HealthStream's CEO Discusses Q3 2012 Results - Earnings Call Transcript

Oct.23.12 | About: HealthStream, Inc. (HSTM)

HealthStream, Inc. (NASDAQ:HSTM)

Q3 2012 Earnings Conference Call

October 23, 2012 09:00 AM ET

Executives

Mollie Condra - Associate Vice President, Investor Relations & Communications

Robert First - Chief Executive Officer

Gerard Hayden - Senior Vice President & Chief Financial Officer

Analysts

Ryan Daniels - William Blair

Matthew Hewitt - Craig-Hallum Capital Group

Richard Close - Avondale Partners

Nick Halen – Sidoti & Company

Andrew Albert – Invicta Capital Management

Frank Sparacino - First Analysis Securities Group

Chris Blackman - Imperial Capital

Operator

Good day ladies and gentlemen and thank you for standing by. Welcome to the HealthStream Incorporated’s Third Quarter 2012 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, today’s conference may be recorded. Now, my pleasure to turn the floor over to Mollie Condra, Associate Vice President, Investor Relations and Communications.

Mollie Condra

Thank you. Good morning and thank you for joining us today to discuss our third quarter 2012 results. Also in the room with me are Robert A. First 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. With that, I’ll turn the call over to our CEO, Robert First.

Robert First

Thank you, Mollie. Good morning everyone, welcome to our third quarter earnings conference call. We have got a lot of exciting material to cover and afterwards Q&A. So, I will jump right in with financial highlights that were represented in our earnings release last evening.

We were excited to report consolidated revenues up 28% to $26.4 million in the third quarter compared to the prior year quarter. Operating income was up 39% to $3.7 million in the third quarter compared to the third quarter of 2011. We also delivered well on the bottom line with net income up 10% to $2.0 million in the third quarter compared to the same period in the prior year and adjusted EBITDA was strong a 30% increase to $5.7 million in the third quarter, that’s up about 30% over the prior year same quarter.

Of course, a little later, Gerry Hayden, our CFO will give a more detailed look at the financial data. So, I thought I would look at some of our strong operational metrics again here. On the core platform, we saw subscriber growth grow by about 65,700 that were under new contracts during the period. That exceeds what we call our long standing targeted goal of contracting 20,000 to 50,000 per quarter. So, now we have three quarters sequentially where we are beating our goal and the way we target an engineer, our sales force to try to generate 20,000 to 50,000 net new subscribers a quarter. So, another strong performance period here exceeding our targeting range with hitting 65,700 new subscribers.

The total number of subscribers is also approaching an exciting number. We are approaching 3 million, it actually stands at 2,975,000, which represents well over half of the nation’s hospital workforce and we are beginning to see pickup in a few other areas on non-hospital, as well as hospital affiliate with non-hospital verticals and our sales team is learning to sell into those verticals. So, we are excited to see that number continue to grow and soon crossing the 3 million milestone, just based on trajectories that should be during the fourth quarter will be an exciting milestone to celebrate.

Our backlog of contracted but not yet implemented remains at approximately 106,000, so we will work through as much that backlog as we can during the fourth quarter and that’s exciting because of course when we implement out of the contracted backlog we began revenue recognition. So the fully implemented number – we implemented approximately 85,200 in the quarter, which brings the total implemented subscribers to 2.869 million healthcare users. Again, another exciting number, another great quarter of implementation execution by our operations teams, so I am proud of what they are doing to bring all of these new customers onboard on to our broader talent management platform.

The renewal rates in the third quarter remains strong, as reported in the earnings release, 97% based on full time equivalents or what we call number of subscribers and 95 based on contract value and the renewal rates reflect the addition of subscribers compared to previously contracted amounts, combined with any pricing adjustments that may occur at renewal. About the middle of the year we indicated a new measure renewal, the trailing four quarter period and so for this trailing fourth quarter period in September 30, 2012, customers representing 101% of subscribers that were up for renewal did impact renewal, while our renewal rate based on contract value was 103%. So, the trailing four quarter renewal rates we think are another good way to look at the stability of our platform and performance of our teams.

For the third quarter 2012, revenues from our patient surveys business which is a recurring revenue product in our research operation, increased 8% over the third quarter of 2011, while still not back to where we both expect and are working to get it we are pleased to see it move in this direction and the increase of 8% is an improvement over the prior quarters and the earlier performance in the first half of the year. So, we are glad to see this needle moving in the right direction of this recurring revenue product set.

The importance of the HCAHPS surveying that we are doing for healthcare providers continues to increase, the payment effects associated with evaluated personal program began on October 1 of this year, so just earlier this month. That means there is going to be even more and more attention paid to these scores and the metrics of these patients surveys as we enter into next year, now that reimbursement premiums are tied to these value-based pressing scores, of which the patient satisfaction measurement constitutes 30% of the – essentially the index that’s used to determine those reimbursements.

While we are seeing new drivers for growth and I will kind of highlight two of them that are kind of more short and medium term drivers that are exciting, as you know, many of our products have drivers like the OSHA requirements, the HIPAA privacy requirements, the HCAHPS requirements we just spoke to, requirements from the joint commission and these underlying requirements help drive kind of what I would call consistent demand for HealthStream’s products and services as the hospital seek to remain compliant with the demand of all these regulations. In the third quarter we saw the significant pickup in sales of the CG-CAHPS survey that’s the Clinicians & Groups Consumer Assessment of Healthcare Providers Survey, it’s called the CG-CAHPS survey. With the increasing number of newly formed patient centered medical homes, the need for measuring patient experiences of the caroused [ph] in the physician and clinical boxes is growing. The national committee for quality assurance requires the measurement of patient experiences and one of the six standards for being recognized as a patient center medical home. So there are new underlying drivers for the adoption of CG-CAHPS survey and we see a strong uptake in the CG -- Clinicians & Groups Consumer Assessment survey at our organization.

In the third quarter, we signed approximately 28 new contracts for CG-CAHPS, which is up from 17 signed last quarter. Some of our new CG-CAHPS sales in the third quarter included a multi-facility healthcare organizations from all areas of the country, including the Northwestern, Western, and Mid-western states. One of those accounts was a $1 million plus agreement with a large health system, so we wanted to give you a sense for the scope and the rate of adoption of the CG-CAHPS survey set for our organization. We are excited to see those results coming in.

One of the more recent drivers that underlies growth is in the area of ICD-10 coding and we get lots of questions about our progress and the market demand for ICD-10 coding. So, I am pleased to report just in the last 6 weeks we are seeing a meaningful improvement and demand for ICD-10 training products. We think that’s largely tied to the fact that CMS announced and clarified a new deadline for the required transition to the ICD-10 standards, it’s set for October of 2014, and although that’s one year later than originally said, now we think having what appears to be now a firm goal post out in front of us is driving now increased adoption and closed sales on our ICD-10 curriculum. I would also believe we have a great partner to pursue this opportunity in an organization precise, it’s just a great company with outstanding content. One of the dimensions we are excited about with our partnership of precise is the fact that their content is designed to orient the entire breadth of the medical staff and the staff at the hospitals and the importance of this migration, not just the coding department and the coders themselves, but the curriculum set is designed to help the entire workforce at the hospital be knowledgeable and aware of this important migration occurring in October 2014.

So, through the partnership they have content bundles that are appropriate for clinical and non-clinical staff. The prices for that content is kind of at a retail basis and not at scale. A range from about $30 to $250 per user depending on the audience and the mix of the adoption. So, there may buy more bundles and be at higher price point, other workers may need orientation overview be at a lower price point. So, we thought that will be helpful to get some perspective.

We closed over 130 contracts for ICD-10 this year and a meaningful portion of those occurred in the last 30 days and so we are seeing a real uptake. Again, in the third quarter towards the end we saw several multi-facility health systems contract for the ICD-10 library, including one large prominent health system with almost 50,000 employees working at over two dozen hospitals. So, again, we are seeing this as another driver. We expect this driver right now with our current view point to continue on through the deadline of October 2014, but I would say I would characterize the last 30 or 45 days as people got comfortable with the need and the fact that the deadline was real we see some movement towards signing up for these ICD-10 libraries.

As you know, we have a very acquisition down the pipeline, M&A pipeline, new partners and products. The last 90 days have been very exciting and if you look back I guess a little over 100 days ago, end of June we acquired Decision Critical and added a new innovative patented electronic portfolio. We have our first sale on that portfolios, so we are excited to see that product out of the gate. We are making investments in reengineering that portfolio to be tied to our core SaaS platform. So that will take a little time and investment to move that acquisition where we wanted but we are very excited about the potential for that product and in fact have our first sale on the portfolio of product and so we are excited to see that initial progress. Again, I would remind everyone that this business development pipeline is very active and each of these developments whether new partner or acquisition requires investment, in some cases reconfiguration and integration. So, we are very busy doing that with the Decision Critical products and their portfolio of products, including their actual portfolio. So, we are excited to see that.

During the third quarter, we continue to expand our customer base for our talent management product offerings and you see a focus on new partnerships and the existing products like the HealthStream Performance Center launched earlier this year and HealthStream Competency Center. These two products had another solid quarter, contracted in a combined basis by another 12 healthcare organizations, some of which include multi-hospital systems. So, we are really pleased to see this dimension of our talent management platform continue to show progress I believe 12 a quarter is about 1 a week, and that’s fairly consistent last quarter. I think we did a few more last quarter, maybe 15, but we are seeing the steady strong performance from the HealthStream Performance Center to do annual performance reviews and HealthStream Competency Center to do clinical reviews of clinical confidence. Again, and that one – the latter being a unique dimension of competency, maintenance and development in healthcare. So, those products, they have a whole dedicated team of those products and they are doing a wonderful job, continuing with the aggressive launch of these products that round out our talent management, our strategy and platform. Also, in the business development front, we signed an exclusive agreement with NurseCompetency. They have an innovative SaaS based competency exams and skills checklist for hospitals. Again targeting the idea of determining is the workforce confident to do the job they are assigned and deliver the patient care that they are responsible for.

The NurseCompetency agreements is exciting, kind of new dimension if you want to think of this way, a new type of content database or examination format of contents. We are very excited to have this new type of assessment tool. And then right behind that NurseCompetency assessed the clinical skills of staff. We entered into agreement with Assess Systems also exclusive, Assess is more the behavioral dimension of (inaudible) exhibit the appropriate behavior for specific healthcare job and opportunities. So, these two tools together work to help HR in the pre-screening and ongoing assessment of their workforce both NurseCompetency and Assess systems are now exclusive opportunities for us to distribute into our growing customer base. So, we are excited about those developments.

Both of those products work on a standalone basis and again in a constant theme we are doing high growth. We will be investing and the integration process and making sure these systems fully leverage our network and don’t just stand alongside them as separate products. Yesterday morning, just prior to earnings and over the weekend we were able to close the acquisition of Sy.Med Development. This is another exciting area for us. I think if you read some of the interviews and public disclosures that where I talk about our strategy around talent management. We talk about this five step framework determining the workforce qualification and then judging their confidence, their engagement, their performance and their ongoing development. The Sy.Med acquisition help support this idea of, is the workforce qualified? And so you’ll see us continue to make investments in this area determining workforce qualifications. Sy.Med is a leading developer of credentialing software services that are used to verify the credentials of mainly the physician and clinical workers. They serve over 800 healthcare clients including 115 hospitals which happens to be their high growth area and the physician data is the more dominant type of data included in Sy.Med’s verification process and it includes data from approximately 184,000 physicians.

This is exciting for many reasons, it is kind of a foray into this area of credentialing and which is in my view a very unique dimension of talent management and healthcare and it positions us well to continue investing in this area of credentialing the workforce and again this business is has installed and SaaS based software although the predominant model for selling has been the installed product and so you’ll see an increased interest from us to move from installed selling to SaaS selling and then of course we need to integrate it. So, as we migrate this business model and integrate the applications themselves, we’ll have additional cost to move them to our ecosystem into our model and of course as you move from installed selling to SaaS selling the revenue would drop from the acquired property which we expect. We paid a little over two times revenue for this acquisition and we are very excited to see that it is well on its way and it is a highly performing company with a great culture that we think fits well with our company and helps us launch into this area of credentialing. We have to watch for more moves in this area.

Since the start of the year, we’ve just had an incredibly busy year of launching SimManager of SimView, performance center, NurseCompetency assess systems, the acquisition decision critical. The acquisition of Sy.Med and so, what you are seeing here is entering a new period of investment as we enter next year as you know we are also considering investing and officially launching additional verticals all of which will be determined as we wrap up the (inaudible) strategic planning process. So, the theme leaving this conference call for me is want a continued investment in growth, focus on the revenue dimension of growth and we are very excited to have all these new component pieces of our growing ecosystem and a rounding out of the unique dimensions of talent management and healthcare. Another important venture is to give a quick update on SimVentures. This is an exciting project that we’ve been working on for several years. The joint venture with Laerdal Medical.

Laerdal Medical, a leading provider of simulation training in healthcare, they are in a unique dimension of the workforce development in healthcare is simulation based training. These high-tech mannequins are used to simulate various clinical situations and through our partnership with Laerdal Medical our joint venture, we have exciting new products that are coming into market. I think this quarter represents the fifth consecutive quarter of sequential growth for our SimVentures as still a small part of our overall business, but we remain very excited about its potential and our steady sequential progress in the growth of the business opportunity around SimVentures.

The revenue allocation from the joint venture to HealthStream was 419,000 and the venture remains EBITDA positive in the third quarter. So, even though we continue to invest. So, we are very excited as to the number of developments at our growing company and our continued focus on what I’ll call the unique dimensions of workforce development and in healthcare you can see this, this interest on all areas of workforce development in healthcare and our development pipelines.

I’ll turn it over to Gerry for quick look at financials and wrap up for the few announcements like our summit for next year and then we’ll go to Q&A, Gerry.

Gerard Hayden

Thank you Bobby and good morning everyone. Bobby has given a lot of color on the results this quarter. So, I’ll try to give some key pencil topics and then save time for questions at the end of the call. Overall, our third quarter year-to-date results demonstrate the strength of the business. The quarter year-to-date revenue growth rates of 28 and in 26% result from core growth. Is this critical acquisition did contribute to revenue during the quarter, but it did not have a significant impact on our overall growth rates.

Operating income grew by a strong 39% over last year’s third quarter. Another point of reference is how the third quarter’s performance impacted the year-to-date operating income expansion. Through this year’s second quarter, operating income had grown by 12.8%; however, after this quarter, the third quarter’s performance that 2012 year-to-date expense is now at 21%. Adjusted EBITDA results reinforce these operating trends as it grew by 30% over the last year’s third quarter and by 23% year-to-date over 2011. The balance sheet remains strong, our cash in particular. At the end of the third quarter, cash stood at $95.9 million versus $91.9 million at June 30, 2012. From (inaudible) perspective, we basically regrouped the approximate cash in closing for the DCI acquisition at the end of the second quarter.

Our business development pipeline as Bobby mentioned remains very active and it includes a wide variety of ideas and exciting opportunities for us here at HealthSteam and yesterday’s Sy.Med Development’s announcement just noted examples how deploying our capital base and innovative in ways to approach new opportunities. Before listening other financial topics I wanted to reinforce one thing, Bobby did say about operating expenses as you most likely know all of our deal costs such legal, banking, financial and operational due diligence, our expense that is incurred on some sort of accounting principles or GAAP.

We’ve now closed two (inaudible) this year, have invested time and money evaluating other divisions of (inaudible) initiatives and we are continuing to evaluate more opportunities. So, that is an ongoing part of our expense days. Also, we want to make you aware of a economy report requirement that we saw in the third quarter. You may be aware if affects beginning balances of differed revenue in acquisitions. You may be aware that the so called fair value rules have been now part of GAAP. One of those fair value rules requires us to write down beginning balanced thousands of differed revenue and the company’s balance sheet. The result of that adjustment is to record reduced GAAP revenues until that acquires for revenue is fully amortized. All new business course closing is recorded at full value. Although, referred revenue right opportunity to using the critical (inaudible) quarter. We did expand the non-GAAP table to back the earnings release to show the results on this quarter’s operations. And because differed revenue is a common occurrence in (inaudible) based businesses. We make sure this GAAP require a (inaudible) in the future. In fact the Sy.Med acquisition which we announced yesterday morning will have a differed revenue write down as well, upon which we did mention in our guidance paragraph.

Our income tax rate increased during the quarter and the primary reason is that during our review of that provision we revised our estimates remaining state income tax loss carry forwards availed to set to assess future state taxable income. (inaudible) increased our tax provision and federal tax rate for this quarter after reduced the carrying value of the net operating loss differed tax asset on the balance sheet to reflect these lower estimated remaining state and all carry forwards. It is poor to recognize that these revisions and estimates did not result in a cash tax liability, newer to the effect are federal income tax loss (inaudible). And finally we updated our guidance remainder of 2012, we expect our revenues to grow between 24 and 26% for the full year over last year and our guidance range for operating income is 18 to 22% and as we mentioned in our earnings release, the additional factors that impact that range including the Sy.Med’s differed revenue write down, we mentioned few minutes ago and also the closing cost for that transaction.

The federal income tax rate to be between 41 and 44% for the full year of 2012 and capital expenditure to be between $8 million and $9 million for the full year.

Thank you for your time and I’ll turn the call back to Bobby.

Robert First

Sure. Thanks Gerry. We have 3 final announcements here. First, I’d like to welcome Sy.Med’s 21 employees, some of which may be listening in today. Yesterday, they joined us in our Downtown National Office for welcome celebrations. So, their headquarters is just a few miles south of our downtown offices. So, we welcome the Sy.Med’s employee base to HealthStream. We’re excited to see them continue their growth and as they leverage our network, even hopefully accelerate that growth.

I want to break the news that we have confirmed our next customer summit and the timing of which is important to all of the financial community. We in an effort to hold that event at the National Music City Center which is our new 1.2 million square foot facility in downtown national and actually two blocks away from our headquarters. It has over – we’re looking forward to holding our conference there, but as you may have noticed if you’ve been through National, it is all under construction and so we’ve scheduled our summit for next year to accommodate that for the fourth quarter early in the fourth quarter of 2013 and so probably in the October timeframe, we’ve actually secured a window on October, but we’re going to announce the actual dates here in the next couple of months. So, we will hold the actual dates, but you can say that the summit will be in the fourth quarter in Nashville in the new Nashville Music City Center, right next to our headquarters. We’re very excited about that.

And another news that is exciting and something for all employees to celebrate. HealthStream was just ranked for the second year in a row in the Forbes magazine’s 2012 list of the top 100 best small cared companies in America and so our entire company can share in this exciting announcement. Last year we actually were also in this list, we ranked 53rd, this year we rank number 27 on the list of Forbes top 100 best small companies in America. Great accomplishment for all of our employees and something they should celebrate. So, I want to congratulate all of our employees for being part of this journey and contributing to our growth story and our success over the last several years. And it is really exciting and fun when an organization like Forbes recognizes our progress. With that I would like to turn it over to the operator for questions and answers where we stand by for your questions.

Question-and-Answer Session

Operator

Thank you sir. (Operator Instructions) Our first questionnaire comes from the line of Ryan Daniels with William Blair, please go ahead, your line is open.

Ryan Daniels - William Blair

Yeah. Good morning. Thanks for taking my question guys. Let me start with a couple of quick financial ones. First up, I am just curious on some of the seasonality on the cost of revenue that looks like in the third quarter every year that goes up even if your sales are kind of flat to down sequential in the Q3 period. I am curious if you have any color kind of what drives that to continue throughout the year regardless of the revenue stream.

Gerard Hayden

Yeah. Hey Ryan, it is Gerry. The third quarter of this year, we had a relatively large course (inaudible) project that had high labor content in the third quarter. So, that is one part what influenced that the cost of revenue this quarter. The other thing over time is the course which becomes a growing part of the revenue stream. You do see the world DPs growing as well.

Ryan Daniels - William Blair

Okay, that is helpful and then can you talk a little bit about the newer contracts signing, I am curious, you talked about for example the strength in ICD-10 sales over the last 30 or 45 days in particular, how does that actually manifest in the income statement? I know you probably don’t have any recognized sales for that. But when you sign the contracts, are you getting cash right away so that that goes in differed revenue? Are we not really not seeing that manifest at all in the financials at this point?

Gerard Hayden

There are two dynamics. One is we usually get some kind of -- let’s call it deposits, so with differed revenue that would go to the balance sheet but not to the income statement. However, our compensation plan tends to front load some of the commission expense. So you would see commission expense without offsetting revenue.

Ryan Daniels - William Blair

Okay, great. And then a couple of more bigger picture questions, Bob I thought you mentioned that your existing sales force is now starting to sell them in some of the ancillary markets and that’s helping with the new ads onto the platform. Is that just the existing sales team branching out and focusing on that? And if so, how are you balancing kind of that push from the sales force versus focusing on the core acute care business?

Robert First

Yes, probably I will just note that, the core is still driving the vast majority of those numbers. I am just seeing a few more pickups here and there around the edges and so I have mentioned that. I didn’t mean to over emphasize that. The core of this number is still out of the core acute care market. So there is no team dedicated or focusing yet on those additional verticals. They will just pick up from it through affiliations, like if a health system acquires a home health agency or affiliates with one, some may extend our service out to those affiliations. So, we are just seeing a little bit more of that. I would note if more than early, an early trend not a significant trend yet, again the vast majority of those new ads are in the core markets.

Ryan Daniels - William Blair

Okay, that’s helpful. One last question, just thinking about some of your commentary around the NurseCompetency, clinical exams, and the skills check versus standalone now. I guess a couple of questions, how do you actually integrate that into the talent platform, kind of what is required for you to do that? Does that actually have a change on the revenue or margin profile as you move from a standalone to an integrated product? Thanks.

Robert First

Sure. In some cases it does affect the revenue profile as we move to an integrated product, or we change the selling model of what was maybe a more traditional model. NurseCompetency is brand new and very small, but important from an example standpoint of the type of content we are excited about. Because these tests include benchmarks and comparative data analysis that as distributed network will create hopefully some form of benchmarks that are referred to. We are excited about the nature of that product.

From a revenue recognition standpoint that would be treated much like a content product and be subscription product recognized overtime through some kind of early indication of the volume commitments from customers. So, again a new product not material revenues but exciting for the nature of the product. Other revenue streams like the acquired business of Sy.Med is largely installed software and their sales organizations and their teams are geared to selling installed software that lingers on a smaller maintenance stream. As we encourage that sales organization to sell the SaaS model, the revenue would appropriately diminish because you would have more visibility into the next, say 24 or 36 months on the SaaS subscription model and less of a pop from selling the installed software. This is a migration we went through 8 or 9 years ago in learning and we are now on the back side of it and enjoying the high visibility into the revenues on learning platform. And so, in some of these acquisitions and investments we will need to take those organizations through that migration and so, as I indicated we paid a little more than two times revenues for the Sy.Med Development acquisition. However, the revenue, if we do our job in the next 12 months would drop meaningfully as they start to sell under the new model. We will see how fast we can make the migration, but it’s just important to note and from the integration standpoint sure there are cost to those migrations and integration sometimes, we can start with looser integrations like seamless logon and others like the portfolio we are actually rebuilding the code base right on our core platform using the architecture of the talent system as the infrastructure for the new portfolio product. So, in each case we will have to have a different approach and but ones we are very familiar with having done all this a decade ago, and different levels of investment. So, we are trying to explain this to everyone that as we accelerate growth and bring new components and partners into our eco system will require new types of investment in cash in IT and program and development, and even model changes which will affect revenue from the topline.

Ryan Daniels - William Blair

Okay, great. Thanks for the color.

Operator

Thank you sir. Our next question comes from Matt Hewitt with Craig-Hallum, please go ahead, your line is open.

Matthew Hewitt - Craig-Hallum Capital Group

Good morning. Handful of questions from me. First and foremost, one of the things that kind of jumped out this quarter for me was related to your differed revenue. There was a fairly large drop from Q2 to Q3. Is some of that related to the acquisition or could you help me understand what’s occurred there in the differed revenue line?

Gerard Hayden

The renewal flow of the pre-payments on contracts and in research in the Q2 we had some larger contracts that had some pre-payments that are fully completed in Q3. So, I guess the normal fluctuation of the flow of the contracts. (inaudible)

Matthew Hewitt - Craig-Hallum Capital Group

It seemed to have been an outside move. It’s been a couple of hundred thousand one way or the other. Mostly that line has been growing. So, I guess to see that drop I was just wasn’t sure if there were something that occurred in Q3.

Gerard Hayden

No.

Matthew Hewitt - Craig-Hallum Capital Group

Okay. Shifting I guess, thank you for providing the additional metrics, especially relating to some of your other platforms. You gave us not only this quarter but I think you gave us last quarter as well. I am curious, do you have plans eventually to give us – like you do for the learning center where a number of employees, just away for us to gauge how penetrated you are with a couple of those other platforms. I know it’s very early with them but I am just curious, is that the plan longer term or how should we be thinking about that?

Robert First

It is. As we enter next year it’s my belief we are going to need to create some new metrics and we have been talking about this for a while and it becomes increasingly evident that as we have a broader talent management solution set that has multiple component pieces with additional subscribers to each component piece, the revenue per subscriber generated by say a subscriber-to-hospital that has access to two or three components or platform versus just one, it’s an important thing to get our hands around and report on. So, we have a long standing history reporting on this core learning piece, I would say as we enter the New Year what we are working to try to achieve is this concept of the number of members and subscribers that are members and then how many components they in fact do subscribe too.

We have tried at different times of this year to find them all, get it where we wanted, we don’t quite have it and so, again, we will look for the next reporting. It’s differed one more time, but just directionally where we are working to go is to move aware from this set of metrics on just this learning piece. Because a growing important as you know are the (inaudible), the performance management pieces, the now portfolio, there is so many ways to be a subscriber now to HealthStream that you can expect a shift into next year that tries to report a new type of metric around capturing this idea of – we have looked at things as much like subscriber months, they would aggregate all of the subscriber months across all the platforms. So, be expectant for reporting paradigm because we are no longer just a single software module, we are a talent platform with multiple components.

Matthew Hewitt - Craig-Hallum Capital Group

Okay, that’s sounds great. We look forward to it. Thank you Bobby. It will just help us get our hands around the opportunity a lot better and it’s much appreciated. Last one from me and it’s actually I guess two fold. You might have pressed on it a little bit, but as far as the gross margin is concerned, up until this year it’s been 62, 63, 64, obviously as you add more and more content partnerships where you are paying royalty rates that is having an impact. In fact, I think it was in Q1 of this year you commented that it was hardcore (inaudible) that has become a contributor to your growth that also does carry pretty significant royalty rates. Was that some of the impact here in Q3 and also, as you do some of these acquisitions, as you make some new acquisitions, will that become an offset as those products grow, seeing as how you then own the content versus partnering?

Robert First

A couple of comments there. Yes, the growth in content, our entire model is built around creating consumption patterns of content. The platform themselves create developmental plans for people that we believe drive content consumption in addition to things like regulatory driver. So the growth in content consumption is a positive effect, but at the gross margin level, yes, it has a negative effect. So, the relative growth rates of platform versus affect the blended gross margin. That’s why we continue to turn our emphasis down towards operating income lines and EBITDA. But, you are right to note that the acceleration of content is a great phenomenon, we hope to continue to pay more and more royalties to our content partners because that’s the model that we are working to build, we are not just a software company, we are an ecosystem of partners and we want our partners to do well and we enjoy paying them the royalties, so that the whole ecosystem is strong. What was the second part of the question? Can you rephrase the second part?

Matthew Hewitt - Craig-Hallum Capital Group

Yes, as you acquire some more products, will that help offset some of that?

Robert First

It will but I think I have tried to be clear earlier and I will restate. I think that some of these acquisitions require a bit of reengineering before we get to leverage out of them. So, these are investments for the three and five year window and we really like the way we are picking up these unique properties. I think in long run, yes, you are absolutely right that the platform components have higher gross margin and the more of them we sell the better the blended gross margin rate will be. So, that’s true of the portfolio of products, but now the credentialing products that is in fact true. So, it’s just a relative balance of those things and the cost and time to reengineering them that will affect how it comes out say next year.

Matthew Hewitt - Craig-Hallum Capital Group

Okay, great. Thank you.

Operator

Thank you, sir. Our next question comes from the line of Richard Close with Avondale Partners, please go ahead, your line is open.

Richard Close - Avondale Partners

Great, thank you. A lot of my questions have already been answered. Maybe to dive into them a little bit more. With respect to the investment and integration into various content and I guess the two acquisitions. Is there any type of – I guess, I don’t want to say guidance, but can you give us some help in terms of what kind of levels of investment the reengineering is going to pay you? I think product, development right now was running around 8.5% of revenue. Is that something we need to think about as ratcheting up to like a 10% level or just trying to get a feel of how significant the levels of investment you are going to incur here over the coming year or so?

Robert First

Yes. I think what I can reinforce now is just to transfer the need to continue increasing the rate of investment. In our next earnings call we will hit with guidance and after we finish our strategic planning process. So it’s right to note the trend. We will try to put good magnitude around that trend and I believe it’s our late February call is when we will do that. So, we are kind of explaining the trend but we will provide precision on it in February.

Richard Close - Avondale Partners

But it’s fair to say that this has to increase over the coming months, coming quarters, basically because you have either signed content relationships and you have to reengineer that or make these acquisitions. So the level of investment is stepping up.

Robert First

That is correct. I think in this high growth environment we are excited to continue to innovate and deploy R&D and the expenses into those areas. But we are also, Richard, this is the time to grow in other areas as well. So, we are beginning to do the pre-hiring releases, what we call in the sales areas for example, if you noticed on our website 4 or 5 brand new sales positions have popped as well. So, in this area clinical courseware executives to help and all of our clinical courseware organizations will be excited to see this new level of commitment, focused to selling clinical courseware through our network. Organizations like AORN, ACN and ANA, this will bring a renewed focus to selling their content into our network with the specific type of expertise in the sales organization. So, I think the theme as we enter next year across the several areas is to continue to focus on top line growth, we are going to need to invest in many areas in the company and probably at a higher rate than our historical models.

Richard Close - Avondale Partners

Okay and that last answer dovetails into where my next question was. With respect to 4 or 5 sales positions popping up, when I look at the sales and marketing expense, if the percentage of revenue, it was quite a bit below what we were looking for. And then Gerry’s question or answer to one of Bryan’s question was talking about some upfront commission expense. And it just seems like those are too -- I guess I would have expected sales and marketing expense to be up, maybe year-over-year, the percentage revenue were at least flat, so I’m not sure how you been leveraged there, what drove that, was there something one-time in that line item, maybe Gerry can help me out there.

Robert A First

Well, I’ll try first as Gerry thinks that, I don’t that there is anything new or different there. We each year really in a third and fourth quarters, when we access how to grow the sales organization begin to release hiring in it. You can already see it, for example, 4 new positions as I mentioned. Commission is not all front loaded, it’s usually about in some products half contract signing and half, a year later. But when we have usually the fourth quarter is one of our strongest periods of closing contracts, and so you’re going to have that first half of the commission hit you all in the last month of the year and the revenue recognition clearly can’t began until sometime of the next year. And so and specifically, if you think about the fourth quarter, you’ll kind of see that phenomenon is definitely one of our largest, it is not our largest by a good stretch in closing of new business. We call the new order value, the value of these multi-year contracts. These commissions are paid on the multi-year value of those contracts as well. So, half of the commission assumed in the month of December for a three year value contract is the way our model works and so, but it has always worked that way and this is the period when we increase investments in the sales organization and then also incur those commissions towards the end of the year, as our sales team celebrate what is usually an outsized performance in the fourth quarter. So it’s kind of that mixture, a good news, a challenging news is that and really if you think about hard enough, it’s all good news when you pay higher commissions, because essentially the backlog being created for new business.

Richard Close - Avondale Partners

Okay that’s helpful. And then with respect to, if you can just refresh me the talent management products or center, performance center competency center. What the revenue model is on that, just a refresh and then I also follow on with these exclusive relationships, on NurseCcompetency and a set system. Can you talk a little bit about the price points, I know that might be a little bit sensitive but I’m trying to get a feel of should we think about, revenue per subscriber, that’s the only metric we really have in terms of number of subscribers. But these new areas that you’re going into, does that have a positive impact on the revenue per subscriber, maybe some discussion around those points, I know that is a lot, so sorry?

Robert A First

Yeah, so the revenue model for the performance in competency centers is identical to the revenue model for the learning center and the operating center and the SimManager part of Sim center. They are all a SaaS based, subscription based multi-year contracts and recognized ratably over the period of implementation. So, hope that helps.

The content what I would say is that right now, the drivers we have approximately 130, 140 partners that are content partners and these two that we announced here are brand new and currently not impactful to the blended rates and in fact that we’re just beginning to sell them, and don’t have revenues from those products. I highlight these products because of a. exclusivity and b. their nature is a little different than our traditional content products. So, it shows that the definition of the type of content we’re delivering, in this case, test and assessments is as being enhanced. So, I would continue and if I were thinking that modeling to model core products like the HeartCode products set, which we occasionally provide detailed updates on being on a weighted basis. The much more material part of the content revenue streams. They come from two or three areas, our Lippincott Nursing Library and from a growth momentum standpoint, our ICD-10 libraries, should be good for next year. The HeartCode and BLS and ACLS and PALS content, then we talk about, the resuscitation content libraries. Those are kind of three key areas if I wanted to peel out of the 140 partnerships and say what are the three key drivers for content, it will be that clinical libraries from Lippincott Williams & Wilkins. The resuscitation libraries from our Laerdal Joint Venture and the ICD-10 libraries in our precise venture. Now, all the others including NurseCompetency and the assess systems, I would consider immaterial part of the mix of how content is growing, but I wouldn’t model any of those individually at this point.

Richard Close - Avondale Partners

Okay, thank you and do you want more here if I can, yeah. The colored details on ICD-10 is great, it is good to hear that you’re seeing that ramp up. Have you guys done any back of the envelope in terms of the number of your current potential or your current contracted subscribers, what’s that ICD-10 opportunity is as a percentage of your what almost three million subscribers?

Robert A Frist

Yeah it’s a little too early to do that because we are seeing different purchasing patterns, some want to go deep for a very small department and create awareness, essentially training and educate a very small department, others, for me the migration is so significant that they buy what I call awareness and orientation packages for more or a higher percentage of their population and we’re just seeing such a mix right now in the approaches that it’s hard to project at this point. We’re excited to see the uptake and more contracts, the nature of it hasn’t created a kind of a mean, median and mode yet, that is worth reporting because we are seeing different adoption strategies. We believe that everyone needs to be oriented, this is, its that important a topic. But different organizations have different approaches to how they are going to meet these ICD-10 migration.

Richard Close - Avondale Partners

Okay, thank you very much, congratulations.

Operator

Thank you Sir. Our next question in queue comes from the line of Nick Halen with Sidoti & Company. Please go ahead, your line is open.

Nick Halen – Sidoti & Company

Good morning guys. So, the first question I had was, I know you guys are really excited about the town management products what you guys are trying to building out and you guys are making investments across a lot of different verticals and things like that, but it kind of seems that SimVentures is to a certain degrees flipped into the background while you expand out these other products, so I was just wondering basically if you are happy or satisfied with how SimVentures are progressing right now?

Robert A First

I would say that the SimVentures is on an early adoption curve that is more linear and is measured in totality in viewing the HeartCode and ACLS products as part of the move towards simulation. The curve is more than just linear but the brand new SimVentures components are kind of on the early adopter, linear, the first hospitals beginning to bring those products in. On a blended basis, looking at the totality of our partnership with Laerdal, I suppose significant, meaningful and fully engaging the mannequin based simulation and training to do the resuscitation continues to impress in is its adoption curve and the rate of change in the industry. The newer SimVentures components that are even kind of more futuristic in their training approach, the adoption of those right now is linear and not called the early adopter phase kind of pre-acceleration curve. I remain excited that it is a contributor financially and a growing part of the business, and so that would characterize in that way.

Nick Halen – Sidoti & Company

And then just lastly for me, I guess just kind of clarify if you can, what are some of the major similarities and differences between your two most recent acquisitions in Sy.Med and Decision Critical?

Robert A First

What are the differences between those two?

Nick Halen – Sidoti & Company

Yeah

Robert A First

Yeah, so the Decision Critical had a small customer base that looked a lot like our customer base, it had a couple of dozen health care system accounts or hospital accounts where they provided the core of learning and a learning platform. So in that sense those customers were beginning to work with to show opportunities for our product sets. So, that one it looked a lot alike us, it was founded in a similar vein and the learning dimension of talent management, but it also had this unique asset and at this portfolio component which again, you heard me mention where rebuilding, so it had a potential for a new product to emerge out of it and not just be more of what we have. And so it was standard and we’re excited about its long run potential. Now, Sy.Med is a new dimension to our account management strategy, it is hitting this idea of determining and answering the question is the work force qualified, and their credentialing process is a unique dimension of managing personnel on a hospital also is all (inaudible) with something called privileging. And one of the things we’re doing at our talent management model is working to make sure it’s differentiated from the rest of the industries. And so what we do there is we seek out, what is different about managing these 5 million health care workers that is part of managing their talent, managing their people, improving their efficiency. And in healthcare, one of the answers to that is that the credentialing and privileging processes inside a hospital, is a unique dimension of managing the workforce. So, here the time and acquisition again, a characteristic as it was largely installed not SaaS, although it has a SaaS product and it was a new dimension to our business model credentialing and privileging instead of just learning and development. And by the way not just different to our model, but we believe different in health care and therefore a differentiator went up against other talent management companies that may not understand the processes of credentialing and privileging the work force as a core component of managing talent and healthcare.

Nick Halen – Sidoti & Company

Great, thank you.

Operator

Thank you Sir. Our next questioner in queue is Andrew Albert. Please go ahead, your line is open.

Andrew Albert – Invicta Capital Management

Hello guys, I was just hoping to drill down a little bit further on the differed revenue that was asked earlier. I know you mentioned it was normal course of business, but the 1.8 million drop seems to be pretty large, I’m looking here the largest you have ever seen before, it was 400gm in terms of a sequential decline and differed revenue, so is there something changing in the model at all and related to that, I guess the differed revenues, now, you have a date up all that much from the beginning of the year which is pretty different from all the prior years, this far unto the year. So if you can just give a little bit more clarity on that, that would be helpful, thank you.

Gerard M. Hayden

Yeah Andrews, this is Gerry here. I am not sure whether I can really mention about that. There has really been no change in the red recognition patterns or the entertainment patterns. One thing that maybe in the real HeartCode customer that was ramping over the early part of the year and that may have, if for maturity in the third quarter, which we have had a review recognition happen in the third quarter, while the cash is paid really earlier on in the year. But I don’t know there is a whole lot of difference in like say, either contracting patterns, red recognition or with the cash payments.

Robert A First

There must be some consonance of a couple of big contracts that got in, essentially executed in the period. So, we’ll look for some more clarity on that, that there was a large multi-hospital health system that went on to our HeartCode products earlier in the year, actually beginning in January and I think it took us some time to implement and that maybe getting those to implementation created a kind of a little bolus through the differed revenue.

Andrew Albert – Invicta Capital Management

Okay, and then with regards to the differed revenue growth, year-to-date. Is the model just becoming more transaction based, such that we wouldn’t see differed revenue grow or just would be new talent management products, I know they’re small at this point, but I imagine that’s’ having a little bump to a differed revenues, so I’m just trying to understand the core business, how differed revenue works there?

Gerard M. Hayden

Well, today once again, we go back to the theme as course were becomes a larger part of the revenue stream, it’s a lower revenue. Its generally both low revenue per subscriber content than the platform and there is more and more of those transactions or those contracts coming through the sales cycle into differed revenue, so that is part of it as well.

Andrew Albert – Invicta Capital Management

Okay, so there is not a lot of prepayment of those course wear?

Gerard M. Hayden

They are, they are just smaller pieces, that’s all. It’s not like as big as a platform contract might be.

Andrew Albert – Invicta Capital Management

Okay, so we shouldn’t expect the differed revenue to grow at the same rate that it had in prior year. Is that kind of a good go-forward?

Gerard M. Hayden

Yeah, it should be a more ratable growth sure, and once again, it’s going to come back. The large HeartCode customers in one of the reasons why it had the big jump in deferred revenue and now they are more historical pattern.

Andrew Albert – Invicta Capital Management

Okay.

Operator

Thank you, sir. Our next question in queue comes from Frank Sparacino with First Analysis, please go ahead, your line is open.

Frank Sparacino - First Analysis Securities Group

Hi guys, just two quick questions. On the ICD-10 – you gave 30 to 250, are those net or gross before royalties? And then secondly would be, on Sy.Med, can you just give us a sense, relative growth rates of that business, was there a 10%, 20%, 30% significant growth business, what does it look like from an EBITDA perspective if there was EBITDA? Thanks.

Gerard Hayden

Sure, I guess I will go in order there. The 30 to 250 is the retail pricing before commissions and royalties, and cost of goods. So, the 30 to 250 on ICD-10 libraries is the retail pricing. And then on Sy.Med, just a couple of things I want to reiterate, we would expect effectively the revenue that has been growing year-over-year and it did have EBITDA, so we identify both of those elements. However, with the reengineering the changing sales model, potentially selling more SaaS. If we are able to increase the rate of selling the SaaS components the revenue may actually decline. So, we need to be very careful modeling that. It’s going to take some time to get that revenue stream where we wanted and kind of get it to a baseline that’s going to be consistently growing. So, I think the revenues from that because it’s largely installed if the sales team sell more of the SaaS products, which we are going to ask them to try to do, the revenue components could decline and not go up. Although, historically even in the start and the maintenance revenue streams from that business has shown growth and positive EBITDA.

Frank Sparacino - First Analysis Securities Group

If I can follow-up just real quick. I was talking just more from historical perspective in terms of the growth rates, but then also on Sy.Med, can you just talk about how the product was priced in roughly a typical average deal with the size of that would be in a license mode?

Robert First

Not at this time because we are going to work on the migration of it and get, probably have new pricing models, maybe new selling models and we are not sure when we will roll those out, it might be the middle of next year, it might be the end of next year, it might be in January. So, there is going to be some work to do on that small and immaterial initial acquisition to get a physician ride in our portfolio of products. So, I don’t really want to talk about pricing because I think it’s going to have – there is going to be a lot of potential change with how we approach that product.

Operator

Thank you, sir. Our next question in queue comes from Chris Blackman with Imperial Capital, please go ahead, your line is open.

Chris Blackman - Imperial Capital

Yes, thank you. Bob, I appreciate all the disclosure. Can you help clarify a little bit the opportunities in some of the ancillary facility areas and maybe clarify some of the areas where you have seen the greatest traction?

Robert First

Yes, I think – we think the opportunities remain strong in those verticals. We have been assessing them for quite some time now. Again, only through affiliations with hospitals we have seen some improvements and additions in those markets. There is a lot of people employed in those markets. They probably don’t have the same revenue per person potential of the hospital and the acute setting that has all types of demands in surgery and the broad mix. The long-term care home health surgery center markets are all interesting, they are probably over time a great opportunity about 5 or 6 million people work across all those (inaudible) what we call secondary or ancillary markets. So, there is a lot of people working in them. Probably their revenue per subscriber potential is a little lower in those markets. And again, we haven’t launched anything official that would dedicate resources to those markets, but that’s all of a consideration as well, as we enter the next year. So, I hope that provides some color. I mean, there is about 5 million people in acute care hospitals. There is another, I’ve heard numbers from 5 to 7 in those secondary markets, when you add them all up. And the largest of those is probably a long term care home health market and several million. So, there is definite opportunity there, and we are working on figure out how to pursue it. We just pursue it through our hospital customers as they acquire, integrate and extend to the accountable care concepts, or do we dedicate teams to go after them, and that’s kind of a pending decision to our retreat and strategic period here at the end of the year.

Chris Blackman - Imperial Capital

I know you have been challenged with trying to determine exactly how to clarify that opportunity in the year to break out those areas, do you expect to breaking those out force then next year, some of the specific markets?

Robert A. First

Well they are juts right now, they are blending into our core numbers and you know, we’ve got a couple of different breakouts people are asking us to make. The first is explaining how these component pieces are spread and we’re working on that. We’ll probably do that before we do the vertical market breakout, so that would be like a further matrix segmentation of the user base, but we’re open to both. I think the first we will probably do a little more detailed reporting on the penetration of platform components.

Chris Blackman - Imperial Capital

Thank you and then on the hiring, and I know you mentioned the sales people that you posted spots for, but, on a larger picture, as far your employment, are you contracting more or have you been able to find the employees that you have been looking for on the last couple of quarters and some of the challenges as far as finding the work force you needed, any updates there?

Robert A. First

Yeah, it’s a fair question. I think this exciting time and downtown national where we’re adding space and people as quickly as you can or adding a recruiter, an HR to help on the recruiting process, trying to lower costs of finding talents. We’re finding wonderful talent in many areas, we’re challenged in others. The developmental teams, the programming development teams were having a hard time, filling those at the rate that we’re trying to add them, and so it’s a little bit of mix bag, it’s an exciting time, we’re bringing in lots of great new talent. I wish that in these in the tech areas, we could have a bigger talent pool in the area of the country. We’re kind of excited to have our Austin office, gives us another pool to recruit from and potentially add to and create mobility between offices. So, we hope that adds to the rate of hiring. But it is a fair statement that we’ve been challenged to fill at the rate that we had hoped in the last several quarters and we’ll just keep working through that until we solve that problem.

Chris Blackman - Imperial Capital

Thank you Bobby.

Operator

Thank you Sir. And with that, that does conclude our questions. I’d like to turn the program back over to Mr. First for any additional or closing remarks.

Robert A. First

Thank you for your participation in this call. We look forward to reporting the next quarter and full year results in some time, I believe in late February. So, thank you again and look forward to the next call.

Operator

Thank you Sir. Again, ladies and gentlemen this does conclude today’s conference. Thank you for your participation and have a wonderful day. Attendees, you may log off at this time.

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