Good day ladies and gentlemen and welcome to the HealthStream Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, today's conference may be recorded. I'd now like to introduce your host for today's conference Ms. Mollie Condra, Vice President of Investor Relations and Communications. Please go ahead, Ms. Condra.

Thank you and good morning. Thank you for joining us today to discuss our second quarter 2019 results. Also in the conference call with me are Robert A. Frist, Jr., CEO and Chairman of HealthStream; and Scotty Roberts, Interim CFO and Vice President Accounting and Finance. 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 can 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. We had an exciting event at the end of the second quarter that we highlighted as our first bullet in the earnings release. The bullet stated, our CEO contributed $2.2 million of his personality owned HealthStream stock to the company in order to facilitate the grant of 78,520 shares of common stock to approximately 820 employees under our 2016 Omnibus Incentive Plan, which resulted in a corresponding $2.2 million charge for stock-based compensation and related expense in the second quarter. Given that event, I'd like to extend a special welcome in this conference call to our employees many of whom may be new shareholders to the company in a couple of days and maybe listening in to one of our quarterly conference calls for the first time today. So, it's an exciting to see so many of our employees realize the opportunity to become an owner of the company that they've helped to build. So, with that start, I'll turn the call over now to CEO, Bobby Frist.

Thank you, Mollie. Good morning, everyone. Welcome to our second quarter 2019 earnings call. Our second quarter performance was positive with revenues that were in line with our expectations up 12% over the same quarter last year and adjusted EBITDA was up 10% over the same quarter last year. We ended the second quarter with a cash balance of approximately $162 million. With those high-level summaries, we reiterated our revenue guidance in our GAAP operating income guidance and Scotty will elaborate more fully on financial results in a few minutes. But I think to start today I want to remind everyone that at HealthStream, we're in the midst of several business transitions all of which are designed to move us towards being a higher margin more profitable company. And I want to go through each of those -- I'll characterize in this three different transitions. I want to go through each of those and give you an update on them and kind of set a program that will help us evaluate our progress in these transitions over the coming quarters and years. Each one presents multi-year opportunities and challenges for the company. And if we are successful, we believe there will be meaningful benefits for HealthStream's long-term growth and profitability. First, the first transition to discuss we have transitioned our sales and marketing efforts from legacy resuscitation products to the newer American Red Cross Resuscitation Suite. Since there are no new sales of the legacy resuscitation products, we expect revenue from those legacy products to continue to decline sequentially each quarter throughout 2019 and 2020. In fact we anticipate revenues from legacy products -- legacy resuscitation products to decline additional $2 million in the third quarter and to decline another $300,000 in the fourth quarter. We anticipate revenues from the…

Thanks, Bobby, and good morning. Before I go over the results, I'll summarize the impact of stock grants to employees on the second quarter, which resulted in $2.2 million of expenses of which $2 million was noncash stock compensation. Stock grant resulted in a reduction to operating income of $2.2 million, a reduction to income from continuing operations of $1.7 million, a reduction of EPS of $0.05 per share and also a reduction to adjusted EBITA $0.2 million. Now, let's begin with our highlights for the second quarter. As a reminder, the discussion of our results today will be for continuing operations only and comparisons are against the prior year second quarter unless otherwise stated. Our revenues were up 12% to $63.8 million. Operating income was down 47% to $2.3 million. Income from continuing operations was down 34% to $2.4 million. EPS from continuing operations was $0.07 per diluted share compared to $0.11 per diluted share in the prior year and adjusted EBITDA from continuing operations was up 10% to $11.8 million. Again, these results included the impact of the stock grant I just mentioned. Revenues from our Workforce Solutions segment were $52.4 million and are up 12%. Our revenue growth came from three areas primarily, the legacy resuscitation products, our proprietary learning and compliance solutions and the Providigm acquisition. The legacy resuscitation revenues increased by 17% to $15.5 million compared to $13.2 million in the prior year. Through the first half of 2019, we've recognized $32.8 million of revenues from these products, representing a year-over-year growth rate of 29%. We continue to expect revenues from the legacy products to decline during the second half of 2019 compared to the first half of 2019 with revenues in the second half of this year expected to range between $26 million and…

Thanks, Scotty. Great financial report and good progress in a lot of core metrics, I would like to close by speaking little bit to our employee base. As a company driven largely by its culture it's true of most companies and their performance driven by their culture that determines how they approach their work. We have some exciting announcements in this quarter. Along with the move into our new corporate office, we published and distributed an updated HealthStream constitution. For over a decade, we have been guided by the vision, the values, and the business principles contained in our constitution. And over 30 employees from all levels of the company worked together for over a year to bring about the updated constitution. We're grateful for their enthusiasm and hard work to bring it to fruition. At the same time, we launched the new corporate social responsibility program which we call Streaming Good. This program was developed and launched by employees. From the ground-up, we're excited about opportunities being created to contribute to the communities which we serve in. For the first year with Streaming Good, we're focused on working with and supporting the American Cancer Society across the nation in all of our offices. In fact, we have a large community event being planned right now that we expect to be held in October. In closing, I would like to thank our employees and everyone involved, who has been instrumental in these exciting developments in our company culture. We believe that culture drives performance, and I'm grateful for all the employee's contribution to these important groundbreaking advances. At this time, I'd like to turn it over to questions from the investor community.

[Operator Instructions] Our first question comes from the line of Ryan Daniels with William Blair. Your line is now open.

Yeah. Thanks for the time and the questions. Bobby, one for you, and looking at the new American Red Cross solutions it appears that those are more adaptive learning capabilities. I'm curious, if you could discuss a little bit more about what the adaptive learning technology is? And then, I'm curious if that's something that's applicable to other solutions or perhaps already being used there? Thank you.

Thank you, Ryan. We believe that these advances in the program are in fact applicable to other programs and there are many dimensions to the new resuscitation program that we think are great advantage in the marketplace in general. The first is that the curriculum itself is adaptive at the individual level. So as an individual user progresses through the program, the curriculum adjusts. What this does it results in more appropriate learning being delivered to each professional and a time savings, which is a huge economic benefit to an organization. If someone can be met where they began with their knowledge and be advanced in their knowledge through adaptive learning then there's a time savings, which is critical for nurses and physicians going through the program. So as opposed to a pre-test and a post-test to evaluate change in knowledge, the test and competency assessments delivered throughout our program result in a curriculum adapting to the individual, which often results in a shortening. There are many, many advances in the program, another exciting advance is, we've taken the common science and knowledge that supports frequency of practice is a known positive variable and a competency. You particularly want to develop refine muscle memory and repeat programs as frequently as you can, particularly in their physical like resuscitation. And in our program what we've done is provide the power to organizations to increase the frequency of practice without increasing the cost of participating in the program. So what we've been able to do is, we've taken this great working knowledge of the science, which means that more practice results in a higher skill and better muscle memory, and hopefully, therefore a better clinical outcome and we've made it a variable in our platform. Our customers in the new Red Cross…

Okay. That's super helpful detail. And then I think you mentioned the $16.5 million in contract value for the new American Red Cross product. I'm curious number one, is that an annual revenue number is that total contract value? And then number two, just kind of where that stands in regards to your expectations? Is it kind of ahead of schedule, on schedule in regards to new sales? And what kind of feedback are you getting in the market from clients that have signed up as it relates to that product? Thank you.

Yeah. A couple of things. So first of note, that is the total contract order value of the multi-year agreements. And you noted that one of the large health systems was a seven-year agreement. We did a separate press release on that. It represents new and migrating customers and it represents customers from -- within the acute-care space and then what we call the continuum space, which is a non-acute space. So it's a really nice early surprise. I would say, we've been -- we've surpassed our expectations for early contract order value and have a myriad of customers across industry and across verticals contracting for and adopting the program. Now from a revenue recognition standpoint, as we mentioned, many of those customers are committing to the program three, four, five and seven years out. And the reason for that is that the first 12, 18, 24 months, they're running off their commitments to the legacy programs, which you know we're extremely successful selling in the fourth quarter of last year. And so these are need to be -- if they're going to commit to switching to some longer-term agreement, and they can run out and execute the finishing of their prior contract on the prior legacy platform. And so, revenue recognition from that $16.5 million in contract order value, which again is a material upside to our initial thinking. In fact, I think we weren't planning on selling much of anything in the first half of the year and we're already at $16.5 million. But the revenue recognition will be weighted and begin only about after 18 months to 24 months from where we sit today. In some cases, it will start earlier as they use parallel adoption of the program, but that's why we're saying, there's no material impact in this year. But I do think it's encouraging another $16.5 million of business already under contract. In many cases, the new customers are beginning implementation now. And as we have mentioned, we do have better margins on this product than the prior product. So, over time, as I talked about three business transitions, we do expect the blended gross margin of the company over time driven by the three transitions I talked about this being a primary one to go up from their current, I believe 58 -- about 58%. So, we're excited about all those things.

Great. Thank you so much. Appreciate the color.

Thank you.

Our next question comes from Matt Hewitt with Craig-Hallum Capital. Your line is now open.

Good morning. Thank you for taking the questions. The first one relates to the new – the hStream progress that you have made, obviously, another big quarter for upgrades. I'm curious are those primarily a one-for-one upgrade from the old metrics that you're providing. I think the last time you provided those you were at 4.9 million of contracted subscribers. So are we seeing almost exclusively just a conversion of that metric, or are you seeing some nice incremental new business into the hStream platform?

Yeah. Great question, Matt because it's actually a little of both. As I mentioned the Verity platform now has a parallel and similar set of technology we call hStream for Verity. And so there's enough parallel assuming the way the technologies are being deployed now that 122,000 of the 2.34 million subscribers to hStream are coming from new sources like Verity. In addition any brand-new customers to the company are going on hStream and there's a mix of brand new customers in that as well. And then, of course, there are conversions as you mentioned. The former number of 4.9 million reflected subscribers to a more narrow side of applications, largely our learning center application. And as those come out for renewal, those customers are getting new capabilities in their old learning platform because they are renewing and upgrading the core operating system. Essentially they're upgrading to hStream. And then that in turn gives them access to applications like MyTeam. And so the majority of the 2.34 million is an upgrade of legacy customers of the HealthStream Learning Center that are getting access to new features through upgrading to the hStream platform. So hope that you understand. But they are coming from three sources. The vast majority are upgrades as you mentioned from the Legacy, but they are brand new customers to our network that get hStream and then there are a new source of customers coming from Verity that includes the hStream for Verity platform component and their contracts as well.

Okay. That's very helpful. Thank you. And then maybe one -- a second question for Scotty. As we look at the back half of year and thank you for providing all of the detail there. But as we think about Q3 and Q4 where some of the legacy resuscitation is falling off and you gave us some good numbers to start with there. Should we see gross margin lift in the back half of the year even though the revenues are coming down just because of the margin structure for the legacy resuscitation? And then it sounds like that will be offset by incremental operating expenses for the new facility, the new hiring plan that you have and whatnot, but I want to make sure we get the gross margin piece right?

Yeah Matt. I think you are well on the path of what we're trying to explain about gross margin improvement. And as the lower margin legacy resuscitation products begin to decline, which we're expecting in the second half of the year versus sequential quarters for the first half and from the second half of last year, I think there should be some slight improvement in margins. Now the revenue declines are not as impactful as we expect going forward but you should start to see some slight improvement in margins just related to that product alone. Now we do have quite a few other products in the portfolio that can influence margins. But if you looked at this in isolation, I think we would assume some and expect some improved margins.

Obviously, Matt when the new products start coming online then you got a real upward push we believe on the gross margins. But we don't think -- as we said we don't think the new revenue streams from the new resuscitation products will start coming in this year. So -- but as we model in the distant future as we talk about these multi-year transitions there's certainly going to be a positive upward force on gross margins as the new come online and the old continue to drop off.

Understood. All right, great. Thank you very much.

Our next question comes from the line of Richard Close with Canaccord Genuity. Your line is now open.

Yeah, just maybe drill down a little bit further on the margin point. Is there any way you guys can quantify what you think the margin expansion opportunity is once you get through the HeartCode ramp down based on the new Red Cross and the SaaS Verity that you called out as well?

Well, I think it will be a little challenging to do that right now because the three transitions we talked about are all going to span 24, 36 months and maybe in some cases a little longer. They all have a positive upward pressure on gross margin, meaning an improvement in gross margins. And so we do expect in the long, long run this year a different gross margin profile of the company. That said, we're speaking to this year and in this year we expect de minimis change. I mean we've been in that 58% to 60% gross margin right now for some time and I think Scotty just indicated maybe a slight uptick from the 58 we just had in the second half of the year. But we would consider that for this year's modeling purposes it would be a very slight uptick.

Okay. And any thoughts in terms of the new SaaS -- Verity SaaS and what the differential maybe was from the old offerings there understanding that the migration will take some time?

They're both fairly high margin products. There's kind of a hybrid component. I think a lot of the costs and benefits there, there will be a slight improvement when you go to the new Verity platform from the overall approach to its deployment and licensing and technologies. The overall improvement in that business will come from the reduction supporting multiple platforms, which is above and below the gross margin line, so supporting four -- effectively four software platforms to that customer base. Our goal obviously is to get down to one platform and that platform is built and deployed and has 100 contracts and it's the new Verity platform. So our goal there, in that line of business, we'll see a little bit of gross margin impact from going to the newer technologies, but we'll all see an overall improvement in the profitability of the business by reducing the number of platforms we support over time. That is probably the longer of the three journeys, the full migration. But again, it is a positive and healthy move at the operating expense level, at the gross margin level as we're able to wean customers off the older platforms and upgrade them to the new one.

Okay. I guess my final question would be on the HeartCode decline I just wanted to make sure I had those numbers correct. Did you say, you expect a $2 million decline in the third quarter and then $300,000 additional in the fourth?

Yes. It's kind of interesting. Scottie gave kind of first half total versus expected second half total, so that's very detailed there. And maybe repeat those real quick Scottie and I'll do the quarters. The first half total revenue from the legacy products was...

We delivered $32.8 million legacy revenues in the first half of the year and we're expecting $26 million to $27 million in the second half of the year. Of course, we did $15.5 million in the second quarter.

So $15.5 million in the second quarter. And then building on that, I mentioned, that we expect a sequential decline of $2 million. So from $15.5 million to I guess $13.5 million is about the way you need to model the third quarter on the legacy resuscitation products. And then obviously simple math that leaves you the fourth quarter only dropping $300,000. So we thought it's interesting that it plateaued a little bit. It will continue its decline in the first quarter of next year and all the way down to zero as we mentioned. But the way we've sold is -- there's a little bit of a plateauing here for a couple of quarters, but a $2 million sequential decline from Q2 to Q3.

Okay. Great. Thank you.

Our next question comes from Frank Sparacino with First Analysis. Your line is now open.

Hi, guys. Just one for me. On the Provider side, can you just talk through -- if I look at the guidance for the year $44 million to $45 million that would suggest the revenue in the back half of the year is flat to down from the Q2 level of $11.4 million call it. So maybe just can you talk through what's happening in the second half of the year, because the growth rate there would be slowing on a year-over-year basis relative to what you've done in the first half as well?

Yes. I think, I mean, there's a lot of activity going on there. We're trying to sort and give our best estimate of our performance. New sales continue to come in, implementations are going a little slower than we expected, but we're getting good at it. And as we mentioned, we have over 100 contracts under review. So I think we've kind of been down the middle on this a little bit conservative in our forecast of the first half to deliver. What's the growth rate first half?

Roughly 11% to 12%.

11% 12% first half. We're just projecting based on all the work that's going on the business a little bit of a flattering of that growth rate for the second half, maybe is a little bit of upside to it. So -- but I think it's just conservatism given the amount of migration work we're doing and the new contract selling we're doing. I guess, we picked what we think is a fair representation of where we'll land.

And maybe just following up there Bobby. I guess longer term, what's your view in terms of that part of the business and long-term growth?

I think we feel good about it and of course, we guide each year and this year we're seeing double-digit growth in the first half. We're seeing good. It's a narrowly focused product set that we think is best-of-breed in the market. And we continue to project and win some competitive takeaways in the areas of relative strength that we have as a business. So we do expect it to continue to be a grower. And also we think that its margin profile can be enhanced as we talk about as we get through these migrations in the coming years. So I think it's a good software business with descent margins as is, which means at the gross margin level, it's productive. It's contributing to cash flows. These are good software businesses. But we are operating in a situation where we're running essentially four platforms, three from the acquired businesses and the new one that we're trying to move everybody to. So there's kind of an abnormally high operating costs in the business, where our goal is over the next 36 months to take some of those costs down. That said, because we're excited about the products, we're adding in areas as we streamline operational cost to one platform over time, we're adding in areas like sales and marketing to continue the growth, because again it's a good product. The blend of all that is a healthy software business with good margins and we hope an improving margin profile over time.

Thank you.

Our next question comes from the line of Vincent Colicchio with Barrington Research. Your line is now open.

Yeah, Bobby. Apologies, if you already answered this. I don't think you did. The main reason that the legacy clients switched to the Red Cross product, was that cost? Was that some of the extra value add you talked about? What was it?

Well, I think that these early customers are really adopting the newer approach. And so, I think they like the flexibility of the interval dial. I think they like the real-time and real professional video instruction that I think is more appropriate for the newer workforce and millennials like to learn that way. So, I think that this is a refreshed approach to an old problem that frankly the prior products just hadn't moved the outcomes much. So, these are early adopters willing to try a new way that we tried to improve every dimension of it from the hardware deploying being higher tech and lower cost to the program itself, which we believe is more flexible and more engaging from the approach to the content development. And then, of course, the time savings and therefore the money savings come from some of the adaptive features we talked about. So, overall, you know how early adopters are. They tend to want to try the new thing to see if it has a positive impact. And so, I think, they're driven by the new approach that's inherent in the product itself more than the cost savings. That said, it's our commitment and the American Red Cross's commitment which is interesting, because American Red Cross is maintaining their non-profit status whereas the legacy products have created a for-profit entity. And so, I think, there's that appeal to a lower cost product, because the partners in this case have maintained their non-profit status in their contribution to these products. So, I think, overall, we're able to deliver a lower cost product potentially because of some of that.

Okay. That’s it for me.

[Operator Instructions] We have a follow-up question from line of Richard Close with Canaccord Genuity. Your line is now open.

Yeah. Thanks. I think you detailed or called out $4 million to $5 million in operating income reduction in the second half, if I'm not mistaken due to some investments in the headquarters move whatnot. Is there anything in that $4 million to $5 million that is essentially maybe considered one-time that doesn't necessarily repeat in 2020?

Yeah. I think the continuation of the legacy resuscitation decline is one that will continue on through the end of 2020. The hirings that's an expectation that we're trying to fulfill in the second half of the year which will have ongoing impact as we retain those employees and staff up. And then lastly, the new building that we just moved into, those are going to be ongoing costs as well. So, I'd say they're all ongoing run rate expenses for us, not one-time.

Okay.

As you remember the rent is going up couple of million a year and it was the more economical of the many choices including staying where we were, the cost of living in Nashville and the cost for corporate rent is going up. But we think that those investments while they will be ongoing are already showing benefit to recruiting and the environment and culture of the company. So, all three of those are ongoing expenses unfortunately and part of the kind of the cost of leaving, the environment and our desire to invest in growing the workforce size as well. We mentioned specifically, for example, adding salespeople to the resuscitation products specifically. So, we've approved and immediately have begun recruiting and I think already made two offers since we approved them a week ago. So, we're going to continue to grow the sales efforts around products that are performing in the market.

Thank you.

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

Thank you everyone for your attendance. We hope we got everything in the right amount of detail in our disclosures. We're excited about many things. But also I characterize these as challenges and opportunities for a reason. I think for shareholders that are willing to follow us along will report our progress on hStream subscribers, our migrations to the new Verity platform. And as we've done here, excruciating detail about our progress with our new resuscitation partners and products, so that you can follow these three transitions along for the next, I would say 36 months or 12 quarters. Our goal would be to come out at the back end of that with a higher margin and more profitable entity. But all these migrations have both opportunities and challenges in them. And I'll remind our employees to -- that we keep our heads down and stay focused through these migrations and transitions so that we can be successful and then as we come out and show progress in the coming years. That said all you analysts remember, these -- the challenges are real. These revenue declines are concrete, $60 million low margin business going to zero is still $60 million business going to zero. We are really excited and encouraged by early returns on our new product sets and the improved margin profile of the company. But the challenges and opportunities are both real. So, we appreciate you following our story and explaining in detail to all of our 12,000 shareholders. And look forward to reporting our next quarter to all of you in the coming months. Thank you.

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