HealthStream's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.22.14 | About: HealthStream, Inc. (HSTM)

HealthStream, Inc. (NASDAQ:HSTM)

Q1 2014 Earnings Conference Call

April 22, 2014 9:00 AM ET

Executives

Mollie Condra - VP, IR and Communications

Robert Frist - CEO and Chairman

Gerry Hayden - SVP and CFO

Analysts

Ryan Daniels - William Blair & Company

Matt Hewitt - Craig-Hallum Capital Group

Scott Berg - Northland Capital Markets

Brent Hogan - Avondale Partners

Frank Sparacino - First Analysis Securities Group

Terry Lally - Spotlight Funds

Operator

Good day, ladies and gentlemen. And welcome to the HealthStream, First Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mollie Condra, Vice President, Investor Relations & Communications, you may begin.

Mollie Condra

Thank you, and good morning. Thank you for joining us today to discuss our first quarter 2014 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.

And with that, I will turn the call over to our CEO, Robert Frist.

Robert Frist

Thank you, Mollie. Good morning everyone, and welcome to our conference call. I want to start with a quick review of our business segments. We operate in two business segments, the Workforce Development Solutions and the Research/Patient Experience Solutions segments. For us a solution is a combination of products and/or services that we offer to healthcare organization focused on helping them achieve a specific business or clinical outcome.

Our Workforce Development segment offers market leading solutions in compliance, resuscitation, ICD-10 training, performance management, competency management and learning management among others. In addition to government mandated surveys our Research and Patient Experience segment combines survey results with consulting a creative solution to improve a patient’s experience while in a clinical setting.

As we think about those solution sets which reflect on the quarter’s performance. The quarterly revenue is up 29%, adjusted EBITDA up 13% and operating income up 4%. Let’s look at some of the underlying contributors to the growth that the Company is demonstrating. Within our ecosystem, each individual end-user utilizes at least one HealthStream subscription-based solution, is counted as one subscriber. Regardless of the number of subscriptions contracted for by or for that end-user.

As of March 31, 2014 HealthStream had approximately 3.58 million total subscribers implemented and 3.85 million total subscribers contracted to use one or more of its subscription-based solutions. In the first quarter, we contracted approximately 140,000 net new subscribers. Contributing to this strong quarterly growth was the win of a large multi-facility health system with over 30,000 employees. This system entered into an enterprise-wide contract for our performance center, competency center and learning center under a multi-year agreement. So it’s nice when we see the solid performance of 140,000 subscribers, but also see a large system win in the quarter.

The Workforce Solutions Development segment continues to benefit from both an increase in the number of total subscribers, as well as greater courseware and application consumption across the subscriber base. As a result our metric, annualized revenue per subscriber increased by 17% from 28.47 in Q1, 2013 to 33.33 this quarter, which is noteworthy given that implemented subscriber count, the denominator in that formula is growing by 18%. The last eight quarters we’ve seen a steady upward trajectory which is indicative of our progress in selling more and more solutions to our growing customer base. Strong contributors to this growth include product sales from ICD-10 solution set, our HeartCode also in the resuscitation category. Our clinical content offerings and our new, relatively new application extensions including our competency and performance center software applications.

Let’s take a moment and turn the call over to Gerry and hit the highlights of the financial analysis and then I’ll come back and address product line specific and marketplace specific updates, go ahead Gerry.

Gerry Hayden

Thank you Bobby and good morning everyone. I’ll provide some additional color on our results. First the financial highlights, as a reminder all the following quarterly numbers show our results in the first quarter of 2014, compared to the first quarter of 2013. As Bobby mentioned briefly, our consolidated revenues were up 29% to $38.3 million and operating income was up 4% to $3.3 million. Net income was $1.9 million in both the first quarter of 2014 and 2013. Adjusted EBITDA was up 13% to $6.1 million.

Let’s look at four areas of our income statement to start off some comments here, revenue growth, gross margin, operating expenses and operating income. First, revenue growth, the foundation to our financial performance continues to be organic revenue growth. As you’ve seen and as Bobby mentioned, our overall growth rates were 29% for the first quarter over 2013. The ICD-10 product contributed about $6.6 million to first quarter revenues, compared to $2 million in last year’s first quarter. This product has been a strong performer for us, but we also want to point out that overall first quarter of 2014 growth was about 15% if you exclude the ICD-10 results.

In addition to the ICD-10 revenue growth, we continue to see positive results in other key product areas such as resuscitation solutions including HeartCode. Although revenues from the Research/Patient Experience where we reported a 14% overall growth, this performance was below our original guidance. This segment’s key recurring revenue metric Patient Insights surveys show a growth of 7% during the quarter. We had incremental contribution from our September 2013 acquisition of BLG. Sales of these new consulting services from Baptist Leadership Group were not at expected levels as because our sales team -- as our sales team learns to incorporate and fit these in these new consolidations into their core offerings.

Gross margins, platform products with higher gross margin performed very well during the first quarter of 2014, but lower gross margin courseware products such as our ICD-10 offering grew even faster which is ultimate gross margin decrease from 37.8% last year to 36% this year. Some comments on operating expenses, as we experienced strong sales results our investment in sales and marketing has proven to be very beneficial. As a result, as a percent of revenue sales and marketing services have increased from 17.5% in the first quarter of 2013 to 18.1% of 2014 first quarter revenues. As you know from past conversations, sales is an important and critical investment area for us and there is relative increase ever since both additions to our sales force and higher commissions resulting from production.

G&A expenses as part of revenue decreased from last year’s first quarter level of 14.4% to 13.6% in Q1 of 2014. It’s important to note that the Q1, 2014 results do include $350,000 of HCCS transaction closing cost. And the pro forma ratio of 2014 G&A expenses excluding these transaction cost would have been 12.7%.

Operating income, before I discuss operating income I’d like to give you some color around the accounting impact of our recent acquisition of HCCS. Although the first quarter results only include one month of HCCS as operating activity, there were two notable financial reporting impacts from HCCS in our results. First, as I just mentioned, we incurred $350,000 of transaction closing cost in the first quarter, which we expensed and includes the generally accepted accounting principles or GAAP. Second, GAAP accounting rules require us to write-down acquired deferred revenue balances to their fair value as part of reporting the initial transaction. This accounting convention results in reduced reported revenue in operating income until we’ve amortized the initial discount. Accordingly, our first quarter operating results include $369,000 of deferred revenue write-downs most of which pertain to HCCS. Including the HCCS transaction cost and deferred revenue write-down, operating income for the first quarter increased by 4% over 2013. Without the HCCS transaction cost and the write-down of deferred revenue, operating income growth on a pro forma basis would have been 15%.

Our balance sheet, our balance sheet remains strong and we’re well positioned to support our development activities, the most recent example of which is the HCCS transaction from March of this year. As of March 31, 2014, our cash balances were $102 million, a $6 million decrease from $108 million at year-end December 31, 2013. However, during the first quarter our cash investment for the HCCS transaction was $12.5 million. In essence, our positive cash flow in the first quarter covered approximately half of our cash investment and this is a very important transaction for us. And as you already know, we have no long-term debt.

We continue to review and evaluate a variety of acquisitions and business development opportunities, while maintaining our discipline in terms of the strategic fit and valuation. One last financial metric to call to your attention is cash flow from operations. Cash flow from operation in the first quarter of 2014 has grown by 135% over last year 2013, increasing from $3.9 million to $9.2 million.

Some comments on guidance. Yesterday’s earnings release contains updated guidance and we anticipate the consolidated revenues will grow between 25% and 29%. We expect Workforce Development Solutions revenues to increase in the 27% to 31% range and so we decided earlier Research/Patient Experience Solutions revenues to grow by approximately 15% to 19%, part of which growth includes revenues from the BLG acquisition which we closed in September of 2013. We anticipate operating income will decrease between 2% to 11% over full year 2013. This operating income range includes between $2.5 million and $3 million related to the combined impact of the deferred revenue write-down which we just discussed, amortization of acquired intangibles, incremental investments in HCCS related sales, marketing and product development to drive future growth and the $350,000 of transaction cost incurred in the first quarter of 2014. We anticipate that our 2014 capital expenditures will be between $9 million and $12 million and our effective tax rate to be between 42% and 44%.

Our revised guidance reflects the anticipated impact of the HCCS acquisition that we announced on March 4, 2013, but does not include the impact from any other business development activities that we may complete during the rest of the year, during 2014. On April 1, 2014, the Protecting Access to Medicare Act of 2014 was signed by the President, which postponed the deadline for requiring the use of the ICD-10 coding system, previously set for October 1, 2014 for at least one year. While we believe that the transition to the ICD-10 coding system will ultimately occur, the deadline set by the Centers for Medicare and Medicaid Services, CMS for healthcare organizations has now been extended three times and CMS has not provided any guidance about the revised scheduling for ICD-10 coding implementation. It is not clear how the postponement will impact our results of operations and the aforementioned guidance is subject to revision based on future developments regarding ICD-10.

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

Robert Frist

Thanks, Gerry. I’d like to cover some market and product line updates and then we’ll move on to questions. First of all we’ll look at the first post-acute care initiative for the Company as we announced in February. We signed exclusive partnerships with the Institute for Professional Care Education, QueTech, and Mather LifeWays. Together these three partnerships added approximately 900 online courses to our library. This is specifically designed for post-acute care organizations.

In the first quarter we launched the national marketing initiative to create brand awareness and thought leadership in the post-acute care space. We’re working in collaboration with an organization called LeadingAge. It’s a leading industry association for the post-acute care market. Our Workforce Development Solutions will be promoted with preferred access to its 6,000 members. During the quarter, we added 1000s of subscribers from this new market. Some of our new post-acute care customers that were added in the first quarter include, Seasons Hospice & Palliative Care, Louisiana Home Care, and Advanced Home Care. So overall we’re starting to see some traction by declaring this new vertical extension and we’re beginning to bring in the subscribers now and create the overall opportunity for growth from our efforts in the post- acute care space.

Maybe a brief update on our HealthStream Performance Center and HealthStream Competency Center Applications. During the first quarter of 2014, we continued to expand our customer base for two of our Workforce Development offerings, the HealthStream Performance Center and HealthStream Competency Center. We added over 50,000 subscriptions in the first quarter of 2014 to these two products and included exciting customers like Yale New Haven Health System and Carson Valley Medical Center and Saint Luke’s Health System. So we’re seeing the traction that we hoped for and continued traction in the two platform extensions, that we call the Competency Center and Performance Center.

Let’s turn some attention to the ICD-10 situation. As of March -- and what I’d first like to do is review all the facts from prior disclosures and then add a few more elements of color to that, and then we’ll move into questions. So let’s look at the past disclosures and facts. As of March 31, 2014, we have approximately 1.6 million healthcare professionals under contract for the ICD-10 training solution, so obviously we delivered a strong first quarter. I believe our last reported quarter we were at 1.2 million, so you can see we added quite a large number of subscribers under contract for the ICD-10 solution during the first quarter.

Revenues from the ICD-10 training solutions were approximately 6.6 million in the first quarter of 2014. Retail prices for ICD-10 sales generally range from $15 to $125 per person, per year and the majority of contracts are for two year terms. Sales to-date indicate enterprise level focus on training and orientation and orienting the wide range of employees impacted by the transition to ICD-10. That has led the average purchase price to fall at the lowest end of the retail price ranges I just mentioned.

As Gerry just referenced, the Protecting Access to Medicare Act of 2014 was signed by the President on April 1 of this year and effectively it postponed the deadline for at least one year, and postponed the requirement there for the use of the ICD-10 coding system. In the 20 days since the April 1st postponement customers had deferred contracting for ICD-10 solutions. Given the postponement, we are in active dialogue with customers to understand the impact of this postponement on their training plans. It is not clear how that postponement will impact our results of operations.

Now let’s turn our attention to our long-standing compliance solution. This is an area that’s exciting area of growth and innovation for our Company. Our product roadmap in the area of our compliance solutions includes improvements of our mandatory regulatory courses for the use on mobile devices later this year and the acquisition of HCCS has expanded our potential buyers to include the hospitals compliance officers. We’re encouraged to see early success in cross-selling HCCS core products into our customer base. So overall the compliance solutions and the acquisition of HCCS, it was very exciting to see us re-double efforts in an area that’s been a core growth driver for us for over a decade.

At this time, I’d like to turn the call over for questions from the investor community.

Question-and-Answer Session

Operator

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

Ryan Daniels - William Blair & Company

Yes, guys. Thanks for taking my question. I think the obvious post of start is some more color on ICD-10. And I am curious if you can talk a little bit about the contracts that have already been signed that I think you mentioned a few minutes ago, and in the past were typically two years in nature. I am curious if there is provisions within those contracts that would allow clients to defer consumption and that could potentially push off some of that revenue maybe into ’15 given that they no longer want to train real time as a push?

Robert Frist

Yes Ryan thanks for the question. We’re not going to comment on specifics of the contracts other than we’ve mentioned the number of people under contract for provision of services. And we won’t go to the details of the contracts today, but they are firm contracts and they are two year averages and the price points we mentioned. And all we can say at this time is, we’re in a dialogue with customers. And really the whole marketplace is in a bit of a state of confusion, given this postponement and the problem with the postponement of course is it’s an indefinite date. And so all of our customers will evaluating their training plans given this indefinite date and deciding how to use the products for which they have contracted. So, that’s really all we can say about the specifics of the contracts other than what I view as a high degree of detail we provided on the contracts that exist.

Ryan Daniels - William Blair & Company

No, that’s good color. And then regarding kind of future uncertainty, I am curious if you can discuss in your revenue guidance when you’re building your model thinking about the year. Did you have a lot of incremental ICD-10 sales occurring in Q2 and Q3 to help you this year, because it’s pretty clear, the people probably won’t be acquiring more ICD-10 training given the delay, regardless of what the existing book of business does?

Robert Frist

Yes I think Ryan, again what I’ll speak to is a kind of what we’ve done year-to-date and what’s under contact. Obviously every quarter it’s grown significantly and as we just reported in the 20 day since the disclosure of this postponement, we haven’t seen, we’ve seen deferred contracting decisions on ICD-10. And so really, we’ll work from the base of what we have, which is the 1.6 million that are under contract.

Ryan Daniels - William Blair & Company

Okay. Fair enough. And then, maybe a couple of other different ones and I’ll hop off. Just on the HCCS acquisition, it looks like in regards to that you got a platform, the COI-SMART or COI-SMART as well as some courseware. I know in the past, you haven’t really looked at acquiring a lot of courseware to make that proprietary was there something unique about this that made you want to bring that in-house, and integrated with the rest of your solutions?

Robert Frist

Yes. In that area we don’t see a strong competition from associations or from other content providers and it’s been a particular area of expertise for our Company for over a decade. And so we did -- and the major medical publishers haven’t had extraordinary focus in these areas of compliance. So we thought it was a nice niche to be only vertical integrated. In fact, some of our vision and plans to that include going mobile as we mentioned, the more complete suite of products and products that also will leverage the data that follows through our network about compliance topics in the not too distant future. And so we have a very exciting roadmap there that will be kind of one of the first fully integrated product sets which is platform, platform extensions, content and a broad suite of content and data which we think will add value to the journey of maintaining compliance for our hospitals. So that’s an exciting area of investment. And we think we found exactly the right organization to acquire to help us strengthen what has always been a core growth driver for our Company.

Ryan Daniels - William Blair & Company

Okay. That makes sense and helpful color. And then last quick one just on the Research/Patient Experience, I know you pull back down a lot, not overly material to the cooperate guidance, but can you discuss may be what you’re doing internally on the sales front to help them solve the recently acquired product a little bit more effectively? Thanks.

Robert Frist

Yes. Selling consulting services is a little different. We think that they are great component to the overall solution. I mean ultimately we think that to differentiate ourselves we have to be able to help hospitals, move the needle on their HCAHPS scores. And to do that we think, as we think in our Company you need to identify what tools and services you need to actually have that actual business or clinical impact. And so to do that we believe that these consulting services and the corresponding IP a lot of which has to do with your development of the workforce was critical to moving the needle. And so it will be a long journey and there will be two key components, one is the productization of the IP. There’s a lot of great IP about how to train and develop the workforce from BLG. And we’ve begun that journey that will take time.

And then second is for our sales organization, to learn to incorporate the assessment and consulting services into their core offerings as they sell the normal data collection and data analysis services. And so I think, if you keep those two things in mind we’re kind of early to the game, we’re a little behind expectations, but I think we have a clear vision and a really good team, a really great team working on those two items and I am confident they’re going to pull it off and we’ll start to see better results in the second half of the year.

Ryan Daniels - William Blair & Company

Okay. Perfect. Thanks guys.

Robert Frist

Thank you, Ryan.

Operator

Thank you. The next question is from Matt Hewitt of Craig-Hallum Capital. Your line is open.

Matt Hewitt - Craig-Hallum Capital Group

Good morning. Thank you for taking the questions. I don’t want to belabor the point too much, but regarding ICD-10 have you had a chance to speak with some of those initial customers to get a sense whether or not they will simply extend the contract beyond the initial two years once we do have a firm date. From what we’ve heard, from what we’ve read, the hospitals are concerned that those that had actually implemented training programs are concerned that if they were to delay or pause, hit the pause button that anything learned so far a lot of that would be lost and they would have to start from scratch again at some point in the future, so what have you heard from customers that were maybe early adopters?

Robert Frist

Well, there’re a lot of hypotheticals and so we’re going to be very careful and talk about what we know instead of projecting things and behaviors that we don’t know. And the first thing you could say, I think our customers are also in a state of assessment and we are yes, in an active dialogue with them. It’s too early to determine in my opinion how it will impact their plans and I think there’re certainly customers that believe as you have mentioned that they don’t want to lose momentum and there’re others that might want to defer the process and cost associated with training and development. And so we’re very early, we’re 20 days post a very vague and lack of clear guidance from our federal government and from CMS about how the industry should plan and react. So we’re not in a position as a Company to comment on its impact as we work through the facts with the customers and they adjust their thinking and plans. Ultimately what happens we depend on essentially the individual systems and how they react to this lack of guidance and leadership and clarity from our government and from CMS and then in turn we will work with them to react to their decisions.

Matt Hewitt - Craig-Hallum Capital Group

Okay, alright, thank you for that. Secondly, as far as BLG is concerned, and you touched on this a little bit in the prepared remarks, but you mentioned it was down a little bit below plan. How much of that if any could be attributed to the weather and I know that sounds a little bit silly but given that business modeling, given that service essentially, is -- could any of it be contributed to the rough spring we had?

Robert Frist

Well I appreciate that thought and I guess there is a logical train of thought because we do offer some seminars and all. But I would say that the day that a SaaS company with highly recurring revenues attributes the challenges to weather is not a good day, so I’m going to say that today it has absolutely nothing to do with the weather.

Matt Hewitt - Craig-Hallum Capital Group

Alright, well I appreciate may be I was reaching a little bit. Alright and then maybe last question from me and I’ll hop back in the queue. The cross-selling and you touched on this that you been successful in cross-selling, but are there any examples with some of these more recent acquisitions where you’ve taken it maybe an install based that you had not previously had tentacles into with your own products, but are there maybe one or two examples where you could say within three months we were able to get them signed up for the core learning platform or one of the other applications?

Robert Frist

Yes, we’re seeing that, I think that’s one of the core drivers here, as you know we have such great market share on the core platform that we have several examples of almost immediate benefit of cross-selling. And I can go back first thinking of the DCI, the decision critical acquisition back a little bit and within a pretty short timeframe we’d begun to sell some of our additional products and content libraries into customers as we were in the process of migrating into our core platform, so we were seeing that.

With our HCCS acquisition, we’re already seeing a cross-selling into accounts, we’ve seen it go both ways where an account that was very interested in their high-end compliance content, now ours, acquired our learning platform quickly for delivery, instead of the older connect model. And we’ve seen customers on our platform make actually large acquisitions of their compliance library post-closing the transaction just a month or so ago. And then in research we’ve seen that as well, we’ve had some great competitive wins recently where we’ve seen customers -- our research solutions in fact the large Health System win we mentioned earlier on our performance and competency and learning system was a major contributor to the 140,000 subscribers this quarter was already an existing and large customer of our research solutions and as an organization we’ve been able to build relationship with the entire executive team at that rather large Health System, which I think overtime as you deliver in one category you get an opportunity to deliver in others. And so, while I wouldn’t directly attribute to the fact that they’ve been a long-standing research customer to the switch that they decided to make to our learning and competency platforms it certainly didn’t hurt. So in all three of those examples, our teams and our sales organization is structured to deliver cross-selling and we’ve run an account management model that allows our sales teams to cross-sell into those accounts.

Matt Hewitt - Craig-Hallum Capital Group

Alright that’s great and thank you very much for that detail. I’ll hop back in the queue.

Operator

Thank you. And the next question is from Scott Berg of Northland Capital. Your line is open.

Scott Berg - Northland Capital Markets

Hi. Good morning Bobby and Gerry. Thanks for taking my questions here.

Robert Frist

Sure.

Scott Berg - Northland Capital Markets

A couple of things, can you talk a little bit more about the traction in the quarter on the pause in your post-acute business you have recently signed the three new partners that bring a lot of courses to your platform which is fantastic. But can you talk about traction may be around subscribers in that segment and then what pipelines may be over the next two quarters I think?

Robert Frist

Yes, sure. So the pipelines are growing, we’re beginning to start to as we get our wheels down and we get our marketing campaigns launched and we have the right content partners and there is much more to come in those areas which give us a more complete solution. We’re beginning to see early traction. I think one of the things we’re trying to do is shift everyone’s attention to these two new core metrics, the revenue per subscriber and the absolute number of subscribers in the contract and not the number of subscribers to specific solution. So we were a little bit vague by saying we had 1000s of subscribers in the quarter, we didn’t say 10s of 100s and that was intentional, but we did have 1000s of subscribers in the quarter. And we’re excited to see us start to have traction with new customers beyond some of the anchor tenants that we got in last year and before Brookdale and Almost Family and others. And so we’re excited that the solution appears to be coming together and we’re beginning to add staff and capacity to continue to pursue that market segment.

Scott Berg - Northland Capital Markets

Thanks. Great. And then I guess from a sales strategy for those customers, do you have existing sales people that are overlapping with the acute care business that are selling into those or have you carved out individual sales people to take that portion of the market?

Robert Frist

It’s really interesting, we do both. And so in the acute care space as we really tally the totals, we see that lot of our large health system customers have material operations in the post-acute space. And so we’ve often said this, but of the 3.8 million under contract there is a good number of them that reflect and may have extended our platform into their post-acute settings, like their survey centers and homecare and long-term care. And so we do have an existing sales team that now has more, that has great account relationships with large health systems and we have more specific products to offer them to extend down within the organization. In addition, we have a carved out or a dedicated team that is focused on the segment exclusively and it is called as in pipelines are only generated from marketing campaigns directed at standalone and free-standing independent post-acute care operations.

We also -- you may know it on our Web site have several post-acute sales positions open now or beginning to add to the team as we get more comfortable with our product offering. And so again overall, again we’ve described this over a long time, we first announced it as a focus area and then we’ve began with some anchor customers and some content strategy and then a national marketing campaign and we’re now are slowing adding to the sales team. And so we feel it’s been a very planful way to enter the market, run it, stub our toe a little bit here and there, but launch kind of launch in deliberate manner overtime.

Scott Berg - Northland Capital Markets

Okay, great. And then I guess my last question is for Gerry. How should we think about gross margins going forward the rest of the year? Obviously with the shift in mix towards the content side driven by -- I see it kind of come down a little bit over the last I will call four or five quarters, but as we exit Q1 is that kind of the margin level, gross margin level we should think about for the rest of the year or do you see anything meaningfully moving up or moving down for the 58% range?

Gerry Hayden

Yes while well we used to assume the gross margin guidance, the overall guidance of operating income. If you go back in time for the last probably three to four years, we’ve seen that margin shift that’s been more and more of courseware sales. At some point that stabilized by virtue of just the mathematics of -- without the -- approaching rates are but that the -- our thinking on the gross margin is part of that overall operating income guidance we offered earlier.

Scott Berg - Northland Capital Markets

Great, thanks. I’ll jump back into the queue.

Operator

Thank you. And the next question is from Brent Hogan of Avondale Partners. Your line is open.

Brent Hogan - Avondale Partners

Hi. This is Brent Hogan in for Richard Close. Most of my questions have already been asked actually, so I was just wondering could you perhaps clarify whether or not your updated guidance includes any effects from the ICD-10 deferred customers?

Robert Frist

The guidance includes all the known facts that we have disclosed and we went down a list of about eight of them in this call, including average price point term, number of subscribers under existing contract, a known fact is that that sales have halted as seen in the last 20 days. But we’ve also been clear what it doesn’t include which is a whole lot of unknowns about the nature of the market’s reaction and the lack of clarity around the date and its potential impact on customer’s behaviors and decision making. And so unfortunately this is an area where clarity is not possible given the situation that the entire industry find itself in.

Brent Hogan - Avondale Partners

Alright. Well I appreciate it. Thank you very much.

Operator

Thank you. (Operator Instructions) And the next question is from Frank Sparacino of First Analysis. Your line is open.

Frank Sparacino - First Analysis Securities Group

Hi guys, just two questions. First on the Research side, if you look at the organic growth this quarter, it was fairly low. I’m just curious if there’s anything specific there from overall hospital operating environment perspective or other factors going on, and any potential changes there. I assume CG-CAHPS continues to roll out at a healthy pace, but any comments there would be helpful.

Robert Frist

Sure. No macro level changes with the product sets or product lines in the environment or the need to do the work and collect the data. A little bit of internal changes as we incorporate the new product sets and figure out their impact and kind of realign the selling strategies, and so maybe a little bit of a attribution to some internal work we have to do to get where we want to be. And then as you can tell from our overall projections for growth for the segment, we’re expecting obviously stronger second half and we maintain that here with the guidance we’ve just provided. Maybe not quite as strong as we had originally thought earlier in the year, but certainly a stronger second half than first half.

Frank Sparacino - First Analysis Securities Group

And lastly, Bobby just when I look at your backlog, the number of subscribers to be implemented, that number continues to grow at very healthy rates and it’s a fairly large number. And I’m just wondering if there is any sort of constraints from your ability to implement or how you look at that figure as it becomes larger and larger?

Robert Frist

Sure, sure, I think we feel pretty good about our capacity to turn those on and reasonable windows not much greater than we have in our many, many year in history. Some of them are larger health systems and actually in some cases we feel those are going along very, very aggressively and rapidly. And so the backlog if you remember in last couple of quarters we’ve had some big system wins. It can move meaningfully when one large say health system gets activated. And we feel on-schedule for those activations and don’t expect to see any major changes in our long-standing historical patterns of implementing and activating. So our teams are outstanding, they’re doing a great job, and have really mature processes for implementing those customers and bringing them online rapidly. And I think it’s one of the highlights of our service position, is our depth of knowledge about the protocol or process and the structure that we use to bring customers online. In fact I think it’s a meaningful way of how we win business. We just understand the language and operating environment and the needs of our customers in a way it allows us to configure and rapidly bring them online. So I expect us to move through those backlogs in a way we always have.

Frank Sparacino - First Analysis Securities Group

Great. Thank you guys.

Operator

Thank you. And the next question is from Terry Lally of Spotlight Funds. Your line is open.

Robert Frist

Hello Terry.

Terry Lally - Spotlight Funds

In that guidance is subject to revisions based on learning more about ICD-10. Can you be more explicit about what you’re expecting for ICD-10 in that guidance whether it’s the Workforce Solutions plus 27% to 31% are the overall revenues of plus 25 to 29?

Robert Frist

Well all the known facts for ICD-10 when were re-factored into both, ICD-10 revenues roll up under the Workforce Development Solutions segment and so the number is provided in there incorporate all the known facts, both about the business and what we know about ICD-10 currently.

Terry Lally - Spotlight Funds

But your base case and we have the 1.6 million customers, and then the expected growth is beyond that. How much of the revenues that you’re expecting for ICD-10 this year is related to the base 1.6 million customers and how much is related to the growth in ICD-10?

Robert Frist

Not quite sure how to -- what you are asking there. I mean again what we know is that contracted value the 1.6 million, we know the average price point per user, as you do. We know the term of the contracts. What we don’t know is what customers are thinking about how they deploy their programs and its future impact, which is why we reserve the right as we learn more to revise guidance based on the future impact. And so it is a complicated situation where we have laid out everything we know and tried to incorporate it in, obviously into our guidance. But there are many, many unknowns that we can’t factor into guidance currently.

Terry Lally - Spotlight Funds

You’ve mentioned that the sales have halted in the last 20 days since this decision, are there any expenses that you can adjust, because it seems like there is downside to revenue as customers push out decisions. Can you adjust anything in the expense structure are there any variable expenses that can offset any revenue shortfalls in ICD-10?

Robert Frist

Well sadly the one expense that will be adjusted would be commissioned, which as you know we’ve really outperformed and had an incredibly strong quarters even through the first quarter of exceeding internal expectations for sales in really many, many product categories, so one variable cost which will come down would be commissions related to sales, which in our model are a little bit front loaded, they are not completely front loaded, they are recognized overtime, but they have a little more wait to closing a contract than a year, a year and a half out. So that is one.

Otherwise though, the way we implement that solution is highly automated it’s delivered online and so there’s not a lot of cost which is -- one of the advantages of these content relationships, there’s a high cost of goods in the royalties we pay, but there is an overall low cost to delivery once we’ve signed the contract other than things like commissions. But not a lot of other variable cost that we can pull out of the model associated specifically with ICD-10.

Terry Lally - Spotlight Funds

On the commissions, do sales people get the average cooperate commission on ICD-10 or is it lower due to the lower gross margin?

Robert Frist

That’s -- we have slightly adjusted commissions on a lot of products. The ICD-10 products with lower gross margins have a lower overall commission and some of the higher margin products like, when someone purely buys and subscribes to our platform. And so overall, I would say that the content products with the lower gross margins when they are sold as a standalone product not a comprehensive solution have lower commission costs.

Terry Lally - Spotlight Funds

Okay. And then the HCCS acquisition, how much does that add to revenues this year, it looks like it’s included in the 27% to 31% Workforce Development growth?

Robert Frist

It is and it is factored in and we don’t break it out by line, but you can see if you look at close we announced the total historical revenues and if you deduct all this deferred revenue accounting and you deduct on both operating income, it hits the top-line revenue recognition and operating income. There’s not a lot left particularly in this first quarter to be contributed from the HCCS acquisition. Now, one positive effect of these changed GAAP accounting rules is that, in ’15 a lot of this comes back as we work off that deferred revenue write-down. And so, we’ll expect to return more to seeing growth out of that asset, after we finish the deferred revenue write-down model, that’s the GAAP model.

Terry Lally - Spotlight Funds

And during the quarter you disclosed that you’d had a series of flutters or correspondence with the SEC, and it looked like it is heavily related to acquisitions and acquisition accounting. How does that change acquisition accounting going forward?

Robert Frist

I don’t know what you’re referring to, that doesn’t seem accurate, I don’t know if any, that you’re mentioning. So may be, be a little clear in your question.

Terry Lally - Spotlight Funds

I saw that you had posted -- that you had different matters back and forth with the SEC?

Robert Frist

Yes.

Gerry Hayden

Terry this is Gerry, the comments are more about the footnotes, there’s no change to the accounting and no restatement of any kind. The comments of the, from the commission were more to try to add a little more color to some of the background to the reason why we did the acquisitions in the narrative and qualitative section of the footnotes.

Terry Lally - Spotlight Funds

Okay. So it won’t impact how you do acquisition accounting, the deferred, what revenues you can recognize?

Gerry Hayden

It will not.

Robert Frist

Yes. It’s correct. It will not.

Terry Lally - Spotlight Funds

Okay. Thank you.

Operator

Thank you. And there are no further questions in the queue at this time. I’ll turn the call back over for closing remarks.

Robert Frist

Thank you all. We look forward to reporting in the next current quarter earnings conference call. And I appreciate the questions. And most importantly the contributions of our employees that have gotten us to deliver the success we’ve enjoyed so far. Thank you much and see you next quarter.

Operator

Thank you. Ladies and gentlemen, this concludes today’s conference. You may now disconnect. Good day.

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