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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑Q

Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2018

Commission File No.: 000‑27701

HealthStream, Inc.

(Exact name of registrant as specified in its charter)

Tennessee	62‑1443555
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

209 10th Avenue South, Suite 450
Nashville, Tennessee	37203
(Address of principal executive offices)	(Zip Code)

(615) 301‑3100

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of October 26, 2018, there were 32,325,409 shares of the registrant’s common stock outstanding.

Index to Form 10‑Q

HEALTHSTREAM, INC.

		Page Number

Part I.	Financial Information	1

Item 1.	Financial Statements	1

	Condensed Consolidated Balance Sheets (Unaudited) – September 30, 2018 and December 31, 2017	1

	Condensed Consolidated Statements of Income (Unaudited) – Three and Nine Months Ended September 30, 2018 and 2017	2

	Condensed Consolidated Statements of Comprehensive Income (Unaudited) – Three and Nine Months Ended September 30, 2018 and 2017	3

	Condensed Consolidated Statement of Shareholders' Equity (Unaudited) – Nine Months Ended September 30, 2018	4

	Condensed Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended September 30, 2018 and 2017	5

	Notes to Condensed Consolidated Financial Statements (Unaudited)	6

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	17

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	25

Item 4.	Controls and Procedures	25

Part II.	Other Information	26

Item 6.	Exhibits	26

	Signature	27

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands)

	September 30,			December 31,
	2018			2017
ASSETS
Current assets:
Cash and cash equivalents	$	130,283		$	84,768
Marketable securities		44,025			46,350
Accounts receivable, net of allowance for doubtful accounts of $1,112 and $1,979 at September 30, 2018 and December 31, 2017, respectively		28,835			36,691
Accounts receivable - unbilled		2,597			1,327
Prepaid royalties, net of amortization		14,205			16,137
Other prepaid expenses and other current assets		10,714			8,330
Current assets of discontinued operations		—			6,125
Total current assets		230,659			199,728

Property and equipment, net of accumulated depreciation of $28,497 and $24,392 at September 30, 2018 and December 31, 2017, respectively		8,683			8,092
Capitalized software development, net of accumulated amortization of $44,316 and $37,174 at September 30, 2018 and December 31, 2017, respectively		16,770			16,014
Goodwill		86,144			86,144
Customer-related intangibles, net of accumulated amortization of $21,692 and $17,033 at September 30, 2018 and December 31, 2017, respectively		55,022			59,681
Other intangible assets, net of accumulated amortization of $9,896 and $7,708 at September 30, 2018 and December 31, 2017, respectively		6,628			8,816
Deferred tax assets		-			45
Deferred commissions		13,474			—
Non-marketable equity investments		3,359			3,772
Other assets		761			754
Long-term assets of discontinued operations		—			28,073
Total assets	$	421,500		$	411,119

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	20,135		$	16,507
Accrued royalties		15,223			12,849
Deferred revenue		62,151			64,938
Current liabilities of discontinued operations		—			6,772
Total current liabilities		97,509			101,066

Deferred tax liabilities		5,082			—
Deferred revenue, noncurrent		2,333			6,287
Other long term liabilities		882			1,048
Long-term liabilities of discontinued operations		—			2,548
Commitments and contingencies

Shareholders’ equity:
Common stock, no par value, 75,000 shares authorized; 32,325 and 31,908 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively		286,128			282,666
Retained earnings		29,583			17,542
Accumulated other comprehensive loss		(17	)		(38	)
Total shareholders’ equity		315,694			300,170
Total liabilities and shareholders’ equity	$	421,500		$	411,119

See accompanying notes to the unaudited condensed consolidated financial statements.

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(In thousands, except per share data)

	Three Months Ended					Nine Months Ended
	September 30, 2018			September 30, 2017		September 30, 2018			September 30, 2017
Revenues, net	$	59,925		$	54,743	$	171,791		$	159,630
Operating costs and expenses:
Cost of revenues (excluding depreciation and amortization)		25,102			22,523		70,586			64,898
Product development		6,600			6,002		19,149			17,929
Sales and marketing		8,559			9,145		26,536			27,764
Other general and administrative expenses		8,997			8,371		24,769			23,269
Depreciation and amortization		6,006			5,971		18,097			17,874
Total operating costs and expenses		55,264			52,012		159,137			151,734

Operating income		4,661			2,731		12,654			7,896

Other (loss) income, net		(548	)		186		241			481

Income from continuing operations before income tax provision		4,113			2,917		12,895			8,377
Income tax provision		1,077			1,182		2,575			2,709
Income from continuing operations		3,036			1,735		10,320			5,668
Discontinued operations
Income (loss) from discontinued operations before income tax provision		—			1,238		(64	)		762
Gain on sale of discontinued operations		—			—		29,490			—
Income tax provision		—			469		10,319			374
Income from discontinued operations		—			769		19,107			388
Net Income	$	3,036		$	2,504	$	29,427		$	6,056

Earnings per share – basic:
Continuing operations	$	0.09		$	0.06	$	0.32		$	0.18
Discontinued operations		—			0.02		0.59			0.01
Earnings per share - basic	$	0.09		$	0.08	$	0.91		$	0.19

Earnings per share - diluted:
Continuing operations	$	0.09		$	0.06	$	0.32		$	0.18
Discontinued operations		—			0.02		0.59			0.01
Earnings per share - diluted	$	0.09		$	0.08	$	0.91		$	0.19

Weighted average shares of common stock outstanding:
Basic		32,322			31,893		32,244			31,848
Diluted		32,415			32,217		32,308			32,183
Dividends declared per share	$	—		$	—	$	1.00		$	—

See accompanying notes to the unaudited condensed consolidated financial statements.

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In thousands)

	Three Months Ended				Nine Months Ended
	September 30, 2018		September 30, 2017		September 30, 2018		September 30, 2017
Net income	$	3,036	$	2,504	$	29,427	$	6,056

Other comprehensive income, net of taxes:
Unrealized gain on marketable securities		16		16		21		31
Total other comprehensive income		16		16		21		31
Comprehensive income	$	3,052	$	2,520	$	29,448	$	6,087

See accompanying notes to the unaudited condensed consolidated financial statements.

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)

Nine Months Ended September 30, 2018

(In thousands)

	Common Stock				Retained			Accumulated Other Comprehensive			Total Shareholders’
	Shares		Amount		Earnings			Loss			Equity
Balance at December 31, 2017		31,908	$	282,666	$	17,542		$	(38	)	$	300,170
Cumulative effect of accounting change		—		—		15,132			—			15,132
Net income		—		—		29,427			—			29,427
Comprehensive income		—		—		—			21			21
Dividends declared on common stock ($1.00 per share)		—		—		(32,518	)		—			(32,518	)
Stock based compensation		—		1,215		—			—			1,215
Common stock issued under stock plans, net of shares withheld for employee taxes		417		2,247		—			—			2,247
Balance at September 30, 2018		32,325	$	286,128	$	29,583		$	(17	)	$	315,694

See accompanying notes to the unaudited condensed consolidated financial statements.

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

	Nine Months Ended September 30,
	2018			2017
OPERATING ACTIVITIES:
Net income	$	29,427		$	6,056
Income from discontinued operations		(19,107	)		(388	)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		18,097			17,874
Stock-based compensation		1,306			1,241
Provision for doubtful accounts		690			820
Deferred income taxes		661			710
(Gain) loss on non-marketable equity investments		(25	)		5
Change in fair value of cost method investments		1,271			—
Other		(22	)		351
Changes in operating assets and liabilities:
Accounts and unbilled receivables		5,865			4,422
Prepaid royalties		1,030			1,006
Other prepaid expenses and other current assets		(682	)		7
Other assets		(927	)		(128	)
Accounts payable and accrued expenses		(10,811	)		1,750
Accrued royalties		2,373			91
Deferred revenue		658			(1,464	)
Net cash provided by continuing operating activities		29,804			32,353
Net cash (used in) provided by discontinued operating activities		(1,003	)		3,310
Net cash provided by operating activities		28,801			35,663

INVESTING ACTIVITIES:
Proceeds from sale of discontinued operations		57,827			—
Proceeds from maturities of marketable securities		59,452			69,566
Purchases of marketable securities		(57,085	)		(79,290	)
Payments to acquire cost method investments		(833	)		(500	)
Payments associated with capitalized software development		(8,042	)		(7,480	)
Purchases of property and equipment		(4,342	)		(4,828	)
Net cash provided by (used in) continuing investing activities		46,977			(22,532	)
Net cash used in discontinued investing activities		(115	)		(2,217	)
Net cash provided by (used in) investing activities		46,862			(24,749	)

FINANCING ACTIVITIES:
Proceeds from exercise of stock options		2,582			322
Taxes paid related to net settlement of equity awards		(335	)		(410	)
Payment of earn-outs related to prior acquisitions		(38	)		—
Payment of cash dividends		(32,357	)		—
Net cash used in continuing financing activities		(30,148	)		(88	)
Net cash used in discontinued financing activities		—			—
Net cash used in financing activities		(30,148	)		(88	)

Net increase in cash and cash equivalents		45,515			10,826
Cash and cash equivalents at beginning of period		84,768			49,634
Cash and cash equivalents at end of period	$	130,283		$	60,460

See accompanying notes to the unaudited condensed consolidated financial statements.

HEALTHSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) for interim financial information and with the instructions to Form 10‑Q and Article 10 of Regulation S‑X. Accordingly, condensed consolidated financial statements do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All intercompany transactions have been eliminated in consolidation. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

On February 12, 2018, the Company divested its Patient Experience (“PX”) business to Press Ganey Associates, Inc. (“Press Ganey”). The sale of the PX business resulted in the divestiture of the Company’s patient experience solutions business segment. The Company has classified the results of its previously owned PX business as discontinued operations in its condensed consolidated statements of income and cash flows for all periods presented. Additionally, the related assets and liabilities are reported as assets and liabilities of discontinued operations in the Company’s condensed consolidated balance sheet as of December 31, 2017. See Note 8 for additional information.

The condensed consolidated balance sheet at December 31, 2017 was derived from the audited consolidated financial statements at that date and adjusted for discontinued operations as noted above but does not include all of the information and footnotes required by US GAAP for a complete set of financial statements. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2017 (included in the Company's Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 26, 2018).

2. RECENT ACCOUNTING PRONOUNCEMENTS

Accounting Standards Recently Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (referred to as Accounting Standards Codification (“ASC”) Topic 606, or “ASC 606”). This guidance supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition (“ASC 605”), and most industry-specific revenue recognition guidance throughout the Industry Topics of the ASC. The updated guidance states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASC 606 also includes Subtopic 340-40, Other Assets and Deferred Costs – Contracts with Customers, which requires deferral of incremental costs of obtaining a contract with a customer. Collectively, ASC 606 and Subtopic 340-40 are referred to as the “new standard.”

The Company adopted the new standard effective January 1, 2018 utilizing the modified retrospective approach. Adoption of the new standard resulted in changes to the Company’s accounting policies for revenue recognition, trade and other receivables, and deferred commissions. See Note 3 for additional information regarding the new standard and its impact on the Company’s balance sheet and statements of income.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10), which addresses certain aspects of the recognition, measurement, presentation, and disclosure of financial instruments. The guidance, among other things, requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. The Company adopted ASU 2016-01 effective January 1, 2018 on a prospective basis. See Note 11 for additional information regarding ASU 2016-01 and its impact on the Company’s balance sheet and statements of income.

Accounting Standards Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02, Leases (“ASC 842”), which requires lessees to recognize assets and liabilities for most leases. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee is not expected to significantly change under such guidance. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2018, such that this standard will be effective January 1, 2019 for the Company. The Company is in the process of implementing the standard in preparation for the January 1, 2019 adoption date, and has identified that the standard is expected to result in changes to current accounting policies, processes, and internal controls, with the most significant impact being to the balance sheet as a result of recognizing right of use assets and liabilities for real estate leases; however, the Company has not yet completed its assessment of the financial impact of the Company’s adoption of this accounting standard on its future consolidated financial statements.

HEALTHSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

2. RECENT ACCOUNTING PRONOUNCEMENTS (continued)

In June 2016, the FASB issued ASU 2016-03, Financial Instruments—Credit Losses (“ASC 326”): Measurement of Credit Losses on Financial Instruments, which amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, ASC 326 eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2019. The Company will adopt this ASU on January 1, 2020 and is currently evaluating the impact that adoption of this ASU will have on the Company’s consolidated financial position and results of operations.

3. REVENUE RECOGNITION AND SALES COMMISSIONS

Adoption of ASC 606, Revenue from Contracts with Customers

On January 1, 2018, the Company adopted the new standard using the modified retrospective approach applied to contracts not completed as of January 1, 2018. As such, results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts continue to be reported in accordance with ASC 605.

The cumulative effect of the changes made to the Company’s consolidated January 1, 2018 balance sheet in connection with the adoption of ASC 606 was as follows (in thousands):

Balance Sheet	Balance at December 31, 2017		ASC 606 Adjustments			Balance at January 1, 2018
Assets
Unbilled receivables	$	1,327	$	31		$	1,358
Prepaid royalties, net		16,137		(902	)		15,235
Other prepaid expenses and other current assets		8,330		(2,900	)		5,430
Current assets of discontinued operations		6,125		(274	)		5,851
Deferred commissions		—		12,552			12,552
Deferred tax assets		45		(45	)		—
Non-current assets of discontinued operations		28,073		3,166			31,239

Liabilities
Deferred revenue, current		64,938		(4,488	)		60,450
Current liabilities of discontinued operations		6,772		(1,374	)		5,398
Deferred tax liabilities		—		5,205			5,205
Deferred revenue, noncurrent		6,287		(2,848	)		3,439

Shareholders’ equity
Retained earnings		17,542		15,132			32,674

The impact of adopting ASC 606 on the Company’s condensed consolidated balance sheet as of September 30, 2018 and statements of income for the three and nine months ended September 30, 2018 was as follows (in thousands):

	September 30, 2018
Balance Sheet	As reported		Balances without Adoption of ASC 606		Effect of Change Higher/(Lower)
Assets
Prepaid royalties, net	$	14,205	$	15,375	$	(1,170	)
Other prepaid expenses and other current assets		10,714		12,459		(1,745	)
Deferred commissions		13,474		—		13,474

Liabilities
Deferred revenue, current		62,151		66,885		(4,734	)
Deferred revenue, noncurrent		2,333		5,673		(3,340	)

Shareholders’ equity
Retained earnings		29,583		27,577		2,006

HEALTHSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3. REVENUE RECOGNITION AND SALES COMMISSIONS (continued)

	Three Months Ended September 30, 2018
Income Statement	As reported		Balances without Adoption of ASC 606		Effect of Change Higher/(Lower)
Revenues, net	$	59,925	$	59,291	$	634

Costs and expenses
Cost of revenues (excluding depreciation and amortization)		25,102		25,154		(52	)
Sales and marketing		8,559		8,982		(423	)
Operating income		4,661		3,552		1,109
Income from continuing operations before income tax provision		4,113		3,004		1,109
Income tax provision		1,077		787		290
Income from continuing operations		3,036		2,217		819
Net income		3,036		2,217		819

Nine Months Ended September 30, 2018

Income Statement

reported

Balances without

Adoption of

ASC 606

Effect of Change

Higher/(Lower)

Revenues, net

171,791

171,053