HealthStream's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Oct.22.13 | About: HealthStream, Inc. (HSTM)

HealthStream, Inc. (NASDAQ:HSTM)

Q3 2013 Earnings Conference Call

October 22, 2013 09:00 AM ET

Executives

Mollie Condra – Associate Vice President-Investor Relations and Corporate Communications

Robert A. Frist Jr. – Chief Executive Officer

Gerard M. Hayden – Senior Vice President and Chief Financial Officer

Analysts

Ryan S. Daniels – William Blair & Co. LLC

Dillon K. Hoover – Craig-Hallum Capital Group LLC

Scott R. Berg – Northland Capital Markets

Frank Sparacino – First Analysis Securities Group

Terry M. Lally – Spotlight Funds Management

Richard Close – Avondale Partners LLC

Operator

Good day, ladies and gentlemen and welcome to the HealthStream, Inc. Third Quarter 2013 Earnings Conference Call. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference Mollie Condra, Associate Vice President, Investor Relations and Communications. Ma'am, you may begin.

Mollie Condra

Thank you and good morning. Thank you for joining us today to discuss our third quarter 2013 results. Also in the room 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 risk 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 I will now turn the call over to our CEO, Bobby Frist.

Robert A. Frist Jr.

Thank you. Good morning and welcome. We have many items to cover; financial metrics, operational metrics and product updates and then some event updates as well. So we’ll dive right in. In the third quarter, just a quick scan on the financial metrics, we clearly had solid performance across the board with consolidated revenues up 28% to $33.7 million. Operating income came in up 4% to $3.9 million. Net income was up 16% to $2.3 million, and adjusted EBITDA was up 10% to $6.3 million. Just kind of a quick sampling across our financial metrics shows, solid and within projections – financial performance.

As you may recall, as we talk about our business we continue to think about introducing new metrics and we introduced our new metric in the first quarter of this year 2013, that took a look at the progress in growing the value of our customer base. That new metric is our Annualized Revenue per Implemented Subscriber. It represents the quarter’s revenue from Internet-based subscription products divided by the average implemented subscribers for that quarter, annualized.

In the third quarter of 2013, our revenue per implemented subscriber was $30.95 which was 15% higher than the third quarter of 2012. If we look back over the last eight quarters, we’ve seen a steady upward trajectory which is indicative of our objective to provide more and more solutions to our customers through the channels we’ve been establishing through our platform.

Given the expansion of HealthStream suite of solutions over the last several quarters, we’re working to introduce additional new metrics that continue to capture what’s happening in this ecosystem. Since historically our HLC was the single core application on our platform we’ve made a routine to report the number of subscribers on the HLC, the HealthStream Learning Center, along with renewal rates in our quarterly earnings releases.

At this time, however our range of solutions has significantly broadened to be a more enterprise-class talent management suite and there are now several applications on our platform that work in combination with our other products to create targeted solution sets.

Our array of solutions has increased as customer relationships have evolved to meet changing and expanding market needs and consequently we are working to provide additional new metrics that better explain the ins and outs of this more comprehensive talent management platform.

Until that time as we continue to develop those metrics, we’re excited to celebrate this one new metric this year Revenue per Implemented Subscriber. And we look forward to introducing additional new metrics that maybe better capture renewal rates in additions to our network as we look forward the next couple of quarters.

Overall we implemented over 80,000 new subscribers in the third quarter, bringing our total to 3.196 million subscribers. Importantly, net of loss and attrition we added a 151,000 net new subscribers under contract. And that brings our total under contract of 3.411 million contracted subscribers. I think that for the longest time I stated that our quarterly goal of net new subscribers is 20,000 to 50,000 per quarter. So obviously, this is an exceptional quarter by any measure and I think we can provide a little more color on – on how that looks.

Roughly a third of the new contracted subscribers in the third quarter were from an amalgamation of new healthcare organizations. So, spread across the entire spectrum. And so that’s consistent with past targets and goals, so a third of the new 151,000 came across the host range of healthcare organizations, hospitals, home care. So we’re excited to see that base line performance.

Another third resulted from additions specific to selected content sales or in this case largely ICD-10, which has clearly been a driver of adding new subscribers even when they are on competing platforms. We see that we have a market leading solution for ICD-10 and we’re able to add subscribers by tracking into that solution, which we feel is a great foot in the door with additional market opportunity.

The third and final part of the 151,000 came from our Brentwood, Brookdale Senior Living, which we announced last quarter with – but it actually got signed at the beginning of this quarter. And now we’re well on our way to implementing Brookdale Senior Living. And so you can see a really nice balance across these three, kind of thirds, 151,000 net new subscribers; a third from the open market, a third from bringing in new ICD-10 customers, and a third from Brookdale Senior Living, which is now in the process of implementation.

And currently in the backlog and this is important, because the backlog, as we implement then they turn to where we can recognize revenue of 215,000 subscribers, of that 215,000 subscribers that are in the process of becoming or being implemented.

Renewal rates for the third quarter of 2013 were 85% based on full time equivalents or number of subscribers and 93% based on contract value. Our renewal rates reflect the addition of subscribers compared to previously contracted amounts combining with any pricing adjustments that may occur at renewal.

During the third quarter, the number of subscribers that were up for renewal was approximately 100,000, which is a typically small related to other quarters. For example last quarter over 0.25 million were up for renewal and we renewed practically all of them.

So – we have a low volume of renewal quarter, it makes the measurement far more sensitive and so we did see a loss of approximately 16,000 subscriptions in the quarter, which largely explains the renewal rates in the quarter.

For the trailing four quarter period, importantly ended September 30, 2013, customers representing 95% of subscribers that were up for renewal, did in fact renew. While renewal rate based on contract value was 96% again for the tailing four quarter period.

I’d like to turn our attention to some business updates. We announced earlier this year, we launched our strategy to offer our Learning & Talent Management suite of solutions to the post-acute care market. As you may remember we reported in our last call, we contracted with two large organizations that were leaders within their space; Brookdale Senior Living and Almost Family.

I’m pleased to report that the implementation of both of those accounts is going smoothly, we’re seeing innovative uses of our platform from Almost Family already using social learning in our community capabilities to reach their broad audience across their 10 operating our business units.

During the third quarter, we signed additional customer contracts in the post-acute space, which I mentioned earlier part of the 151,000 that we have signed. And we remain active in developing new content partnerships in this area. In fact, we look forward to announcing several new content partnerships in the fourth quarter which are keyed up really nicely here at the end of the third quarter.

Turning our attention to SimVentures, our collaborative arrangement with Laerdal Medical, we delivered a strong quarter. Our revenues from this product suite is growing 35% over the prior year same quarter. We delivered about $565,000 revenue from our SimVentures collaborative arrangement.

In the quarter SimManager was contracted for example by the Children’s Medical Center in Dallas, an exciting new addition to customers of our SimVentures product set.

In the third quarter, importantly we also began to bundle SimCenter, which are products of SimVentures. We began to bundle products from the venture with other hot selling products like our HeartCode solutions. So now when we sell our HeartCode solutions we bundle the SimManager product, we call it the SimManager Express with the HeartCode solutions. So now each time we sell a HeartCode solution, we will also be selling a product of SimVentures. It’s a very exciting new way to achieve additional distribution of the SimVentures product sets.

In the third quarter, the adoption of the Sy.Med OneApp – Application which is a credentialing and privileging application continues to grow. Excitingly we had a 24 new contracts to the Sy.Med credentialing product in the third quarter of 2013.

Our Sy.Med credentialing solution provides a unique invention to our Talent Management strategy. It’s kind of this overlooked area of managing talent and healthcare is the credentialing and privileging of the workforce, giving them the rights to access and practice medicine in the various facilities. And this is kind of a detailed process generally managed out of the clinical side of the organization. But it’s certainly a Talent Management function that manage the clinical credentials of your workforce.

So we are very excited to see that product line continue to grow adding 24 new customers. Within our Research business we performed well in the third quarter, particularly with our patient Insights surveys, which are the more recurring revenue components of the Research business. Our patient survey revenues increased 15% over the third quarter of the prior year 2012. Overall our Research business revenues increased by $1 million or 17% over the third quarter of 2012.

An important driver of this growth is our CG-CAHPS product that is clinicians in groups at the survey that focuses on physician and clinician practices. We added 25 new CG-CAHPS customer contracts in the third quarter. Those contracts worth approximately $2 million in total contract value. We added new customers like Alegent Health, Stormont-Vail HealthCare and Pikeville Medical Center to our CG-CAHPS product line in our Research business. So we are excited to see research deliver strong double-digit growth and particularly the performance in the CG-CAHPS product.

In September, we enhanced our patient experience solution also tied to our Research business through the acquisition of Baptist Leadership Group. This is a Pensacola based – Pensacola Florida based consulting practice. The Company through this acquisition gained a competitive suite of assessment tools, training curriculum, staff of experience, coaches and experts. And they are all focused on really one thing improving the patient center performance of HealthStream’s customers.

And so we are very excited to have such a talented team joining our company and add even more dimension to our Research business. We look for their continued contribution for the growth of our Research product lines. We purchased the Baptist Leadership Group or also referred to as BLG for approximately $7.2 million in cash and $500,000 in HealthStream common stock.

We were excited to complete that transaction. We actually saw a small contribution in the remaining month of the quarter from the BLG product lines and we’re excited to get that organization onboard and contributing to the growth of our Research business. But it’s only a slight contribution only one month of the quarter. We’ll see a full quarter impact of that acquisition in this quarter.

I’ll turn it over to Gerry for more detailed look at our financials and then come back and discuss some more product updates and some events. Thank you, Gerry.

Gerard M. Hayden

Thank you, Bobby and good morning everyone. Bobby has laid out the quarter’s highlights, I’ll take a few minutes to add some financial color to our results. The foundation for our solid financial performance was its revenue growth. As Bobby mentioned the third quarter’s consolidated revenue growth it was 28%, with the year-to-date results that’s in the trajectory at 25%.

The Learning & Talent Management segment has benefited from both an increase in the number of subscribers as well as greater courseware consumption across that subscriber base. Our Internet subscriber count has grown by 11% over the last year’s third quarter which equates to an additional 327,000 subscribers. We’ve added the revenue base over the last 12 months.

Growth rate of Learning & Talent parameter is varying per subscriber, that metric has expanded from $26.98 in last year’s third quarter to its current $30.95 which is the 50% growth rate and reflects that a continuing courseware consumption amongst our subscribers. The end result is a 20% growth rate and a recurring Internet-based subscription across the third quarter of 2013.

As Bobby mentioned the Research segment now includes Baptist Leadership Group or BLG, which was 17% growth rate in the third quarter. The Patient Insights category led the way at 50% increase, while the other survey categories employee, physician community also posted net gains.

The CG-CAHPS surveys which we’ve mentioned in previous calls this year were again the contributors of double-digit patient category growth. We are pleased that many of our revenue metrics betrayed the double-digit growth rates though a two additional factors regarding revenue performance are important to mention. First, we are very pleased with the performance of our acquisition such as Sy.Med Development and Decision Critical. And for example as you read in our release Sy.Med contributed $1 million to revenue growth in the third quarter of 2013.

Second and importantly core growth remains the most significant driver behind our overall revenue performance. Year-to-date operating income has grown by 10% over the last year’s first nine months, which is consistent with our guidance. We’ve been investing continuously in 2013. Labor was in terms of increased employee counts and contract labors one of the most obvious form in investment for us.

One example of how labor investments are affecting our financial performance is the growth rate of our product development category on the income statement. For the first nine months and at September 30, 2013 product development expense is about 36% over the same period in 2012. For the first nine months of 2013, we’ve incurred higher operating expenses and royalties, personnel additions and contract labor, sales commissions, depreciation and amortization, business taxes, merger and acquisition program costs and other general expenses.

We continued to review and evaluate actions in business development opportunities and as we mentioned in the past we’ve retained our discipline into the strategic fit and evaluation. As Bobby has mentioned, we’re excited to document BLG team with the HealthStream by September closing, and BLG would be an important and exciting addition to our patient experience products.

Our balance sheet remains well positioned to support our development activities as our cash balances at September 30, 2013 were $104.7 million. It’s interesting to note that the cash as of June 30 was $101.4 million. So we’re able to cover our net $7.2 million cash investment in BLG and generate enough additional cash to increase our balances by $3 million in sequential quarters. As you already know, we have no long-term debt.

One last matter to call your attention is cash flow from operations from the cash flow statement. This serves as a link between our balance sheet and our operating results. Cash flow from operations has grown by 46% for the first nine months of 2013, increasing from $15.6 million to $22.9 million of the first nine months of this year.

Finally, if you saw in the release, we are updating our 2013 guidance and anticipate the consolidated revenues will grow between 26% to 28%. We expect Learning & Management to grow between 30% and 32% with Research revenues to grow by approximately 8% to 10%.

We expect operating income to be approximately 6% to 10% over full year 2012, capital expenditures to be between $8 million and $9 million. And finally, we believe that our effective tax rate will be approximately 41% to 44%.

Thanks for your time. I’ll turn the call back to Bobby.

Robert A. Frist Jr.

Thank you, Gerry. I’d like to head into some solutions and product updates of note. We continue to see progress for two of our new talent management product offerings. These product offerings are integrated part of our enterprise class SaaS-based talent management platform offering. Those products are the HealthStream Performance Center and the HealthStream Competency Center.

Since our launch of the Performance Center approximately 18 months ago, the number of contracted subscribers has reached approximately 250,000. I’m very excited to see the continued uptake and progress of this product set in the market. The 250,000 represents the subscribers across both Performance Center and Competency Center. Those two products are very similar to one another with slight additions to differentiate them from each other.

We added approximately 34,000 of those subscribers in the third quarter of 2013, and as you know the average U.S. hospital has a little less than 1,000 employees. So you can see we’re adding a significant number of new hospital and new customers to the HealthStream Performance Center and HealthStream Competency Center products.

We’re also seeing strong utilization of the products. So we’re not just selling it well, we’re getting into the metrics command. For example, in the first nine months of 2013 over 70,000 assessments have been completed, which is derived from 4.5 million competency ratings. Individual competency ratings have been completed through the SaaS-based platform.

So we’re seeing a shift, the move from paper to automated performance review and automated competency review through our platform in the industry and we’re very excited to see continued adoption of those platforms.

Overall the account management space is an exciting and dynamic environment and our success with other product is attracting increased competition. We’re focused on building core solution sets for key challenges facing health organizations. For example, we’re focused on improving resuscitation rates, improving the clinical onboarding process, helping hospitals meet their OSHA, safety training requirements, the federal requirements.

Our competitors turn to be more focused on pure HR functionality whereas our system combines platform content and data in a way to address specific healthcare challenges like three that I mentioned.

Our solutions, because they address specific problems in healthcare, are more targeted than just to the HR functionality. That said other vendors have built out HR specific capabilities that we don’t currently offer. Some of those capabilities we have an eye to building and others we just simply will never build. So in some of the doorways where we sell like human resources, we are continuously seeing more and more organizations competing for that business. And other doorways like the Chief Nursing Officers, the compliance and risk management area, the competitive landscape is more focused and there are fewer competitors for our combined solution set.

And so we see this interesting mix as we focus more. We can create unique solutions, but also in the HR arena and the pure account management space we’re seeing increased competition. We’re expanding our platform and products in unique and interesting ways that help these organizations to achieve specific business and clinical outcomes. Two areas where we’re achieving great outcomes from our healthcare organizations are through our ICD-10 solution sets, which are helping hospitals, prepare for this large migration to a new coding methodology and our hardcore solutions, which are targeted to help hospitals improve resuscitation rates.

So on ICD-10, earlier this year CMS reaffirmed the deadline of October 2014 for the required transition to the ICD-10 coding system. We believe this regulatory deadline, assuming that it’s not delayed, will continue to be a steady driver for our training solutions for the new coding system. As you know and as we’ve mentioned before, we partner with Precyse and Precyse offers outstanding courseware for ICD-10. We’re able to bring an effective means of training the respective workforces of these healthcare organizations.

Through this partnership with Precyse, we have ICD-10 content for the full range of hospital employees that need training and includes coders, physician, clinical staff, executive staff and non-clinical staff. Since 2011 over 1 million healthcare professionals have contracted for our ICD-10 training solution through their respective organizations.

We continue to see steady sales patterns for our ICD-10 solution. The majority of new contracts that are being signed even in this recent quarter are for a 24-month period. In the third quarter of 2013, over 80 new contracts were signed for our ICD-10 solution. Over a quarter of those 80 contracts were each valued at over $100,000. So you can see both the velocity is strong and the size of the deal is strong. So retail prices in our two-year contracts for ICD-10 range from $30 to $250 per user with the average user price situated near the bottom of that range. We have a 50/50 arrangement with Precyse, which gives us a 50% gross margin on our ICD-10 solution.

We’re excited to be leading the industry and providing what we believe is the very best ICD-10 training solution on the market. Giving the impending deadline we believe it is reasonable to expect our sales velocity will taper as we approach the deadline of October 2014. It is also reasonable to expect revenue for the ICD-10 products will begin to taper after the October 2014 deadline. Our challenge in 2015 will be to backfill such a successful product by developing a maintenance revenue stream and renewal strategy with regard to this product line.

While many healthcare organizations have adopted an enterprise-wide approach to the orientation phase with regard to the new coding system. It is unclear what subset of their employees will require maintenance learning strategy and therefore how many will need a maintenance subscription. We do however believe that the ICD-10 products will continue to drive revenue growth for the remainder of 2013 and throughout 2014.

Shifting gears to HeartCode suite of products, we continue to see strong demand for the HeartCode suite of products. This product suite is focused on teaching multiple levels of recertification skills to healthcare professionals and it is offered through our partnerships with Laerdal Medical and contains content from the American Heart Association.

In the third quarter of 2013, we crossed an exciting milestone of 1 million healthcare professionals who have completed the preparatory training for their CPR certification through the HealthStream platform. So it’s exciting to achieve a couple of milestones; the 1 million mark now and cumulative subscribers through ICD-10 and the 1 million mark of healthcare professionals preparing for their CPR certification through HealthStream.

We see these as important shifts that show that when changes in front of us in the industry, the industry will turn to us and our platforms to prepare for these important – to achieve these important clinical outcomes or be ready for these important business objectives like ready for the ICD-10 migration.

Exciting news also kind of a culmination for the last several months was, our celebration with over 625 customers paying us a visit here in Nashville that came from across the country to attend our 2013 summit, which was our 10th summit and so it’s held right here in Nashville in our new Music City Center in the heart of downtown Nashville. The event was very exciting presuming dozens and dozens of workshops, presentations focused on best practices and other tools to help Nashville workforce, improve quality of their organizations.

The topical tracks that we were able to launch include leadership and strategy, human resources, talent management, education and of course quality themes were throughout the event. Also importantly our eco-system partners participated in the success of this event. Over 20 of our partners participated formally in the exhibition hall, including our core sponsors, Laerdal Medical, Lippincott Williams & Wilkins, and Precyse, which are our core partners behind core growth products for the HealthStream eco-system.

They were able to showcase their products and generate new leads for their clinical and business solutions. Attendees had chance to participate and also receive continued education credit by participating in the programs and we had pre-conference workshops.

Overall, one of the most exciting weeks in the HealthStream history, one of the most successful gatherings of customers interested in quality outcomes with a great blend of executives, representing HR, representing physician engagement, representing the pace and experience objectives of our customers across the country.

So the fantastic week, I want to congratulate all HealthStream employees for the continued success of our organization and certainly the last week was a great time to celebrate that in person with our customers.

At this time, I would like to turn it over to the operator to go to the question-and-answer session.

Question-and-Answer Session

Operator

Thank you ladies and gentlemen (Operator Instructions) Our first question comes from Ryan Daniels of William Blair & Company, your line is now open.

Ryan S. Daniels – William Blair & Co. LLC

Yeah, good morning guys. Thanks for taking my questions and congrats on a strong quarter. Bobby, I want to go back to some of your color on the net subscriber adds, you had indicated that about a third of them are coming to HealthStream given some of your proprietary content like ICD-10. And I’m curious if they are coming over and buying the platform in just ICD-10 or are they coming over and moving more of their Learning & Talent Management programs and the HealthStream right up front?

Robert A. Frist Jr.

Well, some of that, it’s a little of both. Some of them come in – it always connects to our platform. So we have a connection that allows them to tap into our architecture and use features and functions of our platforms and to have successful delivery of the platform. So there is no way to really consume anything from our network without tapping in and synchronizing with our architecture, infrastructure and platform.

So we’re able to generate some revenue from the connectivity to our ecosystem in addition to the value of the content sale. So I guess the short answer is that that they are always connecting to, benefiting from, and using components of our technology architecture when they get access to the content.

Ryan S. Daniels – William Blair & Co. LLC

Okay. Just to unclear that. So that the roughly third you’re talking about that’s just more of a connection versus a full subscription to HLC?

Robert A. Frist Jr.

That is correct. It’s a subscription to the connection components of the platform and it provides several of the capabilities. In fact increasingly we think less about single applications and more about tapping into a license for a certain technology workflow engines. And so we’re able to tap into the one that manages delivery and targeting of the content which is one of the core functions of the HLC.

Ryan S. Daniels – William Blair & Co. LLC

Okay, perfect. Then a couple more quick ones, I’ll hop in the queue. I guess one for Gerry, you talked a little bit about the summit, I just want to make sure we have our modeling expectations right for the upcoming quarter, that’s roughly about a $1 million in incremental costs, is that the way we should be thinking about it this year?

Gerard M. Hayden

In the past we disclosed, it’s roughly $800,000.

Ryan S. Daniels – William Blair & Co. LLC

Okay.

Gerard M. Hayden

We have the numbers for this quarter yet, I mean.

Robert A. Frist Jr.

We haven’t broken out the guidance.

Gerard M. Hayden

Yeah, we haven’t broken it down.

Ryan S. Daniels – William Blair & Co. LLC

In the past you disclosed…

Gerard M. Hayden

Right in the past you go back look it like last year…

Ryan S. Daniels – William Blair & Co. LLC

Yeah.

Gerard M. Hayden

It’s close to $800,000 in expenses.

Ryan S. Daniels – William Blair & Co. LLC

So safe to assume that will be somewhat similar to look at that?

Gerard M. Hayden

Yes.

Ryan S. Daniels – William Blair & Co. LLC

Okay, great. And then, yes, thinking a little bit more about the move in the post-acute care, the momentum you’re seeing both from a content side and business development. I want to get if you will little bit of a state of a union there on how you’re looking at that going forward and what kind of investments you continue to need to make in the 2014 and beyond versus the growth you might see, how are you balancing that looking forward?

Robert A. Frist Jr.

Yes, first I want to go back to the $800,000, that’s the – $800,000 is roughly the expenses of putting on the event. But there are offsetting revenues that come as well so the net expense is not as great as that. So, we don’t disclose the revenues from the event but the event also has revenues.

Ryan S. Daniels – William Blair & Co. LLC

Right.

Robert A. Frist Jr.

Then back to investments, we did see broad investments across every category, Gerry called out that product development growth. We continue to add capacity and capability to our product development teams. Always about this time we release and start to target, hiring and we just completed our retreat planning process with our board in the sales organization. So we expect to see some new positions posted here in the next month or two, so it began to ramp the sales organization again.

For next year, we would like to commend the year with newly added sales team members for our – usually early in January we hold our sales planning retreat with the entire sales organization and marketing organization. So you will see some additional adds in the areas of sales and marketing coming up in the next couple of months.

So really product developments and sales and marketing and then of course service across the board, we continue to strengthen our service organizations. We’ve added as you know to our teams to actualize and help us invest, the cash balances we have, so we’ve added to our G&A, through building a stronger M&A team and integration services team or adding some integration services officer.

So we’ve really, Ryan invested in all categories at a rate, while trying to maintain the trajectory. We said we will deliver that 10% operating income growth over the prior year. And so I expect many of those patterns to continue as we look forward to the next – into the future.

Ryan S. Daniels – William Blair & Co. LLC

Okay, perfect, helpful color. Thanks guys.

Operator

Thank you. Our next question comes from Matt Hewitt of Craig-Hallum. Your line is now open.

Dillon K. Hoover – Craig-Hallum Capital Group LLC

Hey good morning, this is actually Dillion on for Matt. Thanks for taking the questions. I appreciate the color on the renewal rates. So just trying to dig into that little bit further, is it purely a fact just a lower denominator for the quarter or is there any seasonality, obviously there is competitive dynamics work in the industry, are you guys expecting them to snap back next quarter, just trying to dig in a little bit more color on the renewal rates?

Gerard M. Hayden

Yeah, I can provide a little bit more. It’s interesting because some of the losses actually just dialed back the number of subscribers of the organization, but really remain customers of HealthStream. So we actually had three accounts that comprise most of this loss of subscribers, each of which remained a customer of HealthStream, but dialed back the number of subscribers. And at least one that we know is essentially a cost management, they were taking some hard cost out of systems and decided to target to a smaller amount of users in that organization.

And of course there were some competitive losses in there as well, but the majority of this quarter again and unusually small number were up for renewal and several of those that did not renew were simply customers that dialed back the number of targets, the number of targeted subscribers in the organization. So three of them were about 15,000 renewal of the metric, which was the majority – explains the majority of the drawdown. Actually remain customers, but drew down the number of subscribers on renewal that they were targeting with our services.

So that was little different than we have seen in the past, but we were glad that they remained customers and remained under contract as an organization, but dialed back the number of subscribers.

Dillon K. Hoover – Craig-Hallum Capital Group LLC

Okay. And then on the decreased CapEx guidance, just wondering for some – trying different granularity there, were there some projects that you guys had initially planned for the year that were taken off the cable or just in track out how you guys are expecting it to go?

Robert A. Frist Jr.

Yeah, earlier in the year, we had determined our CapEx budget and we’ve obviously revised it down or we had in the half of the year, we had some struggles hiring teams and people at the rate that we had hoped to, and we have done a good job in last several months, catching up while we’ve done some really innovative things in our HR group and new recruiting videos that express our culture. And we’ve really seen a turnaround both increased retention inside the organization, it’s been exciting and increased the traction and to be able to successfully fill open positions little faster rate here in the second half.

So some projects are not starting at the time that we expected, but we continue to add them as quickly as we can and bring those products online, so it is essentially pushing a little bit of the CapEx forward. There is no change in the product roadmaps that we’re planning to build or the number of things we’re planning to execute on, some of them just starting a little bit later. So we’re not going to get expensed them or capitalize them in these periods.

Dillon K. Hoover – Craig-Hallum Capital Group LLC

Okay. And then lastly and I will jump back in the queue, more of a macro question, are you guys seeing any trends up down or sideways for hospital employment? I know healthcare job released today 7,000 for September. It went pretty steady throughout the year, but any kind of color you guys are seeing on the hospital employment would be helpful.

Robert A. Frist Jr.

Yes, I would say that in the prior three or four years the industry was one of the few industries that was a strong net, specifically referring to the hospital, the acute care hospitals, made strong additions to their employment payroll sizes. In the last two quarters we’ve seen a slowing of that. I think one was real close to being negative. And so that is a bit of a change. It never grew really rapidly even in the prior three years, but it was a steady industry, adding steady jobs in the acute care space.

I expect to see continued additions in the post-acute space and the last two quarters we’ve seen kind of flat growth or slightly down and so that is a contrast from the prior three years. This is last two quarters. But I expect overall employment in the full healthcare sector including post-acute, ambulatory, surgery, behavior, behavioral to grow. And so earlier this year, I think as you know in January, we declared an increased focus on those verticals as well. So hopefully that proves well timed and we can continue to make progress as the overall employment grows in healthcare services, but we’ve seen a little bit of a flattening in employment growth rate in the acute care space.

Dillon K. Hoover – Craig-Hallum Capital Group LLC

Thank you.

Operator

Thank you. Our next question comes from Scott Berg of Northland Capital. Your line is now open.

Scott R. Berg – Northland Capital Markets

Bobby and Gerry, congrats on this quarter. First of all, Gerry, can you give us some of the financial details on Baptist Leadership Group in terms of what that organization have been doing historically in terms of maybe revenue cash flow earnings and what your expectations are for the impact for the rest of the fiscal year?

Gerard M. Hayden

Well, we haven’t really in the past disclosed historical performance of our transactions and the BLG results – our expectations is assumed in our guidance for the remainder of this year.

Scott R. Berg – Northland Capital Markets

Okay, fantastic. Bobby, you talked about adding sales headcount going into your sales kick off next year, at the beginning of the year. Do you have any expectations right now in the number that you would are expecting to add maybe from the third quarter and the fourth quarter total?

Robert A. Frist Jr.

We don’t, but it is simple to track as we add on we post almost immediately within 24 hours to our website. And so you’ll get a clean indication of that. Usually what happens here is we begin to feather in the hires that are intended for the next 12 months, try to get them – most of the intended hire is done in the first quarter, but it never ends up quite that clean where we add throughout the year even in the third and fourth quarter.

So we try to get the bulk of the hiring done in the fourth quarter and the first quarter of each year. So we haven’t disclosed the exact number and in fact we haven’t finalized it. We now have ranges where we have – since we have Board supported budgetary parameters laid out and the next few months we’ll be consolidating the ground up build up of our budgets for next year, and the release of hiring. And so we’re right at that inflection point where we are beginning to release some hiring, but we are finalizing everything.

And so most all of that will be reflected in December and certainly about February you’ll have a great clarity on the rate of hiring and if you watch our websites again, it’s easy to track.

Scott R. Berg – Northland Capital Markets

Great. Last question I have is, Bob you talked about some of the demand from a content perspective, especially around ICD-10, which has been strong recently. But how about from the core talent from the core talent from the learning platform standpoint? Are you seeing any noticeable change in trends either positive, negatively in terms of what your pipelines will look like exiting this third quarter relative maybe six months or so ago?

Robert A. Frist Jr.

Well, I think our actual performance has really outstripped most expectations. If you look at the net new subscribers added, 151,000 I mean clearly when we add really large system like our Brookdale, it will add 50,000. But even factoring out Brookdale we have an addition of about 100,000 subscribers across the spectrum of products in a 90 day window.

And so we see continued demand the way we are able to bundle our platform meaning our talent that features and functionality of our talent platform. We also gave a little more clarity on the rate of additions to some of our platform extensions to this is new first time the Competency Center and Performance Center. We’re now getting up to a mass where they’re becoming a market leading talent management capability, the performance management process and the clinical competency management process. Those are core extensions to our platform and we’re beginning to add subscribers to that component piece which is unique, it’s fully integrated but it’s unique in its feature set and capability from a learning platform.

So what I would say is we continue to see demand across the capabilities of our platform and continue to have strong subscriber adds in many different buckets, or just more ways as the platform expands for people to become subscribers to our ecosystem and we are excited to see that move ahead.

Scott R. Berg – Northland Capital Markets

Great. Thanks for taking my questions.

Robert A. Frist Jr.

Thank you.

Operator

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

Frank Sparacino – First Analysis Securities Group

Hi guys. Gerry, first wanted to follow-up I think on a earlier question on Baptist. I know you haven’t disclosed details, but the revenue for that acquisition is included in research but the research guidance hasn’t changed. So what should we infer from that?

Gerard M. Hayden

Well, I think we’ll see that, once it will be in that range I think it’s 8% to 10%, we have for the guidance and that will include of course the three months of BLG for the fourth quarter plus our existing research business base. So that’s what’s the counterfoil, we’ve done our forecasting is included in that segment.

Frank Sparacino – First Analysis Securities Group

And just in terms of what the business is, I mean can you just talk about your relative, is it more of a product company or what’s the revenue mix between actual product versus services?

Gerard M. Hayden

As for the answer, I guess the way it may have drew a little bit of contrast, it did not complete the traditional age, caste patients survey. It is more of a coaching, consulting type business. Like, ranges tend to be multiple year assignments over a course of a number of quarters. So it’s a little bit of an adjoin – we have a small in-house consulting service right now, this part of our business base. This is a different type of consulting but it’s more an adjoin to that patient experience product and if they do not do survey completion like the flagship part of our Research segment.

Frank Sparacino – First Analysis Securities Group

Okay, thanks Gerry. And then Bobby, maybe for you, just on the ICD-10, in terms of that the revenue range you gave per user, I think 30 to 250 I’m curious why were sort of towards the low end of that range and then over time would you expect that number to grow? It seems like people are obviously gravitating toward a certain part of the ICD training today and I don’t know what that is or what that trend will look like over time?

Robert A. Frist Jr.

Well, so the two-year value of a subscriber is $30 to $250 and we wanted to communicate that the average across all subscribers is at the very bottom of that range. And so what that means is that we’re seeing a lot of enterprise-level subscriptions where there are few people, maybe the coders themselves are the higher end of the range, but the bulk of the subscription is a bulk subscription for all employees to be oriented on the topic of ICD-10. And so, they’re obviously at the very low end of that range and comprise the bulk of the number of subscribers and so bringing the average price point to the very low end, the very bottom of the price range that we gave.

And so you can think of it as in this window of orientation and training with this new level of our regulation we’re seeing enterprise-level of full access to the complete library with only a few of them needing the detailed training and of the higher priced modules that are contained in our enterprise-class subscription. And so, we’ve tried to describe and so that generates the $15 to $125 per person per year over two years, which gives the value of a contracted subscriber over a two-year period of $30 to $250 and the average across the 1 million subscribers. So if you look at it that way a big healthcare organization subscribes to give full access to the full library for all employees. The average is at the very bottom of that range.

Frank Sparacino – First Analysis Securities Group

And then maybe just one follow-up there, Bobby. In terms of the higher end training, does that suggest that the hospitals are going to a different resource for that? Is that being done more in a different form in terms of on-site or where is that business going?

Robert A. Frist Jr.

No, it just shows the mix. And so if you have 1,000 employees in your hospital and you have 20 or 30 people that are full-time, they are in the coding, they do the coding. Those are people that need the robust training. Essential they have to be retrained on the new system. They actually do the coding. Everyone else; the executives, they need an orientation. They need to understand what this change is all about. They need to know some of the details, but they are not actually coding. And so really this shows the mix of kind of coders versus everyone else.

Frank Sparacino – First Analysis Securities Group

Thank you.

Robert A. Frist Jr.

Thank you.

Operator

Thank you. Our next question comes from Terry Lally of Spotlight Funds. Your line is now open.

Terry M. Lally – Spotlight Funds Management

Good morning. Gerry, thank you for breaking out the ICD-10 revenues. It’s helpful to isolate the impact. Is there anyway to provide past quarters?

Gerard M. Hayden

We may consider that in the future, but right now the significance of this quarter is while we broke out this one metric for the third quarter.

Terry M. Lally – Spotlight Funds Management

When you say the significance, is that because it crossed 10% of revenues at $11.6 [ph], is it been growing at a faster rate than the corporate average so that I think were increasing as a percentage of sales of the year going on?

Gerard M. Hayden

Yes, the first day because largely the very low base.

Terry M. Lally – Spotlight Funds Management

Anyway to quantify how much ICD-10 contributed to revenue growth overall? It was 45% in the quarter. Anyway way to see what we’ve done year-to-date in terms of ICD-10 impact?

Robert A. Frist Jr.

We can consider that maybe for this field. The future of course gets more and more exposure to it, but once again for the third quarter we opted to give some color on the growth rate, the growth that contributed for our results. And so that was designed to give us some kind of idea of the trajectory of the ICD-10 revenue curve.

Terry M. Lally – Spotlight Funds Management LLC

Okay. And then you’d expect that to continue through the October adoption date and then taper off sales to taper as we approach it and revenues to taper after that?

Robert A. Frist Jr.

Well, certainly we’ll give our 2014 guidance as we have done in the past with our year-end, which of course is the fourth quarter and I think Bobby had some general remarks about the revenue curve in 2014 and 2015 earlier.

Terry M. Lally – Spotlight Funds Management LLC

And then switching to the net regard, when you mention the value per subscriber for ICD-10, it sounds like Bobby you had mentioned this is actually a two-year contract value of the $30 to $250, so that the annual is actually $15 to $125?

Gerard M. Hayden

That’s correct.

Terry M. Lally – Spotlight Funds Management LLC

And then suggesting that was on the bottom end of that range, we’re talking 15-ish, is it 20-ish, is it above or below your average revenue per customer of $30?

Gerard M. Hayden

Well, we’ve provided really all the color we’re going to provide on that for competitive reasons on actual price, but we used the word bottoms very specifically to guide you to the bottom of the range for the average and we put so much more disclosure in today. It’s about all we can give you without telling the actual price for competitive reasons. So we have 1 million cumulative subscribers that gave you the annual and the biannual value and the average contract length of 24 months. And so we just emphasize the words very carefully selected at the bottom of the range as the average price.

Terry M. Lally – Spotlight Funds Management LLC

Okay. So then, if we’re looking down towards $15 a person per year, that’s actually lower than your average revenue per customer. It’s actually pointing down. So your lift in ARPU per year is down.

Gerard M. Hayden

That’s right. You can draw your own conclusions. We’re not going to comment anymore on the pricing of that particular product.

Terry M. Lally – Spotlight Funds Management LLC

Okay. The follow-up to a prior question about the – with most being towards the bottom, seems like those are the general population out there, hardcore coders. What would you expect, you’ve talked in the past about the maintenance levels being lower post ICD-10, what would you expect the user renewal rate versus the ARPU? I guess, obviously we would have thought that it was actually going to be more of a ARPU issue versus – there is a lot of general folks who just need orientation. What would you expect subscriber renewal net rates look like as we hit 2015?

Robert A. Frist Jr.

Well, we just don’t know and we are talking almost a year and a half out and I believe a couple of things. One, the topic will remain a critical topic for years to come. We just don’t know and that’s what we’re trying to describe our observations today, but we just don’t know. We haven’t been through renewal cycle. I do believe that there is a difference in this orientation phase of getting everyone aware of ICD-10 and then what we’ll call a maintenance phase once it’s launched.

So we are beginning to characterize almost a year and a quarter in advance of any potential changes, just some framework for everyone to grasp on to. But we’re really truly uncertain. We may see that it’s such an important issue. They come back for enterprise licensing again for everyone or we may see that they moved toward maintenance model for just the HeartCode coders and may see a blend and the fact is that almost a year and a half before this become an issue for the company, we just don’t know an answer to that question.

Each quarter, we’ll try to provide more clarity and classify our observations of the current quarter trends and I think we’ve provided exceptional detail around this particular product set already.

So we’ll keep you informed as best as we can with the best guidance we have, but right now you are asking questions about 2015 and we just don’t have visibility until then.

Terry M. Lally – Spotlight Funds Management

The gross margin side, it’s has been from volatility and the trend has been down 90 basis points year-over-year and 150 basis points sequentially, but what’s causing the gross margin volatility and where should we expect it to go as ICD-10 and other license products increase the percentage of the mix?

Robert A. Frist Jr.

Yes, I think you have pointed out the right variable, which is the mix of selling some of the platform products have higher gross margins, some of the content products have high gross margins, some of them have high cost of goods and so we are seeing now the relative growth rates, everything is growing, platform, platform subscribers, ecosystem, content consumption is also growing at very rapid pace.

So it’s kind of at the gross margin level, it is the blend of the various margin products and we are seeing as you know, as we know that we have spend a good amount of time on the HeartCode products, which have a higher cost of goods and the ICD-10 products which have a higher cost of goods being relatively successful, but we also saw adding 39,000 subscribers to the performance center and 151,000 subscribers overall to the core platform.

They tend to come in at a lower initial price point. They buy kind of the platform in a small bundle and so we think it’s exciting when they come on board, because over the next three to five years as has been our history, we have been able to grow the revenue per unit or per subscriber. And so the 151,000 is very important kind of baseline addition to see, because it allows us to know now we’ve got a broader audience growth ARPU.

As you hit on the right variable for gross margin, it’s the relative mix of those things. One other thing I should note is that the research business is also now in the higher double-digit or up to the near 20%, I think it deliver 17% this quarter growth and we haven’t seen that kind of growth in that product line in some time. So seems now that most all products are firing on all cylinders.

Terry M. Lally – Spotlight Funds Management

Great, great. Development increased 80 basis points sequentially and 100 basis points year-over-year, what should we expect there, is this part of the impact of Brookdale and the new post-acute content development, are we going to see further increases, how should we be modeling the content development time?

Robert A. Frist Jr.

Yes, I think we need to clarify and I think if I am remembering from the last time that we just discussed that, our development and product development is largely building platform and platform capabilities and not building content. The content is largely provided through our ecosystem of over 100 partners that they build and incur the cost of building content.

So when we talk about product development, as a category for our company, we are largely talking about building out technology and platform and capabilities that underlie the delivery and targeting of content or the facilitation of functions like performance reviews in hospitals.

So I didn’t want to describe the nature of it. So we continue to add development capacity, meaning, coding teams and developmental teams to our organization. Now we do build some content and in our partnership with Brookdale, we will be jointly developing targeted content, because we are kick starting the ecosystem in the post-acute space. And so we have allocated some capital to build out initial libraries.

But also announced in this call that we are looking to add several additional content partnerships where the partner builds the content in the post-acute space in the fourth quarter. And so we really think we’ve got that teed up for you in the fourth quarter. So our capital investments are generally limited in the areas of content and mostly about technology build.

Terry M. Lally – Spotlight Funds Management

It’s mainly around the platform. It looks like an increased 500,000 sequentially. Should we expect that to be a run rate, should we expect continued increases of this to add to the platform?

Robert A. Frist Jr.

It’s certainly a run rate and it’s one we continue to add to. And so our vision for this ecosystem platform is very broad. We have a lot of ambition about what we want to do through the platform and through this kind of growing ecology or ecosystem. Not only building out the Talent Management capability sets, but extending in another unique ways that let others develop with us. And so we’re basically extending the capability set that others can benefit from, and so that’s an area of research and development for our company.

Terry M. Lally – Spotlight Funds Management

Okay. And then just finally the Brookdale contract last quarter you announced that you’re still working out some of the details. When would you expect the post-acute care to be commercialized and hit the market. And if Brookdale actually live on your systems right now and saw the 50,000 added to the subscribers?

Robert A. Frist Jr.

Yes. So we have begun activating the – of course it’s contracted for already. And so they are under contract and then we have an implementation window. We are in the process of implementing now bringing up their facilities and individuals live to the platform. As they go live we began to count them in the implemented subscriber bucket and began billing for them. And so generally from the patient cycles range over right around the quarter for a big account like that or a little less or a little more.

And so we will begin to see the full impact of the Brookdale contract in the first quarter of next year. But even some in the fourth quarter I think live. It’s also important to note that we are implementing both the learning part of the talent system and the competency in performance part of the talent system for Brookdale. So we have multiple implementations going on across organization. In addition to our strategic relationship, where we are outlining the roadmap through content development, so there is a lot of exciting activity around Brookdale. I think by Q1 you’ll see all of their FTEs on board as implemented subscribers.

Terry M. Lally – Spotlight Funds Management

Great, thank you.

Operator

Thank you. Our next question comes from Richard Close of Avondale Partners. Your line is now opened.

Richard Close – Avondale Partners LLC

Okay, thank you. I apologize I missed a bunch of the call with being dropped off here and trouble getting on. So apologies if I repeat anyone’s question. I will keep it short since we are up against the time limit here. Bobby obviously you are executing extremely well in a lot of different parts of your business. And I am just curious what you think as you look at the business where is the most improvement that you as an organization can make in terms of – the continue the long-term growth trajectory that you’ve been executing on over the next several years.

Obviously, you’ve highlighted the ICD-10 opportunity and the benefit there. But just trying to also get a feel in terms of where we stand in terms of, I guess filling that hole when that eventually comes to bail in 2015. And just your thought process in and around that?

Robert A. Frist Jr.

Sure, sure. Well, first of all, I think we are doing a much better job of identifying macro trends and organizing our teams and product sets and platform around the macro trends. We just came off Summit, where we had a session, where all we did was ask our customers for an hour and a half about the big operational challenges that they have.

We had about 200 people or 250 people participating in the session, where they simply told as one of the challenges they faced and where do they need help from a macro level and so, I think the Company is getting better at listening to that and prioritizing future product development and product launches around those trends. I think that’s indicated by how successfully build the ICD-10, I mean this was a known evolution in the industry for many years but few prepared for it in 2011.

And in 2011 late as when we signed our agreement with Precyse, which position us well when purchasing begin in 2012, but really obviously purchasing begin in 2013 and so, I think as an organization we are getting a little better at asking what is big and important to them, and then orchestrating teams and products and evolving our platform related to solve the problem. And I think that’s one of the keys that continue to drive growth so, we are trying to look out and think about other issues we see things like cultural literacy, improving or increasing on the radar then the needs of train across cultural literacy.

We see of course the spread of the way services provided meaning the move into the post-acute space, we think hopefully improves timely as we talked about employment growth rates earlier where hospitals seen a little bit of flattening of employment, payroll growth versus the post-acute space which continues to add. And so we are trying to adjust for that trend as well and so hopefully that gives you a little sense of how we think.

Richard Close – Avondale Partners LLC

All right, would you characterize as you look out over the next several years you just beginning to scratch the surface or has the lot of the heavy lifting or opportunities have been I guess harvested here?

Robert A. Frist Jr.

I think my personal view is that the industry is facing more changes it ever has and its challenges are greater than they have ever been, and in many ways they are still stock for example a meaningful part of the market is still performs – performance reviews and competency reviews in a very manual process, and so by no measure is their full leverage and utilization of technology across the healthcare spectrum and what it can do from improving business kind of outcomes and so, I think the problems or challenges in the industry are very large and we can be a meaningful part of the solutions as we go forward.

Particularly when it’s the workforce that is core to developing the solution whether it’s retaining, assessing, developing the skills of the workforce. That’s a core focus for organization, the other organizations focused on workflow or process or the advice on technique both surgery or medical. But we are focused on the workforce the human capital side of healthcare and we think that’s a primary driver for – how to improve outcomes through the people that actually deliver the care.

Richard Close – Avondale Partners LLC

All right, thank you very much.

Robert A. Frist Jr.

Thank you.

Operator

Thank you. And at this time, I’m not showing any further questions. I would like to turn the call back to management for any closing comments

Robert A. Frist Jr.

Thank you, for participation on the call. Again congratulations to all of our employees on their excellent work as we continue to push ahead. I look forward to seeing you in the next earnings call, and report another quarters progress for our organization. Thank you, very much and enjoy the rest of your day.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a wonderful day.

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