Michael Hays - CEO Kevin Karas - CFO.

Ryan Daniel - William Blair Frank Sparacino - First Analyst.

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter 2014 earnings release conference call. During the presentation all participants will be in a listen only mode, afterwards we will conduct a question and answer session (Operator Instructions). As a reminder, this conference is being recorded, Wednesday, August 6, 2014.

I would now like to turn the conference over to Michael Hays, Chief Executive Officer. Please go ahead..

Thank you, Chris, and welcome everyone to the National Research Corporation's 2014 Second Quarter Conference Call. My name is Mike Hays, the company's CEO, and joining me on the call today is Kevin Karas, our Chief Financial Officer.

Before we continue, I'd ask Kevin to review the 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 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. Overall I was pleased with our performance in the second quarter.

Net new sales which of course is a key driver for future revenue growth increased 25% over the first quarter in 2014 and net income increased a very healthy 18% quarter over quarter, I’ll return here in a minute but first let’s have Kevin review our financial performance for the second quarter.

Kevin?.

Thanks Mike. Net new sales of 4.1 million were added as Mike said in the second quarter 2014 including $562,000 net new sales for Customer Connect. Total contract value during the second quarter was $99.5 million which includes $1.3 million of total contract value for Customer Connect.

The revenue for second quarter 2014 was $24 million, an increase of 7% over the second quarter of 2013. Our revenue growth for the quarter was comprised entirely from organic growth, which is driven by a combination of continuing gains of market share and vertical growth from cross selling and increase in contract value in our existing client base.

The second quarter 2014 results include a 154,000 of revenue from Customer Connect. The consolidated operating income for the second quarter of 2014 was 6.3 million or 26% of revenue compared to $5.5 million or 25% of revenue for the same period last year.

The 2014 second quarter operating income includes $389,000 in operating losses from Customer Connect. Operating income for the second quarter without Customer Connect losses was $6.7 million which represent a 28% operating income margin, an increase in operating income of 20% over the second quarter of 2013.

The total operating expenses for the second quarter increased from $16.8 million in 2013 to $17.7 million in 2014, direct expenses were $7.8 million for the second quarter 2014 compared to $9.5 million for the same period in 2013.

Direct expenses as percent of revenue were 45% for the second quarter of 2014 and are expected to average for the full year of 2014 42% of revenue. The Selling, General & Administrative expenses decreased to $6 million or 25% of revenue for the second quarter of 2014 compared to $6.4 million or 29% of revenue for the same period in 2013.

The second quarter 2013 expenses did include $250,000 of costs related to the recapitalization. The SG&A expense for the second quarter of 2014 without Customer Connect was $5.6 million or 23% of revenue including the incremental expenses that are projected to be incurred for Customer Connect through the remainder of the year.

Consolidated SG&A expense is expected to average 25% of revenue for the full year of 2014. The depreciation and amortization expense for second quarter 2014 was $927,000 compared to $932,000 in the second quarter of the prior year; this decrease is attributed to the decline in tangible asset amortization expense.

Depreciation, amortization expense was 4% of revenue for the second quarter and is also expected to be 4% of revenue for the full year of 2014. The provision for income taxes totaled $2.2 million for the second quarter of 2014, compared to $2 million for the same period in 2013.

Our effective tax rate was 35.3% for the second quarter of 2014 compared to an effective tax rate of 37.1% in the second quarter of 2013. The effective tax rate has decreased this year as a result of reduced expense from state income taxes. We expect that our effective tax rate for the full year of 2014 to be 35%.

And then finally net income for the second quarter of 2014 increased by 18% to $4.1 million compared to $3.4 million in 2013.

Our net income for the second quarter increased to 17% of revenue compared to 15% in 2013 and for the second quarter of 2014 our combined non-GAAP diluted earnings per share was $0.16 a share compared to $0.14 for the second quarter of 2013. With that I’ll turn the call back to Mike..

Thank you, Kevin, as reference new sales are improving and are doing so for a variety of reasons, the most important of which is that health organizations are placing increased value on the voice of the customer. This is driving increased demand for our product portfolios in turn; let me provide you a few examples.

One is our patient experience product portfolio where we are witnessing increased demand driven by the additional CAHPS type requirements, value based purchasing programs and a growing number of other financial incentives and or penalties tied to the patient experience.

We’ve also seen increased international interest for our Picker patient experience measurement tools.

As you are aware Picker tools is the basis of the required H-CAPHS measures in the United States and we have recently signed an intellectual property license with the Australian government that now joins the UK and several other countries in standardizing their nationwide measurements on Picker.

Interest in the voice of the customers also regarding brand equity as healthcare systems acquire acute care hospitals and other providers across the continuum help us to manage the brand becomes the boardroom today. In fact in a recent released paper on mega challenges for healthcare providers, brand strategy and management were high on the list.

Our markets insights product has been tracking healthcare brand equity for 27 years and across all of healthcare we’re the recognized measurement standard for all things brand. Tracking and understanding the impact of social media was also cited in the same report as a key challenge for healthcare.

Our market insight product was early in monitoring social media impact and we’re now looking at a product roadmap to add additional tools to address this growing challenge as identified by healthcare providers.

In summary, brand and social media are two examples of why the demand for our market insight products which is all about listening to the customer is increasing materially.

We don’t talk about market insights product as often as we should and it may surprise many that for 365 days a year in each of the largest 250 markets in the United States, we capture the consumers’ health related attitudes, preferences and behaviors.

In fact, market insights has become the largest consumer tracking study in the country independent of industry.

Clearly this is a powerful and likely insurmountable barrier to entry and we’re maximizing the opportunities we this product to the appetite for the voice of the customer is actually increasing as well voice of the customers’ core to driving the need for Customer Connect as we all have talked about in the past.

In summary, NRC is the voice of the customer for a growing number of healthcare organizations and we have a product road map to drive those voices into a far greater number of hallways and boardrooms of healthcare organizations going forward. Chris, I would like to now open the call to questions please,.

Certainly (Operator Instructions) and our first question comes from the line of Ryan Daniel with William Blair, please go ahead..

Morning guys, thanks for taking the questions.

Kevin let me start with one for you, in discussing the gross margin profile for the year you indicated it should trend at about 42% and I know that’s right about where you are year-to-date but in Q2 you were closer to 45% so I’m curious if there was anything unique this quarter that pushed it up that in turn will normalize in the back half of the year..

Hi Ryan, there was something somewhat atypical in the second quarter, going into the quarter we do typically see a slightly higher variable cost of product due to mix and in volumes in Q2 compared to Q1 so we had expected about a 1% increase to about 42.5% for the quarter, we ended up closer to, I’m sorry around 43.5% and we ended up closer to 45% and that we experienced some incremental expense related to outsourcing, a number of our mail surveys for processing and that was really related to building some backlogs in our print mail operations and to keep up with our service level agreements we outsource some of that work which really is atypical for us and that’s at a higher per unit cost.

So that generated some unexpected incremental expense in Q2 now we’ve addressed that by investing in some additional equipment and we have that in place and have increased our capacity to mitigate finding ourselves in that situation again, so we do not expect that that incremental expense that we saw in Q2 to have an impact for the remainder of the year and that our variable cost as a percent of revenue for the last half of the year should be consistent with what we saw in 2013..

Okay, that’s helpful and is there any potential to further reduce cost by moving those from mail-based to web-based, phone-based is probably more expensive, but to find alternative means to doing that surveying..

Ryan this is Mike.

I guess the short answer is yes and it’s really dependent upon two things, one market appetite and acceptance to move from what has been a historical legacy, traditional mail out- mail back mindset, the other is to be able to have data collection methodologies that really are at a lower cost, quicker turn around producing higher value and clearly the Customer Connect platform was actually thought about and created to do just that, so once Customer Connect obviously it has the use case in transition management but we clearly see the perfection of that platform, coming back into the organization to reduce the variable cost to goods sold.

But again we have to market acceptance and healthcare is fairly slow..

Okay, that’s helpful color and then maybe two more quick ones.

Kevin, during your comments you talked about some growth rates in several of your offerings but obviously overall sales, you know and the 7.5% is still a bit below your longer term targets, so are there any specific areas where either market trends or competitive changes have impacted growth to keep the overall corporate growth a little lower or is this still a residual kind of lower bookings in the quarters prior to this..

From my side I think lot of it’s the filling the pipeline back up from perhaps three to four quarters ago and the pipeline growth we’re seeing in particular but historically has been the softest area is actually ramping back up in fact I think the pipeline again increased fairly materially this last quarter but we haven’t harvest a lot of that from a number of days decision perspective.

So I think we got behind the eight ball over the last year and I think we’re working our way out of that in particular with the [indiscernible]. Kevin, I don’t know if you want to add anything to that..

I think the other piece Ryan specific to Q2 is that we had discussed previously the impact of contract value reductions in our health risk assessment business that segment in particular their revenue in Q2 was down 18% over prior year.

And then the other area and again this speaks to the value of our subscription model which again 86% of our contract value is still subscription-based but the pieces that are not are the health risk assessment business and our Canadian business.

So the other segment that had a weak quarter was in Canada where one of our potential clients surveyed less, their volumes were quite a bit down on the prior year, now again some of that’s timing, but just again the volatility where we have businesses that are not subscription based, that can have an impact quarter to quarter, so the other area that did have some weakness in Q2 was in Canada..

Okay, and then just lastly you mentioned a new contract with the Australian government for your intellectual property, when is that going to start coming through the income statement, is that a ’15 item or will we see that sooner, thanks..

I don’t know the exact start date but it didn’t have any impact within Q2 I don’t know whether it will in Q3 or not I’m not sure of the start date but it will be likely fourth quarter for sure and some of it might creep into third quarter..

(Operator Instructions) Our next question comes from the line of Frank Sparacino with First Analyst, please go ahead..

Hi guys. First maybe to start with, just curious on the market insight product, you talked a little bit about social media and some development efforts, I was wondering if you could go in to more detail in terms of what that would entail, sort of time lines and required investment..

All of that is not 100% clear yet Frank, we’ve just finalized I guess I’d say it’s firmly deep dive with clients and prospects in the marketing and planning space to identify what adjacencies we could dip into given the footprint we have within the marketing and planning world and that produced a long list of opportunity, social media probably in the top one or two.

We’re right now investigating a series of partnerships, I doubt whether it would be an acquisition, it doesn’t make a lot of sense also for us to build it from ground up, so I would say towards the end of the year we’re going into the renewals on the subscription products for 2015, we will have some significant added value to which will represent incremental increase in the annual license fees..

Okay, and just following up on the Australia contract, when you say, they’ve licensed the IP, what’s the structure of that from a revenue standpoint, is it just onetime transaction in nature or is it ongoing just some more color there would be helpful..

It’s an annual license, so it is ongoing fairly modest in the scheme of the $100 million contract value company but nevertheless fairly significant in terms of the acceptance of our intellectual property but we will bring it in evenly over the course of each and every month as they utilize those tools to measure satisfaction across their country.

We are not engaged and elected not to participate in the bidding of the field work in Australia, we felt that there’s quite a bit opportunity right here in our own backyard and we didn’t have to go that far away and set up a servicing production outfit, so it’s true intellectual property license, it will be recognized in the revenue stream natively over the course of months, over the course of each month within each annual period of the contract..

Okay, thank you guys..

And there appears to be no further questions on the phone lines at this time..

Great, thank you Chris and thank you again everyone for joining us on time today. Kevin and I 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..