HealthStream Inc (HSTM) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the HealthStream Inc. Second Quarter 2016 Earnings Conference Call. At this time all participants are in a listen-only mode. (Operator Instructions) I would now like to introduce your host for today's conference, Ms. Mollie Condra, Vice President of Investor Relations and Communications. Ma'am, you may begin.

Thank you. And good morning. Thank you for joining us today to discuss our second quarter 2016 results. Also on the conference call 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.

So, with that start, I will now turn the call over to Bobby Frist.

Thank you, Mollie. Good morning and welcome, everyone, to our Second Quarter 2016 Earnings Conference Call. We have a lot to discuss today. And we'll start with opening characterizations. There were several challenges in the quarter as well as a lot of reasons for optimism. And I want to elaborate on both mentions of that. We're going to turn our attention first to the revenue side and open up with a few highlights.

The first highlight was that the top line revenue increased 5% to $54.8 million. And the second highlight is important because there's going to be some contrasting discussion today, is that we're maintaining our guidance of consolidated revenue growth of 8% to 12% for the full year. We're going to end up being a little bit more backend loaded on the revenue growth model this year than maybe some had thought we were leading into this report.

And one of the things that gives us a lot of confidence as we lead into the second half is that we delivered record sales in our 26 year history, record sales orders in the first half of the year. But no good goes unpunished. Many of those sales were not converted into revenue in the second quarter because the timing of those sales was heavily weighted to the end of the second quarter.

So, again, this first half record sales in our entire history is one of the things that gives us confidence as we push into the second quarter. But a lot of those sales occurred in the last two months of the second quarter and so they didn't quite come in exactly as we had maybe hoped as we kicked off the year. But again the record sales gives us a lot of confidence as we move into the year.

They don't materialize as revenues in the second quarter even though the sales occurred and as you know we paid a commission for those as we closed the contracts for part of the commissions. But we're a subscription-based business model so we have to remind everyone that when we make the sales, we wait until implementation to begin revenue recognition which is why we don't see the full financial benefit of those sales in the second quarter.

As reported in our earnings release we decreased our revenue guidance for our PX business and that reflects a little bit of a challenge, a little bit more information as we move to the middle of the year. That was prompted in part by the loss of an account that will have an effect on the fourth quarter PX revenues, it kind of forced us to reevaluate the churn in the business in the fourth quarter. And a strong pipeline of sales is what partly offsets the loss of that account and so we've lowered guidance to the 6% to 8% growth range. Still better than in some prior quarters. But a little lower than maybe we expected coming into the midpoint of the year here.

And another reason for optimism in the PX business, again the sales pipeline was good, but we also, while we did identify a loss that will effect revenue in the fourth quarter, we also had a strong win in the second quarter. One of the things that was exciting about that win was that it was with a 20,000 person organization in the post-acute space and that organization drew on our full suite of HealthStream products.

And so it was exciting to see that not only did the go with our PX product line in a competitive situation, they loaded up on our talent management and training and development products as well. And so what was exciting about that was to see the full portfolio of HealthStream assets and capabilities come to bear to help a competitive win. And so it was actually a win for the segments of HealthStream, two of the three segments of HealthStream with that rather large post-acute account. And as you know, the post-acute segment is an area of focus for us.

So, again, while guiding to 6% to 8% which is a little lower than we've had in the prior earnings release, we see with the caution of a lost account that we identified since the last report that will come out of fourth quarter, we do have a strong indication of a good system wide win also entering in the second half of the year for the PX business line.

Reported revenues to the provider solutions of the Echo business grew approximately 59%. If you factor out the deferred revenue accounting treatment, growth for the segment was relatively flat. And so again that can look a little challenging but there's a couple of things going on there that I think again are exciting.

One, the sales team has been ramped up and the sales orders are coming in at a rate faster than they have in the past. So, we're excited about that. Second, we're selling a little less of the licensed software and a little more of the subscription software. And in the subscription model. So, that has the effect of pushing some of the revenue out. And third, the fast rate of sales result in a backlog of implementations that we're going to work through in the second half of the year. And you'll start to see the real growth of that kick in in the second half of the year.

And so again, while this convergence of things in the Echo business unit occur in the second quarter, we've done a lot of analysis and we're entering the second half of the year with Echo with a lot of confidence based on the sales team, the sales performance, the backlog which we have confidence that our COO got the business working through and so again we're maintaining our guidance there and in fact we'll see the real organic element of growth kick in in Echo in the second half of the year.

In the workforce development segment, it comes with its own challenges. We spent over three years talking about the bolus of revenue from ICD-10 and we're nearing its financial impact from an absolute dollar sense on the workforce development segment. It's had a tremendous drag on growth in the last almost five quarters as it's been in decline after many quarters of contributing to our growth. And so the workforce development segment has high performing solutions like resuscitation, clinical development, and compliance that drove a 15% year over year organic growth for that segment, that's excluding the impact of ICD and assessment solutions from both periods.

So, if you factor out ICD-10 for the prior year and this year, you'll see a 15% organic growth rate in the workforce development segment. Again, a little lower than maybe some had modeled but 15% is strong and there's really good indicators in the pipeline for the products I just mentioned, resuscitation, clinical development, and compliance that give us again the optimism for the second half.

So, I hope that gives you a little walk through of kind of my sentiments on this quarter. There's a convergence of challenges but an underlying strength that you have to dig a little deep to see, and the confidence that we have entering the second half based on sales and execution.

So, I'll turn it over to Gerry who will dive into the P&L and the balance sheet with a little more detail and then back to my discussion of the business, products and product launches, and upcoming events.

Thank you, Bobby. Good morning, everyone. I'll provide some color on the financial results, including certain items that impacted the quarter.

For the quarter, consolidated revenues were up 5% to $5.8 million. Operating income -- I'm sorry. $54.8 million. Excuse me. Operating income was down 10% to $2.3 million. Net income was down 5% to $1.4 million and earnings per share was $0.04 compared to $0.05 in the second quarter of 2015. Adjusted EBITDA was down 10% to $7.9 million from $8.8 million in the last year's second quarter.

Now let's look at our income statement. Revenues, gross margin, operating expenses, and operating income, and as we review our results we'll place financial context on the impact of the ICD-10 revenue declines. Revenues, as Bobby mentioned, consolidated revenues were up 5% in the second quarter versus the same period last year. We achieved this 5% revenue growth while overcoming a $4.6 million decline in ICD-10 readiness revenues from last year's second quarter. When we exclude ICD-10 readiness revenues from the second quarters of both 2015 and 2016 our consolidated pro forma growth rate is 16%. However when we account for the change in the HealthLine Systems deferred revenue write-down between this year's second quarter and last year's, the pro forma growth rate adjusts to 11%.

The workforce segment is comprised of applications and content solutions which are primarily subscription-based and are targeted at approving the healthcare workforce. This is also the state in which ICD-10 revenues are reported. The workforce solutions segment increased by $400,000 or 1% which increased to $4.6 million due to the decline in ICD-10 revenues. The second quarter pro forma growth rate for workforce -- excuse me, ICD-10 revenues from both periods is 15%, as Bobby also just mentioned.

The second quarter 2016 HealthStream's Workforce ARIS was $35.70 compared to last year's second quarter of $35.35. Subscription-based revenues increased 1% compared to last year's second quarter while subscribers decreased less than 1% over the same period last year. As we noted earlier, growth in subscription-based revenues offset the decline in ICD-10 revenues over last year.

Revenues from -- ICD-10 revenues from training products were $2.2 million in the second quarter, generated from approximately 870,000 ICD-10 readiness subscribers. Through the second quarter, approximately 390,000 subscribers completed their contracts with us which included approximately 54,000 of ICD-10 only subscribers. At the end of the second quarter then there are approximately 480,000 remaining ICD-10 readiness subscribers of which 115,000 are ICD-10 only.

HealthStream's patient experience solutions provide valuable insight to healthcare providers to meet cash requirements, improve the patient experience, engage their workforce, and enhance their physician alignment. Our patient experience solutions segment grew revenues -- I'm sorry, revenues increased by $201,000 or 2% in the second quarter of 2016 compared to second quarter 2015. Revenues from Revenues from Patient Insights surveys, a survey research product that generates recurring revenues, increased 2% over the second quarter of 2015. Revenues from other products, including surveys conducted on annual or bi-annual cycles and consulting and coaching services, collectively increased by $96,000, or 4%, when compared to the second quarter of 2015.

In the provider solutions segment, operating as Echo, a HealthStream company, provides the software that's used to validate the professional credentials of potential employees. Echo products serve as the gatekeepers of workforce quality in healthcare. In the second quarter of 2016, revenues from our provider solutions segment increased by approximately $2.1 million with the HealthLine Systems acquisition accounting for the majority of that increase.

The $2.1 million HealthLine increase was driven largely by the year over year change in the deferred revenue write-down which is the accounting convention that requires us write-down beginning balances to fair value as defined in GAAP. Echo continues to perform to our expectations even though this quarter appears to show flat revenue growth as considering the deferred revenue accounting convention.

This business unit has posted strong sales growth, is working through a backlog of booked business that becomes revenue in the upcoming quarters. As Bobby mentioned also last year's second quarter included more licensed-based sales than this year's second quarter but this year's second quarter included more subscription-based sales than last year. So, there's really a product mix switch going on as well. Nevertheless we believe the underlying indicators still support the Echo growth trajectory which is why we remain enthusiastic.

Gross margins, the gross margin improvement trends that really began last year have continued through the second quarter of 2016. Last year's second quarter, the gross margin was 57% compared to 58.7% gross margin this quarter, a combination of factors that included lower ICD-10 revenues, the growth of revenues from proprietary solutions with higher gross margins were key contributors to this trend.

Operating expense, this quarter's results reflect our ongoing plans to invest in product development to foster long-term growth and strengthen our competitive position. Product development costs grew by 25% from $5.8 million to $7.2 million in the second quarter of 2016. This increase represents investments in all segments, workforce, patient experience, and Echo.

G&A expenses in the second quarter of 2016 were 15.6% of revenues which is an increase from last year's level of 12.9%. Several factors influenced the G&A expenses, such as the rollout of a new financial platform for NetSuite, in which is invested $300,000 during this quarter. This is a major project for us. We successfully completed the implementation during the second quarter. In addition, we incurred approximately $300,000 of expenses due to our ongoing M&A and business development initiatives.

Operating income, operating income was $2.3 million in the second quarter and was adversely impacted by the $439,000 of deferred write-down related to the HealthLine acquisition we recorded this quarter, the lower contribution from ICD-10 revenue streams, expenses related to the NetSuite implementation, and M&A and business development expenses as I just mentioned.

On our balance sheet, our cash position and overall balance sheet remains strong. Our cash balance at June 30 was $139 million. We have no outstanding debt and our full $50 million line of credit capacity is available to us. Our cash position reflects a $3.2 million cash paid at closing for the performance of the HealthLine Systems acquisition which closed on June 30.

Our recently completed NetSuite implementation as I just mentioned did cause a temporary delay to monthly customer billing cycles which resulted in slowdowns in cash receipts during the second quarter. We have since returned to our pre-established billing schedules and are focusing on reducing days outstanding with increased collection efforts.

We believe our overall capital position is likely to support our organic and inorganic growth opportunities and support other capital structure optimization and shareholder value maximization strategies as may be appropriate.

Yesterday's earnings release contains guidance for the 2016 full year. We expect that consolidated revenues will grow between 8% and 12% as compared to 2015 and the growth in our three operating segments will be as follows. Workforce solutions, 2% to 6%. Patient experience, 6% to 8%. Provider solutions, 80% to 84%.

Revenues from ICD-10 readiness training, which were approximately $26.8 million in 2015, are expected to decline by approximately $19 million in 2016 and are reflected in the guidance range for workforce solutions. For the full year 2016 then we anticipate revenues from ICD-10 readiness training will be approximately $8 million to $8.2 million and we expect that will be comprised of an approximate $6.1 million of year to date actual results, $1.1 million in the third quarter of this year and finally $1 million in the fourth quarter.

We anticipate that our full year 2016 operating income will be -- will grow, increase 10% to 14% over 2015. We anticipate that capital expenditures will be between $14 million and $16 million and our effective tax rate will be between 39% and 41% for the full year of 2016.

We also look forward to our client summit in October of this year, meaning that estimating new expenses of $750,000 for the summit will be recorded largely in the fourth quarter of 2016. This guidance includes the anticipated impact of Performance Management Systems and Nurse Registry Consulting Corporation acquisitions but does not include the impact of any other acquisitions we may complete during the remainder of 2016.

Thanks for your time. I'll turn the call back to Bobby.

Thank you, Gerry. As I mentioned on past calls, we have multiple strategies for growth, many of those are organic strategies, launching new products, and also pursuing an active M&A pipeline. In fact, just yesterday we announced our second acquisition in the past 30 days. So, I'm going to take a moment to talk a little bit about both acquisitions.

On June 30 we acquired Performance Management Services Inc. This is a company focused on competency-based performance development of nurses. We are excited to add to our workforce development solutions their industry-leading clinical assessment tool, the performance-based development system. It's widely known to customers across the industry as PDBS. PDBS is particularly well respected among healthcare organizations for its insightful and predictive clinical assessments regarding the judgment of clinicians.

We're excited about this because we think we can add a lot of value to that core technology and it's the kind of asset that's leveragable across our network. So, we're really excited to have acquired that well-established although small organization. Again, it's the type of organization where we think it will serve our customer base really well.

Yesterday we also acquired another clinical assessment company. It's the company known as Nurse Competency. It's a leader in subscription-based clinical assessment and testing. It focuses on knowledge testing. One focuses on judgment testing and the other focuses on knowledge testing.

And so we like the way these two complement each other. In fact, we're combining those two to build out an assessment product and service line inside of HealthStream. And so we're excited about how those two elements we believe will come together under the leadership of one of our clinical leaders and we'll round out and invest in and build out an assessment business, initially targeted towards nursing.

And also exciting about that last acquisition is that Joe and Elease Caracci, the founders of that organization are moving to Nashville. In fact, they were here yesterday so we could welcome them to Nashville. And we were already minority investors in that organization, so we knew them well and have grown to have confidence in them and their organization and where they want to take it. So, we welcome them to Nashville as we combine these two entities into one new assessment business with leadership moving to Nashville to help us grow it. So, it's all very exciting.

With these acquisitions complete, we do want to comment that we continue to invest in, as Gerry mentioned, an active M&A pipeline and business development pipeline as well, investing in partnerships and looking at a full range of activities from minority investing, which again we just completed one minority investment into an acquisition and an active M&A pipeline. So, we're going to keep that business development going and try to keep a good cadence to it as well. It does reflect a little higher level investment in the quarter and therefore a little higher G&A. As you can see, completing two acquisitions and with an active pipeline we're investing more in that form of growth.

Now, I'll comment on a few of the service lines and product areas that performed in the quarter, the clinical courseware products were a large contributor to revenue growth in the quarter. Clinical products include content from our medical association partners, clinical skills and procedures, and the product CECenter, our association content continues to expand and so do the innovative ways in which we plan to make all of this type of clinical content available to our customers.

All together, revenue growth from our clinical courseware products was up 23% year over year and a great area of focus. In fact, if you think of these two recent acquisitions, they give a different dimension and angle to approach the clinical development business, not just content from associations and partners, but now essentially a testing and evaluation service to go along with it. So, we're very excited about that area and delivered 23% year over year growth and you can see some of our most recent investments being added to that segment.

Now, the HeartCode suite of products which is our resuscitation suite, again delivered strong sales performance. In fact, in the second quarter, the sales of our resuscitation products increased 91% over the first quarter sales and you have to remember the first quarter sales were pretty strong as well as we highlighted in the last earnings conference call. Approximately 67 new customer contracts for the resuscitation solutions were signed in the second quarter along with an additional 158 contract renewals.

So, the teams were very, very busy signing new business and implementing and renewing renewals. These products are focused on resuscitation and emergency cardiovascular skills and effectively with the standards of the American Heart Association, the innovations of Laerdal Medical and the delivery and technologies of HealthStream, we're revolutionizing the way resuscitation training occurs across America's healthcare systems.

Relatively speaking, the HeartCode products do carry lower margins for the company. I've mentioned that in the past. I want to remind you of that. They're really outperforming on the revenue side. But we do involve three partners in the product, so they do have a lower gross margin than some of our other products and I want to remind our analysts of that fact. As of June 30, 2016, over $2.56 million CPR training certifications have been completed through HealthStream. And if you just think back a few years ago we were really on the vanguard of moving people from the traditional method of books and instructor led to the form of online certification and manikin-based skill checks. So, it's really exciting to see that product continue to take hold in the market space.

In the second quarter our patient experience segment launched and implemented the first users on our new Engage Rx portal. Engage Rx helps our customers employ Insight Survey and interpret their survey data and know what drives performance. They can also apply best practices for improving outcomes and most importantly build action plans to train and develop their staff. So, we're kind of linking and bridging the concept of measurement and analytics with action planning with the workforce. So, we're seeing an impact and that's well-received, Engage Rx, kind of a new product capability for patient experience.

We also were glad to see patient experience capabilities advance with SMS text surveying. It provides a link to a survey via text messaging. This is timely and cost effective technology because it leverages the strength of healthcare's largest phone survey vendor because it utilizes the millions of phone numbers we capture each year and then converting them into an introduction to our modern web survey platform.

So, we're excited to launch this SMS text surveying capability. We think it will give us an edge in the marketplace and again it leverages our strength of our call center operations in general. And we think in general that the idea of speaking with your customers is better than sending them a mail survey. So, we love that differentiation of talking to customers, listening to the voice of the patient, and collecting the data. And this SMS technology simply invites them in in a more friendly, more rapid way.

In the third quarter this year we look forward to welcoming our customers to Nashville. About every 18 months we launch our customer summit. What's exciting about this summit is we'll be inviting the Echo nation customers and the customers of Echo to collocate their conference with our conference, their user summit with our conference. We think it will make it an even bigger bash and more exciting and one of the things that makes me most excited about this coming summit is that as we've mentioned we have a very robust product introduction cycle.

So, some of these investments we've been making in the first half, you'll definitely see a more rapid pace of new product introduction in the second half, beginning with the mention of the Engage Rx portal today here for the patient experience solutions segment. And so we're really excited to welcome, we think this will be our biggest customer summit ever.

We remind the analysts that it does -- it's a major investment for HealthStream. We invest a lot to bring these customers here. We conduct R&D and use our technology teams, we market and show our products and we engage a very large customer base. I would expect over 1,000 participants this year across the board, including HealthStream. It's going to be an exciting several day conference in Nashville. But remember to model the expenses in the fourth quarter because it is a large investment. I think Gerry mentioned about $750,000.

So, with that, we'd like to turn it over to the investor community for questions. Thank you, Operator.

(Operator Instructions) Nicholas Jansen, Raymond James.

Hi, guys. I just want to dig a little bit deeper into the robust selling activity you talked about in the second quarter and kind of how much visibility you have in the back half of the year growth acceleration because based on I guess my math, you talked about a true organic growth number of about 10% or so when you correct for deferred revenue in ICD-10. But on my math it has to go back to mid-teens in the back half of the year to kind of even get to the lower end of your full year guidance. So, I just wanted to get your thoughts on the visibility of that ramp and how successful selling activity needs to be in the second half in order to achieve those metrics. Thanks.

Yes. Great questions and fair observations. I think that we're encouraged in the second half because it's largely now an execution and implementation game. Their sales were really, really strong, as we mentioned, in the back half of the second quarter, the last few months of this quarter, in fact. I'm sorry, the second quarter. And that gives us the implementation backlog to achieve the growth rates that we projected. So, not a whole lot of new selling has to occur to deliver the numbers.

We have a whole lot of implementation to do, execution, and get to revenue recognition. We entered with a backlog. If we work through that backlog and then the new sales backlog created by these new sales, we still -- that gave us the confidence to maintain our revenue growth ranges. And so, it really is an execution game. We've had a few bumps in the road in the second quarter but we think that we're up to it and we're going to deliver that revenue recognition.

It really isn't as tied to our expectations for sales although we do have strong pipelines and great expectations for sales. As you get to the middle of the year on a SaaS business, the sales that occur from here forward really are more about the future, about the next year, and we plan to work hard and work through the implementation backlog to get the revenue rec we need to deliver the range that we have guided to.

That's very helpful, Bobby. My second question would just be on gross margins, the strength. Obviously some of that's tied to ICD-10 readiness going away. But how sustainable is that 58.7% level. How do we think about what you're assuming on the back half of the year on gross margins? Thank you.

Yes. Some of the margins that we expect recovery on are like operating margins and a good example is this NetSuite implementation we talked about. That took us a little longer and a little harder -- once every 15 years or so you swap out a major infrastructure piece of your business and it just so happened that the first two quarters of this year was that moment in time. We ended up taking longer and investing more than we had planned. But it was the right call and Gerry mentioned about $300,000 more in investments to finish that project. So, there's some one-time things we're confident won't be recurring. In fact, we're also confident that getting through that change will deliver operational synergies and again Gerry mentioned some delayed billing and some cash flow challenges.

But now the cash flow system for delivery invoices enhanced from a new platform. So, it's just one of those things where you've got to look through the quarter to the future and we have some one-time investments like that one that are behind us now and the accounting team is exhausted but excited because they can already see the operational benefits.

And then our COO is excited because the increased visibility we're going to get in the product line contribution margins and product managers are excited because they're going to get more financial details than ever before to run their business. So, there were some one-time things in the quarter that we are confident won't recur.

On the gross margins it's kind of a product mix question and based on selling in the first half and the implementation schedules, we think that gross margins will continue to maintain the fall off in ICD-10 revenue which has a lower gross margin than the one we were just reporting, about 50% gross margin. It tends to have a boosting effect. As we look forward, you think about 2017, the record HeartCode sales which has a lower gross margin may put some pressure on gross margins end of 2017 but we'll get to that in February. As to the remaining balance of the year, we feel pretty good about gross margins and then certain one-time operating costs that are behind us.

As always, thanks for all the color. Thanks.

Matt Hewitt, Craig-Hallum Capital Group.

Good morning. Thanks for taking my questions. First one, on product development, it sounds like you've got a heavy cadence of launches coming here in the second half of the year. That segment, 13% of revenues now for several quarters in a row, as you start to get through some of these launches and introductions of new products, will that trend back down? I mean, I think your historical range was closer to high single digits. Will that taper off a little bit as we get through the second half of this year and into next year or do you anticipate that staying elevated for a lot longer?

I think it's right to say we have in all segments, the Echo segment, if you look at it since the acquisition, particularly the last 12 months, we've added meaningfully to the technology and development teams at Echo but the rate of product introductions for them is really outstanding. They've already got several ancillary and add-on products in the market with those teams and the rate of launching new products is going to continue.

They're kind of add-on and extension products that generate new revenue streams. In that segment in particular you see an early increase rate through the fourth quarter of last year and first and second quarter of this year in investments in technology. We do expect that to level a little bit as we enter the second half of the year and get some of those products in the market. In a similar vein in the workforce segment, as we fall through this ICD-10 decline which has been as you know a major impact, particularly in this quarter and in the next quarter on a year over year basis even greater on negative impact. But it's absolutely impacted the client.

We project about $1.1 million of revenue from ICD-10 readiness products next quarter. We remember that peaked at over $7.4 million over a year ago. So, that's a material change in outlook. But along the way, we haven't stopped investing and you will see a string of investments. In fact, about a month ago we soft launched, on our website you can read about our new nurse residency program which is in our workforce segment. It's a soft launch. It didn't have a press release. And in that product we already have paid pilots and one new contract in full customer for the new nurse residency product. In addition, that product has higher price points than historical HealthStream products.

So, the second half will be loaded with launches. We won't be adding any new dev teams in the second half of the year. We've kind of got what we have. And remember in the first half of the year we used contract to hire labor to get our dev team staff up to staffing expectations. So, we've got kind of an early ramp. So, what I would expect to see is maybe contract labor moves to full-time labor and it stays relatively flat in the R&D lines for the second half of this year. We did it a little different this year.

Instead of being just under hiring, we usually approve a lot of positions in January and it takes time to hire them. We went ahead and rounded out all of our tech teams pretty quickly with contract to hire labor so we could productive in the first half of this year. And our expectation and hope is those contract to hire positions move to full-time and become more of our run rate and we won't see a lot of new tech hiring until next year's budget cycle and we'll see how we perform on the top line before we get through that cycle to execute the plan. I hope that helps you understand why we have again confidence in the remaining two quarters of the year.

It does. Maybe one just follow up real quick and this kind of gets back to the gross margin. Obviously very strong quarter, goes back to I think pre-ICD-10 was the last time you had levels this -- almost 59% this quarter. As we look out, not just even to the second half, I think more like 2017 and beyond, and I know you're typically not comfortable looking out that far in advance, but just generally speaking you've added new content where you own it. You're not sharing with royalties or anything. You've continued to ramp in those areas where you own the content. Can we start to think that maybe you're generating 60% or even maybe a little bit higher gross margins in the not too distant future just given your mix?

I appreciate the question. You're right. We don't comment on 2017 and the future until we get to our strategic retreat and our budget process in our three year planning cycles that occur every year. The only reason I gave a little hint was that I want to remind people that the HeartCode products have three partners involved and it's been a top performing product for us the last two quarters and it has a lower gross margin than even the ICD-10 product. So, I did want to remind people of the structure of that product as you think forward. That's really the only commentary I'll give going forward.

That said, you're correct, products like Checklist Management that's wholly owned and probably sports a gross margin over 90% performed really well in the quarter, adding tens of thousands of subscribers. And we also saw our post-acute section perform well. We mentioned that big win and the really nice thing about that win is they bought products across multiple segments. So, we felt encouraged by that. And so there are many challenges that manifest in the quarter but back to gross margins, I think we'll stick with what we said for the remainder of the year and stick to our guidance and work hard to deliver that in the remaining two quarters of the year.

Thank you.

Robert Close, Canaccord Genuity.

This is Richard Close. Good morning. I was wondering if you could put any more details around the record first half sales in terms of what maybe the year over year growth was on your bookings?

No. We don't guide to bookings. But we wanted to explain why and we don't talk about bookings but we felt it necessary to explain why we had confidence in our guidance this time. And it is based on the fact that we had a heavily weighted backend tail cycle. And that's part of the challenge and the opportunity, right? Because we had expected more of those sales to come in January, February, March, and April, and instead they came in May and June. So, that's really all the commentary that we'll provide on bookings and sales but we wanted you to know with some confidence that we did set records and it created an implementation backlog. So, if we can just get through the execution of implementing, we can deliver the growth rate that we projected.

Okay. And then I've been following the company here for a decent amount of time and I was just curious, I don't remember this happening ever in the past. Was there something that changed or anything that maybe caused the bookings to come later in the quarter?

No. It was just kind of the cycle I think. And since we don't ever talk about it, we've had these before, we've just never had where we needed to explain the revenue side in so much detail. It was such a heavily weighted second half. And more so than we had planned and certainly more given our annual guidance than you guys had all modeled. And so we felt it was necessary to talk about it. But we've had cycles.

Q2 and Q4 are usually stronger periods in general. It's just that relative to maybe our plan and therefore the way you ended up modeling things, it was a little bit more heavily weighted in the last two months. So, there's really not much more I can say about that. We had modeled a little earlier in Q1 and a little bit of a miss on our part and it all came at the end of Q2. There's no particular reason that we can identify. We had some things slip from Q1 to Q2 and our teams found a way to reel them all in and close them all at the end of Q2.

Okay. And then with respect to the DSOs, can Gerry just go over that again? Was that -- anything specific? Or was it just the bookings coming in late in the quarter? What exactly -- I didn't quite catch that.

Yeah. Sure. I'll try to explain a little bit. During our implementation of the NetSuite financial platform, the April to May billing cycles, invoices to the customers went out a bit later than normal. And so that resulted in a slowdown in cash receipts. That's what I was trying to explain with my comments. We're now back on schedule but we need to work hard to get those cash collections back and caught up and reduced and come to zero balances.

Okay. And my final question, and I may have asked this in the last couple quarters, but the advisory board has restructured their sales force to move away from selling individual products to more of a solutions sale. And, Bobby, you talked about this post-acute where they're buying patient experience as well as the core workforce I guess as well. Are you guys selling more on a product by product basis or a more solutions sale yourself? How do you think about that going forward?

Right. I'll just remind you of how our sales organization is structured in general, just to kind of overarching understand, it's structured around the buyers. We've identified about six or seven core buyers across our three segments and we've found ways to structure the sales team. About half of the sales team are account managers that carry quotas. And they build account level plans and they're expected to bring in specialists from these seven or so areas.

And then we target the VP of HR that had a revenue cycle or VP of Finance, the CNO, the CMO, the Head of Risk, the Head of Quality. Those are all -- and the Patient Experience Officer, they're all targets for the sales organization. Now, we go in and solution sell by specialist area. So, you can kind of oversimplify but think of about six or seven teams of 12 to 15 that focus on that buyer and they do indeed go in and show all of the relevant products across sales streams to that buyer.

And so there are kind of groups of products and solutions that are taken in by these specialists to the specific buyer. And the account manager's job is to orchestrate how those six or seven specialists come into the account plan for our existing account structure. Hopefully that gives you a little indication of how we're structured. We're doing a little better job now through the account planning process of bringing in two or three specialists at a time and bundling up what we call a big H sale, which is kind of a HealthStream sale that includes solutions from multiple groups, targeting multiple buyers.

And so we are getting a little better at that, at least in this one big system level win. That was exciting to see all that cross selling occur in that one account. And also the post-acute account was exciting because we've told everyone that expanding the post-acute space is important to us.

Okay. Thank you.

Scott Berg, Needham & Company.

Hi, Gerry and Bobby. Thanks for taking my questions. Just a couple of quick ones here. Gerry, could you help us reconcile deferred revenues that were down more than expected in the quarter kind of given the strong bookings that you guys had talked about in Q2. I guess I'd expect for them to be a little bit stronger and maybe try to understand what all the puts and takes are involved with that line item in the quarter?

Scott, can you say that again? Did you say deferred revenues? Or did you say ICD-10 revenues? What did you say?

Sure. Deferred revenues.

The best way to describe that is the last year, the impact in the first quarter of 2015 -- sorry, the second quarter of 2015 was a reduction in revenues of about $2.7 million, all related to the HealthLine acquisition. This year's second quarter, that number is only $439,000. So, what I was referring to was the increase in revenue is related to the change in that level of deferred revenue write-down in the different periods. So, it's roughly a $2.2 million swing. Does that help answer your question, Scott? Maybe I'm -- ?

Yeah, no. It was more total deferred revenues in the quarter were down. Given the record bookings in the quarter --

Oh, balance sheet.

Yeah. On the balance sheet. Not the -- not related to the acquisition.

The biggest driver there is last year we saw quite a bit of ICD-10 contracts in the balances of deferred revenue. Those have all been amortized into revenue. That's why that balance is down on the balance sheet.

All right. I guess as a follow up to that, is -- Bobby, you had a good quarter on the post-acute side. You at least called out a large transaction that bought kind of a full suite of products. Can you maybe talk about sales pipelines there and any increased traction that you're seeing in post-acute care now that it seems like you've got some content and technologies that are certainly more ready to sell into that segment than what we've seen over the last maybe 12 to 18 months.

It's just been a steady contributor as part of our subscriber account every quarter. And this quarter we highlighted one particular account that has over 20,000 subscribers. That was great to see. I would characterize it as a nice steady pipeline and we're learning to target the middle and upper and lower -- the whole spectrum of that market which has smaller organizations in it.

You've got to learn to sell those and then obviously we delivered one system-level client this quarter. And so I would say we're just getting better at taking our suite in and finding what parts of our suite that we've sold for over a decade to the acute care market is applicable to the post-acute settings. And we're just getting a little bit better at that.

Great. That's all I have. Thanks for taking my questions.

Thank you.

Matthew Gilmore, Robert Baird.

Thanks for taking the question. I wanted to ask another one on the sales activity. I know you don't give the bookings numbers themselves but can you maybe give us a sense for how you define bookings or sales. Is this an annualized revenue contribution? Or is it more of a growth value of the contract which could be spread over multiple years.

Yes. It's spread over multiple years. So, when we think of our internal measures, it's the total contract order value and so that's correct to say that if we sign a two or three year contract, we have multiple ways to look at it but the one we're referring to was the total value of orders, the total contracted value of orders in this first half of the year was greater than ever before.

Got it. As a follow up to that, is it safe to say that the terms of the contracts, in terms of the duration are no different this quarter than in previous years?

I think on average that's a fair statement, yes.

Okay. That's helpful. And then on the patient experience side, do you -- you mentioned the large contract costs and then also this nice win on the post-acute side and you've given some information in terms of what contributed to the win on the post-acute side and being able to leverage multiple aspects of the business. Can you maybe characterize what the loss was? Was that on the acute hospital side? And then what factors contributed to the loss, just so we understand that better?

I think because it actually was post-acute and without naming names it was a competitive situation. And we lost to the competition on the renewal. So, it was an existing account and we'll work hard in a few years to try to bring it back in. And they'll remain a customer for some of our other product service sets. So, it wasn't a loss of the customer. It was a loss of the customer for the patient experience business. And we'll fight hard and try to win them back. But it was just a head to head competition and we lost.

Got it. Great. Thanks for taking the questions.

Vincent Colicchio, Barrington.

Hey, Bobby. It's Vince here. I'm curious, were you able to cross sell other products to any ICD-10 subscribers in the quarter? And how conservative do you think your ICD-10 revenue forecast is for the year?

We're always cross selling but at this point the rate that they are dropping off is probably faster than our ability to predict how many we'll save by cross selling. So, we've kind of modeled them effectively all coming out by the end of Q1 next year. We have a lot of -- as it gets smaller and smaller we get more confident in the scale. And what we're seeing now is the next two quarters, being the one we're in now third quarter and fourth quarter, we expect about $1.1 million in this quarter and a little under $1 million in next quarter.

The reason it's kind of flat is a lot of the extensions we've signed carry people through to January and February of next year and then we expect it to go ahead and drop off. In this particular product category we call ICD-10 readiness, probably close to zero through Q1, a rapid drop off after that. So, we're pretty confident in this run out and what we're working on is the offsetting revenue from the new product called DNA and we continue to sell that as an offsetting product as well. But we are fairly confident that the numbers for your model will be about $1.1 million and a little under $1 million for Q3 and Q4.

Thanks for that color. Could you give us an update on the M&A markets, have valuations gotten any better out there? What does it look like?

You know, I'm not sure that I'm seeing valuations get any better but we're pretty select in what we've been doing lately. You can see from our last couple, we brought in some assets and people that we think are really leveragable across our network. So, that's an exciting new area. And I would say that the pipeline is active for all three segments. So, we're not looking at any one area. We have a couple of ideas in each area and we're going to chase them all down and keep investing in this area because we do think that we have a strong network and part of a network is to deliver a network effect in the long run for shareholders. And so there are definitely more technologies and assets that can lever the breadth and scope of our network.

Do you have any potential acquisitions in your pipeline that would involve proprietary content on the workforce development side?

Well, these last two were just that. If you think of content more broadly as data or database or in this case tests and databases and benchmarks, so what we're really excited about with these two acquisitions that we just announced is they have historical data sets that allow for proprietary benchmarking and the tests themselves are a form of proprietary content. So, both the test questions and the test answers which we have a lot of history on now will form a new type of content for us that I'm pretty excited about.

Thanks for answering my questions.

Frank Sparacino, First Analysis.

Hi, guys. I'll keep it short since we're running out of time. I just wanted to go back to an earlier comment around the provider segment and the shift to more of a subscription versus pure professional license model. Can you give us a sense just of the magnitude of that change? Maybe what the business was when you acquired it in terms of license and where it is today and where you think it's going?

I don't think I have those numbers in front of me. I should have them but I don't. We might have to save that for next quarter. But the business had been around for almost 30 years and it sold all forms of software in its history, including purely installed software. And along the journey they moved to a subscription selling model and then a web-hosted subscription selling model. And increasingly of course we're selling at every turn we can the subscription based web delivered model. But there's still a little bit of a legacy installed revenue recognition and some installed sales but at a lower rate. So, I don't have the magnitude of those shifts. And that's something we can make a note of and talk about in the third quarter.

Thank you, Bobby.

Ryan Daniels, William Blair.

Good morning. Thanks for taking the questions. The color so far on the record sales, I have one more follow up there. Just curious, Bobby, if you can talk about what in particular is resonating? I know you talked about the resuscitation products. But in particular any specific platforms that are proprietary that are selling well or any content that is accounting for those record levels?

The really nice thing about the sales were there were no huge single deals that carried that record and they were spread across a lot of exciting areas. So, for example, our new KnowledgeQ product which you can think of as the third generation of our OSHA mandatory training product which is really what put us on the map, is starting to get some traction. So, what was it -- a couple million in orders? Is that about right? A couple million I orders on the new KnowledgeQ product which you remember we own wholly.

So, we own the content, the data, the platform, it's a fully vertically integrated product. So, it will have high gross margins as well. So, it's fun to see a little traction in the -- in that particular product. Some of the use-based products that involve control centers, which that one, the KnowledgeQ is one of them or getting in the market and so we're seeing steady contribution to the clinical area. I mentioned that as well. CECenter while not breaking any records has been steady.

The clinical association content has performed well. We mentioned the 22% growth rate across the clinical product portfolio. Really, we -- and we had that big win, that really solid win in the post-acute setting where they bought across the entire portfolio. So, it was really a nice balanced selling quarter. Now, I wish it was balanced across the first six months of the year. It all seemed to occur in the last 50 days of the two quarters and so it didn't quite happen the way we had hoped but it did happen.

Okay. That's helpful. And you mentioned now that you have the sales, the key is implementing those clients. Can you talk a little bit about your confidence level there, both with your internal staff to do that and then I'm curious of the client's bandwidth to take that on and ensure that the revenue's recognized through the back half of the year as you anticipate?

Some of it is dependent on the customers in all these cases, when you sell this type of service software and solutions. And so we try to carefully weight that with our historical ability to execute. And we have some new execution areas like in the provider solutions segment where they've been working on improved and enhanced implementation processes for the last several months that we think will come to fruition in the next coming quarters. So, it is an execution challenge but I think we're up for it. We've got good teams that are aware of the challenge. And it gave us the confidence to deliver guidance. So, we try to assess all the risks involved with that and we still feel like we're going to deliver it.

Great. Thanks for the color.

Richard Close, Canaccord Genuity.

Yeah, one thing I did want to ask is with respect to the two acquisitions, I know they were small in nature, but when do you expect those to get ramped up and begin -- really beginning to contribute to revenue?

They'll have a small contribution to revenue in the remaining two quarters but it does represent a new investment area. To be clear, these are two small platforms and we'll want to reengineer parts of them and add technologies to them. Like we do expect those technologies to leverage our investments in Juice Analytics. We'll be building new analytics capabilities wrapped around those products. And so it will take a little time to integrate but we'll see some small revenue contributions, even in the second half of this year.

And finally as you look out and see what the purchasing trends are, are you more optimistic about the long-term growth of the company? Or less optimistic? Any thoughts there?

I'm not going to provide color going out into 2017 and 2018 and 2019. I think we clearly had some challenges this quarter that kind of converged on us and the timing of things didn't happen as planned and we spent more on a big enterprise infrastructure system. But we dug deep and thought hard about the second half of this year. And we feel good about our guidance. I think you know, Richard, we go through a really detailed planning process in the remaining four months of every year and we'll come back out and share the plans for growth and opportunity 2017 forward. We always do that around February.

Great. Thank you.

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

Thank you to everyone following our company, the analysts in particular who work hard to convert our annual guidance into quarterly guidance and quarterly modeling which I know is difficult. We clearly had some challenges for the quarter but there's some optimism all throughout the company and all the segments. So, we're going to work really hard to deliver the second half of this year as we've just guided. We look forward to reporting our third quarter and thank you to all the employees working so hard through this period to put all these new systems, software, infrastructure, and execute the implementations that we need to deliver the second half of the year. Thank you. Look forward to next quarter earnings report.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.