Item 1. Business
General
National Research Corporation ("NRC" or the "Company") believes it is a leading provider of ongoing survey-based performance measurement, analysis and tracking services to the healthcare industry. The Company believes it has achieved this leadership position based on its over 18 years of industry experience and its relationships with many of the industry's largest payers and providers. The Company addresses the growing need of healthcare providers and payers to measure the care outcomes, specifically satisfaction and health status, of their patients and/or members. NRC has been at the forefront of the industry in developing tools that enable healthcare organizations to obtain service quality information necessary to comply with industry and regulatory standards and to improve their business practices so that they can maximize new member and/or patient attraction, member retention and profitability.
Since its founding 18 years ago as a Nebraska corporation (the Company reincorporated in Wisconsin in September 1997), NRC has focused on the information needs of the healthcare industry. The Company offers two primary types of information services: (i) renewable performance tracking services and custom research and (ii) a renewable syndicated service. During 1998, NRC provided services to more than 260 healthcare organizations, including health maintenance organizations ("HMOs"), integrated healthcare systems, medical groups and industry regulatory bodies. The Company gathered and analyzed over 1,415,000 completed surveys for these clients in 1998.
One of the Company's growth strategies has been to expand its client base by adding new sales associates and by pursuing strategic opportunities to acquire other healthcare performance information providers. During 1998, the Company followed this strategy by hiring new sales associates. In June 1998, the Company also acquired Healthcare Research Systems, Ltd. ("HRS"), an Ohio-based provider of survey-based performance measurement, analysis and tracking services to the healthcare industry.
While performance data has always been of interest to healthcare providers and payers, such information has become increasingly important to these entities as a result of regulatory, industry and competitive requirements. In recent years, the healthcare industry has been under significant pressure from consumers, employers and the government to reduce costs. Through the implementation of managed care, which currently covers approximately 75.6% of all Americans, the rate of growth in healthcare costs has been substantially reduced. However, the same parties that demanded cost reductions are now concerned that healthcare service quality is being compromised under managed care. This concern has created a demand for consistent, objective performance information by which healthcare providers and payers can be measured and compared and on which physicians' compensation can, in part, be based.
The NRC Solution
The Company addresses healthcare organizations' growing need to track their performance at the enterprise-wide, departmental and physician/caregiver levels. The Company has been at the forefront of the industry in developing tools that enable its clients to collect, in an unobtrusive manner, a substantial amount of comparative service quality information in order to analyze and improve their practices to maximize new member and/or patient attraction, member retention and profitability.
NRC's performance assessments offer the tangible measurement of health service quality currently demanded by consumers, employers, industry accreditation organizations and lawmakers.
The Company's innovative solutions respond to managed care's redefined relationships among consumers, employers, payers and providers. While many vendors exclusively use static, mass produced questionnaires, NRC also utilizes its dynamic data collection process to create a personalized questionnaire that evaluates service issues specific to each respondent's specific healthcare experience. The flexibility of the Company's data collection process allows healthcare organizations to add timely, market driven questions relevant to matters such as industry performance mandates, employer performance guarantees and internal quality improvement initiatives. In addition, the Company assesses core service factors relevant to all healthcare respondent groups (patients, members, employers, employees, physicians, etc.) and to all service points of a healthcare system (inpatient, emergency room, outpatient, home health, rehabilitation, long-term care, hospice, etc.).
NRC offers two primary types of information services: (i) renewable performance tracking services and custom research and (ii) a renewable syndicated service. The NRC Listening System (the "Listening System") is a renewable performance tracking tool for gathering and analyzing data from survey respondents. The Company has the capacity to measure performance beyond the enterprise-wide level and has the ability and experience to determine key performance indicators at the department and individual physician/caregiver measurement levels, where the Company's services can best guide the efforts of its clients to improve quality and enhance their market position. The Company's custom research enables NRC's clients to conduct specific studies in order to identify areas of improvement and measure market issues and opportunities. The syndicated NRC Healthcare Market Guide (the "Market Guide"), a stand-alone market information and competitive intelligence source as well as a comparative performance database, allows the Company's clients to assess their performance relative to the industry, to access best practice examples and to utilize competitive information for marketing purposes. Recognizing the increasing applications for self-reported healthcare assessments, NRC works with its clients to integrate satisfaction measurement into various areas of their businesses, including physician compensation. As the Company partners with its clients, it seeks to enhance relationships throughout the healthcare organization and thereby both broaden and deepen the scope of its projects.
With the acquisition of HRS in June 1998, NRC added HRS' unique service offerings, including functional disease-specific and health status measurement tools. These additional services for the healthcare industry enhance existing services and products available to the Company's clients.
Growth Strategy
The Company believes that it can continue to grow through: (i) expanding the depth and breadth of its current clients' performance tracking programs, since healthcare organizations are increasingly interested in gathering performance information at deeper levels of their organizations and from more of their constituencies, (ii) increasing the cross-selling of its complementary services, (iii) adding new clients through penetrating the sizeable portion of the healthcare industry that is not yet conducting performance assessments beyond the enterprise-wide level or is not yet outsourcing this function and (iv) pursuing acquisitions of, or investments in, firms providing products, services or technologies that complement those of the Company.
Services
The Company's primary types of information services are as follows:
Renewable Performance Tracking Services and Custom Research. The Listening System and custom research represented 89%, 89% and 90% of the Company's total revenues in 1998, 1997 and 1996, respectively. The Listening System is NRC's state-of-the-art data collection process which provides ongoing, renewable performance tracking. This performance tracking program efficiently coordinates and centralizes an organization's satisfaction monitoring, thereby establishing a uniform methodology and survey instrument needed to obtain valid performance information and improve quality. Using the industry method of mail and/or telephone based data collection, this assessment process monitors satisfaction across healthcare respondent groups (patients, members, employers, employees, physicians, etc.) and service settings (inpatient, emergency room, outpatient, etc.). Rather than be limited to only static, mass produced questionnaires that provide limited flexibility and performance insights, NRC's proprietary software generates individualized questionnaires, which include personalization such as patient name, treating caregiver name, encounter date and, in some cases, the services received. This personalization enhances the response rates and the relevance of performance data. Flexible and responsive to healthcare organizations changing information needs, NRC creates personalized questionnaires that evaluate service issues specific to each respondent's specific healthcare experience and include questions that address core service factors throughout a healthcare organization.
As differentiated from other competitors, the Company gathers data through one efficient questionnaire, the contents of which are selected from the Company's library of questions after a client's needs are determined, as opposed to multiple questionnaires that often bombard the same respondents. As a result, the Company's renewable performance tracking programs and data collection process (i) realize higher response rates, obtain data more efficiently, and thereby provide healthcare organizations with more feedback, (ii) eliminate oversurveying (where one respondent receives multiple surveys) and (iii) allow healthcare organizations to adapt questionnaire content to address management objectives and to assess quality improvement programs or other timely marketplace issues. Recognizing that performance programs must do more than just measure satisfaction, NRC has developed a one-page reporting format called the NRC Action Plan that provides a basis on which to make improvements. NRC Action Plans show healthcare organizations which service factors their customer groups value, which have the greatest impact on satisfaction levels and how their performance in relationship to these key indicators changes over time.
In order to be a sole source provider to its clients, the Company also conducts custom research that measures and monitors market characteristics or issues specific to individual healthcare organizations. NRC's custom research includes consumer recall of promotional and branding campaigns, consumer response to new service offerings and provider perception of health plans and healthcare organizations. The Company generally utilizes phone interviews to collect relevant data for these custom studies.
Renewable Syndicated Service. The Company's renewable nationally syndicated service, the NRC Healthcare Market Guide, serves as a stand-alone market information and competitive intelligence source as well as a comparative performance database. This service accounted for 11%, 11% and 10% of the Company's total revenues in 1998, 1997 and 1996, respectively. Published by NRC bi-annually from 1988 to 1996 and annually since 1996, this survey, which is the largest of its kind, asks consumers via a pre-recruited third-party panel, members of which are sent Market Guide
questionnaires to complete, to evaluate their health plans, health systems, physicians/caregivers and personal health status. Representing the views of one in every 650 households across every county in the continental United States, the Market Guide provides name specific performance data on 600 managed care plans and 2,500 hospitals nationwide and addresses more than 100 data items relevant to healthcare payers, providers and purchasers. Utilizing this proprietary database, the Company is able to produce reports which are customized to meet individual client's specific information needs. Similarly, the service's national name search feature allows a healthcare organization with a national or regional presence to simultaneously compare the performance of all its sites and pinpoint where strengths and weaknesses exist. The service's trending capacity details how the performance of a healthcare organization changes over time. Other data collected in the Market Guide profile health plan market share, consumers' health plan decision making factors, physician/caregiver accessibility, hospital/healthcare system quality and chronic patient populations. The Company gives clients easy access to the customized version of the Market Guide they purchase via its CD-ROM-based desktop delivery system C the Report Card System. This delivery system allows healthcare professionals to generate reports in numerous formats to support their decision making.
Clients
The Company's ten largest clients accounted for 40%, 64% and 64% of the Company's total revenues in 1998, 1997 and 1996, respectively. The United States Department of Defense, through a primary contractor, United Healthcare Corporation, accounted for 14.6% of total revenues in 1998. HealthSouth Corporation accounted for 10.2% of total revenues in 1998. Overall, the Company served more than 260 healthcare organizations in 1998.
Sales and Marketing
The Company has generated the majority of its revenues from client renewals, supplemented by its internal marketing efforts and a direct sales force. To increase geographic penetration, NRC increased its five person sales force to six persons in 1998. New sales associates now direct NRC's sales efforts from Boston, Massachusetts and Ann Arbor, Michigan. The Company is also in the process of searching for additional sales associates. As compared to the typical industry practice of compensating salespeople with relatively high base pay and a relatively small sales commission, NRC compensates its sales associates with relatively low base pay and a relatively high, per sale commission. The Company believes this compensation structure provides incentives to its sales associates to surpass sales goals and increases the Company's ability to attract top quality sales associates. The average healthcare/market research industry experience of the Company's sales associates is over 11 years.
Numerous marketing efforts support the direct sales force's new business generation and project renewal initiatives. NRC conducts an annual direct marketing campaign around scheduled trade shows, including leading industry conferences. NRC uses this lead generation mechanism to track the effectiveness of marketing efforts and add generated leads to its database of current and potential client contacts. Finally, the Company's public relations program includes (i) an ongoing presence in leading industry trade press and in the mainstream press; (ii) public speaking at strategic industry conferences; (iii) monthly "Perspectives on Performance" articles (which are in-depth discussions of performance tracking applications, trends and policies) sent to current clients and top prospects; (iv) fostering relationships with key industry constituencies; and (v) an annual Quality Leaders award program recognizing top-ranking health systems in approximately 100 markets.
The Company's integrated marketing activities facilitate its ongoing receipt of project requests-for-proposals as well as direct sales force initiated prospect contact. The sales process typically spans a 90-day period encompassing the identification of a healthcare organization's information needs, the education of prospects on NRC solutions (via proposals and in-person sales presentations) and the closing of the sale. The Company's sales cycle varies depending on the particular service being marketed and the size of the potential project.
Competition
The healthcare information and market research industry is highly competitive. The Company has traditionally competed both with healthcare organizations' internal marketing, market research and/or quality improvement departments which create their own performance measurement tools and with relatively small specialty research firms which provide survey-based healthcare market research and/or performance assessment. The Company, to a certain degree, currently competes with, and anticipates that in the future it may increasingly compete with (i) traditional market research firms which are significant providers of survey-based, general market research and (ii) firms which provide services or products that complement healthcare performance assessments, such as healthcare software or information systems. Although only a few of these competitors have to date offered survey-based, healthcare market research that competes directly with the Company's services, many of these competitors have substantially greater financial, information gathering and marketing resources than the Company and could decide to increase their resource commitments to the Company's market. There are relatively few barriers to entry into the Company's market, and the Company expects increased competition in its market, which could adversely affect the Company's operating results through pricing pressure, increased marketing expenditures and market share losses, among other factors. There can be no assurance that the Company will continue to compete successfully against existing or new competitors.
The Company believes the primary competitive factors within its market include quality of service, timeliness of delivery, service uniqueness, credibility of provider, industry experience and price. NRC believes that its industry leadership position, exclusive focus on the healthcare industry, dynamic questionnaire, syndicated Market Guide and comparative performance database, and its relationships with leading healthcare payers and providers position the Company to compete in this market.
Intellectual Property and Other Proprietary Rights
The Company's success is in part dependent upon its data collection process, research methods, data analysis techniques and internal systems and procedures that it has developed specifically to serve clients in the healthcare industry. The Company has no patents; consequently, it relies on a combination of copyright, trademark and trade secret laws and employee nondisclosure agreements to protect its systems and procedures. There can be no assurance that the steps taken by the Company to protect its rights will be adequate to prevent misappropriation of such rights or that third parties will not independently develop functionally equivalent or superior systems or procedures. The Company believes that its systems and procedures and other proprietary rights do not infringe upon the proprietary rights of third parties. There can be no assurance, however, that third parties will not assert infringement claims against the Company in the future or that any such claims will not result in protracted and costly litigation, regardless of the merits of such claims.
Employees
As of December 31, 1998, the Company employed a total of 104 persons on a full-time basis. In addition, as of such date, the Company had 246 part-time associates primarily in its survey operations, representing approximately 123 full-time equivalent employees. None of the Company's employees are represented by a collective bargaining agreement. The Company considers its relationship with its employees to be excellent.
Executive Officers of the Registrant
The following table sets forth certain information, as of March 15, 1999, regarding the executive officers of the Company:
Name Age Positions
Michael D. Hays 44 President, Chief Executive Officer and Director Jona S. Raasch 40 Vice President and Chief Operations Officer Patrick E. Beans 41 Vice President, Treasurer, Chief Financial Officer, Secretary and Director
Michael D. Hays has served as President and Chief Executive Officer and as a director since he founded the Company in 1981. Prior thereto, Mr. Hays served for seven years as a Vice President and a director of SRI Research Center, Inc. (n/k/a the Gallup Organization).
Jona S. Raasch has served as Vice President and Chief Operations Officer since September 1988. Prior to joining the Company, Ms. Raasch held various positions with A.C. Nielsen.
Patrick E. Beans has served as Vice President, Treasurer and Chief Financial Officer since August 1997, as Secretary since September 1997, as a director since October 1997 and as the principal financial officer since he joined the Company in August 1994. From June 1993 until joining the Company, Mr. Beans was the finance director for the Central Interstate Low-Level Radioactive Waste Commission, a five-state compact developing a low-level radioactive waste disposal plan. From 1979 to 1988 and from June 1992 to June 1993, he practiced as a certified public accountant.
Executive officers of the Company are elected by, and serve at the discretion of, the Company's Board of Directors. There are no family relationships between any directors or executive officers of NRC.
Item 2.
Item 2. Properties
The Company's headquarters is located in approximately 25,000 square feet of leased office space in Lincoln, Nebraska. This facility houses all the capabilities necessary for NRC's survey programming, printing and distribution; telephone interviewing; data processing, analysis and report generation; marketing; and corporate administration. The lease on this facility expires on December 31, 1999.
The Company leases approximately 18,000 square feet of office space in Columbus, Ohio. This facility houses certain client service and marketing activities. The Company is currently
marketing approximately 8,000 square feet at this facility for sublease. The lease on this facility expires on October 7, 2000. The Company also leases approximately 6,000 square feet of office space in Columbus, Ohio, which houses a telephone call center. The lease on this facility expires on January 31, 2003.
On January 4, 1999, the Company purchased a building in downtown Lincoln, Nebraska, which the Company will renovate during 1999. The Company intends to move its headquarters to the new facility in December 1999 and to occupy approximately 30,000 square feet at the new facility.
Item 3.
Item 3. Legal Proceedings
The Company is not subject to any material pending litigation.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's shareholders during the fourth quarter of the Company's 1998 fiscal year.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters
(a) The Company's Common Stock, $.001 par value ("Common Stock"), is traded on the Nasdaq National Market under the symbol "NRCI." The following table sets forth the range of high and low closing sales prices for the Common Stock for the period from October 10, 1997, the date of the initial public offering of the Common Stock, through December 31, 1998:
High Low Fourth quarter ended December 31, 1997.......... 23 4 7/8 First quarter ended March 31, 1998.............. 9 11/16 5 7/8 Second quarter ended June 30, 1998.............. 10 1/2 8 1/4 Third quarter ended September 30, 1998.......... 9 1/4 3 Fourth quarter ended December 31, 1998.......... 6 15/16 3 1/2
On March 1, 1999, there were approximately 15 shareholders of record and approximately 1,040 beneficial owners for the Common Stock.
The Company does not intend to pay any cash dividends on its Common Stock in the foreseeable future. The Company intends to retain all of its future earnings for use in the expansion and operation of its business. Any future determination to pay cash dividends will be at the discretion of the Company's Board of Directors and will depend upon, among other things, the Company's results of operations, financial condition, contractual restrictions and such other factors deemed relevant by the Board of Directors.
Since its S Corporation election in 1994, the Company has made cash distributions to its shareholders in amounts necessary to allow the shareholders to at least pay the Federal and state income taxes on their proportionate shares of the Company's net income. In connection with the termination of the Company's S Corporation status (which was done concurrently with the Company's initial public offering of the Common Stock), the Company made distributions of $2,230,730 to its existing shareholders. The Company will not make any additional distributions of this kind in the future.
(b) The Company's Registration Statement on Form S-1 (Registration No. 333-33273) (the "Registration Statement") relating to the offer and sale (the "Offering") of an aggregate of 2,415,000 shares of Common Stock was declared effective by the Securities and Exchange Commission on October 9, 1997. Of the 2,415,000 shares of Common Stock registered under the Registration Statement, 1,250,000 shares were sold by the Company and 1,165,000 shares (including 315,000 shares sold pursuant to the exercise of an over-allotment option granted to the underwriters) were sold by a certain shareholder of the Company, Michael D. Hays (the "Selling Shareholder").
During the fourth quarter of 1997, all of the shares of Common Stock registered were sold in the Offering at a price of $15.00 per share, for an aggregate price of $18,750,000 and $17,475,000 for the shares of Common Stock sold by the Company and the Selling Shareholder, respectively. After deducting the underwriting discount of $1.05 per share, the Selling Shareholder received net proceeds equal to $16,251,750 and the Company received net proceeds equal to $17,437,500 less expenses of $596,411 incurred in connection with the Offering. As of December 31, 1998, the net proceeds to the Company are reasonably estimated to be applied as follows:
1. Temporary investments of U.S. government securities of two years or less $10,941,501 2. Acquisition of HRS and related acquisition costs 5,899,588 ---------- Total proceeds to the Company $16,841,089 ==========
Item 6.
Item 6. Selected Financial Data
The selected statement of income data for the years ended December 31, 1998, 1997 and 1996 and the balance sheet data at December 31, 1998 and 1997 are derived from, and are qualified by reference to, the audited financial statements of the Company included elsewhere in this Annual Report on Form 10-K. The selected statement of income data for the years ended December 31, 1995 and 1994 and the balance sheet data at December 31, 1996 and 1995 are derived from audited financial statements not included herein. The balance sheet data at December 31, 1994 is derived from unaudited financial statements not included herein.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-Looking Statements
Certain matters discussed below in this Annual Report on Form 10-K are "forward-looking statements" intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement includes phrases such as the Company "believes," "expects" or other words of similar import. Similarly, statements that describe the Company's future plans, objectives or goals, as well as the estimated costs and timetable for Year 2000 compliance, are also forwarding-looking statements. Such forward-looking statements are subject to certain risks and uncertainties which could cause actual results or outcomes to differ materially from those currently anticipated. Factors that could affect actual results or outcomes include, without limitation, the Company's reliance on a limited number of key clients for a substantial portion of its revenues, the Company's dependence on performance tracking contract renewals, fluctuations in the Company's operating results related to the Market Guide, increased competition, changes in conditions affecting the healthcare industry, the Company's ability to manage its growth and to successfully integrate any possible future acquisitions, the Company's ability to provide timely and accurate performance tracking and market research to its clients and the success of third parties regarding compliance with Year 2000 issues. Shareholders, potential investors and other readers are urged to consider these factors in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included are only made as of the date of this Annual Report on Form 10-K and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.
Overview
The Company believes it is a leading provider of ongoing survey-based performance measurement, analysis and tracking services to the healthcare industry. The Company offers two primary types of information services: (i) renewable performance tracking services and custom research and (ii) a renewable syndicated service.
The Company's renewable performance tracking service, the Listening System, is a performance tracking tool for gathering and analyzing data from survey respondents. Such services are provided pursuant to contracts which are generally renewable annually and that provide for a customer specific study which is conducted via a series of surveys and delivered via a series of updates or reports, the timing and frequency of which vary by contract (such as monthly or weekly). These contracts are generally cancelable on short or no notice without penalty and, since progress on these contracts can be tracked and regular updates and reports are made, clients are entitled to any work-in-process but are obligated to pay for all services performed through cancellation. Typically, these contracts are fixed fee arrangements and a portion of the project fee is billed in advance, and the remainder is billed periodically over the duration of the project. The Company conducts custom research which measures and monitors market issues specific to individual healthcare organizations. The majority of the Company's custom research is performed under contracts which provide for advance billing of 65% of the total project fee with the remainder due upon delivery. Revenues and direct expenses for the Company's renewable performance tracking services and custom research are recognized on a percentage of completion basis.
The Company's renewable nationally syndicated service, the Market Guide, serves as a stand-alone market information and competitive intelligence source as well as a comparative performance database. Published by NRC bi-annually from 1988 to 1996 and annually since 1996, this survey is a comprehensive consumer-based healthcare assessment. Market Guide services are generally provided pursuant to contracts which have durations of four to six months and that provide for the receipt of survey results that are customized to meet an individual client's specific information needs. Typically, these contracts are not cancelable by clients, clients receive no rights in the comprehensive healthcare database which results from this survey, other than the right to use the customized reports purchased pursuant thereto, and amounts due for the Market Guide are billed prior to or at delivery. The Company recognizes revenue when the Market Guides are delivered to the customers pursuant to their contracts, typically in the third quarter of the year. Substantially all of the related costs are deferred and subsequently charged to direct expenses contemporaneously with the recognition of the revenue. The Company generally has some incidental sales of the Market Guide subsequent to completion of each edition. Revenues and marginal expenses related to such incidental sales are recognized upon delivery. The profit margin earned on such revenues is generally higher than that earned on revenues realized from customers under contract at the time of delivery. As a result, the Company's margins vary throughout the year.
Results of Operations
The following table sets forth, for the periods indicated, selected financial information derived from the Company's financial statements, expressed as a percentage of total revenues and the percentage change in such items versus the prior comparable period. The trends illustrated in the following table may not necessarily be indicative of future results. The discussion that follows the table should be read in conjunction with the Company's financial statements.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Total revenues. Total revenues increased 8.5% in 1998 to $17.7 million from $16.3 million in 1997. Revenues from the Company's renewable performance tracking services and custom research increased 8.4% to $15.7 million in 1998 from $14.5 million in 1997 primarily due to the addition of new clients and the acquisition of HRS in June 1998, and, to a lesser extent, an increase in the scope of existing tracking projects. Revenues from the Company's renewable syndicated service increased 9.3% to $1.9 million in 1998 from $1.8 million in 1997. Such increase reflects the addition of new syndicated service clients.
Direct expenses. Direct expenses increased 31.3% to $9.4 million in 1998 from $7.2 million in 1997. The increase in direct expenses in the 1998 was due primarily to an increase in labor and payroll expenses of $1.5 million (which was due partially to increased costs associated with the addition of a telephone call center and with increased revenues) and, to a lesser extent, increases in outside field services of $358,000, telephone expenses of $109,000, rent and office expenses of $78,000 and software conversion costs of $120,000; which were offset by a decrease in printing and postage of $146,000 (which was partially due to the increase in the telephone methodology associated with projects acquired from HRS). Direct expenses increased as a percentage of total revenues to 53.3% in 1998 from 44.1% during 1997 due to an increase in telephone methodology, which increases labor costs, as a percentage of total revenues. Direct expenses as a percentage of total revenues are expected to remain at similar levels in 1999.
Selling, general and administrative expenses. Selling, general and administrative expenses increased 21.7% to $4.8 million in 1998 from $4.0 million in 1997. This increase was primarily due to an increase of $452,000 associated with the expansion of the Company's sales and marketing workforce, an increase of $238,000 associated with the increase in the Company's rent expenses and other costs associated with the Company's new location in Columbus, Ohio since June 1998 and an increase of $196,000 associated with being a public company, which were offset by a decrease of $132,000 in expenses related to enhancements to the Company's software. Selling, general and administrative expenses increased as a percentage of total revenues to 27.4% in 1998 from 24.4% in 1997 due to excess rental space leased by the Company from June 1998 to December 1998 and increased costs related to being a public company.
Depreciation and amortization. Depreciation and amortization expenses increased 167.8% to $426,000 in 1998 from $159,000 in 1997 partially due to the acquisition of HRS. The increase in amortization due to HRS acquisition intangible assets in 1998 was $127,000. Depreciation and amortization expenses increased as a percentage of total revenues to 2.4% in 1998 from 1.0% in 1997.
Acquired in-process research and development cost and severance charge. In connection with the acquisition of HRS in June 1998, the Company incurred a one-time, non-recurring charge of $2.7 million for costs assigned to in-process research and development activities of HRS and operating expenses for severance costs of $304,000 for duplicative employees of the Company as a result of the acquisition. The aggregate charges to income net of taxes associated with the acquisition were approximately $1.9 million, or $0.26 per share.
Provision for income taxes. The provision for income taxes totaled $321,000 (40.9% effective tax rate) for 1998 compared to $376,000 for 1997, plus pro forma taxes for 1997 of $803,000, for total income taxes for 1997 of $1,179,000 (32.8% effective tax rate), which included a $258,000 nonrecurring income tax benefit created by the termination of the Company's S Corporation status in
October 1997 in connection with the Company's initial public offering. Without the nonrecurring income tax benefit, total income taxes for 1997 would have been $1,437,000 (39.9% effective tax rate).
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Total revenues. Total revenues increased 29.2% in 1997 to $16.3 million from $12.6 million in 1996. Revenues from the Company's renewable performance tracking services and custom research increased 27.3% in 1997 to $14.5 million from $11.3 million in 1996 due primarily to the addition of new clients and, to a lesser extent, an increase in the scope of existing tracking projects. Revenues from the Company's renewable syndicated service increased 37.7% to $1.8 million in 1997 from $1.3 million in 1996. Such increase reflects the addition of new syndicated service clients.
Direct expenses. Direct expenses increased 26.3% to $7.2 million in 1997 from $5.7 million in 1996. The increase in direct expenses was due to increases in postage expenses of $630,000, printing expenses of $161,000 and labor and payroll expenses of $642,000. Direct expenses decreased as a percentage of total revenues to 44.1% in 1997 from 45.1% in 1996. The decrease in direct expenses as a percentage of total revenues was due primarily to incidental sales of the 1996 edition of the Market Guide during 1997.
Selling, general and administrative expenses. Selling, general and administrative expenses increased 30.1% to $4.0 million in 1997 from $3.1 million in 1996. This increase was primarily due to an increase of $443,000 associated with the expansion of the Company's sales and marketing work force, an increase of $126,000 in expenses related to enhancements to the Company's dynamic questionnaire production software and an increase of $68,000 in profit sharing expense. Selling, general and administrative expenses increased as a percentage of revenues to 24.4% in 1997 from 24.3% in 1996.
Depreciation and amortization. Depreciation and amortization expense decreased 8.2% to $159,000 in 1997 from $173,000 in 1996 but remained relatively constant as a percentage of revenues at 1.0% and 1.4% in 1997 and 1996, respectively.
Provision for income taxes. The provision for income taxes totaled $376,000 for 1997, plus pro forma income taxes for 1997 of $803,000, for total income taxes for 1997 of $1,179,000 (32.8% effective tax rate), which included a $258,000 nonrecurring income tax benefit created by the termination of the Company's S Corporation status in October 1997 in connection with the Company's initial public offering. Without the nonrecurring income tax benefit, total income taxes for 1997 would have been $1,437,000 (39.9% effective tax rate), which compared to a $1,534,000 pro forma income tax expense for 1996 (40.0% effective tax rate).
Liquidity and Capital Resources
The Company's principal source of funds historically has been cash flow from its operations. The Company's cash flow has been sufficient to provide funds for working capital and capital expenditures.
As of December 31, 1998, the Company had cash and cash equivalents of $4.9 million and working capital of $9.0 million.
During 1998, the Company generated $4.0 million of net cash from operating activities as compared to $1.5 million of net cash generated during 1997. The increase in cash flow was due, in part, to the timing of the collection of account receivables and the timing of costs incurred in advance of billings on certain projects, combined with the decrease in accounts receivable and the growth in unbilled revenues and deferred revenues.
Net cash used in investing activities was $2.6 million for 1998 and $12.1 million for 1997. The 1998 use of cash was primarily a result of the acquisition of HRS in June 1998 and the investment of $1.9 million in furniture, computer equipment, computer software and production equipment. Part of this latter investment was to meet the expansion of the Company's business and was for a reengineering process for the Company's computer software and equipment, which will be the platform for future expansion of the Company's business. These uses of cash were partially offset by a decrease in investments available-for-sale of $5.2 million. The 1997 increase in cash used by investing activities was primarily due to the purchasing of investments available-for-sale, which was offset by an investment of $341,000 in furniture, computer equipment and production equipment to meet the expansion of the Company's business. The Company's investments available-for-sale consist principally of United States government securities with maturities of two years or less.
Net cash used in financing activities was $1.2 million for 1998, compared to net cash provided of $12.5 million in 1997. The 1998 use of cash was primarily a result of the Company's stock repurchase program announced in October 1998. The Company repurchased 213,000 shares of Common Stock during the fourth quarter of 1998 at a cost of $1.1 million. Net cash provided by financing activities for 1997 was the result of the Company's receipt of approximately $16.8 million of net proceeds from its initial public offering. The primary use of cash for financing activities in 1997 was S Corporation distributions to shareholders of $4.4 million.
The Company has budgeted approximately $1.5 million for expenditures in 1999, to be funded through cash generated from operations. The Company expects that capital expenditures during 1999 will be primarily for telecommunications equipment, computer hardware and software, product equipment and furniture. In addition, the Company purchased a building on January 4, 1999 for $1.4 million and plans to spend an additional $3.0 million during 1999 to renovate the building. Following the renovation, the Company intends to move its headquarters to such building in December 1999. The Company intends to secure long-term financing on the building for approximately $3.8 million.
The Company typically bills clients for projects before they have been completed. Billed amounts are recorded as billings in excess of costs or deferred revenue on the Company's financial statements and are recognized as income when earned. As of December 31, 1998 and 1997, the Company had $3.3 million and $2.3 million of deferred revenues, respectively. In addition, when work is performed in advance of billing, the Company records this work as a cost in excess of billings or unbilled revenue. At December 31, 1998 and 1997, the Company had $1.0 million and $560,000 of unbilled revenues, respectively. Substantially all deferred and unbilled revenues will be earned and billed, respectively, within 12 months of the respective period ends.
Stock Repurchase Program
In October 1998, the Company announced plans to repurchase up to 245,000 shares of Common Stock in the open market or in privately negotiated transitions. The Company repurchased 213,000 shares during the fourth quarter of 1998 and an additional 27,000 shares through February 28, 1999.
Year 2000
The Year 2000 ("Y2K") issue is the result of computer systems using two digits, as opposed to four digits, to indicate the year. Such computer systems will be unable to interpret dates beyond the year 1999, which could cause a system failure or other computer errors, leading to a disruption in operations. The Company uses software and related technologies throughout its business that could be affected by the date change in Y2K.
At the end of 1997, an independent third party conducted an assessment of the Company's computer systems and, based on such assessment, the Company developed plans to address issues related to the impact of Y2K on its information systems. The Company has completed the assessment phase for all of its information technology systems and developed a plan of repair or replacement for those systems that were not Y2K complaint.
Many of the external software programs used by the Company were already Y2K complaint. The remaining software is currently being upgraded to new vendor versions, which, in addition to providing increased functionality, address the Y2K issue.
The Company's internal software systems presented no Y2K compatibility issues. Most of the Company's internal hardware systems presented no Y2K compatibility issues. The Company has been upgrading its computer hardware that is not Y2K complaint on an ongoing basis and all mission-critical hardware will be Y2K complaint before the end of 1999. The software used by the Company to deliver information to its clients contains no date related data or code other than that related to licensing issues, and therefore, it not affected by the Y2K issue.
Many of the services sold by the Company originate from data provided by the Company's clients. The Company generally does not use live data provided by its clients, instead the clients transmit member or patient information on a weekly or monthly basis. As a result, the Company's ability to provide services to these clients is dependent on whether such clients' systems for transmitting data to the Company are Y2K compliant. If a client cannot transmit member or patient information to the Company, then the Company cannot provide its services to the client. Therefore, there can be no assurance that the failure of clients of the Company to be Y2K complaint will not have a material adverse effect on the Company. To be prepared to address unexpected occurrences, the Company expects to develop contingency plans during 1999 to assess alternative methods to obtain data from its clients.
The current estimate of total Y2K compliance cost is $95,000. A majority of these costs have been included in the ongoing upgrading and standardization of the Company's systems. Approximately $36,000 of such costs have been incurred to date. Based upon progress to date, the Company does not believe that future costs of Y2K compliance will materially affect the Company's operating results or financial condition.
Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). SFAS 133 requires that all derivatives be recognized as either assets or liabilities in the balance sheet and measured at their fair value. If certain conditions are met, a derivative may be specifically designated as (i) a hedge of the exposure to changes in the fair value of a recognized asset
or liability or an unrecognized firm commitment, (ii) a hedge of the exposure to variable cash flows of a forecasted transaction or (iii) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security or a foreign-currency denominated forecasted transaction. SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company does not expect the effect of SFAS 133 to be significant to its financial reporting.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
The impact of financial market risk exposure to the Company is not significant. The Company's primary financial market risk exposure consists of interest rate risk related to interest income from the Company's investments in United States government securities with maturities of two years or less. The Company has invested and expects to continue to invest a substantial portion of its excess cash in such securities. See Note 3 to the Company's financial statements. Generally, if the overall average return on such securities owned as of December 31, 1998 decreased .25% in 1999 from the average return in 1998, then the Company's interest income would decrease, and pre-tax income would decrease approximately $28,000. This amount is determined by considering the impact of a hypothetical change in interest rates on the Company's interest income.
Item 8.
Item 8. Financial Statements and Supplementary Data
Quarterly Financial Data (Unaudited)
Selected quarterly financial information for the fiscal years ended December 31, 1998 and 1997 is as follows (in thousands, except per share data):
INDEPENDENT AUDITORS' REPORT
The Board of Directors National Research Corporation:
We have audited the accompanying balance sheets of National Research Corporation as of December 31, 1998 and 1997 and the related statements of income, shareholders= equity and cash flows for each of the years in the three-year period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of National Research Corporation as of December 31, 1998 and 1997 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles.
On January 1, 1998, National Research Corporation adopted the American Institute of Certified Public Accountants Statement of Position No. 98-1 (SOP 98-1), Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.
KPMG Peat Marwick LLP
Lincoln, Nebraska February 12, 1999
NATIONAL RESEARCH CORPORATION Notes to Financial Statements
(1) Summary of Significant Accounting Policies
Description of Business and Basis of Presentation
National Research Corporation (the ACompany@) is a provider of ongoing survey-based performance measurement, analysis and tracking services to the healthcare industry. The Company provides market research services to hospitals and insurance companies on an unsecured credit basis. One client accounted for 31.1% and 40.4% of total revenues in 1997 and 1996, respectively. This client canceled its contract for performance measurement studies in December of 1997. A second client accounted for 14.6%, 15.1% and 3.5% of total revenues in 1998, 1997 and 1996, respectively. A third client accounted for 10.2% and 6.2% of total revenues in 1998 and 1997, respectively. The Company operates in a single industry segment.
Basis of Presentation
Pro Forma Net Income and Net Income Per Share - Pro forma net income and pro forma income per share has been computed assuming that the Company had been taxed as a C Corporation for Federal and state income tax purposes for all periods presented. Pro forma income per share has been calculated and presented for Abasic" and Adiluted" data. Pro forma income per share is computed by dividing net income by the weighted average number of common shares. Diluted income per share is computed by dividing net income by the weighted average number of common shares and common equivalent shares outstanding.
Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 98, weighted average shares outstanding for 1997 and 1996 include the pro forma effect of shares that would have had to have been issued (at $13.95 per share, the initial public offering price less the underwriting discount expense) to generate sufficient cash to fund the portion of the approximately $5.6 million of S Corporation distributions and special (cash) compensation expense that are in excess of the net income for the year ended December 31, 1996. The weighted average shares outstanding is calculated as follows:
There are no reconciling items between the Company's reported (pro forma) net income and (pro forma) net income used in the computation of basic and diluted income per share.
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition
The Company derives a majority of its operating revenues from its annually renewable services, which include the NRC Listening System (APerformance Tracking Services") and the NRC Healthcare Market Guide (ARenewable Syndicated Service"). Under the NRC Listening System, the Company provides interim and annual performance tracking to its clients under annual client service contracts, although such contracts are generally cancelable on short or no notice without penalty. Through its syndicated NRC Healthcare Market Guide, the Company publishes healthcare market information to its clients generally on an annual or (prior to 1996) biannual basis. The Company also derives revenues from custom and other research projects.
The Company recognizes revenues from its Performance Tracking Services and its custom and other research projects using the percentage of completion method of accounting. These services typically include a series of surveys and deliverable reports in which the timing and frequency vary by contract. Progress on a contract can be tracked reliably and customers are obligated to pay as services are performed. The recognized revenue is the percent of estimated total revenues that incurred costs to date bear to estimated total costs after giving effect to estimates of costs to complete based upon most recent information. Losses expected to be incurred on jobs in progress are charged to income as soon as such losses are known. Revenues earned on contracts in progress in excess of billings are classified as a current asset. Amounts billed in excess of revenues earned are classified as a current liability. Client projects are generally completed within a twelve-month period.
The Company recognizes revenue on a completed contract basis for its Renewable Syndicated Service contracts with its principal customers. Characteristics of these contracts include durations of four to six months, progress to completion cannot be reasonably defined, and various intermediate steps in the process overlap in stages of progress for different contracts. The Company defers direct costs of preparing the survey data for the Renewable Syndicated Service. The Company recognizes revenues and related direct costs for its Renewable Syndicated Service upon delivery to its principal customers. Customers have no obligation to pay for these services until the services are delivered. The Company generates additional revenues from incidental customers subsequent to the completion of each edition. Revenues and costs for these services are recognized as the customization services are performed and completed.
Property and Equipment
Property and equipment is stated at cost. Major expenditures to purchase property or to substantially increase useful lives of property are capitalized. Maintenance, repairs and minor renewals are expensed as incurred. When assets are retired or otherwise disposed of, their costs and related accumulated depreciation are removed from the accounts and resulting gains or losses are included in income.
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
On January 1, 1998, the Company adopted the American Institute of Certified Public Accountants Statement of Position No. 98-1 (SOP 98-1), Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Under that accounting standard, the Company expenses as incurred computer software costs incurred in the preliminary project stage, which involves the conceptual formulation, evaluation and selection of technology alternatives. Costs incurred related to the design, coding installation and testing of software during the application project stage are capitalized. Costs incurred for training and application maintenance are expensed as incurred. The Company has capitalized approximately $1,494,000 of costs incurred for the development of internal use software for the year ended December 31, 1998, with such costs classified as property and equipment. Prior to January 1, 1998, the Company's accounting policy was to expense as incurred all costs of software developed for internal use. Costs incurred prior to January 1, 1998, for the development of internal use software have not been adjusted or capitalized as a result of the Company's adoption of SOP 98-1.
The Company provides for depreciation and amortization of property and equipment using annual rates which are sufficient to amortize the cost of depreciable assets over their estimated useful lives. The Company uses accelerated methods of depreciation and amortization over estimated useful lives of five to seven years for furniture and fixtures and three to five years for computer equipment.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets, which represent the excess of purchase price over fair value of net assets acquired, are amortized on a straight-line basis over the expected periods to be benefited, 10 to 20 years. The Company assesses the recoverability of these intangible assets by determining whether the amortization of the intangible asset balances over their remaining life can be recovered through undiscounted future operating cash flows of the acquired operation.
Marketable Securities
All marketable securities held by the Company at December 31, 1998 and 1997 were classified as available-for-sale and recorded at cost, which approximates market value. Unrealized holding gains and losses (if any), net of the related tax effect, on available-for-sale securities are excluded from income and are reported as a separate component of shareholders= equity until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis. Fair values are estimated based on quoted market prices.
Income Taxes
Effective August 1, 1994, the Company, with the consent of its shareholders, elected under the Internal Revenue Code to be an S Corporation. In lieu of corporation income taxes, the shareholders of an S Corporation are taxed on their proportionate share of the Company's taxable income. The Company terminated its S Corporation election on October 13, 1997. Therefore, no provision or liability for federal income taxes has been included in these financial statements for the period from January 1, 1997 through October 13, 1997 and for the year ended December 31, 1996. Income taxes have been provided on the Company's taxable income from October 14, 1997 through December 31, 1997 and for the year ended December 31, 1998.
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Upon the termination of its S Corporation election, the Company adopted the asset and liability method of accounting for income taxes of Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes. Under that method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases using enacted tax rates. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances, if any, are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized.
Stock Option Plans
The Company recognizes stock-based compensation expense for its stock option plans using the intrinsic value method. Under that method, no compensation expense is recorded if the exercise price of the employee stock options equals or exceeds the market price of the underlying stock on the date of grant. For disclosure purposes, pro forma net income and income per share are provided as if the fair value method had been applied.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
Comprehensive Income
Other than unrealized holding gains on securities available-for-sale, the Company has no sources of other comprehensive income. Because the cost of the Company's available-for-sale securities approximated market value in 1998, 1997 and 1996, the Company had no other comprehensive income for the three years ended December 31, 1998. Therefore, the Company's comprehensive income consists solely of its net income. Accordingly, a statement of comprehensive income has been omitted from the accompanying financial statements.
Reclassification
Certain amounts for the prior years have been reclassified to conform to the December 31, 1998 presentation.
(2) Acquisition
Effective June 1, 1998, the Company acquired the business of Healthcare Research Systems, Ltd. ("HRS") through an acquisition of assets. Consideration paid by the Company at closing included a cash payment of $5,100,000 plus an estimated payment of $350,000 for the net working capital acquired. The Company also incurred liabilities of $625,362 related to management's plans to exit certain activities of HRS and has paid $170,000 of direct acquisition costs. Management's exit plans include costs for the relocation of certain of HRS' employees and an accrual for minimum operating lease commitments for duplicate space, which will be abandoned or sublet. Management's exit plans have not been finalized, however, and adjustments to the allocation of purchase price may result from the finalization of these plans. The acquisition agreement was subsequently amended to return to the Company the entire $350,000 estimated payment for the net working capital surplus paid at closing and
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(2) Acquisition, Continued
to provide for the Company's assumption of additional pre-acquisition liabilities of HRS of $629,588. The amendment to the acquisition agreement was recorded in the third quarter as an adjustment to the purchase price, increasing goodwill by $629,588.
The acquisition of HRS has been accounted for as a purchase, and accordingly, the operating results of HRS have been included in the Company's financial statements since the date of acquisition. The purchase price of approximately $9,174,950 has been allocated to the following assets based upon management's preliminary estimates of the fair values of identifiable assets of HRS at the date of acquisition. Assets, including in-process research and development, acquired are as follows:
Estimated Fair Value Life ---------- --------- Property and equipment $150,000 5-7 years Workforce in place 272,882 10 years Customer lists 359,048 15 years Goodwill 5,655,478 20 years --------- 6,437,408
In-process research and development 2,737,542 0 years --------- $9,174,950 =========
In October 1998, the amended acquisition agreement removed the contingencies associated with scheduled payments of additional purchase price in 1999. The amendment also reduced the amount of purchase price payable for the first of those scheduled payments to approximately $1,150,000 in March 1999. An additional payment of approximately $1,500,000 for purchase price payable is due in June 1999. The liability for the purchase price payment commitments was recorded in the fourth quarter of 1998, with the additional purchase price allocated to goodwill of HRS.
In 1998, the Company also terminated the employment of certain of its employees whose responsibilities were duplicative of those performed by employees acquired in the HRS acquisition. The terminations resulted in a severance charge of $303,740 in 1998. All severance payments related to this charge were paid prior to December 31, 1998.
The following unaudited pro forma data summarizes the results of operations for the periods indicated as if the acquisition of HRS had been completed on January 1, 1997. The pro forma data gives effect to the actual operating results prior to the acquisition, amortization of acquisition-related intangibles and income taxes. The pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition had occurred on January 1, 1997, or that may be obtained in the future.
Year ended December 31, 1998 1997 ---- ---- (dollars in thousands, except per share amounts)
Revenues................................. $20,834 $22,800 Net income (loss)........................ $ 1,840 $ (73) Net income (loss) per share - basic and diluted...................... $ 0.25 $ (0.01)
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(3) Investments in Marketable Debt Securities
The carrying value of available-for-sale securities by major security type is shown below. Amortized cost approximates fair value.
There were no sales of marketable securities in advance of scheduled maturities of available-for-sale marketable debt securities during 1998, 1997 or 1996. The amortized cost of debt securities at December 31, 1998 and 1997, by contractual maturity, are shown below. Expected maturities will differ from the contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
1998 1997 -------- ------ Amortized Amortized cost cost Due after three months through one year $ 6,958,046 $ 13,219,350 Due after one year through five years 1,050,134 -- ---------- ----------- $ 8,008,180 $ 13,219,350 ========== ===========
(4) Goodwill and Other Intangible Assets
Goodwill and other intangible assets consist of the following at December 31, 1998:
---- Workforce in place $ 272,882 Customer lists 359,048 Goodwill 5,655,478 --------- 6,287,408
Accumulated amortization (127,199) --------- $ 6,160,209 =========
(5) Income Taxes and Pro Forma Income Taxes
Income tax expense (benefit) for 1998 and the period of October 14, 1997 through December 31, 1997 consisted of the following components:
Current Deferred Total ------- -------- ----- 1998: Federal........... $ 713,514 $(442,014) $ 271,500 State............. 195,000 (45,992) 49,800 -------- --------- --------- Total........... $ 808,514 $(488,006) $ 320,508 ======== ======== ======== 1997: Federal........... $ 553,000 $(237,000) $ 316,000 State............. 106,000 (46,000) 60,000 -------- --------- --------- Total........... $ 659,000 $(283,000) $ 376,000 ======== ======== ========
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(5) Income Taxes and Pro Forma Income Taxes, Continued
Income tax expense for the period of October 14, 1997 through December 31, 1997 is based on taxable income of approximately $1,592,500. The difference between the Company's income tax expense as reported in the accompanying financial statements for 1998 and 1997 and that which would be calculated applying the U.S. Federal income tax rate of 34% on pretax income is as follows:
1998 1997 ---- ---- Expected Federal income taxes......................... $ 266,000 $ 541,500 State income taxes, net of federal benefit............ 32,900 70,100 Deferred tax benefits recognized upon termination of the Company's S Corporation election............. -- (258,000) Other................................................. 21,608 22,400 -------- --------
Total.............................................. $ 320,508 $ 376,000 ======== ========
Deferred tax assets at December 31, 1998 and 1997, were comprised of the following:
1998 1997 ---- ---- Deferred tax assets: Allowance for doubtful accounts.............. $ 24,200 $ 24,500 Accrued expenses............................. 162,800 102,725 Bonus and profit sharing accruals............ 99,600 155,775 Intangible assets............................ 484,406 -- -------- --------
Total deferred tax assets................ $ 771,006 $ 283,000 ======== ========
The Company did not record a valuation allowance for its deferred tax assets because management believes that it is more likely than not that the Company will generate sufficient taxable income to fully realize these deferred tax benefits.
The accompanying statements of income reflect a provision for income taxes on a pro forma basis, at a combined rate of 40% (Federal statutory rate of 34% plus estimated state rate, net of federal benefit of 6%) as if the Company was liable for Federal and state income taxes as a taxable corporate entity throughout the periods ending December 31, 1997 and 1996.
The components of the provision for pro forma income taxes are as follows:
Years ended December 31, ------------------------ 1997 1996 ---- ----
Federal............................ $ 642,770 $1,226,921 State.............................. 160,693 306,730 -------- ---------
Pro forma income taxes............. $ 803,463 $1,533,651 ======== =========
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(6) Notes Payable
Notes payable consist of the following at December 31, 1998:
The aggregate maturities of notes payable for each of the years subsequent to December 31, 1998 are: 1999 - $30,754; 2000 - $33,653; 2001 - $36,730; and 2002 - $4,311.
(7) Common Stock
During 1997, the Company reincorporated in Wisconsin and paid a stock dividend of approximately 239.5-to-1, the effects of which were given retroactive effect in the accompanying financial statements. In connection with the reincorporation, the Company also increased its authorized common stock from 100,000 shares to 20,000,0000 shares and authorized up to 2,000,0000 shares of undesignated preferred stock.
In August 1997, the Company decided to pay special cash bonuses aggregating $1,740,000 to two executive officers prior to the termination of its S Corporation status, with such bonuses intended to fund the purchase of Company shares by such individuals in an initial public offering (AIPO@) of the Company's common stock. The related special compensation expense of $1,740,000 was recognized by the Company in the fourth quarter of 1997, concurrent with the completion of the IPO. The special compensation expense reduced the amount otherwise available for distribution to the Company's shareholders prior to the termination of its S Corporation status.
On October 9, 1997, the Company completed its IPO by issuing 1,250,000 shares of common stock at a price of $15 per share. Net proceeds of $16,841,089 were realized by the Company after deducting the underwriting discount and offering expenses.
(8) Stock Option Plans
In August 1997, the Board of Directors adopted and the Company's shareholders approved the National Research Corporation 1997 Equity Incentive Plan (the "Equity Incentive Plan"). The Equity Incentive Plan provides for the granting of options to purchase up to an aggregate of 730,000 shares of the Company's common stock through the date of the Company's annual meeting of shareholders in the year 2001. Options granted may be either nonqualified or incentive stock options. Vesting terms vary with each grant, and option terms are five years. At December 31, 1998, the number of shares available for issuance pursuant to future grants under the Equity Incentive Plan was 329,370 shares.
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(8) Stock Option Plans, Continued
In October 1997, the Board of Directors adopted and the Company's shareholders approved the National Research Corporation Director Stock Plan (the "Director Plan"). As amended in December 1997, the Director Plan provides for formula grants of nonqualified options to each director of the Company who is not an employee of the Company. On the date of each annual meeting of shareholders of the Company, each such director, if reelected or retained as a director at such meeting, is granted an option to purchase 1,000 shares of the Company's common stock. Option exercise prices equal the fair market value of the Company's common stock on the date of grant. Options vest one year following the date of grant and may be exercisable for a period of up to 10 years following the date of grant. In 1998, options to purchase 2,000 shares of the Company's common stock were granted. At December 31, 1998, the number of shares available for issuance pursuant to future grants under the Director Plan was 28,000.
Options to purchase shares of common stock have been granted in 1998 and 1997 with exercise prices equal to the fair value of the common stock on the date of grant. Accordingly, no compensation expense was recorded for these grants. Had compensation cost for the stock option grants been determined using the fair value method, the Company's net income and net income per share would have been reduced to the pro forma amounts indicated below:
The weighted average fair value of options granted in 1998 and 1997 was $1.80 and $6.16, respectively. Pro forma net income reflects the allocation of compensation cost for stock option grants using the fair value method. Compensation cost is allocated between periods based upon the vesting period of the options. Therefore, the full impact of calculating compensation cost using the fair value method is not reflected in pro forma net income amounts presented above because compensation cost is amortized to expense over the vesting period, and additional options may be granted in future years. The fair value for these options was estimated at the date of grant using the Black-Scholes model with the following assumptions:
1998 1997 ---- ---- Expected dividend yield at date of grant.. 0 0 Expected stock price volatility........... 45.0% 45.0% Risk-free interest rate................... 6.0% 6.0% Expected life of options.................. 3.75 to 5.00 years 3.75 years
NATIONAL RESEARCH CORPORATION Notes to Financial Statements, Continued
(8) Stock Option Plans, Continued
The following information relates to options to purchase common stock:
Number of Weighted Average -------------------------- Shares Exercise Price Fair Value ----- -------------- ----------
Balance at December 31, 1996........ -- Granted......................... 168,843 $15.00 $6.16 Canceled........................ (1,713) 15.00 6.16 --------
Balance at December 31, 1997........ 167,130 15.00 6.16 Granted......................... 342,878 4.37 1.80 Canceled........................ (107,378) 13.58 5.58 --------
Balance at December 31, 1998........ 402,630 6.33 2.60 ========
Exercisable at December 31, 1998.... 36,904 15.00 6.16 ========
At December 31, 1998, the range of exercise prices for outstanding stock options was $4.19 to $15.00 and the weighted average remaining contractual life of outstanding stock options was 4.63 years.
(9) Leases
The Company leases office space for a monthly base rental payment plus maintenance and utilities. Rental expense was $385,735, $253,034 and $183,118 during 1998, 1997 and 1996, respectively, and is included in selling, general and administrative expenses in the statements of income. The future minimum lease payments under noncancelable operating leases for each of the five years subsequent to December 31, 1998 approximate $537,000, $256,000, $40,000, $42,000 and $4,000, respectively.
(10) Employee Benefits
The Company sponsors a qualified defined contribution profit sharing plan covering substantially all employees with a minimum service of 1,000 hours and one year of service except for highly compensated employees covered by other nonqualified profit sharing plans. Employer contributions, which are discretionary, vest to participants at a rate of 20% per year. Total profit sharing expense was $0, $97,402 and $75,229 in 1998, 1997 and 1996, respectively.
The Company also sponsors nonqualified profit sharing bonus and incentive plans for employees and members of executive management of the Company. Certain bonuses under the executive management incentive plan are paid over a five-year period. Expense recorded under these plans was $84,013, $607,877 and $552,832 in 1998, 1997 and 1996, respectively.
(11) Subsequent Event
On January 4, 1999, the Company acquired a building in Lincoln, Nebraska. The purchase price of the building was approximately $1.4 million. The Company plans to renovate the building during 1999 and to move its headquarters to the building in December 1999.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item with respect to directors and Section 16 compliance is included under the captions "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance", respectively, in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Shareholders ("Proxy Statement") and is hereby incorporated herein by reference. Information with respect to the executive officers of the Company appears in Part I, page 7 of this Annual Report on Form 10-K.
Item 11.
Item 11. Executive Compensation
The information required by this Item is included under the captions "Board of DirectorsCDirector Compensation" and "Executive Compensation" in the Proxy Statement and is hereby incorporated herein by reference; provided, however, that the subsection entitled "Executive CompensationCReport on Executive Compensation" shall not be deemed to be incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is included under the caption "Principal Shareholders" in the Proxy Statement and is hereby incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
None.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial statements - The financial statements listed in the accompanying index to financial statements and financial statement schedules are filed as part of this Annual Report on Form 10-K.
2. Financial statement schedules - The financial statement schedules listed in the accompanying index to financial statements and financial statement schedules are filed as part of this Annual Report on Form 10-K.
3. Exhibits - The exhibits listed in the accompanying index to exhibits are filed as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 19th day of March, 1999.
NATIONAL RESEARCH CORPORATION
By /s/ Michael D. Hays Michael D. Hays President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Michael D. Hays President, Chief Executive March 19, 1999 - --------------------------- Officer and Director Michael D. Hays (Principal Executive Officer)
/s/ Patrick E. Beans Vice President, Treasurer, March 19, 1999 - --------------------------- Secretary, Chief Financial Patrick E. Beans Officer and Director (Principal Financial and Accounting Officer)
/s/ John N. Nunnelly Director March 19, 1999 - --------------------------- John N. Nunnelly
/s/ Paul C. Schorr, III Director March 19, 1999 - --------------------------- Paul C. Schorr, III
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Page in this Form 10-K Independent Auditors' Report 19
Balance Sheets as of December 31, 1998 and 1997 20
Statements of Income for each of the years in 21 the three-year period ended December 31, 1998
Statements of Shareholders' Equity for each of 22 the years in the three-year period ended December 31, 1998
Statements of Cash Flows for each of the three years 23 in the period ended December 31, 1998
Notes to Financial Statements 24-33
Independent Auditors' Report on Financial Statement Schedule 37
Financial Statement Schedule: 38 II - Valuation and Qualifying Accounts
All other financial statement schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements and notes thereto.
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors National Research Corporation:
Under date of February 12, 1999, we reported on the balance sheets of National Research Corporation as of December 31, 1998 and 1997, and the related statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998, which are included in the Form 10-K. In connection with our audits of the aforementioned financial statements, we also audited the related financial statement schedule in the Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
Lincoln, Nebraska February 12, 1999
EXHIBIT INDEX
Exhibit Number Exhibit Description
(3.1) Articles of Incorporation of National Research Corporation, as amended to date [Incorporated by reference to Exhibit (3.1) to National Research Corporation's Form S-1 Registration Statement (Registration No. 333-33273)]
(3.2) By-Laws of National Research Corporation, as amended to date [Incorporated by reference to Exhibit (3.2) to National Research Corporation's Form S-1 Registration Statement (Registration No. 333-33273)]
(10.1)* National Research Corporation 1997 Equity Incentive Plan [Incorporated by reference to Exhibit (10.2) to National Research Corporation's Form S-1 Registration Statement (Registration No. 333-33273)]
(10.2)* National Research Corporation Director Stock Plan, as amended to date [Incorporated by reference to Exhibit (10.2) to National Research Corporation's Form 10-K for the year ended December 31, 1997 (File No. 0-29466)]
(10.3)* Employment Memorandum, dated as of July 15, 1994, from National Research Corporation to Patrick E. Beans [Incorporated by reference to Exhibit (10.5) to National Research Corporation's Form S-1 Registration Statement (Registration No. 333-33273)]
(10.4)* Separation of Employment Agreement, dated as of June 26, 1998, between National Research Corporation and Sharon Flaherty
(10.5)+ Subcontract, dated as of May 9, 1997, as amended, between National Research Corporation and United HealthCare Corporation [Incorporated by reference to Exhibit (10.7) to National Research Corporation's Form S-1 Registration Statement (Registration No. 333-33273)]
(10.6)+ Letter of Agreement, dated as of June 15, 1998, between National Research Corporation and HealthSouth Corporation.
(10.7) Lease, dated as of January 9, 1998, between National Research Corporation and Gold's Limited Partnership [Incorporated by reference to Exhibit (10.7) to National Research Corporation's Form 10-K for the year ended December 31, 1997 (File No. 0-29466)]
(23) Consent of KPMG Peat Marwick LLP
(27) Financial Data Schedule (EDGAR version only)
(99) Proxy Statement for the 1999 Annual Meeting of Shareholders
[Except to the extent specifically incorporated by reference, the Proxy Statement for the 1999 Annual Meeting of Shareholders shall not be deemed to be filed with the Securities and Exchange Commission as part of this Annual Report on Form 10-K.]
- -------------------- * A management contract or compensatory plan or arrangement.
+ Portions of this exhibit have been redacted and are subject to a confidential treatment request filed with the Secretary of the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. The redacted material was filed separately with the Securities and Exchange Commission.