HealthStream, Inc. (HSTM) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the HealthStream’s Third Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. And later, we will conduct a question-and-answer session and instructions will follow at that time [Operator Instructions]. And as a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Ms. 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 third 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 start, I will now turn the call over to Bobby Frist.

Good morning, everyone. And welcome to our third quarter 2017 earnings conference call. The call is past the detailed information variance out of each carefully written sentence. So everybody here we go, we have a lots of great details for you this morning. Our third quarter performance, if we look at core financial metrics, it was a solid quarter it was a good quarter. Compared to the third quarter of last year, quarterly revenues were up 9% and that was a record for our corporation at $63.6 million. Operating income was 210%, net income was up 116% and adjusted EBITDA was up 41%, so really good measures of also free cash flow and strong cash balance. These results also showed sequential improvement over last quarter, which gives us confidence in our expectation of leveraged operating income growth for 2017. In our Workforce Solutions segment, third quarter revenues were up $1.6 million over the same period of last year in-spite of the $1.2 million quarter-over-quarter decline in ICD-10 revenue, primarily driven by sales of knowledge queue, which is one of our newer compliance solutions that led to Workforce segment with a 26% growth in quarter revenues over the same quarter last year. This performance in that segment, the Workforce segment, was followed closely by our resuscitation solutions, which were kind of in second place in the Workforce Solutions segment. Although, the third quarter revenues in our Patient Experience Solutions segment were down 1% from the same quarter last year, our efforts to improve margins continued to deliver improved operating income leverage. So we saw some nice improvements in the Patient Experience business based on actions taken earlier this year. In our Provider Solutions segment, third quarter revenues were up 58% over the same period last year. This increase reflects a lot of components; the inclusion of revenue from Morrisey Associates acquisition not really a comparable period; and so it shows up in for the full quarter of this year; a lower amount of acquisition related deferred revenue write-downs, and Joe will give more detail on that; a one-time adjustment related to few customer contracts that were reviewed and organic growth of about 15%. So there are many components in that 58% growth in Provider Solutions, but it included a nice balance of organic growth. In last quarter’s call, we mentioned that sales from our Workforce Development and Provider Solutions segment were less than expected. So now we’re talking about the sale of organization and productivity. We gave some concerns around the productivity of the quarter, again, relevant to expectations internally. This quarter, we did see a recovery in the third quarter recovery and sales orders from those same segments. But we know that micro conditions generally continue to be challenging for our client base as we enter the fourth quarter. So maybe a little less certainty around sales velocity as we enter Q4. But Q3 was a good catch up for us in sales order value and contract values. So that felt pretty good. In February of 2017 conference call, we introduced some new product concepts and we, at the time, we commented that they were very exciting concepts, but that they wouldn’t be contributors in ‘17, either from revenue or profitability. What’s exciting is that we’ve recently begun to market and sale some of those products. In fact, all six products have shown revenue and some sales orders in this quarter, which is great. Again, very small but a nice start. And I’ll give you an update on a couple of them. First, our new award winning Nurse Residency Pathway, which is blended learning program, designed to address the challenges that are faced by new nurses as the enter the Workforce and work in acute care settings. We were excited to see that, in the third quarter, Christa’s Southeast Texas Hospital, Saint Elizabeth's Nurse Residency program, so that’s a mouthful. But one of our customers was running our Nurse Residency program with HealthStream’s Nurse Residency pathway as infrastructure. Well, that program achieved ANCC accreditation just recently. And so now we’re pretty excited because that helps us in the marketing of that brand new solution this year. That solution by the way carries out the higher price point than most everything in our portfolio, because it’s a great blend of content assets and subscription to many of our SaaS products that deliver the learning and education. So that’s an exciting breakthrough to the Nurse Residency Pathway. The second update is regards to our OB risk program. At one point, we represented a third party product in this area. We saw that it's going to be successful. So we ended up co-developing with one of our large health system partners, that’s MedStar SiTEL. We co-developed an OV risk program that we co-own now, which will result in a higher margin profile of this part over time. That program is focused on reducing risks by providing staff with knowledge and skill to identify early warning signs of maternal and infant distress, so it's in the high risk area in the clinical settings. At the end of third quarter, we’re really excited, because one of our largest customers in our entire customer base, selected our OB Risk program, the one we co-own and co-develop with MedStar SiTEL, for their OB risk program for system-wide deployment in a multiyear agreement, so an exciting breakthrough on the OB Risk program. I’ll provide update on some of the other new products as they developed into next year, and we're pretty excited about those two anyway. We've seen some early preliminary indications of success. By the way, that same account that purchased the OB Risk program from HealthStream MedStar, and also have the top five account renewed its enterprise-wide use of our core platform and it's an early renewal, about a one year early renewal and they added four years to that early year. So it's essentially a five year contract. Again, one year early. And in the process, they added some additional new products, for example, the knowledge Q product. And I mentioned just earlier that that solution group within our Workforce segment was leading contributor in the quarter from a sales standpoint, the compliance group and knowledge being one of its hotter -- it’s a newer product but it's precede stayed this year. So the knowledge Q product data driven product was also subscribed nearly the same time as there will be risk program in conjunction with a five year renewal at a top five account for HealthStream. So, there’s lot of exciting pieces to that part of equation as we move one of our largest accounts on our newer technologies. There’s a lot to dive in the detail, the numbers. There is a mixture of things that contributed to the relative outperformance of third quarter. And so it's important to listen to the next section as we detail some of the onetime events that help Q3 be exceptional, and may be give a little context why essentially we have a little bit of sequential decline. Although, we're able to raise our guidance for the full year, a little bit of sequential decline as we head into Q4. So listen carefully as I turn it over to our CFO, Gerry Hayden.

Thank you, Bobby, and good morning everyone. Getting to summary of our third quarter results, consolidated revenues were up 9% to $63.6 million, operating income of $4 million was up 210% versus operating income of $1.3 million in last year’s third quarter. Net income was $2.5 million and earnings per share was $0.08 versus net income of $1.2 million and $0.04 per share in the third quarter of 2016. Adjusted EBITDA was up 41% to $11 million from $7.8 million in last year’s third quarter. Now let's look at the four areas of the income statement; segment revenue, gross margins, operating expenses and operating income. Revenues from our Workforce Solutions segment increased by $1.6 million, while overcoming $1.2 million year-over-year decline in ICD-10 readiness revenues in the third quarter. Now, let’s take a quick look at the Workforce Development ARIS. For the third quarter of 2017, HealthStream’s Workforce ARIS was a record $38.37, which is up sequentially over the prior quarter. It is important to keep in mind though that ARIS does not include a complete look at our business as two line 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 and for these reasons, may retire the ARIS measured entirely in 2018. Revenues from our Patient Experience Solutions segment for the third quarter of 2017 were $8.8 million compared to $8.9 million in the third quarter 2016. Revenues from Patient Insight surveys increased by $105,000 and continuing the trend towards great adoption of online patient surveys, which carry little price points and phone surveys that produce higher margins for us. For the third quarter of 2017, the volume of phone based patient surveys declined 28%, while online patient surveys increased by 42% for the same period. Revenues from other Patient Experience Solutions, including surveys conducted on annual or biannual cycles, decreased by $226,000 compared to the third quarter of 2016. This decrease is primarily due to timing of engagements compared to the prior year. In the third quarter of 2017, revenues from our Provider Solutions segment increased by approximately $3.7 million with the Morrisey Associates acquisition, representing approximately $2 million of that increase. The balance of revenue increase is made up of $200,000 reduction in the HealthLine systems Morresey related to deferred revenue write-down, a $600,000 one-time adjustment led to a few customer contracts and $900,000 from organic growth. Now, let's look at gross margins. Our gross margin was 57.9% in this quarter versus 57.4% in last year's third quarter. The third quarter 2017 continued a sequential trend of improving gross margin performance since the fourth quarter of 2016. Several factors contribute to this margin expansion; the Patient Experience gross margin had increased by approximately 680 basis points over the first nine months of this year. This margin improvement reflects the successful relocation of our Laurel phone operations to Nashville, which we completed in the second quarter of this year. It also reflects the ongoing shifts from phone to email, SMS text surveys. Also notable is a greater contribution from Provider Solutions. The gross margin on which improves as in deferred revenue write-down decreases. Let's, now turn to operating expenses. Operating expenses for the quarter were up 2% for the third quarter of 2016. The combination of capitalized software investments and product development expenses were flat between this quarter and last year's third quarter. However, software developments managed their priority as capitalized software development has grown by 30% on a year-to-date basis in 2017. We have also increased our guidance on capital expenditures to reflect this increased level of software development activity. Sales and marketing expenses decreased over the third quarter of 2016, driven primarily by a reduction in general marketing expenses. As a reminder, some that occurred in the fourth quarter of 2016 but will now take place in the fourth quarter of 2017. In fact, for the foreseeable future, we have shifted two regional meetings and events, rather than holding a single large summit in Nashville. Depreciation and amortization increased 14% over last year’s third quarter. This increase is lower than the prior quarters and reflects the inclusion of amortization of acquired intangible assets from the Morrisey acquisition and for the third quarters of 2016 and 2017. It’s important to note that depreciation and amortization still reflects increased levels of capitalized software development amortization as it continues to invest in product development. G&A expenses in third quarter of 2017 increased slightly, but improved as a percentage of revenue to 14.4%, which compares to 15.2% in the third quarter of 2016. Last year’s third quarter included transaction costs related to the Morrisey acquisition. However, third quarter 2017 does include implementation and compliance costs related to new GAAP new recognition accounting standards, known ASC 606. We inhibit the ASC 606 compliance expenses will be approximately $600,000 in the fourth quarter of 2017. We have seen an increasing level of painted volatility and credit risks in our customer base this year as evidenced by greater number of hospital bankruptcies among our customers in 2017 than in prior years. Our bad debt expense had increased from $340,000 in the first nine months of 2016 to $963,000 in the same period this year. Operating income was $4 million in the third quarter of 2017 compared to $1.3 million of operating income in the third quarter of last year. This increase in operating income reflects revenue growth, leverage on our product development and G&A expenses, but we overcame $1 million margin loss from the decline in ICD-10 revenues, the Morriseyd deferred write downs and higher depreciation and amortization expenses. Now, to the balance sheet. Our cash position overall balance sheet remained strong. Our cash balance as of September 30th was approximately $123 million, a $20 million increase since December 31st of last year. A contributor to this cash balance growth has an improved collections and accounts receivable management. The sequential drop in DSO from 71 days at December 31st to 55 days at September 30th of this year resulted in $7.4 million reduction in accounts receivable balances. We have no outstanding debt and our total of $50 million line of credit capacity is available to us. We believe our overall capital position is likely to support our organic and inorganic growth opportunities and support other capital structure optimization and shareholder value maximization strategies as maybe appropriate. Net cash provided by operating activities on our cash flow statement has improved to $36 million for the first nine months of 2017 versus $15 million for the same period last year. Before we discuss guidance, I’ll describe the fluctuation in our effective income tax rate. The effective income tax rate in the third quarter of this year was 20% versus 28% in the third quarter of 2016. Last year’s third quarter income tax rate included more favorable industry tax items than occurred in this year's this quarter. However, our full year guidance for 2017 includes our estimates of any discreet tax items affecting the current year. Yesterday's earnings release contains updated guidance for the 2017 full year. We anticipate the consolidated revenues to grow between 8% and 10% as compared to 2016, and the growth in our three operating segments will be as follows; Workforce Solutions will increase 4% to 6%; we expect a sequential decline in the segment, because some of our larger accounts made through our purchases to satisfy their needs for additional HeartCode licenses in the quarter. Client makes these two purchases from time-to-time item. But it is important to understand the needs impact on Q3 is that the magnitude of these two was greater than we generally see and will probably not be repeated in Q4. Also worth noting in Workforce, we anticipated revenues from ICD 10 readiness will be approximately $1 million in 2017 versus $9 million in 2016, representing an $8 million decline during this current year. Patient Experience Solutions will decline between 1% to 3%. This reduction reflects the expectations that two large clients have revised their timing for deploying [indiscernible] surveys, moving down from this year's fourth quarter into 2018. Second, the subject to Medicare and Medicaid services, CMS has deferred the start date for new cap survey, covering outpatient ambulatory services for OAS CAHPS. As a result, several ambulatory declines had office related until there’s more clarity in the OAS schedule. Provider Solutions revenues will grow between 50% and 54% over last year’s results. We anticipate full year 2017 operating income will increase 65% to 80% over 2016. We anticipate that capital expenditures will be between $18 million and $20 million, and our effective tax rate will be between 32% and 36% for the full year 2017. Finally, this guidance does not include the impact of any acquisitions that we may complete during 2017. Thank you for your time. I'll turn the call back to Bobby.

Sure, thanks, Gerry. There is a lot of important facts in there, and the compliance with the new accounting regulations and a final push to be compliant and that’s over 600,000 in the quarter to get ready for next year, we’ve been working on that all year. There is just a lot of important facts in there, some one-time pick-up in revenues from some true ups, really important to the Workforce segment that won't be repeated in the fourth quarter. So thanks Gerry, lot of great details in there for people to pick up all and model. I would like to take a moment to focus on some of our product lines and business segments from a business development point of view. And report out on our stimulation and resuscitation businesses, which are part of our Workforce Solutions segment. So first, we're committed to broadening the scope and utilization of simulation technologies as a core part of our future at HealthStream. We believe that there’s exciting methods of validating a wide range of clinical competencies, including and beyond resuscitation skills. Next generation mannequins, virtual reality, augmented reality, artificial intelligence and machine learning, are all among the emerging technologies that can be applied in this innovative filed of skilled development for the clinical staff of healthcare organizations. And we’re excited to be in development mode to bring all of those to bear to develop a broad range of clinical skills, including resuscitation. At the end of June this year, we announced our current agreements with Laerdal Medical for the HeartCode, and RQI products will expire on December 31, 2018. As we explained, HealthStream retains the rights and expects to continue selling HeartCode and RQI for the next 14 months, so through the end of next year. But after that point, we will lose our right to continue selling those products. We can, however, sign contracts up for renewal that extend out to 2021 and will service all of our customers with top class service on those products for those that extend beyond the end of '18 to 2020, all the way to 2020. So that’s an opportunity for some clients to renew early and extend through 2020. In preparation for bringing new and improved resuscitation solutions to market in January of '19, once our restrictions on our ability to sell competing product expires, I'm pleased to let you know that we’ve signed two new strategic partners in the last 100 days, the second of which we signed just last week. And we have announced the first one in the prior call. Each of these partner shares our vision of bringing innovation, choice and quality at lower price points to the market than the existing products we carry today. These partnerships will also feature more favorable margins for HealthStream, a better price point for our customers. And importantly, we inserted more product level control in historical and intellectual property control in these new agreements than we have historical had. So we’re really excited about some of those developments. Again, 14 months away from launching new products in resuscitation. And throughout the year next year, we hope to be introducing additional and more partners, bringing stimulation technologies, as I mentioned, to a broader set of clinical skills not just to resuscitation. In the coming months, we’re still in active business development mode to bring new partners in around those types of surrounding technologies, I mentioned. And we’re really excited. But again in January 2019, there would be a lot of focus obviously on launching products in resuscitation skills. I would like to turn a little attention to the patient experience segment. There is interesting dynamic inside of that business. In fact, there is interesting dynamic in a couple of our business segments that does make revenue growth more challenging, but they’re all in the spirit of moving towards higher margin businesses. So in the patient experience business, we continue to see an uptick in new clients purchasing online surveys. The online survey has a lower price point, but a higher margin than phone survey. So lower price point makes growing revenue difficult, but makes improving and delivering higher profits much more probable, actually by definition just higher margin. Existing clients also continue to convert from a phone modality to email and SMS text surveying modality. And so we’ve now converted almost half of all surveys capable of being converted from phone to online surveys as of this point. And we expect this conversion trend to continue throughout the remainder of the year. As you know, we also have closed our Laurel, Maryland interview center and moved those operations to Nashville. And both of those two developments I mentioned are expected to have a positive impact, an ongoing impact on patient experience margins. In our Provider Solution segment, similarly, it has a dynamic in it that will challenge revenue growth in the coming years, but not profitability growth. And that is the move from installed software sales to software as service sales. And we’re doing lots of things there to improve the cash collections and work through the implementation backlogs. And so in the third quarter, the backlog of unimplemented customers of our EchoCredentialing solution was significantly reduced to levels that we consider to be more routine and sustainable. The backlog challenges currently remained for our Morrisey Solutions, but we expect to replicate the success we have in echo with the Morrisey Solutions over the remainder of the year. Also, just this week a lot of exciting announcement in that business occurring as recently as last night as we launch in the future to further blend and merge the product lines of our Provider Solutions segment. So watch for some exciting news there, really around the January timeframe with new product introductions and potentially some new branding as well. As we conclude, I’ll take a moment to thank our employees for their hard work in delivering exceptional quarter. It’s really fun each year we conduct an employee engagement survey, and we completed our most recently in a few months back and it’s exciting that 96 of our employees and over 850 employees responded to our survey internally. 96% of our employees reported to being that we are highly vision driven organization, focused on improving healthcare and 92% reported being highly engaged in their work at HealthStream. These were just -- it’s an outstanding group of people in our Company. We’re trying to all grow and go in the same direction. And I’m really excited that I get the privilege of reporting on their accomplishments. And of course, this quarter was a strong quarter. I caution them as always do. We don’t get too excited when things are great. We don’t get too down when things are challenging. As we look ahead, I mentioned some challenges to top line growth, but all in the spirit improved profitability, which you can just see in things, are measure like our free cash flow measures that Jerry mentioned and general improvements in operating margins that we talked about in patient experience. And ultimately, higher margins in the Provider Solutions segment as well. And so a lot of great news in there. We also mentioned some macro conditions, and so I’m sure there’ll be some follow up questions on that. Jerry noted our bad debt expense has gone up. And so that is an increasing trend we’ve seen just increasing pressure on the Provider Solutions -- the provider marketplace in general. So I’m sure that would get top of the discussion. Again, thanks all our employees who are listening in. It was a solid effort by everyone, and look forward to reporting in the next quarter. Let’s go to Q&A now.

Thank you [Operator Instructions]. And the first question comes from the line of Ryan Daniels of William Blair. Your line is open.

Bobby, I’ll take the bet and ask the initial question on the microenvironment. I think last quarter indicated it was too early to make a call that the end market was seeing some pressure. But it sounds like now you’re definitely seeing that. So two part question; one, what in particular is driving that, is it more margins pressure or just uncertainty? And then number two, how is that changing your sales approach? Meaning, are you going to more of a ROI type approach in pitching products and solutions that can save money versus maybe some broader area? Thanks.

So, thanks Ryan. And we’ve been public for about 18 years, and I’ve never try to attribute performance to macro conditions. I always -- there is always a way to grow and we plan to continue doing that. But we do think it’s important because if G&A, for example, right where we’re showing leverage and efficiency in our G&A at the scale we’re at, we saw an uptake in the bad debt expense, which was disappointing to see and we feel for the pain of some of our customers. I suppose they’re going through a margin pressure period. I don’t know how long it will last. And again, this is a small number contracts as we mentioned, the bad expenses up from about $300,000 to $900,000, but it's just something I haven’t seen quite as many even small hospitals send letters in for bankruptcy or reorganization. So we should note it, we haven’t -- but we don’t know -- it's not -- I don’t think its material role to our performance. But it's just a trend and I thought that we should call out, because it's in our G&A now. And most people are going to expect us to deliver G&A. But along those lines, of course, the shift overall in our mentality in the last say six months and really the products we’ve been trying to build last several years are high ROI tools in factoring data in desired propositions. Like knowledge Q helps people tune their compliance program and see the cost of running their program. It's not just the content of the compliance program as it was in the past. So knowledge as a data dimension to analyzing the cost of your program and let’s people try to minimize their cost but maintain the knowledge in their Workforce on safety and joint mission requirements. Similarly, attacking areas like OB Risk which is a high risk area of medical liability and lot of these hospitals are self insured. And so our OB Risk curriculum, we were just really excited to see as we built that curriculum out of the last year to multiple modules. It's an area of high risk for the organization it has birthing units and OB programs, and directly related to their medical malpractice expenses. And so it was really exciting to see a major health system chose that solution. I believe that they believe it will have a high return on investment, because in this area of recognizing fetal distress calling for systems on time, creates a lot of liability that people aren’t well informed about it. So yes, I think our solutions by being more having a data component as in knowledge queue are focused on high risk areas as an OB Risk, position us to make the arguments for ROI and cost savings at our hospital systems and customers.

Okay that’s very helpful color. And then as my follow up, I'm curious since the Laerdal agreement has now have some time to sink into the market, I'm wondering if you have the opportunity to talk to any of your larger customers about the importance of the AJ car, and if that’s going to be a prerequisite or if they are open to and willing to look to other resuscitation programs that involve some novelties like simulation BR, et cetera. Just any updated outlook there?

Well, first of all, we have a great partner in Laerdal and AJ, and we really change the industry together. We move them from the old models of learning out of books and print together, and that’s in three year partnership for over seven years to a better modality of train. So the first news is that generally the acceptance of those types of learning, there are a lot of excitement about them, the mannequin-based learning was wave one, but all the technology units has wave two, and then AI machine learning is wave three. And so we really set up the market to be receptive of that. And we plan, as we mentioned, to continue to carry those really strong products into the market. In general, there hasn’t proven to be much about additional marketplace for other provider in that solution. And so we have started that dialog with some of our bigger health system customers about just receptivity to trying other approaches, other models may be other brands. And one of our largest said something I really like hearing. Because again there’s no -- these are strong brands, we’ll be an underdog by a long shot. It’s going to be no doubt a challenge to introduce additional, and we plan to introduce multiple new models of getting certificates in this areas, models and partners. But it will certainly be a challenge, because there is one established brand. We’ve just spent seven years telling the market that it's the best and the strongest. But in January of '19, we’re going to begin to show new things different ways and new partners. That discussion with one of our largest clients was really encouraging, because this is the quote. We care about the competency, not the card, and everyone refers to the card as AHA card. And so, I think it will be incumbent on HealthStream and our new partners to prove that we develop the competency and reduce the risk and improve the outcomes. And if we do those things, I think the market will be receptive to alternative solutions. Now, that’s my job to say that. I do believe it. I think our new partners believe it. I’ve heard it directly from the mouth of one of our largest health system customers. But there is no doubt the power of incumbency and the brand that exists. And again, we’re proud of that brand. We’ve enjoyed carrying it to market, and it’s definitely made an impact in resuscitation outcomes. We’re just now required by the relationship change to bring alternatives to market. And I have increasing confidence we’re going to have a good suite of solutions. The other thing to remember is we told all our new partners that we plan to bring choice and selection so the series. So there’s not just one way to do things. I believe there is never just one way to do something. And here we’re going to bring alternative ways, alternative models new credentials to the market. We comply with international guidelines at the same time, so there’s a standards body that’s international, not beholden to one vendor. And I think if we do all those things right, we’ve got a really good shot. And all of our partners going and knowing that our goal is to lower the cost. So in environment we just talked about, it’s really important to have a focus on cost. And so every partner we’ve signed the two, we’ve signed today understand that it is our job to bring lower price points in this area to the market. And I think given the sensitivities we see today and what we just talked about in cost pressures, I think that will resonate as well with the financial officers of all these institutions, particularly if the quote holds true that we care about the competency not the card.

Thank you. And our next question comes from the line of Matt Hewitt of Craig-Hallum Capital. Your line is open.

First question, last quarter, you had mentioned that you have been challenged on ramping up your sales hiring. You were, I think at the time, were roughly 15 sales people short of your goal. I'm curious any progress on that front.

We continue to do mostly organic hiring. I mean, the way to really change that number is to hire recruiters as you know and that drives cost. So we’ve taken a different approach in the last say 12 months of really reducing our lines on recruiting. That has created a slowdown in backfilling. And so we have not -- we have chipped it away here and there, and made some progress. But we’re being more cognizant of our operating leverage and margins. And frankly, I think we probably get a better outcome when we select people carefully by hand instead of being brought in by recruiters. So I think the quality maybe is going to go up, but it is taking us longer to fill the spot. And so we have not really completely plugged that back to hole. Now, as we enter the very end of the year, I do like to try to get new sales positions in place before our sales planning sessions, which are usually end of January or February. And so our goal would be to try to find the way to catch those up and keep accelerating between now and February.

And then a question about the large OB Risk sale in the quarter, it’s a multiyear contract. How will that layer on? Is that a simple flip of the switch and the entire system will have access? Or will that be a steady rollout across that large customer?

It should be a fairly quick implementation. And there it has universal access to cost of system and it does not require hospital-to-hospital implementation. And so, it should be fairly linear once turned on, and now the contracts on pretty quickly, it should begin revenue recognition and product adoption utilization. So, I don’t see an issue that should be a pretty quick power of integration to turn that product on, and make probably available. And again these health systems are very familiar to using our platform, so the integration value is very higher than if they buy from us, they get the power of quick adoption, which I think is valuable to them and valuable to us and our shareholders.

One last one for me. Historically, you’ve been a good partner with your customers. And I think back in times when there has been natural disasters and then you’ve worked with the hospitals to help them either push off at each caps or other surveys or help them get back up and running as quickly and as efficiently as possible. Given what happened here in the third quarter in Texas and in Florida. Was there any impact, was it a similar situation where you were working with your customers to maybe help them navigate some of the challenges that you’re facing because of those weather related storms, or any color along the hurricane line would be helpful. Thank you.

So, I mean certainly, a lot of our customers were directly affected by these hurricanes and the natural disasters that occurred. And certainly many senior executives, including myself, sent corresponsive communication out of understanding sympathy and offers to help. And at least in one business unit offers to make financial to help financially. And so, we do -- that’s a common part of our DNA and HealthStream is to reach out and see what we can do. We actually also let some of our employees have days off to travel down in the disaster areas, and work in those neighborhood, not directly to our customers but in some travel to Texas and spent over a week down there, trying to help out. So, we’ve tried to be part of solution there. What’s fascinating here is our system is so broadly adopted now that when something like that happens, you can see the usage pattern shifts by region and state. It’s almost like a visual map. You can see the hospitals go offline and consumption drops off of course. But you can watch the area of the disaster and impact as we look at utilization on our live network. And we’re so broadly distributed coast-to-coast that it’s almost like a weather map, you can almost look at our hospitals coming offline and then back online. And our job is help them get back online as soon as we can. So, we certainly want to e a part of the solution, and we’re proud of some of our employees that taking their time to do the things that they did.

Thank you. And our next question comes from the line of Richard Close of Canaccord Genuity. Your line is open.

Thank you for the questions, congratulations on the engagement metrics that you posted here. Question on the bad debt, just to follow up on Ryan’s question. On the bad debt, did you see in any specific product area, is it more in Workforce or does that fall into the other pocket of revenue engagement or provider services?

There is no one particular pocket. I know one particular area or segment, it’s been kind of a generic trend across the board in terms of hospital location and hospital size. So there is no one particular identifying characteristic.

With the nurse ready product and OB Risk, may be Knowledge Q, can you talk to us a little bit about the addressable market for those new products within your base? I assume there are sizeable, and you would be bringing these to market. But any type of magnitude you could share with us in terms of that addressable market size?

That’s a plan over time, but let me give you some characterization. Knowledge Q, think of Knowledge Q as a third generation compliance product. So if you think back over our history, we’ve introduced basic joint commission training requirements and OSHA safety requirements, and had a library. And then we updated it to include testing services and evaluations, and we have data and benchmarking and analytics bundled in with content. And we’ve enhanced the content to be mobile and responsive. And so that product is now sold separately, not bundled in with the learning platform, but it does -- there’s some value ascribed to the prior generation product. So that product, I believe, is something that we could potentially sell to everyone. It does have a lower price point, but it is broad adoption. And it’s high margin because we own all of the elements of it. We own platform delivery content data and benchmarking, all of the components of Knowledge Q. So it’s a high margin product. You mentioned the Nurse Residency, that’s an interesting one. It's actually a low volume product. So if you take out hospital runs a good type hospital run three or four cohorts, or maybe two or three cohorts of new nurses a year, they kind have classes they bring in, essentially over the course of year. And the classes are fairly small, 20 to 30 people may be at a medium size hospital. So think of it as 40 to 60 new nurses coming in. And remember these are recent nurse grade, there’s not just new nurse hire. This program is targeted for new graduates. They just graduated, they’re coming into the workforce the first time we give them a prospective of one year program. Now, what's exciting about this product even though it’s low volume say a class of 20, it’s a much higher price point than we’ve ever experienced in almost any of our products in fact. Because it bundles almost everything we have into a one year program. You get access to our checklist, to our learning system, our accountancy management system on a per person basis. You get curriculum from up to four different vendors. And so the price point is we haven’t put this out there yet, but it's over -- it's in the $100 and $100, just shy of $1,000 actually per person per year. And so, it's really high price point, but low volume product. There is about 170,000 new nurse graduates each year coming into the marketplace. You could think of this product as targeting that audience as they join workforce in the hospital, so low volume high price point. Good margins and again includes a mix of products from other partners. And so the margins aren’t as high as knowledge Q. But I believe it’s safe to say the margins are higher than our current average margin or somewhere in there, because it includes a mix of content of mobile partners and platform into the residency program. Again, that’s the program those recently help the hospital earn accreditation for their residency program, which is really exciting from a marketing standpoint. So I hope that helps. One is the one volume low price point. We think it applies to every hospital, actually every employee in every hospital. And in long we have a version for long term care and post acute settings as well. And then that’s knowledge Q and then Nurse Residency is very targeted about 170,000 nurse grads a year coming into the marketplace, but at much higher price point.

I guess one of my final questions here would be. Jerry, you talked about average revenue implemented subscriber metric, and you’re thinking about doing away with that. If you could just go over the puts and takes on that.

So, I think the most important consideration, and I think I mentioned in my remarks was really it covered I believe one third of business, the workforce development segment. It does not include any contribution from patient experience or provider. So that’s one consideration. The second is, as you saw it last year with the ICD 10 only subscribers, the fluctuations in the subscriber count skews on the results. And the third thing is I think as the product line change and morph, the combination seems to be much more important than the distinct calculation by segment. So do I get a comprehensive meaningful incredible overall metric as is not yet, I think, we can all agree to that. So it’s more a question of what we place it with two as much as taking it away.

In order for us then analysts feedback on this we have over last couple of years, we brought this up and we just never quite said, let’s retire because, ideally we have a good replacement price revenue per facility or we would do approximate say Provider Solutions and divide that into the number of employees, and at that end of era. So you get a sense for how much revenue per account or per facility, or find a way to attribute value per subscriber in the other two those business segments. So we haven’t yet figured that out, but I think the other segments are growing in importance. They have slightly different dimensions to their revenue and that metric doesn’t encapsulate those units. So we think we would like to just maybe rely more on GAAP reporting at the holistic level instead of metrics that reflect individual segments. But we’re not completely sure of that, but we’re also given heads up that we may retire that metric in February next year.

If you do decide to change and provide facilities or different metrics, will you provide us some historical data point in order to see what the trends are?

Yes, we would surely provide sometime if we had a new metric, we have to -- it will be more of a proxy metric. So take provider solutions, for example. They sale the large health systems and get business there. And generally, it would be proportionate to say that the revenue they generate from that account could be divided by the number of employees of account, but it's really sold based on a number providers that are credential for the scope of work. And so it’d be more of a proxy if that were added into ARIS in that way to try to derive, like how much revenue do we get of that health system per employee. And the same difficulty with the patient experience surveys. The volume of surveys we do for hospital is probably derived by the size of hospitals and rotations we have, which is also derived from an approximation and number of employee. But if you took the revenue from patient experience at a given hospital divided by number of employees, there would be just a proxy directional indicator of revenue per employee based on the scale metrics, I said. So we’ve tried to put all that together into one metric, and we’re not just quite comfortable releasing it because of the way they’re more derivative. So we’re working on it maybe in sessions. You can give us other ideas on things you would like to see us measure, we’ll take that into advise. But we do know that the ARIS metric is almost too hard to interpret. We’ve pointed out how it can be anomalous at times when you add 0.5 million subscribers at a very low price point that’s dilutive to the margin, or you can lose a very big customer that is below the price point, and ARIS could go up. But you just lost a customer. So we struggle to do the puts and takes on it, and for that reason, we’re thinking about retiring it.

Thank you. And our next question comes from the line of Nicholas Jansen of Raymond James. Your line is open.

I just wanted to drill a little bit deeper into organic growth. I think you mentioned one or two one-timers in the quarter, so just trying to get a better sense of the total magnitude of that revenue benefit. And then second as you strip out Morrisey, ICD-10 some of the deferred revenue puts and takes, your organic growth at least on my math is in that 6% or so range in the quarter. And just wanted to get your thoughts on, given the pressures and patient experience that you’ve talked about given the transition to SaaS on the subscription side for the Provider Solution business. How do we think about that evolving as we true up our models for ’18? Can this be a double-digit business again? Thanks.

So, there is no doubt. We’ve implied some intentional transformations in our business that will challenge, if people only focus on pipeline growth, it will challenge maybe their interest. Because the story, as we mentioned with OB Risk, is transformational the way Netflix got into content a little bit. You see us doing that. So a prior product was driven by a partnership with a lower margin move to one that’s co-developed and co-long and it's higher margin. And so in that case, there’s a focus on margins and having a good replacement product. We also mentioned the two dynamics that make top line growth more challenging. But they’re very healthy dynamics, you’re focused on free cash flow and EBITDA and ultimately I think that’s how businesses should be valued. And so, I think it’s fair to say that we’re going to have pressures in growing the top line in the coming months and even years, as we finish these transformations. But there is no argument that by anyone I’ve ever heard that moving to SaaS is a bad idea from installed revenues that have point in time recognition. There is no argument that in moving in our Patient Experience business, moving to more e-surveys, even though the price points can be drastically lower, the result in gross and net cash flows can be higher from an e-survey than a phone survey. And so just imagine that business is a big transform a dollar of revenue and sale it at a lower price point, but the margins really expand pretty dramatically. So, I think if you’re analyst on HealthStream, watching free cash flow, watching EBITDA, watching operating leverage as we think about the next several years is going to be pretty important. And because these transformations are intentional and focused on delivering better free cash flows, overtime, I think that we may have to change some of our focus as we pull those transformations from top line growth to bottom line growth.

That’s very helpful. And then we think about this cash flow transformation, certainly you already have a pristine balance sheet. How do we think about your M&A pipeline, your desire to spend money on that effort as you go through this transformation, because certainly I would assume any acquisition would perhaps be dilutive to the margin in the short-term. So just want to get your thoughts on M&A? Thank you.

So, before I do that, I want to add one more big transformation that’s known now. We mentioned the drop off in the contract of their dollar, the drop off of access to that product, meaning at the end of next year. And so that will have a known and almost like ICD-10 quantifiable decline in revenues as we’re no longer able to sell that product, and we start selling the new product. Now the good news on that one is the new product we believe is right now based on contracts. We’ll have more than double the current margins. So we only have to sell half as much to make the same amount of money. But the revenues declines from that product is going to be challenging in the coming years, beginning in 2019, not 2020. So I’ve seen some analysts model, some declines in the revenue in 2020. But if you think of it, we can only sell the product through December of next year. And so an accounts come up for renewal in February of '19, we will not have the right to renew that account. We will have the option to sell them something new at what is lower price point to them and it double the margin to us. But we will not have the right to renew them if they want that existing product. So I do think that’s the third element that will pressure top line growth in the coming years, beginning as early as '19. That said, we talk about our capital position, it's really strong. I mean, if you look at free cash flows in the quarter, I think, year-to-date it was about $35 million, it’s up from $15 million in the prior nine months. And so deploying capital into inorganic strategies will have to be part of our story. We’ve got a talented team here that knows how to do and integrate and acquire businesses. And so we expect and you would expect us to deploy in our current balance of $123 million, and use some of our line of credit in our free cash flow in the coming years to have an inorganic component to our story. Of course, the challenge to that is you now want to do done deal just to chase the top line, and we’ll try to be as careful as we’ve always been. But we are cognizant of the need to deploy the capital, the $123 million in cash we think we can probably have access to a greater line of credit in the coming years, as well because our cash flow improvements. And so inorganic growth will be part of our story, I know that’s a bit uncomfortable because it's really hard to model, and it’s hard to model and even to our board because you can't just promise deals, you have to give good deals. But it will be a part of our story, going forward, and we're confident of that and we're working to develop that pipeline.

Thank you. And the next question comes from the line of Matthew Gillmor of Robert Baird. Your line is open.

I just had one, which is, I wanted to get an update on your content partners and your overall strategies. So can you may be update us or remind us on how much of your revenues derived from self developed content versus third party partners, and where you see that going over time? And then outside of layered all, are there other key renewals with your content partners over the next 12 months that we should be monitoring?

So, I’ll take the last question first. There are no other content partners that we depend on at the scale of Laerdal, AHA. It's kind of last piece of model and we need to migrate, either multiple partners or different partners. And so in the prior years, we announced the transformation of clinical skills. For example, we use to just rep one of the top three providers of clinical skills in the world actually, there is three very large multibillion dollar corporations that provide clinical skills training and nursing. And up until about I guess two year ago or 18 months ago, we only represented one of the three, and now I'm proud to say to that we represent two of the three. So we bought variety and choice and those partners have -- created some competition and that’s been favorable to our customers to get better price points and more choice and selection. So I would have said that the secondary dependence would have been in clinical skills that we actually moved away from dependence on one partner in clinical skills about over a year ago. So that’s exciting. Now, the investment in our own content will be very targeted, the way Netflix moved into building some of their own content. But I'll say a couple of things. Third party content from clinical organizations is really important in our model. It's what provide choice and selection and breath, and shows our expertise and domain expertise in healthcare. So maintaining a partnership in over 70 partners and growing is always grown more than a shrink. We’ve lost -- I can think of three that we lost in last five years that we add several more than at each year. So the partner network is growing. The breath of that network, even for a niche products that mainly do 200,000 here, having that product in our catalog and have it easily integrated is an important part of our value proposition. So the breath of our partners is very important. Now, where it makes sense to introduce a house brand is the decision we’re making and we’ve made that in couple of areas. The OB Risk is the first area that’s publicly known, so a very small percentage of our partners and our content is owned by HealthStream. But knowledge Q, as I mentioned earlier, a key and top grower of high margins is also owned and developed by HealthStream. So little like Netflix moved into content development, we’re stepping in -- step functioning into it. And the two key products today that are house-owned are Knowledge Q and OB Risk. And there are some more already in development. In fact, I think we’ve just announced the ED risk program, emergency department risk program and it's going into the marketplace. And so you see supplemental programs that have some house owned dimension to them coming to market. But I don’t want to deal with something -- we’re not going to move all the way to house owned content, it's the power of your association brands. We’ve just signed some new associations to bring their branded gold standard content to market. It’s critical to have the top 10 nursing associations involved in our network of 4.6 million healthcare workers. And so that mix is important.

Thank you. Our next question comes from the line of Scott Berg of Needham. Your line is open.

First of all, Gerry, I am not sure how far along you are in your assessment of implementing ASC 606 next year. But can you maybe give us some highlights on what you think the impact to your model would be next year?

So quick update on process, then I can discuss the second part of your question. We’ve gone through both the accounting research accounting policy portion of the projects completed that. We’re now in the phase of implementation. How we change our institutional workflows, how we’ll read out our contracts to comply with the new standards. In terms of, I gave some general themes we’ve come across, and if we can go from there. But I think what you will find on the revenue recognition side seem to be very similar to how they are today. The one change -- and really this is really quantified in the footnotes in future periods. But the one change, and maybe not just HealthStream but other companies we follow, the commissions accounting will most likely very, very different. And what I mean by that is the new standard requires companies to capitalize commission and then amortize not over the contract life, over the customer life. So, if you think about HealthStream as one example, we’ve had very high renewal rate. So our customer life exceeds our contract period. And so, you can expect a longer amortization period -- work that out with actuarial and all kind of -- or with experts right now. But I think I would signal that as to more notable change you’ll see in the impact on new standard on HealthStream.

And Gerry just to add -- make sure the models -- the costs that we’re estimating for the fourth quarter and maybe the full year on implementing these new standards.

Yes. So the nine months to-date to September, we’ve incurred about 400,000 or so of expense for the compliance efforts. I think my tax mentioned $600,000, we expect in the fourth quarter to wrap up work with E&Y or our auditors plus our own internal execution of new workflows and new platform and so on.

It does cost on G&A…

Yes, through G&A…

So just where we’re getting good operating leverage on G&A we have increased bad debt expense and government regs compliance and accounting that pressure that cost area. So that’s unfortunately but it is what it is, and that we plan to obviously just getting our reports recently. We’re on schedule for compliance with those requirements, and expect to deliver compliance with them beginning on January 1.

Last quickly from me Bobby is, the Laerdal products have sold well for you guys over the last couple of years. And with the change that’s coming in 14 months. Wanted to see what’s you’re hearing from your existing customers, maybe impact to sales cycles right now, and maybe expectations over the next 14 months? Are you expecting to maybe see sales of those products slow to new customers as they wait for your new products? Or do you think that they continue on this new trajectory as they have that?

That’s a big thing we’re trying figure out. We’ve looked at -- remember I mentioned the change over from one clinical partner to two others, and we have actually flip flop from one to two others. And observation when we did that flip flop was that as we ended our ability to sale those products, the sale of product was essentially the same as the prior year, which is really growing. So, it flattened out a bit but it stayed strong. In other words, we didn’t experience a drop off. In fact, we did see some customers trying to secure the rights to that product beyond end of our relationship. And so at the very end there’s little surgeon buying or an increase in buying, I should say. So, we’re trying to figure that out. I think customers it’s a really good product, as I mentioned. I think our customers really value integration. And I think they will probably likely want to secure the product for as long as they can to be fully integrated. And so my thinking is now as we enter this next 14 months is that hospitals will contract for a little longer than average period, like their average period is about 18 months, maybe a little longer than that. And what we’re thinking is they’ll probably some clients will want to secure essentially what is now through a partnership, we want to secure working version of that out to 2020. But it is going to be hard to predict. And so right now, the way we’re modeling is essentially we’ll probably sale about the same amount in this coming year, in the next 12 months beginning in January, as we’re going to sale in this year, maybe it’s a little uptick at the last to deliver modeling. And so, not a decline mostly flat but flat on a really good year here in ’17, so we expect to repeat that in ‘18. And then it’s going to be difficult in ‘19, because we cannot sale, mark or distribute a competing product until January 1, 2019. So we can’t even begin selling replacement products until January 1, 2019. And so, it’s going to be a hard backfill for us. But to answer your specific question, I do think that customers want to secure it, because they do value the integrated products. We’ve seen that over and over again when products come out of network that our customers are willing to shift as we mentioned in clinical scale, a really good shift going on right now to integrate partners from the prior partner. And so again, we're modeling it relatively flat, but it’s a strong year in '17, so I expect strong year in ‘18.

Thank you. Our next question is from the line of Vincent Colicchio of Barrington Research. Your line is open.

Yes, most of mine were asked, Bobby, just one from me. In provider solutions, are you seeing the level of cross selling activity that you’ve expected?

Not yet. I would say we’ve seen that business get cleaned up. We have exciting announcements to -- and remember -- we have the merger of three businesses. And I think we’ve done a really fine job of merging the three businesses. But there is more news to come on that front, including watching new products in January. It’s the new technologies launched in January that will be more leverageable that will receive data from other parts of our ecosystem, other products that we have and back and forth. So I think we’ll see more products. Now, if you mean our accounts buying in to both product sets that I would say, we’re seeing some of that. We are leveraging the relationships to try to have more wins against competitors. But the actual technical integration, which will get us a selling advantage, I think, begins really in January, first quarter of this next year. So we do see lots of accounts that have shared products, I think they value buying mobile products from one vendor. And so that has been helpful, but when we get technological integration that actually is currently scheduled for Q1 of next year that we can really have product leverage in the sales process.

Thank you. Our next question is from the line of Frank Sparacino of First Analysis. Your line is open.

Bobby, just may be quickly. There hasn’t been any talk around the post acute space. So anything noteworthy?

So we’ve got a strong sales team there, and it's a steady contributor to our subscriber growth, so just kind of folded in. We have a great penetration in the acute care market, so some of our growth has been consistently coming from the post acute space, both within health systems that have first few operations and outside the market. And so I would just call it a steady contributor to our story. It’s helping us maintain subscriber growth by adding there. It's definitely a little harder to sell in that space, because it's more fragmented at scale. So we’re learning new models of selling. But pleased with the progress and just I would say steady contributor to our story. We have -- many of our products can be sold into both channels the acute and post acute. We’ve adapted several, as I mentioned Knowledge Q, to have our library on post acute. And so I would just report as study as she goes and part now of our growth opportunity, we’ve articulated our target audiences about 80 million people, and they are 4.6 million. And so adding that market opportunity, gives us the chance to keep growing subscriber account.

Thank you. We do have a follow up question from the line of Richard Close of Canaccord Genuity. Your line is open.

Just really quickly. Can you update us on the last 12 months revenue for Laerdal? I think when you made the announcement originally back in the spring, the trailing 12 months was $39.7 million. Is there any update there?

Well, we’ll look at that. But we probably don’t plan to update on a line-by-line basis every quarter. But we’ll consider that. It was a little over all the products from Laerdal were a little north of $40 million, maybe around $41 million, based on that relationship that’s the totality of revenues at that point, now just a few months ago. So, I don’t suspect it’s changed very much on a trailing 12 month basis.

Thank you. And at this time, I'm showing no further questions. I would like to turn the call back over to Mr. Robert Frist, CEO for his closing remarks.

Thank you for participating in the third quarter call. We look forward to reporting in February our year end results. Thank you much. Bye-bye.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everybody, have a great day.