Table of Contents
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, 2005
Commission File No.: 001-8833
HealthStream, Inc.
(Exact name of registrant as specified in its charter)
| Tennessee | 62-1443555 | |
| (State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
| incorporation or organization) |
| 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)
(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 þ No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
As of November 9, 2005, 21,574,904 shares of the registrant’s common stock were outstanding.
Index to Form 10-Q
HEALTHSTREAM, INC.
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HEALTHSTREAM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
| September 30, | December 31, | |||||||
| 2005 | 2004 | |||||||
| (Unaudited) | (Note 1) | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 5,778,278 | $ | 2,257,372 | ||||
Investments in short term marketable securities |
3,900,000 | 14,025,000 | ||||||
Restricted cash |
168,242 | 184,041 | ||||||
Interest receivable |
23,584 | 25,899 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $184,617
at September 30, 2005 and $234,167 at December 31, 2004 |
4,277,668 | 3,990,590 | ||||||
Accounts receivable — unbilled |
1,108,711 | 596,877 | ||||||
Prepaid development fees, net of amortization |
546,507 | 542,823 | ||||||
Other prepaid expenses and other current assets |
960,682 | 850,529 | ||||||
Total current assets |
16,763,672 | 22,473,131 | ||||||
Property and equipment: |
||||||||
Furniture and fixtures |
1,011,877 | 931,118 | ||||||
Equipment |
7,275,376 | 6,402,343 | ||||||
Leasehold improvements |
1,281,460 | 1,267,133 | ||||||
| 9,568,713 | 8,600,594 | |||||||
Less accumulated depreciation and amortization |
(7,300,766 | ) | (6,281,311 | ) | ||||
| 2,267,947 | 2,319,283 | |||||||
Goodwill |
10,306,557 | 3,306,688 | ||||||
Intangible assets, net of accumulated amortization of $7,134,946
at September 30, 2005 and $6,695,922 at December 31, 2004 |
3,377,196 | 166,220 | ||||||
Other assets |
319,803 | 291,779 | ||||||
Total assets |
$ | 33,035,175 | $ | 28,557,101 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 1,008,086 | $ | 830,941 | ||||
Accrued liabilities |
1,311,835 | 1,117,367 | ||||||
Accrued compensation and related expenses |
349,949 | 284,301 | ||||||
Registration liabilities |
161,170 | 174,697 | ||||||
Commercial support liabilities |
915,531 | 378,893 | ||||||
Deferred revenue |
4,367,532 | 3,987,697 | ||||||
Current portion of capital lease obligations |
130,594 | 24,113 | ||||||
Total current liabilities |
8,244,697 | 6,798,009 | ||||||
Capital lease obligations, less current portion |
190,750 | 29,428 | ||||||
Commitments and contingencies |
— | — | ||||||
Shareholders’ equity: |
||||||||
Common stock, no par value, 75,000,000 shares authorized;
21,568,529 and 20,667,515 shares issued and outstanding
at September 30, 2005 and December 31, 2004, respectively |
93,791,326 | 91,642,383 | ||||||
Accumulated deficit |
(69,191,598 | ) | (69,912,719 | ) | ||||
Total shareholders’ equity |
24,599,728 | 21,729,664 | ||||||
Total liabilities and shareholders’ equity |
$ | 33,035,175 | $ | 28,557,101 | ||||
See accompanying notes to condensed consolidated financial statements.
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HEALTHSTREAM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
| Three Months Ended September 30, | ||||||||
| 2005 | 2004 | |||||||
Revenues, net |
$ | 6,830,640 | $ | 5,032,233 | ||||
Operating costs and expenses: |
||||||||
Cost of revenues |
2,392,075 | 1,776,017 | ||||||
Product development |
719,930 | 659,155 | ||||||
Sales and marketing |
1,340,084 | 1,100,944 | ||||||
Depreciation |
373,697 | 344,426 | ||||||
Amortization of intangibles, content fees and feature enhancements |
278,496 | 192,087 | ||||||
Other general and administrative expenses |
1,244,556 | 1,202,174 | ||||||
Total operating costs and expenses |
6,348,838 | 5,274,803 | ||||||
Income (loss) from operations |
481,802 | (242,570 | ) | |||||
Other income (expense): |
||||||||
Interest and other income |
81,914 | 69,116 | ||||||
Interest and other expense |
(9,958 | ) | (3,818 | ) | ||||
| 71,956 | 65,298 | |||||||
Net income (loss) |
$ | 553,758 | $ | (177,272 | ) | |||
Net income (loss) per share: |
||||||||
Basic |
$ | 0.03 | $ | (0.01 | ) | |||
Diluted |
$ | 0.02 | $ | (0.01 | ) | |||
Weighted average shares of common stock outstanding: |
||||||||
Basic |
21,212,310 | 20,655,825 | ||||||
Diluted |
22,356,561 | 20,655,825 | ||||||
See accompanying notes to condensed consolidated financial statements.
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HEALTHSTREAM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
| Nine Months Ended September 30, | ||||||||
| 2005 | 2004 | |||||||
Revenues, net |
$ | 19,319,462 | $ | 14,631,438 | ||||
Operating costs and expenses: |
||||||||
Cost of revenues |
6,887,196 | 5,417,062 | ||||||
Product development |
2,099,549 | 1,940,236 | ||||||
Sales and marketing |
4,131,547 | 3,462,475 | ||||||
Depreciation |
1,183,808 | 987,809 | ||||||
Amortization of intangibles, content fees, feature enhancements,
and prepaid compensation |
846,674 | 540,751 | ||||||
Other general and administrative expenses |
3,687,579 | 3,568,000 | ||||||
Total operating costs and expenses |
18,836,353 | 15,916,333 | ||||||
Income (loss) from operations |
483,109 | (1,284,895 | ) | |||||
Other income (expense): |
||||||||
Interest and other income |
259,854 | 172,103 | ||||||
Interest and other expense |
(21,842 | ) | (12,423 | ) | ||||
| 238,012 | 159,680 | |||||||
Net income (loss) |
$ | 721,121 | $ | (1,125,215 | ) | |||
Net income (loss) per share: |
||||||||
Basic |
$ | 0.03 | $ | (0.05 | ) | |||
Diluted |
$ | 0.03 | $ | (0.05 | ) | |||
Weighted average shares of common stock outstanding: |
||||||||
Basic |
20,984,144 | 20,561,141 | ||||||
Diluted |
21,962,594 | 20,561,141 | ||||||
See accompanying notes to condensed consolidated financial statements.
3
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HEALTHSTREAM, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2005
NINE MONTHS ENDED SEPTEMBER 30, 2005
| Common Stock | Total Shareholders’ | |||||||||||||||
| Shares | Amount | Accumulated Deficit | Equity | |||||||||||||
Balance at December 31, 2004 |
20,667,515 | $ | 91,642,383 | $ | (69,912,719 | ) | $ | 21,729,664 | ||||||||
Net income |
— | — | 721,121 | 721,121 | ||||||||||||
Issuance of common stock to Employee
Stock Purchase Plan |
83,742 | 159,445 | — | 159,445 | ||||||||||||
Issuance of common stock in acquisition |
479,234 | 1,343,149 | — | 1,343,149 | ||||||||||||
Exercise of stock options |
338,038 | 646,349 | — | 646,349 | ||||||||||||
Balance at September 30, 2005 |
21,568,529 | $ | 93,791,326 | $ | (69,191,598 | ) | $ | 24,599,728 | ||||||||
See accompanying notes to condensed consolidated financial statements .
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HEALTHSTREAM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
| Nine Months Ended September 30, | ||||||||
| 2005 | 2004 | |||||||
OPERATING ACTIVITIES: |
||||||||
Net income (loss) |
$ | 721,121 | $ | (1,125,215 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by
operating activities: |
||||||||
Depreciation |
1,183,808 | 987,809 | ||||||
Amortization of intangibles, content fees, feature enhancements
and prepaid compensation |
846,674 | 540,751 | ||||||
Provision for doubtful accounts |
15,000 | 15,000 | ||||||
Realized loss on disposal of property & equipment |
6,096 | 1,153 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts and unbilled receivables |
(367,020 | ) | (686,991 | ) | ||||
Restricted cash |
15,799 | 493,649 | ||||||
Interest receivable |
2,315 | 99,022 | ||||||
Prepaid development fees |
(323,055 | ) | (461,425 | ) | ||||
Other prepaid expenses and other current assets |
(99,635 | ) | (135,938 | ) | ||||
Other assets |
(28,024 | ) | (106,902 | ) | ||||
Accounts payable |
142,346 | (2,746 | ) | |||||
Accrued liabilities and compensation |
(152,060 | ) | 136,018 | |||||
Registration liabilities |
(13,527 | ) | (508,132 | ) | ||||
Commercial support liabilities |
536,638 | 385,466 | ||||||
Deferred revenue |
170,904 | 427,454 | ||||||
Net cash provided by operating activities |
2,657,380 | 58,973 | ||||||
INVESTING ACTIVITIES: |
||||||||
Acquisition, net of cash acquired |
(9,351,360 | ) | — | |||||
Proceeds from maturities and sales of investments in marketable securities |
15,875,000 | 15,945,525 | ||||||
Purchase of investments in marketable securities |
(5,750,000 | ) | (15,452,045 | ) | ||||
Proceeds
from note receivable — related party |
— | 233,003 | ||||||
Purchase of property and equipment |
(656,894 | ) | (1,398,140 | ) | ||||
Net cash provided by (used in) investing activities |
116,746 | (671,657 | ) | |||||
FINANCING ACTIVITIES: |
||||||||
Exercise of stock options |
646,349 | 128,489 | ||||||
Issuance of stock to Employee Stock Purchase Plan |
159,445 | 76,726 | ||||||
Payments on capital lease obligations |
(59,014 | ) | (41,019 | ) | ||||
Net cash provided by financing activities |
746,780 | 164,196 | ||||||
Net increase (decrease) in cash and cash equivalents |
3,520,906 | (448,488 | ) | |||||
Cash and cash equivalents at beginning of period |
2,257,372 | 3,219,807 | ||||||
Cash and cash equivalents at end of period |
$ | 5,778,278 | $ | 2,771,319 | ||||
SUPPLEMENTAL CASH FLOW INFORMATION: |
||||||||
Capital lease obligations incurred |
$ | 326,817 | $ | 62,804 | ||||
Interest paid |
$ | 15,631 | $ | 9,857 | ||||
Issuance of common stock in connection with acquisition of company |
$ | 1,343,149 | $ | — | ||||
Effects of acquisition: |
||||||||
Estimated fair value of tangible assets acquired |
$ | 718,357 | $ | — | ||||
Estimated fair value of liabilities assumed |
(655,907 | ) | — | |||||
Purchase price in excess of net tangible assets acquired |
10,649,870 | — | ||||||
Stock issued |
(1,343,149 | ) | — | |||||
Cash paid |
9,369,171 | — | ||||||
Less cash acquired |
(17,811 | ) | — | |||||
Net cash paid for acquisition |
$ | 9,351,360 | $ | — | ||||
See accompanying notes to condensed consolidated financial statements.
5
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HEALTHSTREAM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED
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 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 generally accepted accounting principles 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 significant intercompany transactions
have been eliminated in consolidation. Operating results for the three and nine months ended
September 30, 2005 are not necessarily indicative of the results that may be expected for the year
ending December 31, 2005.
The balance sheet at December 31, 2004 is consistent with the audited financial statements at that
date but does not include all of the information and footnotes required by accounting principles
generally accepted in the United States 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, 2004 (included in the Company’s Annual Report on Form 10-K, filed with the
Securities and Exchange Commission).
The statement of cash flows for the nine months ended September 30, 2004 has been revised to
reflect the reclassification of investments in marketable securities for auction rate securities
held by the Company on September 30, 2004. We previously classified investments in auction rate
securities as cash equivalents due to the short-term nature of their relative auction dates. We
modified the statement of cash flows for the nine months ended September 30, 2004 to include
additional gross sales of $10.5 million and purchases of $12.9 million related to our investments
in marketable securities.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 123(R), “Share-Based Payments.” Statement 123(R) supersedes Accounting
Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and will require
companies to recognize compensation expense, using a fair-value based method, for costs related to
share-based payments, including stock options. In April 2005, the Securities and Exchange
Commission amended the effective date of the Statement to begin with the first interim or annual
reporting period of the first fiscal year beginning on or after December 15, 2005. The Company
intends to adopt Statement 123(R) in the first quarter of 2006, and to implement it on a
prospective basis. We are currently assessing the impact the Statement will have on our
consolidated results of operations.
3. ACQUISITION
On March 28, 2005, the Company acquired all of the stock of Data Management & Research, Inc. (DMR)
for approximately $10.7 million, consisting of $9.1 million in cash and 479,234 shares of our
common stock. Of the common stock portion, 319,489 shares are being held in an escrow account for
eighteen months from the acquisition date, subject to any claims for indemnification pursuant to
the stock purchase agreement. The Company also incurred direct, incremental expenses associated
with the acquisition of approximately $0.4 million. DMR provides healthcare organizations a wide
range of quality and satisfaction surveys, data analyses of survey results, and other
research-based measurement tools. The allocation of purchase price is preliminary and may be
subject to change as a result of changes in estimates related to the acquired business. The
preliminary purchase price allocation is disclosed on the statement of cash flows. During the three
months ended September 30, 2005, we allocated an additional $1.0 million of the purchase price to
customer-related intangible assets and extended the life of the related intangible assets to eight
years. This adjustment is based on a valuation analysis performed during the three months ended
September 30, 2005. Amounts recorded for goodwill and intangible assets at September 30, 2005 are
subject to change.
The results of operations for DMR have been included in the Company’s statement of operations,
effective March 29, 2005.
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HEALTHSTREAM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. ACQUISITION (continued)
The following unaudited pro forma results of operations give effect to the operations of DMR as if
the acquisition had occurred as of January 1, 2005 and 2004. These unaudited pro forma results of
operations include certain adjustments arising from the acquisition such as owner compensation and
amortization expense. The pro forma results of operations do not purport to represent what the
Company’s results of operations would have been had such transactions in fact occurred at
the beginning of the period presented or to project the Company’s results of operations in any
future period.
| Three months ended | Nine months ended | |||||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Revenue |
$ | 6,830,640 | $ | 6,320,355 | $ | 20,729,665 | $ | 18,105,012 | ||||||||
Net income (loss) |
$ | 553,758 | $ | 106,028 | $ | 1,194,482 | $ | (347,139 | ) | |||||||
Net income (loss) per share: |
||||||||||||||||
Basic |
$ | 0.03 | $ | 0.01 | $ | 0.06 | $ | (0.02 | ) | |||||||
Diluted |
$ | 0.02 | $ | 0.00 | $ | 0.05 | $ | (0.02 | ) | |||||||
4. STOCK-BASED COMPENSATION
We currently account for our stock-based compensation plans under the intrinsic value-based method
of accounting prescribed by Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued
to Employees” (APB 25) and related interpretations. APB 25 does not utilize the fair value method,
as prescribed by SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123) .
However, we have disclosed the fair value recognition requirements of SFAS No. 123 and the
additional disclosure requirements as specified in SFAS No. 148, “Accounting for Stock-Based
Compensation-Transition and Disclosure,” which amended SFAS No. 123.
If the alternative method of accounting for stock incentive plans prescribed by SFAS No. 123 had
been followed, our net income (loss) and net income (loss) per share would have been as follows:
| Three Months Ended | ||||||||
| September 30, 2005 | September 30, 2004 | |||||||
Net income (loss) as reported |
$ | 553,758 | $ | (177,272 | ) | |||
Add: Stock-based employee compensation expense included in reported net income (loss),
net of related taxes |
— | — | ||||||
Deduct: Total stock-based employee compensation expense determined under fair value
based method for all awards net of related tax effects |
(111,339 | ) | (93,608 | ) | ||||
Pro forma net income (loss) |
$ | 442,419 | $ | (270,880 | ) | |||
Basic net
income (loss) per share — as reported |
$ | 0.03 | $ | (0.01 | ) | |||
Basic net
income (loss) per share — pro forma |
$ | 0.02 | $ | (0.01 | ) | |||
Diluted net
income (loss) per share — as reported |
$ | 0.02 | $ | (0.01 | ) | |||
Diluted net
income (loss) per share — pro forma |
$ | 0.02 | $ | (0.01 | ) | |||
| Nine Months Ended | ||||||||
| September 30, 2005 | September 30, 2004 | |||||||
Net income (loss) as reported |
$ | 721,121 | $ | (1,125,215 | ) | |||
Add: Stock-based employee compensation expense included in reported net income (loss),
net of related taxes |
— | — | ||||||
Deduct: Total stock-based employee compensation expense determined under fair value
based method for all awards net of related tax effects |
(475,897 | ) | (458,543 | ) | ||||
Pro forma net income (loss) |
$ | 245,224 | $ | (1,583,758 | ) | |||
Basic net
income (loss) per share — as reported |
$ | 0.03 | $ | (0.05 | ) | |||
Basic net
income (loss) per share — pro forma |
$ | 0.01 | $ | (0.08 | ) | |||
Diluted net
income (loss) per share — as reported |
$ | 0.03 | $ | (0.05 | ) | |||
Diluted net
income (loss) per share — pro forma |
$ | 0.01 | $ | (0.08 | ) | |||
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HEALTHSTREAM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing the net income (loss) available to common
shareholders for the period by the weighted-average number of common shares outstanding during the
period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the
period by the weighted average number of common and common equivalent shares outstanding during the
period. Common equivalent shares, composed of incremental common shares issuable upon the exercise
of stock options and warrants, and escrowed or restricted shares, are included in diluted net
income (loss) per share only to the extent these shares have a dilutive effect. Common equivalent
shares are dilutive when the average market price during the period exceeds the exercise price of
the underlying shares. The total number of common equivalent shares excluded from the calculations
of diluted net income (loss) per share, due to their anti-dilutive effect, was approximately
1,100,000 and 3,000,000 for the three months ended September 30, 2005 and 2004, respectively, and
approximately 1,300,000 and 3,200,000 for the nine months ended September 30, 2005 and 2004,
respectively.
The following table sets forth the computation of basic and diluted net income (loss) per share for
three and nine months ended September 30, 2005 and 2004:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Numerator: |
||||||||||||||||
Net income (loss) |
$ | 553,758 | $ | (177,272 | ) | $ | 721,121 | $ | (1,125,215 | ) | ||||||
Denominator: |
||||||||||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
21,212,310 | 20,655,825 | 20,984,144 | 20,561,141 | ||||||||||||
Employee stock options and escrowed shares |
1,144,250 | — | 978,450 | — | ||||||||||||
Diluted |
22,356,561 | 20,655,825 | 21,962,594 | 20,561,141 | ||||||||||||
Net income (loss) per share: |
||||||||||||||||
Basic |
$ | 0.03 | $ | (0.01 | ) | $ | 0.03 | $ | (0.05 | ) | ||||||
Diluted |
$ | 0.02 | $ | (0.01 | ) | $ | 0.03 | $ | (0.05 | ) | ||||||
6. BUSINESS SEGMENTS
We have two reportable segments, services provided to healthcare organizations and professionals
(HCO) and services provided to pharmaceutical and medical device companies (PMD). On March 28,
2005, we acquired DMR, a company focused on offering healthcare organizations a wide range of
quality and satisfaction surveys, data analyses of survey results, and other research-based
measurement tools. Accordingly, DMR is included in our HCO business segment. The accounting
policies of the segments are the same as those described in the summary of significant accounting
policies in our Annual Report on Form 10-K for the year ended December 31, 2004. We believe the
accounting policies related to DMR are consistent with our accounting policies. We manage and
operate our business segments based on the markets they serve and the products and services
provided to those markets.
The following is our business segment information as of and for the three and nine months ended
September 30, 2005 and 2004. We measure segment performance based on operating income (loss)
before income taxes and prior to the allocation of corporate overhead expenses, interest income,
interest expense, and depreciation.
| Three months ended | Nine months ended | |||||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Revenues |
||||||||||||||||
HCO |
$ | 5,553,391 | $ | 3,650,153 | $ | 14,793,345 | $ | 10,097,854 | ||||||||
PMD |
1,277,249 | 1,382,080 | 4,526,117 | 4,533,584 | ||||||||||||
Total net revenue |
$ | 6,830,640 | $ | 5,032,233 | $ | 19,319,462 | $ | 14,631,438 | ||||||||
Income (loss) from operations |
||||||||||||||||
HCO |
$ | 2,286,189 | $ | 1,370,927 | $ | 5,636,286 | $ | 3,583,337 | ||||||||
PMD |
7,222 | 68,122 | 325,930 | 180,808 | ||||||||||||
Unallocated |
(1,811,609 | ) | (1,681,619 | ) | (5,479,107 | ) | (5,049,040 | ) | ||||||||
Total income (loss) from operations |
$ | 481,802 | $ | (242,570 | ) | $ | 483,109 | $ | (1,284,895 | ) | ||||||
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HEALTHSTREAM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. BUSINESS SEGMENTS (continued)
| Nine months ended | ||||||||
| September 30, | September 30, | |||||||
| 2005 | 2004 | |||||||
Segment Assets |
||||||||
HCO * |
$ | 17,719,923 | $ | 6,026,379 | ||||
PMD * |
4,408,647 | 4,195,566 | ||||||
Unallocated |
10,906,605 | 17,711,068 | ||||||
Total assets |
$ | 33,035,175 | $ | 27,933,013 | ||||
| * | Segment assets include restricted cash, accounts and unbilled receivables, certain prepaid and other current assets, other assets, certain property and equipment, and intangible assets. Cash and cash equivalents, investments in marketable securities and related interest receivable are not allocated to individual segments. |
7. GOODWILL
We account
for business combinations using the purchase method in accordance
with SFAS No. 141, “Business Combinatons.” We account for goodwill under the provisions of SFAS No. 142, “Goodwill and Other Intangible
Assets.” We test goodwill for impairment using a discounted cash flow model. The technique used to
determine the fair value of our reporting units is sensitive to estimates and assumptions
associated with cash flow from operations and its growth, discount rates, and reporting unit
terminal values. If these estimates or their related assumptions change in the future, we may be
required to record impairment charges, which could adversely impact our operating results for the
period in which such a determination is made. We perform our annual impairment evaluation of
goodwill during the fourth quarter of each year and as changes in facts and circumstances indicate
impairment exists.
On March 28, 2005, we acquired DMR. We continue to evaluate the purchase price allocation and
related valuation of indefinite and finite lived intangible assets, thus the amount of goodwill
recorded at September 30, 2005 related to the acquisition of DMR
is subject to change. During the
three months ended September 30, 2005, we allocated an additional $1.0 million of the DMR purchase
price to customer-related intangibles, which reduced goodwill. There were no changes in the
carrying amount of goodwill during the nine months ended September 30, 2004.
| HCO | PMD | Total | ||||||||||
Balance at January 1, 2005 |
$ | 1,982,961 | $ | 1,323,727 | $ | 3,306,688 | ||||||
Changes in carrying value of goodwill |
6,999,869 | — | 6,999,869 | |||||||||
Balance at September 30, 2005 |
$ | 8,982,830 | $ | 1,323,727 | $ | 10,306,557 | ||||||
| HCO | PMD | Total | ||||||||||
Balance at January 1, 2004 |
$ | 1,982,961 | $ | 1,323,727 | $ | 3,306,688 | ||||||
Changes in carrying value of goodwill |
— | — | — | |||||||||
Balance at September 30, 2004 |
$ | 1,982,961 | $ | 1,323,727 | $ | 3,306,688 | ||||||
8. INTANGIBLE ASSETS
All identifiable intangible assets have been evaluated in accordance with SFAS No. 142 and are
considered to have finite useful lives. We continue to evaluate the purchase price allocation and
related valuation of indefinite and finite lived intangible assets associated with the acquisition
of DMR, thus the balances recorded at September 30, 2005 are subject to change. Intangible assets
with finite lives are being amortized over their estimated useful lives, ranging from one to eight
years. Amortization of intangible assets was $127,083 and $439,024 for the three and nine months
ended September 30, 2005, respectively, and $83,239 and $260,824 for the three and nine months
ended September 30, 2004, respectively. During the three months ended September 30, 2005, we
allocated an additional $1.0 million of the DMR purchase price to customer-related intangibles and
extended the life of such definite lived intangibles from five years to eight years.
Identifiable intangible assets are comprised of the following:
| As of September 30, 2005 | As of December 31, 2004 | |||||||||||||||||||||||
| Accumulated | Accumulated | |||||||||||||||||||||||
| Gross Amount | Amortization | Net | Gross Amount | Amortization | Net | |||||||||||||||||||
Content |
$ | 3,500,000 | $ | (3,500,000 | ) | $ | — | $ | 3,500,000 | $ | (3,350,000 | ) | $ | 150,000 | ||||||||||
Customer-related |
6,340,000 | (3,170,195 | ) | 3,169,805 | 2,940,000 | (2,940,000 | ) | — | ||||||||||||||||
Other |
672,142 | (464,751 | ) | 207,391 | 422,142 | (405,922 | ) | 16,220 | ||||||||||||||||
Total |
$ | 10,512,142 | $ | (7,134,946 | ) | $ | 3,377,196 | $ | 6,862,142 | $ | (6,695,922 | ) | $ | 166,220 | ||||||||||
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HEALTHSTREAM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. INTANGIBLE ASSETS (continued)
Estimated amortization expense for the periods and years ending December 31, is as follows:
October 1, 2005 through December 31, 2005 |
$ | 112,624 | ||
2006 |
508,333 | |||
2007 |
508,333 | |||
2008 |
445,148 | |||
2009 |
425,000 | |||
2010 and thereafter |
1,377,758 | |||
Total |
$ | 3,377,196 | ||
9. INCOME TAXES
Our income for financial reporting purposes differs from our taxable income as a result of
depreciation, tax treatment associated with business combinations, and other items. We expect that
our taxable income for the year will also be reduced by available net operating loss carryforwards,
although we may be subject to the alternative minimum tax. We recorded a provision for federal
income taxes of $15,000 during the nine months ended September 30, 2005.
10. COMMERCIAL SUPPORT GRANTS
Commercial support liabilities represent grant funds received from entities supporting educational
activities, such as live events, in which we are the accredited provider of the continuing
educational activity. The funds are unrestricted, and are primarily used to pay for expenses
associated with conducting the educational activities. The grants will be used to pay for live
event expenses during 2005 and 2006.
11. CONTINGENCIES
We are subject to various legal proceedings and claims that may arise in the ordinary course of
business. In the opinion of management, the ultimate liability with respect to those proceedings
and claims will not materially affect our financial position or results of operations.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Special Cautionary Notice Regarding Forward-Looking Statements
This Quarterly Report includes various forward-looking statements that are subject to risks and
uncertainties. Forward-looking statements include without limitation, statements preceded by,
followed by, or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,”
“estimates” or similar expressions. For those statements, HealthStream, Inc. claims the protection
of the safe harbor for forward-looking statements contained in the Private Securities Litigation
Reform Act of 1995.
The following important factors, in addition to those discussed elsewhere in this Quarterly Report,
could affect our future financial results and could cause actual results to differ materially from
those expressed in forward-looking statements contained in this document:
| - | our ability to effectively implement our growth strategy, as well as manage growth of our operations and infrastructure, including effective identification and integration of acquisitions; | ||
| - | variability and length of our sales cycle; | ||
| - | our ability to accurately forecast results of operations due to certain revenue components being subject to significant fluctuations; | ||
| - | an increase in the percentage of our business subject to renewal. We are in discussions regarding a revised long-term agreement with HCA, Inc. (HCA). On October 1, 2005 our agreement with HCA automatically renewed for one year in accordance with the terms of our agreement, but may be terminated by either party upon forty-five days notice to the other party. Our agreement with Tenet Healthcare Corporation (Tenet), which expires at the end of the fourth quarter of 2005, includes a provision to extend the contract through a series of four annual renewable periods. Our agreement automatically renews if Tenet does not provide sixty days notice of their intent not to renew. Tenet did not provide notice of intent to terminate the agreement, therefore the first annual renewal period will commence January 1, 2006. Our agreement with HCA represented approximately 11% of our revenues in the nine months ended September 30, 2005. No assurance can be given that these contracts will be renewed for extended terms, and if renewed, that the terms will be the same as those in the existing agreements; | ||
| - | our ability to adequately address our customers’ needs in products and services; | ||
| - | the pressure on healthcare organizations and pharmaceutical/medical device companies to reduce costs to their customers could result in financial pressures on our customers to cut back on our services; | ||
| - | our ability to maintain our competitive position against current and potential competitors; | ||
| - | our ability to develop enhancements to our existing products and services, achieve widespread acceptance of new features, and keep pace with technological developments; | ||
| - | our ability to obtain proper distribution rights from content partners to support growth in courseware subscriptions; | ||
| - | our ability to achieve profitability on a consistent basis; | ||
| - | fluctuations in quarterly operating results caused by a variety of factors including the timing of sales, subscription revenue recognition and customer subscription renewals; | ||
| - | loss of a significant customer and concentration of a significant portion of our revenue with a relatively small number of customers; | ||
| - | our ability to adequately develop and maintain our network infrastructure, computer systems, software and related security; | ||
| - | the effect of governmental regulation on us, our business partners and our customers, including, without limitation, changes in federal, state and international laws or other regulations regarding education, training and Internet transactions; and | ||
| - | other risk factors detailed in our Annual Report on Form 10-K and other filings with the Securities and Exchange Commission. |
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Overview and Critical Accounting Policies and Estimates
HealthStream was incorporated in 1990 and began marketing its Internet-based solutions in March
1999. The Company focuses on being a provider of training solutions for entities in the healthcare
industry. Revenues from our healthcare organizations business unit (HCO) are derived from the
following categories: provision of services through our Internet-based learning products,
courseware subscriptions, workforce development tools and services, maintenance and support of
installed learning management products and a variety of other online products. On March 28, 2005,
we acquired Data Management & Research, Inc. (DMR), which provides healthcare organizations a wide
range of quality and satisfaction surveys, analyses of survey results, and other research-based
services. Accordingly, DMR is included in our HCO business segment. Revenues from our
pharmaceutical and medical device company business unit (PMD) are derived from live event
development, content development, Web cast events, and other educational and training services,
including HospitalDirectR.
Our condensed consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States (GAAP). These accounting principles require us
to make certain estimates, judgments and assumptions during the preparation of our financial
statements. We believe that the estimates, judgments and assumptions upon which we rely are
reasonable based upon information available to us at the time they are made. These estimates,
judgments and assumptions can affect the reported amounts of assets and liabilities as of the date
of the financial statements, as well as the reported amounts of revenues and expenses during the
periods presented. To the extent there are material differences between these estimates, judgments
or assumptions and actual results, our financial statements will be affected.
The accounting policies and estimates that we believe are the most critical in fully understanding
and evaluating our reported financial results include the following:
| o | Revenue recognition | ||
| o | Product development costs and related capitalization | ||
| o | Goodwill, intangibles, and other long-lived assets | ||
| o | Allowance for doubtful accounts |
In many cases, the accounting treatment of a particular transaction is specifically dictated by
GAAP and does not require management’s judgment in its application. There are also areas in which
management’s judgment in selecting among available alternatives would not produce a materially
different result. See Notes to Consolidated Financial Statements in our Annual Report on Form 10-K
for the year ended December 31, 2004 filed with the Securities and Exchange Commission, which
contains additional information regarding our accounting policies and other disclosures required by
GAAP. There have been no changes in our critical accounting policies and estimates from those
reported in our Annual Report on Form 10-K for the year ended December 31, 2004.
Acquisition
On March 28, 2005, the Company acquired all of the stock of DMR for approximately $10.7 million,
consisting of $9.1 million in cash and 479,234 shares of our common stock. Of the common stock
portion, 319,489 shares were deposited in an escrow account to be held for eighteen months from the
acquisition date, subject to any claims for indemnification pursuant to the stock purchase
agreement. DMR provides healthcare organizations a wide range of quality and satisfaction surveys,
data analyses of survey results, and other research-based measurement tools.
Revenues and Expense Components
The following descriptions of the components of revenues and expenses apply to the comparison of
results of operations.
Revenues. Revenues for our HCO business unit currently consist of the provision of services through
our Internet-based HealthStream Learning CenterTM (HLC), authoring tools, maintenance
and support services for our installed learning management products, maintenance of content,
competency tools, courseware subscriptions (add-on courseware), as well as revenues from
survey-related services. Revenues for our PMD business unit consist of live event development,
online training and content development, online sales training courses, HospitalDirectR,
live educational activities for nurses and technicians conducted within healthcare organizations,
and continuing education activities at association meetings.
Cost of Revenues. Cost of revenues consists primarily of salaries and employee benefits, employee
travel and lodging, materials, contract labor, hosting costs, and other direct expenses associated
with revenues as well as royalties paid by us to content providers based on a percentage of
revenues. Personnel costs within cost of revenues are associated with individuals that provide
services, handle customer support calls or inquiries, manage our web sites, content delivery and
survey services, coordinate content maintenance services, and provide training or implementation
services.
Product Development. Product development expenses consist primarily of salaries and employee
benefits, content acquisition costs before technological feasibility is achieved, costs associated
with the development of content and expenditures associated with maintaining,
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developing and
operating our training delivery and administration platforms. In addition, product development
expenses are associated with the development of feature enhancements and new products to the extent
that such enhancements don’t expand the anticipated revenues associated with the base product or
further extend the life of such product. In accordance with our policy, we capitalize the cost of
features and content developed by third parties where the life expectancy is greater than one year
and the anticipated cash flows from such content are expected to exceed their respective costs.
Personnel costs within product development include our systems team, product managers, and other
personnel associated with content and product development.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries,
commissions and employee benefits, employee travel and lodging, advertising, promotions, and
related marketing costs. Annually, we host a national users’ group in Nashville known as The
Summit. Personnel costs within sales and marketing include our sales and marketing team as well as
our account management group. Our account management personnel are involved with the contract
renewal process for existing hospital customers, as well as working to ensure our products and
services are fully utilized by our customers.
Depreciation and Amortization. Depreciation and amortization consist of fixed asset depreciation,
amortization of intangibles considered to have finite lives, amortization of content or license
fees, software feature enhancements, and prepaid compensation.
Other General and Administrative Expenses. Other general and administrative expenses consist
primarily of salaries and employee benefits, employee travel and lodging, facility costs, office
expenses, fees for professional services, and other operational expenses. Personnel costs within
general and administrative expenses include individuals associated with normal corporate functions
(accounting, legal, human resources, administrative and executive management) as well as
accreditation professionals.
Other Income/Expense. The primary component of other income is interest income related to interest
earned on cash, cash equivalents and investments in marketable securities. The primary component of
other expense is interest expense related to capital leases and other obligations.
Results of Operations
During the three months ended September 30, 2005, revenues increased $1.8 million, or 35.7%, to
$6.8 million from $5.0 million for the three months ended September 30, 2004. Revenue increases of
$1.3 million resulted from the acquisition of DMR, while revenues from our flagship product, the
HealthStream Learning CenterTM, increased $410,000, or 15% over the prior year quarter.
Growth in add-on courseware revenues also contributed $250,000 of the increase. Our fully
implemented subscriber base was approximately 1,130,000 at September 30, 2005. Revenues from our
PMD unit declined by approximately $100,000 from the prior year quarter, while the mix of revenues
changed. Revenues from live events increased approximately $200,000, but were partially offset by
declines in project-based content development services of $300,000.
Gross margins (which we define as revenues less cost of revenues divided by revenues) for the third
quarter 2005 were 65.0%, up slightly from 64.7% for the third quarter
of 2004. Our net income was
approximately $554,000 for the third quarter of 2005, compared to a net loss of $177,000 for the
third quarter of 2004. This improvement is primarily related to the increase in revenues and
related gross margins. We experienced increases in product development, sales, depreciation,
amortization, and other general and administrative expenses primarily as a result of the DMR
acquisition. Net income per share improved to $0.03 (basic) and $0.02 (diluted) for the
three months ended September 30, 2005 from a loss per share of $(0.01) (basic and diluted) for the
three months ended September 30, 2004.
Three Months Ended September 30, 2005 Compared to Three Months Ended September 30, 2004
Revenues. Revenues increased approximately $1.8 million, or 35.7%, to $6.8 million for the three
months ended September 30, 2005 from $5.0 million for the three months ended September 30, 2004.
Revenues for the third quarter of 2005 consisted of $5.5 million
for HCO and $1.3 million for PMD. In the third quarter of 2004, revenues
consisted of $3.6 million for HCO and $1.4 million for PMD. The increase in HCO revenues related
primarily to revenues from the acquisition of DMR of $1.3 million, $410,000 from our Internet-based
HLC subscriber base, and $250,000 from growth in add-on courseware revenues. Our subscriber base
increased approximately 14%, to approximately 1,130,000 fully implemented subscribers at September
30, 2005 up from approximately 987,000 fully implemented subscribers at September 30, 2004.
Revenues from our Internet-based subscription products represented approximately 60% of revenues
for the three months ended September 30, 2005 compared to 68% of revenues for the three months
ended September 30, 2004. This percentage decrease resulted from the addition of DMR’s revenues,
which are not included within our Internet-based product offering. PMD revenues declined
approximately $100,000 compared to the prior year quarter. Live event revenues increased
approximately $200,000, but were offset by a $300,000 decline in our project-based content
development services. The decline in content development services is a result of transitioning our
sales efforts to subscription based products and other online delivery methodologies.
We expect continued revenue growth during the fourth quarter for HCO, compared to both the fourth
quarter 2004 and third quarter 2005, primarily associated with DMR survey revenues, our
Internet-based subscription products, and content maintenance services. Revenues associated with
DMR are seasonal, with the fourth and first quarters being the strongest. During the fourth
quarter, we expect the percentage of total revenues from our Internet-based subscription products
to remain comparable to the third quarter. We expect fourth
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quarter revenues for PMD to experience
modest increases from the levels experienced in the third quarter, and we expect the mix of
revenues for PMD to remain comparable to the third quarter.
Cost of Revenues. Cost of revenues increased approximately $616,000, or 34.7%, to $2.4 million for
the three months ended September 30, 2005 from $1.8 million for the three months ended September
30, 2004. Cost of revenues as a percentage of revenues decreased to 35.0% of revenues for the three
months ended September 30, 2005 from 35.3% of revenues for the three months ended September 30,
2004. The overall increase in cost of revenues resulted primarily from additional costs associated
with DMR, increases in personnel travel and increased royalties paid by us associated with the
increase in add-on courseware revenues.
Cost of
revenues for HCO increased approximately $720,000 to $1.5 million for
the three months ended September 30, 2005 from $745,000 for the three
months ended September 30, 2004. Cost of revenues for HCO approximated 26.3% and 20.4% of HCO
revenues for the three months ended September 30, 2005 and 2004, respectively. Cost of revenues for
HCO increased due to additional costs associated with DMR, increases in personnel expenses and
related travel, increased contract labor associated with content maintenance services, as well as
an increase in the royalties paid by us to content partners. Cost of revenues for PMD declined
approximately $100,000 as compared to the prior year quarter and approximated 60.9% and 63.7% of
PMD revenues for the three months ended September 30, 2005 and 2004, respectively. Cost of
revenues for PMD decreased as a result of lower personnel expenses and lower direct costs
associated with the declines in project-based content development revenues. We expect
quarter-to-quarter fluctuations in cost of revenues for PMD due to the seasonality in live event
and association activities and the variability related to our project-based content development
services.
Gross Margin. Gross margin (which we define as revenues less cost of revenues divided by revenues)
was 65.0% for the three months ended September 30, 2005 compared to 64.7% for the three months
ended September 30, 2004. Gross margins for HCO were 73.7% and 79.6% for the three months ended
September 30, 2005 and 2004, respectively. The decline in gross
margins for HCO is a result of lower margins associated with DMR. Gross margins for PMD were 39.1% and 36.3% for the
three months ended September 30, 2005 and 2004, respectively.
Product development. Product development expenses increased approximately $61,000, or 9.2%, to
$720,000 for the three months ended September 30, 2005 from $659,000 for the three months ended
September 30, 2004. This increase resulted from personnel expenses associated with DMR. Product
development expenses as a percentage of revenues decreased to 10.5% of revenues for the three
months ended September 30, 2005 from 13.1% for the three months ended September 30, 2004. The
decrease in the percentage of revenues is a result of the increases in revenues.
Product development expenses for HCO increased modestly over the prior year quarter and
approximated 10.2% and 14.6% of HCO revenues for the three months ended September 30, 2005 and
2004, respectively. Product development expenses for PMD were comparable to the prior year period
and approximated 6.8% and 6.6% of PMD revenues for the three months ended September 30, 2005 and
2004, respectively. The unallocated corporate portion of our product development expenses increased
modestly over the prior year period.
Sales and Marketing. Sales and marketing expenses, including personnel costs, increased
approximately $239,000, or 21.7%, to $1.3 million for the three months ended September 30, 2005 up
from $1.1 million for the three months ended September 30, 2004. Sales and marketing expenses
approximated 19.6% and 21.8% of revenues for the three months ended September 30, 2005 and 2004,
respectively. Sales and marketing expenses for HCO increased approximately $75,000 and approximated
16.6% and 23.2% of HCO revenues for the three months ended September 30, 2005 and 2004,
respectively. HCO experienced increases in marketing expenses and
expenses associated with DMR, which
were partially offset by lower commissions. Sales and marketing expenses for PMD increased
approximately $167,000, and approximated 29.2% and 14.9% of PMD revenues for the three months ended
September 30, 2005 and 2004, respectively. The increase for PMD is associated with increased sales
personnel and commissions. The increase in commissions for PMD resulted from increases in sales
order value during the current quarter compared to the prior year quarter.
Depreciation and Amortization. Depreciation and amortization increased approximately $116,000, or
21.6%, to $652,000 for the three months ended September 30, 2005 from $537,000 for the three months
ended September 30, 2004. The increase is associated with amortization of DMR intangible assets,
depreciation of property and equipment, and amortization of capitalized content and feature
enhancements.
Other General and Administrative. Other general and administrative expenses increased approximately
$42,000, or 3.5%, and approximated $1.2 million for both the three months ended September 30, 2005
and 2004, respectively. The increase is associated with DMR personnel and office expenses. Other
general and administrative expenses as a percentage of revenues decreased to 18.2% for the three
months ended September 30, 2005 from 23.9% for the three months ended September 30, 2004. The
decrease in the percentage of revenues is a result of the increases in revenues.
Other Income/Expense. Other income/expense increased approximately $7,000, or 10.2%, to $72,000 for
the three months ended September 30, 2005 from $65,000 for the three months ended September 30,
2004. The increase resulted from an increase in interest income on investments in marketable
securities.
Net Income (Loss). Net income was $554,000 for the three months ended September 30, 2005 compared
to a net loss of $177,000 for the three months ended September 30, 2004. This improvement is a
result of the factors mentioned above.
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Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004
Revenues. Revenues increased approximately $4.7 million, or 32.0%, to $19.3 million for the nine
months ended September 30, 2005 from $14.6 million for the nine months ended September 30, 2004.
Revenues for the first nine months of 2005 consisted of
$14.8 million for HCO and $4.5 million for PMD. In the
first nine months of 2004, revenues
consisted of $10.1 million for HCO and $4.5 million for PMD. The increase in HCO revenues related
primarily to the DMR acquisition of $2.6 million, growth in revenues from our Internet-based HLC
subscriber base of $1.6 million, $678,000 from growth in add-on courseware revenues, and $140,000
from content maintenance services. These HCO revenue increases were partially offset by declines in
revenues from maintenance and support fees associated with our installed learning management
products of $307,000. PMD revenues were comparable to the prior year period, although we
experienced a change in revenue mix. Revenues from live events and online training content
increased $287,000 and $240,000, respectively. These revenue increases were offset by a decline in
project-based content development services of $450,000 and other educational services of $161,000.
These declines are a result of transitioning our sales efforts to subscription based products and
other online delivery methodologies. On a pro forma basis, taking into consideration the effect of
the DMR acquisition as if the acquisition occurred on January 1, 2004, pro forma revenues for the
nine months ended September 30, 2005 would have been $20.7 million compared to $18.1 million for
the nine months ended September 30, 2004.
Cost of Revenues. Cost of revenues increased approximately $1.5 million, or 27.1%, to $6.9 million
for the nine months ended September 30, 2005 from $5.4 million for the nine months ended September
30, 2004. Cost of revenues as a percentage of revenues decreased to 35.6% of revenues for the nine
months ended September 30, 2005 from 37.0% of revenues for the nine months ended September 30,
2004. The increase in cost of revenues resulted from the incremental expenses associated with DMR,
increases in personnel expenses and royalties paid by us to content partners, and was partially
offset by declines in contract labor and materials associated with declines in content development
revenues.
Cost of
revenues for HCO increased approximately $1.8 million to $3.8
million for the nine months ended September 30, 2005 from $2.0
million for the nine months ended September 30, 2004. Cost of
revenues for HCO approximated 26.0% and 20.1% of
HCO revenues for the nine months ended September 30, 2005 and 2004, respectively. Cost of revenues
increases for HCO resulted from the additional expenses associated with DMR, an increase in
royalties paid by us to content partners, as well as increased personnel expenses and contract
labor associated with content maintenance. Cost of revenues for PMD declined $358,000 as compared
to the prior year period and approximated 57.2% and 65.0% of PMD revenues for the nine months ended
September 30, 2005 and 2004, respectively. Cost of revenues for PMD decreased as a result of lower
personnel expenses and lower direct costs associated with the declines in project-based content
development revenues, and was partially offset by royalties paid by us to content partners. We
expect quarter-to-quarter fluctuations in cost of revenues for PMD due to the seasonality in live
event and association activities and the variability related to our project-based content
development services.
Gross Margin. Gross margin (which we define as revenues less cost of revenues divided by revenues)
improved to approximately 64.4% for the nine months ended September 30, 2005 from 63.0% for the
nine months ended September 30, 2004. The improvement is a result of the change in revenue mix and
related cost of revenues discussed above. Gross margins for HCO were 74.0% and 79.9% for the nine
months ended September 30, 2005 and 2004, respectively. The decline for HCO is a result of lower
margins associated with DMR. Gross margins for PMD were 42.8% and 35.0% for the nine months ended
September 30, 2005 and 2004, respectively. The improvement for PMD is a result of lower revenues
and related cost of goods sold from content development services, which have lower margins.
Product development. Product development expenses increased approximately $159,000, or 8.2%, to
$2.1 million for the nine months ended September 30, 2005 from $1.9 million for the nine months
ended September 30, 2004. This increase is primarily related to additional personnel expenses
associated with the DMR acquisition. Product development expenses as a percentage of revenues
decreased to 10.9% of revenues for the nine months ended September 30, 2005 from 13.3% for the nine
months ended September 30, 2004. The decrease in the percentage
of revenues is a result of the increases in revenues.
Product development expenses for HCO increased approximately $77,000 as compared to the prior year
period and approximated 11.0% and 15.3% of HCO revenues for the nine months ended September 30,
2005 and 2004, respectively. Product development expenses for PMD were comparable between periods
and approximated 6.3% and 6.4% of PMD revenues for the nine months ended September 30, 2005 and
2004, respectively. The unallocated corporate portion of our product development expenses increased
approximately $87,000.
Sales and Marketing. Sales and marketing expenses, including personnel costs, increased
approximately $669,000, or 19.3%, to $4.1 million for the nine months ended September 30, 2005 from
$3.5 million for the nine months ended September 30, 2004. Sales and
marketing expenses approximated 21.3% and 23.6% of revenues for the nine months ended September 30,
2005 and 2004, respectively. Sales and marketing expenses for HCO increased approximately $348,000
and approximated 19.8% and 25.5% of HCO revenues for the nine months ended September 30, 2005 and
2004, respectively. HCO increases were a result of the DMR acquisition and increased spending
associated with The Summit. Sales and marketing expenses for PMD increased approximately $316,000
and approximated 22.9% and 15.9% of PMD revenues for the nine months ended September 30, 2005 and
2004, respectively. The increase is associated with increased personnel expenses and commissions.
Depreciation and Amortization. Depreciation and amortization increased approximately $502,000, or
32.8%, to $2.0 million for the nine months ended September 30, 2005 from $1.5 million for the nine
months ended September 30, 2004. The increase is associated with
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depreciation of property and
equipment, amortization of DMR intangible assets, and amortization of capitalized content and
feature enhancements.
Other General and Administrative. Other general and administrative expenses increased approximately
$120,000, or 3.4%, to $3.7 million for the nine months ended September 30, 2005 from $3.6 million
for the nine months ended September 30, 2004. The increase is primarily associated with DMR
personnel and office expenses. Other general and administrative expenses as a percentage of
revenues decreased to 19.1% for the nine months ended September 30, 2005 from 24.4% for the nine
months ended September 30, 2004. The decrease in the percentage
of revenues is a result of the increases in revenues.
Other Income/Expense. Other income/expense increased approximately $78,000, or 49.1%, to $238,000
for the nine months ended September 30, 2005 from $160,000 for the nine months ended September 30,
2004. The increase resulted from an increase in interest income on investments in marketable
securities.
Net Income (Loss). Net income was $721,000 for the nine months ended September 30, 2005 compared to
a net loss of $1.1 million for the nine months ended September 30, 2004. This improvement is a
result of the factors mentioned above. On a pro forma basis, as if the DMR acquisition occurred on
January 1, 2004, pro forma net income would have been $1.2 million for the nine months ended
September 30, 2005 compared to a pro forma net loss of $347,000 for the nine months ended September
30, 2004.
Liquidity and Capital Resources
Since our inception, we have financed our operations largely through proceeds from our initial
public offering, private placements of equity securities, loans from related parties and, to an
increasing extent, from revenues generated from the sale of our products and services.
Net cash provided by operating activities was approximately $2.7 million during the nine months
ended September 30, 2005 compared to $59,000 during the nine months ended September 30, 2004. The
increase over the prior year was primarily related to the improvement from a net loss in 2004 of
$1.1 million to net income of $721,000 in 2005, in addition to cash receipts from commercial
support grants, a decline in accounts receivable (net of acquired balances from DMR), and an
increase in accounts payable. These cash increases were partially offset by the expenditures
associated with the development of content and other prepaid assets, increases in unbilled
receivables, and payments related to accrued liabilities. Days sales outstanding, or the number of
days it takes to collect accounts receivable, increased compared to the prior year, approximating
60 days for the nine months ended September 30, 2005 compared to 57 days for the nine months ended
September 30, 2004. The increase in days sales outstanding is a result of slower collections during
the third quarter of 2005 from certain PMD customers. The Company calculates days sales outstanding
by dividing the accounts receivable balance (excluding unbilled and other receivables) by average
daily revenues for the period. During the nine months ended September 30, 2004, the primary sources
of cash resulted from reduced net loss, cash receipts from commercial support grants and increases
in deferred revenue and accrued liabilities. These cash increases were partially offset by an
increase in accounts receivable and the purchases of content and other prepaid assets.
Net cash provided by investing activities was approximately $117,000 during the nine months ended
September 30, 2005 compared to $672,000 used in investing activities during the nine months ended
September 30, 2004. The primary uses of cash during the nine months ended September 30, 2005
related to cash paid in connection with the acquisition of DMR of $9.4 million, $5.8 million in
purchases of investments in marketable securities and $657,000 of property and equipment
acquisitions. These uses of cash were offset by $15.9 million of proceeds from the sale and
maturity of investments in marketable securities. Property and equipment acquisitions related to
hardware and software to support the growth of our product infrastructure, primarily our
Internet-based learning platform. During the nine months ended September 30, 2004, we received
proceeds of $15.9 million from the maturity of investments in marketable securities and $233,000 in
proceeds from collection of a note receivable — related party, which was offset by $15.5 million in
purchases of investments in marketable securities and $1.4 million in property and equipment
acquisitions.
Cash provided by financing activities was approximately $747,000 for the nine months ended
September 30, 2005 compared to $164,000 during the nine months ended September 30, 2004. Cash
provided by financing activities during 2005 consisted of proceeds from the exercise of stock
options of $646,000 and $159,000 associated with the issuance of
common stock pursuant to our Employee Stock
Purchase Plan,
and was partially offset by payments under capital lease obligations of $59,000. Cash provided by
financing activities during the nine months ended September 30, 2004 consisted of proceeds from the
exercise of stock options of $128,000 and $77,000 associated with the
issuance of common stock pursuant to
our Employee Stock Purchase Plan, and was partially offset by payments under capital lease
obligations of $41,000.
As of September 30, 2005, our primary source of liquidity was $9.9 million of cash and cash
equivalents, restricted cash, investments in marketable securities, and interest receivable. We
have no bank credit facility or other indebtedness other than capital lease obligations. As of
October 31, 2005, we had cash and cash equivalents, restricted cash, investments in marketable
securities, and interest receivable of approximately $10.3 million.
We believe that our existing cash and cash equivalents, restricted cash, and related interest
receivable will be sufficient to meet anticipated cash needs for working capital, new product
development and capital expenditures for at least the next 12 months. Failure to generate
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sufficient cash flow from operations or raise additional capital when required during or following
that period in sufficient amounts and on terms acceptable to us could harm our business, financial
condition and results of operations. Our growth strategy may also include acquiring companies that
complement our products and services. We anticipate that these acquisitions, if any, will be
effected through a combination of stock and cash consideration. The issuance of stock would have a
dilutive effect and could adversely affect our stock price.
Commitments and Contingencies
We expect that content and capital expenditures will range between $0.5 and $1.0 million for the
remainder of 2005.
Our strategic alliances have typically provided for payments to content and distribution partners
and development partners based on revenues, and we expect to continue similar arrangements in the
future. We have capital lease obligations and operating lease commitments for our operating
facilities in Nashville, TN, Franklin, TN, and Denver, CO, and a closed facility in Dallas, TX. We
entered into capital lease arrangements during the three months ended September 30, 2005 that
include future payments of approximately $17,000 over three years.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk from changes in interest rates. We do not have any commodity price
risk. As of September 30, 2005, we had no outstanding indebtedness other than approximately
$321,000 of capital lease obligations. Accordingly, we are not exposed to significant market risk.
We are exposed to market risk with respect to the cash and cash equivalents and marketable
securities in which we invest. At October 31, 2005, we had approximately $10.3 million of cash and
cash equivalents, restricted cash, investments in marketable securities, and accrued interest that
was invested in a combination of short term investments. Current investment rates of return
approximate 3-4%. Assuming a 3.5% rate of return on $10.3 million of investments, a hypothetical
10% decrease in interest rates would decrease interest income and decrease net income on an
annualized basis by approximately $36,000.
We manage our investment risk by investing in corporate debt securities, foreign corporate debt and
secured corporate debt securities with minimum acceptable credit ratings. For certificates of
deposit and corporate obligations, ratings must be A2/A or better; A1/P1 or better for commercial
paper; A2/A or better for taxable or tax advantaged auction rate securities and AAA or better for
tax free auction rate securities. We also require that all securities must mature within 24 months
from the original settlement date, the average portfolio shall not exceed 18 months, and the
greater of 10% or $5.0 million shall mature within 90 days. Further, our investment policy also
limits concentration exposure and other potential risk areas.
The above market risk discussion and the estimated amounts presented are forward-looking statements
of market risk assuming the occurrence of certain adverse market conditions. Actual results in the
future may differ materially from those projected as a result of actual developments in the market.
Item 4. Controls and Procedures
Evaluation of Controls and Procedures
HealthStream’s chief executive officer and principal financial officer have reviewed and evaluated
the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”))
as of the end of the period covered by this quarterly report. Based on that evaluation, the chief
executive officer and principal financial officer have concluded that HealthStream’s disclosure
controls and procedures effectively and timely provide them with material information relating to
HealthStream required to be disclosed in the reports it files or submits under the Exchange Act.
Changes in Internal Control Over Financial Reporting
There was no change in HealthStream’s internal control over financial reporting that occurred
during the period covered by this quarterly report that has materially affected, or that is
reasonably likely to materially affect, HealthStream’s internal control over financial reporting.
PART II — OTHER INFORMATION
Item 6. Exhibits
Exhibits
31.1
— Certification of the Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2
— Certification of the Principal Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1
— Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2
— Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
| HEALTHSTREAM, INC. | ||||
| By: | /s/ Arthur E. Newman | |||
| Arthur E. Newman | ||||
| Chief Financial Officer | ||||
| November 14, 2005 | ||||
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HEALTHSTREAM, INC.
EXHIBIT INDEX
| 31.1 | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 31.2 | Certification of the Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
19
Exhibit 31.1 I, Robert A. Frist, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of HealthStream, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2005 /s/ ROBERT A. FRIST, JR. -------------------------- Robert A. Frist, Jr. Chief Executive Officer
Exhibit 31.2 I, Arthur E. Newman, certify that: 1. I have reviewed this quarterly report on Form 10-Q of HealthStream, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2005 /s/ ARTHUR E. NEWMAN -------------------------- Arthur E. Newman Chief Financial Officer
Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of HealthStream, Inc. (the "Company") on Form 10-Q for the period ending September 30, 2005, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Robert A. Frist, Jr., Chief Executive Officer of the Company certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ ROBERT A. FRIST, JR. - ------------------------------ Robert A. Frist, Jr. Chief Executive Officer November 14, 2005
Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of HealthStream, Inc. (the "Company") on Form 10-Q for the period ending September 30, 2005, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Arthur E. Newman, Chief Financial Officer of the Company certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ ARTHUR E. NEWMAN - ----------------------------- Arthur E. Newman Chief Financial Officer November 14, 2005