Michael Hays - Founder, CEO and Director Kevin Karas - CFO, SVP of Finance, Secretary and Treasurer.

Robert Munnings - William Blair Frank Sparacino - First Analysis Securities Corporation.

Welcome to the First Quarter 2017 Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded Wednesday, May 3, 2017. I would now like to turn the conference over to Michael Hays, Chief Executive Officer. Please go ahead, sir..

Thank you, Tia and welcome, everyone, to National Research Corporation's 2017 First Quarter Earnings 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 conditions with us related to any forward-looking statements that we may make 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 [Technical Difficulty] 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. Our financial performance for the first quarter was largely positive, with the exception of net new sales. As you will recall, net new sales is a measure of all new contracts signed in a given period minus any reductions in the scope of work for current clients.

For the first quarter 2017, total new sales were a respectable $6.6 million, albeit offset by $1.7 million in contract value reductions. This reduction was largely accounted for by 3 current clients, resulting in net new sales of $4.9 million in the quarter.

Generating new sales to fill the hole created by backdoor loss, of course, is never fun, so please be assured that bright lights are shining on the controllable drivers. I'd now like to turn the call back to Kevin and have him review the balance of our performance metrics, after which we will go directly to Q&A.

So please feel free to queue up your questions.

Kevin?.

Thank you, Mike. Total contract value for the first quarter totaled $119.6 million or 7% growth over the same period in the prior year. Health care system clients with agreements for multiple solutions represented 20% of our client base at the end of the first quarter of 2017, up from 16% of our client base at the same time last year.

Subscription-based revenue agreements at the end of the first quarter of 2017 represented 91% of our total recurring contract value.

First quarter of 2017 revenue was $30.3 million, an increase of 9% over the first quarter of 2016, with the increase being comprised entirely of organic growth from adding new clients and increasing contract value for existing clients.

Consolidated operating income for the first quarter of 2017 was $10 million which is 33% of revenue, compared to $8 million or 29% of revenue for the same period last year. Total operating expenses increased by 2% in the first quarter to $20.3 million compared to $19.9 million for the same period last year.

Direct expenses increased 8% to $12.5 million for the first quarter of 2017 compared to $11.5 million for the same period in 2016. Direct expenses as a percent of revenues stayed consistent at 41% for the first quarter in both 2017 and 2016.

The increase in direct expenses in 2017 is attributed to incremental variable cost of product expenses from revenue growth in the quarter, partially offset by savings due to changes in data collection methodologies and reduction in posted trades.

Fixed direct expenses increased primarily from increased allocation of resources on our customer service area. Selling, general and administrative expenses decreased to $6.7 million for the first quarter of 2017 compared to $7.4 million for the same period in 2016.

The decrease in SG&A expenses is primarily due to lower salary benefit costs, shelf registration fees that were expensed in 2016. SG&A expenses were 22% of revenue for the first quarter of 2017 compared to 26% of revenue for the same period in 2016.

Depreciation and amortization expense increased to $1.1 million for the first quarter of 2017 compared to $968,000 in 2016. The increase is a result of additional investments, primarily in our technology platforms. The provision for income taxes totaled $3.5 million for the first quarter of 2017 compared to $2.5 million in the same period in 2016.

The effective tax rate was 34.7% in the first quarter of 2017 compared to 31.2% for the same period in 2016.

The increase in effective rate is primarily due to higher tax benefits that we realized in the first quarter of 2016 from the exercise of options and vesting of restricted stock as well as IRS audit-related tax adjustments that reduced tax expense in 2016. Net income for the first quarter was $6.5 million in 2017 compared to $5.5 million in 2016.

Our combined non-GAAP diluted earnings per share was $0.26 for the first quarter of 2017 compared to $0.22 in 2016. With that, I'll turn the call back to Mike..

Thank you, Kevin. That completes our prepared remarks. And now I'd ask Tia to open the call for questions, please..

[Operator Instructions]. The first question is from the line of Rob Munnings with William Blair..

I was hoping you could give a little bit more color around operating expenses. I know they are pretty low this quarter and in the past, you've said they should be in the 25% to 26% range. Is that still the right way to think about it moving forward? Or....

Rob, yes, this is Kevin. That's correct. I think our kind of expectations for the full year would still be in that range. We're lower in the first quarter, but we're expecting to be in that 25% to 26% range for the full year..

Okay, great. And then, I was hoping you could add a little bit more color around the contract value this quarter. I know you said that the new sales were around $6.6 million.

Could you add a little bit more on kind of what the offsets were? And also, should we think about contract value as $6.6 million moving forward? Or is the number that you reported more indicative?.

Well, the $6.6 million was a new measure that we historically have not reported. Just to be clear, that was total sales for the quarter. Net new sales was $4.9 million.

The delta between those 2 numbers of $1.7 million was a reduction in contract value from current clients and that $4.9 million net new contracts for quarter 1 is relatively low in comparison to previous performance. So I would model, hopefully, on a go-forward basis, something that would be back into the norms of net new sales..

Our next question is from the line of Frank Sparacino with First Analysis..

Maybe following up on the net new sales question.

I know you haven't given that figure out historically, but can you tell me, the $1.7 million reduction this quarter, how that figure has trended maybe over the last year or 2?.

Well, that number is considerably higher than what the historical norms would be. I don't have it on a quarter-by quarter basis, but I would say, 1/3 of that number would be more consistent with historical trends..

And Mike, what would you attribute that reduction to? Was it pressure on the operating budgets at your hospital clients? Was it competitive losses? Or what were the factors?.

Well, there are three different accounts that constituted 80-odd percent of that number and independent of what the underlying cause was. In one case, it was another industry competitor that came in that took a chunk of our current spend. In another case, it was a fairly large reduction attributed theoretically to budget reductions.

But the way I look at it is, all of that, they assess value. So if we're not providing more value than another industry competitor or if we're not providing a greater return on investment than other investments that our client organizations are making, that we're going to come up on the short end of that.

So I think the underlying driver is we're not communicating value to the degree we should, at least in those particular 2 cases..

And maybe one more on that line. If you look at the reduction in budget at one particular client, obviously, your client base is under a lot of pressure.

Do you get a sense -- I mean, are you feeling that more? Do you factor that into kind of your outlook for 2017? Or any thoughts there just on the macro environment?.

Well, I think health care is under budget pressures. I think that they have been almost forever, right, over the last 35-odd years. I don't know that we've ever found a time that it was kind of a spendthrift environment. So we take a hard look at that all the time. It is factored into our growth plans.

I don't know that we're seeing it any more or less than we have historically, but there are pockets, depending upon certain markets, that seem to have a greater hurdle with bringing dollars to the bottom line than others. So I think, it's on a case-by-case basis more so than something that I think is a train to one direction or another.

Although, again, to be redundant, I think health care has always been under a pretty thin margin -- operating margins..

Great. And maybe Kevin, for you. The operating margin performance in Q1 was incredibly strong. I don't know, it doesn't sound like that's really sustainable at the level of that. But I guess, maybe 2-part question.

Just in the short term here, what should we expect? But then longer term, should we have a different kind of financial profile at the business in terms of where the operating margins are at? 35%, is that a realistic number?.

Frank, this is Kevin. First quarter is typically a high watermark just because of some of the -- even though most of our revenue is subscription now, we do get some higher volumes in HRA business. So that's not a good marker to use for the entire year, I mean, as Rob asked.

So I think that settling in for the full year, that 25% to 26% SG&A percentage range is probably more realistic. I think if you look at our operating margins, we've been able to show some increase over the past year. I think we -- we expect that we'll see some -- at least some modest increase in our operating margin for the full year of this year.

But I don't think you can -- yes, clearly, you can't take the Q1 results and extrapolate that over the full year, but I think we will see some modest improvement for the full year..

[Operator Instructions]. It looks like we have no further questions. I'll turn the call back to you..

Thank you, Tia and thank you, everyone, for your time today. As usual, Kevin and I look forward to reporting our progress next quarter. Thank you..

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