Ladies and gentlemen, thank you for standing by and welcome to the HealthStream, Inc. third quarter 2019 earnings conference call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference to your speaker today, Mollie Condra, Vice President, Investor Relations and Communications. Please go ahead, madam.
Thank you, and good morning. Thank you for joining us today to discuss our third quarter 2019 results. Also in the conference call with me are Robert A. Frist, Jr., CEO and Chairman of HealthStream, and Scotty Roberts, CFO and Senior Vice President. I would also like to start by reminding you that this conference call may contain forward-looking statements regarding future events and the future performance of HealthStream that involve risk 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. At this time, I'll turn the call over to Bobby Frist.
Thank you, Mollie. Good morning, everyone. Welcome to our third quarter 2019 earnings call. Our third quarter performance was in line with expectations, and revenues were up 4% over the same quarter last year, and Adjusted EBITDA up 3% over the same quarter last year. Supported by strong cash flows from operations and a record low days sales outstanding, we ended the third quarter with a cash balance of approximately $173 million, strong balance sheet. In a minute, Scotty will elaborate more fully on financial results, so I'm going to dive into some of the operational updates. To start today, I want to provide updates with regard to the three business transitions that we introduced and discussed in previous calls. All three transitions are designed to move us towards being a higher margin, more profitable company in the coming years.
We're about nine months into what I described as a 36-month journey. We're about nine months in. We're about 25% through these migrations, and I'm pleased to report we're making steady progress on all of these transitions. During the quarter, for example, we contracted 48 new accounts for our new resuscitation offering. We increased new Verity platform subscriptions by 50% over the last quarter, and we added approximately 434,000 hStream subscriptions in support of our SaaS to PaaS migration or strategy. If we continue to progress on these three transitions, we expect to cross the 60% gross margin level at this time in 2020. We're kind of excited that we expect to see some of those transitions start to play out in the gross margin line by the middle of next year. Let's look at each one in a little more detail.
First, we have transitioned our sales and marketing efforts from the legacy resuscitation products to our new resuscitation offering, which includes the American Red Cross Resuscitation Suite program and the Innosonian Skills program launched earlier this year. Since there are no new sales of the legacy resuscitation products, we expect revenue from those legacy products to continue declining sequentially each quarter through year-end 2019 and throughout 2020. We're projecting sequential declines in revenues throughout 2020 on the legacy resuscitation products. Specifically, we anticipate revenues from legacy products to decline an additional $800,000 in the fourth quarter to approximately $12.6 million. This is a little bit lower than we had thought at last quarter, but our new forecast puts us at about $12.6 million on legacy resuscitation products. We anticipate revenues from legacy resuscitation products to be zero in the first quarter of 2021.
As a reminder, the new Red Cross Resuscitation Suite program is comprised of Basic Life Support, Advanced Life Support, and Pediatric Advanced Life Support competency-driven development curricula. It brings an updated, highly adaptive, competency-based solution to healthcare professionals. It offers certification to healthcare professionals successfully demonstrating proficiency of life-saving resuscitation knowledge and skills. In fact, the program is live for several accounts, and the first healthcare professionals have achieved certification through the program. I'm pleased to report strong sales momentum of our new resuscitation offering. Just looking back at the history of launch, we announced on January 15th of this year, in that first quarter, we had six new accounts during that launch quarter. In the second quarter, we had 15 new accounts, so an additional 15 accounts. We just announced 48 additional accounts in the third quarter.
Together, through the first nine months of the year, therefore, these 69 accounts totaled over $22.3 million in contract order value signed for our new resuscitation offering. These new contracts are from a mix of hospitals and healthcare facilities from across the continuum of care, including new and transitioning customers. We are not expecting material financial contributions for 2019 from these contracts because many of these customers are running off their legacy resuscitation product licenses. We have a solid sales pipeline and are encouraged by the market's reception to the new resuscitation offering that we believe is more innovative, more effective and more cost efficient than legacy solutions. To support that, we've approved and are recruiting new sales representatives specifically in this solution area. That's an area of investment for us. A second transition involves adoption and migration to our new SaaS-based Verity platform.
In the first quarter of 2018, we announced the launch of Verity, our new SaaS-based platform for managing credentialing and privileging in healthcare organizations. As of the end of the third quarter of 2019, new customer accounts for the Verity platform grew over 50% to approximately 155 contracted customers. This rate means that on average, over four new customers per week were contracted during the third quarter. It's an exciting time as we feel we're building momentum around the new technology platform, both signing customers to migrate and brand new customers. The 155 customers are a nice balance of customers migrating and brand new, and they're also taking advantage of the privileging technologies that are built into the platform.
Given the high quality of the new platform and our history of successfully migrating existing customers to improved solutions, we anticipate continued progress in terms of new sales and migrations of legacy customers, though the migration journey is one that will require several years to fully accomplish. I want to talk about the third transition that we've talked about. The third transition involves our customers upgrading to the hStream platform, which is essential technology working behind the scenes that powers all activity in the HealthStream ecosystem. Again, it's an evolving technology platform, and it's nascent, but effective and active, and some of our new solutions are directly powered by the new hStream technology. In the third quarter, we added approximately 434,000 hStream subscriptions, bringing our cumulative total up to approximately 2.78 million subscriptions at the end of the third quarter.
That's up from 2.34 million contracted subscriptions at the end of the second quarter of 2019. The HealthStream platform as a service capabilities are enabling new functionality, even in some of our most established applications, such as the HealthStream Learning Center. HealthStream Learning Center customers who have upgraded to hStream now enjoy an advanced manager interface known as MyTeam. Initial reception to the upgrade continues to be positive and has exceeded our expectations with over 81,000 managers across 700 organizations actively using the new MyTeam technology. Again, MyTeam is an extension of capabilities of the old HealthStream Learning Center. When a customer upgrades to hStream, they get new capabilities in their older legacy application, the HealthStream Learning Center. It's an exciting way, an upgrade path for the HealthStream Learning Center when customers adopt MyTeam.
We expect to see continued adoption of hStream over the next couple of years, and we're excited about the progress in the last two quarters specifically. I want to remind everyone that these three business transitions, we've described them as multiyear journeys. We don't want anyone to have the perception or concept that these will be done or finished in the next six months. In fact, I opened by saying that we're nine months into a 36-month transition, and each one may take a little ±36 months, but we think we'll see financial benefits to these migrations over the course of the coming years and be through the bulk of these three transitions within 36 months. Again, we're nine months into the 36-month journey. Again, it's a characterization. It's not precise, but we want you to all understand that these are not short-term migrations.
These are things that are going to take us a couple of years to work our way through. Again, we're encouraged by the early returns. As we announced in September, our Board of Directors appointed Scotty Roberts as CFO and Senior Vice President, following his service as our interim CFO since February. We're excited to have him serving as the company CFO. He's an exceptionally talented and competent executive, and he brings 17 years of experience at HealthStream in public financial reporting and all operations, including accounting and finance. Scotty makes a strong addition to the company's executive team, serving as our top financial leader. At this time, I'll turn it over to Scotty to provide a more detailed look into the financial metrics for the third quarter of 2019.
He's also going to give us a little bit of outlook for the rest of the year in his guidance.
Thanks, Bobby. Good morning. As a reminder, the discussion of our financial results today are for continuing operations only, and comparisons are against the prior year third quarter unless stated. Our financial highlights for the third quarter are as follows. Our revenues were up 4% to $62.5 million. Operating income was down 20% to $3.7 million. Income from continuing operations was up 14% to $3.5 million. Our EPS from continuing operations were $0.11 per diluted share compared to $0.09 per diluted share in the prior year. Adjusted EBITDA from continuing operations was up 3% to $11.5 million. Let's review our results in more detail. Revenues from our Workforce Solutions segment totaled $51 million for the third quarter and are up 4% over the prior year.
During the quarter, we experienced organic growth in our platform and content subscription revenues, and our top line also benefited from the Providigm acquisition. These improvements were partially offset by an expected decline from the legacy resuscitation business. The legacy resuscitation revenues decreased by 10%, or $1.6 million, and were $13.4 million compared to $15 million in the prior year. Through the first nine months of this year, we have recognized $46.3 million of revenues from these products with a year-over-year growth rate of 14%. One of our opportunities for backfilling the declining revenue from the legacy products is by marketing and selling our new resuscitation offering. Since the launch of the new resuscitation offering in January of this year, we've sold over $22 million of total contract value, with most contracts averaging five years in length. Revenues from other Workforce products grew organically by 5%.
This growth rate excludes revenues from the legacy resuscitation products and the Providigm acquisition. The Providigm acquisition brought $1.9 million of revenues in during the quarter. Revenues from our Provider Solutions segment were $11.4 million and grew by 6%. Revenue growth is primarily coming from sales of the new Verity platform subscriptions and professional services for client implementations. Compared to last year, Provider Solutions license and subscription revenues were up $1.1 million or 13%, while professional services revenues were down $500,000 or 22%. Our gross margins improved to 59.4% compared to 58.1% in the prior year. This improvement occurred because of the declining revenue from the low-margin legacy resuscitation products, which is being replaced by contributions from some of our other higher-margin products.
As we look out over the next year, we anticipate our gross margins should begin to show improvement over historical levels, which over the past three years have ranged between 57% and 59%. We believe there are three key drivers that can improve our gross margin profile, which are centered around the transition areas Bobby mentioned. The first opportunity for margin improvement is from the decline in lower-margin legacy resuscitation products and our ability to convert customers to our new resuscitation offering. The second is the adoption of the new Verity platform solution, and the third is our continued growth of hStream. If we are successful with these transitions, as we have been over 2019 to date, we anticipate our gross margins to improve to 60% by this time in 2020. Our operating expenses, excluding cost of revenues, were up 11% across the following categories.
Product development expenses increased by 9%, sales and marketing expenses increased by 5%, depreciation and amortization increased by 19%, and G&A expenses increased by 11%. The higher operating expenses compared to last year are due to growth in staffing levels, which are up 12%, the incremental operating expenses from the Providigm acquisition, as well as higher depreciation associated with the relocation of our corporate office earlier this year. Although operating income declined by 20%, our Adjusted EBITDA grew by 3% to $11.5 million from $11.1 million in the prior year third quarter. Now let's review the balance sheet and cash flows. Our cash and investment balances increased by $11 million and ended the quarter at approximately $173 million, and our working capital was $123 million.
Cash flows from operations improved to $52.5 million year-to-date, compared to $29.8 million year-to-date in the prior year, an increase of 76%. This increase resulted from improved cash collections and lower DSO, and incremental cash flows generated from operations. Our DSO for the third quarter was a record low of 40 days compared to 46 days in the prior year. For capital deployment, we incurred $3.1 million of capital expenditures during the quarter, which brings our capital expenditures for the year to approximately $27 million. As a matter of practice, we maintain an active business development pipeline, as indicated by the Providigm acquisition and two minority investments we completed earlier this year. We ended the quarter with a strong balance sheet and access to capital, including $173 million in cash and investments and a $50 million line of credit facility, which support our business development activities.
Let's turn to our financial guidance. We anticipate that consolidated revenues will range between $252 million and $256 million, with revenues from the Workforce Solutions segment ranging between $207 million and $210 million, and revenues from the Provider Solutions segment ranging between $45 million and $46 million. We are increasing our operating income guidance range to be $12.5 million to $14 million and our non-GAAP operating income guidance range to be $14.7 million to $16.2 million, which excludes the $2.2 million stock grant expense we incurred during the second quarter. We anticipate that capital expenditures will approximate $33 million for the year and the annual effective income tax rate to range between 23% and 25%. This guidance does not include the impact of any other acquisitions that we may complete during 2019. That concludes my comments, and I will now turn the call back over to Bobby.
Thank you, Scotty. Before we go into Q&A, I'd like to make a few closing remarks. One thing that's interesting that's happening actually today and yesterday, there's a unique convergence of the three business transitions that we mentioned earlier in the script. In Philadelphia at the National Association of Medical Staff Services or NAMSS conference, we're demonstrating an innovative new technology that integrates several pieces of our story. It's the automated integration of the Red Cross certification with hospitals' medical staff credentialing records through the new Verity platform is being demonstrated. Now, when healthcare professionals successfully complete the Red Cross certification requirements. The record of their certification is transferred automatically through an integration with their Verity credentialing system. That saves the medical staff offices hours of time and paperwork. The bridge between our workforce development platform and our Provider Solutions business segments is made possible via hStream.
The hStream technology, for example, is used to log in to the program and into the mannequins. When certification is complete, the transaction results in an issue of a credential, which is automatically transferred into the new Verity platform. Again, the long history of this is that these medical staff offices and credentialing offices would have to research and acquire that data in very manual processes, even sometimes asking for a faxed copy of the credential to enter into the credentialing system. Now we're demonstrating it live on the exhibit floor today. As someone completes the physical certification on the mannequin, the certificate pops up and shows in the Verity platform.
It's a very exciting leverage of the hStream technology platform as it's used to log into the Innosonian mannequins, a flowing of the credential from essentially the learning network into the credentialing platform of Verity, and it's being demonstrated at the NAMSS conference for the medical staff services. That's where the credentialing process is managed. It's really an interesting bridge that incorporates many elements of what's new and exciting about HealthStream, and I think it's being well-received on the exhibit floor today. At the first of the year, we announced that our addressable market now includes approximately 10.5 million employees, these are healthcare professionals, which is comprised of approximately 5.2 million employees in the acute care space and 5.3 million employees in the more broadly defined continuum of care market.
We define the continuum of care as ambulatory services, including physician offices, health and human services, including behavioral health facilities, and post-acute care, including skilled nursing facilities. With an expanded market comes greater growth opportunities. For example, we announced a new strategic alliance with Medline in October. With over 23,000 employees, Medline is a global healthcare distributor and solution provider that is particularly well-positioned across the continuum of care, with a strong foothold in the post-acute care space. Through our new alliance with Medline, the companies will champion and expand HealthStream's specialized workforce development programs, including a compliance essentials program and professional development program. These programs drive clinical development and meet compliance requirements in those clinical settings. We've already seen a number of new opportunities created, and the first contracts have been signed as a result of our new Medline partnership.
We're excited to have them help us take these solutions into the continuum markets as we've defined them. In the fourth quarter, on November 12th and 13th, we will welcome clients of our Provider Solutions to Thrive'19, which is the second annual Verity National User Group Conference. This event will be held in Scottsdale, Arizona, where clients can connect, learn, and collaborate with peers, thought leaders, and the Verity team. Special learning opportunities are also offered in the pre-conference on November 11th. We look forward to this exciting event, which will kick off in about three weeks from now, and where we anticipate over 300 clients will be in attendance. In May, we launched our new corporate social responsibility program, which we call Streaming Good. This program was developed and launched by employees.
It's from the ground up, and we're excited about the opportunities to contribute to the communities we serve and we work within. For our first year, we are focused on supporting the American Cancer Society, and I'm pleased to report that last week we held an exciting event for this worthy cause. HealthStream hosted a Relay For Life event in Nashville outside of our new Capitol View corporate office to raise funds and awareness for the American Cancer Society. Company-wide, employees are participating in Streaming Good, and it's gratifying to start to see the positive impact this program is having in our local communities and on behalf of the American Cancer Society. I want to congratulate all employees and encourage all of our nearly 850 employees to be actively involved with these programs and our new social responsibility program. We couldn't be more excited about our initial events.
At this time, I'd like to turn it over for questions from the investor community.
Thank you. As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Ryan Daniels with William Blair. Your line is now open.
Yeah. Good morning, guys. Thanks for taking the question. Bobby, a follow-up for you on the legacy resuscitation solutions. Have you had the opportunity to look back at those clients that are running off the legacy solution, let's say, over the next 12 months, and to determine how many of those are actually converting to the new HealthStream solution versus perhaps re-upping with the legacy? Kind of what's your sales conversion or sales capture rate as those clients roll off?
Yeah, Ryan, we haven't reported that, where the blend of the 48 new accounts in the fourth quarter was a nice mix. It was fairly well-balanced from conversions to brand-new accounts, so we felt really good about that. Of course, our team is acutely aware of and watching all customers as they come up for renewal to make sure we're in the hunt. We have not disclosed our conversion rate, and I don't think that's necessarily a healthy metric for the competitive dynamic. Remember, we do maintain partnerships with both entities, and we want to represent and sell and market the American Red Cross Resuscitation Suite program. We also need to maintain a healthy relationship with the Legacy partner, RQI Partners, as well.
Okay, that's fair. I know the last quarter of the year had some requirements, CMS mandated, I think they kick in in November, the requirements of participation for nursing homes. That in tandem with the new Medline partnership, do you expect a kind of a bolus of new contract signings over the next month or so to meet that demand? Has much of that already been put in place because the conditions of participation actually start in a few weeks?
Right. This is Scotty. I think our expectation on that is most of the customers that have adopted the abaqis product have done that in the past couple of years. Some of the changes in regulation, although they are mandated by the government, some of the penalties enforcements won't kick in for another year or so. I think it gives us a little more runway to kind of approach customers to try to pitch our products to them. I don't think there'll be the bolus that you indicated that will occur.
Okay. Just any thoughts on capital deployment? I know the balance sheet is very healthy, especially with the low DSOs and with the strong free cash flow, building up again. Any thoughts on potential uses of cash going forward as it reaches nearly $200 million here towards year-end? Thanks.
Yeah, we're constantly examining that. We tried to communicate, even in the script, that we maintain an active pipeline of all sorts, including minority investments and acquisitions. We did complete one acquisition earlier in the year, and we're trying to tee them up. We have made a few bids on acquisitions where we weren't the prevailing bidder, so we also kind of know our limits. Again, it's an active program that we're investing in to find opportunities for inorganic growth. Also organic growth though, minority investments, content development, our deployment of capital increase. As we just finished our five-year plan with our board, we're increasing our capital allocations towards content development and program development. We're pretty excited about that.
We've gotten great results where we've chosen to invest in a fully kind of vertically integrated product, where we have platform content and data and we own all three pieces.
Right
you'll probably see a slight uptick in investment, capital deployment into what I guess I'll call content or program development. There's a lot of solutions we're building, for example, around the Red Cross Resuscitation Suite that are complementary to the programs that we built or that Red Cross has built. We're excited about that as well. Overall, we're going to do our best to thoughtfully deploy the capital and have an active pipeline, minority investments, M&A activity, and increased capital investment into content and programming.
Okay, great. Thanks for the color.
Thank you. Our next question comes from Matt Hewitt with Craig-Hallum Capital. Your line is now open.
Good morning. Thank you for taking the questions.
Good morning.
Morning.
Just a couple follow-ups. First, regarding the long-term care market, your relationship with Medline, how are those facilities currently attempting to meet the new regulations, the requirements for participation regulations? Is that something that some of these facilities are trying to do internally? Obviously, I would think that the Verity platform is a much simpler way, but what other options do they have out there?
It's the Providigm platform, it's the abaqis platform that is really the acquisition we made of Providigm and came with the abaqis platform, which is kind of a long-standing market leader in helping them prepare for all form of mandate and quality audit process and quality management. What's happening is there's some increased regulation around relating that to staff competency, which is one of the business hypotheses under which we acquired Providigm. What we're seeing now is we're combining our content bundles, like Medline, for example, helps us position the abaqis platform and these new content bundles together into this vertical. They're very prominent in the vertical. These are products to help them differentiate their overall product offering to those organizations. They've helped us over the years position them. Now they have a more complete toolkit to help introduce to the market.
What do they do otherwise? I guess a lot of pen and paper. There are a few competing products to the abaqis platform that are offered by competitors of Medline, for example. There are competing educational products offered by competitors of HealthStream into the market. There's a lot of kind of traditional pen and paper that needs to be displaced and made more efficient as well. The typical competitive landscape. We're really proud to be aligned with Medline. We think they're the strongest in the market, and they're going to help us carry these solutions, which we think are also the strongest in the market, to these customers.
Understood. Okay. Shifting gears, regarding the legacy resuscitation program. As those roll off, you enter 2021, I think you had said that you'll be at zero for the legacy revenues at that point. How will the access fees be accounted for? Because there's going to be some customers that still are going to be using the legacy platform, but RQI is going to be basically paying you a legacy or a access fee, if you will. Will that be accounted for in another bucket, or if you're saying zero, but essentially there's going to be some revenues there? Just help us understand that a little bit.
Yeah, sure. It's another bucket. We've communicated the approximately $59 or $60 million in revenue from the legacy products as its own, based on its own legacy contracts and wind down agreement. That's that $59 million winding down. We announced the RQI Partners agreement, which is a separate revenue stream, which are the access fees, where they do the sales and marketing, and we'll facilitate the connectivity. That will be growing, but it'll be dependent upon customer choice and their own success selling and contracting with hospitals that are on our learning platform, for example. The sequence of events would be that a customer is using our learning platform, and enjoying the benefits of that. They want to maintain their older, what we would call a legacy solution, but they want to maintain that, so they contract for that with RQI Partners.
Then, our ops teams will help make sure that it works for the customer, and, the RQI Partners organization would pay us an access fee, which would show up in revenue. It'd be very low because it's a subset of the contract value. We're no longer contracting for the products, we no longer sell the products, we no longer market the products. That's all on the access partner, as we call them now, RQI Partners.
Okay. That's very helpful. Thank you. Maybe one last one, and then I'll hop back into queue. Regarding your hStream subscriptions, you launched the product in Q3 of 2018, and it's ramped very quickly. It's almost 60% of the last fully implemented and contracted subscriber numbers for the way you reported that previously. How quickly do you get that other 40%? Is that going to ramp on in the next year? Do you expect that rate of conversion to maybe slow as you get closer to that 100%?
Yeah. First of all, as I've articulated, each of the three transitions, I think, are kind of 36-month transitions. I arbitrarily picked January 1 as a start date, even though some things started before that and some will go a little longer than 36 months. Just to characterize all the three, I think the bulk of the migrations, transitions, and movements will be complete within 36 months, and again, starting in January 1, 2019. We're nine months in to the 36-month transitions. I would say that a couple of years are left. Whether 100,000 migrate or 434,000, as in this quarter, is largely dependent on when these accounts are coming up for renewal. If you have a couple of big enterprise accounts coming up for renewal, it might be a high number.
If it's a bunch of smaller accounts coming up for renewal on the old platforms, it would be a lower number. To the extent that we do renew them, they'll count into the hStream subscriptions, where they're upgrading their old contracts to include hStream and other product sets from us. Remember as well that contracting for this new operating system is step one, and then receiving benefits and capabilities from it is step two. Some of the most tangible and obvious benefits are for customers that choose to stay with and renew our learning platform as well. They get this upgrade to MyTeam. There are other benefits that we can roll out with hStream, and we'll be articulating them in the coming months and quarters to both customers and to the market. That's how we're achieving this migration.
Remember, their average contracts were 3-plus years, a third of the accounts would come up for renewal each year. Some had entered longer-term renewals than that, again, I think about 24 more months, and we'll be through the bulk of these migrations.
Understood. All right. Thank you very much.
Thank you. Our next question comes from Richard Close with Canaccord Genuity. Your line is now open.
Great. Thanks for the questions. Just a little bit on gross margin. Obviously, you're targeting, based on your statements, 60% by the middle of next year. As you think about the transitions here, what do you think margins will be out maybe two or three years? Have you thought about that in terms of what maybe a long-term target is, considering these transitions?
Richard. You know that I've never got it beyond a year, but this is one that I think I can touch on because there's kind of a natural fallout from the roll-off of the resuscitation products and the growth in the newer Red Cross Resuscitation Suite program and our new resuscitation product set. I think I can say that by this time next year, we'll feel like we'll cross across that 60% of the gross margin level. My expectation is sustainably. As the legacy products drop off even faster by Q1 of 2021, we think we'd see a much more aggressive move up in the gross margin. Just for now, I will ballpark and say that we should cross through 65% gross margins. Again, this is approximation. It's long run, and so I want to caveat it with all that.
It's this natural migration of the switch out of the legacy revenues for the new that gives me the confidence to say that, in addition to the other migrations we've talked about, the SaaS to PaaS strategy and the Verity migrations, all those together, I think we'll be looking at 65% gross margins by Q1 of 2021, and with even some upside to that into the future. I'll leave it at that for now to give you a little bit more sense for the way we're thinking about it. 60% by the third quarter next year, 65% by the first quarter or so of 2021.
Okay. That's great. Thanks for that insight there. With respect to the most recent quarter, and then in the updated guidance, with respect to the operating expenses, I think on all the line items, you did considerably better than what we were forecasting. Just any thoughts there in terms of maybe how you're trending in terms of product development, sales, and marketing, and then the G&A in terms of, were there any things really to call out that maybe you didn't do as much hiring or things along those lines that led to the better operating expenses in the quarter?
Yeah, let's talk about that a little bit. That's a good question. We were just talking about that before the call started, actually. We had very ambitious hiring plans. We did end up adding a net new of about 80-plus employees in the year, so we did grow our workforce. A good chunk of that, maybe a third of that or so, was through the acquisition of Providigm, but there was also some organic net new hiring of probably 50 or so people across the rest of the company. We did achieve some really good growth as we had planned to in our headcount. However, in our modeling and in our guidance, we had assumed even higher levels.
We were not able to hire to our desired outcome, and that resulted in lower expenses than we had, and therefore kind of outsized earnings in Q3 to what we had hoped. Had we been able to hire everyone we had hoped to, we probably would've had a little lower earnings in this existing quarter. I think probably the single biggest variable is setting our hiring expectations internally, and then how close do we get to achieving them. I would say this year, we underachieved. We're not aggressively trying to correct that, meaning I didn't tell our teams, "Go out and get five headhunting firms and get all these positions filled." We're kind of fighting the natural battle for talent in our markets, including Nashville, which is heating up.
We're doing it diligently, but we're not over-investing, we're not creating a huge cost of rapid recruiting. We're taking our time trying to get the right people, and I think we're doing well at that. The net effect is, yes, we're behind kind of where we thought we would be from a headcount standpoint. That has been a persistent story now for probably a year. I don't want you to get the sense that we're not growing our headcount. We did add in technology, we did add in sales, net new adds in sales, net new adds in almost every area of the company. We're getting things done, but we haven't yet ripped the cord and said, "Look, fill all these jobs instantly." As you know, that costs a lot of money to do that through recruiters.
We're doing our best organic recruiting, and that's resulting in a little bit lower forecast and therefore higher operating income in Q3. We're going to do our best in the fourth quarter to authorize lots of project work and contracts to make up for that deficit in hiring so that we can deploy capital and cash and expenses into product development, product design, things that are expensable and some things capitalizable. We're going to try to amp up Q4 a bit, to essentially invest the money we would have invested in headcount, and I don't know if we'll be able to fully offset the hiring shortfall. Again, it's important to know that we did add a net new 80 employees, so we're not shrinking the employee headcount. We were more aggressive earlier in the year in our expectations for hiring.
Okay. About a year ago, you talked about a transition to, I believe it was Azure and AWS. Any update there in terms of where you stand in that process, maybe the positives associated with that that you think you'll accrue, and then maybe an update on the expenses associated with that? Is that coming in lower than anticipated or above expectations?
It's about at expectations. I think I'd characterize that as a 24-month migration as well, or 27 months, if I had to think of, like, describe another migration. This one is more at hand, and it's managed with a thorough process. As our PaaS strategy grows, we're increasingly moving all the applications up into those two environments you mentioned, Azure and AWS. That does result in duplicative costs, where our legacy platform, HLC, is all a SaaS. It's a great architecture, but it's hosted in a managed hosting environment in a couple of Tier 1 data centers across the country. We are having duplicative costs.
I would say we're going to bear those duplicative costs for the next. I'll go ahead and just align this with the other two migrations because there are hundreds and hundreds and hundreds of HealthStream managed servers in these Tier 1 data centers, and it's going to take us time to get each of our applications moved. We're not in any particular hurry because it's a good, stable, growing model and platform. Again, a lot of the new platform technologies are being built, and so we don't have all the functionality in the new platform to just switch some of the legacy platforms over.
I guess I would say that they're at our budgeted expectations for costs in the model, nothing exceptional either way, and that we're going to take our time, probably the next 27 months, so I'll give us the same timeline as the other three transitions, to get us over to the cloud fully. Again, all of our apps, just to be clear, are SaaS applications that are web hosted and delivered, multi-tenant architecture. They're modern architectures, but as far as the actual hosting environment, managed hosting versus outsourced hosting to AWS and Azure, the Microsoft platform, we're going to take our time on that and manage those costs.
To your point, though, if you look out 30 months from now, when those migrations are complete, we will have a lower cost structure because I think some of our server facilities have over 300, 400, 500 servers in them that would go away, and the capital to refresh them would also go away. Let's call that a 27-month journey as well.
Okay. Would that be included in that sort of 65% type of gross margin?
Yeah.
Additional leg up?
Yeah, we factor it in. Those costs are in our thinking as we look out into, as I mentioned, since a 27-month migration, those kind of duplicative costs are in our assumptions. We still think we can see a move to cross the 60% threshold by this time next year. Then a more rapid move by Q1, Q2 of the next year to that 65% area.
Okay, great. Thank you very much.
We will have both sets of costs. Yeah, thank you.
Great, thanks.
Thank you. As a reminder, to ask a question, you will need to press star one on your telephone. Our next question comes from Frank Sparacino with First Analysis. Your line is now open.
Hi, guys. Just one for me on the talent side of things, given we haven't talked too much about that recently, Bobby. I see there's some new money in startups coming into the space on the hiring side. Any thoughts just in terms of where you're at today, in terms of the talent portfolio products and your thoughts going forward there, Bobby, in terms of the market opportunity and how you sort of balance that maybe with some of the other initiatives you have?
Yeah, thanks. We haven't talked about it in a while. I'd say globally, I'd say we're retrenching to what we're best at. That'd be a fair characterization. The learning and development dimensions, tools like our checklist tool have been good winners. We put those in the talent management bucket. The Learning Center with its refreshed My Team and the new kind of initiative management capabilities we've been building into the platform, we're really excited about. Probably a slight move away from some of the other areas like compensation, like the full talent suite. Yeah. Probably a de-emphasis on what I'd call the secondary and tertiary components of talent management and a doubling down on what I'll call performance management and learning.
Even within learning, there's new innovations coming, and we're right on top of them around, for example, using video-based education and training and providing new products that give the capabilities to manage essentially your own kind of YouTube for your health system, and tied into your learning platform. We have some exciting momentum around this new video-based platform that's connected to our learning platform. Yeah, overall characterization would be we're kind of doubling down on what the core is. From our perspective, it's kind of learning and performance management. We're probably moving away from the secondary and tertiary services like compensation management and recruiting, for example, the ATS moves we made several years ago. We're probably de-emphasizing those overall. The emerging technologies like the new video-based platform we're really excited about.
We think we can continue to differentiate ourselves in what I'll call learning, development, and performance management.
Thank you.
Thank you. I am not showing any further questions at this time. I would now like to turn the call back over to Robert Frist for any further remarks.
Well, thank you, everyone, for participating. Congratulations to the employees on their great efforts for our social responsibility program and helping raise over $20,000 for the American Cancer Society. A great effort there. We look forward to reporting to all investors on the three key transitions again next quarter. Well, actually, it'll be sometime before we're together again, around February. We're proud that we've made good progress on each of the three key transitions and migrations we talked about. I guess we identified a fourth, is the move into these full cloud-hosted solutions as almost a fourth transition to think about. Thank you all. Look forward to our next report.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.