HealthStream Inc (HSTM) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the HealthStream, Inc.'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. It is now my pleasure to turn the floor over to Mollie Condra, Associate Vice President, Investor Relations and Communications. Please go ahead.

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. Frist, Jr., CEO and Chairman of HealthStream, and Gerry Hayden, Senior Vice President and CFO.

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

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

Thank you, Mollie. Good morning, everyone; welcome to our third-quarter earnings conference call. We've 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 and operating income was up 39% to $3.7 million in the third quarter compared to third quarter of 2011.

We also delivered well on the bottom-line with net income up 10% to $2 million in the third quarter compared to the same period in the prior year and adjusted EBITDA was strong at a 30% increase to $5.7 million in the third quarter, that is up about 30% over the prior year same quarter.

And 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 under new contracts during the period. And 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 in the way we target and 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 targeted 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 work force. And we are beginning to see pickup in a few other areas of non-hospital as well as hospital affiliated 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 trajectory that should be during the fourth quarter -- it 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 of that backlog as we can during the fourth quarter. And that is exciting because of course when we implement out of the contracted backlog we begin revenue recognition.

And 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 team. So I am proud of what they are doing to bring all these new customers onboard onto our broader talent management platform.

The renewal rate in the third quarter remained 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 of renewal, the trailing four quarter period. And so, for this trailing four quarter period in September 30, 2012 customers representing 101% of subscribers that were up for renewal did in fact renew 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 of 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. 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. Just the payment effects associated with a value-based purchasing program began on October 1 of this year, so just earlier this month.

And that means there's going to be even more and more attention paid to the scores and the metrics of these patient surveys as we enter into next year now that reimbursements and reimbursement premiums are tied to these value-based purchasing scores, of which the patient satisfaction measurement constitutes 30% of the -- essentially the index that is used to determine those reimbursements.

We are seeing new drivers for growth and I'll 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 hospitals seek to remain compliant with the demand of all these regulations. And in the third quarter we saw a significant pickup in sales of the CG-CAHPS survey, that is the Clinicians and Groups Consumer Assessment of Healthcare Providers survey, it is called the CG-CAHPS survey.

And with the increasing number of newly formed patient centered medical homes the need for measuring patient experiences of the care received in the physician and clinical offices is growing. And the National Committee for Quality Assurance requires the measurement of patient experiences and one of its six standards for being recognized as a patient centered medical home.

So there are new underlying drivers for the adoption of the CG-CAHPS survey and we see a strong uptake in the CG Clinicians and 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 this time last quarter. And some of our new CG-CAHPS sales in the third quarter included multi-facility healthcare organizations from all areas of the country including Northwestern, Western and Midwestern 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 an area of the ICD-10 coding and we get lots of questions about our progress and the market demand for ICD-10 coding. So I'm pleased to report just in the last six weeks we are seeing a meaningful improvement in demand for ICD-10 training products.

We think that is largely tied to the fact that CMS announced and clarified a new deadline for the required transition to the ICD-10 standards; it is set for October of 2014. And although that is one year later than originally set, we think having what appears to be now a firm goalpost out in front of us is driving now increased adoption and closed sales on our ICD-10 curriculum.

We also believe we have great -- a great partner to pursue this opportunity and an organization -- Precyse, just a great company with outstanding content. And one of the dimensions we are excited about with our partnership with Precyse is the fact that their content is designed to orient the entire breadth of the medical staff and the staff at the hospitals in the importance of this migration -- not just the coding department and the coders themselves, but the curriculum set a design 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 kind of at a retail basis and not at scale range from about $30 to $250 per user depending on the audience and the mix of the adoption. So some of the coders may need more bundles and be at higher price points, other workers may need orientation and overview and be at the lower price point.

So we thought that would be helpful to give some perspective. We have 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. And 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 who work in over two dozen hospitals.

So again, we are seeing this as another driver. We expect this driver right now with our current viewpoint 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 active business development 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 portfolio so we are excited to see that product out of the gate. And we are making investments in re-engineering that portfolio to be tied to our core SaaS platform.

And so that will take a little time and investment to move that acquisition where we want it. But we are very excited about the potential for that product and, in fact, have our first sale on the portfolio product. And so we are excited to see that initial progress.

But 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 will be 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 existing products like the HealthStream Performance Center launched earlier this year and the 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 one week and that is fairly consistent with last quarter. I think we did a few more last quarter, maybe 15.

But we are seeing just steady strong performance from the HealthStream Performance Center to do annual performance reviews and the HealthStream Competency Center to do clinical reviews of clinical competence. Again, and that one, the latter being a unique dimension of competency, maintenance and development in healthcare.

So those products, we have a whole dedicated team in those products and they are doing a wonderful job. We continue with the aggressive launch of these products that round out our talent management strategy and platform.

Also in the business development front we signed an exclusive agreement with NurseCompetency. They have an innovative SaaS based competency exam and skills checklist for hospitals, again targeting the idea of determining is the workforce competent to do the jobs they are assigned and deliver the patient care that they are responsible for.

The NurseCompetency agreement is an exciting kind of new dimension. It's a, if you want to think of it this way, a new type of content, kind of database or examination format of content. So we are very excited to have this new type of assessment tool.

And then right behind that NurseCompetency assesses the clinical skills of staff. We entered into an agreement with Assess Systems, also exclusive. Assess is more of the behavioral dimension of talent -- determining if someone exhibits the appropriate behavior for a specific healthcare job and opportunity.

So these two tools together work to help HR in the pre-screening and ongoing assessment of their work force. 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 stand-alone basis and, again, and a constant theme here during high growth, we will be investing in 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 work force qualifications and then judging their competence, their engagement, their performance and their ongoing development.

The Sy.Med acquisition helps support this idea of is the work force qualified? And so you will see us continue to make investments in this area of determining work force 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 includes data from approximately 184,000 physicians.

This is exciting for many reasons; it is kind of a foray into this area of credentialing which is in my view a very unique dimension of talent management in healthcare. And it positions us well in a continued investment in this area of credentialing the work force.

And again, this business is an installed -- is has installed and SaaS-based software, although the predominant model for selling has been the installed product. And so, you will see an increased emphasis 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 costs to move them to our ecosystem and to our model. And so -- 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 performance company with a great culture that we think fits well with our Company and helps us to launch this area of credentialing. Kind of watch for more moves in this area.

Since the start of the year we just had an incredibly busy year of launching SimManager, SimView, Performance Center, NurseCompetency, Assess Systems, the acquisition of 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 year through our strategic planning process.

So the theme leaving this conference call for me is one of continued investment and growth, a 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 unique dimensions of talent management in healthcare.

Another important venture, just to give a quick update on, SimVentures. This is an exciting project that we've been working on for several years; it's a joint venture with Laerdal Medical. Laerdal Medical, a leading provider of simulation training in healthcare. Again, a unique dimension of the work force 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 product sets that are coming into market.

I think this quarter represents the fifth consecutive quarter of sequential growth for our SimVentures. 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, the number of developments at are growing Company and our continued focus on what I will call the unique dimensions of work force development in healthcare.

You can see this emphasis on all areas of work force development in healthcare and our development pipelines. I will turn over to Gerry for a quick look at financials and wrap up with a few announcements like our summit for next year and then we will go to Q&A. Gerry.

Thank you, Bobby, and good morning, everyone. Bobby gave us a lot of color on the results of this quarter, so I will try to hit some key financial topics and then save time for questions at the end of the call.

Overall our third-quarter and year-to-date results demonstrate the strength of the business. The quarter and year-to-date revenue growth rates of 28% and 26% result from core growth. The Decision Critical acquisition did contribute to revenue during the quarter and will 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. For this year second-quarter operating income had grown by 12.8%. However, after this quarter, the third-quarter's performance, that 2012 year-to-date experience is now at 21%.

Adjusted EBITDA results reinforce these operating trends as it grew by 30% over 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 a quantitative perspective we basically recouped the approximate cash at closing for the DCI acquisition at the end of the second quarter.

Our business development pipeline, as Bobby mentioned, remains very active and includes a wide variety of ideas and exciting opportunities for us here at HealthStream. And yesterday's Sy.Med development -- announcement is just another example of how we are deploying our capital base and innovative -- and ways to approach new opportunities.

Before listing [unofficial] topics I want to reinforce one thing Bobby did say about operating expenses. As you most likely know, all of our deal costs such as legal, banking, financial and operational due diligence are expensed as incurred on generally accepted principles or GAAP.

We have now closed two transactions this year, have invested time and money evaluating other division development initiatives and we continue to evaluate more opportunities. So that is an ongoing part of our expense base.

Also we want to make you aware of an accounting report requirement that you saw in the third quarter. You may be aware -- the effects being balances of deferred revenue and acquisitions. You may be aware of the so-called fair value rules that are now part of GAAP. One of those fair value rules requires us to write down beginning balances of deferred revenue on the [acquired use] balance sheet.

The result of that adjustment is to record -- we record reduced GAAP revenues until that acquired deferred revenue is fully amortized. All new business of course after closing is recorded at full value. Although the deferred revenue right opportunity to [missions critical] was relatively small during the quarter we did expand the non-GAAP table at the back of the earnings release to show the results on this quarter's operations.

And because deferred revenue is a common occurrence in [decision] based businesses we may see this GAAP required accounting convention in the future. In fact, the Sy.Med acquisition which we announced yesterday morning will have a deferred revenue write down as well, a point we did mention it 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 of remaining state income tax loss carry forwards available to us at future tax -- state taxable income.

(Inaudible) adjustment increased our tax provision and effective tax rate for this quarter as we reduced the carrying value of the net operating loss deferred tax asset on the balance sheet to reflect these lower estimated remaining state NOL carry forwards.

It is important to recognize that these revisions and estimates did not result in a cash tax liability, nor do they affect our federal income tax loss carry forwards available to us.

And finally, we updated our guidance for the 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, there are additional factors that impact that range including the Sy.Med deferred revenue breakdown we just mentioned a few minutes ago and also the closing cost for that transaction.

We expect our effective income tax rate to be between 41% and 44% for the full year of 2012 and capital expenditures to be between $8 million and $9 million for the full year. Thanks you for your time and I will turn the call back to Bobby.

Sure, thanks, Gerry. We have three final announcements here. First, I would like to welcome Sy.Med's 21 employees some of which may be listening in today. Yesterday they joined us in our downtown Nashville office for a welcome celebration. So their headquarters is just a few miles south of our downtown offices. So we welcome the Sy.Med employee base to HealthStream; we are excited to see them continue their growth as they leverage our network even hopefully accelerate that growth.

I wanted 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 Nashville Music City Center, which is our new 1.2 million square foot facility in downtown Nashville, and actually two blocks away from our headquarters. It has over -- we are looking forward to holding our conference there.

But as you may have noticed if you have been through Nashville, it's all under construction. And so we have 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 time frame -- we've actually secured a window in October but we are 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 are very excited about that.

In other 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 Companies in America. And so our entire Company can share in this exciting announcement.

Last year we actually were also on this list, we ranked 53rd. This year we ranked number 27 on the list of Forbes Top 100 Best Small Companies in America. A great accomplished much 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'd like to turn it over to the operator for questions and answers where we stand by for your questions.

(Operator Instructions). Ryan Daniels, William Blair.

Let me start with a couple of quick financial ones. First off I am just curious on some of the seasonality on the cost of revenues. It looks like in the third quarter every year that goes up even if your sales are kind of flat to down sequentially in the Q3 period. So I am curious if you have any color of what drives that to continue throughout the year regardless of the revenue stream?

Yes, hey, Ryan, it's Gerry. The third quarter this year we had a relatively large courseware project that had a high labor content in the third quarter. So that is one part that would influence that cost of revenue this quarter. The other thing, over time as courseware becomes a growing part of the revenue stream you do see the royalty piece growing as well.

Okay, that's helpful. Then can you talk a little bit about the newer contract signings? I'm curious; you talked about, for example, the strength in ICD-10 sales over the last 30, 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 deferred revenue? Or are we not really seeing that manifest at all in the financials at this point?

There are two dynamics. One is we usually get some kind of let's call it a deposit. So it would be deferred 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 the offsetting revenue.

Okay, great. And then a couple more bigger picture questions. I think, Bobby, upfront, you mentioned that your existing sales force is now starting to sell in some of the ancillary markets and that is helping with the new adds under 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?

Yes, I probably more would just note that the core is still driving the vast majority of those numbers. I'm just seeing a few more pickups here and there around the edges and so I mentioned that, I didn't mean to over emphasize that. The core of this number is still out of the core acute-care market.

But we -- and so there is no team dedicated or focusing yet on those additional verticals. They are just pick up from it through affiliations like if a health system acquires a home health agency or affiliates with one; sometimes they extend our service out to those affiliations. And so we are just seeing a little bit more of that. I would note it more an early trend, not a significant trend yet. But again, the vast majority of those new adds are in the core market.

Okay, that's helpful. And then one last question. Just thinking about some of your commentary around the NurseCompetency clinical exams and the skills checklist as standalone now. I guess a couple questions. How do you actually integrate that into the talent platform? Kind of what is required for you to do that? And then does that actually have a change on the revenue or margin profile as you move from a standalone to an integrated product? Thanks.

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 add -- distribute to our 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 a subscription product recognized over time, with 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 organization and their teams are geared to selling installed software that then goes on a smaller maintenance stream. And 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 eight or nine years ago in learning and we are now at the backside of it and enjoying the high visibility into the revenues on the learning platform. And so we will need to -- 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 revenue for the Sy.Med Development acquisition. However, the revenue I would -- if we do our job in the next 12 months -- would drop meaningfully as they start to sell under the new model. And we will see how fast we can make that migration, but it is just important to note.

And from the integration standpoint, sure there are costs to those migrations. In integrations sometimes we can start with looser integrations like seamless log on 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 there is kind of -- we'll 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 ecosystem we'll require new types of investment in tech and IT and programming development and even model changes, which will affect revenue from the top line.

Okay, great. Thanks for the color.

Matt Hewitt, Craig-Hallum.

A handful of questions for me. First and foremost, one of the things that kind of jumped out this quarter for me was related to your deferred revenue, there was a fairly large drop from Q2 to Q3. Is some of that related to the acquisition or help me understand what has occurred there in the deferred revenue line?

Well, it's the [normal] flow of the prepayments on contracts and in research in the Q2 we had some larger contracts that had some prepayments that are fully completed in Q3. So I guess the normal fluctuation of the flow of the contracts. Nothing unusual or change in (multiple speakers) terms or anything.

Okay, well I just -- it seem to be an outsized move. It's been a couple hundred thousand one way or the other. And mostly that line has been growing. And so I guess to see that drop, that was just -- I wasn't sure if there was something that occurred in Q3.

No.

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'm curious, do you have plans eventually to give us like you do for the learning center where number of employees -- just a way for us to gauge how penetrated you are with a couple of those other platforms? I know that it is very early with them. But I am just curious, is that the plan longer term or how should we be thinking about that?

It is. As we enter next year it is 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 at a hospital that has access to two or three components of a platform versus just one is an important thing to get our hands around and report on.

So we have a long-standing history of 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 to. And we have tried at different times over this year to refine that model, get it where we want it. We don't quite have it.

And so, again, we will look for the next reporting period. So I'm going to defer it one more time, but just directionally where we are working to go is to move away from the set of metrics on just this learning piece because of growing importance, as you know, are the SimVentures pieces, the performance management pieces and now portfolio.

There are 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. We have looked at things as much like subscriber months that would aggregate all of the subscriber months across all the platforms. So be expectant for a new reporting paradigm because we are no longer just a single software module, we are a talent platform with multiple components (multiple speakers).

Okay, that sounds great and we look forward to it. Thank you, Bobby. I made it will just help us get our hands around the opportunity a lot better and so it is much appreciated. Last one for me and it's actually I guess twofold. And you might have touched on it a little bit.

But as far as the gross margin is concerned, up until this year it had been 62 -- 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 (inaudible) as that has become a big 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 of these acquisitions, will that become an offset as those products row seeing as how you then own the content versus partnering?

A couple comments there. Yes, the growth in content -- our entire model is built around creating consumption patterns of content. The platforms themself create developmental plans for people that can, we believe, drive content consumption in addition to things like regulatory drivers. So the growth and content consumption is a positive effect but at the gross margin level, yes, has a negative effect.

So the relative growth rates of platform versus content affect the blended gross margin. That is why we continue to turn our emphasis down towards operating income lines and EBITDA. But -- and so you are right to note that, 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 is 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 royalty so that the whole ecosystem is strong.

Let's see, what was the second part of that question? Can you rephrase the second part?

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

It will, but I think I tried to be clear earlier and I will restate. I think that some of these acquisitions require a bit of reengineering before we get the leverage out of them. So these are -- again, these are investments for the three and five year window. And we really like the way we are picking up these unique properties.

And I think in the 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. And so that is true of the portfolio of products but now the credentialing products that is in fact true. So it is just the relative balance of those things and the cost and time of re-engineering them that will affect how it comes out say next year.

Great, thank you.

Richard Close, Avondale Partners.

A lot of my questions have already been answered. But maybe to dive into them a little bit more. With respect to the investment and integration and the 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 re-engineering is going to take?

I think product development right now it is 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?

Yes, and so, I think what I can reinforce now is just the trend for the need to continue increasing the rate of investment. And our next earnings call is when we will hit with guidance and after we finish our strategic planning process.

So it is right to note the trend. We'll try to put good magnitude around that trend in our -- I believe it is our late February call is when we will do that. And so, we are kind of explaining the trend now, but we will provide precision on it in February.

But it is 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 re-engineer that or make these acquisitions. So the level of investment is stepping up?

That is correct. And I think in this high growth environment we are excited to continue to innovate and deploy R&D expenses into those areas. But we are also, Richard, this is a time to grow in other areas as well. So just -- we are beginning to do the pre-hiring release is what we call in the sales area, for example.

If you noticed on our website four or five brand-new sales positions have popped up as well. So -- in this area of clinical courseware executives to help. And all of our clinical courseware organization will be excited to see this new level of commitment and focus to selling clinical courseware through our network -- organizations like AORN, [AACM] and ANA -- this will bring a renewed focus to selling their content into our network with specific type of expertise in the sales organization.

So I think the theme as we enter next year across several of the areas is to continue to focus on top-line growth, we are going to need to invest in many areas of the Company and probably at a higher rate than our historical models.

Okay. And that last answer dovetails into where my next question was with respect to the four or five at sales positions popping up. When I look at the sales and marketing expense, as a percentage of revenue it was quite a bit below what we were looking for. And then Gerry's question or answer to one of Ryan's questions was talking about some upfront commission expense.

And it just seems like those are two -- I guess I would have expected sales and marketing expense to be up maybe year over year as a percentage of revenue or at least flat. So I am not sure how you gain that leverage there or what drove that. Was there something one time in that line item? Maybe Gerry can help me out there.

Well, I will try first as Gerry thinks about it. I don't think there is anything new or different there. We -- each year really in the third and fourth quarters when we assess how to grow the sales organization, begin to release hiring in it -- you can already see, for example, four new positions that I mentioned.

Commission is not all front loaded, it is 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 are 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 begin until sometime in the next year.

And so, specifically as you think about the fourth quarter you'll kind of see that phenomena because it is definitely one of our largest, if not our largest by a good stretch closing of new business, new -- we will call it new order value, the value of these multi-year contracts. And 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 a 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 is kind of that mixture of good news -- challenging news is that -- and really if you think about it hard enough it is all good news when you pay higher commissions because of the -- essentially the backlog being created for new business.

Okay, that's helpful. And then with respect to -- if you can just refresh me that talent management products or center -- Performance Center/Competency Center, what the revenue model is on that just to refresh? And then also as a follow-on with these exclusive relationships, on NurseCompetency and Assess Systems, can you talk a little bit about the price points?

I know that might be a little bit sensitive. But I am trying to get a feel of should we think about revenue per subscriber, that is the only metric we really have in terms of number of subscribers. But these new areas that you are 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.

So the revenue model for the performance and Competency Center is identical to the revenue model for the Learning Center and the Authoring Center and the SimManager part of SimCenter. They are all SaaS-based subscription-based multi-year contracts and recognized ratably over the period of implementation. So I hope that it helps.

The content -- what I would say is that right now the drivers -- we have 100 -- 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. In fact we are just beginning to sell them and don't have revenues from those products.

I highlight these products because of, A, their exclusivity; B, their nature is a little different than our traditional content product. So it shows that the definition of the type of content we are delivering, in this case tests and assessments, is being enhanced.

So I would continue, if I were thinking about modeling, to model core products like the hardcode product 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, ICD-10 libraries should be good for next year. The HeartCode and BLS, ACLS and PALS content that 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 would be that clinical libraries from Lippincott Williams and Wilkins, the resuscitation libraries from our Laerdal joint venture and the ICD-10 libraries in our Precyse venture.

All the others, including NurseCompetency and the Assess Systems I would consider an immaterial part of the mix of how content is growing, but I wouldn't model any of those individually at this point.

Okay, thank you. And I will just do one more here if I can. The color detailed on ICD-10 is great, it is good to hear that you are 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 that ICD-10 opportunity is as a percentage of your almost 3 million subscribers?

Yes, it is a little too early to do that because we're seeing different purchasing patterns. Some want to go deep for a very small department and create awareness and essentially train and educate a very small department. Other believe the migration is so significant that they buy kind of what I will call awareness and orientation packages for more -- a higher percentage of their population.

And we are just seeing such a mix right now in the approaches that it is hard to project at this point. We are excited to see the uptake and more contracts, the nature of it hasn't created 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, it's that important a topic. But different organizations have different approaches to how they are going to meet this ICD-10 migration.

Okay, thank you very much. Congratulations.

Nick Halen, Sidoti & Company.

So the first question I had was in -- if you guys are really excited about the talent management products you guys are kind of 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 has to a certain degree slipped into the background while you expand out these other product suites. I was just wondering basically if you are happy or satisfied with how SimVentures is progressing right now.

I would say that the SimVentures is on an early adoption curve that is more linear and 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, it is both significant, meaningful and fully engaging. The mannequin-based simulation training to do the resuscitation continues to impress in 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 I will call up the early adopter phase, kind of pre-acceleration curve. I remain excited -- excited that it is a contributor financially and a growing part of the business. And so that characterizes in that way.

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

What are the differences between those two?

Yes.

Yes, so, Decision Critical had a small customer base that looked a lot like our customer base, they had a couple dozen healthcare system accounts or hospital accounts where they provided the core of learning and a learning platform. So in that sense those customers we're beginning to work with to show opportunities for our product sets.

So that one -- it looked a lot like us. It was founded in a similar vein in the learning dimension of talent management. But it also had this unique asset in it, this portfolio component, which again you heard me mention we were rebuilding. So it had a potential for new product to emerge out of it and not just be more of what we have. And so it was patented and we are excited about its long-run potential.

Sy.Med was -- is a new dimension to our talent management strategy, it is hitting this idea of determining -- answering the questions, is the workforce qualified? And the credentialing process is a unique dimension of managing personnel in a hospital, also is often coupled with something called privileging.

And one of the things we are doing in our talent management model is working to make sure it is differentiated from the rest of industries. And so what we do there is we seek out what is different about managing these 5 million healthcare workers that is part of managing the talent, managing the people, improving their efficiency. And in healthcare one of the answers to that is that the credentialing and privileging processes inside hospitals is a unique dimension of managing the work force.

So here the Sy.Med acquisition again, a characteristic is 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 healthcare and therefore a differentiator when 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 in healthcare.

Great, thank you.

Andrew Albert.

I was just hoping to drill down a little bit further on the deferred revenue that was asked earlier. I know you mentioned it was normal course of business. But the $1.8 million drop seem to be pretty large -- I am looking here, the largest we've ever seen before was about $400,000 in terms of a sequential decline in deferred revenue.

So is there something changing in the model at all? And related to that, I guess the deferred revenues now year to date aren't all that much from the beginning of the year, which is pretty different from all the prior years this far into the year. So if you can just give a little bit more clarity on that, that would be helpful. Thank you.

Yes, Andrew, this is Gerry. I'm not sure what else I can really mention about that. There has really been no change in the revenue recognition patterns or the payment patterns. The one thing I -- that maybe we have a large HeartCode customer that was ramping up over the early part of the year and that may have hit full maturity in the third quarter, which would've had a revenue recognition happen in the third quarter while the cash was paid earlier on in the year. But I don't know there's a whole lot of difference in, like I say, either contracting patterns, revenue recognition or with the cash payments.

So it must be some confluence of a couple big contracts that got in --

Yes.

-- essentially executed in the period.

Right.

So we'll look for some more clarity on that. There was a large -- a large multi-hospital health system that went onto our HeartCode products earlier in the year, actually beginning in January. And I think it took us some time to implement it.

Exactly.

That may be it, maybe getting those to implementation created kind of a little bolus through the deferred revenue.

Okay. And then with regards to the deferred revenue growth year to date, is the model just becoming more transaction-based such that we wouldn't see deferred revenue grow or -- I just with the new talent management products I know they are small at this point, but I imagine that is having a little bump to deferred revenue. So I am just trying to understand the core business, how deferred revenue works there?

Well, to once again go back to the theme of course where it becomes a larger part of the revenue stream, it is a lower revenue -- in general a lower revenue per subscriber content than the platform and there is more and more of those transactions, those contracts coming through the sales cycle that is into deferred revenue and revenue. So that is part of it as well.

Okay. So they don't really -- there is not a lot of pre-payment of those courseware?

There are, it's just smaller pieces, that's all. It's not as big as a platform contract might be.

Okay. So we shouldn't expect the deferred revenue to grow at the same rate that it had in prior years, is that kind of a good go forward?

Yes, it should be more ratable growth, sure. And once again, it's going to come back -- the large HeartCode customers is one of the reasons why they've had the big jump in deferred revenue and now the more historical pattern.

Okay. Okay.

Frank Sparacino, First Analysis.

Just two quick questions. On the ICD-10 figures 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, I mean relative growth rate for that business? Was it a 10%, 20%, 30% growth business? And what does it look like from an EBITDA perspective, if there was EBITDA? Thanks.

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 the ICD-10 libraries is the retail pricing.

And then on Sy.Med, just a couple things I want to reiterate. We would expect again effectively the revenue that has been growing year over year and it does have -- it did have EBITDA, so we will identify both of those elements.

However, with the re-engineering, the reduced -- 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 is going to take some time to get that revenue stream where we want it and kind of get it to a baseline that is going to be consistently growing.

So again, I think the revenues from that, because it is 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 to go up. Although historically even the installed and the maintenance revenue streams from that business have shown growth and positive EBITDA.

If I could follow up just real quick, Bobby. So and I was talking just more from an historical perspective in terms of the growth rates if you are willing to share. But then also on Sy.Med, can you just talk about how the product was priced in a roughly typical average deal, what the size of that would be in a license mode?

Not at this time because we are going to work on the migration of it and get -- and probably have new pricing models may be 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 it positioned right in our portfolio of products. So I don't really want to talk about pricing yet because I think it is going to have -- there is going to be a lot of potential change with how we approach that product.

Cris Blackman, Empirical Capital.

Bobby, 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 are seeing the greatest traction?

Yes, I think we think the opportunities remain strong in those verticals, we have been assessing them for quite some time now. And again, only through affiliations with hospitals we've 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 a hospital, an acute setting that has all types of demand and surgery and a broad mix.

So the long-term care, home health, surgery center markets are all interesting. They are probably over time a great opportunity, about 5 million or 6 million people work across all those blended what we call secondary or ancillary markets. So there is a lot of people working in them.

Probably the 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 is all under consideration as well as we enter into 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 have heard members from 5 million to 7 million in those secondary markets when you add them all up. And the largest of those is probably the long-term care home health market and several million.

So there is definite opportunity there and we are working on figuring out how to pursue -- 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 is kind of a pending decision through our retreat and strategic period here at the end of the year.

I know you have been challenged with trying to determine exactly how to clarify that opportunity or to break out those areas. Do you expect to be breaking those out for us then next year, some of the specific markets?

Well, they are just -- right now they are blending into our core numbers and we have got a couple different breakouts people are asking us to make. The first is explaining how these component pieces are spread and we are working on that. We will probably do that before we do the vertical market breakout because that would be like a further metric segmentation of the user base. But we are open to both. I think the first move, we'll probably do a little more detailed reporting on the penetration of platform components.

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

Yes, it's a fair question. I think it's an exciting time in downtown Nashville where we are adding space and people as quickly as we can. We are adding a recruiter in HR to help with the recruiting process trying to lower costs of finding talent.

We are finding wonderful talent in many areas, we are challenged in others. The developmental teams, the programming development teams we are having a hard time filling those at the rate that we are trying to add them. And so it is a little bit of a mixed bag. It's an exciting time, we are bringing in lots of great new talent. I wish that in the tech areas we could have a bigger talent pool in this area of the country.

We are kind of excited to have our Austin office, it 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 have been challenged to fill at the rate that we had hoped in the last several quarters. And we will just keep working through that until we solve that problem.

Thank you, Bobby.

Thank you, sir. And with that that does conclude our questions. I would like to turn the program back over to Mr. Frist for any additional or closing remarks.

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

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.