# NRC HEALTH (NRC) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from NRC HEALTH's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/70487/000143774922005273/nrc20211231_10k.htm
Accession: 0001437749-22-005273
Filing date: 2022-03-04
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/NRC/
All MD&A years: /company/NRC/mda/
Next year: /company/NRC/mda/fy2022/ (FY 2022)

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:

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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.

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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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