HealthStream Inc (HSTM) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the HealthStream second-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 with instructions following at that time. (Operator Instructions). As a reminder, this conference call is being recorded. Now I will turn the conference over to Mollie Condra, Associate Vice President of Investor Relations and Communications. Please begin.

Thank you and good morning. Thank you for joining us today to discuss our second-quarter 2012 results. Also in the room with me are Robert A. Frist, Jr., CEO and Chairman of HealthStream, and Gerry Hayden, Senior Vice President and CFO.

I would also like to remind you that this conference call may contain forward-looking statements regarding future events and the future performance of HealthStream that involve risks and uncertainties that could cause the actual results to differ materially from those projected in the forward-looking statements.

Information concerning these risks and other factors that could cause the results to differ materially from those forward-looking statements are contained in the Company's filings with the SEC, including forms 10-K and 10-Q. With that I will turn the call over to our CEO, Robert Frist.

Thank you, Mollie, good morning, welcome to our conference call. We will start by highlighting a few financials and then turn to operational performance and then turn to your questions shortly thereafter.

On a financial highlights standpoint consolidated revenues were up 23% to $25.8 million in the second quarter over the prior year same quarter while operating income was up a strong 30% to $4 million in the same time period. Net income was up 33% to $2.4 million in the second quarter over the prior year same quarter. And adjusted EBITDA was strong at about $5.9 million in the second quarter which is up 27% over the prior year same quarter. And Gerry Hayden, our CFO, will go into greater detail on financials after I do a bit of an operational performance overview.

The sales execution during the quarter was very strong, we added approximately 125,000 new subscribers that were contracted to use the Learning platform during the quarter. This performance exceeds the range of our long-standing and well stated quarterly goal of contracting 20,000 to 50,000 net new subscribers in a quarter.

So we congratulate the sales organization for bringing in a strong list of accounts including Parkland Health & Hospital System, which importantly also contracted for the HealthStream Competency Center; Sharp Healthcare, a large integrated delivery network based in San Diego California; Good Samaritan Hospital Medical Center, Evergreen Healthcare and the Ohio State Health Network were among many others during the quarter.

But clearly a strong operational performance from the sales organization this quarter. We look forward to celebrating with all of our employees as we cross over the 3 million contracted subscriber milestone in the future.

The good news also is that the sales execution was well supported by execution of our implementation teams. We implemented approximately 124,000 new subscribers that were added to the Learning platform during the second quarter. We now have 2.78 million healthcare subscribers implemented. That's an important milestone because we begin revenue recognition once contracted subscribers become implemented subscribers.

And if we get one gauge of satisfaction we see that our renewal rates for the second quarter were 108% based on FTEs and 102% based on contract value. In the trailing four quarter period ended June 30, 2012 customers representing 99% of subscribers that were up for renewal did indeed renew while a renewal rate based on contract value over that same four quarter period was 102%.

Turning our attention to revenues from our patient survey business, which is the recurring revenue survey product, revenues from that productline increased 7% over the prior quarter. Growth in the patient survey however was offset by a decline in what we call our point in time surveys, which include our physician, employee, community surveys which resulted in an overall research product group revenue decrease of 1% for the quarter, clearly not at expectations.

Our HCAHPS products however continue to show steady demand including sales of our new CG-CAHPS survey which yielded 17 new contracts for the quarter. So we see steady demand for the HCAHPS patient survey work of our research product lines.

Our talent management strategy was bolstered with the acquisition of Decision Critical, which was completed on June 29. That's in Austin, Texas based company that specializes in learning and competency management products for hospitals. We welcome the employees of Decision Critical on board and feel they have much to add to our direction as a talent management company and as the strategy continues to evolve.

Through the acquisition we added to our talent management product suite with the addition of Critical Portfolio, that is a patented electronic portfolio. The portfolio is used to store and view the qualifications and competencies of the hospital workforce. And this is important for hospitals, for example, that have participated in various quality programs, particularly those embarking on the Magnet journey, a designation they can achieve for the quality of their workforce.

The Critical Portfolio documents and reports on key personnel information that is required in the application process of these important designation type recognitions like the Magnet process. We plan to begin selling the Critical Portfolio this quarter as a standalone product and you will see increased investment looking to re-launch it as a fully integrated product with our platform early next year.

So we are excited to grab onto this new patented technology and support the efforts of the very creative team in Austin Texas to build it into our core architecture. It is a stand-alone product as it stands and is effective in that manner, but it will be even more powerful as an integrated product early next year.

Adoption utilization of our talent management product suite continues to get momentum, of course based on our Learning platform but expanding into our competency and performance center products, which help with the performance review and competency assessments of staff.

We contracted 15 healthcare organizations during the second quarter, welcoming new customers like Hutchinson Regional Medical Center, Jamestown Hospital, Jordan Hospital -- all of these and many others are coming on board to round out their approach to talent management, automating and eliminating the paper from their annual review process and improving the methods they use to assess the staff competence, particularly of the clinical staff.

So we welcome the 15 new healthcare organizations during the second quarter. Again, we see we are gaining momentum with this add-on product set as it ties directly to and fully leverages and integrates with our core platform, the Learning technology, that is present in over half of US hospitals.

The content partner network continues to grow. As distribution grows our ability to add exciting new content offered to all of our customers grows and in fact we are seeing strong momentum in content uptake during the quarter.

One of our leading content products, the HeartCode courseware from American Heart Association and Laerdal Medical, continues to be in demand in 2012. Revenues from HeartCode products for the first half of 2012 have grown 60% over the first half of last year. So you can see continued demand of this HeartCode product suite which assists, improves and lowers the cost of resuscitation training in hospitals.

HealthStream also added an updated online version of the American Heart Association's HeartCode product for pediatrics at known as the Pediatric Advanced Life Support course, or PALS we call it, P-A-L-S. At mid-year we have a total of 128 content partners, that is an improvement in all three of the categories we track.

We've added new partners in each of the three areas. The first -- we now have 57 partners and we call our traditional content owner partners; these can be publishers and associations. We're up to 33 of what we call industry content partners, these are like GE, Baxter and Alaris that do industry product support through our productline called Hospital Direct.

And then our SimStore we will touch in a minute, but we added additional partners to our simulation network in SimStore as well. For example, we recently signed altar's medical altar's medical Altus Medical for their MRI safety courses, the Association of Women's Health Obstetric and Neonatal Nurses known as AWHONN for their industry-standard perinatal orientation and education program. So we are excited to add those two exemplary types of new content partners for us.

We expanded the offerings from additional content partners like the American Association of Critical Care Nurses and the Association of Perioperative Registered Nurses both added content to their offerings that already existed.

Quickly I'll provide an update on SimVentures. SimVentures is our collaborative arrangement with Laerdal Medical where we derive a 50% interest in the profits of the product portfolio of the venture, which today includes four core applications. SimVentures continues to grow, is delivering its fifth consecutive quarter of increases in revenue.

HealthStream's revenue allocation was $392,000 in the second quarter, up from the prior quarter and, again, five sequential quarters of improved revenue out of SimVentures. Importantly, the venture and all the investments we are making in it remain EBITDA positive and therefore a financial contributor to our growth and progress.

And I'm very excited about that because we still view SimVentures as a product set of the future, one that is growing and with the amount of R&D going into it we're excited to see that it's EBITDA positive. And we expect continued financial progress for SimVentures in the second half of the year. I'd like to turn it over to Gerry for a more detailed look at the financials and then we will head to questions. Go ahead, Gerry.

Thank you, Bobby, and good morning, everyone. I'll make a few brief remarks about the quarter and then save time for questions at the end. First, we believe that our results reflect favorably on both our financial progress and investments in key parts of our business. The Learning segment posted strong revenue growth this quarter at 34% and Bobby's remarks provided a solid context for how and why we have achieved those results.

The only thing I would add to it his remarks on subscriber counts, renewal rates and sales force performance is that this expansion is entirely core growth.

Over the past several quarterly calls we've mentioned investments in our business in key areas such as sales and marketing. If you look at sales and marketing for the first six months of 2012, that line item was 20.6% of revenues versus 19.9% in the same period last year. Our revenue growth and expanded subscriber base are solid quantitative evidence as to the returns on those investments.

However, it's also important to demonstrate the focus of these initiatives and one place to look is G&A expenses. This expense category continues to leverage against revenue growth while we invest in our sales force. G&A expenses were 12.2% of revenues for the first half of 2012 versus 13.2% of revenues for the first six months of 2011. This improvement in the G&A ratio is even more pronounced when we account for deal expenses such as due diligence, legal and banking, which we would not incur if we were running strictly our core business.

In the first half of 2012 we carried $200,000 of these type of expenses. If you add those expenses back to G&A, the first six months of 2012 would have been 11.8% of revenues, or a decrease of 1.5 percentage points versus 2011.

The balance sheet remains strong and our cash position at approximately $92 million affords us the capital we need to execute our business plans. We continue to evaluate a wide range of acquisition development opportunities that we feel are both additive and complementary to our existing business.

Finally, you've seen that our guidance remains largely consistent with the estimates from the end of the first quarter and expect to grow revenues between 22% and 25%. You will also notice that the revenue growth rate has changed slightly, the lower end has moved from 21% to 22% that we announced at the end of the first quarter while remaining at 25% at the top end.

We are reiterating our operating income guidance to a range between 20% and 26% growth over 2011. We believe this guidance range recognizes both our overall revenue growth prospects as well as our efforts to make (inaudible) investments in our key initiatives. Our income tax rate and (inaudible) estimates remain the same as the first quarter as well. Thank you for your time. I will turn it back to Bobby.

Thanks, Gerry. As we enter the second half of the year we have plans for continued investment in the products launched in the first half of the year, which includes our SimVentures product, SimManager and SimView, continued investment in the HealthStream Performance Center, along with the products gained from the acquisition of Decision Critical as we work to integrate them into our platform and re-launch them.

We are hopeful to -- and begin to see that we are catching up in some of our hiring plans, but we continue with our plans to add staff in necessary areas of the business and so we have an important theme here in the second half of continuing to invest in growth as we move forward. At this time I would like to turn it over for questions to the operator. Thank you.

(Operator Instructions). Richard Close, Avondale Partners.

Congratulations on a strong first half of the year. One question I did want to hit upon was sales and marketing expenses as a percentage of revenue came in pretty significantly below what we had factored in. And I just was curious if you had any commentary or any clarity with respect to that line item in the second quarter. Was there some timing issues with either hiring or accruing for commissions or anything one time that you can call out on that?

Probably the biggest one-time variance would be just making sure you got the Summit allocation right in the model. Of course that was in a different period this year than in the prior year. In both absolute dollars and as a percent of revenues our investment in sales and marketing is higher in the second half -- in the first half of this year than in the first half of last year.

So I think it might be some timing issues around -- potentially around the Summit, which I believe kind of came close to splitting the line between Q1 and Q2. So you might take a look at that in your model and make sure you got the timing right on that (multiple speakers).

And just looking at it, if you adjust last year's number for taking the Summit out I think it was $270,000 that takes it down to about -- last year 19.4% of revenue and this year you are coming in I guess at 18.1%. It just -- it seems like a pretty big delta, which is great if you are receiving leverage on that. I just didn't know if there was other than the Summit anything on a timing basis?

No, that's not what our numbers show. So we will have to -- let us look back and see what you are putting into those categories and we will try to get more clarity either by the end of the call or afterwards with your question.

Okay. And then just real quick, it sounds like good traction on the talent management products. Can you walk us through the revenue model on the talent management and what the average -- or what a typical sale is in that area of performance management/talent management area?

Well, of course the learning system is the core of talent management and it is a subscription three-year product, as you know. And the price ranges for that vary between $10 and $20 per person per year on a contracted basis.

The additional product suites that we are building out, which will now include things like the Critical Portfolio, the Competency Center and the performance center are also from a modeling standpoint are subscription-based products and therefore they are on a subscriber basis, they add dollars per subscriber per year in the same manner. So they are not licensed products, they are subscription SaaS-based products.

And so similarly when we add hospitals to that platform, if a hospital has (inaudible) subscribers we add a per person, per product fee to their overall contract for the core platform. We have not commented on the size of those fees we have mentioned in the past that performance and Competency Center as kind of a retail price level. We try to get about as much as we get for the core Learning platform in addition to the Learning platform.

Now there's obviously a bundling effect that could lower the price. And also I should note that the $10 to $20 price on the Learning platform includes a subscription to a small content library, so you can't purely see the platform revenues out of that initial subscription.

So with those caveats I think you can see that all of those products I mentioned are subscription base recurring revenue on multiyear contracts, they all add dollars per subscriber in an incremental fashion, but occasionally there are bundling pricing discounts. And it is not always purely additive to the base subscription because there are some content -- a small content bundle in the base of products. So I hope that helps although I know you probably just wanted the price point, which we are not going to give today.

Oh, that's okay. And then final question would be on the patient survey business and the opportunity there. You did talk a little bit about the trends. And I guess 13% growth on patient insights in the first quarter, that ratcheted down to 7%. How should we think about the patient survey business as we progress through the second half of this year?

Well, we clearly can do better here, we wish the results were stronger, we are taking actions to make the results stronger. If you look at the first half also and you remember back to our conference call in I believe it was February, the first one of the year, we had mentioned that one of our very largest customers pulled back their research services in the patient business by about $1 million.

And although that account both grew in overall size and added other products to the mix, that specific product line was driven down by almost $1 million. I think we had expected to backfill that loss faster than we did and so in that way we wish we had performed better. But we have overcome the loss of that $1 million and still shown a 7% growth.

And so we still have reason for continued optimism on these HCAHPS product lines because they continue to grow even offsetting that drawdown of that one product line. Remembering of course that that large account both grew in size and product mix for us overall. However, on that specific product line it did come down by a straight $1 million, which at this scale we are proud we've overcome that growth rate.

We obviously had expected to grow even a little faster than the 7%, but it still is a net positive gain and we feel strong that the CG-CAHPS product line is beginning to take hold, you see it mentioned in our earnings release about adding new customers to that product line as well. So we remain at -- that product line can continue to show growth through new customer additions.

Okay, great. Thank you very much. Congratulations.

Nick Halen, Sidoti & Company.

So the first question I had was just in terms of the SimVentures. Obviously doing a great job of growing that business sequentially for the past five quarters I believe you said. I was just kind of wondering how we should approach that -- approach modeling that going forward. And I guess when do you guys expect, in terms of a time line, that you think that could become a more significant source of revenue for you guys?

Well, right now it feels like an early adopter phase for many of these products and we are glad to see breakthroughs in revenues and mixtures of solid contracts and pilots. And so right now I view this as a three-year -- kind of a three-year investment, one that we started making about 18 months ago. And so it is good to see -- and some of the products, remember, were just launched in the first quarter of this year.

So overall we are pleased with its progress and you can see from the current trajectory that it is mapping more linearly right now, which is more consistent with our thinking through year end for that product set. But still great promise in it and we like to share with the market our excitement around the longer run opportunity of these products. But through the end of this year we are looking at more the steady progress that we've seen like in the past five quarters.

Okay, and now I was just wondering if you had any updates on some of the mobile strategies you guys mentioned in the past, I guess the HCAHPS monitor app and HealthStream tests and things like that.

Right, so the HCAHPS monitoring app is a free app, so it's not a revenue generating app, it is used for marketing and relationship building. And so we remain excited about having that in the market as a marketing tool. The [TAS] app still remains unlaunched and we are working still -- we still haven't decided on our mobile rollout strategy.

We haven't seen an overwhelming demand for it, although an interest in it at certain large enterprises, but not an outright demand across our broader base yet. Maybe the full nursing cores haven't gone fully mobile yet for some of those apps. So I would say that that component of our strategy is in rapid development, but economically we just haven't declared its direction yet.

Okay. And then just lastly -- I'm sorry, go ahead.

We think that that the Company's growth trajectory in the next 18 months is better informed by looking at the platform adoptions in the Competency Center, the Performance Center, growth in the consumption per person and subscriber revenue for content which you can see really driving our growth.

So when I think of short-, medium- and long-term drivers, if you take things like content and platform extensions first and things like SimVentures and mobile strategies and push them out 24 months or so I think that is probably a better way to think about how we are layering in the elements of growth for our business.

Okay, great. And then just lastly I guess where do we stand now with the different sources of revenue? I was kind of wondering I guess maybe this is more so for Gerry, what percent of your total revenues currently are recurring?

It would be upwards of 75% to 85% because almost all of Learning is recurring and in Research, the patient category, which is about two-thirds is also recurring.

Okay. Great, thanks, guys.

Ryan Daniels, William Blair.

A quick one to start on the HPC and [HTC], it sounds like a nice quarter with 15 new clients. And I'm curious, if those are all cross-selling into the existing base or if you actually have the sales force kind of leading with that and getting a net new client that isn't on learning, but signing up for HPC or HTC?

Ryan, I should know that answer but I don't. I know that the majority of them minimally are existing customers. But we do have a dedicated going out to find new accounts. They are focused on, as you can imagine, we have a lot of accounts already, but over half of the country. And so the best opportunity -- and many of those are the larger health systems.

So our best opportunity is to get pilots and sales going in that base. However, to your point, we do have a dedicated team that is calling on new accounts, but I just don't have the mix for you right now of those 15 new accounts. My bet is that over 85% of them are existing accounts.

Okay, that is helpful caller. And then just to be sure I am clear, when you talk about the new subscriber adds you are not including any of those 15 accounts in that subscriber number, that is just for Learning, right?

That is correct. And given that most if not all of them are existing accounts, we don't add to the subscriber count when we add, that would just add to the revenue per subscriber when they bring on those -- the new subscription to new products but don't add new subscribers.

Okay, perfect. And then a couple more perhaps quicker one. If we look at the Decision Critical acquisition it sounds like today you are going to be selling that as a stand-alone product, but you are going to fully integrate it next year as part of the platform.

I am curious how the revenue model will morph? Meaning will you, once you integrate that, charge a higher fee for the platform to offset the revenue or it will be a separate add-on to the platform or just an added value to continue to drive sales and strong retention there?

Yes, great. So we believe it is -- as a stand-alone value proposition it will be sold as what we call Platform Extension, so it can be bought either separate, meaning it can be bought individually or in a suite. And we believe it adds value and will maintain value as a separate component. So we will charge for it both separately and put value on it and it is in a suite purchase.

And it is sold on a SaaS model already. Even as a stand-alone product it is a subscription-based Web delivered application, so that is good news. When we talk about integrating we mean things like seamless log-on, authentication of users across our network so that it is easier to turn on and activate for new customers that are already on the platform. And that will require, of course, investment and re-engineering a bit.

But we were pleased to see that the core technology that that application was built in were very consistent with our development both approach methodology and technologies, meaning it's a dot.net SQL back end and front end and they use a developmental approach that we used as well. So we are very excited and optimistic that we will be able to get it even more leverageable on the core platform.

Okay, perfect. Two more quick ones and I will hop off. Just maybe very broadly you are approaching about half the US hospital market if we think it is total employed in the hospital space. And I am curious as you look forward, do think your growth opportunities are actually accelerating even more?

I guess on one side you could say you're already half penetrated; on the other side that penetration gives you such a distribution channel you are probably attracting a little more content, as you said earlier, and that makes you a more valuable partner. So I am curious if you think as you look forward over the next few years that the growth can maintain at this pace or any views you have there?

Fair enough. As you know, Ryan, we only guide one year out. We're really excited to see demand for new products that we think present effectively brand-new opportunities for the Company. So if you think of the performance and Competency Center, for example, we believe that the vast majority of US hospitals are still pen and paper in their performance reviews and their competency modeling for their workforce. so using checklists and other technologies that are very simplified and paper-based.

And so our view is that having an existing relationship on our core platform, Learning, will help us penetrate new market opportunities that are essentially a refresh of our market opportunity to performance and Competency Center.

And so we feel that there is plenty of room to run on areas like eliminating the paper out of the process of doing the annual performance review and better automating the competency assessment process that is required of all of the clinical staff and hospitals through the Performance Center and the Competency Center. We feel those are just kind of greenfield opportunities essentially.

Okay, perfect. Then last one up maybe for Gerry, just to go back to the first question from Richard on the marketing spend. Am I correct in that when you say the Summit pressured operating income by $270,000, that is actually net after the revenue, so the actual cost of the Summit were higher than that, right?

That is correct.

(multiple speakers) the deviation?

That is the net expense impact, you are correct.

Okay. Okay, thanks a lot, guys. Great quarter.

Matt Hewitt, Craig-Hallum.

Good morning and I will reiterate what others have said, congratulations on the good quarter. One of the areas that you showed particular strength was in the fully implemented and contracted. Last quarter I think there was some questions about the contracted number falling within your aspirational goal of 20 to 50. There was a significant jump here in the second quarter. Do you think that was related to the timing of the Summit or were there other factors that caused that big jump from Q1 to Q2?

It's always a complicated thing to try to tease out exactly why when you either over perform or underperform. Clearly this is an over performing quarter to our goal and range and the way we plan and think about our business. So we are very excited about that. There's a nice convergence of a few competitive takeaways that we have been working on for over a year and I listed a few of those earlier. And brand-new wins that are entirely new customers to the fold.

I think Summit is always a nice catalyst for customers that are considering joining the HealthStream ecosystem and becoming a partner on our platform. So that is certainly maybe potentially one component, but really it is just a convergence of a lot of long laid efforts with key accounts.

And like I said, occasionally when you win a couple of big ones it moves us up out of the range. And then when you have a quarter when you don't win a big one it goes back into the range or below the range. And so it is just a really nice convergence of a lot of steady efforts by our sales team I would say over the last 24 months, not anything in the last 90 days that we did special.

Okay. The hiring progress, it sounds like you made some in Q2. Did you still have contract employees during the second quarter or was that just in the first quarter?

We do use contract labor to keep everything moving forward, assist in every area that is growing and, as you can tell, each -- almost every area of the Company is growing. So we use contract labor as a bridge to full-time hiring and to manage specific project initiatives and turn it like improving efficiency of our internal systems.

And so contract labor is kind of a permanent part of our overall landscape, but it comes and goes based on our efficacy in hiring full-time employees often. And so here we see a bit of a catch up in our full-time employees, so some of the contract labor expenses can come down a bit, but full-time run rate costs and full-time employees will go up as we have in the second half of the year.

And I think it's important for everyone to focus on our need to invest in this growing business and not get too over excited about over leveraging the business. We need to make investments in our acquisition, Decision Critical, you can tell from this call we are investing in our M&A pipeline development. So you might make sure that you model those things as ongoing processes.

When you have new products like competency Performance Center with 15 new accounts you have to invest in implementation support to make sure they go well. So I really want to provide strong guidance that we're excited to reiterate all of our guidance, but we still remain confident and those guidance points are our best estimates of our performance as we go forward on a full-year blended basis.

Okay. You just mentioned Decision Critical, can you help us understand a little bit what that will contribute in the second half of the year from a revenue standpoint?

It's a very small acquisition, we don't plan on disclosing the revenues. It was more of a technology acquisition and so it is a very small component of revenue overall. But very exciting patented technologies. And a very, very small customer base which gives us an opportunity to cross sell into as well a small but mighty customer base and a small but mighty product with a great future. So really it is not a material contributor to revenues in the second half, but we are excited about what we can do with the products.

Okay. Maybe one more for me, then I will jump back in the queue. HeartCode, a very strong first half for you. I'm wondering, what is the penetration of the Learning Center customer base for that product.

That is a great question. I don't have that answer at my fingertips here. But it would be a good one for either our next conference call or let me see if I can get my hands on that. But it's a strong mix there. We have, like with each of our sales teams, they can target both new accounts and existing accounts. So we tend to bring both on for the HeartCode products.

And HeartCode products tend to be a great lead in to ultimately winning our platform into the business as well because their platform components are integrated with the HeartCode products and an increasing fashion as well. The answer is I don't have the exact split, but it does come from both sources; it's not just sold to existing customers, we have a dedicated team focused on new account acquisition as well for that product set.

Okay. Thanks, I will jump back in the queue.

Vincent Colicchio, Noble Financial.

Just a couple questions for me. Given the more uncertainty in the economy have you seen any effects, any signs of sales cycles changing in any areas of your business or any changes in pricing that were a surprise as well?

Vince, let's see, in most all our products we try to position as having a strong return on investment to help fulfill or mandate our requirement. And those mandates and requirements have not gone away even with the challenges in the economy.

We have seen some financial pressures across our broader network in hospitals and general cost management, cost containment which we think as long as you are selling on an ROI basis both hypothetical and real, meaning calculated and proposed savings we see continued demand for our products. And so you can sell from our renewal dollar value that prices tend to be holding up fairly well on renewals, so most indications are things are holding up pretty well right now.

And then on the Learning -- on the Learning platform side, are you starting to see traction with non-hospital type facilities?

I guess I do want to come back, Vince, as I thought through on that first question. The elective surveys for research clearly are underperforming expectations and maybe that has something to do with the macro conditions although I can't pinpoint to that. So I would come back and comment that we have continued to have challenges now for two quarters with the more elective components of our research products. And clearly that's dragging down the overall performance of the research product group.

So I would comment on that and without commenting that's a macro condition thing, it has been persistent now for two quarters and we are going to do what we can to improve that outcome and go forward.

On selling into new verticals, we continue to land a mixture of accounts and we still haven't broken out yet of our nearly 2.9 million contracted subscribers the mix. The vast majority of those are in acute care facilities, but we have been winning business in secondary but highly related markets like long-term care, behavioral health, home health. And so there is a certain mixture within the new account acquisitions that comes from those segments.

Again we have not declared any of those segments, meaning yet higher dedicated sales organizations and marketing organizations to launch app those verticals. But their continued affiliation with hospitals and just the general reach of our brand we are beginning to bring more in in those additional verticals.

One opportunity for growth as we think about investments into the next year and as you think about modeling next year would be to start to think about -- again we haven't declared this but maybe in our next conference call we'll give more insight -- a renewed focus and maybe a financial investment focus in areas of launching new markets which obviously those investments would precede earning growth if we were to do those.

And we are in our strategic planning process for the next four months and out of that may come new initiatives for next year, early next year. So I wanted to set the stage with that discussion because it was a great question, Vince. We continue to win small parts of business in those areas and are considering a real investment in the growth of those areas maybe as early as next year.

Nice job, Bobby, that's all I have. Thanks.

Andrew Albert, Invicta.

Thanks for taking my call. I'm in little bit new to the story here and I see that there is some great growth coming out of the third-party content. I have a little insight into that. I was wondering if you can sort of talk about the range of gross margins across those products as it seems to vary widely. Any insight into how to think about that business going forward from a gross profit perspective would be helpful. Thanks.

It depends on the mix and the brand, we add partners and each partner they have their relative strengths both in assisting in the sales and marketing, the power and presence of their brand and when we think about how we share the sales that we put our nearly 65 or 66 person quota carrying sales force behind their brands and products and contract them into the market, we are clearly adding value to their distribution.

And it is constantly a debate a little bit like a distributor and a content owner -- a cable company and a content owner, there's a continuous debate about the value of each party to the transaction.

We have disclosed a very wide range of royalties paid back to content owners that range anywhere from 10% to 60%. And obviously in the process of determining that we try to determine the value that each party brings to the sales and distribution. We have particular strength in gaining enterprise-level contracts with big health systems, which many -- that is a well developed channel for us and we have established selling processes. And so we believe we bring a lot of value to that proposition.

But I know 10% to 60% is a wide range. Obviously the more that the content partner brings to the table in bearing the cost of both content production but also the sales and marketing effort, the power of their brand all influences where we come out in that negotiation.

And so I know that may seem too broad and too vague, but hopefully it helps everyone understand, it's just a content negotiation and each party brings value to the ultimate win. And regardless of the royalty we pay. each new content sale has a nice flow to the bottom line because the incremental cost of delivery once the sale is achieved is fairly low.

If you could also expand a little bit on how often the contract or the royalty rates come up for renewal, is that an ongoing fluid basis? Are there kickers in there where if you hit 3 million subs that obviously your distribution is bigger that that changes the pricing? Any more info would be great.

Sure. The content contracts are usually multi-year agreements and occasionally they will have things like targets where royalty changes will have slight adjustments based on achieving certain outcomes. More often than not they don't. So generally I would say they are multi-year agreements.

So now with -- you can see 128 total content partners, we are in a constant process of renewing. The nice thing about it is our distribution has continues to grow. And even in this last quarter effectively the near record pace was another 24,000 more people to sell to. And so, we -- generally that helps our discussion when the audience for the content continues to grow.

Okay. And then just as I think about modeling going forward since the range is kind of 10% to 60%, which is below the Company's gross margin and you have talked about the long-term consistency of being between 60% to 65%, do you think that the third-party content growth is going to take the Company to below the 60% gross margin range? Obviously it is going to have the positive bottom-line benefit, but I am just trying to think about how I model out the Company going forward.

Yes, I think that is a fair -- no, clearly content has lower royalties and is growing at a very good rate. I mean both are growing at a solid rate, content lately has been growing at a faster rate and has a lower overall margin. I think you pointed out an important piece that we like it when every piece of content sells because it does add to our overall financial health.

But at the gross margin level, which we tend to focus less on because what we are looking at is operating income as a key metric for us. But the gross margins, obviously the more we sell content the more gross margins would be pressured.

And so it is interesting to see like this last quarter 15 new accounts on higher gross margin competency and Performance Center products, it's kind of a relative rate of uptake that determines what happens with gross margins, which is why I've always been impressed that the margins have remained as tight as they have because in any given mix period, depending on the last few quarters performance, it could change the mix.

But again, it has been fairly consistent in that 60% to 64% for some time and so that is about all the color I can provide. I hope that helps you. But clearly 60% growth in our HeartCode products is something to be cognizant of. We work with American Heart, a strong brand, and Laerdal Corporation, also a worldwide presence, and HealthStream is a three-way partnership and that product is growing very rapidly, so something to think about in your modeling.

Okay, great. Thank you.

Matt Hewitt, Craig-Hallum.

Just a couple follow-ups. First, what was the NRP contribution in the quarter? I know historically those tests are traditionally taken once nurses finish their schooling and then they come back every couple years to take it around that same time. Was there a big bolus of that business in Q2?

And there were -- there was a great surge of what I will call orders and then effectively we -- the revenue is smoothed over the consumption periods. And based I would say that product is meeting expectations, we had disclosed maybe slightly exceeding some of our model expectations just slightly.

For example, I think in our road shows recently we talked about up to $200,000 year demand at about $15 per person. We are selling at a slightly higher price point than that because there is a retail channel for the content as well as the business to business channel. And we are seeing a slightly better contracted rate for bringing new subscribers onto that product than the original 200,000 that we had mentioned.

And so I would say that product is slightly exceeding its initial goals. Although it is also challenging our transaction processing. We have never had so much content, so many contracts of such small size and such volume so we are working hard to figure out how to get good systems to support this new kind of consumption-based $15 per complete type of content.

We are very excited about that as a model, but also it is just a new level of kind of contracting that we are doing that is challenging I'm sure our back-office accounting operations and we need to do more to smooth that process. But overall very pleased with the product, we believe it is exceeding what we consider the only guidance we provide on it which was effectively that it would be about $200,000 a year at $15 a person. So we think we are going to be slightly ahead of that target.

Well, that's good news. I guess lastly for me, and I don't want to focus on it too much, but the survey business was weaker, but I'm curious. There were some pretty big storms on the East Coast in the quarter and I know historically you have worked with your customers that have been impacted by storms, working whether it's helping get easements on the HCAHPS or pushing out survey business. I am curious if there was any of that in the second quarter?

Well, thanks for that lead-in, I'd love to blame the weather but we just can't. I think the point in time surveys were disappointing for the last two quarters and we've got some work to do there to get that back on trajectory. I think we can do it and we will continue to do it, but you can see we have really tamped down our own expectations.

It's going to take a little more work than maybe we had hoped when we entered the year and we've got it at 1% to 3% growing on a blended basis. The HCAHPS scores -- the HCAHPS content continues to perform well with competitive wins again growing 7% even in spite of what we talked about the drawback from one customer early in the year. So overall we are going to -- it's going to be a grower and a contributor, but certainly not meeting expectations at 1% to 3% as a blended set of products.

All right, I guess last question for me. ICD-10, I'm just curious, I believe it was pushed out a year, but what kind of adoption are you seeing or is it still really early?

Well, we are seeing with the continued push of the deadlines and now we think we have a date, but there is still some discussion that it could get pushed or just lack of clarity is still hanging out there a bit. We are seeing good contracts come in, but they might be deferred implementations.

So the signatures are coming in, in some cases strong and big health systems, but the execution they are going to probably in some cases delay implementation over a period of maybe a year instead of all surging in the next quarter or two.

So I would expect revenue recognition to get smoothed out over a two-year or three-year period for ICD-10, which I believe overall is healthy. And the good news is the orders are still coming in even with some of the uncertainty around the ICD-10, the actual final conclusions that will be made, there is still some uncertainty around those decisions.

Okay, well congratulations on a good quarter again.

(Operator Instructions). Richard Close, Avondale Partners.

Just really quick, with respect to the secondary markets I am curious in terms of you seeing some interest levels there in signing some new contracts. Is that mainly coming through your existing hospital relationships that maybe is doing stuff in behavioral health or surgery centers, home health, et cetera? Or is that standalone home health companies, behavioral health companies?

What's interesting as we explore these new markets I personally have done some I guess you would call it cold calling or visits to some of the accounts, the larger accounts in those spaces. So we are beginning to learn more about that market.

I have made some trips myself to visit with large providers in those areas and occasionally responding to an RFP to let them know we are serious -- seriously interested, and we think we have good technologies for them.

In addition, our hospitals when they acquire everything from physician practices to affiliate with home health facilities we are seeing a little more of that. So our existing sales team is finding themselves in a few more of those deals than they target.

And so I would say it is a mixture of both exploratory business development, which I am actively involved in personally, and sales team just getting more exposure and overall more exposure to the brand and the provider side of healthcare. So I don't mean to be vague, it really is coming from two or three places, we are picking up a few wins here and there.

Okay, great. Thank you.

And related to that though is just -- a little bit thinking about next year. And again, we don't provide guidance on next year until February until we finish our budget and strategic planning process. But there is a difference between exploring those markets and investing in them. And we are making some investments of time like mine and others to explore. But one thought is when we -- when and if we declare a vertical like that we would need to hire dedicated teams of people to those verticals.

And so you can be thinking about that as you think about next year again as we think about how to define our approach to those market segments. We are very pleased to see the wins coming in and the interest, however it's a good early part of our planning process.

Andrew Albert, Invicta.

You may have mentioned this, so I apologize. But the project-based revenue that increased by about $700,000 over the prior year, I think about $250,000 of that came from increased SimVentures. Can you help me understand what else was in the increase and what exactly goes into that bucket?

Let's take a quick look at that. Hang on a sec, because I'm not sure it came from SimVentures. Hold on one second. Okay so we have just done a quick scan of the SimVentures piece. We don't believe that any of the revenue in that category you mentioned is from SimVentures. SimVentures had its own line item called out the $392,000 in revenue. That is wholly separate from the growth in project-based revenue.

The project-based revenue comes from some occasional developmental work we do for customers, particularly in this case development of courseware. We have a long-standing skill at helping partners, both hospitals and publishers, get their content ready for selling and we project manage to completion some creations of large content libraries.

So in this case both pro-services like implementations that grow because when we win big accounts they sometimes have the pro-services fees. But in this case the 696 is -- there is a large attribution there to what I will call develop -- one time project-based developmental work, typically building content libraries for people that then occasionally end up distributing them or selling them through HealthStream.

And (multiple speakers) is that with a few concentrated customers that increase or is that broad-based across many customers?

That is probably largely concentrated in just a couple of customers.

Okay. And given the -- I was going to say given the economic sensitivity you would think your experience in the research business, that seems to be counter -- acting counter to any economic sensitivity. Any insight you can give us as to why hospitals are undertaking this now?

Some of these are large partners, like we have a large industry partners that I mentioned that are content owners for example by name, GE, Alaris, [NeonCode], McKesson are all what we call industry partners. And industry partners use us to distribute products training through our network.

And so, when they need to build a library of training material for their products they will seek to find someone to build that for them. Occasionally we contract to build that content which then in turn they distribute to our network to our hospitals.

But so, I would say this is more of industry partners that are investing in creating training content for their product sets, which then of course in turn they deliver through our network. And so that is different from our hospital customers building content for their own consumption, just to try to clarify that further.

Okay, got you. All right, thank you.

Thank you. I am showing no further questions at this time. I would like to turn it over to Mr. Frist for any closing remarks.

Thank you all for participating in this call. As you can see, our continued focus on growth through acquisition, continued focus on investment in growth areas, a bit of discussion of future market direction for the Company. We are glad you were able to join this call. I look forward to celebrating with our employees crossing the $3 million mark in the coming year and thank you for your participation, we look forward to the next earnings call.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.