HealthStream Inc (HSTM) 2003 Q3 法說會逐字稿

Good morning, and welcome ladies and gentlemen to the HealthStream third-quarter 2003 earnings conference. (OPERATOR INSTRUCTIONS). I will now turn the conference over to Mr. Robert A. Frist. Please go ahead, sir.

Thank you. Good morning, and welcome to our third-quarter earnings conference call. Also in the room with me are Art Newman, Senior Vice President and CFO; Susan Brownie, Vice President of Finance and Corporate Controller; and Mollie Condra, Director of Investor Relations. Art, would you read the forward-looking statement, please?

This conference call will contain certain forward-looking statements regarding future events and the future performance of HealthStream that involve risks and uncertainties that could cause the actual results to differ materially from those projected in the forward-looking statements. Information concerning these risks and other factors that could cause 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.

Thank you, Art. Our primary goal at HealthStream continues to be to improve the quality of healthcare by improving the quality of health education. Already, with a (indiscernible) customer base of approximately 730,000 fully-implemented subscribers, HealthStream is a leader in the future of education and training in hospitals and health care.

The achievement of positive cash flow during the third quarter positions the company well for growth in the near future. In the past several quarters, we have been focused primarily on three things -- improving operations, improving new product development, and improving our financial progress. I would like to report on each of those three things.

First, operations. Over the course of this year, we have reduced our customer implementation cycles by up to 50 percent; that is, from contract signings to implementation has reduced from approximately 65 days to 45 days.

Also, we have improved the responsiveness of our call centers. The average wait time is now between 9 and 11 seconds to talk to a real person, which is about four times faster than the national average for call centers.

In addition, this year, operationally, we have enhanced our training of our customers on our products and services. We have released online training tools, multimedia training tools, new product manuals, and quick-use guides to our customer base.

In addition to these operational types of improvements, we have focused very well on new product introductions and new product development this year. While on the path to cash flow positive, which often implies there's a more restricted environment, our company has proven to be very innovative, and continues to introduce new products. So far this year, we have launched the HealthStream offering center around the April time frame; HospitalDirect, around late June; and recently, we announced Competency Compass -- last month, which all three of these new products come from our new product pipeline.

In our pipeline, looking ahead, we anticipate the launch of new concept libraries from Pearson Prentice Hall, and most importantly, a new entry-level product for the market that we think will get us the pricings that needs of our customers around some of their regulatory compliance needs. This entry-level product will be aggressively-priced against competitors, and we view it as a way for customers to have simple compliance needs -- a way to get involved in the more-robust learning platforms and extensive products that we have introduced this year and the future.

In addition, and obviously, a main driver for our senior team has been achieving all of this, while also improving our financial performance. And, while I think our metrics do speak for themselves this quarter, I would like to highlight the attainment of EBITDA positive. EBITDA, which we define as earnings or loss, excluding cumulative effect of the change in accounting principle, and before interest, taxes, depreciation, and amortization, improved to an earnings of $74,000, compared to a loss of 1.5 million for the third quarter of 2002. This resulted in an increase in our cash and investment balance by over $500,000 to $18 million. Again, I would like to compliment all of the employees at HealthStream on the attainment of this objective. We have been focused on it for a little over twelve months, and made steady, quarterly progress towards that goal.

In particular, I would like to congratulate and thank my senior officers -- Mike Pote, Senior Vice President; Fred Perner, Senior Vice President; and Arthur Newman, Senior Vice President and CFO -- for their dedication and focus to the attainment of this goal and their leadership throughout this period to achieve EBITDA positive.

Other financial metrics include day sales outstanding, which is a good operationally and financial metric, where our company has improved from approximately 100 days average DSO to 50 days DSO over the course of the last 12 months. Again, very proud that while we have been able to focus on cost containment, we have increased efficiency on almost every measure that you could measure operationally, financially -- and of course, new product development, clearly, has not suffered with this focus.

Looking forward, the company plans to now turn our attention towards growth. We are not completely satisfied with the growth numbers we attained in the quarter -- 7 percent over the prior year. And so what we are going to do about that is put our energies behind our new products, increase our sales forced by up to six personnel by the end of the first quarter. We plan to add these personnel in a way that will also allow us to maintain our objective in the fourth quarter of being EBITDA postitive.

In addition to carefully monitoring our marketing spend -- and most importantly, it is time to get the message to the market about our new products -- The introduction of our new or low-cost products sometime in the next couple of months that will go head-to-head to increase the rate of penetration. All of these things are focused for our company, as we move, forward. And just generally would note that, once a company turns EBITDA positive, I believe the mind set changes a little bit from a defensive posture to an offensive posture. And certainly, that is reflected internally in the company -- across the employees who are excited about the attainment of this milestone. And now we can turn our attention towards growth. Again, complimenting all of the employees on the attainment of these important financial and operational milestones.

I would now like to turn it over to Susan Brownie for a detailed look at our financial performance.

Thanks, Bobby. Revenue through the first quarter of 2003 increased -- sorry for the third quarter of 2003 -- increased by 7 percent to 4.3 million from 4.1 million for the third quarter of 2002. The revenue increase came over the same quarter of 2003 from hospital-based business, while the pharmaceutical and medical device-based business showed moderate decline.

Improvements included 410,000 of revenue growth related to our Internet-based HealthStream Learning Center products; 285,000 of the increase was from add-on (indiscernible), principally related to our HIPPA contract. These increases were partially offset by 250,000 of anticipated decreases in license and maintenance fees associated with our installed learning management product, as well as a 160,000 of decreases in our (indiscernible) of inactivities. The 7 percent revenue decrease over the second quarter of 2003 resulted from a $325,000 decline in live-event (ph) revenues, primarily related to the annual (indiscernible), which occurred during the second quarter.

In addition, declines in the installed learning management fee products were anticipated as well. These declines were partially offset by growth in our Internet-based HealthStream Learning Center products of approximately $60,000. The portion of revenue associated with our Internet-based subscription products grew from 50 percent in the third quarter of 2002; 56 percent in the second quarter of 2003; to 63 percent in the third quarter of 2003. The changes in revenue mix that I just mentioned, are consistent with our continued focus of reaching new customers and transitioning existing accounts.

One of the metrics that we look at are (indiscernible) of revenues between the hospital base and pharmaceutical business. Revenues in the current quarter were split approximately 70 percent in the hospital considering of the business, and 30 percent for the pharmaceutical, medical device-based business, which varies from the 65 percent/35 percent split during the second quarter. This change is consistent with the lower (indiscernible) of that revenue that I discussed with respect to seasonal timing of the (indiscernible) in Congress during the second quarter.

During the third quarter of 2002, our split on a comparable basis was approximately 65/30 between the hospital-based and pharmaceutical-based business, as well. Variations from the prior year same period resulted from HLC growth and the live-events revenue declines that I mentioned.

Changing our focus from revenues -- our gross margin percentages improved from approximately 68 percent for second quarter of 2003 -- I'm sorry, for the third quarter of 2003 -- due to favorable margins associated with the shift in the revenue mix associated with our Internet-based products. Gross margins, as well, improved to 68 percent for the third quarter, compared to 66 percent for the second quarter of 2003. Again, this change is consistent with the revenue mix changes that I previously discussed.

Product development expenses during the third quarter of 2003 declined by 440,000 from levels experienced during the same quarter of 2002, and declined by approximately 40,000 from the second quarter of 2003, primarily due to reductions of personnel.

In addition to reductions of personnel in the year-over-year period, we also reduced spending for contract labor. Our current development spending is focused more tightly on maintenance and performance enhancements associated with our HealthStream Learning Center product. The decline in product development expenses reflects our focus on fewer core products, as well as efficiencies that we have gained from consolidation of our product development efforts across the company.

Sales and marketing expenses from second quarter declined by 540,000, compared with the same quarter of 2002, and also declined by $300,000 from the second quarter 2003. The reduction over the same quarter of the prior year resulted from changes in the commission structure of 2003, and, to a lesser extent, reductions in marketing spending. When comparing the third quarter with the second quarter of 2003, we experienced an expected decline in marketing spend, as a result of the e-Learning summit which occurred during the second quarter of 2003.

The experienced reductions and other general and administrative expenses, as a result of consolidation of corporate and administrative functions between the third quarter of 2002 and the same quarter of 2003, which resulted in savings of approximately 340,000. When comparing other general and administrative expenses to the second quarter, the expense reductions (indiscernible) resulted in savings of approximately 120,000, while depreciation and amortization declined 70,000.

Depreciation and amortization declined as well from the third quarter of 2002 to the third quarter 2003 by 290,000, primarily as a result of certain intangible assets that are associated with prior acquisitions reaching the end of their estimated useful lives. The experience during the third quarter of 2003, being favorable to the second quarter of 2003, occurred primarily -- evenly split between depreciation and amortization changes.

Other income also declined due to lower investment balances and, to a lesser degree, declines in yield rates during 2003. As we have communicated historically, we adopted a new accounting standard, effective January first, 2002. As a result of this new standard, we no longer recognize amortization related to intangible assets with indefinite lines, such as goodwill. For comparative purposes, all of our measures -- both GAAP and non-GAAP -- are presented exclusive as the impact of this accounting change.

Moving to net loss -- we reduced our net loss -- a loss of 623,000, or 3 cents per share for the third quarter 2003. This compares to a loss of 2.4 million, excluding the impact of the accounting change, or 12 cents a share, for the same period in the prior year. And a loss of 1 million, or 5 cents a share, for the second quarter of 2003.

We improved EBITDA, or earnings or loss before interest, taxes, depreciation and amortization -- again, exclusive of the accounting change -- from a EBITDA loss of 1.5 million for the third quarter of 2003 to an EBITDA loss of 259,000 for the second quarter of 2003 -- the EBITDA earnings of 74,000 for the third quarter of 2003, as a result of the reasons I have discussed. Please refer to our earnings release for a reconciliation of net loss to EBITDA.

Moving to the balance sheet -- we ended the second quarter of 2003 with approximately 17.5 million of cash and investments. This actually increased during the third quarter to balances of 18 million. The increase in cash and investments was compared to a decrease during the second quarter of both 2003 and the third quarter of 2002 of approximately 1.3 million. The improvement from the third quarter and from the prior resulted, primarily, from a reduction of DSO, but also in the same period of the prior year, we have achieved considerable operational improvements that have led to improvements there.

DSO at the third quarter end, was approximately 50 days, and this compares favorably, as Bobby mentioned, to approximately 100 days for the third quarter of 200, and approximately -- excuse me -- combined with the operational improvements that we had made from the prior year, combined with the improvement of DSO, has led to the improvement in cash during the quarter. As Bobby mentioned, the milestone that we have reached in the current quarter of positive EBITDA and increasing cash has been a great milestone for all of us and we are eager to maintain that milestone.

As we discussed in the last quarter, we are focused on our renewal ratio as well. We believe it to be an additional indicator of operational performance. The measure renewal rates in two ways -- by the number of customer accounts renewed, and by the annual contract value renewed. For the quarter ended September 30, 2003 the accounts renewal rate was 92 percent, and the annual contract value renewal rate was 94 percent. Cumulatively, for the 9 months ended September 30, the account renewal rate was 88 percent, and the annual contract value renewal rate was 78 percent. As of September 30, we had five customers who's contract had come up for renewal during 2003, who had chosen not to renew. This represented contract value of approximately 108,000.

Our full-year targeted renewal rate was approximately 90,000 -- or 90 percent -- excuse me. Art will now discuss our expectations for the fourth quarter of 2003.

Thanks, Susan. We expect (ph) our fourth-quarter revenue of approximately $4.4 million, which will be comparable to our third quarter results. Anticipated revenue growth will come from our Internet-based HealthStream Learning Center, and from all the Pharma Med device product lines, including live-events, (indiscernible), and content development. (indiscernible) these increases are reductions in maintenance revenues from our (indiscernible) learning management products, and lower ad-on (indiscernible), primarily due to the expiration of certain HIPPA contracts. We expect revenue to be split -- 68 percent for the hospital, and 32 percent for the Pharma Med device for the fourth quarter.

Gross margins for the fourth quarter are expected to be somewhat below experienced during the third quarter, which, as Susan mentioned, came in at 68 percent. The decline is expected as a result of the lower margins associated with live-events and content development revenues. Product development expenses are expected to increase and maintain as we maintain and develop additional features for our HLC product line. Sales and marketing expenses are also expected to increase as a result of increased sales commissions, resulting from increased sales order activity during the fourth quarter. We expect other G&A expenses to decline during the fourth quarter, due to reductions in depreciation and amortization expenses.

Based on these revenue and expense projections, we expect our fourth quarter net loss to improve moderately from the results we reported during the third quarter. For the full year, we expect to show revenue growth of approximately 13 percent over 2002. We believe our continued focus our expense control and expected revenue growth will enable us to achieve cash flow positive results, again, as measured by EBITDA, for the fourth quarter.

Finally, we estimate our cash and investment balance at year-end will approximate 17.5 million, which is inclusive of approximately $500,000 of capital expenditures and other similar development expenses in the fourth quarter of this year.

I will turn it back to Bobby for some closing comments.

Thank you, Susan. Thank you, Art. I would like to summarize with a few closing comments. One is our continued focus on growth. We look forward to educating the market about the complementary nature of all of our products. We are excited about these new product introductions. We believe that HospitalDirect and Competency Compass represent "first to market" solutions that have a uniqueness in their complementary nature with our core product -- the HealthStream Learning Center. And we believe that, moving forward, to improve the financial and operational leverage of our model, we will need to achieve sell-through of those additional products to our existing customer base.

In this quarter, and in the months prior to his quarter, we have launched three new products. I want to give your a little color on that HospitalDirect product launch. Since its launch, we have signed our first contract. It is a smaller contract with a device company that is a pilot program. We have four contracts in negotiation, and seven additional proposals outstanding that we hope to turn into contract negotiations in the near-term.

We are excited about this; we believe that this is a type of product that has the potential to become a competitive necessity among the medical device companies in the market. It really is a product that takes first steps slowly, and then, hopefully, we will ramp up over time.

Competency Compass also launched recently, and we have landed four contracts on that product. And, most exciting about that is -- we have landed contracts, both from existing customers and new customers. For existing customers that sign up for Competency Compass, we see an increase in the dollar value per FTE (ph) of those hospitals -- sometimes as much as 2X the initial subscription rate that they are paying for the HealthStream Learning Center.

So, we are seeing that we have products to sell through the channel. And so you'll see this renewed focus on growth in the following quarters. And importantly, renewed investment -- we have new products in front of us that we are investing in. And we plan on increasing our sales force to get these new products to market as rapidly as possible and have a strong start, leading into '04.

I would like to turn it over to questions now for the team. Operator?

(OPERATOR INSTRUCTIONS). David Francis, Jeffries & Company.

Congratulations on the EBITDA profits. Two questions, both focused on the growth outlook. First, Bobby, could you remind us what the current sales organization looks like right now in terms of headcount and where folks are deployed? And follow that up with where you expect to be deploying these additional six resources that you mentioned on the call.

Yes, David, I can. The current sales force that are -- what you would call the quota-carrying sales force -- consists of about 21 individuals. We have had a bit of a -- I don't know if you would call it a reorganization, but we also have product line managers that are involved in the sales process, and account managers that are not in that number, that do not carry quotas, but are intimately involved with growth of the customer relations, once they are in place. So that -- if you add some of those relationships in that manage existing accounts for growth, it would put you up a little higher -- about another six or eight personnel hired. So quota-carrying salespeople, 21. They are distributed in the field, and here in Nashville and in Denver.

The six that we plan to add will be product specialist, for the most part, to help energize and launch the new products that we mentioned. We expect that at least three of them will be outside ales forces in the field in the regions that exist, and three will probably be inside salespeople, to either support their efforts or mind existing accounts for new opportunities. So we see the total going up to 27 by the end of the first quarter -- of quota-caring salespeople.

As you look at that forward 27 number, how do they break down between hospital and PMD?

Let's see -- well, increasingly, as you know, our products are blended across the environment. What I mean by that is -- HospitalDirect, as a product, has an aspect that is used inside the hospital, and an administrative software component that is used by the device companies. So what we are seeing -- and recently we have combine the sales forces to focus on what we call sales channels -- by the old models, I would say that 21 -- is that right? -- 21 are focused on the hospital channel products, and leaving six to focus on the Pharma Med device channel. But, what we are seeing increasingly, David, is that when we meet with a device company and we're selling a little more across platform -- we demonstrated that recently, where some of our products from both channels are being sold or purchased into one of the channels. So we see cross-pollenization (ph) beginning to occur already in these product lines.

Okay. Then, I guess as a broader-based follow-up -- again, it's very encouraging to see you guys get to the black EBITDA numbers. However, to really drive value for the company and for investors, topline growth is critical. And, to that end, it would appear as though -- and has appeared for some time -- that you guys have a high value proposition set of products and services to sell to both the pharmaceutical and medical device communities, as well as the hospital communities. And, I guess I am curious to know your thoughts on why we have not seen more uptake by customers over the last few quarters. And, what you expect to catalyze that have uptake as we get into '04 and beyond to get topline growth a little bit more robust than we have seen historically.

Well, I guess I will try to characterize a few things. One, we are doing a better job of segmenting how we approach our hospital customers in the small, medium, and large customers. And, we are learning that the value propositions, obviously, for each of them are a little bit distinct. So the first answer is that we're learning to better address the needs of each of those three segments in the hospital market. And we are getting better at figuring out how to address them with the right price point and mix of products. That is relatively new for us to; it is not relatively new to business. It is just we are getting more sophisticated, finally, at assessing the price point sensitivity in small, medium, and large, and even IDMs and chains (ph) separate from that, that want higher service levels, higher account management levels -- that are willing to pay for the higher levels of service.

So, one of the things we are doing is -- we are introducing a new product -- we are calling Compliance Now -- which we intend to be kind of a market penetration product -- one that allows people low price points to enter, get on our platform -- because we are discovering that once on our platform, there are many, many opportunities to increase the value of that customer over time.

Instead of a homogenous one-learning-system-fits-all types of hospital customers, we're doing this market segmentation approach. We think by having an entry-level product that is priced some 30 -- maybe 30 to 40 percent below our competitors -- even the small low-cost competitors, that we can accelerate penetration into the market.

Another note is just the complementary nature of our products. Some of them are very new, like HospitalDirect. But, HospitalDirect, under this first contract, has been adopted -- turned on through all of our hospitals. But, through the specific targeted contract that we announced here in this quarter, we have turned an in-hospital network onto an out-of-hospital network. What this means is that HospitalDirect, as a product, is paid for by the device companies, and we can make it available for free to hospitals, whether they are on our learning platform or not. And, in fact, we are seeing that occur in this very first contract, where a hospital not on any of our current products, is being offered the HospitalDirect productline by the device company, which means we're -- populating more users into our system.

So, I think that the second part to my answer is that we will see cross-pollenization. As we get people in HospitalDirect, it makes them an easier candidate for our platform.

The third thing is that we want to do is intelligent investment in our sales force, both in training and resources, to equip them to compete. I would say we have done an okay job with that, but we plan to turn attention to it now, and equip them with better sales facts, better sales tools, better market intelligence to really make sure that they can get into these accounts. So I would say those three things are the things I expect to help accelerate growth.

These products, and the way they are designed, are complementary -- both technologically and from a customer utilization standpoint. And I expect that they will leverage one another, as we get one or the other into customers. For example, we can offer HospitalDirect in to all of our competitors' hospitals. They can begin using it. And then slowly, over time, begin to switch them to other -- our other products. So, we are excited about that cross-pollenization aspect of our business model. And, next year we will be about proving that.

Thank you.

Jim Stone (ph), Alexander Capital.

I wonder if you could give us the -- you usually give us the statistic of total course completions?

Yes, Jim, we can. It is 1.3 million. It is up from 1.2 million, I believe. We continue to see growth in just the core utilization systems. We have de-emphasized that metric a little bit, because it is not directly correlated to revenue. But, we do think -- and we think that our new renewal rates are probably a better financial indicator of our long-term success. But, we certainly talk about it internally, and we have banners up in our office that -- when we pass each million mark milestone -- which now, we are passing every -- roughly 8 to 9 weeks, we are passing another million courses (ph) through the system. And that continues to accelerate in base usage.

I believe, a few weeks ago, we passed the 7 million course certificate completion mark. And I think that is quite a testiment to the utilization of our system.

I wonder if you could share with us some coloring behind the number of net ads and subscribers. We had roughly 30,000 in this last quarter, and that is down from less-than-half a couple of quarters ago. I wonder if you could tell us -- give us some flavor of what is behind that.

Yes, we can, Jim. As we acknowledged in our written press release, the new account acquisition rate was less than expected. I think there is a little bit of increasing competition from lower-priced products. And, again, we have a plan to address that with a lower-priced platform. I think, in general, we just need to continue to turn our attention to that sales force and supporting them with the right intelligence about who is -- what the available targets are and when. So, I think this sales execution, overall, will be an increased focus.

You should note that our backlog -- while we did not implement quite as many this quarter -- our backlog did increase to 788,000. And, that is still a robust number. As you can see, that is over 50,000 that have not been implemented; they are already under contract. So, some of our wins came towards the end of the quarter, which meant that they went into the contract backlog instead of the implementation cycle.

In terms of getting new institutions, what are some of the reasons that folks are telling you that are not signing up?

Jim, this is Art Newman. There is probably a myriad of reasons. But, I think the top few are, principally, as Bobby mentioned, pricing. And, what we have done there is -- we are implementing, or rolling out, a competitive low-priced entry point product. We have also, this past quarter, did a promotion -- a selective promotion -- to entertain some people to sign up in the quarter. And that has been price, successfully, and we may elect to either continue that or modify that to some degree, going forward.

So I would say that probably the single largest driver is the entry point of getting a company to sign on for the contract. Once we get in, as Susan described to you in our renewal rates, it seems that they are sticking. And, as Bobby mentioned, some of the products that we are rolling out later on this year, in fact, have rolled out -- I believe will be even stickier points to it, and to those customers, because they add incremental value over and above the basic compliance type of products. (multiple speakers)

It would seem to me -- by only having five contracts not renewed, that we are -- have a very high acceptance rate once we are in.

That is right. Some of that is what you would refer to as switching costs, but I think -- we are looking at it as -- we are increasingly adding more than just the basic compliance of what those customers are using this system for. For example, Bobby mentioned the Pearson Prentice Hall -- we look at that as more-or-less like a cable adding a couple of programming channels that are of interest to our customers. And so, the compliance -- Competency Compass, the Pearson Prentice Hall content, the HospitalDirect -- these are all additional value adds that the customer will receive through the HealthStream offering. And, we think that is going to address the question David asked earlier in terms of where are we going to get our growth in this coming year?

In terms of these lower-price competition, is it truly lower-priced, or are you finding an awful lot of the folks that are giving it away for free?

It is a lower-priced product. I think we have shared with you in the past, they offer kind of an install-based product offering, which is not -- it's an ASP-like, but many of their accounts are installed products customers. So, there is a higher up-front costs to their license, because it is sold on a traditional software license methodology. And then a smaller tail on the (indiscernible).

Okay, so then main issue is showing our value versus there's and (indiscernible)?

That is right. I think, finally, our research and development is going to begin to outstrip the smaller competitors. And the larger competitors -- the (indiscernible), Digital (indiscernible), and Sabas of the world, have their own operational issues that to focus on some of the recent merger announcements -- picking which platform they will be selling to their customers. The larger companies have operational things they need to focus on, and the smaller companies, I think, we are finally now at the introduction of all these new products beginning to outstrip their research and development capacities.

Okay, but my main concern is the freebies, which can always cause problems. And now you're saying, no it is others and (indiscernible) So, we just have to prove our better value?

That is correct. I don't think that the freebies provide a sustainable value to the market. And we're getting more and more confident of the value propositions as we help these hospitals develop their workforce to our Competency Compass -- the lower risk on the utilization devices through HospitalDirect. We're getting more confident of our value propositions. So, we are excited about the coming year.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). Mr. Frist, I am showing no further questions in queue.

I want to thank everybody for their time this morning. We look forward to the next conference call.

Thank you ladies and gentlemen. If you wish to access the replay for this call, you may do so by dialing 1-800-428-6051 or 973-709 -2089, with an ID number of 310165.

This concludes our conference for today. Thank you all for participating, and have a nice day. All parties may now disconnect.