HealthStream Inc (HSTM) 2018 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the HealthStream, Inc. Fourth Quarter and Full Year 2018 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the call over to Ms. Mollie Condra, Vice President, Investor Relations and Communications. Ma'am, please begin.

Thank you, and good morning. Thank you for joining us today to discuss our fourth quarter and full year 2018 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; and Scottie Roberts, Vice President, Accounting and Finance, who, as announced last quarter, will soon serve as interim CFO.

I would also like to remind you that this conference call may contain forward-looking statements regarding future events and future performance of HealthStream that could 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 start, I'll now turn the call over to Bobby Frist.

Thank you, Mollie. Good morning, everyone. Welcome to our fourth quarter and full year 2018 earnings call. As we begin the year, I thought of 3 things that I wanted to highlight here at the open. A few examples, then we'll do our detailed financial review and look forward to your questions.

Three things are clear. First, we finished 2018 financially strong. For the full year of 2018, revenues were up 8%. Operating income was up 65%, and adjusted EBITDA was up 18% to $41.5 million. Second, sales of legacy resuscitation products outperformed our expectations in the fourth quarter. They were so strong, in fact, that we now expect revenue from legacy resuscitation products to modestly increase from the $55 million of revenue recorded in 2018. Revenue from legacy resuscitation products is expected to peak near the middle of 2019 and decline to 0 by the first quarter -- or in the first quarter of 2021. Strong fourth quarter sales results have positively impacted revenue expectations for legacy resuscitation products for 2019.

Third, 2019 is off to a fast start. We kicked off the year by acquiring a company, expanding our addressable market, launching a new resuscitation product and adding to our leadership team. It's exciting to kind of go on the offensive. Last month, for example, we announced our acquisition of Providigm, representing an investment in our continuum of care offerings, expanding our footprint in this market. This acquisition is a natural fit because the workforce development requirement in skilled nursing facilities overlap with those of acute care hospitals. It's exciting to deploy our capital into an adjacent market, adjacent growth opportunity, early in the year. Providigm is a Denver-based company focused on quality assurance and performance improvement in skilled nursing facilities. Its primary product is known as the abaqis, which is a leading fast-paced quality improvement program. It's been adopted by over 2,000 U.S.-based skilled nursing facilities and nursing homes. And related to that acquisition are some regulations that are emerging. In 2016, CMS published revised requirements of participation in Medicare and Medicaid for skilled nursing facilities, which introduced a competency-based staffing approach. Beginning in November of 2019, so later this year, CMS will require all skilled nursing facilities to have programs in place to assess competencies, provide competency-based education and document the effectiveness of those programs. We've already begun to invest in curriculum and content development with skilled nursing market that will serve as a bridge between the quality improvement program of abaqis and the competency requirements coming into place through CMS.

This year, and third, we've expanded our addressable market from 8.5 million health care professionals to 10.5 million health care professionals, it's kind of a definitional change, so I'll walk you through it. Our addressable market now includes 5.2 million employees in the acute care space and a more broadly defined continuum of care market, totaling 5.3 million health care professionals. We now define the continuum of care as ambulatory services, including physician offices, health and human services, including behavioral health care facilities and postacute care, including nursing facilities. You could see some of the additions to our definition in what I've just expanded upon.

So this expanded market definition comes with a greater growth opportunity as we'll expand our sales organizations to take our new products and services into this broader defined market.

At this time, Gerry Hayden and Scottie Roberts will provide a more detailed discussion of the financial metrics in the fourth quarter, full year 2018 results and provide a financial outlook for 2019. I'll turn it over to Gerry.

Thank you, Bobby, and good morning, everyone. Before reviewing our fourth quarter results, I'd like to note that all results are from continuing operations only and that 2018 results are presented in accordance with ASC 606, which we adopted at the beginning of 2018, whereas results for 2017 are presented in accordance with ASC 605.

Here are some highlights from our fourth quarter. Revenues were up 8% to $59.8 million. Operating income was $2.8 million, up from $1.5 million in the prior year, with an $897,000 positive impact from the application of ASC 606. Income from continuing operations was $2.9 million, down from $3.2 million in the prior year with an $877,000 positive impact via application of ASC 606.

Earnings per share, EPS, from continuing operations of $0.09 diluted compared to EPS of $0.10 diluted in the prior year. Adjusted EBITDA from continuing operations of $9.5 million, up from $8.2 million in the prior year with an $897,000 positive impact via application of ASC 606.

Now let's look at our income statement. Revenues from Workforce Solution segment were $49.1 million and grew by 8% over the prior year. Revenues from our Provider Solutions segment were $10.7 million, and they grew by 10% over the prior year. Both new sales and renewals contribute to the year-over-year growth in both of our business segments.

Now, our gross margins. Our gross margin was 57.5% this quarter and 59.6% in the same quarter last year. This decline is primarily due to higher revenues from our lower margin legacy resuscitation products.

Let's turn the page to operating expenses. Operating expenses were up less than 1% over the prior year as declines in sales and marketing from the application of ASC 606 mostly offset increased expenses in other categories.

During 2018, we continued making investments in product developments, which resulted in a 6% increase in product development expenses over the prior year. Sales and marketing was down $1.7 million due to lower sales commissions from the adoption of ASC 606, and those commissions are now capitalized rather being expensed upfront as we were under ASC 605. However, sales production in the fourth quarter remained strong.

G&A expenses increased $1.5 million or about 16.2% of revenues compared with 14.9% of revenues in the prior year. The growth in G&A expenses is attributable to decrease in the software expenses to support our business operations, due diligence cost related to Providigm acquisition, which we closed in January of 2019, and also high contract related costs.

Operating income and adjusted EBITDA. Our operating income was $2.8 million, up 88% from $1.5 million in the prior year. The operating income margin improved to 4.7% compared to 2.7% in last year's fourth quarter. This adjusted EBITDA improved by 16%, growing to $9.5 million from $8.2 million in the prior year. For the full year of 2018, operating income was $15.5 million, up 65% from $9.4 million in 2017, and full year adjusted EBITDA improved by 18% to $41.5 million from $35.2 million in the 2017 full year.

Now, our balance sheet. Our cash position and working capital remain strong. Our cash and investment balances at year-end 2018 was positive $168.8 million and working capital was approximately $136.4 million. Days sales outstanding were 51 days for the fourth quarter compared to 46 days for the third quarter. We continued to show progress in our receivables management. For example, the fourth quarter 2018 DSO of 51 days compares favorably with the 59 days in the fourth quarter of 2017. In addition, 2018 bad debt expense has decreased by over $500,000 over the full year of 2017. We renewed our line of credit during the fourth quarter and assumed the term -- extended the term date out to November 2020. We have no outstanding debt and maintain our full $50 million borrowing capacity. 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.

At this point, let me introduce Scottie Roberts, who will give us a background of financial outlook.

Thank you, Gerry, and good morning, everyone. Before we discuss our 2019 guidance, I will provide some background and context on 2 topics affecting guidance. The first is our acquisition of Providigm, which we expect to contribute approximately $8 million of revenues from its existing product offerings in 2019. We expect that the combination of additional investments, the amortization of acquired intangibles and the impact of deferred revenue write-downs related to Providigm will result in a reduction in our consolidated operating income of approximately $2 million during 2019.

The second topic is the move to our new corporate location in Nashville, Tennessee in spring of 2019. This move consolidates most of our middle Tennessee operations. In the third quarter conference call, we discussed operating expense increases as approximately $2 million in 2019 associated with the relocation, which also factored into our 2019 guidance. This incremental operating expense increase reflects current national market conditions but is still less expensive than renewing the lease in our current location.

Now, I'll discuss our financial expectations for 2019. Yesterday's earnings release included financial guidance for 2019, which also includes the recent acquisition of Providigm, which we consummated on January 10, 2019 and included our Workforce Solutions segment. We anticipate the consolidated revenues in the range between $251 million and $258 million for 2019 with revenues from the Workforce Solutions segment ranging between $207 million and $213 million and revenues from the Provider Solutions segment ranging between $44 million and $45 million. We anticipate operating income to range between $10 million and $12.4 million for 2019. We anticipate higher levels of operating expenses associated with our new corporate office, additional investments and product development and sales for our new resuscitation products as well as investments to support the growth and expanded market positioning of solutions we attained through the acquisition of Providigm.

We anticipate that capital expenditures will be approximately $35 million, which includes approximately $15 million associated with our new corporate office, which, again, consolidates operations in offices through a central location in Nashville. We expect the annual effective income tax rate to range between 26% and 28%. This consolidated guidance does not include the impact of any other acquisitions that we may complete during 2019.

Thank you for your time. I look forward to working with you in my capacity as the interim CFO. I will now turn the call back to Bobby.

Thank you, Scottie and Gerry. I'd like to start with a quick update on our profits with our Verity business as we do this concluding section. We started the year of 2018 with the announcement of the new unified brand name for our Provider Solutions business, Verity, a HealthStream Company. The unified name signify the combining of the HealthLine and Morrisey businesses along with the launch of our new SaaS-based platform for this business also called Verity. As we've previously discussed, the migration of HealthLine and Morrisey customers from a hybrid SaaS platform to a new Verity SaaS platform, will extend over several years. We've done this kind of migration in our past when we acquired Learning Management Systems and had to migrate them to our new SaaS application. I think we're well positioned to know how to migrate Morrisey and HealthLine customers to our new Verity SaaS platform.

As of the year-end 2018, 36 customers have contracted for the new Verity platform, and our first customer has been fully implemented on the new Verity platform. As our company had extensive experience and expertise in making such migrations, we anticipate continued and steady progress in this migration effort as customers enjoy the benefits of the new Verity platform throughout 2019.

We need to spend some time talking about the resuscitation business. I think it will be helpful to divide that conversation into 3 parts. The first part will address our brand new suite of resuscitation solutions with the American Red Cross. We're really excited about those new product offerings. The second part will address the legacy American Heart Association and Laerdal products that we sold through the end of last year, which I mentioned during the opening of this call. And finally, in the third part, I'd like to discuss our new network connectivity agreement with RQI Partners, which is a joint venture between Laerdal and the AHA.

So let's take the first part. On January 17, we announced the launch of the American Red Cross Resuscitation Suite, which effectively marks the beginning date of our 7-year collaboration. The American Red Cross is one of the most constant and recognizable organizations in the world. Their new resuscitation suite designed for health care -- specifically for health care professionals, doctors and nurses, combines cutting-edge technology with the latest science to offer a new standard of quality and competency development in resuscitation skills. We're excited to bring this innovative new curriculum and choice to the market. The new Red Cross Resuscitation Suite is comprised of BLS, ALS and PALS competency development curricula. It brings updated, highly adaptive competency-based development solutions to health care professionals. It offers certification to health care professionals who are successfully demonstrating proficiency of lifesaving resuscitation, knowledge and skills. HealthStream has designed the capability that makes it easy to set and manage the frequency of practice. With the flexibility to set practice intervals, immersive real time videos and personalized adaptive learning plan, clinical staff have all the tools they need to develop and maintain resuscitation competency and improve patient outcomes. This curriculum is simply unprecedented in its flexibility and capability. Launched 33 days ago, initial receptivity to the Red Cross Resuscitation Suite is positive. Although sales activity has begun now, we've not forecasted material revenue from the new resuscitation suite in 2019, really, for 2 reasons. One, because it will take time to progress through the customer view, budget cycles and implementation; and two, because we sold so much of the legacy platform into our existing base that allow the market -- is committed to that product for some time period. We look forward to updating you on this exciting new curriculum over the course of the year.

Okay. The second part of the discussion is about AHA legacy products, which are known as HeartCode and RQI. As a reminder, at the end of June 2017, we now said our reseller agreements for HeartCode and RQI would expire on December 31, 2018. These agreements did, in fact, expire as expected and will not be renewed. As you know, through December 31, 2018, we have the right to sell up to 2-year subscriptions for these products and sell them we did. It seems that pretty much everyone that wanted to purchase HeartCode or RQI to use over our network and learning platform for the next 2 years, did so, many topped off their existing orders to make sure they enjoy the benefits of the integrated service through the end of 2020.

As a reminder, at the end, HeartCode and RQI generated approximately $55 million of revenue in 2018. In 2019, we expect revenues from these legacy products to modestly exceed the $55 million achieved in 2018. We expect 2019 revenues from legacy products to peak near midyear and decline sequentially thereafter. To be clear, we expect revenue from these 2 products to be 0 during the first quarter of 2021.

That brings us to our final resuscitation topic, which we originally announced on December 6. At that time, we told you about our new agreement with RQI Partners. It's a joint venture between Laerdal and AHA. It's important not to confuse this agreement as an extension or renewal of our expired retailer agreement with Laerdal. Under this new agreement, HealthStream will not be marketing, selling or contracting for HeartCode or RQI. To be clear, we'll be marketing and selling the new American Red Cross resuscitation solutions. Our agreement with RQI Partners provides for continuity of service for customers that desire to purchase HeartCode and RQI from RQI Partners in the future and have it delivered via HealthStream's Learning Center. This is in line with the open marketplace concept we have discussed on previous calls. RQI Partners will remit a fee to us when sales of new HeartCode and RQI are delivered over the HealthStream Learning Center. Given the success we had selling legacy products at the end of last year, we do not believe that this fee will be material in 2019 as majority of our customers who use HeartCode and RQI have already purchased them through us and have contracts to receive them through 2019 and in many cases, through 2020.

I'd like to turn our attention to our new Platform-as-a-Service strategy and our new Platform-as-a-Service platform that we call hStream. Let's turn our attention to hStream and describe it first. With over 4.9 million health care professionals subscribers, HealthStream's SaaS-based platform has long been one of the most adopted workforce development platform in health care. To facilitate innovation and growth of our ecosystem, HealthStream's new platform technology, hStream, was launched 9 months ago. Already, health care organizations representing 1.51 million subscriptions have contracted for hStream. I think our last disclosed number was just a month or so ago, where it was about 1 million, so this is a material update from where we ended the year-end at about 1 million to about 1.51 million. The HealthStream Platform-as-a-Service capabilities are facilitating new types of application and media partnerships to deliver valuable services and impactful content to our health care organization customers. hStream, importantly, also serves as a bridge between our workforce development and Provider Solutions business segments. In the third quarter, Verity began introducing hStream subscriptions in contracts for its new SaaS platform. Because of this, we believe that hStream subscription is an increasingly important metric for measuring progress across our business initiatives. In fact, the year-end earnings release issued yesterday will be the last time we provide our legacy subscriber metrics, which focus on a narrow representation of our learning applications. We look forward to reporting the progress of hStream both in terms of subscriptions to it and the value it brings to customers and partners in the coming year.

Now, we've invested in many areas as we wrapped up the year and we plan to continue those investments as we enter the new year. To support the many exciting developments we've just discussed, press forward on our momentum, we have recently invested in new senior leadership by expanding our executive team. We have added Scott McQuigg, who will lead our hStream Solutions Business; and Trisha Coady, who will lead our Clinical Solutions Business, for our executive team. As Senior Vice President of hStream Solutions, Scott McQuigg will identify, grow and develop new hStream content, hStream application and hStream partnerships. Scott's career include the cofounding of HealthLeaders, an award-winning leading health care media and research business, and his role as CEO and cofounder of GoNoodle, which developed a popular kid's media and tech platform, which went viral and is now played by 14 million kids each month. As a health care, media and technology veteran, Scott brings valuable expertise to HealthStream in the execution of our hStream strategies.

In her new role as Senior Vice President and General Manager of Clinical Solutions, Trisha Coady is responsible for all the company's clinical products and solutions, including those in the areas of clinical staff development and resuscitation. Her deep clinical knowledge, experience as an entrepreneur, 5-year success growing our clinical solutions business and strong leadership skills make her well suited to lead this important area of our workforce development segment. I'd like to welcome Trisha and Scott to our senior executive team.

In our third quarter earnings release, we announced that Gerry had tendered his resignation from the company as CFO. He will remain in his position as CFO through the filing of our Form 10-K for the full year 2018, which we expect to occur later this month. While stepping down from his position as CFO at that time, Gerry will remain employed as a senior adviser through the end of the first quarter of 2019. To ensure a smooth transition following Gerry's departure as CFO, Scottie Roberts, who just presented our 2019 financial outlook and serves as our Vice President of Accounting and Finance, will assume the position of interim CFO. Scottie, who is a certified public accountant, joined HealthStream 17 years ago after working at Ernst & Young. His broad experience in public financial reporting and deep knowledge of financial operations, both in general and company-specific terms, make him particularly qualified to serve as interim CFO and as a candidate to steal the CFO position permanently. As Gerry completes his last earnings conference call, I want to thank him for his tremendous service to HealthStream for over a decade as our CFO and also the 2 years he served previously on our Board of Directors. His leadership and financial expertise have played an important role in our growth and he has successfully navigated the company through many growth opportunities. Gerry's leaving a great legacy in many ways, including his mentorship with Scottie sitting here to his right. I wish Gerry all the best in his future endeavors.

At this time, I'd like to turn it over for questions from the investor community.

(Operator Instructions) Our first question comes from the line of Ryan Daniels of William Blair.

Bobby, maybe one for you, first, on the new hStream metric. Can you talk a little bit more about how we should view that, how that correlates with revenue for the organization? I know we used to have subscribers in the ARPU metric, which we could use to back into some of the revenue growth. So talk a little bit more about how you view that metric and how that drives revenue growth.

Yes. For a little while, it's -- for probably the next several quarters, it's very important to watch its progression. So the first thing to drive the future of the company is to try to get all of our customers across all our platforms connected to hStream so it can drive the benefit. The new platform, what we're doing now is, hopefully by middle of the year, every contract for every product will include a connectivity or an insertion of the hStream membership and connectivity to that platform. And so first of all, it just serves as a unifying metric. And so we're beginning to -- when we sell a Learning Center, it requires a subscription to the hStream platform. When we sell the Verity platform, it requires a subscription to the Verity for hStream extension. And so the first and most important concept is it's a unifying metric. And Ryan, because we've worked for years at this, we were trying to create a unifying metric that would kind of be a foundational metric as we go forward for many years. But as we have the PX business, we couldn't figure out a way to measure everything. That's the first thing. Second thing is the old metrics were a measure of, really, the penetration of a few of the key products in the workforce segment. So it's kind of the inverse of the -- it's a unifying metric in that, the old metric was less dimensional than what it measured. So we think the importance of that metric for this year is to make sure it is rapidly adopted. As we included, as renewals come up, we're in serving the language and the subscription to the hStream platform and to each contract, and you can tell from the movement already, I think we announced it 9 months ago, it's at 0 and we're at 1.5 million now. So progress will be measured quarterly and we need to move all customers to this new platform in 36 months. And you can see we're well on our way. Now, as it relates to revenues, for a little while, it won't be as directly correlated to revenue because the opportunities are derived once it's in place. Most of our platforms, the hStream subscription, will have an increased value proposition and an increased price that allows for new bundling strategies of content and platform and allows connectivity to new applications and partnerships. And all of those things will drive new type of network fees to hStream and our network. So I think most importantly, it's a unifying metric and over time, it will be more correlated directly to revenue. But as analysts, I think what we need to measure is the rate of adoption. We've got to get it in place so that our new strategies can take hold.

Okay, that's very helpful color. And then as my follow-up and I'll hop off, the new CMS nurse competency requirement, obviously, that's a nice kind of macro tailwind for you if it's going to be a requirement to put in place. Do you have all the solutions to kind of meet what your partners will need for that? Or is there more partnerships/product development on the horizon to get you to a full set of what's needed to hit those requirements?

Well, we have a lot of what's needed, especially with the acquisition of Providigm. But we are, as I mentioned in the call, we're already investing and rounding out the concept because you need to map activities from the quality and the audit process to remediation and development strategies for employees. And we're building those mappings now, we're working with the leadership of Providigm to determine the holes in our education strategies and education libraries, and we're already underway, scoping and building those new curriculum components. And so we have some investing to do here to get it where we want it and also enhance the Providigm products up to where we like them to be for HealthStream, also connect them to the hStream platform over the course of this year. And so there's some work to do at Providigm. I think we've mentioned that in addition to those investments I mentioned, the deferred revenue write-down and others, that Providigm's going to have a negative drag on our operating income of about $2 million in '19.

All right. Okay. Gerry, I wish you all the best. Thanks for everything over the years.

Thank you, Ryan. Thank you.

And our next question comes from the line of Matt Hewitt of Craig-Hallum Capital.

First one for me, what has been the initial feedback now that all of the partners are in place regarding new resuscitations? We realize it's going to take time to see contribution from a revenue perspective, but what has been the feedback from your customers so far?

Well, we're 33 days now, which is probably closer to 25 business days, if you take out the weekends. And our full sales team trained during the months of late December and January, so they're fully equipped now to tell the story and they're booking up -- they're fully booking up their schedules to get out there and do the demos. Our feedback is very, very positive. The learning paradigm and the learning methodology is -- it just -- it's -- the objective has been -- it's 28 years, is better than the existing models. The momentum of the products kind of take a little time to build, as we said, we did acquire a lot of selling of the legacy products in the fourth quarter. We're also neutralizing some of the competitive advantages in the other products. For example, our products include the flexibility to train more frequently without charging the customer more for that training. And so we really do plan to be competitive, not just to have better technology, better product, better learning methodology, but also a considerably lower price point for an equivalent science-based program. And so I think the sensitivities around costs and the need for new methodology of learning, that we're very optimistic at 33 days in, that we got a winning product to take to market. And so I think also, the customers seem receptive to choice. I think after doing something one way for over a decade and frankly, in a market not seeing much, if any, change in actual outcomes as measured by clinical outcomes, I think that there's receptivity to trying something new. And of course, this will play out over the next several years and we'll see. But we're entering the year with a lot of confidence. And by the way, there's a lot more to come. And so there are many, many more elements to the program unannounced that are leading development now and we're excited to announce both new partnerships and new technologies that are yet -- as of yet unannounced. So, for example, one of our innovations is to make the new resuscitation suite agnostic to the manikin technology. And so we've signed with a company called Innosonian and they're our launch partner. We've signed with a company called Ambu, both are international providers of high-tech training manikins and both have agreed to be hStream-certified to the hStream platform. We expect additional announcements in this area and more interoperability and compatibility announcements with our Red Cross Resuscitation Suite program. And so there are innovations embedded like that, that mean that they are forthcoming. There are more announcements to come.

Great. We'll look forward to future updates on that. Maybe a couple of follow-up questions for Gerry and/or Scottie, depending upon who wants to chime in. But regarding Providigm, how should we be thinking about the margins for that suite? Gross margin, I guess, might be easiest, in '19 and then maybe going forward once you're through some of the extra heavy-lifting from expense and deferred revenue write-down contribution.

Yes. Well, let me just assume the workforce segment as a total. The one thing we could describe it qualitatively is it's a SaaS-type platform, a SaaS-type technology model. And so we could expect the margins, once we get past investment and some efficiencies in growth, to be more in line with what you'd expect from a SaaS-type business.

Okay. And then last one for me, just for modeling purposes. The $2 million of extra OpEx for the headquarter move in the first half, is that -- will there be any tail to that into the second half? Or should we model most of that $2 million here in Q1 and Q2?

Yes, let me take that one, or I can ask anyone to take that one, but -- so we were in a downtown office building for about 20 years and enjoyed really, really below-market rates for our 70,000 square-foot operations here in downtown Nashville. And we came up for renewal and those rates were going to go up tremendously. So we went shopping and looked at 7 or 8 locations all around the middle of downtown. And as you can imagine, in Nashville, it becomes extremely popular for corporate locations, Amazon, AllianceBernstein, E&Y, all moving in and building new buildings in downtown. Rent rates at Nashville have soared. What we did, though, we found the least expensive of about 6 options, including renewing here. And the least expensive option will result in an ongoing revenue rent increase of $2 million per year. And so it is an ongoing increase in our cost to occupy and consolidate our operations in Middle Tennessee and remain in the -- or near the central business district of downtown Nashville. So it's not a onetime expense. It's an ongoing increase in our cost of lease expense to remain and keep our workforce centralized in Middle Tennessee. And the $2 million will be expect -- actually be a little higher than that on an annual base because that $2 million represents about 3 quarters of the year. We don't move into the new headquarters for another 45 days or so, 60 days. So right when we're getting good operating leverage, rent goes up on us. But it was absolutely the right thing to do, and again, it was the lowest cost alternative of 6 options, including just renewing and staying put where we are. And so we're actually really excited to have a fresh point of view. We think it will prove to be an economic -- a good decision given that rate of growth at Nashville, and we're excited to get everybody back together because we're spread over 2, 3 office locations in Middle Tennessee.

And our next question comes from the line of Richard Close of Canaccord Genuity.

I was wondering if you could just go over the acquisition revenue that's included. I just want to make sure I had that correctly. And then on the $2 million in expenses associated with, I guess, the acquired intangibles, the deferred revenue write-down and the investment, if you can sort of give us maybe the composition of that $2 million in those buckets, that would be great.

Yes. So Richard, this is Gerry. We discussed about $8 million of revenue in 2019 with the Providigm acquisition, and most, again, that's the new Workforce segment. And then breakdown is the result how to lump into one side of expenses but investments and product development, other sales and marketing, intangible assets, amortization from the acquisition and also they will be hedged, as most of the acquisitions, a write-down of deferred revenue in the balance sheet as of closing.

Okay. So I guess I'm just trying to gauge what the deferred revenue write-down is as we think about our models for 2020 that could impact...

Its growth is about $250,000 to $300,000.

Okay, great. And then since we're moving on from the subscriber number, I did notice that there was a decrease in the implemented subscribers. I think it was only 4,000 from the third quarter, if I'm not mistaken. Just curious if there was something to call out on that.

Yes, there was. One of the larger health systems took their nonemployed positions and nonemployed, I guess, volunteers and just generally, the nonemployed population off the platform. And so we saw a reduction from that, it resulted in that net decrease. The contracted subscribers, as you probably also noted, went up about 80,000, so it was a strong -- I was kind of hoping to get over 5 million before we retire the metric, but we didn't quite get there at 4,933,000.

Okay. And then as we think about the new -- I mean, I guess calling out the skilled nursing side of things, I know in the past you've talked about the posts are non-issue, and I guess it was all lumped together. Have you had any exposure on the postacute side in the past? And how should we think about maybe the uptake in that marketplace? Are you displacing someone potentially? And just what are the, I guess, market trends for the services that you guys provide in that area?

Yes, I think, first of all, it is an important part of our plans. As you can tell, we kind of reconstitute our definition of the verticals we're going after that you had lumped into what we now call the continuum of care, which is all the postacute and ambulatory and skilled nursing and all -- and physician offices, we now put all in that what we call continuum. And so by reconstituting that definition, we bumped up those that we're marketing to and selling, actively selling to about $10.5 million. So -- and that growth from $8.5 million to $10.5 million largely comes from more broad pursuit of those postacute and ambulatory and physician office opportunities. So that's the first thing. Second thing is, a good number of our new subscribers in the last several quarters have been coming from those verticals. So those are the growth markets right now. Home health markets are growing, whereas in the hospital market, it seeks more consolidation and acquisitions and the other verticals you see growth adding more employees in those segments. So it will be the important ongoing business pursuit of ours to expand. One of the good -- another good thing is we think the Red Cross brand will resonate well in the postacute market settings, financially stronger brand than the prior brands we've marketed. So we're excited to get into those markets and those are less -- have less penetration, so you could imagine the progress we saw, the legacy products. We got pretty good adoption and penetration. So I think some of our early wins for our resuscitation products will probably come from those postacute and continuum, as we call them, segments. So the second point is, in the past, say, 4 or 5 quarters, of those 8,000 subscribers, a nice number of them did come from those settings that were not acute settings. And so Providigm represents a nice new anchor point, SaaS business application, linking quality to development and training, and we'll keep looking for things to strengthen that business pursuit, probably on representing kind of, hopefully, the first target of capability and content and services in those markets. So we do plan to strengthen, continue to strengthen our investment in the pursuit of those markets.

And our next question comes from the line of Frank Sparacino of First Analysis.

First question for me is on the Verity side of things. As you look at 2019, the guidance you gave, I'm just curious kind of what's -- what are the positives and negatives in terms of the growth that you've given? I would have thought the growth would have been a little bit higher in that segment of the business. Maybe it's being impacted by the migration that you alluded to, Bobby. But just any thoughts there in terms of how quickly that market's growing and how you're faring?

Yes. I think we probably would hope for a little faster growth overall and a little faster adoptions of the SaaS. But it took time to build the right product, and I would say, what we're hearing is the receptivity to the new product is very high. But we did want to kind of benchmark in this call where we are in migration. And as you can tell in our numbers we disclosed a few minutes ago, that we're really this kind of first solid quarter into the migration. And so we wanted to kind of set expectations for where we're starting and provide updates throughout the year. So there's about 36 contracts on the brand new platform, and I do think that the market receptivity to that platform is going to be very strong. It's several years in development and is flat out better than the products we had before and the products we're competing with in the market. So we feel better about the competitive position. That said, migrating a couple of thousand legacy customers to the new platform is going to be a multiyear journey as we've articulated. And so we just want to caveat that. And so we lowered our growth expectations a little bit. It is important to note though, it is a hybrid SaaS in the SaaS model, so the gross margins are good. It generates solid EBITDA performance and contributes to cash flows, and so while adding to its sales and product development and growing the senior executive team leading it, it's also generating cash. So it's effectively profitable growth. Yes, a little bit [nice sale], a little higher topline growth rate, but I do feel that this unit's well positioned for '19 and beyond.

Great. And just one follow-up for me. Bobby, as it relates to the RQI JV partnership, I'm trying to think of -- and it's maybe cynical or not the right way to look at it, but it would seem to me that for HealthStream, there's a modest benefit in that agreement. There's a lot more benefit being added on the other side. I don't know if they have a replacement in terms of an underlying platform to deliver, but am I looking at that the right way or no?

I think it definitely will make their products stickier. And we've spent a decade selling those products and they're good products and the customers obviously have benefited from them and deployed them. And as you can tell from our sales in the fourth quarter, they really wanted the joint service model that we delivered. They could have easily just said, we'll just wait a quarter and buy from RQI Partners, but they really all topped off to make sure they got the integrated service. And then of course, we announced that we were going to provide contingent support. But I think the ease of contracting through us and the proven delivery model resulted in quite a lot of sales in the fourth quarter. So it may have benefited them more but it also represents the milestone of the change from a single provider to the market to seriously bringing 2 essential providers to the market. And so, in order to hit that inflection point and bring the American Red Cross fully to the table competitively, it's the right way to service customers but also create choice and competition where there has never been any in the marketplace. So I think on balance, they may have benefited a little bit more by making their products sticky. We obviously benefited because we have a longer runway to introduce new products now. As you can tell, we had, maybe earlier, expected revenues to decline in '19. The declines will be steeper and harder in '20 and 2021. But we've essentially deferred the decline in that area of business for a whole year. It buys a lot more time to get the message out on new products and strengthen our overall power to deploy, and continue to deploy capital. So I think all parties will benefit. Ultimately, the customers will have the best benefit because they will have choice, and HealthStream is the one bringing that choice. So I think that also will be respected and appreciated by our customers. But it was kind of an essential move for both parties. Remember, our entire organization is solely focused on sales and marketing of the American Red Cross program now. And as they sell their products, they can promise compatibility but we're out now presenting the new options to the market and very excited about it.

And our next question comes from the line of Vincent Colicchio of Barrington Research.

Bobby, can you remind us of the mechanics of the revenue recognition with the Laerdal products? I was a little surprised at the size of the revenue running into Q2.

Well, let's see. So we'll go into 2 buckets here. So the legacy agreements, we would sell on subscription or utilization basis. And so, if you think of customers, say, buying a 2-year topoff, we would recognize revenue ratably over the period based on consumption patterns or license consumption. And so we sold a lot. But I don't think their consumption pattern changed a lot, but we did renew a lot of those contracts. As you can tell, we expected slightly more than $55 million in revenue from the legacy products, which is up from $18 million, actually, so there's a lot of irony to that. We expect the second quarter somewhere around middle of the year, second quarter, early third quarter, to be the peak in those revenues. And then it'll begin the decline, and that decline will continue quarter-over-quarter all the way to 0 sometime in the middle of the first quarter of 2021 of those 2 products. And so we think it should be fairly easy for you to model and estimate the model in the 4 quarters of '19 now because it will be a little better than $55 million spread across the 4 quarters of the peak in Q2. So hopefully, that's fairly easy to model for '19.

That's helpful. And then could you frame your capital allocation priorities for '19?

Yes. And so obviously, a big piece of capital is going to go into our new building. We chose to self-finance the buildout and everything because our cost of capital is lower than working it into the rent allowance, and so a big chunk of capital is going to go into building out that new consolidation, the new office building and getting everybody moved over there. But that's not the priority. That's just a fact. The priorities are, of course, in software development and R&D, launching the new resuscitation products, it will be OpEx, but we're going to grow our investments in sales and marketing. And then on a capital standpoint, concept development, for the first time, is going to make a more material debut into our business model. A little Netflix-like, but we have quite a large audience now, nearly 5 million. I wish I could round up to that -- or I guess, it's 4.933 million. And so we're going to invest in targeted areas of content development, and so you'll see a little bit more of that in our capital plans. Everything else, to capital out software development and all will go up a little bit each year.

And we have a follow-up question from Richard Close of Canaccord Genuity.

Just 2 quick follow-ups, just on the headquarter. I guess, this call, you're saying it's $2 million in annual expenses higher than previously. I think on the last quarter, you mentioned that it was going to be $2 million in '19. In terms of higher expenses, I could have that wrong. So I just want a clarification on that front.

Yes, we -- I think that is accurate. I think both statements ironically are accurate. So it is $2 million more in '19 and on a run rate basis, I guess, the first time we've indicated, it will be -- it's a rent increase. So it will be annually $2 million more in the model.

Okay. And then my last question would be on the RQI. Can you go through that in terms of maybe the margin profile on that versus HeartCode and then maybe the margin profile on that versus the Red Cross?

Yes. Well, probably not in great detail. But I can say this, that the margin on that, because it's a feed that connects the network, we don't have any real sales costs, any marketing costs. We don't have -- none of those support costs, just the support and make sure the customers are happy with the integration. We don't have any product development cost. So it really is a fairly high -- a lower fee and lower revenue but it is a large contribution margin because it really is a pay to connect and a pay to ensure a smooth operation of their product. And so they'll pay for the contract, they'll recognize the revenue from the topline standpoint and pay us a connectivity fee. That connectivity fee as an integration fee will -- it will be a nice fee for us. It won't completely offset the prior margin that we enjoyed but it's a really nice high contribution margin fee coming from that relationship. Now again, we don't expect to see much of those fees in '19 because there's really not many coming out for renewal. And so when that kicks into play is when a customer on our platform comes up for renewal, they'd say, yes, we want to keep receiving that product. They license -- or purchase the product from RQI Partners. RQI Partners will then bill them and send us the fee. And so it requires a whole cycle of renewals to come out before we start generating those again rather high-margin fees. And so I hope that just general characterization helps you some. On the American Red Cross program, we're not going to give a lot of details in that but we have said in the past that it's materially higher gross margin for us. That said, the sales and marketing costs and the launch costs of the new products are fairly high and we don't want to underinvest in those. And so its blended contribution, early, is going to be probably fairly low, and in fact, in the call, we said that its absolute contribution even on the topline can be fairly low because of the reasons we said earlier, that we had such a successful fourth quarter, selling the prior products. So I hope those characterizations help but we're probably not going to do anymore product-by-product gross margin analysis across our portfolio.

And I'm showing no further questions at this time. I would now like to turn the call back to Robert Frist for closing remarks.

Thank you. We look forward to the leadership of Gerry for another month, and I really appreciate his 12 years of service to the organization. We're looking forward to Scottie Roberts stepping up as the interim CFO. Welcome to the new leaders of our team, and thank you to all HealthStreamers for your contribution to a great year 2018 and a lot of hard work going into launching the new products and services in 2019. Look forward to speaking to all of you on our next earnings conference call. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.