HealthStream - Earnings Call - Q4 2018

Transcript

Speaker 0

Good day, ladies and gentlemen, and welcome to the HealthStream Incorporated Fourth Quarter and Full Year twenty eighteen Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time. As a reminder, today's conference is being recorded. I would now like to turn the call over to Ms.

Molly Condra, Vice President, Investor Relations and Communications. Ma'am, please begin.

Speaker 1

Thank you, and good morning. Thank you for joining us today to discuss our fourth quarter and full year twenty eighteen results. Also on the conference call with me are Robert A. Frist, Jr, CEO and Chairman of HealthStream and Jerry Hayden, Senior Vice President and CFO and Scotty Roberts, Vice President, Accounting and Finance, who, as announced last quarter, will soon serve as Interim CFO. I would also like to remind you that this conference call may contain forward looking statements regarding future events and the future performance of HealthStream that could involve risks and uncertainties that could cause the actual results to differ materially from those projected in the forward looking statements.

Information concerning these risks and other factors that could cause the results to differ materially from those forward looking statements are contained in the company's filings with the SEC, including Forms 10 ks and 10 Q. So with that start, I'll now turn the call over to Bobby Frist.

Speaker 2

Thank you, Molly. Good morning, everyone. Welcome to our fourth quarter and full year twenty eighteen earnings call. As we begin the year, I thought of three things that I wanted to kind of highlight here at the open, a few examples, and we'll do our detailed financial review and look forward to your questions. Three things are clear.

First, we finished 2018 financially strong. For the full year of 2018, revenues were up 8%, operating income was up 65% and adjusted EBITDA was up 18% to 41,500,000.0 Second, sales of legacy resuscitation products outperformed our expectations in the fourth quarter. They were so strong, in fact, that we now expect revenue from legacy resuscitation products to modestly increase from the $55,000,000 of revenue recorded in 2018. Revenue from legacy resuscitation products is expected to peak near the 2019 and decline to zero by the first quarter or in the 2021. Strong fourth quarter sales results have positively impacted revenue expectations for legacy resuscitation products for 2019.

Third, 2019 is off to a fast start. We kicked off the year by acquiring a company, expanding our addressable market, launching a new resuscitation product and adding to our leadership team. It's exciting to kind of go on the offensive. Last month, for example, we announced our acquisition of Providigm, representing an investment in our continuum of care offerings and expanding our footprint in this market. This acquisition is a natural fit because the workforce development requirements in skilled nursing facilities overlap with those of acute care hospitals.

It's exciting to deploy our capital into an adjacent market, adjacent growth opportunity early in the year. Providigm is a Denver based company focused on quality assurance and performance improvement in skilled nursing facilities. Its primary product is known as Abacus, which is a leading SaaS based quality improvement program. It has been adopted by over 2,000 U. S.-based skilled nursing facilities and nursing homes.

And related to that acquisition are some regulations that are emerging. In 2016, CMS published revised requirements of participation in Medicare and Medicaid for skilled nursing facilities, which introduced a competency based staffing approach. Beginning in November 2019, so later this year, CMS will require all skilled nursing facilities to have programs in place to assess competencies, provide competency based education and document the effectiveness of those programs. We've already begun to invest in curriculum and content development for the skilled nursing market that will serve as a bridge between the quality improvement program of Abacus and the competency requirements coming into place through CMS. This year, and third, we've expanded our addressable market from 8,500,000 health care professionals to 10,500,000 health care professionals.

It's kind of a definitional change, so I'll walk you through it. Our addressable market now includes 5,200,000 employees in the acute care space and a more broadly defined continuum of care market totaling 5,300,000 health care professionals. We now define the continuum of care as ambulatory services, including physician offices, health and human services, including behavioral health care facilities, and post acute care, including skilled nursing facilities. You can see some of the additions to our definition in what I just expanded upon. So this expanded market definition comes with a greater growth opportunity as we'll expand our sales organizations to take our new products and services into this broader defined market.

At this time, Jerry Haven and Scotty Roberts will provide a more detailed discussion of the financial metrics for the fourth quarter, the full year 2018 results and provide a financial outlook for 2019. I'll turn it

Speaker 3

over to Gerry.

Speaker 4

Thank you, Bobby, and good morning, everyone. Before reviewing our fourth quarter results, I'd like to note that all results are from continuing operations only and that 2018 results are presented in accordance with ASC six zero six, which we adopted at the beginning of 2018, whereas results for 2017 are presented in accordance with ASC six zero five. Here's some highlights from our fourth quarter. Revenues were up 8% to $59,800,000 Operating income was $2,800,000 up from $1,500,000 in the prior year,

Speaker 2

with an $897,000

Speaker 4

positive impact from the application of ASC six zero six. Income from continuing operations was $2,900,000 down from $3,200,000 in the prior year with an $877,000 positive impact the application of ASC six zero six. Earnings per share, EPS from continuing operations of zero nine dollars diluted compared to EPS of $0.10 diluted in the prior year. Adjusted EBITDA for continuing operations of $9,500,000 up from $8,200,000 in the prior year with an $897,000 positive impact in the application of FAC six zero six. Now let's look at our income statement.

Revenues. Revenues from our workforce solutions segment were $49,100,000 and grew by 8% over the prior year. Revenues from our provider solutions segment were $10,700,000 and they grew by 10% over the prior year. Both new sales and renewals contributed to the year over year growth in both of our business segments. Now our gross margins.

Our gross margin was 57.5% this quarter and 59.6% in the same quarter of last year. This decline is primarily due to higher revenues from our lower margin legacy resuscitation products. Let's turn right into operating expenses. Operating expenses were up less than 1% over the prior year, as declines in sales and marketing from the application of ASC six zero six mostly offset increased expenses in other categories. During 2018, we continued making investments in product development, which resulted in a 6% increase in profitable expenses over the prior year.

Sales and marketing were down $1,700,000 due to lower sales commissions for the adoption of ASC six zero six. And those commissions are now capitalized rather than expensed upfront as they were under ASC six zero five. However, sales production in the fourth quarter remained strong. G and A expenses increased $1,500,000 or about 16.2% of revenues compared to 14.9% of revenues in the prior year. The growth in G and A expenses attributable to decreases in software expenses to support our business operations, due diligence costs related to the Private Dine acquisition, which we closed in January 2019, and also higher contract labor costs.

Operating income and adjusted EBITDA. Our operating income was $2,800,000 up 88% from $1,500,000 in the prior year. The operating income margin improved to 4.7% compared to 2.7% in last year's fourth quarter. Adjusted EBITDA improved by 16%, growing to $9,500,000 from $8,200,000 in the prior year. For the full year 2018, operating income was $15,500,000 up 65% from $9,400,000 in 2017.

And full year adjusted EBITDA improved by 18% to $41,500,000 from $35,200,000 in the 2017 full year. Now our balance sheet. Our cash position and working capital remained strong. Our cash and investment balances at year end twenty eighteen were approximately $168,800,000 and working capital was approximately $136,400,000 Days sales outstanding were fifty one days for the fourth quarter compared to forty six days for the third quarter. We continue to show progress in our receivables management.

For example, the fourth quarter twenty eighteen DSO of fifty one days compares favorably with the fifty nine days in the 2017. In addition, 2018 bad debt expense has decreased by over $500,000 over the full year of 2017. We renewed our line of credit during the fourth quarter on a similar term while extending the maturity date out to November 2020. We have no outstanding debt and maintain our full $50,000,000 borrowing capacity. We believe our overall capital position is likely to support our organic and inorganic growth opportunities and support other capital structure optimization and shareholder value maximization strategies as may be appropriate.

At this point, I'll introduce Scotty Roberts, who will give us some background and financial outlook.

Speaker 3

Thank you, Gerry, and good morning, everyone. Before we discuss our 2019 guidance, I will provide some background and context on two topics affecting guidance. The first is our acquisition of Protodigm, which we expect to contribute approximately $8,000,000 of revenues from its existing product offerings in 2019. We expect that the combination of additional investments, the amortization of acquired intangibles, and the impact of deferred revenue write downs related to Providigm will result in a reduction in our consolidated operating income of approximately $2,000,000 during 2019. The second topic is the move to our new corporate location in Nashville, Tennessee in the 2019.

This move consolidates most of our Middle Tennessee operations. In the third quarter conference call, we discussed operating expense increases of approximately $2,000,000 in 2019 associated with the relocation, which is also factored into our 2019 guidance. This incremental operating expense increase reflects current national market conditions, but is still less expensive than renewing the lease in our current location. Now I'll discuss our financial expectations for 2019. Yesterday's earnings release included financial guidance for 2019, which also includes the recent acquisition of Providigm, which we consummated on January 1039, and is included in our Workforce Solutions segment.

We anticipate that consolidated revenues will range between $251,000,000 and $258,000,000 for 2019, with revenues from the Workforce Solutions segment ranging between $2.00 $7,000,000 and $213,000,000 and revenues from the Provider Solutions segment ranging between $44,000,000 and $45,000,000 We anticipate operating income to range between $10,000,000 and $12,400,000 for 2019. We anticipate higher levels of operating expenses associated with our new corporate office, additional investments in product development and sales for our new resuscitation products, as well as investments to support the growth and expanded market position of solutions we attained through the acquisition of Providigm. We anticipate that capital expenditures will be approximately $35,000,000 which includes approximately 15,000,000 associated with our new corporate office, which again consolidates operations and offices to a central location in Nashville. We expect the annual effective income tax rate to range between 2628%. This consolidated guidance does not include the impact of any other acquisitions that we may complete during 2019.

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

Speaker 2

the call back to Bobby. Thank you, Scotty and Jerry. I'd like to start with a quick update on our progress with our Verity business as we do this concluding section. We started the year of 2018 with the announcement of the new unified brand name for our Provider Solutions business, Verity, a healthstream company. The unified name signify the combining of the Helpline and Morrissey businesses along with the launch of our new SaaS based platform for this business called also called Verity.

As we have previously discussed, the migration of Helpline and Morrissey customers from a hybrid SaaS platform to the new Verity SaaS platform will extend over several years. We've done this kind of migration in our past when we acquired Learning Management Systems and had to migrate them to our new SaaS application. I think we're well positioned to know how to migrate Morrissey and Helpline customers to our new Verity SaaS platform. As of the year end 2018, 36 customers have contracted for the new Verity platform, and our first customer has been fully implemented on the new Verity platform. As our company has extensive experience and expertise in making such migrations, We anticipate continued and steady progress in this migration effort as customers enjoy the benefits of the new Verity platform throughout 2019.

We need to spend some time talking about the resuscitation business. I think it will be helpful to divide that conversation into three parts. The first part will address our brand new suite of resuscitation solutions with the American Red Cross. We're really excited about those new product offerings. The second part will address the legacy American Heart Association and Laredol products that we sold through the end of last year, which I mentioned during the opening of this call.

And finally, in the third part, I'd like to discuss our new network connectivity agreement with RQI Partners, which is a joint venture between Laerdal and the So let's take the first part. On January 17, we announced the launch of the American Red Cross Resuscitation Suite, which effectively marks the beginning date of our seven year collaboration. The American Red Cross is one of the most trusted and recognizable organizations in the world. Their new resuscitation suite designed for health care specifically for health care professionals, doctors, and nurses, combines cutting edge technology with the latest science to offer a new standard of quality and competency development in resuscitation skills. We're excited to bring this innovative new curriculum and choice to the market.

The new Red Cross Resuscitation Suite is comprised of BLS, ALS, and PALS competency development curriculum. It brings updated, highly adaptive competency based development solution to health care professionals. It offers certification to health care professionals successfully demonstrating proficiency of lifesaving resuscitation knowledge and skills. HealthStream has designed a capability that makes it easy to set and manage the frequency of practice. With the flexibility to set practice intervals, immersive real time videos, and personalized adaptive learning plan, clinical staff have all the tools they need to develop and maintain resuscitation competency and improve patient outcomes.

This curriculum is simply unprecedented in its flexibility and capability. Launched thirty three days ago, initial receptivity to the Red Cross Resuscitation Suite is positive. Although sales activity has begun now, we have not forecasted material revenue from the new resuscitation suite in 2019, really for two reasons: one, because it will take time to progress through the customer review, budget cycles and implementation and two, because we sold so much of the legacy platform into our existing base that a lot of the market is committed to that product for some time period. We look forward to updating you on this exciting new curriculum over the course of the year. Okay.

The second part of the discussion is about legacy products, which are known as HeartCode and RQI. As a reminder, at the June 2017, we announced that our reseller agreements for HeartCode and RQI would expire on December 3138. These agreements did, in fact, expire as expected and will not be renewed. As you know, through December 3138, we had the right to sell up to two year subscriptions to these products. And sell them, we did.

It seems that pretty much everyone that wanted to purchase HeartCode or RQI to use over our network and learning platform for the next two years did so, many topped off their existing orders to make sure they enjoy the benefits of the integrated service through the 2020. As a reminder, at the end, HardCode and RQI generated approximately $55,000,000 of revenue in 2018. In 2019, we expect revenues from these legacy products to modestly exceed the $55,000,000 achieved in 2018. We expect 2019 revenue from legacy products to peak near midyear and decline sequentially thereafter. To be clear, we expect revenue from these two products to be zero during the 2021.

That brings us to our final resuscitation topic, which we originally announced on December 6. At that time, we told you about our new agreement with RQI Partners. It's a joint venture between Laerdal and It's important not to confuse this agreement as an extension or a renewal of our expired reseller agreement with Laerdal. Under this new agreement, HealthStream will not be marketing, selling or contracting for HARCode or RQI. To be clear, we will be marketing and selling the new American Red Cross resuscitation solutions.

Our agreement with RQI Partners provides for continuity of service for customers that desire to purchase hard coding RQI from RQI Partners in the future and have it delivered via HealthStream's learning center. This is in line with the open marketplace concept we have discussed on previous calls. RQI partners will remit a fee to us when sales of new HeartCode and RQI are delivered over the HealthStream learning center. Given the success we had selling legacy products through the end of last year, we do not believe that this fee will be material in 2019 as the majority of our customers who use HARCode and RQI have already purchased them through us and have contracts to receive them through 2019 and, in many cases, through 2020. I'd like to turn our attention to our new platform as a service strategy and our new platform as a service platform that we call hStream.

Let's turn our attention to hStream and describe it first. With over 4,900,000 health care professional subscribers, HealthStream's SaaS based platform has long been one of the most adopted workforce development platforms in health care. To facilitate innovation and growth of our ecosystem, HealthStream's new platform technology, hStream, was launched nine months ago. Already, health care organizations representing 1,510,000 subscriptions have contracted for hStream. I think our last disclosed number was just a month or so ago where it was about 1,000,000.

So this is a material update from where we ended the year end at about 1,000,000 to about 1,510,000. WealthStream platform as a service capabilities are facilitating new types of application and media partnerships to deliver valuable services and impactful content to our health care organization customers. AgedStream, importantly, also serves as a bridge between our workforce development and provider solutions business segments. In the third quarter, Verity began introducing hStream subscriptions and contracts for its new SaaS platform. Because of this, we believe that hStream subscription is an increasingly important metric for measuring progress across our business initiatives.

In fact, in the year end earnings release issued yesterday, will be the last time we'll provide our legacy subscriber metrics, which focus on a narrow representation of our learning applications. We look forward to reporting the progress of hStream both in terms of subscriptions to it and the value it brings to customers and partners in the coming year. Now we've invested in many areas as we wrapped up the year, and we plan to continue those investments as we enter the new year. To support the many exciting developments we've just discussed, press forward on our momentum, we have recently invested in new senior leadership by expanding our executive team. We have added Scott McQuigg, who will lead our hStream Solutions business, and Tricia Cody, who will lead our Clinical Solutions business for our executive team.

As Senior Vice President of hStream Solutions, Scott McQuigg will identify, grow, and develop new hStream content, hStream application, and hStream partnerships. Scott's career includes the co founding of Health Leaders, an award winning leading health care media and research business, and his role as CEO and co founder of GoNoodle, which developed a popular kids' media and tech platform, which went viral and is now played by 14,000,000 kids each month. As health care, media and technology veterans, Scott brings valuable expertise to HealthStream and the execution of our hStream strategies. In her new role as Senior Vice President and General Manager of Clinical Solutions, Tricia Cody is responsible for all of the company's clinical products and solutions, including those in the areas of clinical staff development and resuscitation. Her deep clinical knowledge, experience as an entrepreneur, five year success growing our clinical solutions business and strong leadership skills make her well suited to lead this important area of our workforce development segment.

I'd like to welcome Tricia and Scott to our senior executive team. In our third quarter earnings release, we announced that Gerry had tendered his resignation from the company as CFO. He will remain in his position as CFO through the filing of our Form 10 ks for the full year 2018, which we expect to occur later this month. While stepping down from his position of CFO at that time, Gerry will remain employed as a senior adviser through the end of the 2019. To ensure a smooth transition following Gerry's departure as CFO, Scotty Roberts, who just presented our 2019 financial outlook and serves as our Vice President of Accounting and Finance,

Speaker 4

will assume the position of Interim CFO.

Speaker 2

Scotty, who is a certified public accountant, joined HealthStream seventeen years ago after working at Ernst and Young. His broad experience in public financial reporting and deep knowledge of financial operations, both in general and company specific terms, they can particularly qualify to serve as interim CFO and as a candidate to fill the CFO position permanently. As Jerry Hagen completes his last earnings conference call, I want to thank him for his tremendous service to HealthStream for over a decade as our CFO and also the two years he served previously on our Board of Directors. His leadership and financial expertise have played an important role in our growth, and he has successfully navigated the company through many growth opportunities. Jerry is leaving a great legacy in many ways, including his mentorship of Scotty sitting here to his right.

I wish Jerry all the best in his future endeavors. At this time, I'd like to turn it over for questions from the investor community.

Speaker 0

Our first question comes from the line of Ryan Daniels of William Blair. Your line is now open.

Speaker 5

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

So talk a little bit more about how you view that metric and how that drives revenue growth.

Speaker 2

Yes. For a little while, it's probably the next several quarters, it's very important to watch So the first thing to drive the future of the company is to try to get all our customers across all of our platforms connected to hStream so they can drive benefit. The new platform, what we're doing now is hopefully by the middle of the year, every contract for every product will include a connectivity or an insertion of the hStream membership and connectivity to that platform. And so first of all, it just serves as a unifying metric.

And so we're beginning to when we sell a learning center, it requires a subscription to the hStream platform. When we sell the Verity platform, it requires a subscription to the Verity for hStream extension. And so the first and most important concept is it's a unifying metric. And you know, Ryan, because we've worked for years at this, we were trying to create a unifying metric that would kind of be a foundational metric as we go forward for many years. But as we have the PX business, we couldn't figure out a way to measure everything.

That's the first thing. Second thing is the old metrics were a measure of really the penetration of a few of the key products of the workforce segment. So it's kind of the inverse of the it's a unifying metric in that the old metric was less dimensional than what it measured. So we think the importance of that metric for this year is to make sure it is rapidly adopted. As we include it as renewals come up, we're inserting the language and the subscription to the hStream platform into each contract.

And you can tell from the movement already, I think when we announced it nine months ago, it's at zero, and we're at $1,000,000 now. So progress will be measured quarterly, and we need to move all customers to this new platform in thirty six months. And you can see we're well on our way. Now as it relates to revenue, for a little while, it won't be as directly correlated to revenue because the opportunities are derived once it's in place. Most of our platforms, the HCM subscription will have an increased value proposition and increased price.

It allows for new bundling strategies of content and platform. It allows connectivity to new applications and partnerships. And all of those things will drive new type of network fees to HealthStream and our network. So I think most importantly, it's a unifying metric. And over time, it will be more correlated directly to revenue.

But as analysts, I think what we need to measure is the rate of adoption. We've got to get it in place so that our new strategies can take hold.

Speaker 5

Okay. That's very helpful color. Then it's my follow-up, and I'll hop off. The new CMS nurse competency requirements, obviously that's a nice kind of macro tailwind for you. It's going to be a requirement to put in place.

Do you have all the solutions that kind of meet what your partners will need for that? Or is there more partnershipsproduct development on the horizon to get you to a full set of what's needed to hit those requirements?

Speaker 2

Well, we have a lot

Speaker 4

of what's needed, especially with the

Speaker 2

acquisition of Providigm. But we are as I mentioned in the call, we're already investing and rounding out the content because you need to map activities from the quality and the audit process to remediation and development strategies for employees. And we're building those mappings now. We're working with the leadership of Providigm to determine the holes in our education strategies and education libraries, and we're already underway scoping and building those new curriculum components.

Speaker 4

And so we have some investing to do

Speaker 2

here to get it where we want it and also enhance the program products up to where we like them to be for Lstream. Also connect them to the hStream platform over the course of this year. And so there is some work to do at Program. I think we mentioned that in addition to those investments I mentioned, the deferred revenue write down and others, the Program is going have a negative drag on our operating income of about $2,000,000 in 'nineteen.

Speaker 0

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

Speaker 2

Good morning and

Speaker 6

thank you for taking your questions. First one for me, what has been the initial feedback now that all the partners are in place regarding new resuscitation suite? Realize it's going to take time to see contribution from a revenue perspective, but what has been the feedback from your customers so far?

Speaker 2

Well, we're thirty three days in, which is probably closer to twenty five business days if you take out the weekends. And our full sales team trained during the month of late December and January, so they're fully equipped now to go tell the story. And they're booking up they're fully booking up their schedules to get out there and do the demos. Our feedback is very, very positive. The learning paradigm and the learning methodology is just it's and I object I've been in this twenty eight years is better than the existing models.

The momentum of the product is going to take a little time to build. As we said, we did quite a lot of selling of the legacy products in the fourth quarter. But we're also neutralizing some of the competitive advantages in the other products. For example, our product includes the flexibility to train more frequently without charging the customer more for that training. And so we really do plan to be competitive, not just to have better technology, better product, better learning methodology, but also a considerably lower price point for an equivalent science based program.

And so I think the sensitivities around costs and the need for new methodologies of learning that we're very optimistic at thirty three days in that we've got a winning product to take to market. And so I think also the customers seem receptive to choice. I think after doing something one way for over a decade and frankly in the market not seeing much, if any, change in actual outcomes as measured by clinical outcomes, I think that there's receptivity to trying something new. And of course, this will play out over the next several years and we'll see. But we're entering the year with a lot of confidence.

And by the way, there's a lot more to come. And so there are many, many more elements of the program unannounced that are leading development now. And we're excited to announce both new partnerships and new technologies that are as of yet unannounced. So for example, one of our innovations is to make the new resuscitation suite agnostic to the mannequin technology. And so we've signed with a company called Unisonium, and they're our launch partner.

We've signed with a company called Ambu. Both are international providers of high-tech training mannequins. And both have agreed to be hStream certified to the hStream platform. We expect additional announcements in this area, more interoperability and compatibility announcements with our Red Cross Resuscitation Suite program. And so there are innovations embedded like that that mean that there are forthcoming.

There are more announcements to come.

Speaker 6

Great. Thanks. We'll look forward to future updates on that. Maybe a couple of follow-up questions for Gerry and or Scotty, depending upon who wants to chime in. But regarding Providigm, how should we be thinking about the margins for that suite?

Gross margin, I guess, might be easiest in 2019 and then maybe going forward once you're through some of the extra heavy lifting from expense and deferred revenue write down contribution?

Speaker 4

Yeah. There will be some suit in the workforce segment as a total. The one thing we can describe qualitatively is a SaaS type platform, a SaaS type technology model. And so we can expect the margins, once we get past investment and some efficiencies and growth, to be more in line with what you expect from a SaaS type business.

Speaker 6

Okay. And then last one for me. Just for modeling purposes, the $2,000,000 of extra OpEx for the headquarter move in the first half, is that will there be any tail to that into the second half? Or should we model most

Speaker 7

of that 2,000,000 here

Speaker 6

in Q1 and Q2? Thank you.

Speaker 2

Yes. Let me take that one or actually anybody can take that one. But so we were in a downtown office building for over about twenty years and enjoyed really, really below market rates for our 70,000 square foot operations here in Downtown Nashville. And we came up for renewal and those rates were going to go up tremendously. So we went shopping and looked at seven or eight locations all around the middle of downtown.

And as you can imagine, Nashville has become extremely popular for corporate locations, Amazon, AllianceBernstein, E and Y, all moving in and building new buildings downtown. Rent rates in Nashville have soared. What we did though, we found the least expensive of about six options, including renewing here. And the least expensive option will result in an ongoing revenue rent increase of $2,000,000 per year. And so it is an ongoing increase in our cost to occupy and consolidate our operations in Middle Tennessee and remain the near the Central Business District of Downtown Nashville.

So it's not a onetime expense. It's an ongoing increase in our cost of lease expense to remain and keep our workforce centralized in Middle Tennessee. The $2,000,000 will be it's actually a little higher than that on an annual basis because that $2,000,000 represents about three quarters of the year. We don't move into the new headquarters for another forty five days or so or sixty days. Got it.

All right. Thank you. So right when we're getting good operating leverage, rent goes up on us. But it was absolutely the right thing to do. And again, it was the lowest cost alternative of six options, including just renewing and staying put where we are.

And so we're actually really excited to have a fresh point of view. We think it will prove to be an economic a good decision given the rate of growth of Nashville. And we're excited to get everybody back together because we're spread over two or three office locations in Middle Tennessee.

Speaker 0

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

Speaker 8

Great. Thank you. I was wondering if you could just go over the acquisition revenue that's included. I just want to make sure I have that correctly. And then on the $2,000,000 in expenses associated with, I guess, the acquired intangibles, the deferred revenue write down and the investment, if you can sort of give us maybe the composition of that $2,000,000 in those buckets, that would be great.

Speaker 4

Yes. So Richard, this is Jerry. We discussed about $8,000,000 of revenue in 2019 from the Protodyne acquisition. And once again, that's in the workforce segment. And then three categories all kind of lumped into one set of expenses, but investments in product development, other sales and marketing, intangible asset amortization from the acquisition.

And also there'll be, as with most of our acquisitions, write down of the deferred revenue from the balance sheet as of closing.

Speaker 8

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

Speaker 4

that coming back in It's relative. So that's about 250,000 to $300,000

Speaker 8

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

Speaker 2

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

Speaker 8

Okay. And then as we think about the new I mean, I guess calling out the skilled nursing side of things, I know in the past you've talked about the post or non acute and I guess it was all lumped together. Have you had any exposure on the post acute side in the past? And how should we think about maybe the uptake in that marketplace? Are you displacing someone potentially?

And just what are the, I guess, market trends for the services that you guys provide in that area?

Speaker 2

Yes. I think, first of all, it is an important part of our plans. As you can tell, we kind of reconstitute our definition of the verticals we're going after that you would lump into what we now call the continuum of care, which is all the post acute and ambulatory and skilled nursing and all and physician offices, we now put all in that, what we call, the continuum. And so by reconstituting that definition, we've bumped up those that we're marketing to and selling actively selling to, to about $10,500,000 So and that growth from 8,500,000.0 to 10,500,000.0 largely comes from more broad pursuit of those post acute and ambulatory and physician office opportunities. So that's the first thing.

Second thing is a good number of our new subscribers in the last several quarters have been coming from those verticals. So those are the growth markets right now. Home health markets are growing, whereas in the hospital market, see more consolidation and acquisitions. In the other verticals, you see growth adding more employees in those segments and segments. So it will be an important ongoing business pursuit of ours to expand.

One of the good another good thing is we think the Red Cross brand will resonate well in the post acute market settings, potentially a stronger brand than the prior brands we marketed. So we're excited to get into those markets. And those are less have less penetration. As you can imagine, the prior brands we sold, the legacy products, we got pretty good adoption and penetration. So I think some of our early wins for our resuscitation products will probably come from those post acute and continuum, as we call it, segments.

So the second point is that in the past, say, four or five quarters, of those age out subscribers, a nice number of them did come from those settings that were non acute settings. And so the program represents a nice new anchor point, SaaS business application linking quality to development and to training. And we'll keep looking for things to strengthen that business pursuit, Proton representing kind of hopefully the first target of capabilities and content and services into those markets. So we do plan to strengthen continue to strengthen our investment in the pursuit of those markets.

Speaker 8

Okay. Thank you.

Speaker 0

And our next question comes from the line of Frank Spiracino of First Analysis. Your line is now open.

Speaker 7

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

But just any thoughts there in terms of how quickly that market is growing and how you're faring?

Speaker 2

Yes. I think we probably would have hoped for a little faster growth overall and a little faster adoption of the SaaS. But it took time to build the right product. And I would say what we're hearing is the receptivity to new product is very high. But we did want to kind of benchmark in this call where we are in the migration.

So as you can tell from the numbers we disclosed a few minutes ago that we're really this is kind of the first solid quarter into the migration. And so we wanted to kind of set expectations for where we're starting and provide updates throughout the year. So there's about 36 contracts on the brand new platform. And I do think that the market receptivity of that platform is going to be very strong. It's it's several just years in development and it is just flat out better than the products we had before and the products we're competing with in the market.

So we feel better about our competitive position. That said, migrating a couple of thousand legacy customers to the new platform is going to be a multiyear journey as we've articulated. And so we just want to caveat that.

Speaker 4

And so we've lowered our growth expectations a little bit. It is important

Speaker 2

to note though that it is a hybrid SaaS and SaaS model, so the gross margins are good. It generates solid EBITDA performance and contributes to cash flows. And so while adding to its sales and product development and growing the senior executive team leading, it is also generating cash. And so it's effectively profitable growth. Yes, it would have been nice to have a little higher top line growth rate, but I do feel that business unit is well positioned for 2019 and beyond.

Great. And just one follow-up for me.

Speaker 7

Bobby, as it relates to the RQI JV partnership, I'm trying to think of, and this may be synagogue or not the right way to look at it, but it would seem to me that for HealthStream there's a modest benefit in that agreement. There's a lot more benefit being had on the other side. I don't know that they have a replacement in terms of an underlying platform to deliver. But am I looking at that the right way or no?

Speaker 2

I think it definitely will make their products stickier. And we've spent a decade selling those products, and they're good products, and the customers obviously have benefited from them and deployed them. And as you can tell from our sales in the fourth quarter, they really wanted the joint service model that we delivered. They could have easily just said, we'll just wait a quarter and buy from RQI Partners, but they really all topped off to make sure they got the integrated service. And then, of course, we announced that we were going to provide continuous support.

But I think the ease of contracting through us and the proven delivery model resulted in quite a lot of sales in the fourth quarter. So it may have benefited them more, but it also represents a milestone and the change from a single provider to the market to seriously bringing two potential providers to the market. And so in order to hit that inflection point and bring the American rent costs fully to the table competitively, it's the right way to service customers but also create choice and competition where there has never been any in the marketplace. So I think on balance, they may have benefited a little bit more by making their products sticky. We obviously benefited because we have a longer runway to introduce new products now.

As you can tell, we had maybe earlier expected revenue to decline in 2019. The declines will be steeper and harder in 2020 and 2021, but we've essentially deferred the decline in that area of business for a whole year. It provides a lot more time to get the message out of the new products and strengthen our overall product portfolio and continue to deploy capital. So I think all parties will benefit. Ultimately, the customers will have the best benefit because they will have choice.

And HealthStream is the one bringing that choice. So I think that will also be respected and appreciated by our customers. But it was kind of an essential move for both parties. Remember, our entire organization is solely focused on sales and marketing of the American Red Cross program now. And as they sell their product, they can promise compatibility.

But we're out now presenting the new options to the market and very excited about it.

Speaker 4

Thank you, Bobby. That's very helpful.

Speaker 0

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

Speaker 2

Yes. Bobby, could you remind us of the mechanics of the revenue recognition with the layered oil products? I was

Speaker 4

a little surprised at the size of

Speaker 2

the revenue running into Q2.

Speaker 4

Well, let's see. So we'll go into

Speaker 2

two buckets here. So the legacy agreements, we would sell on a subscription or utilization basis. And so if you think of customers, say, buying a two year top off, we would recognize revenue ratably over the period based on consumption patterns or license consumption. And so we sold a lot, but I don't think the consumption pattern changed a lot, but we did renew a lot of those contracts. So we as you can tell, we expect to do slightly more than 55,000,000 in revenue from the legacy products, which is up from 2018 actually, which is a lot of irony to that.

We expect the second quarter, somewhere around the middle of the year, second quarter, early third quarter, to be the peak those revenues. And then it will begin the decline. And that decline will continue quarter over quarter all the way to zero sometime in the middle of the first quarter twenty twenty one of those two products. And so we think it should be fairly easy for you to model and estimate the model in the April now because it would be a little better than $55 inch probably across four quarters with a peak

Speaker 4

in Q2. So hopefully, that's

Speaker 2

a fairly easy model for 2019. That's helpful. And then could you frame your capital allocation priorities for 2019? Yes. And so obviously, big piece of capital

Speaker 4

is going to go into our

Speaker 2

new building. We chose to self finance the build out and everything because our cost of capital is lower than working it into the rent allowance. And so a big chunk of capital is going to go into building out that new consolidation, the new office building and getting everybody moved over there. But that's not the priority. That's just a fact.

The priorities are, of course, in the software development, R and D, launching the new resuscitation products will be OpEx, but we're going grow our investments in sales and marketing. And then on a capital standpoint, content development for the first time is going to make a more material debut into our business model. A little Netflix like, but we have quite a large audience now, nearly 5,000,000. Wish I could round up to that. I guess it's $4,933,000 And so we're going to invest in targeted areas of content development.

And so you'll see a little bit more of that in our capital plans. Everything else, capitalized software development and all, will go up a little bit each year. Thank you for that. Thanks for answering my questions. Thank you.

Speaker 0

We have a follow-up question from Richard Close of Canaccord Genuity. Your line is now open.

Speaker 8

Yes. Just two quick follow ups. Just on the headquarter, I guess, this call, you're saying it's $2,000,000 in annual expenses higher than previously. I think on the last quarter, mentioned that it was going to be $2,000,000 in 2019 in terms of higher expenses. I could have that wrong.

So I just want a clarification on that front.

Speaker 2

Yes. We probably I think that is accurate. I think both tickets ironically are accurate.

Speaker 4

So it is $2,000,000 more

Speaker 2

in 2019. And then on a run rate basis, I guess, the first time we've indicated it will be it's a rent increase. So it will be annually 2,000,000 more in the model.

Speaker 8

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

Speaker 2

Yes. Well, probably not in great detail, but I can say this, that the margin on that, because it's a fee to connect the network, we don't have any real sales costs, any marketing costs. We don't have we have de minimis support costs just to support and make sure the customers are happy with the integration. We don't have any product development costs. So it really is a fairly high it's a lower fee and lower revenue, but it is a large contribution margin because it really is a pay to connect and a pay to ensure a smooth operation of their product.

And so they'll pay for the contract. They'll recognize the revenue from the top line standpoint and pay us a connectivity fee. That connectivity fee and integration fee will it will be a nice piece for us. It won't completely offset the prior margin that we enjoyed, but it's a really nice high contribution margin fee coming from that relationship. Now again, we don't expect to see much of those fees in 2019 because there's really not many coming up for renewal.

And so when that kicks into play is when a customer on our platform comes up for renewal. They say, yes, we want to keep receiving that product. They license or purchase the product from RQI Partners. RQI Partners will then bill them and send us the fee. And so it requires a whole cycle of renewals to

Speaker 3

come up before we start

Speaker 2

generating those, again, rather high margin fees.

Speaker 3

And so

Speaker 2

I hope that just general characterization helps you some. On the American Red Cross program, we're not going to give a lot of details on that. But we have said in the past that it is materially higher gross margin for us. That said, the sales and marketing costs and launch costs of the new product are fairly high, and we don't want to underinvest in those. And so blended contribution early is going to probably be fairly low.

And back in the call, we said that its absolute contribution, even on top line, is going be fairly low because of the reasons we stated earlier, that we had such successful fourth quarter selling the prior products. So I hope those characterizations help, but we're probably not going to do any more product by product gross margin analysis across our portfolio.

Speaker 8

Okay, great. Thanks.

Speaker 0

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

Speaker 2

Thank you. We look forward to the leadership of Jerry for another month, and I really appreciate his twelve years of service to the organization. We're looking forward to Scotty Roberts stepping up as the interim CFO. Welcome to the new LeaderStar team. And thank you to all HealthStreamers for your contribution to a great year in 2018 and a lot of hard work going into launching these new products and services in 2019.

We look forward to speaking to all investors on our next earnings conference call. Thank you.

Speaker 0

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