Mollie Condra – Vice President-Investor Relations and Communications Bobby Frist – Chairman and Chief Executive Officer Gerry Hayden – Senior Vice President and Chief Financial Officer.

Matt Hewitt – Craig-Hallum Scott Berg – Needham Steve Halper – Cantor Fitzgerald Richard Close – Canaccord Genuity Frank Sparacino – First Analysis Vincent Colicchio – Barrington Research.

Good day, ladies and gentlemen, and welcome to the HealthStream Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference, Ms. Mollie Condra, Vice President of Investor Relations and Communications. Ma’am, you may begin..

Thank you, and good morning. Thank you for joining us today to discuss our third quarter 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.

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 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 turn the call over to Bobby Frist..

Thank you. Good morning, and welcome to our third quarter 2018 earnings call. We have a lot of news to cover, as we dive into the numbers and look at the accomplishments of the quarter. But before we do that, I’d like to recognize one thing that occurred in the quarter that I’d like to discuss.

In our earnings release issued yesterday, we announced that our CFO, Gerry Hayden, has tendered his resignation from the company. He will remain in his position as CFO to the filing of our Form 10-K for the full year 2018, which we expect to occur in March of 2019.

The Board of Directors will always see a process to fill the CFO position working with me and the rest of management. Following Gerry’s departure as CFO, Scotty Roberts, our Vice President of Finance and Accounting, will serve as interim CFO. Scotty is the CPA, who joined the company 16 years ago after working at Ernst & Young.

As Gerry’s prodigy, Scotty has broad experience in financial reporting and financial operations, making him an ideal interim CFO and a candidate to fill the position permanently. All of us at HealthStream want to thank Gerry for his tremendous service in the company for over a decade as our CFO.

And then, actually he served for three years prior to that period on our Board of Directors, and we’re grateful for that service as well. His leadership and financial expertise have played an important role in our growth as we’ve successfully navigated the company through many opportunities.

He has built, led an outstanding Accounting and Finance department and team, and he’s mentored a strong bench of financial talent that will serve the company well for many years to come..

Thank you, Bobby. It’s been an honor to serve the company as CFO over the last decade and work with everyone here at HealthStream. I look forward to we’re wrapping up the year and including my tenure at HealthStream, it looks good getting up 10-K filed, as Bob mentioned, next March.

After that time, I’m working as a Senior Executive Advisor, working closely with Scotty Roberts to ensure a very smooth transition. He’s very capable and well with qualified stepping into the CFO role here at HealthStream..

All of us at HealthStream wish Gerry, a much success whenever future endeavors he choose to pursue. I’m sure you’ll have some more questions about that in the open dialogue at the end. Let’s dive into the quarter, and the numbers, and the details.

Compared to the third quarter of last year, quarterly revenues were up 9%, operating income was up 71%, income from continuing operations was up 75% and adjusted EBITDA was up 22%, while in most all accounts in all core measures the metrics were solid.

However, we didn’t end the quarter exactly where we expected to with regard fulfilling open staff positions. So expenses were a bit lower-than-expected in the quarter. And as we look to the fourth quarter, we expect to begin to ramp some more of that hiring, particularly in the preparation for launch of new products early next year.

In addition, we benefited from a few nonrecurring revenues in the quarter, which Gerry will further elaborate on in just a moment. Overall, our third quarter results give us confidence in achieving updated guidance we provided yesterday.

We intend to continue as planned with increased investment and accelerated hiring in preparation with the launch of exciting new higher margin products early next year.

As we discussed in our call last quarter, we are investing in products like our new resuscitation solutions, which will carry higher gross margins in the legacy products that they replaced. In fact, the new resuscitation solutions will carry approximately double our existing resuscitation product margins.

As these products and solutions are adopted by customers, we expect to see a positive impact on gross margins in the years to come. As a reminder, at the end of June 2017, we announced that our current agreements with Laerdal Medical for the HeartCode and RQI products will expire on December 31, 2018.

HealthStream retains the right to, and expects to, continue selling HeartCode and RQI for the remainder of this year. And we’ll provide uninterrupted service to our customers for the duration of their contracts, which can extend through December 31, 2020. HeartCode and RQI generated approximately $51.3 million of trailing 12 months revenue.

At the end of this year and approximately 70 days, we will stop selling those products and expect the revenue from them to decline in 2019 and run out over the course of 2020. To be clear, we expect revenue from these two products to be 0 in the first quarter of 2021.

We’re committed to creating a marketplace that brings more choice and selection to our customers for a wide range of clinical solutions, including resuscitation. In fact, we’re on track to launch new resuscitation solutions in January of 2019 to 70 days away.

The new resuscitation solutions will feature multiple new strategic partners, each with individual areas of expertise and focus like science, credentialing, curriculum, simulation and hardware and software technologies.

As we’ve previously shared with you, we’ve already signed three seven-year-plus partnership agreements to develop new innovative high-quality resuscitation solutions. We are pleased to announce that in the third quarter, we signed our fourth seven-year partnership agreement.

HealthStream and our four new partners are excited about the progress we’re making to be ready for launch of the new resuscitation solutions in January 2019. Of course, as we prepare these new products and solutions to go-to-market, our expenses and capital investments will increase throughout the remainder of this year and on in to early next year.

At this time, Gerry Hayden will provide a more detailed discussion of the financial metrics for the third quarter results..

Thank you, Bobby, and once again, good morning, everyone. Before reviewing our third quarter results, I’d like to note that, one, all results are from continuing operations only.

So for example, 2017 and 2018 results exclude the gain on a sale of our previously divested Patient Experience business segment, the result of operations of that segment prior to the divestiture.

And two, 2018 results are presented in accordance with the new Accounting Standards Codification 606, Revenue from Contracts with Customers, also known as ASC 606, whereas results from – for 2017 are presented in accordance with ASC 605. Excuse me, here are some highlights from the third quarter. Consolidated revenues were up 9% to $59.9 million.

Operating income was $4.7 million in the third quarter of 2018, up from $2.7 million in the third quarter of 2017, with a $1.1 million positive impact in the third quarter of 2018 from the application of ASC 606, the new accounting standard.

Net income from continuing operations was $3 million in the third quarter of 2018, up from $1.7 million in the third quarter of last year, with $819,000 positive impacts in the third quarter of 2018 from the application of ASC 606.

Earnings per share, or EPS, from continuing operations was $0.09 per share diluted in the third quarter of 2018 compared to EPS from continuing operations of $0.06 per share diluted in the third quarter of last year.

Adjusted EBITDA from continuing operations was $11.1 million in the third quarter of 2018, up from $9.1 million in the third quarter of 2017, with a $1.1 million positive impact in the third quarter of this year in application of the ASC 606.

Our 2018 financial reporting includes two developments that originated in the first quarter of this year and continue to be reflected in the presentation of our operating results in the third quarter and pardon me, remainder of this year. Excuse me, once again, pardon me.

One is the divestiture of the Patient Experience business segment, whether the mandatory adoption of ASC 606, which is the new GAAP standard for reporting revenue. As you already know, the divestiture of the Patient Experience business segment occurred on February 12, 2018.

Our income statement continues to segregate the gain on the sale and the income or loss from discontinued operations from continuing operations. Our comments focus on the continuing operations, which consist of our workforce development and Provider Solutions business segments.

The second financial reporting development is the implementation of ASC 606 into our GAAP reporting. There are two areas affected by our ASC 606 reporting, recognizing revenue and commissions accounting. In third quarter of 2018, recorded revenue in accordance with ASC 606 was similar to historical ASC 605 method the same period last year.

The most significant difference with regard to our financial results is that commissions are accounted for as capitalized costs and amortized under ASC 606, while these same costs would have been expensed under ASC 605 level.

The realization of capitalized commissions recognized in the third quarter of 2018 was lower than what would have been recognized as commission expense in the same period under ASC 605. Now let’s look at certain areas of our income statement, we will touch on highlights from each of the two business segments. Revenues.

Revenues from our Workforce Solutions segment increased by $4.5 million in the third quarter of 2018, a variety of subscription products contributed to the increase in these quarter’s workforce revenues, and including higher revenues from our resuscitation and compliance products.

Overall, we benefit from higher revenues from the HeartCode and RQI products. In particular, the federal government customer of HeartCode, which is also one of the largest customers for this product, switched from our standard subscription model to a consumption based model, based on government contracting requirements.

Their consumptions on the third quarter helped contribute to our overall revenue growth at a higher rate than last year’s third quarter. Because a consumption revenue model is a bit less predictable to the extent these customers’ consumption levels fluctuate, our revenues may also be impacted.

In the third quarter of 2018, revenues from our Provider Solutions segment increased by approximately $700,000. This revenue growth, net of deferred revenue write-downs, was primarily a result of professional services revenues from Morrisey Associates, Inc., which we acquired in August of 2016.

Revenues benefit from recognition of some of the acquired deferred revenue from Morrisey in the third quarter such balances are now almost fully recognized, we don’t expect any significant recognition from the acquired deferred revenue balances going forward.

As Bobby, referenced – and as I just discussed, we had a couple of onetime revenue declines in the third quarter that totaling of approximately $1.6 million, which included the shift to its consumption-based accounting for the government contract and it recognize deferred revenue at Morrisey. Now, gross margins.

Our gross margin was 58.1% this quarter and 58.9% in the same quarter last year, primarily due to increased revenues from the existing lower-margin resuscitation products, HeartCode, RQI, for example.

In addition, cost of revenues also reflects, a strategic decision to migrate the cloud-based processing structure about workforce and Provider Solutions.

Accordingly, where we saw an overlapping expenses from this migration period, now our overall hostings can this grow – overall hosting cost increased about 38% between this year and last year’s third quarter. Operating expenses. Operating expenses for the third quarter 2018 were up 2.2% over the same period last year in 2017.

The combination of capitalized software investments and product development expenses increased 11% between this quarter and last year’s third quarter. Software development remains a priority, and we maintained our development capacity. We also plan to increase our rates of R&D investments throughout the remainder of this year.

Sales and marketing expenses are down by approximately $586,000 from last year’s third quarter, due to lower sales commissions from the adoption of ASC 606, and some lower marketing costs. We do expect to increase sales and marketing investments through the remainder of 2018 this – the last quarter.

Depreciation and amortization were flat with last year’s third quarter. This is primarily due to the full inclusion of amortization of acquired intangible assets through the Morrisey acquisition in both the third quarters’ of 2017 and 2018.

It’s important to note that, depreciation and amortization still reflects increased levels of capitalized software development amortization. G&A expenses in third quarter of 2018 increased to approximately 7.5% over the third quarter of 2017, and about 15% of revenues compared to 15.3% of revenues in Q3 of 2017.

The growth in G&A expense category is primarily related to increases in the software expenses. Operating income. Operating income was $4.7 million in the third quarter of 2018 compared to $2.7 million in the third quarter of last year.

The increase in operating income reflects revenue growth, and leverage on our product development, and sales and marketing expense categories. Other income or loss. For the past several years, we’ve established a small portfolio of minority investments that we believe our strategic.

For example, back in 2016, we successfully acquired full ownership of ignoring investments we held in this competency, which has now become a major part of our clinical staff solution group.

The accompanied investments under the equity method or the cost method, depending on factors, such as our percent of ownership and/or our ability to exercise influence over the investee.

In 2018, we adopted a new GAAP rule that requires us to adjust the carrying value of cost method investments, where evidence indicates that fair value has changed either positively or negatively. Fair value adjustments can create potential volatility in our earnings when they occur, which was the case during this quarter.

We currently have three investments in three companies totaling $3.4 million in carrying value as of September 30, after giving effect to a $1.3 million noncash charge, due to the decline in fair value in one of these trillion dollar investments.

This charge was driven by capital rates by the investee and the valuation below our original investment basis. Now let’s look at our balance sheet. Our cash position and overall balance sheet remains strong. Our cash balance at September 30 was approximately $174 million, a $43 million increase since December 31, 2017.

Excuse me, the $43 million increase reflects the net cash proceeds from the Patient Experience divestiture in February of this year, improved cash collections on accounts receivable, and is offset by the special $1 per share dividend, which was paid on April 3, 2018.

Since December 31, 2017, accounts receivable has decreased by approximately $6.6 million, resulting in days sales and accounts receivable of 46 at the end of this third quarter. The 46 days represents the lowest level of DSOs since 2002. We have no outstanding debt and our full $50 million line of credit capacity is available to us.

We believe our overall capital position is likely to support our organic and inorganic growth opportunities and support other capital structure optimization and shareholder maximization strategies as maybe appropriate. Yesterday’s earnings included updated guidance.

And consistent with our second quarter earnings release, issued July 23, 2018, we are presenting our updated guide – 2018 financial outlook utilizing ASC 606 with respect to our anticipated 2018 results. For 2018, we continue to anticipate that the consolidated revenues will increase 6% to 8% as compared to 2017.

We anticipate the revenue growth in our Workforce Solutions segment will be in a 4% to 6% range, and our Provider Solutions segment to grow 10% to 20% when compared to 2017. We anticipate operating income for 2018 to increase between 45% and 60% as compared to last year 2017.

We expect the capital expenditures will be approximately $19 million during 2018. We expect the annual effective income tax rate to range between 20% and 22% for this year. This guidance does not include the impact of any acquisitions or strategic investments, which we may complete during the remainder of this year. Thanks for your time.

I’ll turn the call back over to Robert..

Thanks, Gerry. We’ve got a few more conferences to cover before we turn it over to questions. And so I want to provide an update on our initiatives we introduced last conference call. As we’ve discussed before, the HealthStream network is now made up of approximately 4.9 million users and over 75 partnerships.

In our second quarter, we introduced a new and improved way for customers and partners to access and participate in our network. We call it hStream. Our new hStream technologies represent enhancements to our platform in the beginning of our new platform as a service capabilities.

We released hStream on April 30 of this year, and it is currently has approximately 587,000 subscriptions under contract as of Q3. For each existing customer contract that comes up for renewal, along with any new customer contracts, we are including a subscription to hStream.

A subscription to hStream enables many exciting new features and benefits for customers. Stay tuned, in the coming months, we’ll provide more details regarding the new product enabled by hStream, the new partnerships that leverage hStream and the new services that are powered by hStream.

Importantly, hStream also serves as a bridge between our workforce development and Provider Solutions business segments. In the third quarter, for example, Verity has began including hStream subscriptions in contracts for its new SaaS platform.

Because of this, we believe that hStream subscriptions will soon be the most – representative metric for measuring the progress of our business. In fact, we intend for our 2018 year and earnings release to be the last time we provide our legacy subscriber metrics, which focused on a narrow representation of our learning applications.

Instead, we intend to replace those metrics by reporting the number of hStream subscriptions. We look forward to reporting the progress of hStream, both in terms of subscriptions and the value it brings to our customers and partners. One last note.

In the spring of 2019, we are scheduled to move into a new national office, which was prompted by the end of our current long-term lease and interest in consolidating multiple offices in Mill, Tennessee. In absolute terms, our operating expenses associated with occupying new location will increase by approximately $2 million in 2019.

This increase is less expensive in the alternative renewing and remaining in our current location and continuing to occupy multiple locations in Mill, Tennessee. We’re excited to move into the new office. It is an area known as Capitol View, which is part of the thriving tech community near Downtown Nashville.

We think this new location will be – will provide great energy and excitement to our culture and also assist with recruiting new tech workers to our business. At this time, I’d like to turn it over for questions from the investor community..

[Operator Instructions]. And our first question comes from Matt Hewitt with Craig-Hallum..

Good morning. And congratulations on the strong quarter..

Thank you, Matt..

A couple of questions about the resuscitation, and then I’ve got a different follow-up question.

Regarding the resuscitation, what percentage of your customers today are under contract through 2020?.

I don’t have that number in front of me here. So that’s probably – well, there is so much still open about the current products.

I mean, in the last eight weeks of selling are so critical to our future forecasts that we’re going to probably need to take their questions now, write them all down and come back in February when we provided guidance and answer them all. So I don’t have that number in front of me right now, but we will provide it in the February earnings call.

So if you have other questions related to that. By then, we’ll have a more perfect view of the two-year trajectory and wind down of those businesses. We’ll know the shape of the revenue curve essentially. Right now, it’s $51 million. It will probably peak in Q1 of next year, and then begin its decline to 0 by the first quarter of 2021.

So if you have any more detailed questions, we’ll write them down and consider them all for our February release, where at that time, we’ll have wrapped full year of sales. We’ll know pretty much the – almost the exact revenue curve and be able to answer related questions like the percent of the customers that you just asked.

And any other related questions, go ahead and lay them out..

Okay. And then one other question regarding that product. The resuscitation card that the American Heart Association provides, that was potential sticking point with some customers.

Have you figured out, as you talk to some of those customers that have been up for a renewal, where they sit on that? I mean, is there going to be – are you going to be able to work around that card?.

No, we are – obviously, our new partnerships are signed and developing and they include new partners for all the dimensions I’ve spoke out, including a new credential that’s based on international science that we think it’s globally accepted. But we’re not in a dialogue with any customers about their acceptance of our new products.

In fact, they are remaining unannounced, and we won’t launch or begin discussing with our customers those new products until January..

Okay, fair enough. I’ll shift away from that. During your prepared remarks, you had mentioned that there was some higher cloud hosting costs.

Is there any way for you to mitigate some of that going forward? Or is that just going to be a stepped-up expense going forward?.

Well, we’ve always done managed hosting as we’re a SaaS application, so we have our own managed hosting costs, where we provide our multitenant SaaS applications and a managed hosted environment. So we have those costs.

As we move those services, which are already web-based to Amazon Web and Azure and other hosts – and a fully managed hosted services, outsourced services, we’ll probably see some more overlapping of those costs, particularly into the next year.

Of course, ultimately, I would say within 18 months, our capital outlays for acquiring hardware that goes into our managed hosting facilities will decline, and we’ll start to see a benefit of the move to Amazon and Azure, the two primary hosting services we’ve selected. So we will have some overlapping expenses, probably into the next year.

And – but then ultimately, again, as we look beyond that, we’ll start to see through that financial benefit to those moves..

Okay, great. And then one last one from me regarding hStream. Thanks for the heads-up that you’re going to be switching the metrics that you provide. How quickly do you anticipate, I think you said approximately 580 – or 580,000 subscriptions now.

How quickly do you anticipate that catching up to the 4.9 million fully implemented subscriber number that’s your – you provided this quarter?.

Sure. When we think it go pretty fast because so far since April, we have met no resistance at including it into the contracts. In fact, we met some enthusiasm because as we mentioned, customers get some immediate technical benefits and upgrades to their products when they include it.

And so, if you think of our renewal cycles on our platforms and the fact now that the hStream subscription is included with most all of, and hopefully by Q1, all hStream products will include a subscription, we think it should move rather quickly.

I would say, if you think of our average contract life spanning two to four years, let’s pick three as the midpoint, within 36 months, we should have the whole network migrated.

And maybe faster if renewal coming faster and there are reasons for early renewals, for customers to get access to this benefits of hStream, which there are numerous benefits already. And let’s say, 30, 36 months is probably a good target..

Okay..

Our next question comes from Scott Berg with Needham. Your line is now open..

Hi, Bobby, congrats on the good quarter and thanks for taking my question as well.

Bobby, I was hoping you could help us explain why is the new hStream seems the right metric to use going forward? Trying to understand what maybe the direct revenue opportunities or general economics of the – of that platform are? And why maybe that’s the right meaningful number to value? Or at least to get a view on how the business is growing?.

Well. Sure, Scott. So, one fulfillment, as you know we’ve moved from having almost a singular application, our learning application, to a set of applications. And now with hStream, we have an infrastructure that supports all applications at HealthStream.

And so at first look, hStream is a more fundamental, included set of architecture with every piece of technology that we sell. And so in that – in effect, from a business standpoint, it’s like our iOS, it’s like our operating system. And secondarily, it’s common across all of our business units.

So we’ve started a long time ago measuring the penetration adoption of our learning platform. And as we expanded the learning platform to tools like our checklist to our competencies center, the singular metric of measuring subscriber to learning system was an important metric, but it wasn’t an encompassing growth in other areas.

And so over the last two – last quarter, and this quarter, and next quarter, we’re beginning every one, the migration for this measure that we think will represent a more fundamental core metric that is inclusive of all of our business units across all of our segments. And then secondarily, it does represent new functionality.

And so it is platform-as-a-service capability and the host of capabilities allow us to build both new features, new products, share revenue with partners in new ways and sign new forms of partnership agreements to have access to and leverage the network that’s in place.

And so again, it represents a bit of a move from a software-as-a-service application suite to a platform-as-a-service. It is more fundamental to all of the business segments, all the new products, like Verity, include subscriptions to hStream, and so we think it is more global and more representative of our future direction as a company.

And as you can tell, just since April, we put about 580,000 subscribers on hStream. So it’s going to move fairly quickly as well because it’s so powerful. The other thing to think about hStream that may help everyone is that a little – a good analog might also be from an economic standpoint. Think of it a little bit like Amazon Prime.

We’re beginning to bundle value into hStream. Some of the value we bundled into it allows us to up charge, it creates more opportunity – financial opportunity. Some are premium services that give trial access to new technologies that could turn into subscriptions.

And some are disruptive to existing applications in the market from competitors that should shift – help shift market share to our platform-as-a-service.

And so for all of those reasons, we think that as we think about the next four years, that metric is a more fundamental metric than measuring the market penetration of a singular application like the learning center, which is approximately what that 4.9 million number represents.

And it’s been exciting to watch that grow, obviously, 20,000 to 50,000 subscribers net new each quarter, including this quarter. So that has been fun, but there are half a dozen of the products now that have market share and all of them are relatable back to these new metric now..

Got it. Very helpful. And then one follow up maybe for Gerry. Sad to see you leave. Congrats on whatever the next adventure leads you to. Hopefully, some R&R. But on the onetime fees in the quarter, especially the contract with the shift to consumption.

How much volatility does that create in the model or variance, I guess, as going forward? Because, my guess, is that those additional revenues are probably pulled forward from future periods since they were consumed in the quarter versus future quarters.

And just trying to understand if that’s maybe going to create, I don’t know what the right number is, $0.5 million to $1 million variance maybe between two quarters? And then maybe what’s your visibility to those, at least on a short-term basis?.

Yes. So maybe a couple of overriding comments. Very few, there are a few contracts, as the consumption-based. Most all subscription-based was kind of, an anomaly because large customers are still anomaly. Second, this – the revenue spread, I think, the way to look at that is just take the variance this quarter, spread it over two quarters or so.

That’s probably with the right run rate to a normalize, did that helped?.

That helps very much. Thank you very much for taking my questions..

Thanks Scott..

Our next question comes from Steve Halper with Cantor Fitzgerald. Your line is now open..

Hi, last quarter, you talked about – you mentioned some consciousness about the launch of the new resuscitation products.

How do you feel about that three months later, as we are approaching that launch?.

Well, of course, it’s daunting. It’s a new product that gets an incumbent that has a strong product that we’ve represented well for a long time. But it is also a very exciting. There is new energy in the market. And with our partners to see that there is more than one way to achieve an outcome and in fact maybe improve on outcomes.

And so I think that our partners, we have a lot of energy. I think watching the development process internally, there’s a lot of excitement. But the caution is that it’s new and its launch is in January. And it’s going to take cycles to get it into the market and see its acceptance.

So the energy inside the company and within our partners is high and as is the excitement for the future, but it is not a small path to create choice and selection, where previously there has been none..

Right.

So do you feel better about it than you did three months ago?.

I do, yes. But that doesn’t mean that in the first quarter, we’re going to be able to fill the holes of a very strong and large product that’s historically grown. And so I absolutely feel better, but you have to think, my caveat is more about the horizon. We are trying to explain this as a long-term opportunity and issue.

It’s not a Q1 fix having a new product for what has been a long dominant and positive experience with prior products..

Got it. Thank you..

Our next question comes from Brian Hoffman with Canaccord Genuity. Your line is now open..

All right. Yes. So it’s Richard Close. Thanks for the questions. I’m just trying to understand this hStream a little better. I know, you tried to explain it to me last quarter. But just – so let’s say, I’m a learning customer and that’s all I want is the learning platform.

Why do I need this hStream? And how is it included in the product? I’m just trying to better understand why an existing customer gets the new platform and/or is the learning platform integrated in hStream? And just is there an upside to revenue associated with re-signing with hStream? Just can you walk – try to walk me through all that?.

Yes, sure. Yes, I can. And we’ve identified about six or seven value propositions that will play out over the next two years.

But that’s a – I’ll take the first one that you hit on, which is, why would our customer of the current learning platform be excited to renew their contract and add hStream to it? And what does that mean economically? So the net economic impact will be a smaller slight positive.

If you had, take a prior contract in your – on the learning center and you upgrade, we’ve effectively broken the application, which is the learning center from hStream, which is this, platform-as-a-service architecture. And so in your purchase of the learning center, you would see the bill kind of effectively split.

And just for simplicity, let’s say, it’s split in half. But it’ll be split in half and then a slight up charge for hStream, because of the value that it’s going to bring. And let me give you some example of the value. So the HealthStream Learning Center connected to the old architecture had certain capabilities.

They are wonderful, they got us a lot of the market share we enjoy today, but there are new capabilities immediately available to the new customer of the old learning system connected to the new hStream platform. One of the first is a new set of capabilities we call My Team.

And My Team is a new set of management tools for managers to better manage learning of the direct reports to them. And so there’s a new set of features that our sales team is very excited about that are only enabled by connecting to hStream.

And so upon renewal, we can go back to the HLC, the learning customer and show them the new features they’ll get if they include the hStream subscription in their contract. And then again, there’ll be a slight net up charge on that renewal for the hStream capability.

So that is an example to start out, there’s actually a new set of features that are powered only by hStream. One other example, and this instead of an up charge, here is an opportunity, but hStream is the technology that powers what we call individual transcript portability.

And so what it does, it creates a unique identification model for each person in our network and allow those persons to track and move their longitudinal educational history with them along their lifetime and not just be pegged just to their educational institution.

And so the concept of individual – the individual being at the center of the universe and being able to have access to their records beyond their employment at the organization is a new fundamental tenant of the platform-as-a-service and the hStream capability. We’re finding household excited about e-portfolio.

I think our latest number of subscribers on e-portfolio is – which is a total transcript, is up to about 1.7 million, and that capability has new possibilities when connected to hStream. And so there are many more value propositions. We are in pilots right now, with a – an additional service.

Think again, think it is on Amazon Prime, where you bundle value into it. Again at a slight up charge for hStream, there’ll be some bundled value services that currently, we believe are also customers pay other vendors for.

And so we are electing, and a pilot now for a couple of hospitals to provide free and included, let me say three, if it’s included in hStream and hStream as a small charge, but this is a value-added service of doing some federally required sanction screening inclusive of your membership in hStream.

So every one of our customers that upgrade to hStream will essentially for a small up charge get access to a free service that they are likely paying another vendor for on sanction screening. And so essentially, we’ll be continuously helping validate and check against federal sanctioned databases anybody in the hStream network.

So there’s three examples on enhanced application capability, the portable transcript connected to the e-portfolio concept, we talked about over the years is now here and this idea of bundled value again like the concept of free music and shipping at Amazon, we continue to pack value into that hStream subscription.

And of course, then every application connects to hStream and gets some of those advantages to the capabilities within each application, hopefully making each application more valuable as well. I hope that helps.

There’s much more to come on this, probably through individual announcements of these bundled value and where the customer gets value out of the hStream subscription..

Okay. That is helpful. As a, I guess, follow-up to that, let’s say, I’m that learning customer, I come up for renewal and I balk at the upcharge to hStream, I decide not to upgrade to the hStream. Do I essentially walk away from you? Or do I renew....

It hasn’t happened yet. And – so it hasn’t happened yet since April. I guess it could happen, and it might create a bit of conundrum. What we probably do is elect to leave them on the older architecture, if we wanted to retain them. But right now, we’re batting 100% right now.

I’m sure across 4,000 customers, we’ll find one, who doesn’t want the incremental value for small incremental cost. And we’re trying to make the value, it’s overwhelming like Amazon Prime that it’s really, it’s a no-brainer.

For example, we’ve also moved 300 free industry courses, almost like the Amazon video we have 300 free industry courses, including with your hSteam subscription. And so this – our concept is like Amazon Prime, the overwhelming value and little debate involved in the renewal. And so far, we’re batting 100%..

Okay. And based on your comments here, with respect to this 1.7 million in e-portfolio, that’s with the specific individual.

So are you saying, let’s say I move from hospital A to a wholly different entity hospital B, I’m able to take my, essentially, my education records and certifications that portfolio with me?.

That is correct. And so it’s currently powerful. It changes the opportunity and relationship with those individuals in our network, and it’s a place where they can carryforward their resume and some of their accomplishments.

And what’s happening is the institutions are agreeing to release some of the institutional record-keeping to the individual, which if you think about it, and then you kind of do that anyway, if the individual earns education while working at a hospital, they go down to the records department and ask for a copy of the CE credits they’ve already earned.

And then its a administrative burden that get them, those records for their individual life portfolio. Essentially, what guide us, made that process more seamless and allow the individuals to begin to carry those records with them, which are already their records..

Now is that free to the individual? Or do they pay a nominal fee, subscription fee or anything?.

It is free..

Okay, great. With respect to my final question here. Gerry, on the consumption, move to a consumption contract with the federal or government entity.

Do you see this as any type of trend going forward where other customers might be shifting to that type of format?.

No, not really. So what we see, as we look as, might be, kind of an anomaly this federal contract. They’ve looked at over the course of the HeartCode products, the subscription-based model roughly attracts consumption for most customers anyway, so they are very much in sync with each other. This is one of our large cost, one anomaly..

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

On the compliance side of things, I’m curious, Bobby, is there any particular sort of macros being that continues to drive the growth and the compliance side of the business?.

We see some emerging opportunities. But we have a season, yes, they’re in development. We’re talking to new partners around the opioid crisis, which we think could turn into an opportunity and in an area where much help is needed, and much education is needed.

But just a core compliance functionality of things like HIPAA and OSHA and remains in a corporate and Verity agreements. They all remain in place. For better or worse of our industry, there’s a lot of government oversight and a lot of continuing requirements in those areas.

So there have been a few new smaller areas, but – and we are evaluating what’s happening around opioid epidemic as opportunity and it’s an important means for industry, but there is nothing immediately. I’ll just say it’s just the base drivers that have always driven that part of the business.

We do have some innovative new products, both in the market now, the KnowledgeQ part we talked about and in development. And one of things that’s interesting about those products is that they leverage a little bit more of the power of our network by using data and benchmarking services.

So we think we’re adding more value to our compliance products now than we did in previous generations of the products themselves..

And just one follow-up for me. I know you don’t want to get into 2019 guidance, but just – as I look at the commentary around, obviously, the transition to ASC 606 has been a benefit this year. But being behind in hiring this year, ramping up the sales in terms of getting ready for the new transition on the resuscitations guide.

It seems that it’s unlikely we’re going to see definite the margin expansion we’ve seen this year.

Is it more reasonable to assume a very modest increase next year? Or any comments there?.

Well, we – as you pointed out, we don’t provide guidance through our full budget cycle. We finished, or treating our five-year planning process. We just wrapped that up a month ago, and now we’re in detailed budget and that results in annual guidance in February.

That said, we have provided, I think, a couple of important things that do you need to be thinking about in your modeling already. One related to our office move, which we just disclosed here at the end of the call of essentially the cost of office space is going up tremendously in Nashville.

And in spite of a move to a more economical location and renewing where we are, our costs for rent will go up, we believe about $2 million are all-in occupancy costs. So that is something to be aware of, there’s another driver there.

And then secondarily, of course, the biggest factor is the rate of decline and the resuscitation business that will pressure us and a lot of sales. The only, the hidden silver lining of that is, it is one of our lowest gross margin products. So as it actually began its dissent, gross margins will enhance.

And to the extent that the new product get solved it all, gross margins can move up. So the long run profitability and leverage for the company to gross margin level, I think it starts to show through that level middle of next year. But overall, you’re exactly right. We’re launching a new product.

We are moving to a new office and our need to increase the sales effort, the marketing efforts, the product development efforts are all continuous. So – and so that’s the limit of the guidance that I can provide now, but there’s clearly two factors that have downward pressure on at least next year.

We’re trying to explain though the power of the shifts that we’re making in each of our businesses from the divestiture of the low margin PX to the launch of the double margin resuscitation product to the move to a SaaS platform at Verity and the sunsetting, the eventual sunsetting of the installed products at Verity.

All of those moves, if you think years two and three and four start to have overall impact on the profitability and leverage of the company.

But I would characterize 2019 and maybe in the part of 2020 as relatively tougher to show gains than we had – we’ve obviously, delivered on all of our promises this year, exceeding in this case, raising guidance.

And so we’re really trying to reset the bar to look at two and three horizons for everybody and appreciate the moves we are making today and the impact we’ll have, say 18, and 24 and 36 months out..

Thank you, Bobby..

Thank you..

Our next question comes from Jared Hayes [ph] with William Blair. Your line is now open..

Hey thank you. Congrats on the quarter again. Just real quick here.

I wanted to see if there was an update on the transition from the HealthLine and Morrisey legacy platform claims over to the new Verity platform? I guess, I’m wondering, what has been the initial uptick? And any early feedback that you may have on the new platform?.

Yes, there’s a lot of excitement on the platform. We think it’s a marketing-leading platform. We are, intentionally slowing walking a bit. There, actually is more demand to implement than we are currently leading to the gate as we learn to implement the new solutions.

So we’re seeing a bit of a lag and uptake some of that intentional as we work out the newness of the system and get it where we wanted. And so I would say overall, we think we have a market-leading product. The early reception is good, the demand implement is high, but we are experiencing some slow downs in getting it implemented in Q2 and in Q3.

Hope that will get resolved and all those models perfected as we enter into Q1 of next year. But currently, I would say, we’re behind our plans on getting it activated. I don’t think it’s a product issue. The product has been incredibly well-received.

We just attended a national conference, and the energy, enthusiasm and excitement for its capabilities we believe are market changing..

Okay, great. That’s very helpful. And then just one other thing I wanted to touch on. Going back to the cash balance. I’m wondering, if you could provide a little bit more color on potential uses of that cash. I know, kind of mentioned, potential organic or inorganic growth opportunities.

And then more specifically, if M&A is something that you’re looking at, any color that you can provide on the marketplace as far as valuation multiples or things of that nature that you are seeing in the market right now?.

Yes, so we have an active M&A program. I think all of last year and through March of this year was kind of consumed with that divestiture, it turned out to be a little more complicated, but very successful. As you know, it resulted in both improvement in our cash balance and it really distributed a dividend.

So, but that did take and distract our acquisition pipeline. But since it’s conclusion, we are rebuilding the pipeline. We have a lot of active dialogue, and we do expect to deploy capital and M&A activity over the coming months and years. We don’t quantify or discuss deals really until they’re closed.

But if you ask me, do we have active intent to deploy capital on M&A, the answer is yes. We are trying to be our normal thoughtful organization on how we proceed with that. But M&A, we do believe we’ll contribute to our overall growth story in the next, really next year and thereafter..

Great. Thank you..

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

As filling some open staff positions.

Could you give us more color on what positions you’re referring to? And if this is an issue that may linger, given the tight labor market?.

Yes, I think it’s a combination of many things. The shifting nature of development our company this platform-as-a-service. We’re recruiting new types of people. The focus on data, data and data assets are now we’re looking at hiring people with data expertise, data visualization expertise.

So there is a bit of, we’re looking for new types of people to join the company, and so that creates challenges. The labor market is tight in – across the country, but in Nashville, in particular. And so that’s creating a little bit of slowness.

So yes, I think it will be a persistent and ongoing challenge for all the tech companies, and we think, we are up in the challenge. And other ways too, some of this has been intentional meaning like a sales organization for the new resuscitation product.

We didn’t want to ramp up all that hiring in the middle of the year, so it will be a full core press to sales positions between now and January to strengthen and get that organization, where we wanted by a launch in mid-January. So some of it was a bit intentional and some of it is market-based..

And then in terms of the competitive landscape, has there been any new product introductions by meaningful competitors in some of your more successful Workforce Solutions product areas?.

I haven’t seen anything, any revolutionary changes that’s changing any material market share. There’s a large group of competitors for almost everything that we do. And – but I haven’t seen anybody bring an equivalent of an iPhone to market that has set up all the attention.

I think in some ways, our new hStream launch and the bundled energy around our new resuscitation products. I think, we’ve got some great things in the not-too-distant future..

Okay. That’s it from me. Thank you..

And we have a follow-up question from Brian Hoffman with Canaccord Genuity. Your line is now open..

Yes. This is Richard, again. Just a clarification on the new office. The $2 million in extra costs, is that $2 million – should we think about that when you move in? And maybe just, what’s the target date? I think you said spring, if I’m not mistaken.

So is that when the $2 million, incremental $2 million, starts to accrue, I guess? And then, Gerry, maybe how do we think about that facility cost in terms of, is that all in G&A? Or is that spread out in the different buckets on the P&L?.

Yes, so Richard, first question, the $2 million was start to kick in Q2, four and roughly. So we take the last three quarters of 2019, as opposed to the full calendar year. The second, your second question, some part of the expense will be in depreciation and amortization.

One of the things, we did to be very efficient in saving – and save money on the project was we need to finance these sort of improvements ourselves, which is a much, much lower, we require the cost of capital, let’s say, if we want the money on a lease term.

So how – the amortization is one part of that expense, but the actual cash occupancy cost rent will be in G&A..

Okay. And then, Bobby, just to clarify some of your comments on the facility costs, you said something I thought that longer term it would be better for you. Is that – but then, you also said, you have these higher costs.

So I was just trying to clarify, maybe I misunderstood?.

Yes, so the comments on the cultural contributions that having everybody in one place from, right now, we’re spread across 20 miles apart in Brentwood and Nashville. So that will be a positive. I think the recruiting value of the new office will be good for the millennial workforce, which is over half of our workforce now.

The teams that are – the people are choosing to live downtown, so the location is really excellent. And overall, relative to several other announcements we looked at, including staying here, the cost – we’re getting better deals, and how do we just stayed in place and renewed.

But I know that, I have found some relative gain, it’s just that we thought we were really looking at about eight or nine locations and pick the best cost value to our company, which would be much lower than had we just even stayed and negotiated a renewal in the current business rent, which is in the central business district.

So we moved out just a little bit. More methods to employ. We think a vibrant new committee and what was called Capitol View will help us recruiting. And so I was speaking to the intangible benefits, but in a pure financial sense that will cost us more to be there..

At this time, I’m showing no further questions. I’d like to turn the call back over to that CEO for closing remarks..

Thank you, everyone, for listening. Thank you to our employees for their delivery of an incredible an outstanding quarter resulted in raised guidance. I want to thank Gerry Hayden for his contributions over the years, and also his dedication to work with us for several more months to get to the 10-K filing.

And even after as our senior advisor to our company, he will be facilitating onboarding our interim CFO, Scotty Roberts, who will probably introduce also on that next call. Obviously, so we’re proud of Gerry’s contributions, excited for him as he thinks of new opportunities and appreciative of all of his and to the company over 12 years.

So thank you all for listening. I look forward to reporting the next quarter..

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