NATIONAL RESEARCH CORP Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

The following discussion of our results of operations and financial conditions
should be read in conjunction with our condensed consolidated financial
statements and related notes appearing elsewhere in this Quarterly Report on
Form 10-Q.



Our purpose is to enable human understanding. We believe that understanding the
story is the key to unlocking the highest-quality and truly personalized care.
We are a leading provider of analytics and insights that facilitate measurement
and improvement of patient engagement and customer loyalty for healthcare
organizations. Our heritage, proprietary methods, and holistic approach enable
our partners to better understand the people they care for and design
experiences that inspire loyalty and trust, while also facilitating regulatory
compliance and the shift to population-based health management. Our end-to-end
solutions enable our clients to understand what matters most to each person they
serve - before, during, after, and outside of clinical encounters - to gain a
longitudinal understanding of how life and health intersect, with the goal of
developing lasting, trusting relationships. Our ability to measure what matters
most and systematically capture, analyze and deliver insights based on
self-reported information from patients, families and consumers is critical in
today's healthcare market. We believe that access to and analysis of our
extensive consumer-driven information is becoming more valuable as healthcare
providers increasingly need to more deeply understand and engage the people they
serve to build customer loyalty.



Our portfolio of subscription-based solutions provides actionable information
and analysis to healthcare organizations across a range of mission-critical,
constituent-related elements, including patient experience, service recovery,
care transitions, health risk assessments, employee engagement, reputation
management, and brand loyalty. We partner with clients across the continuum of
healthcare services. We believe this cross-continuum positioning is a unique and
an increasingly important capability as evolving payment models drive healthcare
providers and payers towards a more collaborative and integrated service model.



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



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Results of Operations



The following tables set forth, for the periods indicated, selected financial
information derived from our consolidated financial statements and the
percentage change in such items versus the prior comparable period, as well as
other key financial metrics. The discussion that follows the information should
be read in conjunction with our consolidated financial statements.



Three Months Ended September 30, 2022, Compared to Three Months Ended September
30, 2021





                                                                                               Percentage
                                                (In thousands, except percentages)              Increase
                                                 Three Months Ended September 30,              (Decrease)
                                                  2022                      2021             2022 over 2021
Revenue                                     $          37,691         $          37,767                 (0.2 )
Direct expenses                                        14,524                    13,707                  6.0
Selling, general, and administrative                   10,762                     9,523                 13.0
Depreciation, amortization and impairment               1,296                     1,399                 (7.4 )
Operating income                                       11,109                    13,138                (15.4 )
Total other income (expense)                             (262 )                    (514 )              (49.0 )
Provision for income taxes                              2,549                     2,967                (14.1 )
Effective Tax Rate                                       23.5 %                    23.5 %                  -

Operating margin                                         29.5 %                    34.8 %              (15.2 )








Revenue. Revenue in the 2022 period decreased compared to the 2021 period
primarily due to the elimination of Canadian revenue of $660,000 due to the
scheduled closure of the Canadian office in the 2022 period. Revenue in the US
increased by $584,000 consisting of growth in recurring revenue in our existing
client base of $2.9 million and non-recurring revenues of $103,000. This was
partially offset by a decrease in US recurring revenue from new customer sales
of $2.4 million.  We do not expect Canadian revenues in the future due to the
closure of the Canadian office.



Direct expenses. Variable expenses decreased $8,000 in the 2022 period compared
to the 2021 period primarily from lower survey and other subscription services
of $324,000 due to lower volumes partially offset by increased conference
expenses of $296,000 due to higher room rental and audio-visual costs. Variable
expenses as a percentage of revenue were 15.3% in the 2022 and 2021 periods.
Fixed expenses increased $825,000 primarily as a result of increased salary and
benefit costs to attract and retain associates of $674,000 and contracted
services to support our clients and invest in workforce automation of $277,000.



Selling, general and administrative expenses. Selling, general and administrative expenses increased in the 2022 period compared to the 2021 period, mainly due to the new marketing initiatives of $1.0 million to expand brand awareness and support sales development.

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Depreciation, amortization and impairment. Depreciation, amortization and
impairment expenses decreased in the 2022 period compared to the 2021 period
primarily due to certain software development and intangible assets being fully
amortized after the 2021 period.



Operating income and margin. Operating income and margin decreased in the 2022
period compared to the 2021 period due to growth in salary and benefit costs to
attract and retain associates including a new benefit addition, as well as
additional investments in our workforce automation tools and new marketing
initiatives.



Total other income (expense). Total other income (expense) decreased in the 2022
period compared to the 2021 period primarily due to lower interest expense from
the declining balance on our term loan of $125,000 and a reduction in
intercompany revaluation adjustments from changes in the Canadian to U.S. dollar
foreign exchange rate of $84,000 due to closure of the Canadian office.



Provision for income taxes and effective tax rate. Provision for income taxes
decreased in the 2022 period compared to the 2021 period primarily due to
decreased taxable income as the effective tax rate remained consistent between
periods.





Nine Months Ended September 30, 2022, Compared to Nine Months Ended September
30, 2021



                                                                                             Percentage
                                               (In thousands, except percentages)             Increase
                                                 Nine Months Ended September 30,             (Decrease)
                                                  2022                    2021             2022 over 2021
Revenue                                     $         113,424       $         109,656                  3.4
Direct expenses                                        43,062                  38,184                 12.8
Selling, general, and administrative                   32,159                  29,060                 10.7
Depreciation, amortization and impairment               3,902                   5,016                (22.2 )
Operating income                                       34,301                  37,396                 (8.3 )
Total other income (expense)                             (958 )                (1,266 )              (24.3 )
Provision for income taxes                              8,184                   8,297                 (1.4 )
Effective Tax Rate                                       24.5 %                  23.0 %                6.5

Operating margin                                         30.2 %                  34.1 %              (11.4 )
Recurring Contact Value                     $         148,036       $         151,525                 (2.3 )
Cash provided by operating activities                  28,161                  34,270                (17.8 )






Revenue. Revenue in the 2022 period increased compared to the 2021 period due to
an increase in US revenue of $5.3 million partially offset by decreased Canadian
revenue of $1.5 million due to the scheduled closure of the Canadian office in
the 2022 period. US revenue increased due to growth in recurring revenue in our
existing client base of $11.5 million partially offset by decreases in US
recurring revenue from new customer sales of $5.9 million and non-recurring
revenues of $246,000.  We do not expect Canadian revenues in the future due to
the closure of the Canadian office.



Direct expenses. Variable expenses increased $525,000 in the 2022 period
compared to the 2021 period due to growth in conference expenses of $1.4 million
due to additional conferences being held in the 2022 period compared to the 2021
period and the shift to allow live or virtual attendance at conferences
partially offset by lower survey and other subscription services of $906,000.
Variable expenses as a percentage of revenue were 14.4% in the 2022 and 2021
periods. Fixed expenses increased $4.4 million primarily as a result of
increased salary and benefit costs to attract and retain associates of $3.4
million, contracted services to support our clients and invest in workforce
automation of $656,000 and increased travel costs of $326,000 due to COVID
travel restrictions being lifted.



Selling, general and administrative expenses. Selling, general and
administrative expenses increased in the 2022 period compared to the 2021 period
primarily due to innovation investments to support further development of our
Human Understanding Solutions of $1.3 million, new marketing initiatives of $1.4
million, increased travel costs of $500,000 due to COVID travel restrictions
being lifted, new associate coaching benefit expense of $372,000, as well as
increased business insurance costs of $303,000, partially offset by decreases in
public company and other legal and accounting costs of $969,000.



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Depreciation, amortization and impairment. Depreciation, amortization and
impairment expenses decreased in the 2022 period compared to the 2021 period
primarily due to additional depreciation expense in 2021 from shortening the
estimated useful lives of certain building assets of $403,000, incurring an ROU
asset impairment of $324,000 from subleasing a remote office location in 2021
and a decrease of $392,000 due to certain software development and intangible
assets being fully amortized after the 2021 period.



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



Total other income (expense). Total other income (expense) decreased in the 2022
period compared to the 2021 period primarily due to lower interest expense from
the declining balance on our term loan of $345,000.



Provision for income taxes and effective tax rate. Provision for income taxes
decreased in the 2022 period compared to the 2021 period primarily due to
decreased taxable income. The effective tax rate increased in the 2022 period
compared to the 2021 period mainly due to decreased tax benefits from the
exercise and vesting of share-based compensation awards of $316,000 and a 0.6%
increase in our state tax rate which fluctuates based on the various
apportionment factors and rates for the states we operate in.



Recurring Contact Value. Recurring contract value declined in the 2022 period
compared to the 2021 period in part due to our strategy to focus on growing our
digital core solutions, resulting in the elimination of certain legacy
offerings. Our core digital solutions had 2.2% positive recurring contract value
growth at September 30, 2022 compared to September 30, 2021. In addition, sales
declined due to the difficulties of selling to our clients during the COVID-19
pandemic as well as increased turnover within our sales force. Our recurring
contract value metric represents the total revenue projected under all renewable
contracts for their respective next annual renewal periods, assuming no upsells,
downsells, price increases, or cancellations, measured as of the most recent
quarter end.



Cash provided by operating activities. Cash provided by operating activities
decreased mainly due changes in deferred revenue primarily due to timing of
initial billings on new and renewal contracts, changes in income taxes
receivable and payable due to the timing of income tax payments and decreased
net income net of non-cash items. See the Consolidated Statements of Cash Flows
included in this report for the detail of our operating cash flows.





Cash and capital resources



Our Board of Directors has established priorities for capital allocation, which
prioritize funding of innovation and growth investments, including merger and
acquisition activity as well as internal projects. The secondary priority is
capital allocation for quarterly dividends and share repurchases. We believe
that our existing sources of liquidity, including cash and cash equivalents,
borrowing availability, and operating cash flows will be sufficient to meet our
projected capital and debt maturity needs for the foreseeable future.



As of September 30, 2022, our principal sources of liquidity included $28.4
million of cash and cash equivalents, up to $30 million of unused borrowings
under our line of credit and up to $75 million on our delayed draw term note. Of
this cash, $2.7 million was held in Canada. The delayed draw term note can only
be used to fund permitted future business acquisitions or repurchasing our
Common Stock.



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Our cash flows from operating activities consist of net income adjusted for
non-cash items including depreciation and amortization, deferred income taxes,
share-based compensation and related taxes, reserve for uncertain tax positions,
loss on disposal of property and equipment and the effect of working capital
changes. Cash provided by operating activities decreased mainly due changes in
deferred revenue, changes in income taxes receivable and payable and decreased
net income net of non-cash items. These were partially offset by changes in
trade accounts receivable which fluctuate with the timing of billing and
collections and deferred contract costs due to a reduction in deferral of these
costs which increased cash flow from operating activities.



We had a working capital surplus of $8.0 million and $33.3 million on September
30, 2022 and December 31, 2021, respectively. The change was primarily due to
decreases in cash and cash equivalents and increases in dividends payable,
partially offset by increases in trade accounts receivable and decreases in
accrued wages and bonuses and accrued expenses. Cash and cash equivalents
decreased mainly due to repurchase of shares of our Common Stock for treasury.
Dividends payable increased due to timing of declarations and payments of
dividends. Trade accounts receivable increased due to timing of billing and
collections. Accrued wages and bonuses decreased due to timing and growth of the
year-end bonus. Accrued expenses decreased mainly due to payment of the deferred
acquisition consideration. Our working capital is significantly impacted by our
large deferred revenue balances which will vary based on the timing and
frequency of billings on annual agreements.



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



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



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


Dividends



Cash dividends of $15.0 million were paid in the nine months ended September 30,
2022. Dividends of $5.9 million were declared in the three months ended
September 30, 2022 and paid in October 2022. The dividends were paid from cash
on hand. Our board of directors considers whether to declare a dividend and the
amount of any dividends declared on a quarterly basis.



Acquisition Consideration



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



Capital Expenditures



We paid cash of $7.9 million for capital expenditures in the nine months ended
September 30, 2022. These expenditures consisted mainly of computer software
development for our Human Understanding solutions and building renovations to
our headquarters of $2.5 million and $3.5 million, respectively. We estimate
future costs related to our headquarters building renovations to be $3.1 million
and $16.4 million in 2022 and 2023, respectively, which we expect to fund
through operating cash flows.



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Debt



Our amended and restated credit agreement (the "Credit Agreement") with First
National Bank of Omaha ("FNB") was amended and restated on September 30, 2022
and includes (i) a $30,000,000 revolving credit facility (the "Line of Credit"),
(ii) a $23,412,383 term loan (the "Term Loan") and (iii) a $75,000,000 delayed
draw-down term facility (the "Delayed Draw Term Loan" and, together with the
Line of Credit and the Term Loan, the "Credit Facilities"). We may use the
Delayed Draw Term Loan to fund any permitted future business acquisitions or
repurchases of our Common Stock and the Line of Credit to fund ongoing working
capital needs and for other general corporate purposes.



The term loan has an outstanding balance of $23.4 million and is payable in monthly installments of $462,988 through May 2027. The term loan bears interest at a fixed annual rate of 5%.



Borrowings under the Line of Credit and the Delayed Draw Term Loan, if any, bear
interest at a floating rate equal to the 30-day Secured Overnight Financing Rate
("SOFR") plus 235 basis points (4.53% at September 30, 2022). Interest on the
Line of Credit accrues and is payable monthly. Principal amounts outstanding
under the Line of Credit are due and payable in full at maturity, in May 2025.
As of September 30, 2022, the Line of Credit did not have a balance. There were
no borrowings on the Line of Credit during the nine-month periods ended
September 30, 2022 or 2021. There have been no borrowings on the Delayed Draw
Term Loan since origination.


We are required to pay outstanding unused commitment fees each quarter in arrears pursuant to the Line of Credit and Deferred Drawn Term Loan Facility at a rate of 0.20% per annum based on daily portions actual unused amounts of the line of credit and the deferred draw term loan. Loan facility, respectively.



The Credit Agreement contains customary representations, warranties, affirmative
and negative covenants (including financial covenants) and events of default.
The negative covenants include, among other things, restrictions regarding the
incurrence of indebtedness and liens, repurchases of our Common Stock and
acquisitions, subject in each case to certain exceptions. Pursuant to the Credit
Agreement, we are required to maintain a minimum fixed charge coverage ratio of
1.10x for all testing periods throughout the term(s) of the Credit Facilities,
which calculation excludes, unless our liquidity falls below a specified
threshold, (i) any cash dividend in a fiscal quarter that, together with all
other cash dividends paid or declared during such fiscal quarter, exceeds
$5,500,000 in total cash dividends paid or declared, (ii) the portion of the
purchase price for any permitted share repurchase of our shares paid with cash
on hand, and (iii) the portion of any acquisition consideration for a permitted
acquisition paid with cash on hand. We are also required to maintain a cash flow
leverage ratio of 3.00x or less for all testing periods throughout the term(s)
of the Credit Facilities. All obligations under the Credit Facilities are to be
guaranteed by each of our wholly owned domestic subsidiaries, if any, and, to
the extent required by the Credit Agreement, direct and indirect wholly owned
foreign subsidiaries. As of September 30, 2022, we were in compliance with our
financial covenants.



The Credit Facilities are secured, subject to permitted liens and other agreed
upon exceptions, by a first-priority lien on and perfected security interest in
substantially all of our and our guarantors' present and future assets
(including, without limitation, fee-owned real property, and limited, in the
case of the equity interests of foreign subsidiaries, to 65% of the outstanding
equity interests of such subsidiaries).



Leases



We have lease arrangements for certain computer, office, printing and inserting
equipment as well as office and data center space. As of September 30, 2022, we
had fixed lease payments of $581,000 and $420,000 for operating and finance
leases, respectively payable within 12 months.



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Taxes



The liability for gross unrecognized tax benefits related to uncertain tax
positions was $1.4 million as of September 30, 2022. See Note 4, "Income Taxes",
to the Consolidated Financial Statements contained in this report for income tax
related information.



As of September 30, 2022, the balance of the deemed repatriation tax payable
imposed by the U.S. Tax Cuts and Jobs Act of 2017 (the Act") was $164,000, which
we expect to pay by the end of 2022.



Share buyback programs



On May 19, 2022 our Board of Directors approved a new stock repurchase
authorization of 2,500,000 shares of Common Stock (the "2022 Program"). Under
the 2022 Program we are authorized to repurchase from time-to-time shares of our
outstanding Common Stock on the open market or in privately negotiated
transactions. The timing and amount of stock repurchases will depend on a
variety of factors, including market conditions as well as corporate and
regulatory considerations. The 2022 Program may be suspended, modified, or
discontinued at any time and we have no obligation to repurchase any amount of
Common Stock in connection with the 2022 Program. The 2022 Program has no set
expiration date.



During the three months ended September 30, 2022, we repurchased 87,135 shares
of our Common Stock under the 2022 Program for an aggregate of $3.1 million. As
of September 30, 2022, the remaining number of shares of Common Stock that could
be purchased under the 2022 Program was 1,987,517 shares.



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Critical accounting estimates

There have been no changes to our critical accounting estimates described in the Annual Report on Form 10-K for the year ended December 31, 2021 that materially affect our condensed consolidated financial statements and accompanying notes.

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