National Research Corporation (NRC) Q1 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the National Research Corporation First Quarter 2012 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 2, 2012. I would now like to turn the conference over to Mr. Michael Hays, Chief Executive Officer. Please go ahead, sir.

Thank you, Rosie, and welcome, everyone, to National Research Corporation's 2012 First Quarter Conference Call. My name is Mike Hays, the company's CEO. And joining me on the call today are both Susan Henricks, our President and Chief Operating Officer; and Kevin Karas, our Chief Financial Officer. Before we continue, I'd ask Kevin to review conditions related to any forward-looking statements that may be made as part of today's call. Kevin?

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

Thank you, Kevin. And again, welcome everyone. As we touched upon during our last earnings call, the statement, "empowering customer-centric healthcare across the continuum," sets forth a vastly expanded strategy for NRC. I'm excited to continue that discussion with you today and highlight what that means for the company. Before we dive into that strategic topic, let me turn the call back to Kevin to review our first quarter financial performance.

Thank you, Mike. Revenue for the first quarter was $22.4 million, an increase of 13% over the first quarter of 2011. Revenue growth for the quarter was comprised entirely from organic growth, which was driven by a combination of continued gains in market share and vertical growth in our existing client base. Contract value at the end of the first quarter increased by 11% over the first quarter of 2011, resulting in total contract value of $85.2 million as of March 31, 2012. As a result of our focus over the past several years of establishing renewable, recurring service arrangements at our clients, we now have over 98% of our total current contract value which is comprised of annual recurring revenue agreements. We also ended the quarter with subscription contract agreements representing 75% of total contract value compared to 57% total contract value at the end of the first quarter of 2011. Subscription agreements also generated 68% of our total revenue in the first quarter of 2012 compared to 49% of total revenue in the first quarter of 2011. Based on our first quarter results, we continue to project organic revenue growth for the full year of 2012 in the 15% to 20% range. Direct expenses increased in the first quarter of 2012 to $8.9 million compared to $6.8 million for the same period in 2011. This increase is a result of increased variable costs related to revenue growth as well as a change in timing and expenses, which increased first quarter direct expenses on a comparable basis to 2011. Direct expenses also increased from additional investments in technology, research and service resources that support our strategy of empowering customer centric healthcare across the continuum. As a result, direct expenses as a percent of revenue are expected to be in an average of 39% to 40% for the full year of 2012, representing a 1% to 2% increase compared to 2011. Offsetting this increase, our SG&A expenses as a percent of revenue are expected to decrease from 2011 to an average of 28% to 29% for the full year of 2012. SG&A expenses for the first quarter of 2012 were 27% of revenue compared to 31% of revenue in the first quarter of 2011. This decrease is due to the Wausau location closing costs that were incurred in 2011, as well as increased leverage of our general administrative expenses in the first quarter of 2012. At the same time, we have continued to invest in business development resources, building our sales force to 71 associates at the end of the first quarter. Depreciation and amortization expense remained consistent at $1.2 million for both first quarters of 2012 and 2011. Depreciation and amortization expense is expected to remain in the 6% of revenue range for the full year of 2012. Our first quarter income tax expense increased from $2 million in 2011 to $2.1 million in 2012. The effective tax rate for the 3 months ended March 31, 2012, is lower than in the same period in 2011, primarily due to the recording of federal tax credits of $111,000 in the first quarter, as well as a reduction in Canadian statutory annualized tax rates. Our net income for the first quarter of 2012 increased by 11% to $3.8 million compared to $3.5 million in 2011. Our diluted earnings per share for the first quarter increased by 10% to $0.56 in 2012 compared to $0.51 for the same period last year. With that, I'll turn the call back to Mike.

Thank you, Kevin. Thinking now about where the company is headed, let's start with where we are. As you are all very familiar, we know patients and what is most important to them regarding their care experience. Our heritage is all about patient-centered care, in fact, we coined the word. Today, however, a deeper understanding of the patient is critical, and we are addressing that need by evolving our strategy. At its core, our expanded strategy is all about understanding patients as customers, meaning when they are outside the physical service setting in which they receive care. This additive robust understanding of the healthcare customer in their everyday life including health risks, preferences and behaviors is now among the required perspectives for our clients given the new realities of healthcare reimbursement. The other aspect of this strategy is the fact that our expanded offering will provide insights across the entire healthcare continuum providing our client organizations an integrated view of their customers as they transition in and out and between the multiple service settings typically required even for a single episode of care. As well, a cumulative profile of the customer over time will provide insights never before available across multiple episodes of care for a given individual. In a nutshell, customer centric healthcare across the continuum is a longitudinal lifetime profile of the customer, a profile ever-expanding and robust, reflected not only at the individual while receiving care in any care setting but also the persons interaction with a broader definition of health in their everyday life. So the big question is why are healthcare providers scrambling to gain greater understanding of their customers? Well, the answer really lies in the following fact. For most of us, the actual time spent in a traditional care setting, whether it be a doctor office, emergency room, as an outpatient, within a hospital or home care, represents far less than 1% of one's life. However, the balance or 99% of one's time is clearly not void of health-related interactions, decisions and behaviors. In fact, health is a daily reality for all of us. And more often than not, our activities of daily living dictate what healthcare services we consume and our decision-making process as to which provider we select for care. Under the new reimbursement models, providers will increasingly be at risk for the health of their customers, which of course completely shifts the healthcare revenue model from volume of procedures to value. Keeping customers out of the hospital and when and if care is needed, ensuring that customer decides on the least costly care setting with the best possible outcomes will essentially be the name of the game. Given this dramatic shift in reimbursement, it will simply become impossible for any provider to manage the risks or influence decisions if all they know about their customers is limited to the less than 1% of the time that person is a patient. The importance of a customer is not new to any other industry except healthcare. Most organizations have benefited from a complete and robust understanding of the customer for decades. As this need is embraced by the healthcare industry, the resulting information spend will be enormous. Take consumer package goods for an example, which is a category that spends over $5 billion annually on understanding their customers, and as we all know, is a far smaller industry segment than is healthcare. This customer-centric information space is just emerging in healthcare, however, signs suggest rapid adoption. In addition to reimbursement, another driver of this adoption is the sheer volume of publicly available information, not the least of which is performance information that, for the first time, has quantified the reality that not every provider is of high-quality. It has come to a surprise to most consumers that their decision as to which provider they select will essentially determine the quality of the care outcome. This available performance information has intercepted interestingly enough with the increased proportion of cost of care being paid directly by the customer. And as anyone can predict, an informed customer results in a far more engaged individual when it comes to spending their own money. The customer is now the decision-maker for the largest sector of the economy, a powerful role that providers historically have never really had to deal with to the degree they must today. I believe the company is well-positioned to capitalize on this movement. We have, over the past few years, expanded our market presence beyond the hospital to across the provider continuum, and today through acquisition and organic growth, we hold dominant share in the important post-acute care settings of short stay, home care, skilled nursing and hospice. Today, we serve over 15,000 points of care to which we have ready access and the ability to propose this vastly expanded offering. And most important, we have the credentials to own this space. Our patronage to inherit it is all about understanding the most important aspects of the patient experience. Following that patient home after every episode of care and tracking their health risks, behaviors and preferences is clearly a natural extension of our core competencies. In closing, I'd like to say the space that we are defining and taking ownership is clearly in our sweet spot. It's very large and contains many opportunities to monetize. I look forward to updating you on this journey on each of our upcoming earnings calls. Rosie, with that, I'd like to open the call up to questions, please.

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

Let me start with a couple of quick financial questions for housekeeping. Kevin, you mentioned the tax rate was a little bit lower in the first quarter. Should we still assume a 36% rate still going forward for the remainder of the year?

Yes, Ryan. That's correct. That was a -- that will not recur in future quarters so you should use the higher rate.

Okay. And then in some of the past calls, you've talked a little bit about the growth in clients using multiple products. Do you have any metrics there that you could share with us in regards to what the growth has been, maybe year-over-year as of the first quarter?

Yes, I do. Year-over-year, that growth rate, number of clients adding multiple products, is 27%.

Okay, great. And then the last housekeeping question and a few big picture ones. In the first quarter, I think you mentioned the subscription revenue as of the quarter was a little bit lower than in Q4. Can you just remind us what some of the products are that our non-subscription based that tend to have an uptick in Q1? If they can push that metric down a little bit or were there any unique sales that push that metric down?

Ryan, there was nothing unique. The portion of our business that occurs, that impacts that number up is the payer solutions revenue. So that revenue for the healthcare's assessment work we do is non-subscription. And a majority of that occurs in Q1 and Q2. So that the impact of the high percentage of payer solutions revenue in the first quarter is what impacts that subscription revenue percentage.

Okay. Perfect. Very helpful. And then maybe 2 or 3 big picture ones. Just any update on some of the more novel products, I guess, one, I'm thinking of in particular, is Illuminate. I'm curious if you're continuing to see growing interest in traction there ahead of the October readmit penalty?

Brian, this is Mike. We actually -- the pipeline for Illuminate is actually growing, but interestingly enough, it seems like the majority of interest in purchase decisions for the product have been predicated on it as a tool to increase patient experience force within the publicly reported age caps than truly a managing tool for avoidable readmissions as we originally positioned the product. That said, I think we understand the deficits of Illuminate as a management tool for readmissions. And we are looking at essentially building that out, but also and more importantly, using that technology as an embedded ingredient within the patient experience offer to gain upside revenue from that installed base.

Okay. That's helpful color, Mike. And then 2 more and I'll hop off. Just on the HCAHPS surveys, you mentioned that, curious if you could give an update on the physician office surveys. I know you highlighted that a quarter or 2 ago as a potential bigger growth opportunity looking forward in that the kind of acute and some of the post-acute home health have been more penetrated by physicians more than noble offerings. Are you still seeing good growth there?

Yes, we are. And you are continuing to be correct in the outlook. As you are aware, many and most acute-care hospitals are actually employing or acquiring physician practices, embedding them as part of their continuum of care under the single brand, and their hospitals are very accustomed to publicly reporting a standardized patient experience measure, that being HCAHPS. So, most if not all, organizations have raised physician component of CAHPS and incorporate that within their measurement protocol and, quite frankly, some incentive programs for their physicians, employed physicians. So we see that as having accelerated growth trajectory over the next 12 to 18 months.

Okay, perfect. And last one and I'll hop off here. Just, Mike, a really great and interesting overview of kind of the shifting consumer centric marketplace and healthcare. I guess my curious is relative to your current offerings, again, you've shared with us in the past what you have that kind of followed the consumer more outside of the acute-care walls, both at home and in some of the home healthcare and hospice settings. If you look at your portfolio and think about the continuum of care, are there any obvious areas for need of internal development or potential M&A activity to really complete that continuum, if you will?

Yes. I think that as we look at a more robust offering that really does encapsulate a person's life longitudinally, not only do we need a little bit broader footprint across the continuum, specifically, that would include independent physician groups that are outside the employment of a acute-care hospital or integrated system. And it would be nice for us to build out some of the technology platform so as to be able to track, observe, report and push out reports to our client organizations relative to their customer's behavior while not within the 4 walls. And as you know, we've built out our technology team fairly significantly over the last 6 months to a year in and about on developing that capability. But as we speak, we also look at ways that we can augment that activity through M&A activity.

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

Kevin, just to confirm, on the new sales activity, the $4 million this quarter. Is the comparable figure $4.9 million last year?

I believe that's correct, Frank. No, no, no. $4.2 million last year. Of the net new sales, $4.2 million.

Okay. And then, what was that figure by the way in Q4, Kevin?

It was $6 million in Q4.

Okay. On the -- in the press release, it talked about an expectation, I guess, for growth after Q2, which would imply significant year-over-year growth in the second quarter, roughly in the 40% plus range. Is that -- am I doing the math right there, Kevin?

You mean in terms of the difference from our first quarter growth rate and the full year growth rate?

No. In the press release, you talked about an expectation to be, after the June quarter, sort of 20% plus growth from an operating income perspective, which would imply obviously that Q2 is a substantial year-over-year growth. So that's the math I was doing. Just want to make sure I'm looking at it right.

For operating income, yes, that's correct. You are looking at that correctly.

Okay. And then just can you remind me on the -- I know last year on the payer solutions side and the health risks assessments that some of that business slipped out of Q1 into Q2. And I assume these expenses are associated with that. Was it more of a normal year this year in terms of the Q1 activity? Or is there any spillover that will happen in Q2?

That's a good question. And this year is more of a normal year. You are correct. And to the degree, we saw the payer volumes move last year out into Q2, we -- those volumes follow the normal trend this year, moving back into Q1. So that is correct.

And then just my last question for you would be, we started the year at 30% growth from a revenue perspective year-over-year, and obviously, we'll need to accelerate throughout the year to get into the range that you talked about. I'm just curious what will be the factors that will drive the accelerating growth as we progress throughout the year?

Well, the 2 major levers are our ability to generate new sales and our rate of client retention. And going into Q1, our retention rates continue to improve year-over-year. So that's very encouraging. And our sales pipeline has grown considerably. So we expect to be able to perform in a level both in retention and new sales to track to the revenue that we expect for the year.

[Operator Instructions] And we have a follow-up question from the line of Frank Sparacino from First Analysis.

Maybe one more. I know coming into the year last quarter, we had talked about sort of relative growth for some of the different segments like the CG-CAHPS, which you've already talked about, but I'm just curious on the HCAHPS side of things. Any sort of color you'd give on that market during the quarter? I know that those growth rates are well below the overall 15% to 20%, but just curious if you can provide any commentary.

Frank, this is Mike. Relative to the regulatory requirement of HCAHPS, most if not all hospitals that will do HCAHPS are doing HCAHPS. So in terms of new industry spend against that small regulatory requirement, which is relatively modest under the banner of HCAHPS, I can't imagine a category size growth on that particular product line or growth relative to HCAHPS to come in increasing our market share. However, as you know, HCAHPS is a relatively small proportion of our total patient experience measurement volume. And as organizations now are focused on value-based purchasing, which essentially patient experience is a component thereof, you will see increased spend against people measurement, perhaps new and unique, more real-time measurement, as well as greater focus on improvement of products and services, similar perhaps to our Illuminate offering. So I think the absolute regulatory spend against HCAHPS is unlikely to have material growth, all of the ancillary drivers and levers around why HCAHPS' requirement clearly do hold upside.

And maybe just a follow-up on that Mike in terms of, I guess, the catalyst to drive from a VTT perspective. And I know surely here, hospitals will start to see where they stand. And I think some of the initial reports they've already received. But would you expect that maybe as we get into the second half of the year that, that becomes more of a driver? Or is there any timing that you think it would be noteworthy?

That's a good question. I don't know. Some of that awareness and reality of course has hit the provider community. For those that discounted it as a material event have probably now woke up. For those organizations that will not recapture if you wish the money that was at reward through value-based purchase payments, it clearly will be a big number. We anticipate that anyone below average, right, which is by definition is half of the market, should look around and see what they can do to improve their scores. Amongst the alternatives is to switch organizations that help them improve the patient experience. And so those organizations, for an example, with the highest market share have the highest number of clients below average. So it would seem like the fishing hole will become pretty interesting towards the latter half of the year.

Mr. Hays, there are no further questions at this time. You may proceed.

Thank you. And we want to thank everybody for their time today. And I want to make a special thank you to all the associates who are listening on the call today for contributing to a great quarter, and of course, on an ongoing basis, we all appreciate your contributions as well. So we look forward to reporting our progress next quarter. Thank you.

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