1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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 providers, payers and other healthcare organizations in the United States and Canada. The Company’s solutions enable its clients to understand the voice of the customer with greater clarity, immediacy and depth.

The Company’s

six

operating segments are aggregated into

one

reporting segment because they have similar economic characteristics and meet the other aggregation criteria from the Financial Accounting Standards Board (“FASB”) guidance on segment disclosure. The

six

operating segments are Experience, The Governance Institute, Market Insights, Transparency, NRC Health Canada and Transitions (formerly Connect), which offer a portfolio of solutions that address specific needs around market insight, experience, transparency and governance for healthcare providers, payers and other healthcare organizations.

The condensed consolidated balance sheet of the Company at

December 31, 2017,

was derived from the Company’s 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) the Company considers 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 the Company’s Form

-K for the year ended

December 31, 2017,

filed with the Securities and Exchange Commission (the “SEC”) on

March 14, 2018.

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 its wholly-owned subsidiary, National Research Corporation Canada, doing business as NRC Health Canada. All significant intercompany transactions and balances have been eliminated.

The Company’s Canadian subsidiary uses as its functional currency the local currency of the country in which it operates. It translates its assets and liabilities into U.S. dollars at the exchange rate in effect at the balance sheet date. It translates its revenue and expenses at the average exchange rate during the period. The Company includes translation gains and losses in accumulated other comprehensive income (loss), a component of shareholders’ equity. Gains and losses related to transactions denominated in a currency other than the functional currency of the country in which the Company operates and short-term intercompany accounts are included in other income (expense) in the consolidated statements of income.

Revenue Recognition

January 1, 2018,

the Company adopted Accounting Standards Update (“ASU”)

2014

09,

Revenue- Revenue from Contracts with Customers

and all related amendments (“ASC

606”

or “new revenue standard”) using the modified retrospective method for all incomplete contracts as of the date of adoption. The Company applied the practical expedient to reflect the total of all contract modifications occurring before

January 1, 2018

in the transaction price and performance obligations at transition rather than accounting for each modification separately. Results for reporting periods beginning on or after

January 1, 2018

are presented under ASC

606,

while prior period amounts are

not

adjusted and continue to be reported under the accounting standards in effect for the prior period. As discussed in more detail below and under “Deferred Contract Costs”, the largest impact of implementing the new revenue standard was the deferral and amortization of direct and incremental costs of obtaining contracts. In addition, there were other revisions to the revenue recognition primarily related to performance obligation determinations and estimating variable consideration. The Company recorded a transition adjustment of approximately

$2.7

million, net of

$814,000

of tax, to the opening balance of retained earnings.

The Company derives a majority of its revenues from its annually renewable subscription-based service agreements with its customers, which include performance measurement and improvement services, healthcare analytics and governance education services. Such agreements are generally cancelable on short or

notice without penalty. See Note

for further information about the Company's contracts with customers. Under ASC

606,

the Company accounts for revenue using the following steps:

●

Identify the contract, or contracts, with a customer

●

Identify the performance obligations in the contract

●

Determine the transaction price

●

Allocate the transaction price to the identified performance obligations

●

Recognize revenue when, or as, the Company satisfies the performance obligations.

The Company’s revenue arrangements with a client

may

include combinations of more than

one

service offering which

may

be executed at the same time, or within close proximity of

one

another. The Company combines 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 as a single performance obligation. For contracts that contain more than

one

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. The Company estimates the amount of total contract consideration it expects to receive for variable arrangements based on the most likely amount it expects to earn from the arrangement based on the expected quantities of services it expects to provide and the contractual pricing based on those quantities. The Company only includes 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 will

not

occur. The Company considers the sensitivity of the estimate, its 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.

Prior to

2018,

total contract consideration was allocated to each separate unit of accounting that was separately sold by the Company or a competitor, based on relative selling price using a selling price hierarchy: vendor-specific objective evidence (“VSOE”), if available,

third

-party evidence (“TPE”) if VSOE was

not

available, or estimated selling price if VSOE nor TPE was available. VSOE was established based on the services normal selling prices and discounts for the specific services when sold separately. TPE was established by evaluating similar competitor services in standalone arrangements. If neither existed for a deliverable, the best estimate of the selling price (“ESP”) was used for that deliverable based on list price, representing a component of management’s market strategy, and an analysis of historical prices for bundled and standalone arrangements. Revenue allocated to an element was limited to revenue that was

not

subject to refund or otherwise represented contingent revenue.

The Company’s arrangements with customers consist principally of

four

different types of arrangements:

) subscription-based service agreements;

)

one

-time specified services performed at a single point in time;

) fixed, non-subscription service agreements; and

) unit-priced service agreements.

Subscription-based services -

Services that are provided under subscription-based service agreements are usually for a

twelve

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 annually in advance, but

may

also be billed on a quarterly and monthly basis.

One-time services –

These agreements typically require the Company to perform a specific

one

-time service in a particular month. The Company is entitled to fixed payment upon completion of the service. Under these arrangements, the Company recognizes revenue at the point in time the service is completed by the Company and accepted by the customer.

Fixed, non-subscription services –

These arrangements typically require the Company 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. Prior to

2018,

these arrangements were recognized under the proportional performance method based on cost inputs, output measures or key milestones such as survey set-up, survey mailings, survey returns and reporting.

Unit-price services –

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

The Company recognizes contract assets or unbilled receivables related to revenue recognized for services completed but

not

invoiced to the clients. Unbilled receivables are classified as receivables when the Company has 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.

The following tables summarize the impact the adoption of ASC

606

had on the Company’s consolidated financial statements (in thousands, except per share data):

Consolidated balance sheet:

	As reported June 30, 2018			Adjustments			Balances without Adoption of ASC 606
Accounts receivable, net	$	10,689		$	5		$	10,694
Other current assets		125			(72	)		53
All other current assets		12,819			--			12,819
Total current assets		23,633			(67	)		23,566
Deferred contract costs		3,369			(3,369	)		--
All other noncurrent assets		75,883			--			75,883
Total assets	$	102,885		$	(3,436	)	$	99,449

Deferred revenue	$	16,660		$	61		$	16,721
Other current liabilities		16,257			--			16,257
Total current liabilities		32,917			61			32,978
Deferred income taxes		5,808			(802	)		5,006
Other long term liabilities		37,343			--			37,343
Total liabilities		76,068			(741	)		75,327

Retained earnings		(99,810	)		(2,697	)		(102,507	)
Accumulated other comprehensive income		(2,333	)		2			(2,331	)
Other stockholders’ equity		128,960			--			128,960
Total stockholders’ equity		26,817			(2,695	)		24,122
Total liabilities and stockholders’ equity	$	102,885		$	(3,436	)	$	99,449

Consolidated statement of income:

	Three months ended June 30, 2018									Six months ended June 30, 2018
	As reported			Adjustments			Balances Without Adoption of ASC 606			As reported		Adjustments			Balances Without Adoption of ASC 606
Revenue	$	28,017		$	120		$	28,137		$	59,034	$	48		$	59,082

Direct expenses		10,996			(28	)		10,968			23,904		(59	)		23,845
Selling, general and administrative		7,940			(173	)		7,767			15,808		57			15,865
Depreciation and amortization		1,325			--			1,325			2,608		--			2,608
Total operating expenses		20,261			(201	)		20,060			42,320		(2	)		42,318
Operating income		7,756			321			8,077			16,714		50			16,764
Other income (expense)		63			--			63			71		--			71
Income before income taxes		7,819			321			8,140			16,785		50			16,835
Provision (benefit) for income taxes		(129	)		74			(55	)		1,531		12			1,543
Net income	$	7,948		$	247		$	8,195		$	15,254	$	38		$	15,292
Earnings per share of common stock:
Basic earnings per share:
Common (formerly Class A)	$	0.29		$	0.01		$	0.30		$	0.47	$	--		$	0.47
Class B		0.27			--			0.27			1.31		--			1.31
Diluted earnings per share:
Common (formerly Class A)	$	0.28		$	0.01		$	0.29		$	0.45	$	--		$	0.45
Class B		0.26			0.01			0.27			1.27		0.01			1.28

Consolidated statement of comprehensive income:

	Three months ended June 30, 2018								Six months ended June 30, 2018
	As reported			Adjustments		Balances without adoption of ASC 606			As reported			Adjustments		Balances without adoption of ASC 606
Net Income	$	7,948		$	247	$	8,195		$	15,254		$	38	$	15,292
Cumulative translation adjustment		(283	)		4		(279	)		(698	)		2		(696	)
Comprehensive Income	$	7,665		$	251	$	7,916		$	14,556		$	40	$	14,596

Consolidated statement of cash flows:

	Six months ended June 30, 2018
	As reported			Adjustments			Balances without adoption of ASC 606
Cash flows from operating activities:
Net income	$	15,254		$	38		$	15,292
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,608			--			2,608
Deferred income taxes		996			12			1,008
Reserve for uncertain tax positions		92			--			92
Non-cash share-based compensation expense		995			--			995
Impairment of property and equipment		2			--			2
Change in assets and liabilities:
Trade accounts receivable and unbilled revenue		3,955			128			4,083
Prepaid expenses and other current assets		(2,393	)		(2	)		(2,395	)
Deferred contract costs		2			(2	)		--
Accounts payable		481			--			481
Accrued expenses, wages, bonus and profit sharing		(2,371	)		--			(2,371	)
Income taxes receivable and payable		(1,235	)		--			(1,235	)
Deferred revenue		5			(176	)		(171	)
Net cash provided by operating activities		18,391			(2	)		18,389
Net cash used in investing activities		(2,773	)		--			(2,773	)
Net cash used in financing activities		(43,058	)		--			(43,058	)
Effect of exchange rate changes on cash		(595	)		2			(593	)
Change in cash and cash equivalents		(28,035	)		--			(28,035	)
Cash and cash equivalents at beginning of period		34,733			--			34,733
Cash and cash equivalents at end of period	$	6,698			--		$	6,698

Deferred Contract Costs

Deferred contract costs, net is stated at gross deferred costs less accumulated amortization. Beginning

January 1, 2018,

with the adoption of the new revenue standard, the Company defers commissions and incentives, including payroll taxes, 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

five

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 the Company expects to receive less than the expected future costs directly related to providing those services. The Company deferred incremental costs of obtaining a contract of

$445,000

and

$1,272,000

in the

three

and

six

months ended

June 30, 2018,

respectively. Total amortization was

$639,000

and

$1,254,000

for the

three

and

six

months ended

June 30, 2018,

respectively. Amortization of deferred contract costs included in direct expenses was

$29,000

and

$59,000

for the

three

and

six

months ended

June 30, 2018,

respectively. Amortization of deferred contract costs included in selling, general and administrative expenses was

$610,000

and

$1,195,000

for the

three

and

six

months ended

June 30, 2018,

respectively. Additional expense included in selling, general and administrative expenses for impairment of costs capitalized due to lost clients was

$7,000

and

$19,000

in the

three

and

six

months ended

June 30, 2018,

respectively. The Company has elected the practical expedient to expense contract costs when incurred for any nonrenewable contracts with a term of

one

year or less. Prior to

2018,

all commissions and incentives were expensed as incurred. The Company recorded a transition adjustment on

January 1, 2018

as an increase to retained earnings of

$2.6

million, net of

$776,000

of tax, to reflect

$3.4

million of commissions and incentives related to contracts that began prior to

2018,

net of accumulated amortization.

Fair Value Measurements

The Company’s 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 the Company’s market assumptions. The inputs are then classified into the following hierarchy: (

) Level

Inputs—quoted prices in active markets for identical assets and liabilities; (

) Level

Inputs—observable market-based inputs other than Level

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 are

not

active, or other inputs that are observable or can be corroborated by observable market data; and (

) Level

Inputs—unobservable inputs.

Commercial paper and Eurodollar deposits are included in cash equivalents and are valued at amortized cost, which approximates fair value due to their short-term nature. Eurodollar deposits are United States dollars deposited in a foreign bank branch of a United States bank and have daily liquidity. Both of these are included as a Level

measurement in the table below.

The following details the Company’s financial assets and liabilities within the fair value hierarchy at

June 30, 2018

and

December 31, 2017:

Fair Values Measured on a Recurring Basis

	Level 1		Level 2		Level 3		Total
	(In thousands)
As of June 30, 2018
Money Market Funds	$	767	$	--	$	--	$	767
Total	$	767	$	--	$	--	$	767

As of December 31, 2017
Money Market Funds	$	13,971	$	--	$	--	$	13,971
Commercial Paper		--		10,490		--		10,490
Eurodollar Deposits		--		10,017		--		10,017
Total	$	13,971	$	20,507	$	--	$	34,478

There were

transfers between levels during the

three

month period ended

June 30, 2018.

The Company's long-term debt is recorded at historical cost. The fair value of long-term debt is classified in Level

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

	June 30, 2018		December 31, 2017
	(In thousands)
Total carrying amount of long-term debt	$	39,781	$	1,067
Estimated fair value of long-term debt	$	39,813	$	1,066

The Company believes that the carrying amounts of trade accounts receivable, accounts payable and accrued expenses approximate their fair value due to the short maturity of those instruments. Long-lived assets that are

not

recognized or disclosed at fair value in the financial statements on a recurring basis, which includes 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, 2018,

and

December 31, 2017,

there was

indication of impairment related to these assets.

Contingencies

From time to time, the Company is 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.

Since the

September 2017

announcement of the original proposed recapitalization plan (“Original Transaction”) (see Note

three

purported class action and/or derivative complaints have been filed in state or federal courts by

three

individuals claiming to be shareholders of the Company. All of the complaints name as defendants the Company and the individual directors of the Company. Two of these lawsuits were filed in the United States District Court for the District of Nebraska— a putative class action lawsuit captioned

Gennaro v. National Research Corporation, et al

., which was filed on

November 15, 2017,

and a putative class and derivative action lawsuit captioned

Gerson v. Hays, et al

., which was filed on

November 16, 2017.

These lawsuits were consolidated by order of the federal court under the caption

In re National Research Corporation Shareholder Litigation

. A

third

lawsuit was filed in the Circuit Court for Milwaukee County, Wisconsin—a putative class action lawsuit captioned

Apfel v. Hays, et al

., which was filed on

December 1, 2017.

The allegations in all of the lawsuits were very similar. The plaintiffs alleged, among other things, that the defendants breached their fiduciary duties in connection with the allegedly unfair proposed transaction, at an allegedly unfair price, conducted in an allegedly unfair and conflicted process and in alleged violation of Wisconsin law and the Company’s Articles of Incorporation. The plaintiffs in these lawsuits sought, among other things, an injunction enjoining the defendants from consummating the Original Transaction, damages, equitable relief and an award of attorneys’ fees and costs of litigation. After the announcement of a revised proposed recapitalization plan (the “Recapitalization”), the plaintiffs abandoned their efforts to enjoin the transaction. However, the plaintiffs in

In re National Research Corporation Shareholder Litigation

in Nebraska filed an Amended Complaint on

March 23, 2018

seeking damages for alleged breach of fiduciary duties in connection with the Original Transaction and alleged omission of material facts in the proxy statement relating to the Recapitalization. The plaintiffs in the

Apfel

case in Wisconsin filed an amended complaint on

April 4, 2018

seeking damages for alleged breach of fiduciary duties in connection with the Original Transaction and the Recapitalization. The Company and its directors will defend themselves against these lawsuits vigorously, and have moved to dismiss both lawsuits. These motions are pending. As of

June 30, 2018,

losses have been accrued as the Company does

not

believe the losses are probable or estimable.

Recent Accounting Pronouncements

Not

Yet Adopted

January 2016,

the FASB issued ASU

2016

01,

Financial Instruments—Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. ASU

2016

changes certain recognition, measurement, presentation and disclosure aspects related to financial instruments. ASU

2016

is effective for financial statements issued for fiscal years beginning after

December 15, 2017,

and interim periods within those fiscal years. Early adoption is

not

permitted. The Company believes its adoption will

not

significantly impact the Company’s results of operations and financial position.

February 2016,

the FASB issued ASU

2016

02,

Leases (Topic

842

). This ASU requires lessees to recognize a lease liability and a right-to-use asset for all leases, including operating leases, with a term greater than

twelve

months on its balance sheet. This ASU is effective in fiscal years beginning after

December 15, 2018,

with early adoption permitted, and requires a modified retrospective transition method. As of

June 30, 2018,

the Company had approximately

$4.0

million of operating lease commitments which would be recorded on the balance sheet under the new guidance. However, the Company is currently in the process of further evaluating the impact that this new guidance will have on its consolidated financial statements and does

not

plan to elect early adoption. The Company expects to utilize the optional practical expedients to

not

reassess whether expired or existing contracts contain leases,

not

reassess the lease classification for expired or existing leases and reassess initial direct costs for existing leases.

June 2016,

the FASB issued ASU

2016

13,

Financial Instruments – Credit Losses (Topic

326

): Measurement of Credit Losses on Financial Instruments. This ASU will require the measurement of all expected credit losses for financial assets, including trade receivables, held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The guidance is effective for annual reporting periods beginning after

December 15, 2019

and interim periods within those fiscal years. The Company believes its adoption will

not

significantly impact the Company’s results of operations and financial position.