Ladies and gentlemen, thank you for standing by, and welcome to the HealthStream, Incorporated Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the confidence to your speaker today, Mollie Condra, Vice President Investor Relations and Communications. Please go-ahead madam.

Thank you, and good morning. Thank you for joining us today to discuss our third quarter 2019 results. Also, in the conference call with me are Robert A. Frist, Jr., CEO and Chairman of HealthStream; and Scotty Roberts, CFO and Senior Vice President. I would also like to start by reminding 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, at this time, I’ll turn the call over to Bobby Frist.

Thank you, Mollie. Good morning everyone. Welcome to our third quarter 2019 earnings call. Our third quarter performance was in line with expectations with our expectations and revenues were up 4% over the same quarter last year. Adjusted EBITDA up 3% over the same quarter last year. Supported by strong cash flows from operations and a record-low days sales outstanding we ended the third quarter with a cash balance of approximately 173 million, so strong balance sheet. In a minute, Scotty will elaborate more fully on financial results, so I’m going to dive into some of the operational updates. To start today, I want to provide with updates with regards to three business transitions that we introduced and discussed in previous calls. All three transitions are designed to move us towards being a higher margin, more profitable company in the coming years. We’re about nine months into what I described as a 36-month journey. So, we’re about nine months and we’re about 25% through these migrations and I’m pleased to report we’re making steady progress on all of these transitions. During the quarter, for example, we contracted 48 new accounts for our new resuscitation offering. We increased new Verity platform subscriptions by 50% over the last quarter, and we added approximately 434,000 hStream subscriptions and support of our SaaS to PaaS migration or strategy. If we continue to progress on these three transitions, we expect to cross the 60% gross margin level at this time in 2020. So, we’re kind of excited that we expect to see some of those transitions start to playoff in the gross margin line by the middle of next year. So, let's look at each one in a little more detail. First, we have transitioned our sales and marketing efforts from the legacy resuscitation products…

Thanks, Bobby, and good morning. As a reminder, the discussion of our financial results today are for continuing operations only and comparisons are against the prior-year third quarter unless [Technical Difficulty]. Our financial highlights for the third quarter are as follows. Revenues were up 4% to 62.5 million. Operating income was down 20% to 3.7 million. Income from continuing operations was up 14% to 3.5 million. Our EPS from continuing operations were $0.11 per diluted share, compared to $0.09 per diluted share in the prior year. And adjusted EBITDA from continuing operations was up 3% to 11.5 million. Now, let’s review our results in more detail. Revenues from our Workforce Solutions segment totaled 51 million for the third quarter and were up 4% over the prior year. During the quarter, we experienced organic growth in our platform and content subscription revenues, and our topline also benefited from the Providigm acquisition. These improvements were partially offset by an expected decline from the legacy resuscitation business. The legacy resuscitation revenues decreased by 10% or 1.6 million and were 13.4 million, compared to 15 million in the prior year. Through the first nine months of this year, we’ve recognized $46.3 million of revenues from these products with a year-over-year growth rate of 14%. One of our opportunities for backfilling the declining revenue from the legacy products is by marketing and selling our new resuscitation offering. Since of the launch of the new resuscitation offering in January of this year, we’ve sold over 22 million of total contract value with most contracts averaging five years in length. Revenues from other Workforce products grew organically by 5%. This growth rate excludes revenues from the legacy resuscitation products and the Providigm acquisition and the Providigm acquisition brought 1.9 million of revenues in during the quarter. Revenues…

Thank you, Scotty. Before we go into Q&A, I’d like to make a few closing remarks. One thing that’s interesting that’s happening actually today and yesterday is there is a unique convergence of the three business transitions that we mentioned earlier in the script. In Philadelphia, at the National Association of Medical Staff Services, or NAMSS conference, we’re demonstrating some new – an innovative new technology that integrates several pieces of our story. It’s the automated integration of the Red Cross certification with hospitals and medical staff credentialing records through the new Verity platform is being demonstrated. So, now, when healthcare professionals successfully complete the Red Cross certification requirements, the record of their certification is transferred automatically through an integration with their Verity credentialing system. That saves the medical staff officers' hours of time and paperwork. The bridge between our Workforce development platform and our Provider Solutions business segments is made possible via hStream. The hStream technology, for example, is used to login to the program and into the manikins, and so, when certification is complete, that transaction results in an issue of a credential, which is automatically transferred into the new Verity platform. And again, the long history of this is that these medical staff officers and credentialing officers would have to research and acquire that data in very manual processes, even sometimes asking for a faxed copy of the credential to enter into the credentialing system, and now we’re demonstrating it live on the exhibit floor today as someone completes the physical certification on the manikin, the certificate pops up and shows in the Verity platforms. So, it’s a very exciting leverage of the hStream technology platform as its used to login to the – into some of the manikins, a flowing of the credential from essentially the…

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

Yes, good morning, guys. Thanks for taking the question. Bobby, a follow-up for you on the legacy resuscitation solutions, have you had the opportunity to look back at those clients that are running off the legacy solution, let’s say over the next 12 months and to determine how many of those are actually converting to the new HealthStream solution versus perhaps reopening with the legacy? So, kind of what’s your sales conversions or sales capture rate as those clients roll-off?

Yes, Ryan, we haven’t reported that. We’re – the blend of the 48 new accounts in the fourth quarter was a nice mix. It’s fairly well-balanced from a conversion to brand new account, so we felt really good about that. And of course, our team is acutely aware of and watching, all customers [indiscernible] make sure we’re in the hunt, but we have not disclosed our conversion rate, and I don’t think that’s necessarily a helping metric for the competitive dynamic. Remember, we do maintain partnerships with both entities and we want to represent and sell and market the American Red Cross Resuscitation Suite program, but we also need to maintain a healthy relationship with the legacy partner, our QR partners as well.

Okay, that’s fair. And then, I know the last quarter of the year had some requirements, CMS mandated, and I think they kick in November, the requirements or participation for nursing homes. So, that in tandem with the new Medline partnership, do you expect kind of a [indiscernible] of new contract signings over the next month or so to meet that demand? Or is much of that already been put in place because the conditions of participation actually start in a few weeks?

This is Scotty. I think our expectation of that is most of the customers that have adopted the abacus product have done that in the past couple of years, and some of the changes in regulation, you know, although they were mandated by the government, some of the penalties enforcements won’t kick in for another year or so. And so, I think this gives us a little more runway to kind of approach customers to try to picture our products for them, but I don’t think there will be [indiscernible] that you indicated that will occur.

Okay. And then, just any thoughts on capital deployment? I know, you know, the balance sheet is very healthy especially with the low DSOs and with, you know, the strong free cash flow building up again, so any thoughts on potential uses of cash going forward as it reaches, you know, nearly $200 million here towards year-end? Thanks.

Yes. I mean we’re constantly examining that and we tried to communicate even in the script that we maintain an active pipeline of all sorts, including minority investments and acquisitions. We did complete one acquisition earlier in the year and we're trying to team up. We have made a few bids on acquisitions where we weren’t prevailing better. So, we also kind of we know our limits. And again, it's an active program that we’re investing in to find opportunities for inorganic growth. Also, organic growth though minority investments, content development, our deployment of capital increase. As we just finished our five-year plan with our Board, we’re increasing our capital allocations towards a content development and program development. So, we’re pretty excited about that. We’ve gotten great results where we’ve chosen to invest in a fully kind of vertically integrated product where we have platform content and data and we own all three pieces.

Right.

So, we probably see a slight uptick in investment, capital employment and to, what I guess I’ll call content or program development. There’s a lot of solutions we’re building, for example, around the resuscitation suite that are complementary to the programs that we’ve built or that Red Cross has built. So, we’re excited about that as well. And so, overall, we’re going to do our best to thoughtfully deploy the capital and have an active pipeline, minority investments, M&A activity and increased capital investment into content and programming.

Okay, great. Thanks for the color.

Thank you. And our next question comes from Matt Hewitt with Craig-Hallum Capital. Your line is now open.

Good morning. Thank you for taking the questions.

Good morning.

Good morning.

Just a couple of follow-ups. First, regarding the long-term care market, I mean your relationship with Medline, how are those facilities currently attempting to meet the new regulations – the requirements for participation regulations? Is that something that some of these facilities are trying to do internally? Or, you know, obviously I would think that the Verity platform is a much simpler way, but what other options do they have out there?

Well, to the Providigm platform, which is the Abacus platform, that is really the – the acquisition we made at Providigm and came with the Abacus platform, which is kind of a long-standing market leader in helping them prepare for all form of mandate and quality audit process and quality management. And what’s happening is there’s some increased regulation around relating not just staff competency, which is one of the business hypotheses under which we acquire Providigm. And what we’re seeing now is we’re combining our content bundles like Medline, for example, helps us position the Abacus platform and these new content bundles together into these – into this vertical. And so, they're very prominent in the vertical. These are products that help them differentiate their overall product offering to those organizations, and they’ve helped us over the years to position them. And now, they have a more complete tool kit that help introduce to the market. What they do otherwise? I guess a lot of pen and paper. There are a few competing products for the Abacus platform that are offered by competitors of Medline, for example. There are competing educational products offered by competitors of HealthStream into the market, and there's a lot of kind of traditional pen and paper that needs to be displaced and made more efficient as well. So, you know, a typical competitive landscape, but we’re really proud to be aligned with Medline. We think they're the strongest in the market and they’re going to help us carry these solutions, which we think are also the strongest in the market to these customers.

Understood. Okay. And then, shifting gears, regarding the legacy resuscitation program, so as those roll-off, you enter 2021 I think you had said you’ll at zero for the legacy revenues at that point. How will the access fees be accounted for? Because there's going to be some customers that still are going to be using the legacy platform, but, you know, RQI is going to be basically paying you a legacy – a access fee, if you will, will that be accounted for in another bucket? Or is your saying zero, but essentially there's going to be some revenue there? Just help us understand that a little bit.

Yes, sure. It's another bucket, and so, we’ve communicated, you know, approximately [50 out of 60 million] revenue from the legacy products at its own, you know based on its own legacy contracts and wind down agreement, and so, that's that 59 million winding down. We announced the RQI partners agreement, which is a separate revenue stream, which is the access fees where they do the sales and marketing and we’ll facilitate the connectivity and that will be growing, but it will be dependent upon kind of customer choice and their own success selling and contracting with hospitals that are on our learning platform, for example. And so, the sequence of events would be that a customer is using our learning platform and enjoying the benefits of that, they want to maintain their older, what we would call, legacy solution, but they want to maintain that, so they contract for that with RQI partners. And then, our ops teams will help make sure that it works for the customer and the RQI partners organization would pay us an access fee, which would show up in revenue and its – but it’d be very low because it is a subset of the contract, right. So, we’re no longer contracting for the products, we no longer sell the products; we no longer market the products. That’s all on the access partner, as we call it now, the RQI partners.

Okay. That’s very helpful. Thank you. Maybe one last one and then I’ll hop back into queue. Regarding your hStream subscriptions, you launched the product in Q3 of 2018 and its ramped very, very quickly. Its almost 60% of the last fully implemented and contracted subscriber numbers for the way you reported that previously. How quickly do you get that other 40%? Is that going to ramp on in the next year? Or do you expect that rate of conversion to maybe be slow as you get, you know, closer to that 100%?

Yes. It should. First of all, as I’ve articulated, each of the three transitions I think are kind of 36-month transitions and they are kind of arbitrarily picked, you know, January 1 as a start date even though something started before that and some will go a little longer than 36 months, but just to characterize all the three, I think the bulk of the migrations, transitions, and movements will be completed within 36 months, and again, starting January 1 of 2019. So, we’re nine months in to the 36-month transitions. So, I would say that couple years are left and whether, you know, 100,000 migrator or 434,000 as in this quarter, its largely dependent on when these accounts are coming up for renewal. And so, if you have a couple of big enterprise, accounts coming up for renewal might be a high number. If it's a bunch of smaller accounts coming up for renewal on the old platforms, it would be a lower number. And then, to the extent that we do renew them, you know, they’ll account into the hStream subscriptions where they are upgrading their old contracts and include hStream and other product sets from us. And remember as well that, you know, contracting for this kind of new operating system is kind of step one, and then, receiving benefits and capabilities from it is step two, and some of the most tangible and obvious benefits are for customers that choose to stay with and renew our learning platform as well. They get this upgrade to MyTeam. There are other benefits that we can roll out with hStream and we’ll be articulating them in the coming months and quarters to both customers and to the market. But that’s how we’re achieving this migration. You remember that average contracts are kind of three plus years. And so, a third of the accounts will come up for renewal each year, some would enter longer term renewals in that. So, again, I think about 24 more months and we’ll be to the bulk of these migrations.

Understood. Alright, thank you very much.

Thank you. And our next question comes from Richard Close with Canaccord Genuity. Your line is now open.

Great. Thanks for the questions. Just a little bit on gross margins, obviously, you’re targeting, based on your statements, 60% by the middle of next year. As you think about the transitions here, what you think margins will be, you know, out maybe two or three years? Have you thought about that in terms of like what may be a long-term target is considering these transitions?

Okay, Richard. Now, you know, that I’ve never guided beyond a year, but this is one that I think I can touch on because there’s kind of a natural follow-up from the roll-off of the resuscitation products and the growth in the newer Red Cross Resuscitation Suite program, and our new resuscitation product set. So, I think I can say that, you know, by this time next year, we’ll feel like we’ll cross across that 60% of the gross margin level. My expectation is sustainably. And then, as the legacy products drop off even faster by Q1 2021, we think we’d see a much more aggressive move up in the gross margins. And so, just for now – just for now, I'll ballpark and say that, you know, we should cross through 65% gross margins against approximation, its long run, and so we'll caveat with all that, but it is this natural migration of the switch out of the legacy revenues for the new that gives me the confidence to say that – in addition to the other migration that we’ve talk about and the SaaS to PaaS past strategy and the Verity migrations, all those together, you know, I think, you know, we’ll be looking at 65% kind of gross margins by Q1 of 2021, and with even some upside to that into the future. But all this – I'll leave it at that for now to give you a little bit more sense for the way we’re thinking about it. You know 60% by the third quarter next year, 65% by the first quarter or so of 2021.

Okay. That's great. Thanks for that insight there. And then, with respect to the most recent quarter, and then in the updated guidance with respect to operating expenses, I think on all the line items you did considerably better than what we were forecasting, and just any thoughts there in terms of, you know, may be how you’re trending in terms of product development, sales and marketing, and then the G&A in terms of – are there – were there anything as really to call out that, you know, maybe you didn't do as much hiring or, you know, things along those lines that led to the better operating expenses in the quarter?

Yes. Let's talk about that a little bit. That’s a good question. So, we’re just talking about that before the call started actually, and we had a very ambitious hiring plan. We did end up adding a net new about 80 plus employees in the year, so we did grow our workforce, a good chunk of that, maybe a third of that or so was through the acquisition of Providigm, but there was also some organic net new hiring of probably 50 or so people across the rest of the company. So, we did achieve some really good growth as we had planned to in our headcount. However, in our modeling, and then, in our guidance, we had assumed even higher levels. And so, we were not able to hire to our desired outcome and that resulted in lower expenses than we had, and therefore, kind of outsized earnings in Q3 to what we had hoped. So, had we been able hire everyone we had hoped to? We probably would have had a little lower earnings in this existing quarter. And so, I think probably the single biggest variable is setting our hiring expectation internally, and then, how close do we get to achieving them. And I would say, this year, we underachieved. We’re not aggressively trying to correct that, meaning, I didn't tell our teams go out and get five [head hunting] firms and get all these positions filled. So, we’re kind of fighting the national battle for talent in our market, including national, which is heating up and we’re doing it diligently, but were not overinvesting like treating a huge cause of rapid recruiting. We’re taking our time trying to get the right people, and I think we’re doing well at that. But the net effect is, yes,…

Okay. And about a year ago, you talked about a transition to, I believe it was Azure and AWS. Any updates there in terms of where you stand in that process maybe the positives associated with that that you think you’ll accrue? And then, maybe an update on the expenses associated with that? Is that coming in lower than anticipated or, you know, above expectations?

It's about at expectations. You know, I think it's going to take – I think I’d characterize that as a 24-month migration as well or 27 months. If I had to think of – or like describe another migration, this one is more at hand and it's managed with a thorough process. But as our PaaS strategy grows, we’re increasingly moving all the applications up into those two environments you mentioned, the Azure and AWS, and that does [indiscernible] duplicative cost where our legacy platform, HLC is all a SaaS, you know, it’s a great architecture, but it's hosted in managed hosting environment and a couple of Tier 1 data centers across the country. And so, we are having duplicate costs, but I would say, we’re going to bear those duplicative cost for the next – and I’ll go ahead just to align this with the other two migrations because you know, there are hundreds and hundreds and hundreds of HealthStream managed servers in these Tier 1 data centers and it’s going to take us time to get each of our applications moved and we’re not in any particular hurry because it's a good, stable growing model and platform. And again, a lot of the new platform technologies are being built. And so, we don't have all the functionality in the new platform to just switch some of the legacy platforms over. And so, I guess I would say that they’re at our budgeted expectations for cost in the model, nothing exceptionally the way, and that we’re going to take our time probably next 27 months. So, I’m going to give us the same time line as the other three transitions to get us over to the cloud fully. Again, all of our access to be clear. Our SaaS applications that our webhosted and delivered, multi-tenant architecture, so they are modern architectures, but as far as the actual hosting environment, managed hosting versus outsourced hosting to AWS and Azure, the Microsoft platform. We are going to take our time on that and manage those cost. Now, to your point though, if you look out 30 months from now, if – when those migrations are complete, we will have a lower cost structure, because there is a – I think some of our server facilities have over 300, 400, 500 servers in them that would go away and the capitals who refresh them would also go away, but let’s call that a 27 month journey as well.

Okay, and would that be included in that sort of 65% type of gross margin or is that a [indiscernible]?

Yes. Those costs are in our thinking as we look out and as I mentioned since a 27 month migration, those kind of duplicative costs are in our assumptions and we still think we can see a move to cross the 60% threshold by this time next year and then a more rapid move by Q1, Q2 of the next year to touch that 65% area. So, we will touch the cost.

Great. Thanks.

Thank you. [Operator Instructions] Our next question comes from Frank Sparacino with First Analysis. Your line is now open.

Hi, guys. Just one from me on the talent side of things given we haven’t talked too much about that recently Bobby. You know, I see there is some new money in start-ups coming into the space on the hiring side, but any thoughts just in terms where you are at today in terms of the talent portfolio products and your thoughts going forward there Bobby in terms of the market opportunity and how you sort of balance that maybe with some of the other initiatives you have?

Yes, thanks. We haven’t talked about it a lot. I would say, Globally I would say, we are retrenching to what we are best at, that would be a fair characterization, the learning and development dimensions, tools like our checklist tool have been good winners, we put those in the talent management bucket. The learning center with its refreshed MyTeam and the new kind of initiative management capabilities we have been building into the platform, we are really excited about. Probably a slight move away from some of the other areas like compensation, like the full talent suite, yes and so, probably deemphasis on what I would call the secondary and tertiary components of talent management and a doubling down on what I will call performance management and learning. And then, even within learning there is new innovations coming and we are right on top of them around for example, using video-based education and training and providing new products that give the capabilities to manage. Essentially your own kind of YouTube for your health system and tied into your learnings platform and so we have some exciting momentum around this new video-based platform that is connected to our learning platform. And so, overall our characterization would be, we are kind of doubling down on what the core is. From our perspective, it is kind of learning and performance management. We are probably moving away from the secondary and tertiary services like compensation management and recruiting, for example the ATS moves we made several years ago, probably deemphasizing those overall and then the emerging technologies like the new video-based platform really excited about. So, we think we can continue to differentiate ourselves and what I’ll call learning development and performance management.

Thank you.

Thank you. I am not showing any further questions at this time. I would now like to turn the call back over to Robert Frist for any further remarks.

Well, thank you everyone for participating. Congratulations to the employees on their great efforts for our social responsibility program and helping raise over $20,000 for the American Cancer Society, a great, great effort there. We look forward to reporting to all investors on the three key transitions again next quarter. Actually, it will be sometime before to gather again around February. And we are proud, that we’ve made good progress on each of the three key transitions and migrations we talked about. I guess we identified a fourth, is the move into these full Cloud hosted solutions as almost a fourth transition to think about. Thank you all. Look forward to our next report.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating, you may now disconnect.