National Research Corporation (NRC) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the National Research Corporation Third Quarter 2012 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, November 7, 2012. It's now my pleasure to turn the conference over to Michael Hays, Chief Executive Officer with National Research Corporation. Please go ahead, sir.

Thank you, Lindsay, and welcome, everyone to National Research Corporation's third quarter 2012 conference call. My name is Mike Hays, the company's CEO. And joining me on the call today is Susan Henricks, President and Chief Executive Officer; and Kevin Karas (sic), 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 reported last evening, the company had a great quarter, which adds yet another data point to what has been a very long and positive trend. I'd like to take this moment and thank everyone of the hundreds of NRC associates that not only contributed to this great quarter, but also, and more importantly, helped client organizations everyday to provide a better experience for millions of patients. As we all know, nothing great ever happens to any organization without great associates, and I want to thank each and every one of you. With that, let me have Kevin review our third quarter financial performance. Kevin?

Thank you, Mike. Revenue for the third quarter was $21.6 million, which is an increase of 15% over the third quarter of 2011. Revenue growth for the quarter is comprised entirely from organic growth, which was driven by a combination of continued gains in market share and vertical growth from cross-selling and increasing contract value in our existing client base. Net new sales of $4.7 million were added in the third quarter, resulting in total contract value of $91.7 million as of September 30, 2012. As a result of our continued focus over the past several years of establishing renewable, recurring service arrangements with our clients, we continue to see that over 98% of our total contract value is comprised of annual recurring revenue agreements. We also ended the quarter with subscription-based agreements representing 78% of contract value, compared to 70% of contract value at the end of the third quarter of 2011. Subscription agreements generated 78% of our total revenue for the third quarter of 2012 and 74% of our total revenue in 2012 on a year-to-date basis. Our total operating expenses for the third quarter increased by 9.6% from $14.4 million to $15.7 million in 2012. Direct expenses increased to $8.8 million for the third quarter 2012 compared to $7.5 million for the same period in 2011. This is a result of increased variable costs related to revenue growth as a result of additional investments in technology, research and service resources that support our strategy of empowering customer-centric healthcare across the continuum. Direct expenses as a percent of revenue are expected to be at an average of 41% for the full year of 2012. Selling, general and administrative expenses increased 4% to $5.8 million for the 3-month period ending September 30, 2012, compared to $5.6 million for the…

Thank you, Kevin. As Kevin pointed out, organic growth driven by cross-selling the company's broad product portfolio into our current installed base of 12,000 healthcare providers and 100 payer clients, as well as winning major new clients throughout the year, has resulted in increasing growth rate this quarter. From both current and new clients, we continue to hear NRC's products and solutions are delivering high value by enabling them to capture market share, retain customers and engage patients which, of course, reduces costs and improves clinical outcomes. On a go-forward basis, let me just mention a couple of things about the organization before we open it up for Q&A. The market's appetite for our products and services is rapidly expanding as the industry is addressing the new normal of today's requirements of value-based purchasing and reducing readmissions. These market dynamics suggest an interesting growth trajectory for the company over the next several years. However, even more robust growth for our industry and, consequently, NRC is starting to build as provider organizations are taking on more risks and becoming the owners of their customers health. An ever-increasing number of healthcare providers will own the healthcare risk of an ever-increasing segment of their marketplace. And the ability to thrive in this new risk-bearing environment will determine all providers by ability. As we know, many will not make it, while others will expand as they are today more so than any time in history. Among the most mission-critical requirements will be their understanding the patients' preferences and managing all care transitions. However, even among the most integrated systems, yet alone today's single silo providers, care transition failures between service settings, including the transition to home are everyday occurrences. Engaging patients and understanding preference is missing in the world of healthcare, even among the best of the best. We plan to change that provided -- by providing client organizations with a robust lifetime profile of every one of their customers. A profile that will include self-reported outcomes, patient experience, related to care delivery, and most importantly, activities of daily living, which will bring visibility regarding customers' preferences to the organization as never before. As our clients take on more risk and seek to capture value-based purchasing dollars and, of course, avoid readmission penalties, they can never know too much about the customer. Operator, at this point, I'd like to open the call to questions.

[Operator Instructions] And the first question we have comes from the line of Ryan Daniels with William Blair.

Mike, let me ask a question, just following up on your comments there about creating the longitudinal profile of the patient as these systems begin to bear more risk. I guess I appreciate the self-reported data given what you do in the HRAs and clearly, the patient experience. But maybe talk a little bit about the activities of daily living and what you currently do today to track that. And then maybe what the future might hold or what other areas you're looking to further expand that element of the patient tracking outside of the care continuum?

Okay. Basically, Ryan, as you know today, a lot of our information is collected from the patient in and around their experiences while in the care setting. However, products like market insight or Healthcare Market Guide track consumers at large and better understand their preferences relative to which organization they'd like to be treated at, as well as their activities of daily living as it relates to health. What chronic conditions they have, how they look at health, how they look at well-being, how they even define healthcare. And that particular database is subscribed to by hundreds of organizations around the country. So in building this longitudinal record of the customer, part of it will be taking our current products that collect information while the individual is within the care setting, as well as attitudes, behaviors and preferences while they're at home, connecting those together, and so we have a cumulative benefit of knowing both pieces of the puzzle for every person. In addition to that, we look forward to adding available secondary information that is available from a host of sources to continue to add more cumulative knowledge about that individual. So as I've said before, and perhaps you understand this, is that a patient actually spends 1% of their life within the 4 walls of the care setting and 99% of their time at home. But if I'm a provider that is at risk for 100% of their health and healthcare behaviors and decisions, I really need to be visible in their daily life. And so again, in summary, by taking information we have about that person while they're in a care setting as well as attitudes, preferences and behaviors while they're not, combining those together, we want to create a longitudinal robust profile of that individual so our provider clients can manage risk at a better rate.

Okay. That's extremely helpful color. I appreciate that. And then maybe a couple of other broader ones. Just -- given the huge opportunity that you're seeing as these systems begin to take on more and more risks, I'm curious how you look at the sales force investments. Maybe number one, you could talk about kind of the current team. I think we're just under 70 last quarter. And I'm a bit curious if it still stands there and how that's tracking towards quotas and maturity of the team. And as you look out over the next few years, given such a robust opportunity, how do you do view the investments in the sales force?

With the current headcount of sales force is roughly plus or minus that 70. So we haven't incrementally increased it over the last quarter. On a go-forward basis, it's my view, you can never invest enough in business development. And every time we've doubled the sales force, we've doubled our capture rate of new business, as well as upsell opportunity within the current base. So I would hope, given the leverage that we're gaining in some other areas of the business, that we can continue to invest disproportionately in building the sales force. Because you're right. The number of points of sale and the size of each one of the future opportunities, it's been a dwarf what we historically have thought about in terms of opportunities. So we need to be ready and we need to invest in the business development side of the business.

Okay, great. And 2 more, and I'll hop off. Just first, I want to get your view on kind of what work you're doing or thoughts around more of the real-time customer satisfaction. There's been a little bit of movement in the marketplace on the M&A front recently. But curious what your thoughts are on maybe round management capabilities or kind of Point-of-Care, bedside-type patient surveys.

You're exactly right. The capturing of patient experience post-event is really not where the world is going. And moving that feedback closer to Point-of-Care and when and ever possible prior to discharge is really the name of the game. We have 2 products. One has been out for some period of time which is Illuminate, which captures feedback within 24 hours of discharge. We have a rounding product that we just rolled out this last quarter, which moves inside the walls of the organization prior to discharge and automates the process of rounding. And by taking the piece of information prior to discharge, directly after discharge and the more formal measurements through that HCAHPS process, blending all those together is really where the world's at. So Illuminate is doing very, very well. Rounding just got rolled out, but out of the gate, has tremendous interest and we'll see over the coming quarters how well that takes its traction.

Okay, perfect. And then last one, just on the Patient-Centered Medical Homes. It seems like a lot of the accreditation bodies are now requiring surveys to be completed to be considered a patient-centered medical home. And I'm curious if you're seeing one momentum there on the survey front with your hospital partners. And then number 2, is that also opening up more opportunities to sell kind of outside of your core hospital base to those independent physician groups?

When CQA's accreditation for medical home, as you well know, does require feedback, as do many and most of the accreditation activities, whether it be medical home and/or other kind of up accreditation processes. So yes, we are seeing an increase in that. Medicals homes has brought, an increase in the provider community. And dollar sales in that particular area, along with CG-CAHPS is increasing at an increasing rate. What's interesting with the medical home requirement is that, hopefully, they will be one of the first step out ahead of some of the slower mail-back, paper-and-pencil type survey methodologies and embrace web-based recording. And I think when that happens, to your earlier point, we'll compress the time it takes the organizations to get feedback about the patients. So medical homes will set an interesting competitive dynamic on data collection methodologies as well.

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

Mike or Kevin, Susan, I wanted to first to see if you'd comment just on what you're seeing with respect to the roll out of CG-CAHPS among the existing base that you have today?

Well most of the update that we have on CG-CAHPS of late has been amongst current acute care providers that have employed physician populations which, I think, today stands at around 55% of physicians who are employed by an acute care facility. To a lesser degree, we're seeing traction in the balance, the independent medical groups and within the independent medical groups is disproportionately to the larger multi-specialty group practices. We do see that product, that revenue runway accelerating here over the next year as that becomes a more common-day topic among physicians. But the immediate application or traction has been in and around our current acute care hospitals that have or own their own physician populations.

And Mike, do have a sense, I mean, for the existing clients you have today which are using you guys for CG-CAHPS, has it been a competitive process? Or has it been -- since you've got the acute side basically defaulting to you?

Well, I don't think anything defaults in the healthcare world. So I'd say, it is competitive. However, there is more and more of an orientation, and especially as the way we're presenting our value proposition to integrate all the data points along kind of a longitudinal profile of the customer. So more often than not, that will differentiate us among our current clients to suggest that you really ought not look at a separate and disparate piece of information that can't be integrated with the balance of your patient experience measurement. So that clearly creates an opportunity of point-of-sale to differentiate. So I wouldn't say it's a default. I think you have to earn every piece of business. But that clearly is working for us.

And do you have a sense, I mean, on what the market opportunity is there? I mean, if you look at your installed base hospitals today in terms of their employed physicians, what that tally is or what the market opportunity is for you guys on the CG-CAHPS side?

Frank, we haven't ever truly quantified it. It's enormous, and I think the real opportunity is going to be driven by the take rate. In other words, how rapidly organizations adopt CG-CAHPS. We're seeing a faster acceleration among acute care Hospitals that have been used to the CAHPS world for years. And as value-based purchasing structures along that continuum, of course, they're looking at the physician offices and physicians in general to bring value to that value-based purchasing proposition. The independent standalone physicians, the larger there are, they more rapidly they will adopt. The smaller they are, the less likely they will. There will be a segment of the population, probably in the 25% range, that are independent solo practitioners, quite frankly, have a full practice today. And their likelihood to spend money out of their own pocket for this short of being forced, which today they are not. they may never come along. So in summary, we're seeing rapid adoption within the acute care market against their current physician population, although I don't have a quantifiable number to provide you. And then within the independent physician groups, there is a pretty clear black-and-white line separated by size.

Okay. And maybe lastly, Mike, just on sort of the vision for the company. Going back to some of the earlier questions from Ryan around the lifetime value, where do you think you are in terms of delivering on that vision?

Well, everything -- I always do. I always think we're behind, right? So that must mean we're still behind. We have most all of the data points within the current product portfolio that we routinely collect data on each and every day pretty well organized in our thoughts and how that cumulatively brings together. We do need a couple of assets that we currently do not have as an organization to provide the seamless integration of those data sets, as well as to then capture and integrate secondary data that we don't currently collect into that one master file. So we're early in the game. We have not rolled out what we refer to as Customer Connect yet. We're doing a lot of market testing, and that's proven positive. But there's a couple of assets we need to either build, acquire or do something in order to really stand it up and bring it alive. So early.

[Operator Instructions] At the moment, we have a follow up question from the line of Frank Sparacino with First Analysis.

Maybe lastly, not to leave Kevin out, but on the guidance for 2012, the outlook, 15% to 20% growth, I assume there's no change there. But any comments would be helpful.

Frank, this is Kevin. And I think, as we -- this came up on the last call. Obviously, we're trending at the low-end of that range. So I think that's still our best estimate right now where we'll be for the year.

And at the moment, we appear to have no further questions registered.

Great. Well, in closing, let me just thank everybody for their time today. And as always, 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 again for your participation and ask that you please disconnect your lines.