HealthStream, Inc. (HSTM) Q2 2017 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to HealthStream's Second Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mollie Condra, Vice President of Investor Relations and Communications. Ma’am, you may begin.

Thank you, and good morning. Thank you for joining us today to discuss our second quarter 2017 results. Also on the conference call with me are Robert A. Frist Jr., CEO and Chairman of HealthStream, and Gerry Hayden, Senior Vice President and CFO. I would also like to remind you that this conference call may contain forward-looking statements regarding future events and the future performance of HealthStream that involve risks and uncertainties that could cause the actual results to differ materially from those projected in the forward-looking statements. Information concerning these risks and other factors that could cause the results to differ materially from those forward-looking statements are contained in the company’s filings with the SEC, including Forms 10-K and 10-Q. So with that opening, I will turn it over to Bobby Frist.

Thank you, Mollie. Good morning everyone and welcome to our second quarter 2017 earnings conference call. As always I'll start with a few highlights and then turn it over to Gerry for some details on financial performance. Our second quarter performance on our core financial metrics did turn out pretty strong this quarter. Compared to the second quarter last year, quarterly revenues were up 12% reaching $61.5 million. Operating income was up 23% and net income was up 62% and adjusted EBITDA was up 25%. These results showed sequential improvement over the last quarter and it is that sequential improvement that gives us confidence in our expectation of continued leverage operating income growth for 2017. Second quarter revenues were up 10% over the same period last year for our Workforce Solutions segment. The continued drag and we've talked about this for almost three years, but the continued drag of the ICD-10 revenue drop off was offset by strong contributions from our Compliance Solutions as well as the continued performance of resuscitation products. In our Provider Solutions segment second quarter revenues were up 53% over the same period last year. This was due in part the inclusion of the Morrisey acquisition in this year's year-to-date results after we acquired that business in the third quarter of 2016. In our Patient Experience Solutions segment second quarter revenues were down slightly at 4% less than the same quarter last year. I'm going to elaborate in more detail on each of these three segments in the second half of the discussion after Gerry gives a more detailed look at core financial metrics. I'll turn it over to Gerry. Gerry, now I do want to dive on those two points and I want to say to the very end, I'm glad to get them up here early and front. So there are two points about that quarter that are worth highlighting from my point of view. The first point relates to sales and so these are our sales generation during the second quarter. They were less than expected in our Workforce Development and our Provider Solutions segments while sales from our Patient Experience segment they were ahead of plan. While our sales pipeline remained healthy our Q2 sales performance did not meet expectations. That was what led us to pull down our revenue guidance range for the full year. I'm sure we'll talk more about that later in Q&A as well. The second point relates to our combined focus and continued focus on returning to operating income leverage which is evidenced from our 23% [ph] growth in operating income and 62% growth in net income compared to the same period last year. We've taken several measures both in changing partnerships to improve margins, how we operate business segments with the closing of our remote office to improve efficiency, improve margins and improve leverage. Some of this will continue to materialize in the second half of the year. And we achieved this leverage operating income growth despite a $1 million margin loss on the ICD-10 readiness products on a year-over-year basis and the deferred revenue write-down related to our August 2016 acquisition of Morrisey Associates. So a core focus for the company is generating more operating leverage and generating more operating income from the revenue growth we're delivering. With those two points upfront, I'd like to turn over to Gerry for a more detailed look at the financials.

Thank you, Bobby, and good morning everyone. I'll provide some additional information about our financial results including certain items that impacted the quarter. The second quarter consolidated revenues were up 12% to $61.5 million, operating income of $2.9 million was up 23% versus operating income of $2.3 million in the last year’s second quarter. Net income was $2.3 million, earnings per share was $0.07 versus net income of $1.4 million and $0.04 per share earnings in the second quarter of 2016. Adjusted EBITDA was up 25% as Bobby just mentioned to $9.9 million from $7.9 million of last year’s second quarter. During the second quarter, the Morrisey Associates acquisition, which closed in August of 2016, contributed approximately $2.6 million of revenue and incurred an operating loss of $468,000 primarily due to the deferred revenue write-down accounting convention. Now [let’s look at this quarter’s][ ph] income statement, segment revenues, gross margins, operating expenses and operating income. Revenues from our Workforce Solutions segment increased by $4.1 million while overcoming a $2 million year-over-year decline in ICD-10 readiness revenues in the second quarter. Now let’s take a quick look at the Workforce ARIS. For the second quarter of 2017, HealthStream’s Workforce ARIS was $38.16, which is up when compared to last year’s second quarter of $35.70 and this year's first quarter of $37.68, so we grew ARIS both quarter over quarter and sequentially. ARIS as we discussed in previous quarters is also subject to movements that can seem counterintuitive; for example, adding a high desirable number of subscribers can actually drive the ARIS down if the amount sold to each subscriber does not equal or exceed the actual previous quarter’s ARIS. Similarly, losing subscribers who pay less with previous quarter’s ARIS can drive ARIS up. It’s also important to keep in mind that ARIS does not include a complete look at our business, as two out of our three business segments, Patient Experience and Provider Solutions, are not included in ARIS at all. We continue to evaluate new metrics that encompass all of our business. Revenues from our Patient Experience Solutions segment for the second quarter of 2017 were $8.6 million compared with $9 million in the second quarter of 2016. Revenues from Patient Insights surveys declined by $140,000 and continuing the trend towards [Indiscernible] adoption of online patient surveys which [Indiscernible] lower price points than phone surveys but produced higher margins for us. For example, for the first six months of 2017 the volume of phone based patient surveys declined 28% while online patient surveys increased by 12% in the same period. However, the Patient Experience gross margin has increased by 400 basis points over the first half of this year. Revenues from other Patient Experience Solutions including surveys conducted on annual or biannual cycles decreased by $266,000 compared to the second quarter of last year. This decrease is primarily due to the timing of engagements compared to the prior year. The second quarter of 2017 revenues from our Provider Solutions segment increased by approximately $3 million, the Morrisey Associates acquisition representing approximately $2.6 million of that increase. Now let's look at gross margins. Our gross margin was 57% in this quarter versus 59% in last year's second quarter. The impact of the Morrisey deferred revenue write-down and the final Laurel office closure costs are the primarily reasons for this lower gross margin. This does represent continued sequential improvement as the gross margin has increased from 55% in the fourth quarter of 2016 to its current 57%. Now turning to operating expenses, operating expenses for the quarter were up 8% from the second quarter of 2016. The combination of capitalized software investments and product development expenses grew by 8% year-over-year, even though the product revenue category on the income statement showed a year-over-year decline of $200,000. Sales and marketing expenses increased mainly due to higher commission costs. Depreciation and amortization also increased 29% over last year’s second quarter, reflecting increased level of capitalized software development amortization and the amortization of acquired intangible assets from the Morrisey acquisition. G&A expenses in the second quarter of 2017 were relatively flat, but improved as a percentage of revenue to 13.9%, which compares to 15.6% in the second quarter of 2016. It is important to note that G&A expenses are expected to increase in the second half of this year as we incur implementation and compliance costs related to new GAAP revenue recognition accounting standard known as ASC 606. We anticipate that that this expense will be approximately [$1.3] [ph] million over the next six months. Our operating income was $2.9 million in the second quarter of 2017 compared to $2.2 million of operating income in the second quarter of 2016. The increase in operating income reflects leverage on our product development and G&A expenses while [indiscernible] the $1 million margin loss from the decline in ICD-10 revenues and also deferred revenue write-downs and the higher appreciation of amortization expenses I just mentioned. Now our balance sheet, our cash position in the overall balance sheet remained strong. Our cash balance at June 30, was approximately $116 million a $13 million increase since December 31. A contributor to this cash balance has been improved collections, a sequential drop in DSO from 71 days at December 31, 2016 to its current 57 days resulting in $7.5 million reduction in the accounts receivable balances. In the outstanding debt in our full $50 million line of credit capacity is available to us. We believe our overall capital position is slightly supportive of our organic and inorganic growth opportunities and support other capital structure optimizations and shareholder value maximization strategies as may be appropriate. Cash flow from operations on our cash flow statement has improved to $23 million in the first six months of 2017 versus $25,000 in the same period in 2016. So moving to guidance I'll describe the fluctuation in our [indiscernible]. January 1, 2017 we adopted a new GAAP accounting standard that applies to book income tax accounting. Specifically the new statement flows the tax benefits and stock option exercises through the income statement as far as the income tax provision. In past years that transaction went direct to the balance sheet bypassing the tax provision. What's important for you to note is that there is no change to our federal income tax position or cash flows and I would say this adoption will terminate [ph] federal income tax liabilities. The [indiscernible] contains update guidance for the 2017 full year. We anticipate the consolidated revenues will grow to 8% and 10% as compared to 2016 and the growth in our three operating segments will be as follows: Workforce Solutions 4% to 6%, Patient Experience Solutions 3% to 5%, Provider Solutions 10% to 51% and the Workforce segment anticipate ICD-10 revenues in this revenue to be positive $1 million in 2017 versus $9 million in 2016 certainly a low decline during this 2017. We continue to anticipate that our full year operating income will increase 50% to 65% over 2016. We anticipate our capital expenditures will be between $15 million and $17 million and our effective income tax rate will be between 32% and 36% for the current year. This guidance does not include the impact of any other acquisitions that we may close during the remainder of this year. Thank you for your time. I'll turn the call back to Bobby.

Thank you, Gerry. I think what I'd like to do is dive into the segments a little more detail and I'll give some business updates on each of them. So let's start with Workforce Solutions. At the end of the second quarter around June 26 we announced that our current agreements with Laerdal Medical for the HeartCode and RQI products will expire and they will expire on December 31, 2018. It's important that the HealthStream retains the right to and expect to continue selling HeartCode and RQI for the next year and a half and importantly we will provide uninterrupted service to our customers for the duration of their contracts. Those contracts could be extended through December 31, 2020. As we stated, this news does not affect our financial guidance for 2017. And so related to that, we are committed to broadening the scope and utilization of our simulation technologies as a method of validating a wide range of clinical competencies including and beyond resuscitation skills. Next Generation manikins, virtual reality and augmented reality are among the innovative and disruptive technologies we plan to bring to market. Those technologies will enable us to deliver choice, low cost and more effective simulation based training solutions in the future. To this end we are in active negotiations with a number of strategic partners. In fact, just last week we signed a long term agreement with a new partner. This agreement will feature unique integrations with HealthStream's platform including HealthStream's emerging technologies such as our credentialing systems, the Echo Credentialing Systems and e-Portfolio a newly announced product. In the coming months we expect to introduce a number of new partners and technologies as part of our expanded approach to using simulation technology for a broad range of clinical areas which will include model clinical specialties, nurse on-boarding and beginning in January of 2019 resuscitation skills. I'd like to turn our attention to the Patient Experience segment for just a moment. We continue to anticipate improved margins from this segment, particularly in the second half of the year. For example, during the quarter we continue to see an uptake in new clients per single online surveys as Gerry mentioned. These have a higher margin then phone surveys and existing clients are converting from phone to email and SMS text surveys. We've now converted about a third of all surveys capable of being converted from phone to online surveys and we expect this conversion trend to continue throughout the remainder of the year. As you know, we closed our Laurel, Maryland interview center in June and have consolidated operations to our national interview center which is a newer center and the cost of that closure was borne in the first and second quarters and so we expect to have those costs out of the system in the second half of the year. Both of these developments, the shift to the higher margin products and the closure of Maryland office should continue to have positive impact on Patient Experience margins for the remainder of the year. In our Provider Solutions segment we are focused on switching to software-as-a-service model and shortening implementation cycles. In previous calls we've talked about an implementation backlog and so we [indiscernible] on that. And over the last three quarters we've made meaningful improvements in our Provider Solutions segment which are resulting in moving customers forward in the implementation process. In the second quarter, the backlog of unimplemented customers on our Echo Credentialing Solution was significantly reduced to levels that we consider to be routine and sustainable. Now backlog challenges currently remain for our Morrisey acquisition and solutions, but we expect to replicate it successfully and enjoy it with Echo across the Morrisey customer base applying the same methodologies, protocol, procedures and now experienced staff and correcting these backlog issues. So we expect improvement over time in the next few quarter in the Morrisey associated backlog. Earlier this month we announced several exciting changes to our senior leadership team and I want to highlight a few of those before we turn it over to questions. Jeff Doster was previously in the role of our Chief Technology Officer. He was named Chief Information Officer; a new position at HealthStream. We also announced that Scott Fenstermacher was promoted as Vice President & Head of Sales, which will make him our top sales leader overseeing sales in our Workforce and Patient Experience segments. And finally with the move of Jeff Doster to CIO we added Jeff Cunningham. Jeff Cunningham joins us as Chief Technology Officer, so having split this role to accommodate more rapid development and evolution of our platform, our security, reliability and scalability now having both a CIO and a CTO. We congratulate Jeff Doster and Scott Fenstermacher on their promotions and Jeff Cunningham, we'd like to welcome to our leadership team at HealthStream. At this time, I'd like to turn it over for questions.

Thank you. [Operator Instructions] Our first question comes from Ryan Daniels with William Blair. Your line is open.

Good morning, guys. Thanks for taking the questions. Bobby, first one for you, you mentioned some weaker sales than anticipated in Q2 and I am curious if you can go into a little more detail regarding if that was related to any specific products number one, and then number two, do you view it more as a competitive issue or is it more of a market related issue where you see more hesitation in client base?

Yes, Ryan, let me try to characterize some of that, I mean it's - we came off a strong fourth quarter and then a strong first quarter. First quarter having exceeded our expectations in many categories, these internal quotas and budgets that we have set, and so we moved into the second quarter with some optimism, but we did see a slowdown and particularly in the Workforce product sets and no particular product, we just had high expectations across these set of products even Compliance that was outperforming was a little below our expectation. Some of our clinical products that we talked about in the past were also below our expectation. Again this is partly a function of us having high expectations, but we did meet our internal goals. And I don’t know if I can attribute this to macro conditions. There are a few internal issues. We are behind in our open sales positions. We have 15 open positions, some of these are attributable to the fact that we have elected to do direct hiring instead of through recruiters, so it's slowed down our hiring a little bit. So that was a contributor but also on an individual production basis we just didn’t meet expectations and again it’s predominately across the Workforce Solutions segment. I am not willing to say that it was macro conditions, you know one quarter end, and so this is sales productivity issue, and may be too higher expectations which we recalibrated around now and unfortunately had to adjust our guidance as reflective of our lower expectation and lower result in the second quarter. So, you know, it’s a combination of all, I really can’t turn on any one thing. The individual productivity was lower than expected across Workforce I would say broadly and we are down headcount about 15 from our plan and we are trying to fill those but at a different rate. We are not going to just go out and use recruiters and have really high costs. We are going to be more selective in trying to bring in the right people and there was a little bit of deal push, but you know we will see how we pick that up in the third quarter. So, I am not going to give any specific attributions, just say for disappointed in the results and had to recalibrate our guidance.

Okay, no that’s helpful. And then another big picture question, last quarter you talked a lot about the rollout of a new enterprise platform for HPC, can you give a little bit of an update there on number one, the mobile platform and really customer feedback and then number two, what percentage and what number of the book of business you transitioned to that?

Yes, it's fantastic results on this new rollout, it’s fully integrated with the HLC, so the Competency Center and Performance Centers have a dual upgrade that you are mentioning. It’s actually going very well. I believe we are over 80% switched. There is only one more wave of deployment coming in middle of next month in mid August. We’ve had three waves of deployments that have taken over 80% of our customers through the migration. What I am most excited about is exactly how quiet it has been meaning great receptivity, no work flow issues. We have done, I think a really good job. I congratulate our teams on a really good job of this material upgrade and swap out of the technologies. We staged the customers in ways where they accepted and were ready for those migrations, so again very solid acceptance. It provides a new level of integration and capability to customers to have the learning and performance centers operate much more functionally together and I’ve just got an update here written down for me that we're about 92% converted. So, there is only 8% left. It will occur in mid August and reports from the field are fantastic. I think this should we expect help put some sales momentum on that product as we build more referenceable accounts on this new and exciting platform.

Okay, great. And then a quick housekeeping for Gerry. Do you have the cost of the office closure during the second quarter, as I know that’s kind of a one-time item?

About [$200,000] [ph].

Okay, great, thanks for the color; I will hop back into queue.

Thank you. Our next question comes from Matthew Gillmor with Robert Baird. Your line is open.

Hi, thanks for taking the question. I wanted to ask a little bit more on the sales trends, can you give us some sense for the trend that’s been or what happened with renewals? And then Bobby, I think you just mentioned there was some deal push too, can you may be provide some details on what you meant by that?

Yes, there were - so renewals we felt were strong. They were good in the quarter with no anomalies or anything of any size or scope that would draw our attention and so renewals on core products were solid and good. So, don’t think that that was the issue. I mean there is a normal amount of churn in all the products, but again nothing exceptional and no concerns related to renewals. The deal push through is just a couple of deals that were biz-dev related that are strategic in nature and also come with product sales. They are a little more complicated to negotiate because it is not just an outright sale. The consumption and use of products is coupled to what we hope will be another long-term strategic partnership. And so that was a mixture of the sales teams efforts and the business development functions of our company and got a little complicated and we still hope and expect that that new relationship will come on board, but we had hoped for at the end of the second quarter. So, when I referenced the deal push, they’re just a couple [Indiscernible] of scale and so we're [Indiscernible] yet, so we're working on those here in Q3.

And just as a quick follow up to that, are those embedded in guidance or would that be not something that’s included in the growth?

Yes, it wouldn’t be outside the guidance. The relationships and the product sales are factored into how we talk about the full year and so I wouldn’t characterize it as outside. I would say that we're expecting to land this relationship and what comes with it this year.

Okay, and then may be one on the go forward strategy for resuscitation and I appreciate the comments you made on the next generation simulation and the products you expect to bring to market. In our discussions with hospitals it seems like the AHA card is really what’s required versus another CPR certification. So can you sort of help explain how the AHA sort of comes in to this? Is your strategy more focused on convincing hospitals to accept another credential or are you going to somehow kind of get the backing of the AHA with your new products? Thanks.

Yes, we’re going to roll that out over time. I mean the first thing to note is that we have a year and a half to focus on the current relationships with both Laerdal and AHA and successfully take those products to market as we’ve done for many years. And so, I think the first thing to note is just to it is our hope and expectation that many of these relationships will last all the way to 2020 and so we are talking about things in the future. So, the nature of our strategy to combat the loss of Laerdal is comprehensive and evolving and we just announced for example one new partnership related to it. In this segment and solution group in our business we hope to expand the use of simulation technologies beyond what historically has been a single use around resuscitation. So the first thing to note is just strategically we will be announcing and working with more types of partners that enhance our simulation base form of competency evaluation across a broader set of skills. And so we won’t be backfilling resuscitation with just resuscitation. You did mention an AHA card, it is true. It is not required or a legal requirement that it’s an AHA card. Really what’s important I think to the markets are the standards of the training. The AHA card has become historically the leading credential in the states and certainly the most important way to recognize compliance standards or compliance with the standards. The standards are set by international bodies. One is called the ILCOR of which the AHA is a member of and the ILCOR publishes standards in the U.S. So there are alternatives, but the market has become used to and accept - most accepting of the AHA credentials. And so our strategy over the next couple of years maybe to embrace alternative credentials and then maybe to try to work to bring the standard credentials back in. So, again it will play out over many years and the only thing we’re going to announce today is the strategic broadening of focus on competency-based validation through these new technology including mannequins and then we have to find one definitive new partnership that takes us in that direction.

Okay, thank you very much.

Thank you. Our next question comes from Matt Hewitt with Craig Hallum Capital. Your line is open.

Good morning, couple of questions, first if some of the new products that you've launched here already this year, six of them high gross margin, maybe a little bit of an update on how those are progressing through the sales channel?

Sure, sure. As we’ve reported they all have sales in the first half of the year. We also reported that they wouldn’t have an impact on 2017. So, they are all brand new products. We are excited because they do leverage our network and our platform and we think that some of them are important to our new partnerships that are being formed where they will leverage some of those technologies and capabilities. Some of them that I am excited about because they carry different price points and involve broader partnerships; for example our Nurse Residency Pathway which is a higher guided ads. It helps hospitals to onboard new nurses and organized their first year of development when they come out from nursing school and so we share the same optimism. We continue to have sales on the products and we expect and hope for them to have more material contribution in the future probably beginning in 2018 as we get our real down and get organized on all of these products. So, we remain just as excited. We continue to have sales on them. In fact, one I didn’t mention is that’s becoming equally exciting is comes from the acquisition of PVS. We acquired market and skills and knowledge assessment tool and also a reasoning and judgment assessment tool for nursing last year. And we just had a major sale on that brand new product after its been resurfaced and rescans or reflect the HealthStream look and feel and that product is in resurgence and so we are excited to see that new clinical reasoning product take off and have a big run in the first half of this year. The product was historically called PVS product and we are excited about that and that is six, maybe that’s the seventh one to watch.

Okay, great. And then digging into the sales execution a little bit, I've noticed the last couple of quarters your contracted [indiscernible] minute subscribers have come in a little bit below your historical targets of around 25,000 a quarter, is that what you are seeing on the new contracted or the new ads or is the execution, where you would like to see some improvement on the follow on orders or penetrating accounts deeper with some of your other solutions?

I think we are getting the penetration because that’s reflected in the ARIS, right, so the ARIS has been moving up because we continue to do good cross selling and up selling and we are pleased with that. The subscriber account growth rate had slowed down a bit. There is a little bit more natural churn and scale on some of the base products, but we are adding as well and so the new business development teams are out adding and bringing new subscribers in. It’s more in keeping with what we used to articulate as our historical goal and norms of 20,000 to 50,000 per quarter net new subscribers and so we’ve been pushing right on that envelope. We've just had so of the exceptional periods. We also have a little bit of drag on the number from the final rollout of the ICD-10 only subscribers and so there is a little bit of roll-off still in last couple of quarters which is kind of adding effectively to the churn, but some of those ICD-10 only subscribers again there is little bit roll-off. We are almost done with that though as we - the second half of this year in part won’t be much more of that.

Okay, one more from me and then I will hop back into queue. And an area that we haven’t talked about or I feel like we haven’t talked about much for a couple of quarters anyway is your penetration outside of the hospital setting, the long-term care, ambulatory, may be an update on how things are going in those markets and where you see that I guess contributing over the second half of the year? Thank you.

Yes, sure, you know we declared that vertical a few years back and it’s been a consistent part of our growth story. The mix of adding new customers and the post Q settings and pre-Q settings has been solid contributor to our growth story and so it continues to perform. And we're learning more about which of our products are can be best carried in that vertical and we're seeing some good update of some of the core content products in those areas as well. So overall just a solid reported progress and nothing remarkable, but solid steady incremental improvements.

Thank you. Our next question comes from Richard Close with Canaccord. Your line is open.

Great, thanks for the questions. A little bit on the new partnership that you're talking about and maybe some of these simulation products, is the idea there that you roll out some of these newer products that you're talking about as part of this new partnership and any other partnerships that you get over the next year and a half and then, sort of those back fill on the resuscitation and then you expect to have a resuscitation partnership or product in the market beginning day one on that January 1?

Yes, those are some of the key elements from that, one is that, there is a series, now we've kind of opened our eyes to the possibly of this area. We expect a series of announcements over the next year and a half to strengthen our go-to-market strategies bringing these simulation technologies directly to our customers and are broadening set of partnerships and a broader set of areas of impact. So, historically kind of our core competence was on introducing, supporting and carrying in the message that resuscitation training could be better done using simulation technologies. And I think over the next year and a half since there are no provisions, you will see us making much more aggressive moves into other areas of clinical skill development with new partners other than Laerdal in these other clinical areas. And so we're excited about that because these fresh new partnerships see more potential being franchised on what HealthStream has become to leverage our emerging new technologies that I mentioned like our ePortfolio. So key is this new strategic partnership was an arrangement around supporting our ePortfolio standards for healthcare workers. So, yes I'd say over the next year and half we hope for and expect a series of announcements that will bolster the expertise and capabilities we have in this area and of course along the way we'll be signing new partners that also reinforce our plan to take new products in resuscitation market beginning on day one of January 2019. And so that business development will be ongoing. Sometimes we'll announce the partners and sometimes we won't depending on where – the stage we're at, like the partnership may take time to develop necessary products and get them to market and get a customer using them. So, we usually announce things once we're ready for customers to take the products. So, that's a little bit of our strategy and we want to give you some confidence that we're beginning to move on it already with this first signing and it's a long term strategic alliance with appropriate measures to incorporate all our new technologies like the ones that I mentioned.

And how would you expect the margins to be on those products with the new partners, are you able to have better dynamics on the margin line than previously?

Well, we do expect that. You know, the relationship with Laerdal was very successful and it essentially was although our agreement was on Laerdal involved third parties like AHA and so the margins were some of the lowest margins in our entire portfolio. And I think in these new agreements we're taking opportunity to kind of restructure and make sure that the full value of what we bring to the equation is in place. So, we will expect and do expect and in fact the first agreement reflects an improvement in margins in these go-to-market products. But you know, again this is a long play. It's going to take several years and it's important to reinforce again both to our customers and Laerdal on AHA that we are partners until January 1 of 2019 and potentially be on and we plan to carry those products to market, service our customers, our joint customers with great excellence and make sure that they get the full benefit of these excellent products from AHA and Laerdal. And so, we continued to be a key player in the role for the next year and a half and we hope and expect many of our clusters will actually extend those agreements through 2020 and so, again we're talking about in that case 3.5 years is supporting the existing portfolio products engineering revenues for them. And so, that's all the comments we can provide at this time, we have many sequential steps over the next year to have to try to rebuild and strengthen the loss of this Laerdal relationship.

One follow up question with respect to the new partnerships and the newer products that you're talking about there, are those new dollars for the hospital, your customers that they have to come up for these products or would these products be replacing something or something older you know paper based or what not that they're currently using?

Yes, current like resuscitation market there would be new and enhanced ways of affecting change in measuring competency and skills, so in some cases they require increased investments but certainly have higher IRR. And I think will be more relatable to better clinical outcomes or better business outcomes like our residency program where we mentioned, we believe that the curriculum like that could affect first year IRR rates and lower than that have a great economic in doing so. And so I think that some will require a little bit of increased investments in the hospitals, but I think these are going to be higher IRR solutions that really move deal along, that were really move the needle on competence and quality and so I think they will be very investable.

Okay and my final question would be on provider solutions. I think you did mention in talking about new sales that and that was a little light as well if I'm not mistaken, but you did highlight the last three quarters and the improvement in the implementation and I guess conversion of the backlog. I guess I'm a little surprised in terms of maybe the year-over-year growth excluding Morrisey maybe was in a little bit more considering the backlog conversion improvement so, if you could just talk a little bit about that and how we should think about revenue growth ex-Morrisey going forward?

Sure, so we’re still working off the lot of inherited issues. The implementation backlog is most predominate issue, but also the switch to selling SaaS software, remember we had expected both companies that we acquired had installed software and we had models and expected some continuation of selling installed software whereas our teams made a much faster shift to selling the SaaS or on a subscription model which spread the revenue more over longer term periods and so as you know in model that it made switches from installed software to SaaS software. It depends on the rate of change and the customer base on the ability to deliver revenue growth. Getting an installed software sales fully recognized in the first you know period you sell it versus spending something over 36 months, it's quite a trade off. We think it’s an important and valuable trade off for the long run. So what I would say is that the trade off is occurring faster than we occurred meaning that we are selling I believe, almost no installed software now and selling things on the subscription and SaaS model approach and so without bringing a installed sales the revenue growth which will lower than we had initially thought we would deliver. But in my view over a three or four year period I thought good news is that the faster migration, still more consistent and recurring revenue streams. So, they had two issues there, the first was the two apps and execution issue we inherited some clearly immature implementation processes and we are professionalizing them. I really truly feel that those are at hand, meaning the team understands them, has worked through a full set of them, has normalize them at least for one of the businesses, the Echo businesses and as now Fireman's principles to the Morrisey, so I feel like that, well is reported last couple of quarters. Will not be an issue that persists much longer, another quarter or two and then we're really good by operations.

Okay, thank you. I appreciate it.

Thank you. Our next question comes from Scott Berg with Needham & Company. Your line is open.

Great, thank you for taking my question. This is [indiscernible] in for Scott. The first question is around the recent changes to the sales organization. Can you talk about any initial or any upcoming changes that you're going to make to the go to market strategy, changes that comp and the metrics that you can use to kind of engage productivity and then the second parts of that is what are you going to do to kind of mitigate any potential I guess any near term headwinds to sales cycles or turnover in the sales organization that sometimes plays out with leadership change.

Yes, yes so, I mean first we feel really good about new leader and yes, he is a veteran on HealthStream, so he is familiar with our methodologies and ways. So it’s a little different from bringing an outside person so that the mal change is probably a little less. Secondly, there probably won’t be significant change. We tend to do changes to our structure and commission plans and how we approach the market on an annual basis, really towards the very end of the year and into the January, February timeframe. So, I imagine an expect that that will also be through Scott, the new head of sales. I mean he may make some adjustments here and there to how he is organized, but in general we make the larger changes and address incentives and we readjust markets and opportunities. Usually I want to hear around at the January timeframe. We have a national sales meeting. So, I think we have the right person in the spot, that it is important to know that Scott's background is in the clinical area and clinical for us is an important driver of our growth and in some ways what we just talked through on the resuscitation product and expanding the scope of operations there also plays to Scott's background. So I think we have the right leader in place. I did not expect a lot of disruptions this year. With regards to the current performance, clearly we were disappointed. We had higher expectations for growth. I’ll point out that these are - they’re all growing, we just we missed our expectations and had to recalibrate. So while we are disappointed in that we’re going to figure out which parts are working and tune those as we enter next year with our new leader.

Great and the final question is on the guidance the report on the topline, but maintained the operating income, so just curious to know where is that expense or cost savings going to be coming from? Thank you.

Yes, sure some of the [indiscernible] we're making moves to improve margin and leverage what we call our ecosystem and our platform and some of the moves are more overt like the ones we talked through on our Patient Experience segment and we've actually had an office closing, centralizing services and double down some of the higher margin products. And in other areas sort of a recalibration well for selling, or focusing on some of the more completely owned products that have, they carry a higher margin and so success in some of our areas of compliance as it becomes one of our leading growth story. It's virtually interesting. Go back to last year, but we [indiscernible] generate the most sales momentum and shifted few times across the couple key clinical products for a while is the certification products for about three quarters and lately it's been our compliance products that are ones that are and they have to be higher margin as well. And so, within the businesses and – emphasis toward the higher margin products we did adjust incentive a bit to improve the focus on what we call our higher margin products sets as we entered into this year. I think we’ll see the benefit of that and some of the business units in the second half of the year. So, I’ll be staying more acute focused on EBITDA generation and margin and leveraging assets that exist within the company is what’s going to drive the enhanced EBITDA and operating leverage.

Great, thank you for the questions.

Thank you. Our next question comes from Vincent Colicchio with Barrington Research. Your line is open.

Yes, bobby I’m curious. You said you’re not ready to say there is a macro impact, but I guess I’m curious, do you think you’re seeing any impact from the ACA uncertainty?

I really can't contribute things to that uncertainty than to, our buyers have compliance needs that they have to meet, they have needs for obtaining their staff almost irrespective of the payments and so they have to compete with the hospitals across the street and so they need to invest in these solutions and help them retain their staff and develop their staff and avoid risk. And so I've said many hot spot they need to make capital investments to retain their staff and development so they don’t have the kind of risks that no one wants to pay for anymore. And so I think there is strong rationale for buying our compliance orient solutions and the ones that generate better clinical and business outcomes, but it's fair to acknowledge that they are under growing, increasing uncertainty and pressure from all of the activities of both our government and our competitive landscape. So, I don’t like to attribute anything to macro condition like assume responsibility so you all can do better. We always have products that we can sell in any macroeconomic condition and we’re going to do our best to figure out those products and sell them.

Okay, on the stimulation side you seem upbeat on your prospects outside of resuscitation, you know broadening your focus there. Stimulation really hasn't taken off like we expected, what's different now if anything?

I do you think the technologies and the measured impact they can have on outcomes, the general acknowledge of how to utilize in other industries have real outcomes and impacts, this continued growth and awareness of the favorable impact that they can have on learning and development and therefore on outcomes and they to think of outcomes and so, I just think we're further down the curve, also the technologies themselves are advancing and we’ve seen emerging technologies from new corners of the world and out of Silicon Valley and other places that I think are another wave of disruption coming from the traditional manikin based approach and you will see us leaning into those technologies as well. So, I think they provide both more educational benefit and potentially easier adoption and more intuitive utilization and lower costs. So I think it is just the steady advanced technology I think will get to the flexion point in the next couple of years.

Okay and then Gerry what was the contribution of Morrisey in the quarter?

Well it was $2.6 million and operating loss of 15,000 [ph].

Both product and mix, contribution of Morrisey was your question?

Yes.

Okay, thanks.

Thank you. [Operator Instructions] Our next question comes from Nicholas Jansen with Raymond James. Your line is open.

Hey, guys. Thanks for the time. A lot of my questions have been answered, but just wanted to focus on your capital allocation philosophy from here. Certainly it's been almost a year since the Morrisey deal, just wanted to kind of get your thoughts on the desire to increase M&A given some of the challenges you’ve seen in the business this year and certainly with the potential all in the revenue starting in 2019 kind of how would you be considering may be accelerating some of your M&A thinking to fill that void? Thanks.

Yes, sure so we always are actively looking, but obviously have been more active in prior periods than in the last say two or three quarters. Some of that intentional where we develop pipeline for M&A but don’t pursue deals that we work through. We have lots of work through here with the closing of Laurel, the improvement of margins and in PX [ph], the implementation backlogs from prior acquisitions. You know, the difference is I’m feeling more comfortable that all those issues are at hand and were on the clear on the back side of all those curves and we do have a strong capital position with $116 million in cash and $50 million in line of credit and always acquisitions has been part of driving that. The last time we had this kind of challenge we effectively I think management effectively swapped the ICD-10, 50% gross margin business which was non-occurring with two acquisitions though whole new business segment. They had higher recurring nature and higher gross margin with the acquisitions of Morrisey and HealthLine and putting them together. And so I would say that it will be part of our strategy to increase our activity and search. We were always active in M&A. It’s always a part of our management teams core competence. We are a little bit of brief here couple of quarters to settle in all of these prior acquisitions and through them up as I mentioned one of our smaller acquisition is PVS [ph], we are nearly a $1 million sale on those products recently and now that I feel really good about how all those are progressing or operationally enhanced, we do expect and plan to deploy capital and to do M&A in the coming months and years.

Thanks, Bob. My second question I know you guys think about operational investments kind of once a year and you set budgets for them, but how do we think about some of the organic investments you are making this year? When do we start seeing them kind of pay dividends from a revenue acceleration perspective and then conversely do we feel like we’re at a good expense base where we can sustain this operating margin leverage that you’re delivering in 2017? Thank you.

Yes, I'd say, as you did point out we work on three-year plans on the whole, we roll out one year plans in the market where we talked about our capital allocation strategy early in each year around February 10 and so just kind of to reiterate for this year we are very comfortable with our investment levels and CapEx levels to build and launch and support new products that we are bringing to market. And we’re going to let those six or seven new products we mentioned, plus one I mentioned earlier today kind of seven from the acquisition find their way to market over the next several quarters and then announce a new capital allocation strategy and investment strategy next year. But at least for the next couple of quarters as we mentioned through the reiteration of guidance we expect continued operating leverage and are comfortable with our levels of capital investment and expense investment and product development. In fact we had a really nice wave of new products coming out and we slowed down the adding of teams in development while we stabilize and support the products we’ve already taken to market and that’s a cycle here for at least this year. We'll evaluate it again as we enter next year.

Thank you.

Thank you. I show no further questions in queue. I’d now like to turn the call back over to Mr. Frist for closing remarks.

Thank you very much for listening on our quarter earnings conference call. We look forward to reporting the next one and thank you to all employees who are keeping the ship steady and growing the business. I look forward to reporting our third quarter call in the near and upcoming months. Thank you all. Good Bye.

Thank you. Ladies and gentlemen that does conclude today’s conference. Thank you very much for your participation. You may now disconnect. Have a wonderful day.