HealthStream Inc (HSTM) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to HealthStream's Second Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like introduce your host for today's conference, 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 2017 results. Also in 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 risks and uncertainties that could cause the actual results to differ materially from those projected in the forward-looking statements. Information concerning these risks and other factors that could cause the results to differ materially from those forward-looking statements are contained in the company's filings with the SEC, including Forms 10-K and 10-Q.

So with that opening, and I'll turn it over to Bobby Frist.

Thank you, Mollie. Good morning, everyone, and welcome to our second quarter 2017 earnings conference call. As always, I'll start with a few highlights and turn it over to Gerry for some details, on financial performance.

Our second quarter performance on our core financial metrics did turn out pretty strong this quarter. Compared to the second quarter last year, quarterly revenues were up 12%, reaching $61.5 million. Operating income was up 23%. Net income was up 62%, and adjusted EBITDA was up 25%. The results showed sequential improvement over the last quarter, and it's that sequential improvement that gives us confidence in our expectation of continued leveraged operating income growth for 2017.

Second quarter revenues were up 10% over the same period last year for our Workforce Solutions segment. The continued drag -- and we've talked about this for almost 3 years, but the continued drag of the ICD-10 revenue drop-off was offset by strong contributions from our compliance solutions as well as the continued performance of resuscitation products.

In our Provider Solutions segment, second quarter revenues were up 53% over the same period last year. This was due in part to the inclusion of the Morrisey acquisition and this year's year-to-date results after we acquired that business in the third quarter of 2016.

In our Patient Experience Solutions segment, second quarter revenues were down slightly at 4% less than the same quarter last year. I'm going to elaborate in more detail in each of these 3 segments in the second half of the discussion after Gerry gives a more detailed look at our core financial metrics.

I'll turn it over to Gerry.

If only -- Gerry, no, I do want to dive in. There's 2 points that I want to save until the very end. I'll go ahead and get them up here early in the front. So there are 2 points about the quarter that are worth highlighting from my point of view. The first point relates to sales. And so these are our sales generation during the second quarter. They were less than expected in our Workforce Development and our Provider Solutions segments, while sales from our Patient Experience segment they were ahead of plan.

While our sales pipeline remains healthy, our Q2 sales performance did not meet expectations. That was what led us to pull down our revenue guidance range for the full year. And I'm sure we'll talk more about that later in Q&A as well.

Second point relates to our combined focus and continued focus on returning to operating income leverage, which has averaged from our 23% growth in operating income and 62% growth in net income compared to the same period last year. We've taken several measures both in changing partnerships to improve margins, how we operate business segments with the closing of a remote office to improve efficiency, improve margins and improved leverage. Some of this will continue to materialize in the second half of the year.

And we achieved this leveraged operating growth -- income growth despite a $1 million margin loss on the ICD-10 readiness products on a year-over-year basis and the deferred revenue write-down related to our August 2016 acquisition of Morrisey Associates. So a core focus for the company is generating more operating leverage and generating more operating income from the revenue growth we're delivering.

With those 2 points up front, I'd like to turn it over to Gerry for a more detailed look at the financials.

Thank you, Bobby, and good morning, everyone. I'll provide some additional information about our financial results, including certain items that impacted the quarter.

For the second quarter, consolidated revenues were up 12% to $65.1 million.

$61.5 million.

I'm sorry, $61.5 million, excuse me. Operating income of $2.9 million was up 23% versus operating income of $2.3 million in last year's second quarter. Net income was $2.3 million. Earnings per share was $0.07 versus net income of $1.4 million and $0.04 per share earnings in the second quarter of 2016. Adjusted EBITDA was up 25%, as Bobby just mentioned, to $9.9 million or $7.9 million in last year's second quarter.

During the second quarter, the Morrisey Associates acquisition, which closed in August of 2016, contributed approximately $2.6 million of revenue and incurred an operating loss of $416,000, primarily due to the deferred revenue write-down accounting convention.

Now let's look at the 4 areas of the income statement: segment revenue, gross margin, operating expenses and operating income.

Revenue. Revenues from our Workforce Solutions segment increased by $4.1 million, while overcoming the $2 million year-over-year decline in ICD-10 readiness revenues in the second quarter.

Now let's take a look quick look at the Workforce ARIS. For the second quarter of 2017, HealthStream's Workforce ARIS was $38.16, which is up when compared to last year's second quarter of $35.70 and this year's first quarter of $37.68. So we grew ARIS both quarter-over-quarter and sequentially. ARIS, as we discussed in previous quarters, is also subject to movements that can seem counterintuitive. For example, adding a highly desirable number of subscribers can actually drive the ARIS down if the amount sold to each subscriber does not equal the -- or exceeded the actual previous quarter's ARIS. Similarly, losing subscribers who pay less than the previous quarter's ARIS can drive ARIS up. It's also important to keep in mind that ARIS does not include a complete look at our business, as 2 of our 3 business segments, Patient Experience and Provider Solutions, are not included in ARIS at all.

We continue to evaluate new metrics that encompass all of our business. Revenues from our Patient Experience Solutions segment in the second quarter of 2017 were $8.6 million compared to $9 million in the second quarter of 2016. Revenue from Patient Insights surveys declined by $140,000 and continued the trend towards greater adoption of online patient surveys, which carry lower price points than phone surveys but produce higher margins for us. For example, for the first 6 months of 2017, the volume of phone-based patient surveys declined 28%, while online patient surveys increased by 12% in the same period. However, the Patient Experience gross margin has increased by 400 basis points over the first half of this year.

Revenues from other Patient Experience Solutions, including surveys conducted on annual or biannual cycles, decreased by $266,000 compared to the second quarter of last year. This decrease is primarily due to the timing of engagements compared to the prior year. In the second quarter of 2017, revenues from our Provider Solutions segment increased by approximately $3 million, with Morrisey Associates acquisition representing approximately $2.6 million of that increase.

Now let's look at gross margins. Our gross margin was 57% this quarter versus 59% in last year's second quarter. The impact of the Morrisey deferred revenue write-down and the final rule on office closure cost are the primary reasons for this lower gross margin. This quarter does represent continued sequential improvement as the gross margin has increase from 55% in the fourth quarter of 2016 to its current 57%.

Let's turn our attention to operating expenses. Operating expenses for the quarter were up 8% over the second quarter of 2016. The combination of capitalized software investments and product development expenses grew by 8% year-over-year, even though the product development category on the income statement showed a year-over-year decline of $200,000.

Sales and marketing expenses increased mainly due to higher commissions costs. Depreciation and amortization also increased 29% over last year's second quarter, reflecting increased levels of capitalized software development amortization and the amortization of acquired intangible assets from the Morrisey acquisition.

G&A expenses in the second quarter of 2017 were relatively flat but improved as a percentage of revenue to 13.9%, which compares to 15.6% in the second quarter of 2016. It's important to note that the G&A expenses are subject to increase in the second half of this year as we incur implementation and compliance costs related to the new GAAP [rev] -- recognition accounting standard known as ASC 606. We anticipate that this expense will be approximately $1.3 million over the next 6 months.

Operating income. Operating income was $2.9 million in the second quarter of 2017 compared to $2.3 million operating income in the second quarter of 2016. The increase in operating income reflects leverage on our product development and G&A expenses, while we overcome the $1 million margin loss from the decline in ICD-10 revenues, the Morrisey deferred revenue write-downs and the higher depreciation and amortization expenses I just mentioned.

Now our balance sheet. Our cash position and the overall balance sheet remains strong. Our cash balance at June 30 was approximately $116 million, a $30 million increase since December 31. A significant contributor to this cash balance has been improved collections. The sequential drop in DSO to 71 days at December 31, 2016, to its current 57 days resulted in a $7.5 million reduction in accounts receivable balances.

We have no outstanding debt, and our full $50 million line of credit capacity is available to us. We believe our overall capital position is likely to support our organic and inorganic growth opportunities and support other capital structure optimizations and true [value] maximization strategies as may be appropriate.

Cash flow from operations on our cash flow statement has improved to $23 million in the first 6 months of 2017 versus $285,000 for the same period in 2016.

So before I assess guidance, I'll describe the fluctuation in our effective income tax rate. Effective January 1, 2017, we've adopted a new GAAP accounting standard that applies to book income tax accounting. Specifically, the new standard flows the tax benefits, the stock option exercises through the income statement as part of the income tax provision. In past years, that transaction went directly to the balance sheet, bypassing the tax provision. The most important thing to note is that there's no change to our federal income tax position for our cash flows. We have already taken this adoption with the (inaudible) of federal income tax liabilities.

Yesterday's earnings release contains updated guidance for the 2017 full year. We anticipate that consolidated revenues will grow between 8% and 10% as compared to 2016, and the growth in our 3 operating segments will be as follows: Workforce Solutions, 4% to 6%; Patient Experience Solutions 3% to 5%; Provider Solutions, 47% to 51%; (inaudible) ICD-10 revenue -- (inaudible) revenues will be approximately $1 million in 2017 versus $9 million in 2016, approximately an $8 million decline during this current, 2017.

We continue to anticipate that our full year operating income will increase 50% to 65% over 2016. We anticipate that our capital expenditures will be between $15 million and $17 million and our effective income tax rate will be between 32% and 36% for this current year. This guidance does not include the impact of any acquisitions that we may close during the remainder of this year.

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

Thank you, Gerry. I think what I'd like to do is to dive in the segments in a little more detail. I'll give some business updates on each of them. So let's start with Workforce Solutions. At the end of the second quarter, around June 26, we announced that our current agreements with Laerdal Medical for the HeartCode and RQI products will expire, and they will expire on December 31, 2018.

It's important to note that HealthStream retains the right to and expect to continue selling HeartCode and RQI for the next 1.5 years. And importantly, we'll provide uninterrupted service to our customers for the duration of their contracts. Those contracts could be extended through December 31, 2020. As we stated, this news does not affect our financial guidance for 2017.

And so related to that, we are committed to broadening the scope and utilization of our simulation technologies as a method of validating a wide range of clinical competencies, including and beyond resuscitation skills. Next-generation mannequins, virtual reality and augmented reality are among the innovative and disruptive technologies we plan to bring to market. Those technologies will enable us to deliver choice, lower cost and more effective simulation-based training solutions in the future.

To this end, we are in active negotiations with a number of strategic partners. In fact, just last week, we signed a long-term agreement with a new partner. This agreement will feature unique integrations with HealthStream's platform, including HealthStream's emerging technologies such as our credentialing systems, the EchoCredentialing systems, and ePortfolio, a newly announced product. In the coming months, we expect to introduce a number of new partners and technologies as part of our expanded approach to using simulation technology for a broad range of clinical areas, which will include multiple clinical specialties, nurse onboarding and beginning in January of 2019 resuscitation skills.

I'd like to turn our attention to the Patient Experience segment for just a moment. We continue to anticipate improved margins from this segment, particularly in the second half of the year. For example, during the quarter, we continued to see an uptake in new clients purchasing online surveys, as Gerry mentioned. These have a higher margin than phone surveys, and existing clients are converting from phone to e-mail and SMS text surveys.

We've now converted about 1/3 of all surveys capable of being converted from phone to online surveys, and we expect this conversion trend to continue throughout the remainder of the year. As you know, we closed our Laurel, Maryland, interview center in June and consolidated operations to our Nashville interview center, which is a newer center. And the cost of those -- of that closure was borne in the first and second quarters, and so we expect to have those costs out of the system in the second half of the year. Both of these developments, the shift to the higher-margin products and the closure of the Maryland office, should continue to have a positive impact on Patient Experience margins for the remainder of the year.

In our Provider Solutions segment, we are focused on switching to the software-as-a-service model and shortening implementation cycles. In previous calls, we've talked about an implementation backlog, and so a brief update on that. Over the last 3 quarters, we've made meaningful improvements in our Provider Solutions segment, which are resulting in moving customers forward in their implementation process.

In the second quarter, the backlog of unimplemented customers on our EchoCredentialing solution was significantly reduced to levels that we consider to be routine and sustainable. The backlog accounts currently remain for our Morrisey acquisition solutions, but we expect to replicate the success we enjoyed with Echo across the Morrissey customer base, applying the same methodologies, protocol, procedures and now experienced staff and correcting these backlog issues. So we expect improvement over time the next few quarters in the Morrissey-associated backlog.

Earlier this month, we announced several exciting changes to our senior leadership team. And I want to highlight a few of those before we turn it over to questions. Jeff Doster was previously in the role of our Chief Technology Officer. He was named Chief Information Officer, a new position at HealthStream.

We also announced that Scott Fenstermacher was promoted to Vice President and Head of Sales, which will make him our top sales leader, overseeing sales in our Workforce and Patient Experience segments.

And finally, with the move of Jeff Doster to CIO, we added Jeff Cunningham. Jeff Cunningham joins us as Chief Technology Officer, so having split this role to accommodate more rapid development and evolution of our platform security, reliability and scalability, now having both a CIO and a CTO.

We congratulate Jeff Doster and Scott Fenstermacher on their promotions. And Jeff Cunningham, we like to welcome to our leadership team at HealthStream.

At this time, I'd like to turn it over for questions.

(Operator Instructions) Our first question comes from Ryan Daniels with William Blair.

Bobby, first one for you. You mentioned some weaker sales than anticipated in Q2. And I'm curious if you can go into a little more detail regarding if that was related to any specific products, number one. And number two, do you view it more as a kind of competitive issue? Or is it more of a market-related issue where you're seeing more hesitation in the client base?

Yes, Ryan. Let me try to characterize some of that. I mean, it's -- we came off a strong fourth quarter and then a strong first quarter, first quarter having exceeded our expectations in many categories, be it internal quotas and budgets that we set. And so we moved into the second quarter with some optimism, but we did see a slowdown and particularly in the workforce product sets. And no particular products, we just had high expectations across the set of products, even compliance, which is outperforming, was a little below expectation. So our clinical products that we've talked about in the past were also below expectation. Again, this is probably a function of having high expectations. But we did miss our internal goals. And I don't know if I can attribute it to macro conditions. There are a few internal issues. We are behind in our open sales divisions. We have about 15 open positions, some of this is attributable to the fact that we have elected to do direct hiring instead of through the recruiters. So it's slowed down our hiring a little bit. So that was a contributor of it. Also, on an individual production basis, we just didn't meet expectations and, again, predominantly across the Workforce Solutions segment. I'm not willing to say that it was macro conditions. We're 1 quarter in. And so it was just sales productivity issue and maybe too high expectations, as we've recalibrated around now and, unfortunately, had to adjust our guidance, reflective of lower expectation and lower results in the second quarter. So the combination of variables, I really can't pin it on any one thing. The individual productivity was lower than expected across Workforce, I would say, broadly. And we are down headcount, about 15 from our plan. And we're trying to fill those but at a different rate. We're not going to just out and use recruiters and have really high costs. We're going to be more selective and try to bring in the right people. And there was a little bit of deal push, but we'll see how we pick that up in the third quarter. So I'm not going to give any specific attributions except to say we're disappointed in the results and we had to recalibrate our guidance.

Okay, that's helpful. And then another big picture question. Last quarter you talked a lot about the rollout of the new enterprise platform for HPC. Can you give a little bit of an update there on, number one, the mobile platform and early customer feedback? And then number two, what percentage and what number of the book of business you've transitioned to that?

Yes. It's fantastic results on this new rollout. It's fully integrated with the HLC. So the competency center and performance centers have a dual upgrade that you're mentioning. It's actually going very well. We're -- I believe we're over 80% switched. There's only one more wave of deploys coming in the middle of next month, mid-August. We've had 3 waves of deployments that have taken over 80% of our customers through the migration. What I'm most excited about is exactly how quiet it has been, meaning great receptivity, no workflow issues. We've done, I think, a really good job. I congratulate our teams on a really good job of this material upgrade and swap out of the technologies. We staged the customers in waves where they accepted and were ready for those migrations. So again, very solid acceptance. It provides a new level of integration and capability to customers to have the learning and performance centers operate much more functionally together. And I've just got an update here written down for me that we're about 92% converted. So there's only 8% left. It'll occur in mid-August, and the reports from the field are fantastic. I think this should, we expect, help some sales momentum on that product as we build more referenceable accounts on this new and exciting platform.

Okay, great. And then a quick housekeeping for Gerry. Do you have the cost of the office closure during the second quarter, as I know that's kind of a onetime item?

About [$110,000] $200,000.

Our next question comes from Matthew Gillmor with Robert Baird.

I wanted to ask a little bit more on the sales trends. Can you give us some sense for the trend that mean -- or what happened with renewals? And then Bobby, I think you just mentioned there was deal push too. Can you maybe provide some details on what you meant by that?

Yes. There were -- so renewals we felt were strong. They were good in the quarter, no anomalies or anything of any size or scope that would draw our attention. And so renewals on core products were solid and good. So don't think that, that was the issue. I mean, there's a normal amount of churn in all the products but, again, nothing exceptional and no concerns related to renewals. The deal flows too were just a couple of deals that were biz dev related that are strategic in nature and also come with product sales. They're a little more complicated to negotiate because it's not just an outright sale. The consumption, the use of product, is coupled to what we hope will be another long-term strategic partnership. And so that was a mixture of the sales team's efforts and the business development functions of our company and got a little complicated. And we still hope and expect that, that new relationship will come on board. But it -- we had hoped for it at the end of the second quarter. So when I referenced the deal push there, just a couple, and they were of scale, and so -- and we still haven't brought them in yet, so we're working on those here in Q3.

And just as a quick follow-up to that. Are those embedded in guidance? Or would that be not something that's included in the growth?

Yes. It wouldn't be upside to guidance. It was -- the relationships and products sales are factored into how we thought about the full year. And so I wouldn't characterize it as upside. I would say that we're expecting to land this relationship and what comes with it this year.

Okay. And then maybe one on the go-forward strategy for resuscitation, and I appreciate the comments you made on the next-generation simulation and the products you expect to bring to market. In our discussions with hospitals, it seems like the AHA card is really what's required versus another CPR certification. So can you sort of help explain how the AHA sort of comes into this? Is your strategy more focused on convincing hospitals to accept another credential? Or are you going to somehow kind of get the backing of the AHA with your new products?

Yes, we're going to lay all that out over time. I mean, the first thing to note is that we have 1.5 years to focus on the current relationships with both Laerdal and AHA and successfully take those products to market as we've done for many years. And so I think the first thing to notice is to -- it is our hope and expectation that many of these relationships will last all the way to 2020. And so we're talking about things in the future. And so the nature of our strategy to combat the loss of Laerdal is comprehensive and evolving. And we just announced, for example, one new partnership related to it. In this segment and solution group in our business, we hope to expand the use of simulation technologies beyond what has historically been a single use around resuscitation. So the first thing to note is just strategically we'll be announcing and working with more types of partners that enhance our simulation-based form of competency evaluation across a broader set of skills. And so we won't be backflowing resuscitation with just resuscitation. You did mention an AHA card. It is true it is not required or a legal requirement that it's an AHA card. It's really what's important I think in the market are the standards of the training. The AHA card has become historically the leading credential in this space and certainly the most important way to recognize compliance standards or compliance with the standards. The standards are set by international bodies. One is called ILCOR, which AHA is a member of, and then ILCOR publishes standards in the U.S. So there are alternatives, but the market has become used to and accept -- most accepting of the AHA credential. And so our strategy over the next couple of years maybe to embrace alternative credentials and it maybe to try to work to bring the standard credentials back in. So again, it'll play out over many years. And the only thing we're going to announce today is the strategic broadening of focus on competency-based validation through these new technologies, including mannequins, and then we have signed 1 definitive new partnership that takes us in that direction.

Our next question comes from Matt Hewitt with Craig-Hallum Capital.

A couple of questions. First, some of the new products that you've launched here already this year, 6 of them, high gross margin. Maybe a little bit of an update on how those are progressing through the sales channel?

Sure, sure. As we reported, they all have sales in the first of the year. We also reported that they wouldn't have an impact on '17. So they're all brand-new products. We're excited because they do leverage our network and our platform, and we think that some of them are important to our new partnerships that are being formed where they'll leverage some of the technologies and capabilities. Some of them that I'm excited about because they carry different price points and involve broader partnerships, for example, our Nurse Residency Pathway, which is a higher value add. It helps hospitals onboard new nurses and organize their first year of development when they come out of nursing school. And so we share the same optimism. We continue to have sales on the products. And we expect and hope for them to have material contribution in the future, probably beginning in '18, as we get our wheel down and get organized on all of these products. So we remain just as excited. We continue to have sales on them. In fact, one that I didn't mention that is kind of equally exciting is the -- comes from the acquisition of PBDS. We acquired a market -- a skills and knowledge assessment tool and also a reasoning and judgment assessment tool for nursing last year. And we just had a major sale on that brand-new product after it's been resurfaced and reskinned to reflect the HealthStream look and feel, and that product is in a resurgence. And so we're excited to see that new clinical reasoning product take off and have a big win in the first half of this year. The product was historically called -- a PBDS product, and we're excited about that one. I would add that to this list of 6. Maybe that's the seventh one to watch.

Okay, great. And then digging into the sales execution a little bit. I've noticed the last couple of quarters your contracted and implemented subscribers have come in a little bit below your historical targets of around $25,000 a quarter. Is that where you're seeing it on the new contracted or the new adds? Or is the execution where you'd like to see some improvement on the follow-on orders or penetrating accounts deeper with some of your other solutions?

I think we're getting the penetration because that's reflected in the ARIS, right? So the ARIS has been moving up because we're continuing to do good cross-selling and upselling, and we're pleased with that. The subscriber count growth rate has slowed down a bit. There's a little bit more natural churn and scale on some of the base product, but we aren't adding as well. And so the new business development teams are out adding and bringing new subscribers in. It's more in keeping with what we used to articulate as our historical goal in norms of 20,000 to 50,000 per quarter net new subscribers. And so we've been pushing right at that envelope. We've just had so many exceptional periods. We also have a little bit of drag on the number from the final roll-off of the ICD-10-only subscribers. And so there's a little bit of roll-off still in the last couple of quarters, which is kind of adding effectively to the churn, but some of those ICD-10-only subscribers, again, there's a little bit of roll-off. We're almost done with that though as we -- the second half of this year probably won't be much more of that.

Okay. One more for me, and then I'll hop back in the queue. An area that we haven't talked about or I feel like we haven't talked about that much for a couple of quarters anyway is your penetration outside of the hospital setting, the long-term care, ambulatory. Maybe an update on how things are going in those markets and where you see that, I guess, contributing over the second half of the year.

Yes, sure. We declared that vertical a few years back, and it's been a consistent part of our growth story. The mix of adding new customers in the post-acute settings and pre-acute settings has been solid contributor to our growth story. And so it continues to perform. And we're learning more about which of our products can be best carried in that vertical, and we're seeing some good uptake of some of the core content products in those areas as well. So overall, just a solid report of progress and nothing remarkable, but solid, steady incremental improvements.

Our next question comes from Richard Close with Canaccord.

A little bit on the new partnership that you're talking about and may -- some of the simulation products. Is the idea there that you roll out some of these newer products that you're talking about as part of this new partnership and any other partnerships that you get over the next 1.5 years? And then sort of those backfill on the resuscitation? And then you expect to have a resuscitation partnership or product in the market beginning day 1 on that January 1?

Yes. Those are some of the key elements in that. One is that there's a series -- now we've kind of opened our eyes to the possibility in this area. We expect a series of announcements over the next 1.5 years to strengthen our go-to-market strategies, bringing the simulation technologies directly to our customers and a broadening set of partnerships and a broader set of areas of impact. So historically, kind of our core competence was on introducing, supporting and carrying in the message that resuscitation training could be better done using simulation technologies. And I think over the next 1.5 years, since there are no prohibition, you'll see us making much more aggressive moves into other areas of clinical skill development with new partners other than Laerdal in these other clinical areas. And so we're excited about that because these fresh new partnerships see more potential being fresh eyes on what HealthStream has become to leverage our emerging and new technologies that I mentioned like our ePortfolio. So the key to this new strategic partnership was an arrangement around supporting our ePortfolio standards for health care workers. So yes, I'd say over the next 1.5 years we hope for and expect a series of announcements that will bolster the expertise and capabilities we have in this area. And of course, along the way we'll be signing new partners that also reinforce our plans to take new products in the resuscitation market beginning on day 1 of January '19. And so that business development will be ongoing. Sometimes we will announce the partners, and sometimes we won't, depending on where -- the stage we're at. Like the partnership may take time to develop necessary product and get them to market and get a customer using them. So we usually announce things once we're ready for customers to take the products. So that's a little bit of our strategy, and we wanted to give you some confidence that we're beginning to move on already with this first signing, and it's a long-term strategic alliance with appropriate measures to incorporate our -- all of our new technologies like the ones that I mentioned.

And how would you expect the margins to be on those products with the new partners? Are you able to have better dynamics on the margin line than previously?

Well, we do expect that. The relationship with Laerdal was very successful, and it essentially was -- although our agreement was only with Laerdal involved third parties like AHA. And so the margins were some of the lowest margins in our entire portfolio. And I think in these new agreements, we're taking the opportunity to try to restructure and make sure that the full value of what we bring to the equation is in place. So we will expect and do expect and in fact the first agreement reflects an improvement in margins in these go-to-market products. But again, this is a long play. It's going to take several years. And it's important to reinforce, again, both to our customers and to Laerdal and AHA, that we are partners until January 1, '19, and potentially beyond. We plan to carry those products to market, service our customer, our joint customers with great excellence and make sure that they get the full benefit of these excellent products from AHA and Laerdal. And so we continue to be a key player in the role for the next 1.5 years. And we hope and expect that many of our customers will actually extend those agreements through 2020. And so again, we're talking about, in that case, 3.5 years of supporting the existing portfolio of products and generating revenue for them. And so that's all the color we can provide this time. There are many sequential steps over the next 1.5 years to try to rebuild and strengthen the loss of this Laerdal relationship.

One follow-up question with respect to the new partnerships and the newer products that you're talking about there. Is -- are those new dollars for the hospital, your customers, that they have to come up for these products? Or would these products be replacing something -- something older, paper based or whatnot that they're currently using?

Yes, kind of like the resuscitation market, there would be new and enhanced ways of affecting change and measuring competency and skill. So in some cases, they require increased investment but certainly have higher IRR and I think will be more relatable to better clinical outcomes or better business outcomes, like our residency program that we mentioned. We believe that a curriculum like that could affect first year turnover rates and lower them down and have a great economic benefit in doing so. And so I think that some will require a little bit of increased investment from the hospitals. But I think these are going to be higher IRR solutions that really move the needle on competence and quality, and so I think they'll be very investable.

Okay. And my final question would be on Provider Solutions. I think you did mention in talking about new sales that, that was a little light as well, if I'm not mistaken. But you did highlight the last 3 quarters and the improvement in the implementation and, I guess, conversion of the backlog. I guess, I'm a little surprised in terms of maybe the year-over-year growth, excluding Morrissey, maybe wasn't a little bit more, considering the backlog conversion improvement. So if you could just talk a little bit about that and how we should think about revenue growth ex Morrissey going forward.

Sure. So we're still looking off a lot of inherited issues. The implementation backlog is the most predominant issue, but also the switch to selling SaaS software. Remember, we had expected -- both companies that we acquired had installed software. And we had models and expected some continuation of selling installed software, whereas our teams made a much faster shift to selling the SaaS or on the subscription models, which spread the revenue more over longer-term periods. And so as you know, in models that have made switches from installed software to SaaS software, it depends on the rate of change in the customer base on the ability to deliver revenue growth. Getting an installed software sale fully recognized in the first period you sell it versus spreading something over 36 months, it's a trade-off. We think it's an important and valuable trade-off for the long run. So what I would say is that the trade-off is occurring faster than we incurred, meaning that we are selling, I believe, almost no installed software now and selling things on the subscription and SaaS model approach. And so without bringing any installed sales, the revenue growth looks a little lower than maybe we had initially thought we would deliver. But in my view, over a 3 or 4-year period, that's all good news. It's just a faster migration to a more consistent and recurring revenue stream. So there are kind of 2 issues there. The first was a true ops and execution issue. We inherited some fairly immature implementation processes, and we're professionalizing them. I really truly feel that those are at hand. We -- the team understands them, has worked through a full set of them, has normalized them at least for one of the businesses, the Echo businesses, and is now applying those principles to Morrissey. I feel like that, while we reported last couple of quarters, will not be an issue that persists much longer. Another quarter or 2, and then we'll have really good operations.

Our next question comes from Scott Berg with Needham & Company.

This is Peter Levine in for Scott. First question is around the recent changes to the sales organization. Can you talk about any initial or any upcoming changes that you're going to make to the go-to-market strategy, changes to comp and the metrics that you're going to use to kind of gauge productivity? And then the second part to that is what are you going to do to kind of mitigate any potential, I guess, any near-term headwinds to the sales cycles or turnover in the sales organization that sometimes plays out with leadership change?

Yes, yes. So I mean, first, we feel really good about our new leader. And he's a veteran of HealthStream, so he's familiar with our methodologies and ways. So it's a little different from bringing in an outside person, so the amount of change will probably be a little less. Secondly, there probably won't be significant change. We tend to do changes to our structure and commission plans and how we approach the market on an annual basis, really towards the very end of the year and into the January-February time frame. So I imagine and expect that, that will also be true of Scott, the new Head of Sales. I mean, he makes -- he may make some adjustments here and there to how it's organized. But in general, we make the larger changes and address incentive and readjust markets and opportunities usually once a year, around the January time frame when we have our national sales meeting. So I think we have the right person in the spot. Of important note that Scott's background is in the clinical areas, and clinical for us is an important driver of our growth. In some ways what we just talked through on the resuscitation products and expanding the scope of operations there also plays to Scott's background. So I think we have the right leader in place. I do not expect a lot of disruption this year. Regards to the current performance, clearly, we were disappointed. We had higher expectations for growth. I'll point out that we're -- these are -- they're all growing. We've just -- we've missed our expectations and had to recalibrate. So while we're disappointed in that, we're going to figure out which parts are working and tune those as we enter next year with our new leader.

The final question is on guidance. You've brought down the top line but maintained the operating income. So just curious to know, where is that expense or cost savings coming from?

Yes, sure. So in each of our segments, we're making moves to improve margin and leverage what we call our ecosystem and our platform. And some of those moves are more overt, like the ones we've talked through on our Patient Experience segment, where we actually had an office closing, centralizing services and double down some of the higher-margin products. In other areas, it's a recalibration of what we're selling. We're focusing on some of the more completely owned products that have -- that carry a higher margin and so success in some of our areas of compliance as it becomes one of our leading growth story. It was really interesting to look back over the last year. The lead products where the most sales momentum has shifted a few times across a couple of key clinical products. For a while, it was the resuscitation product for about 3 quarters. And lately, it's been our compliance products, so the ones that are -- and they happen to be higher margin as well. And so within the businesses, there's a bit of shift in emphasis towards the higher-margin products. We did adjust incentive a bit to improve the focus on what we call our higher-margin product sets as we entered into this year. I think we'll see the benefit of that in some of the business units in the second half of the year. So just -- I'll just say more a key focus on EBITDA generation and margin and leveraging assets that exist within the company is what's going to drive the enhanced EBITDA and operating leverage.

Our next question comes from Vincent Colicchio with Barrington Research.

I'm curious. You said you're not ready to say there's a macro impact. But I guess, I'm curious, do you think you're seeing any impact from the ACA uncertainty?

I really can't attribute things to that uncertainty, Vince. I -- our buyers have compliance needs that they have to meet. They have needs for retaining their staff. Almost irrespective of the payment system, they have to compete with the hospital across the street. And so they need to invest in these solutions to help them retain their staff and develop their staff and avoid risk. And so (inaudible) they're in a tough spot. They need to make capital investments to retain their staff and develop them, so they don't have the kind of risks that no one wants to pay for anymore. And so I think there's a strong rationale for buying our compliance-oriented solutions and the ones that generate better clinical and business outcomes. And -- but then -- but it also is fair to acknowledge that they're under growing increasing uncertainty and pressure from all of the activities of both our government and their competitive landscape. So I don't like to attribute things to the macro condition. I like to assume responsibility to figure out what we can do better. We always have products that we can sell in any macroeconomic condition, and we're going to do our best to figure out those products and sell them.

On the simulation side, you seem upbeat on your prospects outside of resuscitation, broadening your focus there. Simulation really hasn't taken off like we expected. What's different now, if anything?

I do think that technologies and the measured impact they can have on outcomes, the general acknowledgment of how they're utilizing other industries to have real outcomes and impacts, just continued growth and awareness of the favorable impact that they can have on learning and development and therefore on outcomes -- business and clinical outcomes. And so I just think we're further than the curve. Also, the technologies themselves are advancing. And we've seen emerging technologies from new corners of the world and out at Silicon Valley and other places that I think are another wave of disruption coming from the traditional mannequin-based approach. And you'll see us leaning into those technologies as well. So I think they provide both more educational benefit and potentially easier adoption and more intuitive utilization and lower cost. So I think it's just -- the steady advance technology, I think, we'll get to an inflection point in the next couple of years.

Okay. And then Gerry, what was the contribution of margin in the quarter?

Revenue was $2.6 million and an operating loss of $468,000. From what -- what was the question, Vince? The contribution of Morrisey was your question?

Yes.

(Operator Instructions) Our next question comes from Nicholas Jansen with Raymond James.

A lot of my questions have been answered. But just wanted to focus on your capital allocation philosophy from here. Certainly, it's been almost a year since the Morrisey deal. Just wanted to kind of get your thoughts on the desire to increase M&A given some of the challenges you've seen in the business this year. And then certainly, with the potential hole in the revenues starting in 2019, kind of how would you be considering maybe accelerating some of your M&A thinking to fill that void?

Yes, sure. So we always are actively looking but obviously been more active in prior periods than in the last, say, 2 or 3 quarters. Some of that intentional where we've developed the pipeline for M&A but don't pursue deals as we work through. We've got a lot to work through here with the closing of Laurel, the improvement of margins in PX, the implementation backlogs from prior acquisitions. The difference is I'm feeling more comfortable that all those issues are at hand, and we're on the -- clearly on the backside of all those curves. And we do have a strong capitalization of $116 million in cash and $50 million line of credit. And always, acquisitions have been part of our strategy. In fact, the last time we had this kind of challenge, we effectively -- I think management effectively swapped the ICD-10 50% gross margins business, which was nonrecurring, with 2 acquisitions to build a whole new different segment that has a higher recurring nature and a higher gross margin with the acquisition of Morrisey and HealthLine and putting them together. And so I would say that it will be part of our strategy to increase our activity and search. We were always active in M&A. It's always a part of our management team's core confidence. We had a little bit of a breather here, a couple of quarters, to settle in on all these -- the prior acquisitions and tune them up. As I mentioned, one of our smaller acquisitions, PBS, we had nearly a $1 million sale on those products recently. And now that I feel really good about how all those are progressing, are operationally in hand, we do expect and plan to deploy capital into M&A in the coming months and years.

My second question, I know you guys think about operational investments kind of once a year and you set budgets for them. But how do we think about some of the organic investments you're making this year? When do we start seeing them kind of pay dividends from a revenue acceleration perspective? And then conversely, do we feel like we're at a good expense base where we can sustain this operating margin leverage that you're delivering in 2017?

Yes, I'd say, as you did point out, we work on 3-year plans with our board. We roll out 1-year plans to the market where we talk about our capital allocation strategy early in each year, around February. And so just kind of -- to reiterate, for this year, we are very comfortable with our investment levels and CapEx levels to build and launch in support of new products that we're bringing to market. And we're going to let those 6 or so new products we mentioned plus 1 that I mentioned earlier today, a count of 7, from the acquisition find their way into the market over the next several quarters and then announce a new capital allocation strategy and investment strategy next year. But at least for the next couple of quarters, as we've mentioned through the reiteration of guidance, we expect continued operating leverage and are comfortable with our levels of capital investment and expense investment and product development. Effectively, we had a really nice wave of new products coming out. And we've slowed down the adding of teams in development, while we stabilize and support the products we've already taken to market. And that's a cycle here for at least this year. We'll evaluate it again as we enter next year.

I show no further questions in queue. I'd now like to turn the call back over to Mr. Frist for closing remarks.

Thank you very much for listening in on our quarter earnings conference call. We look forward to reporting the next one. And thank you to all employees who are keeping the ship steady and growing the business. We look forward to reporting our third quarter call in near and upcoming months. Thank you all. Goodbye.

Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may now disconnect. Have a wonderful day.