Greetings and welcome to the First Quarter 2019 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 8, 2019. I would now like to turn the conference over to Michael Hays, Chief Executive Officer. Please go ahead..

Thank you, operator and welcome everyone to National Research Corporation’s 2019 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 would ask Kevin to review conditions related to any forward-looking statements that maybe 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..

Thanks, Kevin and again welcome everyone. Contract value growth in our Voice of the Customer digital platform continues, with more and more current clients expanding their uses of the platform and new logo wins displacing Press Ganey add to our market footprint.

The industry is realizing the value of reallocating healthcare system legacy patient satisfaction spend against a higher value offering, which is creating C-suite and enterprise-wide attention.

After Kevin shares with us his prepared remarks regarding the financial performance in the quarter, we’ll discuss how the Voice of the Customer platform is evolving. With that, Kevin, I will turn the call back to you..

Thank you, Mike. Total contract value at the end of the first quarter of 2019 totaled $130.1 million, representing 7% growth over the same period in the prior year. Healthcare systems with agreements for multiple solutions represented 25% of our client base at the end of the first quarter, up from 23% at the same time last year.

Total contract value for our digital Voice of the Customer platform solutions increased to $79.1 million compared to $59.4 million at the end of the first quarter of 2018. First quarter 2019 revenue was $31.5 million, an increase of 1.5% over the first quarter of 2018.

First quarter revenue for our digital Voice of the Customer platform solutions increased to 58% of total revenue compared to 45% of total revenue in the first quarter of 2018. Our consolidated operating income for the first quarter of 2019 was $10.7 million or 34% of revenue compared to $9 million or 29% of revenue for the same period last year.

Total operating expenses of $20.8 million decreased by 6% in comparison to prior year. Direct expenses decreased by 10% to $11.7 million for the first quarter of 2019 compared to $12.9 million for the same period in 2018. Direct expenses as a percent of revenue were 37% for the first quarter in 2019 compared to 42% in 2018.

Direct expenses decreased due in large part to variable cost of product savings driven by the continued shift in our revenue mix from legacy solutions to Voice of the Customer platform solutions.

The expense savings over the past 3 years have been significant, with variable direct expenses as a percentage of revenue decreasing to 18% for the first quarter of 2019 compared to 24% in the first quarter of 2016. These savings have provided significant incremental cash flow for reinvestment in the business and increased returns to shareholders.

Selling, general and administrative expenses decreased to $7.7 million for the first quarter of 2019 compared to $7.9 million for the same period in 2018. SG&A expenses were 24% of revenue in the first quarter of 2019 and 25% of revenue in the first quarter in 2018.

Selling, general and administrative expenses decreased primarily as a result of a reduction in legal and accounting costs associated with the recapitalization in 2018 partially offset by increased software and hosting expenses.

Depreciation and amortization expense increased to $1.4 million for the first quarter of 2019 compared to $1.3 million in 2018. This increase in expense is driven by additional investments in our technology platform.

Other income and expense changed from $9,000 of net other income in the first quarter of 2018 to $844,000 of net other expense in the first quarter of 2019. This change was primarily due to increased interest expense from the new term loan originated in April of 2018 and foreign exchange rate changes on the revaluation of intercompany transactions.

The company’s income tax expense was 1.7% for the first quarter in both 2019 and 2018. The effective tax rate was 17% for the first quarter of 2019 compared to an effective rate of 19% for the same period in 2018.

The decrease in the effective rate is primarily due to nondeductible recapitalization expenses that were incurred in the first quarter of 2018 and increased tax benefits from the exercise of options and dividends paid to non-vested shareholders in the first quarter of 2019 as compared to 2018.

Net income for the first quarter was $8.2 million in 2019, up from $7.3 million in 2018. With that, I will turn the call back to Mike..

Thank you, Kevin. As Kevin reported, our Voice of the Customer platform now accounts for over half of our revenue. That said, we understand reported consolidated top line revenue makes it hard to track and fully comprehend the transformation of the business and growth in the Voice of the Customer platform revenue.

To provide more visibility, let me highlight an interesting fact. Today, 650 plus client organizations account for $101 million or 78% of NRC Health’s $130 million total contract value. At year end 2015, this group accounted for $53 million in contract value.

The double of contract value among today’s core clients in just 3 years has been driven by the Voice of the Customer platform’s expanding solution offerings.

While we have yet to fully digitize 100% of this group’s current spend, meaning more upside within this group of 650 clients is apparent, these 650 clients do, some longstanding, some recent, have compounded annual contract value growth rates of over 20% since 12/31/2015.

As we have transitioned the business over the past 3 years or so by divesting and deemphasizing select products, we have at the same time converted legacy experience spend to our Voice of the Customer platform. The underlying double-digit growth among core clients has been masked.

And as we work through the transition, these growth rates will become more visible from reported top line consolidated revenue. This completes our prepared remarks. So operator, I would now ask to open the call to questions, please..

Thank you. Certainly. [Operator Instructions] Our first question comes from the line of Frank Sparacino with First Analysis. Please proceed with your question..

Hi, guys. Maybe just with respect to the legacy clients that you have today, what percentage of those do you think will ultimately convert? I assume it’s not all of them, some of them you might have some attrition in there.

But ultimately, I guess I mean how do you force their hand if you force their hand at all?.

Great question. Frank, this is Mike. More than likely, there will always be a component of our client base that just hasn’t found the right time to convert. We hope that perhaps over an elongated period of time even that minority section or segment will in fact convert.

But our modeling suggests that they are somewhere around 10% of our business that will remain paper and pencil. Again, some that will be CAHPS-related work that digital transformation really doesn’t address or has permitted at least at this point in time.

And some of those clients will be, in fact, just wed to paper and pencil perhaps for the duration. We don’t see ourselves cutting them off. They are still partners of the organization and we still offer value to them and a whole host of different products over and above just patient experience measurement.

So, we clearly will value them outside of perhaps them being laggards in the product adoption curve..

Sure. That’s helpful.

And one follow-up for me, with respect to the metric you gave around the 650 plus core clients with a CAGR that’s 20% plus, could you deconstruct what’s driving that 20% growth as that would be helpful?.

Sure. We would be happy to. So first, let’s get grounded in what the basis so that will help all of this gain visibility. So there is 650 clients as of now in 2019 that have generated $101 million worth of contract value in the area of experience, market insights, transparency and care transitions.

And if we were to ask ourselves the question of where did those clients come from which we did looking back to year end 2015 that group of clients, some were in existence, some of course had joined NRC Health in recent years, but that same group of brands accounted for $53 million.

So there is a doubling of contract value essentially over the last 3 years or so among what we would categorize as our core clients today, the 650 plus. The growth has been interesting.

It not only has been through increased contract value from converting legacy paper and pencil to a digital platform, but it also has been a significant increase in market insights, cross-sell or up-sell, Care Transitions and Transparency.

Just by way of example, while the care experience spend amongst that group has increased roughly 1.6 fold over that 3-year period, market insights has increased twofold, we have a 5x growth on Transparency and a 3x growth on transitions.

So as you can see, it’s an increased spend of experience that being digitized and more use cases across the enterprise and more service settings. But it also is taking advantage of the different modules, such as Care Transitions and Transparency that are embedded within the digital platform itself.

So up-sells, cross-sells and obviously new logos has generated the $50 million to $100 million 20% CAGR over the last 3 years..

That’s great, Mike. Very helpful. Thank you..

Thank you..

[Operator Instructions] Mr. Hays, there are no further questions at this time. I will turn the call back to you. Please continue with your presentation or closing remarks..

Thank you, operator and thank you everyone for spending the time with Kevin and I this morning. And we look forward to sharing our performance over the next quarter during our next earnings call. Thank you again..

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines..