National Research Corporation (NRC) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter 2012 earnings release conference call. [Operator Instructions] Afterwards we'll conduct a question and answer session. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 8, 2012. I would now like to turn the conference over to Michael Hays, Chief Executive Officer. Please go ahead, sir.

Thank you, Mary, and welcome, everyone, to National Research Corporation's 2012 Second Quarter Conference Call. My name is Mike Hays, the company's CEO. And joining me on the call today are Susan Henricks, 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 have discussed in the past, the statement empowering customer-centric healthcare across the continuum represent a vastly expanded strategy for NRC, and I'm excited to say the market appetite for our product portfolio continues to accelerate. New sales this past quarter were $6 million, the same sales numbers booked in quarter 4 of 2011, which at the time you'll recall represented a company record. This pace of new sales performance combined with enhanced renewal rates has now driven total contract value to $89 million. Before we drive into this and other drivers of the business, let me have Kevin review our second quarter financial performance.

Thank you, Mike. Revenue for the second quarter was $20.6 million, an increase of 13% over the second 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 from cross-selling and increasing contract value in our existing client base. As Mike suggested, the net new sales of $6 million were added, resulting in total contract value of $89.2 million as of June 30, 2012. As a result of our focus over the past several years of establishing renewable, recurring service arrangements with our clients, over 98% of that current total contract value is comprised of annual recurring revenue agreements. We also ended the quarter with subscription-based agreements, representing 75% of contract value compared to 64% of contract value at the end of the second quarter of 2011. Subscription agreements also generated 75% of total revenue for the second quarter of 2012, and on a year-to-date basis represents 71% of our total revenue in 2012. Total operating expenses for the second quarter increased by 6% from $14.5 million in 2011 to $15.4 million in 2012. Within that, direct expenses increased to $8.6 million for the second quarter this year compared to $7.3 million for the same period in 2011. This increase is a result of increased variable costs related to our revenue growth as well as additional investments and technology research and service resources to 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 40% for the full year of 2012. SG&A expenses decreased 7% to $5.6 million for the quarter ending June 30, 2012 compared to $6 million for the same period in 2011. Our…

Thank you, Kevin. As you can see, we had a great quarter financially driven by increased new business being generated as well as enhanced renewal rates and clearly increased tailwinds associated with our product portfolio. At this point in time, I'd like to have Susan provide a few examples of where the new business is coming from. Susan?

Thanks, Mike. New sales for the quarter were derived from provider types and segments across the continuum, including children's hospitals; academic medical centers; national and regional healthcare systems, including for-profit and not-for-profit; as well as post-acute service providers. In addition, we expanded the spend from payor organizations. Products purchased also varied and included offerings across our entire product portfolio, including consumer preference and brand equity; patient experience; health risk assessments; and Illuminate, our care transitions product. New business in the quarter was a mix of new client wins against competitors such as Avatar, Health Stream and Press Ganey with the balance being additional spend from current clients. For example, over $300,000 was from a new children's hospital client. NRC was chosen because of our picker patient experience tool's direct alignment with CAHPS and the number of pediatric hospitals we work with. Over $600,000 was from academic medical centers. In the academic world, NRC was chosen this quarter for products including picker patient experience and Illuminate. In the post-acute market, $530,000 in new business was booked from several assisted living and nursing home facilities, primarily for resident and family experience. Large healthcare systems selected NRC in the quarter for patient experience and Ticker for a contract value of $850,000. In addition, a for-profit system purchased Illuminate for $145,000. From the payor perspective, this quarter, we brought in $600,000 in new business primarily to handle health risk assessments. I hope these examples have been helpful. And, Mike, I will now turn the call back to you.

Thank you, Susan, very helpful, thanks again. As one can see from the examples Susan has just walked through, our ability to expand market share and cross-sell our installed base additional subscription-based products is working. In fact, average recurring annual spend for our acute-care clients that purchase more than 1 NRC product now stands at $207,000 annually, while clients that only purchase 1 offering averages $48,000. This fourfold increase or this simple math points to a minimum upside of $111 million for current products among current acute-care clients. We also continued to deepen our footprint across the continuum and expand our share in the payer [ph] market. Both of these facts helped build a strong base for customer connect. Customer connect, as we have touched on in the past calls, is the outcome of repurposing many of our current offerings to create a longitudinal lifetime profile of an individual, a robust profile of self-reported outcome, such as our patient experience tool set, which relates to care delivery but also activities of daily living while that customer is now at home. All of this brings greater visibility to providers about their customers, which has never before been possible. As our clients take on more financial risks and seek to capture value-based purchasing dollars and avoid readmission penalties, they can never know too much about their customers. Operator, now, I'd like to open the call to questions, please.

[Operator Instructions] And our first question comes from Ryan Daniels with William Blair.

Let me ask the first one just on some of the details you provided on the quarterly sales to the various entities and various types of products or service offerings. Can you speak to traditionally how long it takes from making the sale before that revenue will actually show up in the income statement? And I assume it varies by product, so you can either say on average or maybe go through some of the products and give us a view there.

Ryan, this is Mike. The best way to think about all new business that comes in, is that we will recognize revenue ratably over the course of that annual contract, which on average will suggest that 50% of a year's worth of new business is recognized in that particular year. So in the first quarter, as you might imagine, we have 3 additional quarters, on which to recognize so 75% plus of that contracts in Q1 would be recognized in that current calendar year, and then the subsequent ratability of revenue recognition would decrease proportionately for the subsequent quarters. So use that number of 50%, you'll be within the ballpark.

So these are contracts, it's not like they might not have been solid but they're not going to start until the end of the third quarter or during the fourth quarter. They typically -- once installed, they're going to start pretty quickly?

Yes, there might be some but would that would be a rare occurrence. Usually you can start on contract signed. There may be a little bit of a setup time, but essentially they're current period.

Okay. Yes, that's what I want to clarify. And then maybe one for either you or Kevin. Obviously, great sales, some of that may have been later than originally anticipated. I'm curious if you think if your revenue outlook for the year, if the sales have come heavier, kind of, in the second quarter, does that kind of bring you down towards the 15% level versus that 15% to 20% guidance you were thinking about? Is that a fair way to think of it?

I would say so, yes.

Okay. And then 2 maybe more broader ones. You highlighted Illuminate, both on the call and in the press release, and I'm curious in a couple of regards there: number one, what's the pipeline look like heading into the value-based purchasing initiative? I know you talked about that as a way to improve HCAHPS scores and satisfaction. And then, number two, you also talked about the need to enhance it a little bit more from an IT perspective on the avoiding readmission front to also help with that. So could we get an update on both of those fronts?

Sure, this is Mike again. Illuminate has taken off, as you can see, a fourfold increase in contract value over the course of the last 12 months with a disproportionate amount of that more recently than earlier. As you suggested, the product originally was intended to deal with avoidable readmissions solely but we found a by product or what is actually becoming a primary product benefit, that being value-based purchasing and increasing the publicly-reported CAHPS scores. And that really is the tailwind that we're seeing for that product. We have not retooled it to address the avoidable readmissions in a stronger proof point basis as of yet, but we are working on that. So we would see that today in the current pipeline in any way, being on value-based purchasing side as its benefit versus the avoidable readmissions. But it is building significantly.

Okay, very helpful color. And then maybe the last one, just remind us, it sounds like renewals also were quite stronger in the period. I'm curious what the average term of the renewal is? I know some of your peers in the industry, and it looks like they're going from kind of a one-year renewal to a multi-year renewal? And I'm curious if you debated that internally on kind of what the average renewal term is, if it's 1 year or more than that?

Hello, Ryan, this is Kevin. Most of our agreements have traditionally been annual agreements with an annual anniversary date of renewal. We are moving to multi-year agreements. I don't have an exact breakdown of, kind of, the average age of our complete base but more and more, we are moving to multi-year agreements. But as you know, in our current contract value, we always count 12 months' worth of revenues, so even though we get more and more multi-year agreements the majority are still annual, but that multi-year is the direction we're moving.

The next question comes from Frank Sparacino with First Analysis.

I just want to go back to your comments and maybe, Kevin or Mike, as well just around sort of the mix between the new business versus existing clients, and I don't know if you can give us a better sense as to what that mix is in the current quarter and if that's any different than what you've sort of seen historically or what you expect going forward?

It's probably pretty close to historical rates of 50-50.

Yes, there's really no reason to assume that would change anything based on what we know.

Right.

Okay. And then, Mike or Kevin, just on the -- I think the statistics you threw out on the $207,000. I just want to understand that figure again, if you could just define that for me.

Frank, this is Kevin. So within our acute care client base, we have multiple products. And of the clients that are buying more than 1 product, their average contract value in the amount of business that we do with them each year is $207,000. For the clients that are only purchasing 1 product, the average contract value is $48,000. So that's the distinction, where we see as clients move into that multi-product category, there is a significant increase in the book of business for that client.

Okay. And can you just talk about the way the sales force is aligned today in terms of trying to increase that wallet share within the base versus sort of new activity?

The sales force that we currently have and pretty much historically has followed this suit. Is it the sales associates who are responsible both in terms of new logos as well as increasing share of wallet among current install base? The mix of business, as Susan suggested, is roughly 50-50, might be 60-40 in a particular quarter. The orientation of the sales associates is that their commission is based on incremental increase over price of current contract spend, so they're incentivized to focus on cross-selling and up-selling current clients multiple products. That traditionally happens at renewal, although it's not limited to that particular timeframe but disproportionately in and around an annual account review will be a set of needs assessment and inquiries to the client organization to better understand how they're solving business problems outside of whatever our current offering is that they're purchasing. Hopefully that leads to dialogue and a sale or an upgrade or cross-sell to that current client. Parallel to that, within that geographic area to which the sales associate is focused on, they routinely are traveling to that geographic territory and knocking on doors of new organizations.

Great. And maybe lastly, Mike, is -- when you look at the net new sales this quarter and the strength there, are there certain things you would attribute that to? I mean, in terms of the new messaging and perhaps how the ploys [ph] have has responded to that and the message sort of resonating with the client base as well? Is there anything you would specifically cite in there?

I'd like to think it's all about new messaging but we've just ruled that out. So my best guess is that will take yet another lifetime to get established. I think that the real power is coming through the tenure and increase of productivity of the sales associates. So of the 68 sales associates that we currently have, 23 of those individuals are from 0 to 12 months in terms of tenure than average far less sales productivity than those that are in each of the other subsequent 12-month buckets. So if you simply age our sales associates' tenure, the increased experience that they have with the organization, with the industry and with our products clearly is paying off handsomely. So I think that the messaging and customer connect and the longitudinal profile of the individual customer will help provide a basis on which a overall or overarching sales pitch can be communicated. I think it really is skills of our sales associates that's doing the heavy lifting today.

And just as a follow-up on the 68 figure, can you provide what it was over the last couple of quarters? Is that -- has that grown?

Do you have that, Kevin, by any chance?

Yes. Frank, this is Kevin. A couple of quarters back, that number was slightly low at 64. So I think if you go back, the big increase is from where it was a couple of years ago where it was actually in the 40s. So most of the buildup was coming into this year or into the middle of last year. And so we've been in the -- we were 64 a couple of quarters ago. We're 68 right now.

[Operator Instructions] And our next question is a follow-up question from Ryan Daniels.

Two more quick ones, if I could. Number one, I'm just curious with the publicity to help insurance exchanges are getting post the Supreme Court upholding of the law. Is that an area where you see room for future growth for the organization be it from health risk assessments, which may be required as part of that, to also maybe working with providers and insurers to give them more information on that end-market consumer that might be buying insurance on the exchange?

Ryan, this is Mike. You hit it on the head. The upside opportunity is if the state's write in similar requirements as the feds did on Medicare Advantage, health risk assessment. So as you might imagine, the health exchange wanting to have a pretty good assessment to triage, new members from -- in the health exchange into some intervention program to avoid the claims and obviously, they won't have the retrospective claims they need to power up the analytics. So assuming that metric or tool is embedded, which many are starting to discuss, it clearly broadens the opportunity for health risk assessments. And we see that contract in potentially with the individual state authority. And as you also know, some of the state exchanges are actually going to be managed by predominant health plans, so to the degree that we have a relationship with a large payer that we do health risk assessment for the Medicare Advantage. And in fact, there is a requirement in a particular health exchange for that same dynamic or same metric. Theoretically, one can see us being ported over to that book of business. We are seeing that in a little bit of different fashion than the health exchange, where our current Medicare Advantage payer clients are contracting with states to essentially create a managed Medicaid population for all the reasons that you can imagine, state budget, et cetera, the success of Medicare Advantage, and that health risk assessment tool has been ported over. In fact, I believe it was that situation exactly this quarter that Susan represented an increase in health risk assessment from the payer community. If I'm not mistaken, it was that environment or situation that created the opportunity, is that right, Susan?

Yes.

Okay. So long way to say yes.

It's very helpful color though. It seems like a big opportunity given your leadership position there. And then the final one, I think this may have been -- Kevin, you mentioned that -- talking about the sales force, but you referenced the term customer connect, and I don't know that I'm familiar with that. I apologize if you've talked about it in the past. But is that kind of a new program to outreach with your customers or web-based customer portal or anything? Just any more color on that might be helpful.

Ryan, it's pretty much a working -- internal working name that we've -- are using customer connect and really is repurposing current products to connect to one another to create a longitudinal profile on an individual. So just very briefly, we do picker patient experience-type work, where we will interview an individual relative to their care experience at point of care. And we subsequently, again, as you know, we just discussed new health risk assessments and we have a protocol Healthcare Market Guide, which you know well, that deals with brand equity and preference. If you can imagine the same individual having a record or a profile that has embedded within that data from every one of our products, customer connect will create a cumulative benefit of the provider or payer organization simply knowing more about their customer. So it's not so much a new product, so it's not so much a new product as it is repurposing with an analytical layer on top of existing offerings, but more importantly connecting them together to create one integrated offering versus what historically has been separate single-purpose applications.

Okay, so it's exactly what you've been talking about is the move towards customer-centric care is kind of your internal vision upgrading that profile. Perfect.

[indiscernible] point, the terminology is not embedded so it is our sales associates that are doing all the heavy lifting.

And, Mr. Hays, I'm showing no further questions at this time. I'll turn the conference back to you.

Thank you. And just to summarize, let me say thanks for everybody for joining us today. We have a lot going on. We look forward to communicating our progress next quarter. Thank you.

Thank you. Ladies and gentlemen, that concludes our conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a good day.