experienced revenue reductions from COVID-19 as some clients reduced or eliminated services they purchased from us as cost reducing measures, which increased our revenue growth in 2021. We expect our revenue growth in 2022 to align more closely in relation to our recurring contract value growth.

Direct expenses. Direct expenses increased in 2021 compared to 2020 due to growth in volume-based data collection costs to support the growth in revenue partially offset by decreased postage, printing, and paper costs primarily resulting from increased use of digital survey methodologies. Conference expenses also increased due to additional conferences being held in 2021 compared to 2020 and shift to allow live or virtual attendance at conferences. Variable expenses as a percentage of revenue have leveled with changes in survey methodologies at 14.4% and 14.2% in 2021 and 2020, respectively. Fixed expenses increased primarily as a result of increased salary and benefit costs to attract and retain associates, contracted services and software and platform hosting expenses.

Selling, general and administrative expenses. Selling, general and administrative expenses increased in 2021 compared to 2020 primarily due to increases in salary and benefit costs to attract and retain associates, public company and other legal and accounting costs, contracted services, software and platform hosting expenses and other taxes due to a favorable tax ruling in 2020 reversing sales tax expense.

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Depreciation, amortization and impairment. Depreciation, amortization and impairment expenses decreased in 2021 compared to 2020 primarily due to additional depreciation and impairment expense in 2020 from shortening the estimated useful lives of certain building assets and a goodwill impairment adjustment for the Canadian reporting unit. This was partially offset by our transformation to a distributed workforce environment, which includes building renovation costs for our headquarters, as well as subleasing a remote office location at a discounted rate, which resulted in an ROU asset impairment in 2021.

Operating income and margin. Operating income and margin grew due to leveraging the revenue growth through the efficiencies inherent within our subscription model as well as the discipline in managing our cost structure.

Total other income (expense). Total other income (expense) increased in total net (expense) primarily due to revaluation on intercompany transactions due to changes in the Canadian to U.S. dollar foreign exchange rate partially offset by lower interest expense due to the declining balance on our term loan.

Provision for income taxes and effective tax rate. Provision for income taxes and effective tax rate grew in 2021 compared to 2020 primarily due to decreased tax benefits from the exercise and vesting of share-based compensation awards and higher state income taxes.

Recurring Contact Value. Recurring contract value grew as sales continued to exceed loss and downsells. Retention rates grew in 2021 compared to 2020, but sales declined due to the difficulties of selling to our clients during the COVID-19 pandemic as well as increased turnover within our sales force. Our recurring contract value growth declined in 2021 in comparison to 2020 due in part to our strategy to focus on growing our digital core solutions, and therefore, the decision was made to eliminate certain legacy offerings. 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.

Cash provided by operating activities. Cash provided by operating activities grew mainly due to growth in cash collections on trades accounts receivable, change in income taxes receivable and payable, and growth in deferred revenue primarily due to timing of initial billings on new and renewal contracts.

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 December 31, 2021, our principal sources of liquidity included $54.4 million of cash and cash equivalents, up to $30 million of unused borrowings under our line of credit and up to $15 million on our delayed draw term note. Of this cash, $6.5 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.

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, loss on disposal of property and equipment and the effect of working capital changes. Cash provided by operating activities grew mainly due to strong cash collections on trades accounts receivable, change in income taxes receivable and payable, decreases in deferred contract costs due to the changes in the costs to acquire new sales and growth in deferred revenue primarily due to timing of initial billings on new and renewal contracts. This was partially offset by decreased depreciation, amortization and impairment and increased accrued expenses, wages, and bonuses.

We had a working capital surplus of $33.3 million and $22.4 million on December 31, 2021 and 2020, respectively. The change was primarily due to increases in cash and cash equivalents and prepaid expenses, partially offset by increases in dividends payable, accrued expenses and deferred revenue. Dividends payable increased due to timing of declaration and payments of dividends. Prepaid expenses and accrued expenses increased due to timing of payment for services and supplies. 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 consisted of acquisition consideration for our January 2021 acquisition of PatientWisdom and purchases of property and equipment including computer software and hardware, leasehold and building improvements and furniture and equipment.

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

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

Dividends

Cash dividends in the aggregate amount of $12.2 million were declared in 2021 with $9.2 million paid in 2021 and the remaining $3.0 million paid in January 2022.The dividends were paid from cash on hand. Our board of directors considers whether to declare a dividend and the amount of any dividends declared on a quarterly basis.

Acquisition Consideration

On January 4, 2021, we acquired substantially all assets and assumed certain liabilities of PatientWisdom, Inc., a company with a health engagement solution that will further our purpose of operationalizing human understanding through tangible and actionable insights. $3.0 million of the total $5.0 million all-cash consideration was paid at closing. We paid the remaining $2.0 million in January 2022. All payments were made with cash on hand.

Capital Expenditures

We paid cash of $5.5 million for capital expenditures in the year ended December 31, 2021. These expenditures consisted mainly of computer software development for our Human Understanding solutions and building renovations to our headquarters of $2.8 million and $1.8 million, respectively. Future costs related to our headquarters building renovations are estimated at $15 million and $7 million in 2022 and 2023, respectively.

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 $33,002,069 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”). 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 $26.6 million and is payable in monthly installments of $462,988 through May 2025, with a balloon payment due at maturity in May 2025. 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 plus 225 basis points (2.35% at December 31, 2021). 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 2023. As of December 31, 2021, and 2020, the Line of Credit did not have a balance. There were no borrowings on the Line of Credit during 2021. 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 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. 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 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, and (iii) the portion of any acquisition consideration for a permitted acquisition paid with cash on hand. 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 guaranteed by our subsidiary. As of December 31, 2021, we were in compliance with our financial covenants.

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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 December 31, 2021, we had fixed lease payments of $531,000 and $488,000 for operating and finance leases, respectively payable within 12 months. A summary of our operating and finance lease obligations as of December 31, 2021 can be found in Note 10, "Leases", to the Consolidated Financial Statements contained in this report.

Taxes

The liability for gross unrecognized tax benefits related to uncertain tax positions was $1.1 million as of December 31, 2021. See Note 7, "Income Taxes", to the Consolidated Financial Statements contained in this report for income tax related information.

As of December 31, 2021, the balance of the deemed repatriation tax payable imposed by the U.S. Tax Cuts and Jobs Act of 2017 (the Act”) was $182,000, which we expect to pay by the end of 2022.

We generally do not make unconditional, non-cancelable purchase commitments. We enter into purchase orders in the normal course of business, but these purchase obligations do not exceed one year.

Stock Repurchase Program

Our Board of Directors authorized the repurchase of up to 2,250,000 shares of Common Stock in the open market or in privately negotiated transactions under a stock repurchase program. We repurchase shares of our common stock from time to time after considering market conditions and in accordance with repurchase limits authorized by our Board. During 2021, we repurchased 111,548 shares of our Common Stock under this authorization for an aggregate of $4.6 million. As of December 31, 2021, the remaining number of shares of Common Stock that could be purchased under this authorization was 168,943 shares, which we expect to repurchase during 2022.

Recent Accounting Pronouncements

See Note 1 to our consolidated financial statements for a description of recently issued accounting pronouncements.

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