NATIONAL RESEARCH CORP

Description of business and basis of presentation

National Research Corporation, doing business as NRC Health (“NRC Health,” the “Company,” “we,” “our,” “us” or similar terms), is a leading provider of analytics and insights that facilitate measurement and improvement of the patient and employee experience while also increasing patient engagement and customer loyalty for healthcare organizations in the United States. Our purpose is to humanize healthcare and support organizations in their understanding of each person they servenot as point-in-time insights, but as an ongoing relationship. We believe that understanding the story is the key to unlocking the highest-quality and truly personalized care. Our end-to-end solutions enable health care organizations 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 portfolio of solutions represents a unique set of capabilities that individually and collectively provide value to our clients.

Our condensed consolidated balance sheet at* December 31, 2023*was derived from our audited consolidated balance sheet as of that date. All other financial statements contained herein are unaudited and, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) that we consider necessary for a fair presentation of financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States.

Information and footnote disclosures included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto that are included in our Form10-K for the year ended* December 31, 2023,filed with the Securities and Exchange Commission (the “SEC”) on February 27, 2024.*

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

The condensed consolidated financial statements include the accounts of the Company and our wholly-owned subsidiary, National Research Corporation Canada. All significant intercompany transactions and balances have been eliminated.

Our Canadian subsidiary used Canadian dollars as its functional currency. We translated its assets and liabilities into U.S. dollars at the exchange rate in effect at the balance sheet date. We translated its revenue and expenses at the average exchange rate during the period. During* December 2022,we substantially liquidated our investment in Canada As a result, currency translation changes were recognized in Other income (expense), net in our Condensed Consolidated Statements of Income. In thethree*-month period ended* June 30, 2024*we repatriated the remaining cash from Canada.

Revenue Recognition

We derive a majority of our revenues from our annually renewable subscription-based service agreements with our customers, which include performance measurement and improvement services, healthcare analytics and governance education services. Such agreements are generally cancelable on short orno notice without penalty. See Note2 for further information about our contracts with customers. We account for revenue using the following steps:

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Our revenue arrangements with a client* mayinclude combinations of more thanone* service offering which* maybe executed at the same time, or within close proximity ofone* another. We combine contracts with the same customer into a single contract for accounting purposes when the contract is entered into at or near the same time and the contracts are negotiated together. For contracts that contain more thanone separately identifiable performance obligation, the total transaction price is allocated to the identified performance obligations based upon the relative stand-alone selling prices of the performance obligations. The stand-alone selling prices are based on an observable price for services sold to other comparable customers, when available, or an estimated selling price using a cost-plus margin or residual approach. We estimate the amount of total contract consideration we expect to receive for variable arrangements based on the most likely amount we expect to earn from the arrangement based on the expected quantities of services we expect to provide and the contractual pricing based on those quantities. We only include some or a portion of variable consideration in the transaction price when it is probable that a significant reversal in the amount of cumulative revenue recognized willnot occur. We consider the sensitivity of the estimate, our relationship and experience with the client and variable services being performed, the range of possible revenue amounts and the magnitude of the variable consideration to the overall arrangement. Our revenue arrangements donot contain any significant financing element due to the contract terms and the timing between when consideration is received and when the service is provided.

Our arrangements with customers consist principally offour different types of arrangements:1) subscription-based service agreements;2)one-time specified services performed at a single point in time;3) fixed, non-subscription service agreements; and4) unit-priced service agreements.

Subscription-based services -Services that are provided under subscription-based service agreements are usually for atwelve- month period and represent a single promise to stand ready to provide reporting, tools and services throughout the subscription period as requested by the customer. These agreements are renewable at the option of the customer at the completion of the initial contract term for an agreed upon price increase each year. These agreements represent a series of distinct monthly services that are substantially the same, with the same pattern of transfer to the customer as the customer receives and consumes the benefits throughout the contract period. Accordingly, subscription services are recognized ratably over the subscription period. Subscription services are typically billed either annually or quarterly in advance but* may*also be billed on a monthly basis.

One-time services–* These agreements typically require us to perform a specificone*-time service in a particular month. We are entitled to a fixed payment upon completion of the service. Under these arrangements, we recognize revenue at the point in time we complete the service and it is accepted by the customer.

Fixed, non-subscription services–* *These arrangements typically require us to perform an unspecified amount of services for a fixed price during a fixed period of time. Revenues are recognized over time based upon the costs incurred to date in relation to the total estimated contract costs. In determining cost estimates, management uses historical and forecasted cost information which is based on estimated volumes, external and internal costs and other factors necessary in estimating the total costs over the term of the contract. Changes in estimates are accounted for using a cumulative catch-up adjustment which could impact the amount and timing of revenue for any period.

Unit-price services–* *These arrangements typically require us to perform certain services on a periodic basis as requested by the customer for a per-unit amount which is typically billed in the months following the performance of the service. Revenue under these arrangements is recognized over the time the services are performed at the per-unit amount.

Revenue is presented net of any sales tax charged to our clients that we are required to remit to taxing authorities. We recognize contract assets or unbilled receivables related to revenue recognized for services completed butnot invoiced to the clients. Unbilled receivables are classified as receivables when we have an unconditional right to contract consideration. A contract liability is recognized as deferred revenue when we invoice clients in advance of performing the related services under the terms of a contract. Deferred revenue is recognized as revenue when we have satisfied the related performance obligation.

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Deferred Contract Costs

Deferred contract costs, net is stated at gross deferred costs less accumulated amortization. We defer commissions and incentives, including payroll taxes, and certain implementation costs if they are incremental and recoverable costs of obtaining a renewable customer contract. Deferred contract costs are amortized over the estimated term of the contract, including renewals, which generally ranges from three tofive years. The contract term was estimated by considering factors such as historical customer attrition rates and product life. The amortization period is adjusted for significant changes in the estimated remaining term of a contract. An impairment of deferred contract costs is recognized when the unamortized balance of deferred contract costs exceeds the remaining amount of consideration we expect to receive net of the expected future costs directly related to providing those services. We have elected the practical expedient to expense contract costs when incurred for any nonrenewable contracts with a term ofone year or less. We deferred incremental costs of obtaining a contract of $197,000 and $70,000 in thethree-month periods ended* June 30, 2024and2023,* respectively. We deferred incremental costs of obtaining a contract of $311,000 and $233,000 in thesix-month periods ended* June 30, 2024and2023,* respectively. Deferred contract costs, net of accumulated amortization was $1.2 million and $1.5 million at* June 30, 2024and December 31, 2023,respectively. Total amortization by expense classification for the periods ended June 30, 2024and2023* was as follows:

Additional expense included in selling, general and administrative expenses for impairment of costs capitalized due to lost clients was $7,000 for thethree-month periods ended* June 30, 2023and $34,000 and $15,000 in thesix*-month periods ended* June 30, 2024and2023,* respectively. There wereno impairments in thethree-month period ended* June 30, 2024.*

Trade Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable, determined based on our historical write-off experience, current economic conditions and reasonable and supportable forecasts about the future. We review the allowance for doubtful accounts monthly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

The following table provides the activity in the allowance for doubtful accounts for thesix-month periods ended* June 30, 2024and2023* (In thousands):

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Leases

We determine whether a lease is included in an agreement at inception. We recognize a lease liability and a right-of-use (“ROU”) asset on the balance sheet for our operating leases under which we are lessee. Operating lease ROU assets are included in operating lease right-of-use assets in our condensed consolidated balance sheet. Finance lease assets are included in property and equipment. Operating and finance lease liabilities are included in other current liabilities and other long-term liabilities. Certain lease arrangements* mayinclude options to extend or terminate the lease. We include these provisions in the ROU asset and lease liabilities only when it is reasonably certain that we will exercise that option. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term and is included in direct expenses and selling, general and administrative expenses. Our lease agreements donot* contain any residual value guarantees.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments during the lease term. ROU assets and lease liabilities are recorded at lease commencement based on the estimated present value of lease payments. Because the rate of interest implicit in each lease isnot readily determinable, we use our estimated incremental collateralized borrowing rate at lease commencement, to calculate the present value of lease payments. When determining the appropriate incremental borrowing rate, we consider our available credit facilities, recently issued debt and public interest rate information.

Due to remote working arrangements, we reassessed our office needs and subleased our Seattle location under an agreement considered to be an operating lease beginning in* May 2021.We havenot* been legally released from our primary obligations under the original lease and therefore we continue to account for the original lease separately. Rent income from the sublessee is included in the statement of operations on a straight-line basis as an offset to rent expense associated with the original operating lease included in other expenses.

Fair Value Measurements

Our valuation techniques are based on maximizing observable inputs and minimizing the use of unobservable inputs when measuring fair value. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. The inputs are then classified into the following hierarchy: (1) Level1 Inputs—quoted prices in active markets for identical assets and liabilities; (2) Level2 Inputs—observable market-based inputs other than Level1 inputs, such as quoted prices for similar assets or liabilities in active markets, quoted prices for similar or identical assets or liabilities in markets that arenot active, or other inputs that are observable or can be corroborated by observable market data; (3) Level3 Inputs—unobservable inputs.

The following details our financial assets within the fair value hierarchy at* June 30, 2024and December 31, 2023:*

There wereno transfers between levels during thesix months ended* June 30, 2024.*

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Our long-term debt described in Note4 is recorded at historical cost. The fair value of fixed rate long-term debt is classified in Level2 of the fair value hierarchy and was estimated based primarily on estimated current rates available for debt of the same remaining duration and adjusted for nonperformance and credit. The fair value of our variable rate long-term debt is believed to approximate the carrying value because we believe the current rate reasonably estimates the current market rate for our debt.

The following are the carrying amount and estimated fair values of long-term debt:

The carrying amounts of accounts receivable, line of credit, accounts payable, and accrued expenses approximate their fair value. All non-financial assets that arenot recognized or disclosed at fair value in the financial statements on a recurring basis, which includes ROU assets, property and equipment, goodwill, intangibles and cost method investments, are measured at fair value in certain circumstances (for example, when there is evidence of impairment). As of* June 30, 2024and December 31, 2023,*there wasno indication of impairment related to these assets.

Annually, we consider whether the recorded goodwill and indefinite lived intangibles have been impaired. However, goodwill and intangibles must be tested between annual tests if an event occurs or circumstances change to indicate that it is more likely thannot that an impairment loss has been incurred (“triggering event”).

****Commitments and Contingencies

From time to time, we are involved in certain claims and litigation arising in the normal course of business. Management assesses the probability of loss for such contingencies and recognizes a liability when a loss is probable and estimable. Legal fees, net of estimated insurance recoveries, are expensed as incurred. We donot believe the final disposition of claims at* June 30, 2024*will have a material adverse effect on our consolidated financial position, results of operations or liquidity.

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The following table disaggregates revenue for thethree- andsix-month periods ended* June 30, 2024and2023* based on timing of revenue recognition (in thousands):

The following table provides information about receivables, contract assets, and contract liabilities from contracts with customers (In thousands):

Significant changes in contract assets and contract liabilities during thesix-month periods ended* June 30, 2024and2023* are as follows (in thousands):

We have elected to apply the practical expedient tonot disclose the value of unsatisfied performance obligations for contracts with an original expected length ofone year or less. Total remaining contract revenue for contracts with original duration of greater thanone year expected to be recognized in the future related to performance obligations that are unsatisfied at* June 30, 2024*approximated $43.8 million, of which $8.9 million, $17.3 million, $13.7 million, $3.7 million, $181,000 and $46,000 are expected to be recognized during 2024, 2025, 2026, 2027, 2028 and 2029, respectively.

The effective tax rate for thethree andsix-month periods ended* June 30, 2024increased to 26% from 23% and 24% from 23%, respectively, for the same period in2023.* The change in thethree andsix-month periods was mainly due to decreased tax benefits of $132,000 and $53,000, respectively from the exercise of share-based compensation awards and increased state income taxes of approximately $80,000 and $112,000, respectively, which fluctuate based on various apportionment factors and rates for the states in which we operate.

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Our long-term debt consists of the following:

Our amended and restated credit agreement (the “Credit Agreement”) with First National Bank of Omaha (“FNB”) 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 dividends, 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 is payable in monthly installments of $462,988 through* May 2027*and bears interest at a fixed rate per annum of 5%.

Borrowings under the Delayed Draw Term Loan and Line of Credit, if any, bear interest at a floating rate equal to the30-day Secured Overnight Financing Rate (“SOFR”) plus 235 basis points (7.68% at* June 30, 2024).*Interest on the Line of Credit and Delayed Draw Term Loan 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 June 30, 2024,we had $9,000,000 of borrowings outstanding and the availability to borrow $21,000,000 on the Line of Credit. The weighted average borrowings on the Line of Credit for thethree* andsix months ended* June 30, 2024was $10 million and $9.5 million. There wereno borrowings on the Line of Credit in thesix* months ended* June 30, 2023.The weighted average interest rate on borrowings on the Line of Credit during thethree*-month andsix-month periods ended* June 30, 2024*was 7.67% and 7.68%, respectively.

Principal payments are due on the Delayed Draw Term Loan in monthly installments of $226,190 through* April 2027and a balloon payment for the remaining balance of $10.2 million is due in May 2027.We had the availability to borrow an additional $56 million on the Delayed Draw Term Loan at June 30, 2024.*

We are obligated to pay ongoing unused commitment fees quarterly in arrears pursuant to the Line of Credit and the Delayed Draw Term Loan facility at a rate of 0.20% per annum based on the actual daily unused portions of the Line of Credit and the Delayed Draw Term Loan facility.

The Credit Agreement is collateralized by substantially all of our assets, subject to permitted liens and other agreed exceptions, and 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. In* June 2023,the Credit Agreement was amended to exclude our costs associated with our building renovation from or after January 1, 2023,from the fixed charge coverage ratio calculation. 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, (iii) the portion of any acquisition consideration for a permitted acquisition paid with cash on hand, and (iv) up to $25 million of costs associated with our building renovation from or after January 1, 2023.*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 direct and indirect wholly owned domestic subsidiaries, if any, and, to the extent required by the Credit Agreement, direct and indirect wholly owned foreign subsidiaries.

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We measure and recognize compensation expense for all share-based payments based on the grant-date fair value of those awards. All of our existing stock option awards and unvested stock awards have been determined to be equity-classified awards. We account for forfeitures as they occur. We refer to our restricted stock awards as “non-vested” stock in these condensed consolidated financial statements.

Our2004 Non-Employee Director Stock Plan, as amended (the*“2004* Director Plan”), is a nonqualified plan that provides for the granting of options with respect to 3,000,000 shares of our common stock. The2004 Director Plan provides for grants of nonqualified stock options to each of our directors who we donot employ. On the date of each annual meeting of shareholders, options to purchase shares of common stock equal to an aggregate grant date fair value of $100,000 are granted to each non-employee director that is elected or retained as a director at each such meeting. Stock options vest approximatelyone year following the date of grant and option terms are generally the earlier often years following the date of grant, orthree years from the termination of the non-employee director’s service.

Our2006 Equity Incentive Plan (the*“2006* Equity Incentive Plan”), as amended, provides for the granting of stock options, stock appreciation rights, restricted stock, performance shares and other share-based awards and benefits up to an aggregate of 1,800,000 shares of our common stock. Stock options granted* may*be either incentive stock options or nonqualified stock options. Options to purchase shares of common stock are typically granted with exercise prices equal to the fair value of the common stock on the date of grant. We do, in certain limited situations, grant options with exercise prices that exceed the fair value of the common stock on the date of grant.

Performance-Based Stock Option Awards

We grant stock options to selected executives with vesting contingent upon meeting certain Company-wide performance goals. The performance goals for options issued in2024 are based on reaching a total recurring contract value target, measured at the end of the performance period,* December 31, 2026.Vesting is also dependent upon remaining in our employment through the performance period. The performance awards issued in2024* have asix-year contractual term. We recognize compensation expense prospectively from the date it is deemed probable that the performance goal will be met through the end of the performance period. We granted 404,833 performance-based stock option awards during thesix-month period ended* June 30, 2024.No performance-based stock options were awarded in2023.*

The fair value of performance-based stock options granted was estimated using a Black-Scholes valuation model with the following weighted average assumptions:

The risk-free interest rate assumptions were based on the U.S. Treasury yield curve in effect at the time of the grant. The expected volatility was based on historical monthly price changes of our stock based on the expected life of the options at the date of grant. The expected life of options is the average number of years we estimate that options will be outstanding. We consider groups of associates that have similar historical exercise behavior separately for valuation purposes.

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The following table summarizes performance-based stock option activity under the2006 Equity Incentive Plan for thesix-month period ended* June 30, 2024:*

Service-Based Stock Option Awards

We also grant stock options to directors and selected executives with vesting based on specified service periods. Vesting terms vary with each grant and option awards are generally five toten years following the date of grant. We recognize compensation expense on a straight-line basis over the service period specified in the award. We granted 54,530 and 96,359 service-based stock option awards during thesix-month periods ended* June 30, 2024and June 30, 2023,*respectively.

The fair value of service-based stock options granted in2024 was estimated using a Black-Scholes valuation model with the following weighted average assumptions:

The risk-free interest rate assumptions were based on the U.S. Treasury yield curve in effect at the time of the grant. The expected volatility was based on historical monthly price changes of our stock based on the expected life of the options at the date of grant. The expected life of options is the average number of years we estimate that options will be outstanding. We consider groups of associates that have similar historical exercise behavior separately for valuation purposes.

The following table summarizes service-based stock option activity under the2006 Equity Incentive Plan and the2004 Director Plan for thesix-month period ended* June 30, 2024:*

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There was $584,000 of cash received from stock options exercised for thesix-month periods ended* June 30, 2023,andno cash received from options exercised in thesix*-month periods ended* June 30, 2024.We recognized $112,000 and $278,000 of non-cash compensation forthree*-month periods ended* June 30, 2024and2023,* respectively, and $64,000 and $554,000 of non-cash compensation for thesix-month periods ended* June 30, 2024and2023,* respectively, related to options, which is included in selling, general and administrative expenses.

As of* June 30, 2024,*the total unrecognized compensation cost related to non-vested performance-based and service-based stock option awards was approximately $5.5 million which was expected to be recognized over a weighted average period of 2.4 years.

Non-vested Stock Awards

No non-vested shares of common stock were granted under the2006 Equity Incentive Plan during thesix-month periods ended* June 30, 2024and2023.* As of* June 30, 2024,there wereno* non-vested shares of common stock outstanding andno related remaining unrecognized compensation cost to recognize. We recognized non-cash compensation (benefit) expense of ($169,000) and $27,000 for thethree-month periods ended* June 30, 2024and2023,* respectively, and ($156,000) and $54,000 for thesix-month periods ended* June 30, 2024and2023,* respectively, related to this non-vested stock, which is included in selling, general and administrative expenses. The following table summarizes information regarding non-vested stock granted to associates under the2006 Equity Incentive Plan for thesix-month period ended* June 30, 2024:*

The following represents the carrying amount of goodwill at* June 30, 2024:*

Intangible assets consisted of the following:

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Basic net income per share was computed using the weighted-average shares of common stock outstanding during the period.

Diluted net income per share was computed using the weighted-average shares of common stock and, if dilutive, the potential common stock outstanding during the period. Potential shares of common stock consist of the incremental common stock issuable upon the exercise of stock options and vesting of restricted stock. The dilutive effect of outstanding stock options is reflected in diluted earnings per share by application of the treasury stock method.

We had 796,694 and 276,949 options of common stock for thethree-month periods ended* June 30, 2024and2023,* respectively, which have been excluded from the diluted net income per share computation because their inclusion would be anti-dilutive. We had 674,428 and 265,673 options of common stock for thesix-month periods ended* June 30, 2024and2023,* respectively, which have been excluded from the diluted net income per share computation because their inclusion would be anti-dilutive.

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On* July 15, 2024,we acquired all issued and outstanding shares of stock of Nobl, Inc., a company with rounding solutions for healthcare organizations. The acquisition expands our service offerings in patient and employee experience, enhancing our ability to provide real-time feedback. In accordance with the Stock Purchase Agreement, we paid $5.5 million of the all-cash consideration at closing subject to a customary working capital adjustment. The closing payment was funded through borrowings on our Line of Credit. The Stock Purchase Agreement also provides for up to $1.0 million in earn-out payments in the event certain performance-based measures are met during the period following the acquisition through June 30, 2026.Acquisition related expenses of $42,000 are included in Selling, General and Administrative expenses forthree* andsix-month periods ending* June 30, 2024.We are currently finalizing the accounting for this transaction and expect to complete our preliminary allocation of the purchase consideration to the assets acquired and liabilities assumed by the end of thethird* quarter of2024. Pro-forma information hasnot been presented because the amounts are insignificant.

On* August 5, 2024,we amended our Credit Agreement for our Credit Facilities. The amended Credit Agreement extends the maturity date of our Line of Credit to May 2027.The balance outstanding on our Term Loan is payable in equal monthly installments amortized over aten*-year period and bears interest at a floating rate equal to the30-day SOFR plus 235 basis points. The Delayed Draw Term Loan is payable in equal monthly installments amortized over aten-year period. All outstanding principal and accrued interest on the Term Loan and Delayed Draw Term Loan is payable in* May 2027.*The amendment also extends the use of the Delayed Draw Term Loan to capital expenditures and revises the building renovations excluded from the fixed charge coverage ratio covenant from $25 million to $27.5 million.

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