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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
Commission File Number 000-27701
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 | 37203 | |
| Nashville, Tennessee | (Zip Code) | |
| (Address of principal executive offices) |
(615) 301-3100
(Registrant’s telephone number, including area code)
Securities Registered Pursuant To Section 12(b) Of The Act:
(Registrant’s telephone number, including area code)
Securities Registered Pursuant To Section 12(b) Of The Act:
| Title of each class | Name of each Exchange on which registered | |
| Common Stock, No Par Value | NASDAQ Global Stock Market |
Securities Registered Pursuant To Section 12(g) Of The Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of
15(d) of the Act. Yes o No þ
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting
company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No þ
The aggregate market value of the Common Stock issued and outstanding and held by non-affiliates of
the Registrant, based upon the closing sales price for the Common Stock on the NASDAQ Global Stock
Market on June 29, 2007 was $56,927,415. All executive officers and directors of the registrant
have been deemed, solely for the purpose of the foregoing calculation, to be “affiliates” of the
registrant.
As of March 25, 2008, there were 22,331,526 shares of the Registrant’s common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive Proxy Statement for its 2008 Annual Meeting of Shareholders
are incorporated by reference into Part III hereof.
HEALTHSTREAM, INC.
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ANNUAL REPORT ON FORM 10-K
ANNUAL REPORT ON FORM 10-K
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PART I
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934. Such forward-looking statements include, among others,
those statements including the words “expects,” “anticipates,” “intends,” “believes,” “may,”
“will,” “should,” “continue” and similar language or the negative of such terms or other comparable
terminology. Although we believe that the expectations reflected in the forward-looking statements
are reasonable, HealthStream’s actual results may differ significantly from those projected in the
forward-looking statements. Factors that might cause or contribute to such differences include, but
are not limited to, those discussed in the section “Risk Factors” in Item 1A of this Annual Report
on Form 10-K and elsewhere in this document. In addition, factors that we are not currently aware
of could harm our future operating results. You should carefully review the risks described in
other documents HealthStream files from time to time with the Securities and Exchange Commission.
You are cautioned not to place undue reliance on forward-looking statements, which speak only as of
the date of this Annual Report on Form 10-K. HealthStream undertakes no obligation to publicly
release any revisions to the forward-looking statements or reflect events or circumstances after
the date of this document.
Item 1. Business
OVERVIEW AND HISTORY
HealthStream, Inc. (HealthStream or the Company) provides Internet-based learning and research
solutions to meet the training, information, and education needs of the healthcare industry. Our
learning products are used by healthcare organizations to meet a broad range of their training and
assessment needs, while our research products provide our customers information about patients’
experiences, workforce challenges, physician relations, and community perceptions of their
services. HealthStream’s customers include healthcare organizations, pharmaceutical and medical
device companies, and other members of the healthcare industry. Our customer base across both
learning and research business units includes over 2,200 healthcare organizations (predominately
acute-care facilities) throughout the United States.
The Company’s flagship learning product is the HealthStream Learning Center® (HLC), our
proprietary, Internet-based learning platform, which at December 31, 2007 had approximately
1,705,000 contracted hospital-based subscribers. We deliver educational and training courseware to
our customers through the HLC platform. We also provide to and on behalf of pharmaceutical and
medical device companies, development and delivery of education initiatives to reach hospital-based
healthcare professionals, including physicians and industry sales representatives. Our research
products were added as a result of our acquisitions of Data Management & Research, Inc. (DMR) in
March 2005 and The Jackson Organization, Research Consultants, Inc. (TJO) in March 2007, which
expanded our service offerings to include quality and satisfaction surveys, data analyses of survey
results, and other research-based measurement tools focused on patients, physicians, employees, and
members of the community.
Headquartered in Nashville, Tennessee, the Company was incorporated in 1990 and began providing its
Internet-based solutions in 1999 and providing its survey and research solutions in 2005. Including
satellite offices in Laurel, Maryland, Franklin, Tennessee, and Denver, Colorado, HealthStream had
approximately 280 full-time and 140 part-time employees as of December 31, 2007. From an initial
focus on technology-based training, HealthStream has evolved to provide full-service delivery of education,
training, research, and information to healthcare organizations.
INDUSTRY BACKGROUND
According to the deputy director of the National Health Statistics Group at the Centers for
Medicare and Medicaid Services (CMS), spending in the healthcare industry reached approximately
$2.1 trillion in 2006, or 16.0 percent of the gross domestic product. Hospital care expenditures
accounted for approximately 31 percent of the $2.1 trillion industry. Approximately 10.4 million
professionals are employed in the healthcare segment of the domestic economy, with approximately
5.0 million employed in hospitals, our target market for the HealthStream Learning Center,
HealthStreamDirect™, and HealthStream’s survey and research products.
All of the five million hospital-based healthcare professionals that work in the nation’s
approximately 5,000 acute-care hospitals are required by federal mandates and accrediting bodies to
complete training in a number of areas. This training includes safety training mandated by both the
Occupational Safety and Health Administration (OSHA) and The Joint Commission, as well as training
on patient information confidentiality required under the Health Insurance Portability and
Accountability Act (HIPAA).
In hospitals, staffing issues and personnel shortages have also contributed to the need for
facility based workforce development as well as additional competency based training. The 2007
American Hospital Association (AHA) Survey of Hospital Leaders reported that there were
approximately 116,000 vacancies for registered nurses (RNs) in the nation’s hospitals as of
December 2006. Moreover, approximately 44% of hospitals indicated that recruitment of RNs has grown
more difficult in the last year according to the same report. It is estimated that the U.S.
shortage of RNs will increase to 340,000 by the year 2020 and will increase at three times the
current rate over the next 13 years (Health Affairs, January/February, 2007). We believe
that offering training and education for hospital personnel is increasingly being utilized as a
retention and recruitment incentive.
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Many healthcare professionals use continuing education to keep abreast of the latest developments
and meet licensing, certification, and credentialing requirements. Continuing education
requirements include continuing education for nurses, emergency medical services personnel, first
responder personnel, radiologic personnel, and physicians. Pharmaceutical and medical device
companies must also provide their medical industry sales representatives with training mandated for
the healthcare industry and training for new products. They also provide support for education and
training for those audiences that use their products in healthcare organizations.
A large portion of the nation’s hospitals utilize research and survey tools to gain valuable
insight about patients’ experiences, to assess workforce competency and engagement, to determine
the status of physician relations and to measure the perceptions about the hospitals’ in the
communities they serve. Industry-wide, interest is increasing in research, due, in part, to the
CAHPS® (Consumer Assessment of Healthcare Providers and Systems) Hospital Survey
launched by CMS in partnership with the Agency for Healthcare Research and Quality (AHRQ).
According to the Deficit Reduction Act of 2005, hospitals must submit data for certain required
quality measures—which for inpatients includes the CAHPS® Hospital Survey—in order to receive the full
market basket increase to their reimbursement payment rates from CMS. Hospitals
that fail to submit this survey data will incur a reduction of two percentage points in
the inpatient market basket update amount for the following federal fiscal year. We have been designated as a certified vendor and will continue to offer
CAHPS® Hospital Survey services.
Finally, the hospital industry continues to operate under intense pressure to reduce costs as a
result of reductions in government reimbursement rates and increased focus on cost containment
consistent with participation of patients in managed care programs. In addition, hospitals, as well
as pharmaceutical and medical device companies, continue to experience rising operating costs,
coupled with increased pressure to measure and report on the outcomes of the dollars spent on
training. Our products and services are designed to meet these needs by reducing healthcare
organizations’ costs of training while improving learning outcomes, enhancing reporting
capabilities, and supporting customers’ business objectives.
HEALTHSTREAM’S SOLUTIONS
HealthStream’s products and services are organized into two segments, 1) HealthStream Learning and
2) HealthStream Research, which collectively help healthcare organizations meet their ongoing
training, education, information, and compliance needs. We believe we are positioned to better
support our healthcare organization customers in their efforts to transform insight into action as
they measure and benchmark key data points for their constituencies and then incorporate the
results into training and improvement through our learning products.
HealthStream Learning
Within HealthStream Learning, we bring training and education content together with administrative
and management tools through our Internet-based platforms, the HealthStream Learning
Center® and a more streamlined version, HealthStream Express™. Our learning management
system supports healthcare administrators in configuring training to meet the precise needs of
different groups of employees, modifying training materials, and documenting that training has been
completed. At December 31, 2007, 1,705,000 healthcare professionals had contracted subscriptions
for our Internet-based HLC services. Pricing for the HLC is subscription based, with fees based on
the number of subscribers, courseware provided, and other factors. We offer training,
implementation, and account management services to facilitate adoption of our platform. Fees for
training are based on the time and efforts of the personnel involved.
Our Internet-based platform and our courseware are hosted in a central data center that allows
authorized subscribers Internet access to our services, thereby eliminating the need for onsite
local implementations of installed learning management products. A significant number of our
customers that historically used our installed learning management products have transitioned to
our Internet-based platform. We no longer sell our installed learning management products, and we
plan to phase out support of these products during 2008.
Along with the Internet-based HLC, we also offer healthcare organizations full-service capabilities
to create online courses by converting their existing course material, self-authoring new materials
through our Authoring Center product, and electively sharing these materials with other
HealthStream customers through a courseware exchange. We also offer Authoring Pro, an upgraded
product which includes an industry leading image library, owned by A.D.A.M., Inc., as an additional
subscription to this product. Pricing for these products is subscription based, with fees based on
the number of subscribers and level of penetration of services.
We expect to launch an updated product in 2008 that will allow us to offer our customers tools to
assess competency and performance. Competency assessment is a requirement of hospitals and
healthcare organizations for maintaining accreditation, based on requirements from The Joint
Commission to evaluate, document, and report performance competencies. We anticipate that our new
product will provide an effective means of determining which competencies are associated with each
position and evaluating and documenting competency assessments. This new product is also intended
to facilitate the development of a custom training program of courses available through the HLC
that uniquely responds to the needs identified for each employee.
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Through HealthStream Direct, we develop, manage, and distribute online, live, and print education
and training activities for provider-based healthcare professionals and physicians, as well as
online education and training activities for sales representatives. Certain of the education
activities we develop and distribute provide continuing education credit for learners completing
them. Pricing for these products varies based on the size, scope, and nature of the project. Most
of these activities are supported by either pharmaceutical or medical device companies.
Our strategy for HealthStream Learning is to continue growing our customer base of approximately
1,705,000 contracted subscribers using the Internet-based HLC, as well as expanding penetration of
additional courseware, tools, and other professional services across our customer base. We will
continue to seek opportunities to leverage this customer base through the deployment of
pharmaceutical and medical device training and education.
HealthStream
Research
HealthStream Research complements HealthStream Learning’s product and service offerings by
providing hospital-based customers with patient, physician, employee, and community surveys, data
analyses of survey results, and other research-based measurement tools. HealthStream Research was
formed after the acquisition of TJO in March 2007, which expanded our customer base and product
strengths. Our services are designed to provide thorough analyses that provide insightful
recommendations for change; to provide benchmarking capability using our comprehensive databases;
and to provide consulting services to identify solutions for our customers based on their survey
results. Clients are able to access and analyze their survey results data through Insights Online,
our secure web-based reporting tool. Our survey and research solutions focus on
providing industry-leading, statistically valid data to assist our customers with their
decision making related to their organization’s performance improvement objectives. In addition to
collecting and reporting data, we provide expert analysis and consulting to help customers
understand their survey results and the underlying impact on their business. It is with this
insight that healthcare organizations are able to develop plans for improved performance that is
able to be delivered through HealthStream’s learning solutions. Pricing for these services is based
on the survey type, delivery method, size of the survey instrument, sample size, frequency of
survey cycles, and other factors.
During the first quarter of 2008, we launched the HCAHPS Preparation and Improvement Library as our
first online courseware designed specifically to address the findings as a result of our patient
survey research. We expect to continue to develop additional online courseware to support
our customers’ improvement initiatives driven by HealthStream Research’s physician survey research
findings as well as additional courseware targeted at patient survey research findings.
Our strategy for HealthStream Research includes continuing to grow our customer base of
approximately 1,100 hospitals, expand the products and services provided to each customer, and
introduce HealthStream Learning solutions to address survey research findings. We will continue to
expand our offering of research and information tools that are aligned with healthcare quality
initiatives and continuous improvement efforts.
BUSINESS COMBINATIONS
We acquired TJO in March 2007. We acquired DMR in March 2005. For additional information regarding
these acquisitions, please see Note 2 of the Consolidated Financial Statements and Item 7,
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” included
elsewhere in this report.
CUSTOMERS
We provide our training, information and education solutions to customers across a broad range of
entities within the healthcare industry, including healthcare organizations (including government
entities) and pharmaceutical and medical device companies. Examples of customers that have
purchased or contracted for products and services from HealthStream include: HCA, Inc., Tenet Healthcare Corporation, Community Health Systems, Inc., Lifepoint
Hospitals, Inc., Ardent Health Services, LLC, Health Management Associates, Inc., and Baxter Healthcare Corporation.
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SALES AND MARKETING
We market our products and services primarily through our direct sales teams, our consultants, and
our account relationship managers who are based at our corporate headquarters in Nashville,
Tennessee and in our satellite offices located in Laurel, Maryland, Franklin, Tennessee and Denver,
Colorado, as well as remote home office sales locations. As of December 31, 2007, our HealthStream
Learning sales and relationship management personnel consisted of 32 employees and our HealthStream
Research sales and consultant personnel consisted of 21 employees. Our geographically dispersed
field sales organization is divided into one team focused on selling our learning products and a
separate sales team focused on selling our research products. In addition to sales professionals,
we also employ strategic account personnel that manage our largest customer relationships as well
as account relationship managers and consultants who work to develop and expand relationships,
including contract renewals.
We conduct a variety of marketing programs to promote our products and services, including product
catalogs, user groups and trade shows, online promotion and demonstrations, telemarketing
campaigns, public relations, distribution of product specific literature, direct mail and
advertising. Annually, we host a national users’ group in Nashville known as “The Summit,” and
during 2007, we hosted our first annual HealthStream Research client conference. We utilize these
client conferences to reach out to existing and potential customers and business partners, provide
training and educational services, and demonstrate our new and existing product offerings. We have
marketing teams that are responsible for these initiatives and for working with, and
supporting, our product managers and sales teams.
OPERATIONS
We believe our ability to establish and maintain long-term customer relationships, adoption of our
products and services, recurring sales, and development and maintenance of new and existing
products are dependent on the strength of our operations, customer service, product development and
maintenance, training, and other support teams. As of December 31, 2007, these personnel consisted
of approximately 78 employees for Learning and approximately 255 employees for Research, of which
140 were employed on a part-time basis. Our Learning operations team consists of personnel
associated with customer support, implementation services, product development and maintenance,
training, and project management. Our Research operations team consists of personnel associated
with phone interviewing, distributing and processing paper-based survey instruments, data analysis
and reporting of survey results, and project management.
TECHNOLOGY MANAGEMENT
Our services are designed to be secure, reliable, and expandable. Our software is a combination of
proprietary and commercially-available software and operating systems. This combination of software
supports acquisition and conversion of content, hosting and management of that content, publication
of our web sites, downloads of courseware, registration, tracking of users, and reporting of
information for both internal and external use. We designed our services to allow each component to
be independently scaled by adding commercially-available hardware and a combination of
commercially-available and proprietary software components.
Our network infrastructure, web sites, and servers that deliver most of our services are hosted by
third party providers. Our primary data center and hosting facility is in Chicago, while a second
data center and hosting facility is located in Nashville (with a separate vendor). Our second
hosting facility has been utilized to support product and platform testing by customers, but we
continue to work to configure this location as a backup facility. Both providers maintain our
equipment in a secure environment, including multiple redundancies in power sources and network
connections. Our providers’ hosting centers are connected to the Internet through multiple,
redundant high-speed fiber optic circuits. Our survey products are hosted on servers located at our
Franklin, Tennessee and Laurel, Maryland offices. Company personnel monitor all servers, networks,
and systems on a continuous basis. Together with our providers, we employ several levels of
enterprise firewall systems to protect our databases, customer information, and courseware library.
Backups of customer data are performed on a daily basis. Data is secured at a remote location on a
weekly basis.
COMPETITION
The healthcare education industry is highly fragmented, varies significantly in delivery methods
(i.e., written materials, live events, satellite broadcasts, video, CD-ROM products and online
products), and is composed of a wide variety of entities competing for customers. The sheer volume
of healthcare information available to satisfy continuing education needs, rapid advances in
medical developments, and the time constraints that healthcare professionals face make it difficult
to quickly and efficiently access the continuing education content most relevant to an individual’s
practice or profession. Historically, healthcare professionals have received continuing education
and training through offline publications, such as medical journals and CD-ROMs, and by attending
conferences and seminars. In addition, other healthcare workers and pharmaceutical and medical
device manufacturers’ sales and internal regulatory personnel usually fulfill their education and
training needs through instructor-led programs from external vendors or internal training
departments. While these approaches satisfy the ongoing education and training requirements, they
are typically costly and inconvenient. In addition, live courses are often limited in the breadth
of offerings and do not provide a method for tracking training completion. The related results of
these traditional methods, both from a business and compliance standpoint, are difficult to track
and measure. While hospitals and
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health systems occasionally survey their patients, physicians and
employees using their own internal resources, the practice is limited since
the do not typically possess valuable comparative benchmarking data which is available from
independent survey research vendors.
In addition to the competing delivery methods described above, we also have direct competitors. A
number of companies offer competitive installed and web based learning management products to the
healthcare industry. We also compete with learning management system providers such as SABA and
SumTotal Systems that provide their services to multiple industries, including healthcare. We also
compete with large medical publishers that have operating units that offer learning management
systems that focus on healthcare, including Cengage Learning’s Net Learning and Reed Elsevier
Group’s MC Strategies. In the survey business, we see competition from large nationally recognized
survey research firms such as Press Ganey Associates, National Research Corporation, Gallup, and
others. Our survey business also experiences direct competition from vendors who provide survey
research services to other industries including Kenexa and Foresight. Finally, recently we have
also seen an increase in a teaming approach between consulting and technology entities to address
larger scale projects.
We believe our learning solutions, which include both products and services that facilitate
training for healthcare professionals, a wide assortment of courseware, a mechanism for measuring
satisfaction or other results, and the ability to provide all our services on a single platform
over the Internet, provide us with a competitive advantage. In our survey research business, we
believe our large proprietary database of physician survey results, technology infrastructure
designed to automate the processing of survey results, proprietary core survey instruments and
action plan development methodology, and our ability to quickly deliver relevant online courseware
targeted at addressing survey related findings provide us with a competitive advantage. We believe
that the principal competitive factors affecting the marketing of information, training and
development services to the healthcare industry include:
| l | features of the HLC product, including reporting, management functionality, ability to manage a variety of events or modalities, courseware assignment, scalability, and the ability to track utilization and results; | ||
| l | scope and variety of Internet-based learning courseware available, including mandated content for OSHA, The Joint Commission, patient safety, and HIPAA requirements, competency-based content, as well as the ability of our customers to create and host their own web-enabled courseware; | ||
| l | scope and quality of professional services offered, including survey execution, implementation, benchmarking, training and the expertise and technical knowledge of the customers’ employees; | ||
| l | competitive pricing, which supports a return on investment when compared to other alternative delivery methods; | ||
| l | customer service and support; | ||
| l | effectiveness of sales and marketing efforts; and | ||
| l | company reputation. |
Collectively, we believe these capabilities provide us with the ability to improve the quality of
healthcare by developing the people who deliver care.
GOVERNMENT REGULATION OF THE INTERNET AND THE HEALTHCARE INDUSTRY
The Internet
The laws and regulations that govern our business change rapidly. The United States government and
the governments of some states and foreign countries have attempted to regulate activities on the
Internet. The following are some of the evolving areas of law that are relevant to our business:
| l | Privacy and Security Law. Current and proposed federal, state and foreign privacy and security regulations and other laws restricting the collection, use, security and disclosure of personal information could limit our ability to collect information or use the information in our databases or derived from other sources to generate revenues. It may be costly to implement security or other measures designed to comply with any new legislation. | ||
| l | Encryption Laws. Many copyright owner associations have lobbied the federal government for laws requiring copyrighted materials transmitted over the Internet to be digitally encrypted in order to track rights and prevent unauthorized use of copyrighted materials. If these laws are adopted, we may incur substantial costs to comply with these requirements or change the way we do business. | ||
| l | Content Regulation. Both foreign and domestic governments have adopted and proposed laws governing the content of material transmitted over the Internet. These include laws relating to obscenity, indecency, libel and defamation. We could be liable if content delivered by us violates these regulations. |
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| l | Information Security Accountability Regulation. A number of bills are pending in Congress that would require disclosure of security breaches involving personal information, and Congress has considered bills that would require companies to engage independent third parties to audit the companies’ computer information security. Many states have enacted legislation requiring disclosure of security breaches involving personal information. For example, California has enacted legislation requiring disclosure of security breaches involving personal information and medical information. We may incur costs to comply with these security requirements. Because many of these laws are new and there is little guidance related to many of these laws, it is difficult to estimate the cost of our compliance with these laws. If the Company is required to make a public announcement regarding a breach of security or if one of the Company’s customers is required to make a public announcement in connection with a breach of security by the Company, the Company’s business could be negatively impacted. | ||
| l | Sales and Use Tax. Through December 31, 2007, we collected sales, use or other taxes on taxable transactions in all states in which we have employees or have a significant level of sales activity. While HealthStream expects that this approach is appropriate, other states or foreign jurisdictions may seek to impose tax collection obligations on companies like us that engage in online commerce. If they do, these obligations could limit the growth of electronic commerce in general and limit our ability to profit from the sale of our services over the Internet. |
Laws and regulations directly applicable to e-commerce and Internet communications are becoming
more prevalent. Congress continues considering laws regarding Internet taxation. The dynamic nature
of this regulatory environment increases the uncertainty regarding the marketplace impact of such
regulation. The enactment of any additional laws or regulations may increase our cost of conducting
business or otherwise harm our business, financial condition and operating results.
Regulation of Education, Training and Other Services for Healthcare Professionals
Occupational Safety and Health Administration (OSHA). OSHA regulations require employers to provide
training to employees to minimize the risk of injury from various potential workplace hazards.
Employers in the healthcare industry are required to provide training with respect to various
topics, including blood borne pathogens exposure control, laboratory safety and tuberculosis
infection control. OSHA regulations require employers to keep records of their employees’
completion of training with respect to these workplace hazards.
The Joint Commission. The Joint Commission mandates that employers in the healthcare industry
provide certain workplace safety and patient interaction training to
employees. Training required by
The Joint Commission may include programs on infection control, patient bill of rights, radiation
safety and incident reporting. Healthcare organizations are required to provide and document
training on these topics to receive The Joint Commission accreditation. In addition, The Joint
Commission imposes continuing education requirements on physicians that relate to each physician’s
specific staff appointments.
Health Insurance Portability and Accountability Act (HIPAA). HIPAA regulations require certain
organizations, including most healthcare providers and health plans, to adopt safeguards regarding
the use and disclosure of health-related information. HIPAA regulations also require organizations
that maintain or transmit health information electronically in connection with certain transactions
to provide reasonable and appropriate safeguards to protect the privacy, integrity and
confidentiality of individually identifiable healthcare information. These healthcare organizations
are required to establish, maintain and provide training with regard to their policies and
procedures for protecting the integrity and confidentiality of individually identifiable healthcare
information. Healthcare organizations are required to document training on these topics to support
their compliance.
Continuing Nursing Education (CNE). State nurse practice laws are usually the source of authority
for establishing the state board of nursing requirements. The state board of nursing establishes
the state’s CNE requirements for professional nurses. CNE credits are provided through accredited
providers that have been approved by the American Nurses Credentialing Center (ANCC) Commission on
Accreditation and/or the state board of nursing. CNE requirements vary widely from state to state.
Twenty-nine states require registered nurses to certify that they have accumulated a minimum number
of CNE credits in order to maintain their licenses. In some states, the CNE requirement only
applies to re-licensure of advance practice nurses, or additional CNEs may be required of this
category of nurses. Required CNE ranges from 12 to 50 credits annually, with reporting generally on
a bi-annual basis. Board certifications (e.g., CNOR – certification of perioperative nursing) also
require CNE credits, with certain percentages required in specific categories based on the
certification type. We are an accredited provider of CNE by the ANCC.
Continuing Medical Education (CME). State licensing boards, professional organizations and
employers require physicians to certify that they have accumulated a minimum number of continuing
medical education hours to maintain their licenses. Generally, each state’s medical practice laws
authorize the state’s board of medicine to establish and track CME requirements. Thirty-five state
medical licensing boards currently have CME requirements, as well as Puerto Rico, Guam, and the
U.S. Virgin Islands. The number of CME hours required by each state ranges from 12 to 50 hours per
year. Other sources of CME requirements are state medical societies and practice specialty boards.
The failure to obtain the requisite amount and type of CME could result in non-renewal of the
physician’s license to practice medicine and/or membership in a medical or practice specialty
society. The American Medical Association’s (AMA) Physician Recognition Award certificate (PRA) is
widely accepted as proof of participation in CME. The AMA classifies continuing medical education
activities as either category 1, which includes formal CME activities, or category 2, which
includes most informal activities. Sponsors want to designate CME activities for AMA PRA category 1
because this has become the benchmark for quality in formally organized educational activities.
Most agencies nationwide that require CME participation specify AMA PRA category 1 credit. Only
institutions and organizations accredited to provide CME can designate an activity for AMA PRA
category 1.
The Accreditation Council
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for Continuing Medical Education (ACCME), is responsible for
awarding accreditation status to state medical societies, medical schools, and other institutions
and organizations that provide CME activities for a national audience of physicians. Only
institutions and organizations are accredited. The ACCME and state medical societies do not
accredit or approve individual activities. State medical societies, operating under the aegis of
the ACCME, accredit institutions and organizations that provide CME activities primarily for
physicians within the state or bordering states. We are an accredited provider of CME by the ACCME.
Consumer Assessment of Healthcare Providers and Systems (CAHPS). CMS has partnered with AHRQ to
develop a standardized survey instrument and data collection methodology for measuring patients’
perspectives on hospital care. The intent of the survey is to produce comparable data on the
patients’ perspectives to allow consumer-based comparisons between hospitals, align incentives to
drive hospitals to improve their quality of care, and increase the transparency of hospital
reporting. According to the Deficit Reduction Act of 2005, hospitals must submit data for certain
required quality measures—which for inpatients includes the CAHPS® Hospital Survey—in order to receive
the full market basket increase to their reimbursement payment rates from CMS. While hospital
participation is voluntary, hospitals that fail to submit this survey data, will incur a reduction of two percentage points in the inpatient market basket update amount for the following federal fiscal year. Through both DMR and TJO,
we have received certified vendor designation, and will continue to offer CAHPS®
Hospital Survey services.
Allied Disciplines. Various allied health professionals are required to obtain continuing education
to maintain their licenses. For example, emergency medical services personnel may be required to
acquire up to 20 continuing education hours per year, all or a portion of which can be fulfilled
online. These requirements vary by state and depend on the classification of the employee.
Other Continuing Education. We are also an accredited provider of continuing education and
continuing pharmacy education by the Association of Surgical Technologists, Inc. (AST) and the
Accreditation Council for Pharmacy Education (ACPE), respectively.
Regulation of Educational Sponsorship and Support
The Office of Inspector General (OIG) issued Compliance Program Guidance for Pharmaceutical Manufacturers in April 2003 and
issued Compliance Program Guidance for the Durable Medical Equipment, Prosthetics, Orthotics, and
Supply Industry in July 1999 (collectively, the Guidelines). These documents include guidelines
related to continuing educational activities supported by pharmaceutical and medical device
companies. The Guidelines already have and may continue to affect the type and extent of commercial
support we receive for our continuing education activities. The trade associations for the
pharmaceutical and medical device industries (PhRMA and AdvaMed, respectively) have also
promulgated their own codes of ethics. The AMA has established its own code of ethics regarding
Gifts to Physician from Industry to provide standards of conduct for the medical profession. The
Company follows the rules and guidelines provided by ACCME, ANCC, and other continuing education
accrediting bodies to ensure that its continuing education programming is free from commercial bias
and consistent with the Guidelines.
During 2006, both the ANCC and ACPE adopted ACCME Standards of Commercial Support which ensures
independence in continuing medical education activities supported by grant funds from industry.
Because of the adoption of the ACCME Standards, a component of the standards limits the individuals
that may deliver educational activities (including clinical education activities and live events).
Further, ACCME, ANCC, and ACPE are currently collaborating to develop a Joint Accreditation for the
Provider of Continuing Education for the Healthcare Team (Joint Accreditation). This will allow an
organization that is seeking accreditation or reaccreditation status with all three accrediting
bodies the ability to complete one self study application although each credentialing body conducts a separate accreditation process. We believe this will also
streamline the reaccreditation timeline for accredited organizations. Until this Joint
Accreditation is completed, we will not be able to analyze the Joint Accreditation’s impact on our
accredited education activities.
The U.S. Food and Drug Administration and the Federal Trade Commission
Current FDA and FTC rules and enforcement actions and regulatory policies or those that the FDA or
the FTC may develop in the future could have a material adverse effect on our ability to provide
existing or future applications or services to our end users or obtain the necessary corporate
sponsorship to do so. The FDA and the FTC regulate the form, content and dissemination of labeling,
advertising and promotional materials, including direct-to-consumer prescription drug and medical
device advertising, prepared by, or for, pharmaceutical, biotechnology or medical device companies.
The FTC regulates over-the-counter drug advertising and, in some cases, medical device advertising.
Generally, regulated companies must limit their advertising and promotional materials to
discussions of the FDA-approved claims and, in limited circumstances, to a limited number of claims
not approved by the FDA. Therefore, any information that promotes the use of pharmaceutical or
medical device products that is presented with our services is subject to the full array of the FDA
and FTC requirements and enforcement actions. We believe that banner advertisements, sponsorship
links and any educational programs that lack independent editorial control that we may present with
our services could be subject to FDA or FTC regulation. While the FDA and the FTC place the
principal burden of compliance with advertising and promotional regulations on the advertiser, if
the FDA or FTC finds that any regulated information presented with our services violates FDA or FTC
regulations, they may take regulatory action against us or the advertiser or sponsor of that
information. In 1996, the FDA announced it would develop a guidance document expressing a broad set
of policies dealing with the promotion of pharmaceutical, biotechnology and medical device products
on the Internet. The FDA has yet to issue that guidance document, and it is not clear when such
document may be released. The FDA guidance document may reflect new
regulatory policies that more tightly regulate the format and content of promotional information on
the Internet.
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Other Government Regulations
The U.S. Securities and Exchange Commission (the SEC) chartered the Advisory Committee on Smaller
Public Companies (the Committee) on March 23, 2005. The charter directed the Committee to assess
the current regulatory system for smaller public companies, including the impact of the
Sarbanes-Oxley Act of 2002, and make recommendations for change. During April 2006, the Committee
issued its final report to the SEC, which included a recommendation to establish a system of scaled
securities regulations for smaller public companies. During December 2007, the SEC issued new rules
for smaller reporting companies, expanding the number of companies that qualify for its scaled
disclosure requirements. The Company continues to monitor these regulations and rulings to ensure
that we appropriately allocate our resources to maintain compliance with all applicable
regulations. Currently, our compliance with Section 404 of the Sarbanes-Oxley Act is applicable for
calendar year 2008, but the SEC has issued a rule proposal to delay the compliance date until 2009
for non-accelerated filers, which would be applicable to us.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
To protect our proprietary rights, we rely generally on copyright, trademark and trade secret laws,
confidentiality agreements and procedures with employees, consultants and other third parties,
agreements with consultants, vendors and customers, and control access to our software,
documentation and other proprietary information. We own Federal trademark and service mark
registrations for the marks “HEALTHSTREAM”, “HOSPITAL
DIRECT”, “OR PROTOCOL”, and “QUALITY CHECK”.
The
courseware that we license to our customers is developed through a combination of license
agreements with publishers or authors, assignments and work-for-hire arrangements with third
parties, and development by employees. We require publishers, authors and other third parties to
represent and warrant that their content does not infringe on or misappropriate any third-party
intellectual property rights, that they have the right to provide their content and have obtained
all third-party consents necessary to do so. Our publishers, authors and other third parties also
agree to indemnify us against certain liability we might sustain due to the content they provide.
If a third party asserts a claim that we have infringed their patents or other intellectual
property, we may be required to redesign our products or enter into royalty or licensing
agreements. In addition, we license technologies from third parties for incorporation into our
services. Royalty and licensing agreements with these third parties may not be available on terms
acceptable to us, if at all. Additionally, the steps we have taken to protect our intellectual
property and proprietary rights may not be adequate. Third parties
may infringe or misappropriate our intellectual property. Competitors may also independently develop technologies that are substantially equivalent
or superior to the technologies we employ in our products or services. If we fail to protect our proprietary
rights adequately, our competitors could offer similar services, potentially significantly harming
our competitive position and decreasing our revenues.
AVAILABLE INFORMATION
The Company files reports with the SEC, including annual reports on Form 10-K, quarterly reports on
Form 10-Q and other reports from time to time. The public may read and copy any materials we file
with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The
public may obtain information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The Company is an electronic filer and the SEC maintains an Internet site at
http://www.sec.gov that contains the reports, proxy and information statements, and other
information filed electronically. Our website address is www.healthstream.com. Please note that our
website address is provided as an inactive textual reference only. We make available free of charge
through our website, the annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after
such material is electronically filed with or furnished to the SEC. The information provided on our
website is not part of this report, and is therefore not incorporated by reference unless such
information is otherwise specifically referenced elsewhere in this report.
OUR EMPLOYEES
As of December 31, 2007, we employed approximately 280 full-time and 140 part-time persons. Our
success will depend in large part upon our ability to attract and retain qualified employees. We
face competition in this regard from other companies, but we believe that we maintain good
relations with our employees. We are not subject to any collective bargaining agreements.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The following is a brief summary of the business experience of each of the executive officers of
the Company. Officers of the Company are elected by the Board of Directors and serve at the
pleasure of the Board of Directors. The following table sets forth certain information regarding
the executive officers of the Company:
| Name | Age | Position | ||||
Robert A. Frist, Jr.
|
40 | Chief Executive Officer, President and Chairman of the Board of Directors | ||||
Arthur E. Newman
|
59 | Chief Financial Officer and Executive Vice President | ||||
J. Edward Pearson
|
45 | Senior Vice President and President of HealthStream Research™ | ||||
Kevin P. O’Hara
|
38 | Senior Vice President, General Counsel, and Compliance Officer | ||||
Robert A. Frist, Jr., one of our co-founders, has served as our chief executive officer and
chairman of the board of directors since 1990 and president since 2001. Mr. Frist graduated with a
Bachelor of Science in business with concentrations in finance, economics and marketing from
Trinity University.
Arthur E. Newman became our interim chief financial officer upon the departure of Susan A. Brownie
in August 2007. Mr. Newman previously served as our chief financial officer and senior vice
president since joining the Company in January 2000. From April 1990 to August 1999, Mr. Newman
served as executive vice president overseeing finance, human resources, information systems and
customer service and fulfillment for Lippincott, Williams and Wilkins, formerly Waverly, Inc., a
publicly traded medical sciences publisher. From August 1999 to January 2000, Mr. Newman served as
the chief technology officer for Wolters Kluwer’s scientific, technical and medical companies
consisting of five separate units. Mr. Newman holds a Bachelor of Science in chemistry from the
University of Miami and a Masters of Business Administration from Rutgers University.
J. Edward Pearson joined the company in June 2006 as senior vice president, responsible for our
survey and research business. Effective with the acquisition of TJO on March 12, 2007, Mr. Pearson
was named president of the newly formed HealthStream Research™ group. From 2002 to June
2003, Mr. Pearson served as chief executive officer for Medibuy, an internet-based healthcare
exchange and supply chain efficiency solutions provider. From June 2003 to June 2006, he served as
president and chief executive officer of DigiScript, an Internet-based training and communication
solutions provider for the life sciences industry. He earned a Bachelor of Business Administration
in accounting from Middle Tennessee State University.
Kevin P. O’Hara was promoted to senior vice president and general counsel in February 2007. Mr.
O’Hara assumed compliance officer responsibilities during August 2007. Prior to joining
HealthStream in 2002, Mr. O’Hara served as vice president of operations and development at
smallbusiness.com from 2000 to 2001. He practiced as an attorney with Bass, Berry, & Sims PLC in
Nashville, Tennessee from 1996 to 2000, with a specialty in technology, electronic commerce, and
healthcare. He earned a Bachelor of Arts degree and a J.D. from Vanderbilt University.
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Item 1A. Risk Factors
We believe that the risks and uncertainties described below and elsewhere in this document are the
principal material risks facing the Company as of the date of this report. In the future, we may
become subject to additional risks that are not currently known to us. Our business, financial
condition or results of operations could be materially adversely affected by any of the following
risks and by any unknown risks. The trading price of our common stock could decline due to any of
the following risks or any unknown risks.
Risks related to our business model.
We may be unable to effectively execute our growth strategy which could have an adverse effect on
our business and competitive position in the industry.
Our business strategy includes increasing our market share and presence through sales to new
customers, further penetration and additional sales to existing customers, introductions of new
products and services, and maintaining strong relationships with our existing customers. Some of
the risks that we may encounter in executing our growth strategy include:
| l | expenses, delays and difficulties of identifying and integrating new products or services into our existing organization; | ||
| l | inability to leverage our operational and financial systems sufficiently to support our growth; | ||
| l | inability to generate sufficient revenue from new products to offset investment costs; | ||
| l | inability to effectively identify, manage and exploit existing and emerging market opportunities; | ||
| l | inability to maintain our existing customer relationships; and | ||
| l | increased competition from new and existing competitors. |
If any of these risks are realized, our business could suffer.
We may be unable to effectively identify, complete or integrate the operations of future
acquisitions.
As part of our growth strategy, we are actively reviewing possible acquisitions that complement or
enhance our business. We may not be able to identify, complete or integrate the operations of
future acquisitions. In addition, if we finance acquisitions by issuing equity securities, our
existing shareholders may be diluted which could affect the market price of our stock. As a result,
if we fail to properly evaluate and execute acquisitions and investments, our business prospects
may be seriously harmed. Some of the risks that we may encounter in implementing our acquisition
strategy include:
| l | expenses, delays or difficulties in identifying and integrating acquired companies into our organization; | ||
| l | inability to retain personnel associated with acquisitions; | ||
| l | diversion of management’s attention from daily operations; and | ||
| l | inability to generate sufficient revenues, profits, and cash flows from acquisitions to offset our investment costs. |
Revenue recognition for certain products and services is dependent upon customer scheduling and
acceptance.
As revenues from our subscription business continue to increase, a larger portion of our revenues
will be predictable; however, quarterly performance may be more subject to fluctuations. Our
HealthStream Research products and services are typically contracted by healthcare organizations
for multi-year terms, but the frequency and timing of survey cycles can vary from quarter to
quarter and year to year. Also, other project based products, such as live events and professional
services, are subject to the customers’ involvement in the provision of the product. The magnitude
of these project based service contracts may vary widely from quarter to quarter and year to year,
and thus may effect our ability to accurately predict quarterly and annual financial performance.
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Our sales cycle is lengthy and can vary widely.
The period from our initial contact with a potential customer and the first purchase of our
solution by the customer typically ranges from three to nine months, and in some cases has extended
much further. The range in the sales cycle can be impacted by factors including an increasing trend
towards a more formal requests for proposals (RFP’s) process and more competition within our
industry, as well as formal budget timelines which impact timing of purchases by target customers.
As a result of these factors, we have only limited ability to forecast the timing and type of
initial sales. This, in turn, makes it more difficult to predict quarterly and annual financial
performance.
We may not be able to maintain our competitive position against current and potential competitors,
especially those with significantly greater financial, technical, marketing, and other resources.
Several of our competitors and many potential competitors have longer operating histories and significantly greater financial,
technical, marketing, and other resources than we do. We encounter direct competition from both
large and small e-learning companies and other companies focused on training and continuing
education in the healthcare industry. We also face competition from larger survey and research
companies.
Given the profile and growth of the healthcare industry and the growing need for education,
training, research, and information, it is likely that additional competitors will emerge.
We believe we maintain a competitive advantage against our competitors with the
comprehensive array of products and services we offer. If our competitors were to offer a
complete e-learning solution to the healthcare industry, our competitive position could be
adversely affected. These companies may be able to respond more quickly than we are to new or
changing opportunities, technologies, standards or customer requirements. Further, most of our
customer agreements are for terms ranging from one to three years, with no obligation to renew. The
short terms of these agreements enable customers to shift to one of our competitors.
Growth in courseware subscription revenues depends, in part, on our obtaining proper distribution
rights from our content partners.
Most of our agreements with content providers are for initial terms of two to three years. The
content partners may choose not to renew their agreements with us or may terminate the agreements
early if we do not fulfill our contractual obligations. If a significant number of our content
providers terminate or fail to renew their agreements with us on acceptable terms, it could result
in a reduction in the number of courses we are able to distribute, causing decreased revenues. Most
of our agreements with our content partners are also non-exclusive, and our competitors also offer,
or could offer, training and continuing education content that is similar to or the same as ours.
If publishers and authors, including our current content partners, offer information to users or
our competitors on more favorable terms than those offered to us or increase our license fees, our
competitive position and our profit margins and prospects could be harmed. In addition, the failure
by our content partners to deliver high-quality content and to revise their content in response to
user demand and evolving healthcare advances and trends could result in customer dissatisfaction
and inhibit our ability to attract and retain subscribers of our courseware offerings.
We may not be able to develop enhancements to our existing products and services or achieve
widespread acceptance of new features or keep pace with technological developments.
Our revenue growth is expected to be generated through sales to new customers as well as increasing
sales of additional courseware subscriptions and other products and services to existing customers.
Our identification of additional features, content, products and services may not result in timely
development of complementary products. In addition, the success of certain new products and
services may be dependent on continued growth in our base of Internet-based customers or adoption
of new methodology by new customers. Because healthcare training continues to change and evolve, we
may be unable to accurately predict and develop features, content and other products to address
these needs of the healthcare industry. If new products, features, or content are not accepted by
new or existing customers, we may not be able to recover the cost of this development and our
business will be harmed. Continued growth of our Internet-based customer population is dependent on
our ability to continue to provide relevant products and services in a timely manner. The success
of our business will depend on our ability to continue providing our products and services as well
as enhancing our courseware, product and service offerings that address the needs of healthcare
organizations.
Our product and service offerings include third party technology, the loss of which could
materially harm our business. Errors in third party software or our inability to license this
software in the future could increase our costs and decrease our revenues.
We use some licensed third party technology components in our products. Future licenses to this
technology may not be available to us on commercially reasonable terms, or at all. The loss of or
inability to obtain or maintain any of these licenses could result in delays in the
introduction of new products or could force us to discontinue offering portions of our learning
management solutions until equivalent technology, if available, is identified, licensed and
integrated. The operation of our products would be impaired if errors occur in the third party
technology or content that we incorporate, and we may incur additional costs to repair or replace the defective
software. It may be difficult for us to correct any errors in third party software because the
software is not within our control. Accordingly, our revenue could decrease and our costs could
increase in the event of any errors in this technology. Furthermore, we may become subject to legal
claims related to licensed technology based on product liability, infringement of intellectual
property or other legal theories.
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Financial Risks
A significant portion of our revenue is generated from a relatively small number of customers.
We derive a substantial portion of our revenues from a relatively small number of customers. A
termination of our agreements with our significant customers or a failure of these customers to
renew their contracts on favorable terms, or at all, would have a material adverse effect on our
business.
A significant portion of our business is subject to renewal each year. Therefore, renewals have a
significant impact on our revenue and operating results.
For the year ended December 31, 2007, approximately 50 percent of our net revenues were derived
from our Internet-based subscription products. Our Internet-based HLC customers have no obligation
to renew their subscriptions for our products or services after the expiration of the initial
subscription period, and in fact, some customers have elected not to renew their subscription. In
addition, our customers may renew at a lower pricing or activity level. During the year ended
December 31, 2007, we renewed 110% of the annual HLC contract value up for renewal and 99% of the
subscribers which were up for renewal. Because a significant portion of our customer contracts have
only renewed one time, we do not have sufficient historical data to accurately predict future
customer renewal rates. Our customers’ renewal rates may decline or fluctuate as a result of a
number of factors, including their dissatisfaction with our service. If we are unable to renew a
substantial portion of the contracts that are up for renewal or maintain our pricing, our revenues
could be adversely affected, which would have a material adverse affect on our results of
operations and financial position. Contracts for our survey and research services typically range
from one to three years in length, and customers are not obligated to renew their contract with us
after their contract expires. If our customers do not renew their arrangements for our services, or
if their activity levels decline, our revenue may decline and our business will suffer.
The timing of our revenue recognition from sales activity is dependent upon achievement of certain
events or performance milestones, and our inability to accurately predict them will impact our
operating results.
Our ability to recognize revenues is dependent upon several factors including the transfer of
customer-specific information such as unique subscriber IDs, which are required for us to implement
customers on our Internet-based learning platform. Accordingly, if customers do not provide us with
the specified information in a timely manner, our ability to recognize revenues will be delayed,
which could adversely impact our operating results. In addition, completion and acceptance by our
customers of developed content and courseware must be achieved, survey responses must be received,
and utilization of courseware is required in connection with subscription Internet-based learning
products for us to recognize revenues. As we noted above, while we have been successful in
achieving growth in our subscription based revenues, our project based revenues are likely to be
subject to significant fluctuations.
Because we recognize revenue from subscriptions for our products and services over the term of the
subscription period, downturns or upturns in sales may not be immediately reflected in our
operating results.
We recognize approximately 50% of our revenue from customers monthly over the terms of their
subscription agreements, which have initial contract terms ranging from one to three years,
although terms can range from less than one to up to five years. As a result, much of the revenue
we report in each quarter is related to subscription agreements entered into during previous
quarters. Consequently, a decline in new or renewed subscriptions in any one quarter will not
necessarily be fully reflected in the revenue in that quarter and will negatively affect our
revenue in future quarters. In addition, we may be unable to adjust our cost structure to reflect
these reduced revenues. Accordingly, the effect of significant downturns in sales and market
acceptance of our products and services may not be fully reflected in our results of operations
until future periods. Additionally, our subscription model also makes it difficult for us to
rapidly increase our revenue through additional sales in any period, as revenue from new customers
must be recognized over the applicable subscription term.
We may not be able to meet our strategic business objectives unless we obtain additional financing,
which may not be available to us on favorable terms or at all.
Our current cash reserves, revolving credit facility, and results of operations are expected to be
sufficient to meet our cash requirements through at least 2008. However, we may need to raise
additional funds in order to:
| l | develop new, or enhance existing, services or products; | ||
| l | respond to competitive pressures; | ||
| l | finance working capital requirements; or | ||
| l | acquire complementary businesses, technology, content or products. |
At December 31, 2007, we had approximately $3.6 million in cash, cash equivalents, restricted cash,
and related interest receivable. We also have up to $15.0 million of availability under a revolving
credit facility, subject to certain covenants. We expect to incur up to $5.0
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million of capital expenditures, software feature enhancements and content purchases during 2008 to
support our business. In September 2007 we authorized a stock repurchase plan, with approval to
acquire up to $3.0 million of our common stock. We continue to actively review possible business
acquisitions that would complement our products and services. We may not have adequate cash and
investments or availability under our revolving credit facility to consummate one or more
acquisitions. We cannot assure you that if we need additional financing that it will be available
on terms favorable to us, or at all. If adequate funds are not available or are not available on
acceptable terms, our ability to fund expansion, take advantage of available opportunities, develop
or enhance services or products or otherwise respond to competitive pressures would be
significantly limited. If we raise additional funds by issuing equity or convertible debt
securities, the percentage ownership of our existing shareholders may be reduced.
We have significant goodwill and identifiable intangible assets recorded on our balance sheet that
may be subject to impairment losses that would reduce our reported assets and earnings.
As of December 31, 2007, our balance sheet included goodwill of $21.1 million and identifiable
intangible assets of $5.7 million. Economic, legal, regulatory, competitive, contractual, and other
factors may affect the carrying value of goodwill and identifiable intangible assets in the future.
If any of these factors impair the value of these assets, accounting rules require us to reduce
their carrying value and recognize an impairment charge, which would reduce our reported assets and
earnings in the period an impairment is recognized.
Our stock price is likely to be volatile.
The market price of our common stock is likely to be volatile and could be subject to significant
fluctuations in response to factors such as the following, many of which are beyond our control:
quarterly variations in our operating results; operating results that vary from the expectations of
securities analysts and investors; changes in expectations as to our future financial performance;
changes in market valuations of other online service companies; future sales of our common stock;
stock market price and volume fluctuations; general political and economic conditions, such as a
recession or war or terrorist attacks or interest rate or currency rate fluctuations; and other
risk factors described in this Annual Report on Form 10-K. Moreover, our stock is thinly traded,
and we have a relatively small public float. These factors may adversely affect the market price of
our common stock. In addition, the market prices for stocks of many Internet related and technology
companies have historically experienced significant price fluctuations that in some cases appear to
bear no relationship to the operating performance of these companies.
Risks Related to Sales, Marketing and Competition
We continue to refine our pricing and our products and services and cannot predict whether the
ongoing changes will be accepted.
Over the past few years we have implemented several changes and continue to make changes in our
pricing and our product and service offerings to increase revenue and to meet the needs of our
customers. We cannot predict whether our current pricing and products and services, or any ongoing
refinements we make will be accepted by our existing customer base or by prospective customers. If
our customers and potential customers decide not to accept our current or future pricing or product
and service offerings, it could have a material adverse effect on our business.
Risks Related to Operations
Difficulties in the adoption of the new version of our Internet-based HLC platform could harm our
business.
We released a new version of our Internet-based HLC platform during the fourth quarter of 2006
and as of February 29, 2008 had transitioned our entire subscriber base to this platform. During
the transition process we experienced issues with the new platform such as defects in the software,
data migration errors, and customer orientation to certain changed or new features. In response,
we increased our resources to better identify, manage, and respond to issues raised by our
customers, and as a result, we incurred approximately $1.0 million of incremental expenses to
address and remediate these issues during 2007. If customers are not satisfied with the new version
of our Internet-based HLC platform, they may not renew their contract with us, we may incur
additional expenses to address and resolve their concerns with the product/service, and we may need
to provide service credits in excess of our accrual for service interruptions.
We may be unable to adequately develop our systems, processes and support in a manner that will
enable us to meet the demand for our services.
We have provided our online products and services since 1999 and continue to develop our ability to
provide our courseware and learning management systems on both a subscription and transactional
basis over the Internet. Our future success will depend on our ability to effectively develop the
infrastructure, including additional hardware and software, and implement the services, including
customer support, necessary to meet the demand for our services. Our inability from time to time to
successfully develop the necessary systems and implement the necessary services on a timely basis
has resulted in our customers experiencing some delays or interruptions in their service. Such
delays or interruptions may cause customers to become dissatisfied with our service and move to
competing providers of
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traditional and online training and education services. If this happens, our revenues could be
adversely affected, which would have a material adverse effect on our financial condition.
Our business operations could be significantly disrupted if we lose members of, or fail to
integrate, our management team.
Our future performance is substantially dependent on the continued services of our management team
and our ability to retain and motivate them. The loss of the services of any of our officers or
senior managers could harm our business, as we may not be able to find suitable replacements. We do
not have employment agreements with any of our key personnel, other than our chief executive
officer, and we do not maintain any “key person” life insurance policies.
We may not be able to hire and retain a sufficient number of qualified employees and, as a result,
we may not be able to grow as we expect or maintain the quality of our services.
Our future success will depend on our ability to attract, train, motivate, and retain other highly
skilled technical, managerial, marketing, customer support, and interviewing center personnel who
conduct phone surveys. Competition for certain personnel is intense, especially for developers, web
designers and sales personnel, and we may be unable to successfully attract sufficiently qualified
personnel. We have experienced difficulty in the past hiring qualified personnel in a timely manner
for these positions. The pool of qualified technical personnel, in particular, is limited in
Nashville, Tennessee, which is where our headquarters are located. Our interviewing center is
located in Laurel, Maryland, and we may experience difficulty in maintaining and recruiting
qualified individuals to perform these services. We will also need to maintain the size of our
staff to support our anticipated growth, without compromising the quality of our offerings or
customer service. Our inability to locate, hire, integrate and retain qualified personnel in
sufficient numbers may reduce the quality of our services.
We must continue to upgrade our technology infrastructure, both hardware and software, to
effectively meet demand for our services.
We must continue to obtain reasonably priced, commercially available hardware and continue to
enhance software to accommodate the increased use of our platform and increased courseware in our
library. In order to make timely decisions about hardware and software enhancements, we must be
able to accurately forecast the growth in demand for our services. This growth in demand for our
services is difficult to forecast and the potential audience for our services is large. If we are
unable to increase the data storage and processing capacity of our systems at least as fast as the
growth in demand, our customers may encounter delays or disruptions in their service. Unscheduled
downtime could harm our business and also could discourage current and potential customers and
reduce future revenues.
Our network infrastructure and computer systems and software may fail.
An unexpected event like a telecommunications failure, fire, earthquake, or other catastrophic loss
at our Internet service providers’ facilities or at our on-site data facility could cause the loss
of critical data and prevent us from offering our products and services. Our business interruption
insurance may not adequately compensate us for losses that may occur. In addition, we rely on third
parties to securely store our archived data, house our web server and network systems and connect
us to the Internet. While our service providers have planned for certain contingencies, the failure
by any of these third parties to provide these services satisfactorily and our inability to find
suitable replacements would impair our ability to access archives and operate our systems and
software.
We may lose users and lose revenues if our security measures fail.
If the security measures that we use to protect personal information are ineffective, we may lose
users of our services, which could reduce our revenues. We rely on security and authentication
technology licensed from third parties. With this technology, we perform real-time credit card
authorization and verification, as well as the encryption of other selected secure customer data.
We cannot predict whether these security measures could be circumvented by new technological
developments. In addition, our software, databases and servers may be vulnerable to computer
viruses, physical or electronic attacks and similar disruptions. We may need to spend significant
resources to protect against security breaches or to alleviate problems caused by any breaches. We
cannot assure that we can prevent all security breaches.
Risks Related to Government Regulation, Content and Intellectual Property
Government regulation may require us to change the way we do business.
The laws and regulations that govern our business change rapidly. The United States government and
the governments of states and foreign countries have attempted to regulate activities on the
Internet. Evolving areas of law that are relevant to our business include privacy law, proposed
encryption laws, content regulation, information security accountability regulation, and sales and
use tax laws and regulations. Because of this rapidly evolving and uncertain regulatory
environment, we cannot predict how these laws and regulations might affect our business. These uncertainties make it difficult to ensure compliance with the laws and regulations
governing the Internet. These laws and regulations could harm us by subjecting us to liability or
forcing us to change how we do business.
In addition, certain laws mandate that our customers contractually require us to protect the
privacy and security of certain personal and health related information.
If we fail to abide by these required contractual provisions, our customers may terminate their contracts with us.
See “Business — Government Regulation of the Internet and
the Healthcare Industry” for a more complete discussion of these laws and regulations.
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Our inability to maintain CMS certification to conduct HCAHPS surveys may adversely affect our
business.
Our survey product offerings include providing HCAHPS survey services to assist customers in their
compliance with CMS regulations. We are currently designated as a CMS certified vendor to offer
HCAHPS survey data collection services. If we are unable to maintain this certification, we would
not be able to offer our customers this survey instrument and our business may suffer.
Any reduction or change in the regulation of continuing education and training in the healthcare
industry may adversely affect our business.
Our business model is dependent in part on required training and continuing education for
healthcare professionals and other healthcare workers resulting from regulations of state and
Federal agencies, state licensing boards and professional organizations. Any change in these
regulations that reduce the requirements for continuing education and training for the healthcare
industry could harm our business. In addition, a portion of our business with pharmaceutical and
medical device manufacturers and hospitals is predicated on our ability to maintain accreditation
status with organizations such as the ACCME, ANCC, AST, and ACPE. The failure to maintain status as
an accredited provider could have a detrimental effect on our business.
Government regulations may reduce our business activity with pharmaceutical and medical device
customers.
In April 2003, the OIG of the Department of Health and Human Services (HHS) issued “OIG Compliance
Program Guidance for Pharmaceutical Manufacturers.” In July 1999, the OIG issued Compliance Program
Guidance for the Durable Medical Equipment, Prosthetics, Orthotics and Supply Industry. These
guidelines collectively identify three areas of risks for pharmaceutical and medical device
companies and recommend certain best practices to be included in a compliance plan designed to
avoid the risk of federal healthcare program abuse. The guidance highlighted a number of
arrangements that have the potential to trigger fraud and abuse violations, including educational
grants.
In April 2007 the U.S. Senate Finance Committee released a report critical of practices
related to the funding of educational programs by pharmaceutical manufacturers. Congress is
considering legislation that would require manufacturers of drugs, devices, and medical supplies to report to HHS,
anything of value, including educational programs, given by such manufacturers to physicians. This legislation
would require that HHS make such information publicly available on the Internet.
The Company follows the rules and guidelines provided by the ACCME, ANCC and other
continuing education accrediting bodies to ensure that its continuing education programming is free
from commercial bias and consistent with the OIG guidance. The majority of the Company’s accredited
continuing education programming is funded by educational grants from our pharmaceutical and
medical device customers. There is no assurance that our pharmaceutical and medical device
customers will continue to provide educational grants consistent with past practices. In fact, we
have experienced a reduction in live event activities we provide which are supported by
pharmaceutical and medical device companies. To the extent that our customers continue to curtail
or restructure their business practices, our business with this customer base may suffer.
We may be liable to third parties for content that is available from our online library.
We may be liable to third parties for the content in our online library if the text, graphics,
software or other content in our library violates copyright, trademark, or other intellectual
property rights, our content partners violate their contractual obligations to others by providing
content to our library, or the content does not conform to accepted standards of care in the
healthcare profession. We attempt to minimize these types of liabilities by requiring
representations and warranties relating to our content partners’ ownership of the rights to
distribute as well as the accuracy of their content. We also take necessary measures to review this
content ourselves. Although our agreements with our content partners contain provisions providing
for indemnification by the content providers in the event of
inaccurate content, our content partners may not have the financial resources to meet this obligation. Alleged
liability could harm our business by damaging our reputation, requiring us to incur legal costs in
defense, exposing us to awards of damages and costs, and diverting management’s attention away from
our business. See “Business — Intellectual Property and Other Proprietary Rights” for a more
complete discussion of the potential effects of this liability on our business.
Protection of certain intellectual property may be difficult and costly.
Despite protection of certain proprietary rights, a third-party could, without authorization, copy
or otherwise misappropriate our content, information from our databases, or other intellectual
property. Our agreements with employees, consultants and others who participate in development
activities could be breached and result in our trade secrets becoming known or independently
developed by competitors. We may not have adequate remedies for any breach. In addition, the laws
of some foreign countries do not protect our proprietary rights to the same extent as the laws of
the United States, and effective intellectual property protection may not be available in those
jurisdictions. We currently own several trademarks and domain names. The current system for
registering, allocating and managing domain names has been the subject of litigation and proposed
regulatory reform. Additionally, legislative proposals have been made by the federal government
that would afford broad protection to owners of databases of information, such as stock quotes.
This protection of databases already exists in the European Union. There has been substantial
litigation in the computer and online industries regarding intellectual property assets,
particularly patents. Third parties may claim infringement by us with respect to current and future
products, trademarks or other proprietary rights, and we may
counterclaim against such third parties in
such actions. Any such claims or counterclaims could be time-consuming, result in costly
litigation, divert management’s attention, cause product release delays, require us to redesign our
products or require us to enter into royalty or licensing agreements, any of which could have a
material adverse effect upon our business, financial condition and operating results. Such royalty
and licensing agreements may not be available on terms acceptable to us, if at all.
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We may be unable to protect our intellectual property, and we may be liable for infringing the
intellectual property rights of others.
Our business could be harmed if unauthorized parties infringe upon or misappropriate our
intellectual property, proprietary systems, content, services or other information. Our efforts to
protect our intellectual property through copyright, trademarks and other controls may not be
adequate. In the future, litigation may be necessary to enforce our intellectual property rights or
to determine the validity and scope of the patents, intellectual property or other proprietary
rights of third parties, which could be time consuming and costly. Intellectual property
infringement claims could be made against us, especially as the number of our competitors grows.
These claims, even if not meritorious, could be expensive and divert our attention from operating
our company. In addition, if we become liable to third parties for infringing their intellectual
property rights, we could be required to pay a substantial damage award and develop comparable
non-infringing intellectual property, to obtain a license, or to cease providing the content or
services that contain the infringing intellectual property. We may be unable to develop
non-infringing intellectual property or obtain a license on commercially reasonable terms, if at
all.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our principal office is located in Nashville, Tennessee. Our lease for approximately 32,000 square
feet at this location expires in April 2010. The lease provides for a five-year renewal option with
rent at rates which are substantially similar to current rates. Rent at this location is
approximately $23,000 per month.
In connection with the acquisition of TJO in March 2007, we are leasing approximately 19,000 square
feet of office space in Laurel, Maryland. The lease expires in March 2012 and provides for two
renewal options for two years each. Rent at this location is approximately $29,000 per month, with
annual rental increases of approximately three percent.
We are leasing approximately 8,000 square feet of office space in Franklin, Tennessee. Rent at this
location is approximately $8,700 per month through August 2008. The lease expires in August 2008,
and contains a one year renewal option at the rate of $9,000 per month.
We are leasing approximately 4,600 square feet of office space in Denver, Colorado. In February
2008, we exercised an option to terminate this lease. Rent at this location is approximately $3,600
per month through termination in July 2008.
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities.
The following table sets forth, for the periods indicated, the high and low sales prices per share
of our common stock as reported on the NASDAQ Global Market under the ticker symbol HSTM:
| Common Stock Price | ||||||||||||||||
| 2007 | 2006 | |||||||||||||||
| High | Low | High | Low | |||||||||||||
First Quarter |
$ | 4.63 | $ | 3.31 | $ | 3.72 | $ | 2.39 | ||||||||
Second Quarter |
4.33 | 3.39 | 5.03 | 3.25 | ||||||||||||
Third Quarter |
3.41 | 2.52 | 3.90 | 2.50 | ||||||||||||
Fourth Quarter |
3.73 | 2.83 | 4.19 | 3.14 | ||||||||||||
On March 4, 2008, there were 160 registered holders and approximately 2,825 beneficial holders of
our common stock. Because many of such shares are held by brokers and other institutions on behalf
of shareholders, we are unable to estimate the total number of shareholders represented by these
record holders.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock, and we do not anticipate
paying cash dividends in the foreseeable future. We intend to retain earnings to finance the
expansion of our operations.
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STOCK PERFORMANCE GRAPH
The graph below compares the cumulative total shareholder return on our common stock since December
31, 2002, with the cumulative total return of companies on the Nasdaq Composite Index and the
Nasdaq Computer & Data Processing Index over the same period (assuming the investment of $100 in
our common stock, the Nasdaq Composite Index and the Nasdaq Computer & Data Processing Index on
December 31, 2002 (for our stock and the indices) and reinvestment of all dividends).
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN (1)
Among HealthStream, Inc., The NASDAQ Composite Index
And The NASDAQ Computer & Data Processing Index
Among HealthStream, Inc., The NASDAQ Composite Index
And The NASDAQ Computer & Data Processing Index
| (1) | $100 invested on 12/31/02 in stock or index-including reinvestment of dividends. Fiscal year ending December 31. |
RECENT SALES OF UNREGISTERED SECURITIES
There have been no sales of unregistered securities since December 31, 2006.
ISSUER PURCHASES OF EQUITY SECURITIES
On September 20, 2007, the Company’s Board of Directors authorized the Company to purchase up to
$3.0 million of its common stock over a one year period. The plan may be limited or terminated at
any time. The table below sets forth activity under the stock repurchase plan for the quarter ended
December 31, 2007:
| (d) | ||||||||||||||||
| (c) | Maximum number (or | |||||||||||||||
| (a) | Total number of shares (or | approximate dollar value) of | ||||||||||||||
| Total number of | (b) | units) purchased as part of | shares (or units) that may yet | |||||||||||||
| shares (or units) | Average price paid per | publicly announced plans | be purchased under the plans | |||||||||||||
| Period | purchased | share (or unit)(1) | or programs | or programs | ||||||||||||
Month #1 (October 1 – October 31) |
— | $ | — | — | $ | 3,000,000 | ||||||||||
Month #2 (November 1 – November
30) |
27,200 | 2.94 | 27,200 | 2,920,033 | ||||||||||||
Month # 3 (December 1 – December
31) |
— | — | — | 2,920,033 | ||||||||||||
Total |
27,200 | $ | 2.94 | 27,200 | $ | 2,920,033 | ||||||||||
| (1) | - The weighted average price paid per share of common stock does not include the cost of broker commissions. |
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Item 6. Selected Financial Data
The selected statements of income data for the three-year period ended December 31, 2007 and the
balance sheet data as of December 31, 2007 and 2006 are derived from our consolidated financial
statements that have been audited by Ernst & Young LLP, our independent registered public
accounting firm, which are included elsewhere in this report. You should read the following
selected financial data in conjunction with our consolidated financial statements and the notes to
those statements and “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” located elsewhere in this report.
HealthStream acquired TJO on March 12, 2007 and DMR on March 28, 2005. TJO’s results of operations
are included within our consolidated statement of operations effective March 13, 2007. DMR’s
results of operations are included within our consolidated statement of operations effective March
29, 2005. As a result of these acquisitions, the annual results presented below are not comparable.
Revenues may be subject to fluctuations as discussed further in “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” located elsewhere in this annual report.
During 2007, we recognized a portion of our deferred tax assets, resulting in an income tax benefit
of approximately $2.0 million. During 2006, we adopted SFAS No. 123(R) “Share-Based Payment” which
resulted in approximately $742,000 of stock based compensation expense for 2007 and $682,000 for
2006. As a result of this accounting change, the annual results presented below are not comparable.
The operating results for any single year are not necessarily indicative of the results to be
expected in the future.
| Year Ended December 31, | ||||||||||||||||||||
| 2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||||||||
| (in thousands, except per share data) | ||||||||||||||||||||
STATEMENT OF OPERATIONS DATA: |
||||||||||||||||||||
Revenues, net |
$ | 43,949 | $ | 31,783 | $ | 27,359 | $ | 20,057 | $ | 18,195 | ||||||||||
Operating costs and expenses: |
||||||||||||||||||||
Cost of revenues (excluding depreciation and
amortization) |
16,162 | 10,869 | 9,746 | 7,277 | 6,268 | |||||||||||||||
Product development |
4,308 | 3,503 | 2,928 | 2,531 | 3,247 | |||||||||||||||
Sales, marketing, general and administrative expenses |
17,060 | 12,613 | 10,411 | 9,433 | 9,431 | |||||||||||||||
Depreciation and amortization |
4,503 | 2,889 | 2,678 | 2,107 | 3,048 | |||||||||||||||
Total operating costs and expenses |
42,033 | 29,874 | 25,763 | 21,348 | 21,994 | |||||||||||||||
Income (loss) from operations |
1,916 | 1,909 | 1,596 | (1,291 | ) | (3,799 | ) | |||||||||||||
Other income (expense) |
226 | 619 | 338 | 243 | 387 | |||||||||||||||
Income (loss), before income taxes |
2,142 | 2,528 | 1,934 | (1,048 | ) | (3,412 | ) | |||||||||||||
Income tax (benefit) provision |
(1,945 | ) | 28 | 21 | — | — | ||||||||||||||
Net income (loss) |
$ | 4,087 | $ | 2,500 | $ | 1,913 | $ | (1,048 | ) | $ | (3,412 | ) | ||||||||
Net income (loss) per share – basic |
$ | 0.19 | $ | 0.12 | $ | 0.09 | $ | (0.05 | ) | $ | (0.17 | ) | ||||||||
Net income (loss) per share – diluted |
$ | 0.18 | $ | 0.11 | $ | 0.09 | $ | (0.05 | ) | $ | (0.17 | ) | ||||||||
Weighted average shares of common stock outstanding – basic |
21,999 | 21,577 | 21,051 | 20,586 | 20,383 | |||||||||||||||
Weighted average shares of common stock outstanding –
diluted |
22,701 | 22,359 | 21,942 | 20,586 | 20,383 | |||||||||||||||
| At December 31, | ||||||||||||||||||||
| 2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||||||||
| (in thousands) | ||||||||||||||||||||
BALANCE SHEET DATA: |
||||||||||||||||||||
Cash and cash equivalents |
$ | 3,599 | $ | 10,726 | $ | 5,726 | $ | 2,257 | $ | 3,220 | ||||||||||
Investments in marketable securities – short and long term |
— | 1,700 | 6,175 | 14,025 | 13,958 | |||||||||||||||
Goodwill and
intangible assets |
26,851 | 13,073 | 13,582 | 3,473 | 3,817 | |||||||||||||||
Working capital (deficit) |
(906 | ) | 11,148 | 9,428 | 15,379 | 16,286 | ||||||||||||||
Total assets |
53,361 | 41,008 | 35,216 | 28,436 | 28,399 | |||||||||||||||
Deferred revenue |
9,493 | 5,376 | 4,503 | 3,866 | 3,059 | |||||||||||||||
Long-term debt and capital leases, net of current portion. |
1,064 | 107 | 216 | 29 | 1 | |||||||||||||||
Shareholders’ equity |
35,714 | 29,634 | 25,800 | 21,730 | 22,558 | |||||||||||||||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of the financial condition and results of operations of HealthStream
should be read in conjunction with “Selected Financial Data” and HealthStream’s Consolidated
Financial Statements and related notes thereto included elsewhere in this report. This discussion
contains forward-looking statements that involve risks and uncertainties. HealthStream’s actual
results may differ significantly from the results discussed and those anticipated in these
forward-looking statements as a result of many factors, including but not limited to those
described under “Risk Factors” and elsewhere in this report.
The following discussion provides an overview of our history together with a summary of our
critical accounting policies and estimates. Our critical accounting policies and estimates include
revenue recognition, product development costs and related capitalization, impairment of goodwill,
intangibles and other long-lived assets, allowance for doubtful accounts, accrual for service
interruptions, stock based compensation, income taxes, and nonmonetary exchanges.
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OVERVIEW
We provide our services to healthcare organizations, pharmaceutical and medical device companies,
and other members within the healthcare industry. Our services are primarily focused on the
delivery of education and training products and services (HealthStream Learning), as well as survey
and research services (HealthStream Research). HealthStream Learning products and services include
our Internet-based HealthStream Learning Center®, authoring tools, courseware subscriptions, online
training and content development, online sales training courses, live events, HospitalDirect® and
other products focused on education and training to serve professionals that work within healthcare
organizations. Effective with the acquisition of TJO in March 2007, we launched HealthStream
ResearchTM. HealthStream Research reflects the combination of DMR and TJO, which
collectively provide a wide range of quality and satisfaction surveys, data analyses of survey
results, and other research-based measurement tools focused on patients, employees, physicians, and
members of the community. Our learning solutions help healthcare organizations improve their
required regulatory training, while also offering an opportunity to train their employees in
multiple clinical areas. Our research products provide customers valuable insight into measuring
quality and satisfaction of physicians, patients, employees, and members of the community.
Revenues for the year ended December 31, 2007 were approximately $43.9 million compared to $31.8
million for the year ended December 31, 2006, an increase of 38.3%. Net income improved to $4.1
million for 2007 compared to $2.5 million for 2006, an increase of 63.5%. Net income for 2007
includes an income tax benefit of approximately $2.0 million associated with the recognition of a
portion of the Company’s deferred tax assets. Diluted earnings per share were $0.18 for 2007
compared to $0.11 for 2006. Revenues from HealthStream Learning grew $2.4 million, and revenues
from HealthStream Research grew by $9.8 million, including revenues of $9.7 million from the March
12, 2007 acquisition of TJO. We had approximately 1,541,000 fully implemented subscribers on our
Internet-based HLC platform at December 31, 2007, representing over 1,500 hospitals in the United
States. During 2007, we renewed approximately 333,000 HLC subscribers, representing a 99% renewal
rate for the subscribers up for renewal, and a 110% renewal rate based on the annual contract value
up for renewal. As of December 31, 2007 our cash and investment balances approximated $3.6 million
and we maintained full availability under our $15.0 million revolving credit facility.
During 2007, we transitioned approximately 95% of our customer base to a new and enhanced version
of our Internet-based HLC. The last five percent of
our subscribers transitioned to the new platform in February 2008, at their own requests. We have
invested a significant amount of capital and internal resources to develop and deploy this new
version of our flagship product, including approximately $1.0 million
of incremental costs during 2007 to support our customer’s
transition to this product. We expect this new version of the
HLC will be the cornerstone to our future growth and will enable us to more
efficiently integrate the delivery of new product offerings to healthcare professionals who
subscribe to our learning solutions.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Revenue
Recognition
We recognize revenues from our Internet-based learning products and courseware subscriptions based
on a per person subscription basis, and in some cases on a per license basis. Our fees are based on
the size of the facilities’ or organizations’ employee user population and the service offerings to
which they subscribe. Revenue is recognized ratably over the service period of the underlying
contract.
Revenues from survey and research services are recognized when survey results are delivered to
customers via either Internet-based reporting throughout the survey period or by providing final
survey results once all services are complete. Revenues for survey and reporting services, which
are provided through the use of Internet-based reporting methodologies, are recognized using the
proportional performance method, consistent with SEC Staff Accounting Bulletin No. 104, “Revenue
Recognition,” reflecting recognition throughout the service period which corresponds with the
survey cycle and reporting access by the customer, which typically ranges from one to five months.
Revenues for survey and reporting services, which include delivery of survey results to the
customer when all services are completed, are recognized upon completion. All other revenues are
recognized as the related services are performed or products are delivered to the customer.
Revenues for these services can be subject to seasonal factors based on customers requirements that
can impact the timing, frequency, and volume of survey cycles.
Revenues from professional services include content maintenance, consulting, and implementation
services. Fees are based on the time and efforts involved, and revenue is recognized upon
completion of performance milestones using the proportional performance method.
We offer training services for clients to facilitate integration of our Internet-based products.
Fees for training are based on the time and efforts of the personnel involved. Basic online
training is generally included in the initial contract, however, incremental training revenues are
generally recognized upon completion of training services.
Revenues from installed learning management products are associated with ongoing maintenance and
technical support services, typically based on a percentage of the original contract amount and are
recognized as revenue over the term of the service period, generally one year.
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We recognize revenue from live event development services using a proportional performance method
based on completion of performance milestones. Revenues from content maintenance and development
services are recognized using a percentage of completion method based on labor hours, which
correspond to the completion of performance milestones and deliverables. Sales of products and
services to pharmaceutical and medical device companies can be subject to seasonal factors as a
result of meeting and conference dates for such companies.
Revenues associated with online training are recognized over the term of the subscription period or
over the historical usage period, if usage typically differs from the subscription period. All
other service revenues are recognized as the related services are performed or products are
delivered.
We expect to continue to generate revenues by marketing our Internet-based products and our survey
and research services through healthcare organizations and to a lesser extent, through
pharmaceutical and medical device companies. We expect that the portion of our revenues related to
services provided via our Internet-based learning products will increase in absolute dollar
amounts. The percentage of total revenues from our Internet-based subscription products has
declined compared to historical periods, whereas revenues from our survey and research services are
not Internet-based. Specifically, we will seek to generate revenues from healthcare workers by
marketing to their employers or sponsoring organizations. The fees we charge for courseware
resulting from this marketing is typically paid by either the employer or sponsoring organization.
Product Development Costs
We account for web site development costs in accordance with EITF Issue No. 00-2 “Accounting for
Web Site Development Costs” and for capitalized software feature enhancements in accordance with
SOP 98-1 “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,”
which provide guidance on when to capitalize versus expense costs incurred to develop internal use
software or web sites. We capitalize costs incurred during the development phase for such projects
when such costs are material. Maintenance and operating costs are expensed as incurred.
Product development costs primarily include our costs to initially develop and maintain software
feature enhancements and content for our Internet-based learning product. Once planning is
completed and development begins, we capitalize payments to third parties associated with the cost
of software feature enhancement development or content where the life expectancy is greater than
one year and the anticipated cash flows from such software feature enhancements or content are
expected to exceed the cost of the related asset. During 2007 and 2006, we capitalized
approximately $300,000 and $400,000, respectively, related to development of content by third
parties. Such amounts are included in the accompanying consolidated balance sheets under the
caption “prepaid development fees” and “other assets.” During 2007 and 2006, we capitalized
approximately $2.6 million and $2.3 million, respectively, for development of software feature
enhancements by third parties. Such amounts are included in the accompanying balance sheets under
the caption “capitalized software feature enhancements.” A significant portion of these capitalized
costs were associated with the development of the new version of our Internet-based HLC platform
and a new competency assessment product. We amortize content and software feature enhancements over
their expected life, which is generally one to four years. Capitalized content and software feature
enhancements are subject to a periodic impairment review in accordance with our impairment review
policy.
In connection with product development, our significant estimates involve the assessment of the
development period for new products, as well as the expected useful life of costs associated with
new products, software feature enhancements and content. Once capitalized, software feature
enhancements and content development costs are subject to the policies and estimates described
below regarding goodwill, intangibles and other long-lived assets.
Product development costs also include our systems team, which manages our efforts associated with
product development and maintenance, database management, quality assurance and security. This
team is responsible for new internal product development, integration of external new products, and
continued enhancements and regularly scheduled maintenance to our learning and research platform
products. This team was also responsible for the migration of customers to the new version of our
Internet-based HLC platform. Personnel who are responsible for our overall product portfolio as
well as prioritization of new product development are also included in product development costs.
Goodwill, intangibles and other long-lived assets
We account for goodwill, intangibles and other long-lived assets in accordance with Statement of
Financial Accounting Standards (SFAS) No. 142, “Goodwill and Intangible Assets,” and SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets.” We measure for impairment at the
reporting unit level using a discounted cash flow model to determine the estimated fair value of
the reporting units. Our discounted cash flow model contains significant assumptions and accounting
estimates about discount rates, future cash flows and terminal values that could materially affect
our operating results or financial position if they were to change significantly in the future and
could result in an impairment. We perform our goodwill impairment test whenever events or changes
in facts or circumstances indicate that impairment may exist and also during the fourth quarter
each year.
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Allowance for Doubtful Accounts
We estimate the allowance for doubtful accounts using both a specific and non-specific
identification method. Management’s evaluation includes reviewing past due accounts on a case-by
case basis, and determining whether an account should be reserved, based on the facts and
circumstances surrounding each potentially uncollectible account. An allowance is also maintained
for accounts not specifically identified that may become uncollectible in the future. Uncollectible
accounts are written-off in the period management believes it has exhausted every opportunity to
collect payment from the customer. Bad debt expense is recorded when events or circumstances
indicate an additional allowance is necessary based on our specific and non-specific identification
approach.
Accrual for Service Interruptions
We provide customers with a fully hosted learning management application, and our Internet-based
learning products are subject to periodic downtime. Due to the complexity of our hosted
applications, variability in customer utilization patterns, changes in technology, and potential
software defects, our hosted applications could experience periodic downtime. We maintain an
accrual which is intended to provide for customer concessions in the event customers experience
inconveniences or operation disruption resulting from downtime of our applications. Our accrual for
service interruptions totaled approximately $394,000 as of December 31, 2007. Certain of our
customers who have transitioned to our new platform have experienced difficulties in accessing or
using certain features of our system, and we expect to provide these customers with product and
service credits.
Stock Based Compensation
We began recognizing compensation expense using a fair-value based method for costs related to
share based payments including stock options on January 1, 2006. Measurement of such compensation
expense requires significant estimation and assumptions, however we believe that the Black Scholes
option pricing model we use for calculating the fair value of our stock based compensation plans
provides a reasonable measurement methodology using a framework that is widely adopted.
We have a stock option plan and an employee stock purchase plan which qualify as stock based
compensation plans. During the years ended December 31, 2007 and 2006, we recorded $742,344 and
$682,068, of stock based compensation expense, respectively. We typically grant stock options to
our management group on an annual basis, or when new members of the management group begin their
employment. We grant stock options to members of our board of directors in conjunction with our
annual shareholders meeting, or as new members are added on a pro rata basis based on the time
elapsed since our annual shareholders’ meeting. We expect to continue this practice for the
foreseeable future; however, we may adjust the size of the annual grant. As of December 31, 2007,
total future compensation cost related to non-vested awards not yet recognized was $1,247,528 net
of estimated forfeitures, with a weighted average expense recognition period of 2.6 years. Future
compensation expense recognition for new option grants will vary depending on the timing and size
of new awards granted, changes in the market price or volatility of our common stock, changes in
risk-free interest rates, or if actual forfeitures vary significantly from our estimates.
Accounting for Income Taxes
The Company accounts for income taxes using the liability method in accordance with SFAS No. 109,
“Accounting for Income Taxes.” The Company has significant net operating loss carryforwards (NOLs)
which may be available to reduce future tax expense. These NOLs are subject to annual limitations
under the Internal Revenue Code Section 382, which could result in the expiration of certain
portions of the Company’s NOLs before they are fully utilized. Historically, the Company has
maintained a full valuation allowance against its deferred tax assets, and taxable income has been
offset through the use of net operating loss carryforwards. Management periodically assesses the
realizability of its deferred tax assets, and during the fourth quarter of 2007 management
concluded that it is more likely than not that approximately $2.0 million of the Company’s deferred
tax assets will be realized. The Company continues to maintain a valuation allowance of
approximately $13.8 million for the remaining portion of its deferred tax assets, which primarily
consist of net operating loss carryforwards.
Nonmonetary Exchange of Content Rights and Deferred Service Credits
During 2007 and 2006, we recorded content rights and deferred service credits in connection with a
nonmonetary exchange with one of our customers. In order to account for this transaction, we
estimated the fair value of the related assets and service credits, assessed whether the value
assigned to the content was recoverable, and did and continue to amortize the related assets over
their estimated useful lives. Our future operating results will be impacted by the amortization of
the content rights and by the customer’s utilization of the service credits. We will also review
these assets periodically to determine whether they are recoverable during the remaining useful
life. Revenues for services provided in exchange for service credits will be recognized in
accordance with our revenue recognition policies.
BUSINESS COMBINATIONS
Data Management & Research, Inc. 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. The Company also incurred direct, incremental expenses
associated with the acquisition of approximately $0.4 million. Of the common stock portion, 319,489
shares were released from escrow to the former shareholder of DMR on September 28, 2006. DMR
provides healthcare organizations a wide range of quality and satisfaction surveys, data analyses
of survey results, and other research-based measurement tools focused on physicians, patients, and
employees. This acquisition has been accounted for using the purchase method of accounting.
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Table of Contents
DMR’s results of operations have been included in the Company’s results in the HealthStream
Research business unit from the date of the acquisition.
The Jackson Organization, Research Consultants, Inc. On March 12, 2007, the Company acquired all of
the issued and outstanding common stock of TJO for approximately $12.6 million, consisting of approximately $11.5 million payable in cash
and 252,616 shares of HealthStream common stock. Approximately $1.6 million of the cash
consideration is being held in escrow and will be released upon the occurrence of future events.
All of the common stock shares are held in an escrow account until
September 12, 2008, and are subject to any claims for indemnification pursuant to the stock purchase agreement.
As of December 31, 2007 the Company had incurred direct, incremental expenses associated with the
acquisition of TJO of approximately $0.7 million. TJO provides healthcare organizations with
quality and satisfaction surveys, data analyses of survey results, and other research-based
measurement tools. This acquisition has been accounted for using the purchase method of
accounting. TJO’s results of operations have been included in the Company’s results in the
HealthStream Research business unit from the date of the acquisition.
RESULTS OF OPERATIONS
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 HealthStream Learning business segment consist of the provision of
services through our Internet-based HLC, authoring tools, a variety of courseware subscriptions
(add-on courseware), maintenance and support services for our installed learning management
products, maintenance of content, live event development, online training and content development,
online sales training courses (RepDirect™), live educational activities for nurses and other
professionals conducted within healthcare organizations, continuing education activities at
association meetings, and HospitalDirect®. Revenues for our HealthStream Research business segment
consist of quality and satisfaction surveys, data analyses of survey results, and other
research-based measurement tools focused on physicians, patients, employees, and other members of
the community.
Cost of Revenues (excluding depreciation and amortization). Cost of revenues consists primarily of
salaries and employee benefits, stock based compensation, employee travel and lodging, materials,
outsourced phone survey support, 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
facilitate product delivery, provide services, conduct, process and manage phone and paper-based
surveys, handle customer support calls or inquiries, manage the technology infrastructure for our
hosted applications, manage content 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, stock based compensation, content acquisition costs before technological feasibility is
achieved, costs associated with the development of content and expenditures associated with
maintaining, developing and operating our training delivery and administration platforms. In
addition, product development expenses are associated with the development of new software feature
enhancements and new products. Personnel costs within product development include our systems team,
product managers, and other personnel associated with content and product development and product
portfolio management.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries,
commissions and employee benefits, stock based compensation, employee travel and lodging,
advertising, trade shows, promotions, and related marketing costs. Annually, we host a national
users’ group in Nashville known as “The Summit,” and a separate conference for our
Research customers, the costs of which are included in sales and marketing expenses. Personnel
costs within sales and marketing include our sales and marketing team and strategic account
management, as well as our account management group. Our account management personnel work to help
our customers effectively utilize our products.
Depreciation and Amortization. Depreciation and amortization consist of fixed asset depreciation,
amortization of intangibles considered to have definite lives, amortization of content development
fees, and amortization of capitalized software feature enhancements.
Other General and Administrative Expenses. Other general and administrative expenses consist
primarily of salaries and employee benefits, stock based compensation, 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, internal
information systems, and executive management) as well as personnel who maintain our accreditation
status with various organizations.
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 a promissory note, capital leases and our revolving
credit facility.
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Table of Contents
2007 Compared to 2006
Revenues. Revenues increased approximately $12.2 million, or 38.3%, to $43.9 million for 2007 from
$31.8 million for 2006. Revenues for 2007 consisted of $27.5 million, or 62.5% of total revenue for
HealthStream Learning and $16.5 million, or 37.5% of total revenue for HealthStream Research. In
2006, revenues consisted of $25.1 million, or 78.9% of total revenue for HealthStream Learning and
$6.7 million, or 21.1% of total revenue for HealthStream Research. HealthStream Research revenues
include the results of TJO commencing with its acquisition on March 12, 2007.
Revenues for HealthStream Learning increased approximately $2.4 million, or 9.5%, during 2007. Of
this increase, $3.2 million was derived from our Internet-based subscription learning products,
which includes revenue increases from the HLC of $1.8 million, courseware subscriptions of $1.3
million, and HospitalDirect™ of $145,000. Revenues from these products increased 17% over the
prior year and approximated $21.9 million for 2007. The remaining revenue growth came from custom
online courseware development services which increased $595,000, and implementation and consulting
services which increased $322,000 over the prior year. These revenue increases were partially
offset by a decline in revenues from: our live event business of $1.3 million, resulting from
fewer live event activities during 2007; maintenance fees from our installed learning management
product of $197,000; and clinical education activities of $158,000. Our Internet-based HLC
subscriber base increased approximately 14% during 2007, from approximately 1,352,000 fully
implemented subscribers at the end of 2006 to approximately 1,541,000 fully implemented subscribers
at the end of 2007. We expect revenues from our Internet-based HLC
and add-on courseware to continue to
increase in 2008. We also expect revenues from project-based live events and content development
services to remain comparable or decline slightly during 2008 as we continue to transition our
sales efforts to subscription based products and other online delivery methodologies.
Revenues from HealthStream Research increased approximately $9.8 million, or 145.6%, during 2007,
of which $9.7 million resulted from the March 12, 2007 acquisition of TJO. Organic research
revenues for 2007 were flat compared to the prior year due to certain customers postponing their
survey cycles until 2008. Revenues from our patient and community survey instruments, which have
more recurring and predictable cycles, accounted for 63.5% of our Research revenues during 2007
compared to 45.9% during 2006. A significant portion of this increase in revenue mix resulted from
the TJO acquisition. We expect revenues from HealthStream Research to increase during 2008
resulting from growth in sales to both new and existing customers as well as the full year impact
of TJO.
Cost of Revenues (excluding depreciation and amortization). Cost of revenues increased
approximately $5.3 million, or 48.7%, to $16.2 million for 2007 from $10.9 million for 2006. Cost
of revenues as a percentage of revenues increased to 36.8% of revenues for 2007 from 34.2% of
revenues for 2006.
Cost of revenues for HealthStream Learning increased approximately $293,000, or 3.3%, and
approximated 33.8% and 35.8% of revenues for 2007 and 2006, respectively. This expense increase is
primarily related to increased royalties paid by us associated with increases in courseware and
training subscriptions as well as approximately $350,000 of incremental costs to support our
customers in connection with their transition to our new HLC platform, and was partially offset by
lower direct costs resulting from fewer live events when compared to the prior year. We expect
increases in cost of revenues for HealthStream Learning during 2008 associated with royalty
expense, as we continue to increase our focus on selling courseware subscriptions.
Cost of revenues for HealthStream Research increased approximately $5.0 million, or 264.5%, and
approximated 41.8% and 28.1% of revenues for 2007 and 2006,
respectively. This expense increase for
HealthStream Research resulted primarily from incremental personnel to support the survey delivery
process, including our interviewing center staff, as well as increased costs associated with
outsourced phone interview services. The expense increase as a percentage of revenues is primarily
due to changes in revenue mix. We expect increases in cost of revenues for HealthStream Research
during 2008 associated with both the full year impact of TJO as well as growth in revenues.
Gross Margin (excluding depreciation and amortization). Gross margin (which we define as revenues
less cost of revenues divided by revenues) declined to 63.2% for 2007 from 65.8% for 2006. This
decrease resulted from the change in revenue mix discussed above, and was primarily associated with
the growth in revenues and direct costs from our research products. Gross margins for HealthStream
Learning were 66.2% and 64.2% for the years ended December 31, 2007 and 2006, respectively. Gross
margins for HealthStream Research were 58.2% and 71.9% for the years ended December 31, 2007 and
2006, respectively. We expect gross margins to improve moderately during 2008 resulting from
expected changes in revenue mix and cost of revenues, noted above.
Product Development. Product development expenses increased approximately $805,000, or 23.0%, to
$4.3 million for 2007 from $3.5 million for 2006. Product development as a percentage of revenues
decreased to 9.8% for 2007 from 11.0% for 2006. Product development expenses for HealthStream
Learning increased approximately $680,000, and approximated 13.4% and 11.9% of revenues for 2007
and 2006, respectively. Approximately $600,000 of the expense increase resulted from additional
costs to support our customer’s transition to the new version of our HLC platform. Product
development expenses for HealthStream Research increased approximately
$146,000 due to additional personnel and approximated 3.1% and 5.5% of revenues for 2007 and 2006,
respectively. In addition to the expenses incurred, we also capitalized approximately $2.6 million
and $2.3 million of costs associated with development of software feature enhancements during 2007
and 2006, respectively. We expect product development expenses to increase during 2008 as we
continue to invest resources in new product development and support of our existing platform
products.
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Table of Contents
Sales and Marketing. Sales and marketing expenses, including personnel costs, increased
approximately $2.2 million, or 31.2%, to $9.2 million for 2007 from $7.0 million for 2006. This
increase is primarily associated with incremental personnel and related expenses resulting from the
TJO acquisition, as well as incremental HealthStream Learning personnel and increased sales
commissions. These expense increases were partially offset by lower marketing spending. Sales and
marketing expenses approximated 21.0% and 22.1% of revenues for the years ended December 31, 2007
and 2006, respectively.
Sales and marketing expenses for HealthStream Learning increased $414,000 and approximated 23.2%
and 23.7% of revenues for 2007 and 2006, respectively. The increase in expenses is associated with
additional sales personnel and commissions, and was partially offset by lower marketing expenses,
including those related to our annual customer conference, The Summit. The expense decrease as a percentage of
revenues is due to the increase in revenues. Sales and marketing expenses for HealthStream Research
increased $1.9 million and approximated 16.6% and 13.2% of revenues for 2007 and 2006,
respectively. This increase is primarily associated with the TJO acquisition. We expect sales and
marketing expenses to increase during 2008 associated with growth in our sales teams.
Depreciation and Amortization. Depreciation and amortization increased approximately $1.6 million,
or 55.9%, to $4.5 million for 2007 from $2.9 million for 2006. Depreciation, which is included in
the unallocated corporate function, increased $542,000 resulting from new capital expenditures and
assets acquired from TJO during the current year. The amortization increase of $1.1 million
resulted from TJO intangible asset amortization and amortization of capitalized software feature
enhancements associated with the new HLC platform and other content assets. Amortization for
HealthStream Learning increased $654,000, or 67.1%, and approximated 5.9% and 3.9% of revenues for
the years ended December 31, 2007 and 2006, respectively. This increase is primarily associated
with amortization of capitalized software feature enhancements associated with the new HLC platform
and other content assets. Amortization for HealthStream Research increased $418,000, or 82.2%, and
approximated 5.6% and 7.6% of revenues for the years ended December 31, 2007 and 2006,
respectively. The expense increase is associated with the TJO acquisition, while the decrease as a
percentage of revenue is due to the increase in revenue.
We expect depreciation and amortization to increase during 2008. These increases will result from
new capital expenditure depreciation, amortization of TJO intangible assets, and amortization of
capitalized software feature enhancements.
Other General and Administrative. Other general and administrative expense increased approximately
$2.3 million, or 40.3%, to $7.8 million for 2007 from $5.6 million for 2006. This increase is
primarily due to the TJO acquisition, including personnel, facilities, and other operating costs.
Other general and administrative expense as a percentage of revenues was 17.9% and 17.6% for 2007
and 2006, respectively.
Other general and administrative expense for HealthStream Learning decreased $132,000, primarily
due to lower personnel costs. Other general and administrative expense for HealthStream Research
increased $1.7 million, primarily from the TJO acquisition and additions of other personnel. The
unallocated corporate portion of other general and administrative expense increased $655,000
primarily associated with increased investments in products and services to support the growth of
our business. We expect other general and administrative expense for 2008 to increase primarily
associated with the full year impact of TJO, additional personnel costs, and higher professional
fees associated with our compliance with Sarbanes-Oxley.
Other Income (Expense). Other income (expense) decreased approximately $392,000, or 63.4%, to
$226,000 for 2007 from $619,000 for 2006. Interest income from cash and investments in marketable
securities decreased $371,000 resulting from lower cash and investments balances during 2007.
Interest expense increased $22,000 over the prior year associated
with a promissory note issued in connection with the purchase of
certain software licenses, and our revolving credit facility.
Income Tax (Benefit) Provision. The Company recognized an income tax benefit of approximately $2.0
million during 2007 based on management’s conclusion that a portion of the Company’s deferred tax
assets would be realized. This income tax benefit was partially offset by $42,000 of income tax
expense associated with the alternative minimum tax. During 2006, the Company recognized income tax
expense of $28,000 associated with the alternative minimum tax. Taxable income for both 2007 and
2006 was substantially offset by the Company’s net operating loss carryforwards. We expect our 2008
effective tax rate to be minimal and substantially less than the statutory rates, resulting from
expected utilization of our net operating loss carryforwards.
Net Income. Net income was approximately $4.1 million, or $0.18 per diluted share, for the year
ended December 31, 2007 up from $2.5 million, or $0.11 per diluted share, for the year ended
December 31, 2006. This improvement is the result of the $2.0 million income tax benefit
and increased gross profits, but was somewhat offset by other expense increases mentioned above.
Net income per share for 2008 is expected to range between $0.12 and $0.15 per diluted share. Our
2008 estimates do not reflect an income tax benefit associated with the realization of additional
deferred tax assets. These estimates are subject to the risks and uncertainties as further
described in “Item 1A. Risk Factors” located elsewhere in this report.
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Table of Contents
2006 Compared to 2005
Revenues. Revenues increased approximately $4.4 million, or 16.2%, to $31.8 million for 2006 from
$27.4 million for 2005. Revenues for 2006 consisted of $25.1 million, or 78.9% of total revenue for
HealthStream Learning and $6.7 million, or 21.1% of total revenue for HealthStream Research. In
2005, revenues consisted of $22.9 million, or 83.6% of total revenue for HealthStream Learning and
$4.5 million, or 16.4% of total revenue for HealthStream Research.
Revenues for HealthStream Learning increased approximately $2.2 million, or 9.6%, during 2006.
Revenues from our Internet-based HLC subscriber base increased $2.2 million over 2005, resulting
primarily from growth in our subscriber base. Revenues from courseware subscriptions increased
$198,000 over the prior year. We also experienced declines in revenues from maintenance and support
fees associated with our installed learning management products of $243,000, and project-based
content development services of $108,000. Our Internet-based HLC subscriber base increased
approximately 15% during 2006, from approximately 1,173,000 fully implemented subscribers at the
end of 2005 to approximately 1,352,000 fully implemented subscribers at the end of 2006.
Revenues for HealthStream Research increased approximately $2.2 million, or 49.8%, during 2006.
Growth in HealthStream Research revenues during 2006 resulted from the full year impact of the DMR
acquisition and also included organic growth of $823,000. We experienced increased revenues from
our patient, physician, employee, and community survey instruments during 2006.
Cost of Revenues (excluding depreciation and amortization). Cost of revenues increased
approximately $1.1 million, or 11.5%, to $10.9 million for 2006 from $9.7 million for 2005. The
increase in cost of revenues resulted from incremental expenses associated with the growth in
survey and research services, and higher direct costs associated with the delivery of our live
event services, particularly a significant event held during the second quarter of 2006. In
addition, increased royalties paid by us and stock based compensation expense contributed to the
increase in cost of revenues over the prior year.
Cost of revenues for HealthStream Learning increased $727,000, or 8.8%, and approximated 35.8% and
36.1% of revenues for 2006 and 2005, respectively. Cost of revenue increases for HealthStream
Learning resulted from increased royalties paid by us, as well as expense overages in production
costs associated with a significant live event held during the second quarter of 2006, which
resulted in a financial loss of approximately $200,000.
Cost of revenues for HealthStream Research increased approximately $397,000, or 26.6%, and
approximated 28.1% and 33.3% of revenues for 2006 and 2005, respectively. This expense increase is
consistent with the increase in revenues.
Gross Margin (excluding depreciation and amortization). Gross margin (which we define as revenues
less cost of revenues divided by revenues) improved to 65.8% for 2006 from 64.4% during 2005. This
improvement is primarily the result of revenue increases associated with our Internet-based HLC and
our survey and research services, but was partially offset by lower margins from our live events
business. Gross margins for HealthStream Learning were 64.2% and 63.9% for 2006 and 2005,
respectively. This improvement resulted from increased revenues associated with our Internet-based
HLC product. Gross margins for HealthStream Research were 71.9% and 66.7% for 2006 and 2005,
respectively. This improvement resulted from changes in revenue mix of our survey products.
Product development. Product development expenses increased approximately $575,000, or 19.6%, to
$3.5 million for 2006 from $2.9 million for 2005. This increase resulted from HealthStream Learning
and was associated with additional personnel expenses and stock based compensation expense. Product
development efforts for 2006 were primarily associated with the
development and deployment of a new version of our Internet-based HLC
platform, the ongoing maintenance and support for our existing HLC learning
products, and product portfolio management as well as new courseware offerings and competency
tools. Product development expenses as a percentage of revenues approximated 11.0% of revenues for
2006 compared to 10.7% of revenues for 2005. In addition to the expenses incurred, we also
capitalized approximately $2.7 million and $1.1 million of costs associated with development of
software feature enhancements and content during 2006 and 2005, respectively.
Product development expenses for HealthStream Learning increased approximately $591,000, or 24.6%,
and approximated 11.9% and 10.5% of revenues for 2006 and 2005, respectively. The increase resulted
from additional personnel associated with the maintenance of our Internet-based learning products
and the development and deployment of new products, including a new version of our Internet-based HLC
platform. Product
development expenses for HealthStream Research increased approximately $94,000, or 34.3%, and
approximated 5.5% and 6.1% of revenues for 2006 and 2005, respectively. This expense increase
resulted from additional personnel. The unallocated corporate product development expenses
decreased approximately $111,000, primarily resulting from lower personnel expenses.
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Table of Contents
Sales and Marketing Expenses. Sales and marketing expenses, including personnel costs, increased
approximately $1.6 million, or 28.8%, to $7.0 million for 2006 from $5.4 million for 2005, and
approximated 22.1% and 19.9% of revenues for 2006 and 2005, respectively. The increase resulted
from additional sales personnel and account management personnel, increased direct marketing
campaign expenses, stock based compensation expense, and increased spending associated with our
annual customer conference, The Summit, which was attended by approximately 710 customer
representatives in 2006 compared to approximately 540 in 2005.
Sales and marketing expense for HealthStream Learning increased approximately $1.2 million, or
25.1%, and approximated 23.7% and 20.8% of revenues for 2006 and 2005, respectively. The expense
increases are associated with increases in sales and account management personnel, and increased
spending associated with direct marketing campaigns and The Summit. Sales and marketing expense for
HealthStream Research increased approximately $401,000, or 83.2%, and approximated 13.2% and 10.8%
of revenues for 2006 and 2005, respectively. The expense increase is associated with additional
sales and account management personnel. Sales and marketing expense for our unallocated corporate
functions decreased modestly during 2006.
Depreciation and Amortization. Depreciation and amortization increased approximately $211,000, or
7.9%, to $2.9 million for 2006 from $2.7 million for 2005. Amortization increased $343,000
associated with additional content fees and capitalized software feature enhancements. Depreciation
declined by $132,000 resulting from certain property and equipment reaching the end of their
estimated useful lives and fewer capital expenditures needed to replace equipment, which somewhat
offset the increase in amortization.
Other General and Administrative. Other general and administrative expenses increased approximately
$635,000, or 12.8%, to $5.6 million for 2006 from $5.0 million for 2005. This increase is primarily
associated with stock based compensation expense of $358,000, personnel expense increases, higher
employee recruiting costs, and expense increases associated with our status as a public company and
other corporate support functions. Other general and administrative expenses as a percentage of
revenues decreased to 17.6% for 2006 from 18.1% for 2005. The percentage decrease is a result of
the increases in revenues.
Other Income/Expense. Other income/expense increased approximately $281,000, or 83.2%, to $619,000
for 2006 from $338,000 for 2005. This increase resulted from an increase in interest income on
investment in marketable securities, attributable to both increased invested balances and higher
rates of return.
Provision for Income Taxes. The provision for income taxes for 2006 and 2005 is associated with the
federal alternative minimum tax. Taxable income for both 2006 and 2005 was substantially offset by
the utilization of our net operating loss carryforwards.
Net Income. Net income increased approximately $587,000, or 30.7%, to $2.5 million for 2006 from
$1.9 million for 2005. The improvement over 2005 resulted from the increase in revenues and other
factors mentioned above, noting that $682,000 of stock based compensation was expensed during 2006
with no comparable expense during 2005.
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SELECTED QUARTERLY OPERATING RESULTS
The following tables set forth selected statements of income data for the eight quarters ended
December 31, 2007 both in absolute dollars and as a percentage of total revenues. The information
for each quarter has been prepared on substantially the same basis as the audited statements
included in other parts of this report and, in our opinion, includes all adjustments, consisting of
only normal recurring adjustments, necessary for a fair presentation of the results of operations
for these periods. You should read this information in conjunction with HealthStream’s Consolidated
Financial Statements and related notes thereto included elsewhere in this report. The operating
results for any quarter are not necessarily indicative of the results to be expected in the future.
Factors
Affecting Quarterly Operating Results
Revenues from our subscription products are recognized ratably over the subscription term. Revenues
from sales of products and services to pharmaceutical and medical device companies can be subject
to seasonal factors resulting from the timing of conferences and live events. Survey and research
revenues are impacted by seasonal factors resulting from the volume, timing, and frequency of
survey cycles. The results of operations for TJO have been included in the Company’s statements of
income, effective March 13, 2007. During the fourth quarter of 2007, we recognized a portion of our
deferred tax assets, resulting in an income tax benefit of approximately $2.0 million.
| Quarter Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2007 | 2007 | 2007 | 2007 | |||||||||||||
| (In thousands, except per share data) | ||||||||||||||||
STATEMENT OF INCOME DATA: |
||||||||||||||||
Revenues, net |
$ | 8,101 | $ | 12,047 | $ | 11,809 | $ | 11,992 | ||||||||
Operating costs and expenses: |
||||||||||||||||
Cost of revenues (excluding depreciation and amortization) |
2,915 | 4,359 | 4,336 | 4,552 | ||||||||||||
Product development |
1,079 | 1,100 | 1,165 | 963 | ||||||||||||
Sales and marketing |
1,734 | 2,821 | 2,294 | 2,364 | ||||||||||||
Depreciation |
356 | 476 | 560 | 555 | ||||||||||||
Amortization |
500 | 722 | 757 | 577 | ||||||||||||
Other general and administrative expenses |
1,608 | 2,160 | 1,967 | 2,113 | ||||||||||||
Total operating costs and expenses |
8,192 | 11,639 | 11,079 | 11,124 | ||||||||||||
Income (loss) from operations |
(91 | ) | 408 | 730 | 868 | |||||||||||
Other income, net |
140 | 22 | 27 | 39 | ||||||||||||
Income before income taxes |
49 | 430 | 757 | 907 | ||||||||||||
Income tax provision (benefit) |
4 | 5 | 18 | (1,972 | ) | |||||||||||
Net income |
$ | 45 | $ | 425 | $ | 739 | $ | 2,879 | ||||||||
Net income
per
share:(1) |
||||||||||||||||
Basic |
$ | 0.00 | $ | 0.02 | $ | 0.03 | $ | 0.13 | ||||||||
Diluted |
$ | 0.00 | $ | 0.02 | $ | 0.03 | $ | 0.13 | ||||||||
Weighted average shares of common stock outstanding: |
||||||||||||||||
Basic |
21,936 | 21,970 | 22,025 | 22,064 | ||||||||||||
Diluted |
22,603 | 22,782 | 22,664 | 22,755 | ||||||||||||
| Quarter Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2006 | 2006 | 2006 | 2006 | |||||||||||||
| (In thousands, except per share data) | ||||||||||||||||
STATEMENT OF INCOME DATA: |
||||||||||||||||
Revenues, net |
$ | 7,523 | $ | 8,224 | $ | 7,481 | $ | 8,556 | ||||||||
Operating costs and expenses: |
||||||||||||||||
Cost of revenues (excluding depreciation and amortization) |
2,575 | 3,162 | 2,378 | 2,754 | ||||||||||||
Product development |
889 | 837 | 891 | 886 | ||||||||||||
Sales and marketing |
1,629 | 2,033 | 1,648 | 1,710 | ||||||||||||
Depreciation |
336 | 328 | 375 | 367 | ||||||||||||
Amortization |
308 | 339 | 385 | 452 | ||||||||||||
Other general and administrative expenses |
1,237 | 1,397 | 1,509 | 1,450 | ||||||||||||
Total operating costs and expenses |
6,974 | 8,096 | 7,186 | 7,619 | ||||||||||||
Income from operations |
549 | 128 | 295 | 937 | ||||||||||||
Other income, net |
134 | 153 | 165 | 167 | ||||||||||||
Income before income taxes |
683 | 281 | 460 | 1,104 | ||||||||||||
Income tax provision (benefit) |
25 | (8 | ) | (14 | ) | 25 | ||||||||||
Net income |
$ | 658 | $ | 289 | $ | 474 | $ | 1,079 | ||||||||
Net income per share:(1) |
||||||||||||||||
Basic |
$ | 0.03 | $ | 0.01 | $ | 0.02 | $ | 0.05 | ||||||||
Diluted |
$ | 0.03 | $ | 0.01 | $ | 0.02 | $ | 0.05 | ||||||||
Weighted average shares of common stock outstanding: |
||||||||||||||||
Basic |
21,284 | 21,475 | 21,619 | 21,928 | ||||||||||||
Diluted |
22,139 | 22,469 | 22,364 | 22,463 | ||||||||||||
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| Quarter Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2007 | 2007 | 2007 | 2007 | |||||||||||||
| (% of Revenues) | ||||||||||||||||
STATEMENT OF INCOME DATA: |
||||||||||||||||
Revenues |
100.0 | 100.0 | 100.0 | 100.0 | ||||||||||||
Operating costs and expenses: |
||||||||||||||||
Cost of revenues (excluding depreciation and amortization) |
36.0 | 36.2 | 36.7 | 38.0 | ||||||||||||
Product development |
13.3 | 9.1 | 9.9 | 8.0 | ||||||||||||
Sales and marketing |
21.4 | 23.4 | 19.4 | 19.7 | ||||||||||||
Depreciation |
4.4 | 4.0 | 4.7 | 4.6 | ||||||||||||
Amortization |
6.2 | 6.0 | 6.4 | 4.8 | ||||||||||||
Other general and administrative expenses |
19.9 | 17.9 | 16.7 | 17.6 | ||||||||||||
Total operating costs and expenses |
101.1 | 96.6 | 93.8 | 92.8 | ||||||||||||
Income (loss) from operations |
(1.1 | ) | 3.4 | 6.2 | 7.2 | |||||||||||
Other income, net |
1.7 | 0.2 | 0.2 | 0.4 | ||||||||||||
Income before income taxes |
0.6 | 3.6 | 6.4 | 7.6 | ||||||||||||
Income tax provision (benefit) |
0.1 | 0.1 | 0.1 | (16.4 | ) | |||||||||||
Net income |
0.5 | 3.5 | 6.3 | 24.0 | ||||||||||||
| Quarter Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2006 | 2006 | 2006 | 2006 | |||||||||||||
| (% of Revenues) | ||||||||||||||||
STATEMENT OF INCOME DATA: |
||||||||||||||||
Revenues |
100.0 | 100.0 | 100.0 | 100.0 | ||||||||||||
Operating costs and expenses: |
||||||||||||||||
Cost of revenues (excluding depreciation and amortization) |
34.2 | 38.4 | 31.8 | 32.2 | ||||||||||||
Product development |
11.8 | 10.2 | 11.9 | 10.3 | ||||||||||||
Sales and marketing |
21.7 | 24.7 | 22.0 | 20.0 | ||||||||||||
Depreciation |
4.5 | 4.0 | 5.1 | 4.3 | ||||||||||||
Amortization |
4.1 | 4.1 | 5.1 | 5.3 | ||||||||||||
Other general and administrative expenses |
16.4 | 17.0 | 20.2 | 16.9 | ||||||||||||
Total operating costs and expenses |
92.7 | 98.4 | 96.1 | 89.0 | ||||||||||||
Income from operations |
7.3 | 1.6 | 3.9 | 11.0 | ||||||||||||
Other income, net |
1.8 | 1.8 | 2.2 | 1.9 | ||||||||||||
Income before income taxes |
9.1 | 3.4 | 6.1 | 12.9 | ||||||||||||
Income tax provision (benefit) |
0.3 | (0.1 | ) | (0.2 | ) | 0.3 | ||||||||||
Net income |
8.8 | 3.5 | 6.3 | 12.6 | ||||||||||||
| (1) | – Due to the nature of interim earnings per share calculations, the sum of quarterly earnings per share amounts may not equal the reported earnings per share for the full year. |
Liquidity and Capital Resources
Net cash provided by operating activities was approximately $7.1 million during 2007 compared to
$4.0 million during 2006. Our primary sources of cash were generated from receipts from the sales
of our products and services. The number of days sales outstanding
(DSO) was 63 days for 2007 compared to 64 days for 2006. The Company
calculates DSO by dividing the average accounts receivable balance (excluding unbilled and other
receivables) by average daily revenues for the year. The $2.1 million increase in accounts
receivable at December 31, 2007 compared to December 31,
2006 resulted primarily from approximately $1.1 million in TJO
balances, as well as delays in
cash receipts from our HealthStream Learning customers, including delayed receipts of commercial
support grants, of which a portion relate to pass through expenses we paid during 2007. The primary uses of cash to fund our operations include personnel expenses, sales
commissions, royalty payments, payments for contract labor and other direct expenses associated
with delivery of our products and services, and general corporate expenses, as well as payments
associated with content development.
Net cash used in investing activities was approximately $13.9 million for 2007, while $536,000 of
cash was provided by investing activities during 2006. During 2007, we utilized approximately $11.8
million of cash and investments to purchase TJO, $2.6 million for software feature enhancements,
and $1.3 million for purchases of property and equipment, which was partially offset by net
proceeds from sales of investments in marketable securities of $1.7 million. Software feature
enhancement costs for both 2007 and 2006 were associated with development costs of the new version
of our Internet-based HLC platform and other new products, while hardware and software spending
supported our Internet-based product infrastructure and other operational requirements.
Net cash used in financing activities was approximately $286,000 for 2007, while $466,000 of cash
was provided by financing activities during 2006. The primary uses of cash during 2007 included
payments under the promissory note issued in connection with the
purchase of certain software licenses and capital lease obligations and
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repurchases of our common stock. The primary sources of cash for both 2007 and 2006 resulted from
proceeds associated with the issuance of common stock from both the exercise of employee stock
options and the Employee Stock Purchase Plan. Cash received from stock options is dependent on many
factors, including our stock price, option exercise prices, and the option holder’s intent to
exercise. Due to these factors we are unable to estimate future proceeds from stock options or rely
on such proceeds to support our cash requirements.
Although our revenues increased and net income improved over the prior year, we experienced a
working capital deficit at December 31, 2007 compared to positive working capital at December 31,
2006. The decrease in working capital resulted primarily from decreases in cash balances during
2007 to fund the acquisition of TJO and other capital expenditures, as well as increases in our
current liabilities, including deferred revenue and the current portion of long term debt. As of
December 31, 2007, our primary source of liquidity was $3.6 million of cash and cash equivalents,
restricted cash, and related interest receivable. The Company also has a $15.0 million revolving
credit facility loan agreement, all of which was available at December 31, 2007.
We believe that our existing cash and cash equivalents, restricted cash, related interest
receivable, cash generated from operations and available borrowings under our revolving credit facility will be sufficient to meet
anticipated cash needs for working capital, new product development and capital expenditures for at
least the next 12 months. As part of our growth strategy, we are actively reviewing possible
acquisitions that complement our products and services. We anticipate that future acquisitions, if
any, would be effected through a combination of stock and cash consideration. We may need to raise
additional capital through the issuance of equity or debt securities and/or borrowings under our
revolving credit facility, or another facility, to finance any future acquisitions. The issuance of
our stock as consideration for an acquisition would have a dilutive effect and could adversely
affect our stock price. There can be no assurance that additional sources of financing will be
available to us on acceptable terms, or at all, to consummate any acquisitions. Failure to generate
sufficient cash flow from operations or raise additional capital when required in sufficient
amounts and on terms acceptable to us could harm our business, financial condition and results of
operations.
Commitments and Contingencies
We expect that our capital expenditures, software feature enhancements, and content purchases will
approximate $5.0 million in 2008. We expect to fund these capital expenditures with existing cash
and investments and from cash generated from operations, and if necessary from our revolving credit
facility. From January 1 through February 29, 2008, we had capital expenditures of approximately
$266,000, primarily related to hardware, software, content, and software feature enhancements.
Our strategic alliances have typically provided for payments to content partners based on revenues
and development partners and other parties based on services rendered. We expect to continue
similar arrangements in the future. We have commitments under capital lease obligations for
computer hardware and operating lease commitments for our operating facilities in Nashville, TN,
Laurel, MD, Franklin, TN, and Denver, CO. We also have scheduled monthly payments due under a
promissory note.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements primarily consist of operating leases, purchase
commitments, and our revolving credit facility, which is described further in Note 13 to the
Company’s consolidated financial statements contained elsewhere in this report.
Recent Accounting Pronouncements
On September 20, 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS
No. 157 defines fair value, establishes a framework for measuring fair value in accordance with
accounting principles generally accepted in the United States, and expands disclosures about fair
value measurements. On February 12, 2008, the FASB issued FASB Staff Position SFAS No. 157-2,
Effective Date of FASB Statement No. 157 (the “FSP 157-2”). FSP 157-2 amended SFAS No. 157, to
delay the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial statements on a
recurring basis (that is, at least annually). FSP 157-2 defers the effective date of SFAS No. 157
to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years
for items within the scope of FSP 157-2. The Company is subject to the remaining provisions of SFAS
No. 157 beginning January 1, 2008. The adoption of SFAS No. 157 did not have a material impact on
our financial condition, results of operations, or cash flow.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities.” This new standard provides companies with an option to report selected
financial assets and liabilities at fair value. Generally accepted accounting principles have
required different measurement attributes for different assets and liabilities that can create
artificial volatility in earnings. The FASB believes that Statement 159 helps to mitigate this type
of accounting-induced volatility by enabling companies to report related
29
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assets and liabilities at fair value, which would likely reduce the need for companies to comply
with detailed rules for hedge accounting. Statement 159 also establishes presentation and
disclosure requirements designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities. The new Statement does not
eliminate disclosure requirements included in other accounting standards, including requirements
for disclosures about fair value measurements included in SFAS No. 157 and No. 107. This Statement
is effective beginning January 1, 2008 for the Company. Management does not believe the adoption of this new standard will have a
significant impact on the Company’s financial position and results of operations.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” Statement 141(R)
establishes principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling
interest in the acquiree and the goodwill acquired. Statement 141(R) changes the accounting for
acquisition-related restructuring cost accruals, the recognition of changes in the acquirer’s
income tax valuation allowance, and no longer permits the capitalization of certain acquisition
costs. In addition the Statement establishes disclosure requirements to enable the evaluation of
the nature and financial effects of the business combination. This Statement is effective beginning
January 1, 2009 for the Company. Management is currently evaluating the impact that adoption of
this new standard will have on Company’s financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial
Statements—an amendment of Accounting Research Bulletin No. 51.” Statement 160 establishes
accounting and reporting standards for ownership interests in subsidiaries held by parties other
than the parent, the amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained
noncontrolling equity investments when a subsidiary is deconsolidated. Statement 160 also
establishes disclosure requirements that clearly identify and distinguish between the interests of
the parent and the interests of the noncontrolling owners. This statement is effective beginning
January 1, 2009 for the Company. Management is currently evaluating the impact that adoption of
this new standard will have on Company’s financial position, results of operations or cash flows.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk from changes in interest rates. We do not have any foreign currency
exchange rate risk or commodity price risk. As of December 31, 2007, our outstanding indebtedness
included a promissory note of approximately $1.7 million and approximately $157,000 of capital
lease obligations. We may become subject to interest rate market risk associated with borrowings
under our revolving credit facility, which bears interest at a variable rate based on the 30 Day LIBOR Rate
plus 150 basis points. We are also exposed to market risk with respect to our cash balances. At
December 31, 2007, the Company had cash and cash equivalents, restricted cash, and related interest
receivable totaling approximately $3.6 million. Current investment rates of return approximate 4.5
– 5.0%. Assuming a 4.75% rate of return on $3.6 million, a hypothetical 10% decrease in interest
rates would decrease interest income and decrease net income on an annualized basis by
approximately $17,000.
The Company manages its investment risk by investing in corporate debt securities, foreign
corporate debt, secured corporate debt, and municipal 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. The Company also requires
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, the Company’s investment policy also limits concentration exposure and other
potential risk areas. As of December 31, 2006, all of our investments in marketable securities
were in auction rate securities. As of December 31, 2007, we maintained no investments in
marketable securities.
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.
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Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| Page | ||||
| 32 | ||||
| 33 | ||||
| 34 | ||||
| 35 | ||||
| 36 | ||||
| 37 | ||||
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of
HealthStream, Inc.
HealthStream, Inc.
We have audited the accompanying consolidated balance sheets of HealthStream, Inc. as of December
31, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity, and
cash flows for each of the three years in the period ended December 31, 2007. These financial
statements are the responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. We
were not engaged to perform an audit of the Company’s internal control over financial reporting.
Our audit included consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of HealthStream, Inc. at December 31, 2007 and 2006,
and the consolidated results of its operations and its cash flows for each of the three years in
the period ended December 31, 2007, in conformity with U.S. generally accepted accounting
principles.
As discussed in Note 1 to the consolidated financial statements, in 2007 the Company changed its
method of accounting for uncertainty in income taxes, and in 2006 the Company changed its method of
accounting for share-based payments.
/s/ Ernst & Young LLP
Nashville, Tennessee
March 27, 2008
March 27, 2008
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HEALTHSTREAM, INC.
CONSOLIDATED BALANCE SHEETS
| December 31, | December 31, | |||||||
| 2007 | 2006 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 3,599,346 | $ | 10,725,780 | ||||
Investments in marketable securities |
— | 1,700,000 | ||||||
Restricted cash |
13,504 | 264,714 | ||||||
Interest receivable |
17,340 | 68,435 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $72,895
and $112,234 at December 31, 2007 and 2006, respectively |
8,668,093 | 6,518,624 | ||||||
Accounts receivable — unbilled |
1,051,198 | 1,274,511 | ||||||
Deferred tax assets, current |
360,312 | — | ||||||
Prepaid development fees, net of amortization |
991,732 | 1,055,135 | ||||||
Other prepaid expenses and other current assets |
976,883 | 603,461 | ||||||
Total current assets |
15,678,408 | 22,210,660 | ||||||
Property and equipment: |
||||||||
Equipment |
11,812,721 | 8,218,525 | ||||||
Leasehold improvements |
1,800,633 | 1,773,701 | ||||||
Furniture and fixtures |
1,597,768 | 1,091,494 | ||||||
| 15,211,122 | 11,083,720 | |||||||
Less accumulated depreciation and amortization |
(10,827,932 | ) | (8,899,863 | ) | ||||
| 4,383,190 | 2,183,857 | |||||||
Capitalized software feature enhancements, net of accumulated amortization of $1,453,720
and $622,298 at December 31, 2007 and 2006, respectively |
4,458,644 | 2,572,111 | ||||||
Goodwill |
21,146,864 | 10,317,393 | ||||||
Intangible assets, net of accumulated amortization of $8,682,555
and $7,756,161 at December 31, 2007 and 2006, respectively |
5,704,587 | 2,755,981 | ||||||
Deferred tax assets, noncurrent |
1,629,550 | — | ||||||
Other assets |
360,214 | 968,484 | ||||||
Total assets |
$ | 53,361,457 | $ | 41,008,486 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 1,741,917 | $ | 1,616,105 | ||||
Accrued liabilities |
3,519,055 | 2,465,123 | ||||||
Accrued compensation and related expenses |
727,280 | 874,064 | ||||||
Registration liabilities |
7,243 | 240,399 | ||||||
Commercial support liabilities |
265,050 | 315,210 | ||||||
Deferred revenue |
9,492,970 | 5,375,625 | ||||||
Current portion of long term debt |
706,698 | — | ||||||
Current portion of capital lease obligations |
124,099 | 176,574 | ||||||
Total current liabilities |
16,584,312 | 11,063,100 | ||||||
Long term debt, less current portion |
1,031,037 | — | ||||||
Capital lease obligations, less current portion |
32,490 | 106,780 | ||||||
Other long term liabilities |
— | 204,167 | ||||||
Commitments and contingencies |
— | — | ||||||
Shareholders’ equity: |
||||||||
Common stock, no par value, 75,000,000 shares authorized;
22,315,485 and 21,928,687 shares issued and outstanding
at December 31, 2007 and 2006, respectively |
97,126,520 | 95,134,550 | ||||||
Accumulated deficit |
(61,412,902 | ) | (65,500,111 | ) | ||||
Total shareholders’ equity |
35,713,618 | 29,634,439 | ||||||
Total liabilities and shareholders’ equity |
$ | 53,361,457 | $ | 41,008,486 | ||||
See accompanying notes to the consolidated financial statements.
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HEALTHSTREAM, INC.
CONSOLIDATED STATEMENTS OF INCOME
| For the Year Ended December 31, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Revenues, net |
$ | 43,949,264 | $ | 31,783,469 | $ | 27,359,406 | ||||||
Operating costs and expenses: |
||||||||||||
Cost of revenues (excluding depreciation and amortization) |
16,162,505 | 10,869,303 | 9,745,470 | |||||||||
Product development |
4,307,738 | 3,502,790 | 2,928,112 | |||||||||
Sales and marketing |
9,212,405 | 7,020,051 | 5,452,168 | |||||||||
Depreciation |
1,947,998 | 1,405,616 | 1,537,959 | |||||||||
Amortization |
2,555,182 | 1,483,552 | 1,140,481 | |||||||||
Other general and administrative expenses |
7,848,058 | 5,593,026 | 4,958,508 | |||||||||
Total operating costs and expenses |
42,033,886 | 29,874,338 | 25,762,698 | |||||||||
Income from operations |
1,915,378 | 1,909,131 | 1,596,708 | |||||||||
Other income (expense): |
||||||||||||
Interest and other income |
286,930 | 657,431 | 367,707 | |||||||||
Interest and other expense |
(60,595 | ) | (38,838 | ) | (29,984 | ) | ||||||
Total other income (expense) |
226,335 | 618,593 | 337,720 | |||||||||
Income before income taxes |
2,141,713 | 2,527,724 | 1,934,428 | |||||||||
Income tax (benefit) provision |
(1,945,496 | ) | 28,044 | 21,500 | ||||||||
Net income |
$ | 4,087,209 | $ | 2,499,680 | $ | 1,912,928 | ||||||
Net income per share: |
||||||||||||
Basic |
$ | 0.19 | $ | 0.12 | $ | 0.09 | ||||||
Diluted |
$ | 0.18 | $ | 0.11 | $ | 0.09 | ||||||
Weighted average shares of common stock outstanding: |
||||||||||||
Basic |
21,998,845 | 21,576,553 | 21,051,373 | |||||||||
Diluted |
22,700,996 | 22,358,648 | 21,942,182 | |||||||||
See accompanying notes to the consolidated financial statements.
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HEALTHSTREAM, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
| Total | ||||||||||||||||
| Common Stock | Accumulated | Shareholders’ | ||||||||||||||
| Shares | Amount | Deficit | Equity | |||||||||||||
Balance at December 31, 2004 |
20,667,515 | $ | 91,642,383 | $ | (69,912,719 | ) | $ | 21,729,664 | ||||||||
Net income |
— | — | 1,912,928 | 1,912,928 | ||||||||||||
Exercise of stock options |
344,413 | 654,955 | — | 654,955 | ||||||||||||
Issuance of common stock to Employee Stock Purchase Plan |
83,742 | 159,445 | — | 159,445 | ||||||||||||
Issuance of common stock in connection with acquisition |
479,234 | 1,343,149 | — | 1,343,149 | ||||||||||||
Balance at December 31, 2005 |
21,574,904 | 93,799,932 | (67,999,791 | ) | 25,800,141 | |||||||||||
Net income |
— | — | 2,499,680 | 2,499,680 | ||||||||||||
Stock based compensation |
— | 682,068 | — | 682,068 | ||||||||||||
Exercise of stock options |
285,681 | 490,467 | — | 490,467 | ||||||||||||
Issuance of common stock to Employee Stock Purchase Plan |
68,102 | 162,083 | — | 162,083 | ||||||||||||
Balance at December 31, 2006 |
21,928,687 | 95,134,550 | (65,500,111 | ) | 29,634,439 | |||||||||||
Net income |
— | — | 4,087,209 | 4,087,209 | ||||||||||||
Stock based compensation |
— | 742,344 | — | 742,344 | ||||||||||||
Exercise of stock options |
123,697 | 248,517 | — | 248,517 | ||||||||||||
Issuance of common stock to Employee Stock Purchase Plan |
37,685 | 121,723 | — | 121,723 | ||||||||||||
Issuance of common stock in connection with acquisition |
252,616 | 960,170 | — | 960,170 | ||||||||||||
Repurchase of common stock |
(27,200 | ) | (80,784 | ) | — | (80,784 | ) | |||||||||
Balance at December 31, 2007 |
22,315,485 | $ | 97,126,520 | $ | (61,412,902 | ) | $ | 35,713,618 | ||||||||
See accompanying notes to the consolidated financial statements.
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HEALTHSTREAM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the Year Ended December 31, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
OPERATING ACTIVITIES: |
||||||||||||
Net income |
$ | 4,087,209 | $ | 2,499,680 | $ | 1,912,928 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||||
Depreciation |
1,947,998 | 1,405,616 | 1,537,959 | |||||||||
Amortization |
2,555,182 | 1,483,552 | 1,140,481 | |||||||||
Income tax (benefit) from recognition of deferred tax assets |
(1,989,862 | ) | — | — | ||||||||
Stock based compensation expense |
742,344 | 682,068 | — | |||||||||
Impairment of capitalized software feature enhancements |
— | — | 55,000 | |||||||||
Provision for doubtful accounts |
30,000 | 15,000 | 40,000 | |||||||||
Realized loss on disposal of property and equipment |
844 | 2,713 | 5,698 | |||||||||
Changes in operating assets and liabilities, excluding effects of acquisitions: |
||||||||||||
Accounts and unbilled receivables |
(110,661 | ) | (2,410,722 | ) | (524,468 | ) | ||||||
Restricted cash |
251,210 | (26,176 | ) | (54,497 | ) | |||||||
Interest receivable |
51,095 | (13,911 | ) | (28,625 | ) | |||||||
Prepaid development fees |
(642,297 | ) | (730,083 | ) | (428,509 | ) | ||||||
Other prepaid expenses and other current assets |
(234,473 | ) | (115,137 | ) | 164,614 | |||||||
Other assets |
371,562 | 2,806 | 91,044 | |||||||||
Accounts payable |
125,812 | 682,210 | 68,155 | |||||||||
Accrued liabilities and accrued compensation and related expenses |
(20,667 | ) | 657,151 | 475,073 | ||||||||
Registration liabilities |
(233,156 | ) | 9,257 | 56,445 | ||||||||
Commercial support liabilities |
(50,160 | ) | (923,914 | ) | 860,231 | |||||||
Deferred revenue |
223,310 | 777,701 | 427,710 | |||||||||
Net cash provided by operating activities |
7,105,290 | 3,997,811 | 5,799,239 | |||||||||
INVESTING ACTIVITIES: |
||||||||||||
Acquisitions, net of cash acquired |
(11,814,274 | ) | (270,004 | ) | (9,524,076 | ) | ||||||
Proceeds from maturities and sale of investments in marketable securities |
2,500,000 | 18,785,000 | 20,500,000 | |||||||||
Purchases of investments in marketable securities |
(800,000 | ) | (14,303,816 | ) | (12,650,000 | ) | ||||||
Payments associated with capitalized software feature enhancements |
(2,566,438 | ) | (2,274,684 | ) | (626,122 | ) | ||||||
Purchases of property and equipment |
(1,264,565 | ) | (1,400,637 | ) | (752,222 | ) | ||||||
Net cash (used in) provided by investing activities |
(13,945,277 | ) | 535,859 | (3,052,420 | ) | |||||||
FINANCING ACTIVITIES: |
||||||||||||
Issuance of common stock to Employee Stock Purchase Plan |
121,723 | 162,083 | 159,445 | |||||||||
Proceeds from exercise of stock options |
248,517 | 490,467 | 654,955 | |||||||||
Repurchase of common stock |
(80,784 | ) | — | — | ||||||||
Payments on capital lease obligations |
(171,675 | ) | (186,591 | ) | (92,440 | ) | ||||||
Payments on promissory note |
(404,228 | ) | — | — | ||||||||
Borrowings under revolving credit facility |
(1,500,000 | ) | — | — | ||||||||
Payments under revolving credit facility |
1,500,000 | — | — | |||||||||
Net cash (used in) provided by financing activities |
(286,447 | ) | 465,959 | 721,960 | ||||||||
Net (decrease) increase in cash and cash equivalents |
(7,126,434 | ) | 4,999,629 | 3,468,779 | ||||||||
Cash and cash equivalents at beginning of period |
10,725,780 | 5,726,151 | 2,257,372 | |||||||||
Cash and cash equivalents at end of period |
$ | 3,599,346 | $ | 10,725,780 | $ | 5,726,151 | ||||||
SUPPLEMENTAL CASH FLOW INFORMATION: |
||||||||||||
Interest paid |
$ | 59,398 | $ | 36,404 | $ | 23,524 | ||||||
Income taxes paid |
$ | 43,000 | $ | 21,000 | $ | 15,000 | ||||||
NON-CASH INVESTING AND FINANCING ACTIVITIES: |
||||||||||||
Capital lease obligations incurred |
$ | — | $ | 88,067 | $ | 420,777 | ||||||
Acquisition of content rights in exchange for future services |
$ | 191,667 | $ | 904,167 | $ | — | ||||||
Issuance of common stock in connection with acquisitions |
$ | 960,170 | $ | — | $ | 1,343,149 | ||||||
Purchase of property and equipment through issuance of long term debt |
$ | 2,141,963 | $ | — | $ | — | ||||||
See accompanying notes to the consolidated financial statements.
36
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Reporting Entity and Segments
HealthStream, Inc. (the “Company”) was incorporated in 1990 as a Tennessee corporation and is
headquartered in Nashville, Tennessee. We operate our business in two segments: 1) HealthStream
Learning and 2) HealthStream Research. Our HealthStream Learning products consist of
Internet-based services and solutions to meet the ongoing training, information, and education
needs of the healthcare community. These solutions provide, deliver and track computer based
education for our customers in the United States through our application service provider (ASP)
products. We also develop, manage, and distribute online, live, and print education and training
activities for provider-based healthcare professionals and physicians as well as online education
and training activities for medical industry sales representatives. HealthStream Research products
offer healthcare organizations a wide range of quality and satisfaction surveys, analyses of
survey results, and other research-based services.
Recognition of Revenue
Revenues are derived from providing services through our Internet-based learning products,
provision of survey and research services, maintenance and support of our installed learning
management products, courseware subscriptions, live event development, content maintenance and
development and other education and training services.
We recognize revenue in accordance with American Institute of Certified Public Accountants (AICPA)
Statement of Position (SOP) 97-2, “Software Revenue Recognition,” SEC Staff Accounting Bulletin
No. 104, “Revenue Recognition,” Emerging Issues Task Force (EITF) Issue No. 99-19 “Reporting
Revenue Gross Versus Net,” EITF Issue No. 00-3 “Application of AICPA Statement of Position 97-2,
Software Revenue Recognition, to Arrangements that Include the Right to Use Software Stored on
Another Entity’s Hardware,” EITF Issue No. 00-21 “Revenue Arrangements with Multiple Deliverables”
and other authoritative guidance. This guidance provides that revenue recognized from software and
other arrangements is to be allocated to each element of the arrangement based on the relative
fair values of the elements. While elements include software products and post contract customer
support, fair value of each element is based on objective evidence specific to the vendor. If fair
value cannot be determined for each element of the arrangement, all revenue from the arrangement
is deferred until fair value can be determined or until all elements of the arrangement are
delivered and customer acceptance has occurred. Sales of our Internet-based learning products
include customer support, implementation services, and training; therefore all revenues are
deferred until the Internet-based learning product is implemented, at which time revenues are
recognized ratably over the subscription service period. In the event that circumstances occur,
which give rise to uncertainty regarding the collectibility of contracted amounts, revenue
recognition is suspended until such uncertainty is resolved. Fees for these services are billed on
either a monthly, quarterly, or annual basis.
Revenues derived from the delivery of services through our Internet-based learning products and
courseware subscriptions are recognized ratably over the term of the subscription service
agreement. Software support and maintenance revenues associated with our installed learning
management products are recognized ratably over the term of the related agreement, generally one
year. Other training revenues are generally recognized upon the completion of training.
Revenues recognized from our survey and research services are determined using both the
proportional performance method and the completed contract method. Revenues are generally earned
over the estimated survey cycle, which typically ranges from less than one month to up to five
months. The survey cycle is generally initiated based on the receipt of the first survey response
and runs through provision of related survey reports to the customer. If survey results are not
available to the customer during the survey fielding cycle, revenues are recognized at time of
report delivery. All other revenues are recognized as the related services are performed or
products are delivered. Fees for these services are billed upon initiation of the survey cycle,
with progress billings made throughout the survey cycle.
Revenues derived from live event development services are recognized using the proportional
performance method based on the completion of performance milestones. Revenues from professional
services, content maintenance, and custom development services are recognized using a percentage
of completion method based on labor hours, which correspond to the completion of performance
milestones and deliverables. All other revenues are recognized as the related services are
performed or products are delivered. Fees for these services are generally billed at project
initiation and upon completion of various milestones.
37
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries,
all of which are wholly-owned. All inter-company accounts and transactions have been eliminated in
consolidation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes. Actual results
could differ from those estimates and such differences could be material to the consolidated
financial statements.
Cash and Cash Equivalents
We consider cash and cash equivalents to be unrestricted, highly liquid investments with initial
maturities of less than three months.
Restricted Cash
Cash received for registration fees is classified as restricted cash on the accompanying
consolidated balance sheets. The use of this cash is restricted because it is held on behalf of
the commercial supporter until services have been rendered, at which time the registration fees
are used to pay certain expenses and fees for conducting those services. Excess registration funds
are typically remitted to the commercial supporter or applied to other projects. Any deficiency in
registration funds is billed to the commercial supporter.
Accounts Receivable-Unbilled and Deferred Revenue
Accounts receivable-unbilled represents revenue earned for contracts accounted for on the
proportional performance basis for which invoices have not been generated or contractual billing
dates have not been reached. Deferred revenue represents amounts, which have been billed or
collected, but not yet recognized in revenue.
Allowance for Doubtful Accounts
The Company estimates its allowance for doubtful accounts using a specific identification method.
Management determines the allowance for doubtful accounts on a case-by-case basis, based on the
facts and circumstances surrounding each potentially uncollectible receivable. An allowance is
also maintained for accounts that are not specifically identified that may become uncollectible in
the future. Uncollectible receivables are written-off in the period management believes it has
exhausted every opportunity to collect payment from the customer. Bad debt expense is recorded
when events or circumstances indicate an additional allowance is required based on our specific
identification approach.
Changes in the allowance for doubtful accounts and the amounts charged to bad debt expense were as
follows:
| Allowance Balance at | Charged to Costs and | Allowance Balance at | ||||||||||||||
| Beginning of Period | Expenses | Write-offs | End of Period | |||||||||||||
Year ended December 31, |
||||||||||||||||
2007 |
$ | 112,234 | $ | 30,000 | $ | 69,339 | $ | 72,895 | ||||||||
2006 |
$ | 115,090 | $ | 15,000 | $ | 17,856 | $ | 112,234 | ||||||||
2005 |
$ | 234,167 | $ | 40,000 | $ | 159,077 | $ | 115,090 | ||||||||
38
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Investments in marketable securities
Investments in marketable securities are classified as available-for-sale and are stated at fair
market value, with any unrealized gains and losses, net of tax, reported in other comprehensive
income on the accompanying consolidated balance sheets. Realized gains and losses and declines in
market value judged to be other-than-temporary on investments in marketable securities are
included in interest and other income on the accompanying consolidated statements of income. The
cost of securities sold is based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in interest and other income on the
accompanying consolidated statements of income.
The Company has historically invested in auction rate securities, corporate debt securities,
foreign corporate debt and secured corporate debt securities with minimum acceptable credit
ratings. The Company has classified investments in auction rate securities as short-term
investments although their scheduled maturities may have been greater than 12 months. This
determination was based on management’s intent of holding such securities for less than 12 months
from the balance sheet date. The Company held no investments in marketable securities as of
December 31, 2007.
Capitalized Software Feature Enhancements
We account for capitalized software feature enhancements in accordance with SOP 98-1 “Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use.” Capitalized software
feature enhancements are stated on the basis of cost, and are presented net of accumulated
amortization. We capitalize costs incurred during the development phase for such projects when
such costs are material. These assets are amortized using the straight-line method, generally over
one to four years. The Company capitalized approximately $2.6 million and $2.3 million during 2007
and 2006, respectively. Maintenance and operating costs are expensed as incurred. As of December
31, 2007 and 2006, we had no capitalized internal development costs for computer software
developed for resale.
Property and Equipment
Property and equipment are stated on the basis of cost. Depreciation and amortization are provided
on the straight-line method over the following estimated useful lives, except for assets under
capital leases and leasehold improvements, which are amortized over the shorter of the estimated
useful life or their respective lease term.
| Years | ||||
Furniture and fixtures |
5-10 | |||
Equipment |
3-5 | |||
Goodwill and Intangible Assets
Goodwill represents the excess of purchase price over fair value of net tangible assets acquired.
We account for goodwill and intangible assets in accordance with Statement of Financial Accounting
Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” We measure goodwill for
impairment at the reporting unit level using a discounted cash flow model to determine the fair
value of the reporting units. We will perform our goodwill impairment test whenever events or
changes in facts or circumstances indicate that impairment may exist, or at least annually during
the fourth quarter each year.
Intangible assets acquired through acquisitions are comprised of content, contract rights,
customer relationships, non-competition agreements and favorable lease rights. As of December 31,
2007 intangible assets with remaining unamortized balances include contract rights, customer
relationships and non-competition agreements recorded in connection with the acquisitions of The
Jackson Organization, Research Consultants, Inc. (TJO) and Data Management and Research, Inc.
(DMR). Intangible assets are considered to have definite useful lives and are being amortized on
a straight line basis over the expected periods to be benefited, generally three to five years for
content, two to eight years for contract rights, customer lists and customer relationships, six
months to four years for non-competition agreements, and over the lease term for favorable lease
rights. Our weighted average amortization period for definite lived intangible assets as of
December 31, 2007 is 7.7 years. Intangible assets are reviewed for impairment whenever events or
changes in facts or circumstances indicate that the carrying amount of the assets may not be
recoverable.
39
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Long-Lived Assets
We account for assets of a long term nature (“long-lived assets”) in accordance with SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets,” which requires that companies
consider whether events or changes in facts and circumstances, both internally and externally, may
indicate that an impairment of long-lived assets held for use are present. We measure any
impairment using observable market values or
discounted future cash flows from the related
long-lived assets. The cash flow estimates and discount rates incorporate management’s best
estimates, using appropriate and customary assumptions and projections at the date of evaluation.
Management periodically evaluates the carrying value of long-lived assets, including property and
equipment, other assets and intangible assets. We recorded a $55,000 impairment charge within our
Learning segment associated with capitalized software feature enhancements for the year ended
December 31, 2005. There were no impairments identified or recorded for the years ended December
31, 2007 or 2006.
Other Assets
Other assets are comprised of the long term portion of content development fees and other assets
of a long term nature.
Income Taxes
Income taxes have been provided using the liability method in accordance with SFAS No. 109,
“Accounting for Income Taxes.” Under the liability method, deferred tax assets and liabilities are
determined based on the temporary differences between the financial statement and tax bases of
assets and liabilities measured at tax rates that will be in effect for the year in which the
differences are expected to affect taxable income. Under SFAS No. 109, all available evidence,
both positive and negative, should be considered to determine whether, based on the weight of that
evidence, a valuation allowance is needed. Future realization of the tax benefit of an existing
deductible temporary difference or carryforward ultimately depends on the existence of sufficient
taxable income of the appropriate character within the carryback or carryforward period available
under the tax law. SFAS No. 109 identifies four possible sources of taxable income that may be
available under the tax law to realize a tax benefit for deductible temporary differences and
carryforwards: 1) future reversals of existing taxable temporary differences, 2) future taxable
income exclusive of reversing temporary differences and carryforwards, 3) taxable income in prior
carryback year(s) if carryback is permitted under the tax law, and 4) tax-planning strategies that
would, if necessary, be implemented to realize deductible temporary differences or carryforwards
prior to their expiration. Management reviews the realizability of deferred tax assets each period
and has established a valuation allowance for the portion of its net deferred tax assets that are
not more likely than not expected to be realized.
Beginning January 1, 2007, the Company accounts for income tax uncertainties under the provisions
of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of
FASB Statement No. 109” (“FIN 48”). This Interpretation clarifies the accounting for uncertainty
in income taxes recognized in the financial statements, and requires companies to use a
more-likely-than-not recognition threshold based on the technical merits of the tax position
taken. Tax positions that meet the more-likely-than-not recognition threshold should be measured
in order to determine the tax benefit to be recognized in the
financial statements. The Company expenses any penalties or interest
associated with tax obligations as general and administrative
expenses and interest expense, respectively. The Company did not
record a transition adjustment upon adoption of FIN 48.
Commercial Support Liabilities
Commercial support liabilities represent grant funds received from entities supporting educational
activities, such as live events, in which we are the accredited provider. The funds are
unrestricted, and are primarily used to pay for expenses associated with conducting the event.
Accrual for Service Interruptions
We maintain an accrual for service interruptions that may occur from our Internet-based learning
products. The accrual is estimated using management’s judgment and analysis of potential risk of
loss associated with downtime of our hosted applications. At December 31, 2007, and 2006, the
accrual for service interruptions balance was approximately $394,000 and $314,000, respectively,
and is included on the accompanying consolidated balance sheets under the caption “accrued
liabilities.”
Advertising
We expense the costs of advertising as incurred in accordance with SOP 93-7, “Reporting on
Advertising Costs.” Advertising expense for the years ended December 31, 2007, 2006, and 2005 was
approximately $226,000, $329,000, and $123,000, respectively.
40
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Shipping and Handling Costs
Shipping and handling costs that are associated with our products and services are included in
cost of revenues.
Product Development Costs
Product development costs include internal and external costs to develop and convert content for
our Internet-based learning and installed learning management products. We account for these
assets in accordance with EITF Issue No. 00-2 “Accounting for Web Site Development Costs.” We
capitalize the cost of content developed by third parties where the life expectancy is greater
than one year and the anticipated cash flows from such content is expected to exceed its cost. The
Company capitalized approximately $317,000 and $399,000 of content development costs during 2007
and 2006, respectively. Capitalized content development costs are included in the accompanying
consolidated balance sheets under the captions “prepaid development fees” and “other assets.” We
amortize content development over its expected life, which is generally one to three years.
Content development costs that have been capitalized are subject to a periodic impairment review
in accordance with our policy. We did not capitalize any internal web site development costs
during 2007 or 2006, since the costs were related to planning or operation of such products and
sites.
Net Income Per Share
We compute net income per share in accordance with SFAS No. 128, “Earnings Per Share.” Under the
provisions of Statement 128, basic net income per share is computed by dividing the net income
available to common shareholders for the period by the weighted average number of common shares
outstanding during the period. Diluted net income per share is computed by dividing the net income
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, escrowed or restricted shares, and shares subject to
vesting are included in diluted net income per share to the extent these shares are dilutive.
Common equivalent shares are dilutive when the average market price during the period exceeds the
exercise price of the underlying shares. Common equivalent shares that have an anti-dilutive
effect on diluted net income per share have been excluded from the calculation of diluted weighted
average shares outstanding for the years ended December 31, 2007, 2006, and 2005.
Concentrations of Credit Risk and Significant Customers
We place our temporary excess cash investments in high quality, short-term money market
instruments. At times, such investments may be in excess of the FDIC insurance limits.
We sell our products and services to various companies in the healthcare industry that are located
in the United States. We perform ongoing credit evaluations of our customers’ financial condition
and generally require no collateral from customers. We did not have any single customer
representing over 10% of net revenues during 2007. We had one significant customer, HCA, who
comprised approximately 11%, or $3.5 million, of net revenues during 2006 and approximately 14% or
$3.9 million, of net revenues during 2005. The total amounts receivable from HCA at December 31,
2006 was approximately $470,000.
Stock Based Compensation
As of December 31, 2007, the Company has two stock based compensation plans, which are described
in Note 11. Prior to January 1, 2006, we accounted for stock option grants in accordance with
Accounting Principles Board Opinion (APB) No. 25 “Accounting for Stock Issued to Employees” and
related interpretations. During the year ended December 31, 2005, we did not recognize stock based
compensation expense within our consolidated statements of income because the exercise price of
our employee stock options was not less than the market price of the underlying stock on the date
of grant.
The Company adopted SFAS No. 123(R), “Share-Based Payment” on January 1, 2006 and implemented it
using the modified-prospective method for transition purposes. Therefore, prior period financial
results have not been restated. The modified-prospective method requires compensation expense to
be recorded for all unvested share-based payments outstanding prior to adoption and for all
share-based payments issued subsequent to adoption using a fair value approach. We use the Black
Scholes option pricing model for calculating the fair value of awards issued under our stock based
compensation plans.
The impact on our results from operations from adopting SFAS No. 123(R) resulted in additional
compensation expense of approximately $742,000, or $0.03 per diluted share for 2007, and
approximately $682,000, or $0.03 per diluted share for 2006.
41
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Prior to adopting SFAS No. 123(R), we accounted for our stock based compensation plans under the
intrinsic value-based method of accounting prescribed by APB 25 and related interpretations. The
following pro forma table reflects our net income and net income per share had the fair value
provisions of SFAS No. 123 “Accounting for Stock Based Compensation” been followed during the year
ended December 31, 2005:
| Year Ended | ||||
| December 31, | ||||
| 2005 | ||||
Net income as reported |
$ | 1,912,928 | ||
Add: Stock based employee compensation expense included in reported
net income, 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 |
(586,804 | ) | ||
Pro forma net income |
$ | 1,326,124 | ||
Basic net income per share – as reported |
$ | 0.09 | ||
Basic net income per share – pro forma |
$ | 0.06 | ||
Diluted net income per share – as reported |
$ | 0.09 | ||
Diluted net income per share – pro forma |
$ | 0.06 | ||
Fair Value of Financial Instruments
The following methods and assumptions were used in estimating fair value for financial
instruments:
Cash, cash equivalents and restricted cash: The carrying amounts approximate the fair value
because of the short-term maturity or short-term nature of such instruments.
Accounts receivable, accounts receivable-unbilled, interest receivable, accounts payable, accrued
liabilities and deferred revenue: The carrying amounts, net of any allowance for doubtful
accounts, approximate the fair value because of the short-term nature of such instruments.
Investments in marketable securities: The carrying amounts approximate the fair value based on
quoted market prices.
Promissory
Note: The carrying amount approximates fair value based on
current market rates for similar arrangements available to the
Company.
Newly Issued Accounting Standards
On September 20, 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”).
SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance
with accounting principles generally accepted in the United States, and expands disclosures about
fair value measurements. On February 12, 2008, the FASB issued FASB Staff Position SFAS No. 157-2,
Effective Date of FASB Statement No. 157 (the “FSP 157-2”). FSP 157-2 amended SFAS No. 157, to
delay the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial statements on a
recurring basis (that is, at least annually). FSP 157-2 defers the effective date of SFAS No. 157
to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years
for items within the scope of FSP 157-2. The Company is subject to the remaining provisions of
SFAS No. 157 beginning January 1, 2008. The adoption of SFAS No. 157 did not have a material
impact on our financial condition, results of operations, or cash flow.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities.” This new standard provides companies with an option to report selected
financial assets and liabilities at fair value. Generally accepted accounting principles have
required different measurement attributes for different assets and liabilities that can create
artificial volatility in earnings. The FASB believes that Statement 159 helps to mitigate this
type of accounting-induced volatility by enabling companies to report related assets and
liabilities at fair value, which would likely reduce the need for companies to comply with
detailed rules for hedge accounting. Statement 159 also establishes presentation and disclosure
requirements designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities. The new Statement does not
eliminate disclosure requirements included in other accounting standards, including requirements
for disclosures about fair value measurements included in SFAS No. 157 and No. 107. This Statement
is effective beginning January 1, 2008 for the Company. Management does not believe the adoption of this new standard will have a
significant impact on the Company’s financial position and results of operations.
42
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” Statement 141(R)
establishes principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling
interest in the acquiree and the goodwill acquired. Statement 141(R) changes the accounting for
acquisition-related restructuring cost accruals, the recognition of changes in the acquirer’s
income tax valuation allowance, and no longer permits the capitalization of certain acquisition
costs. In addition the Statement establishes disclosure requirements to enable the evaluation of
the nature and financial effects of the business combination. This Statement is effective
beginning January 1, 2009 for the Company. Management is currently evaluating the impact that
adoption of this new standard will have on Company’s financial position, results of operations or
cash flows.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated
Financial Statements—an amendment of Accounting Research Bulletin No. 51.” Statement 160
establishes accounting and reporting standards for ownership interests in subsidiaries held by
parties other than the parent, the amount of consolidated net income attributable to the parent
and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of
retained noncontrolling equity investments when a subsidiary is deconsolidated. Statement 160 also
establishes disclosure requirements that clearly identify and distinguish between the interests of
the parent and the interests of the noncontrolling owners. This statement is effective beginning
January 1, 2009 for the Company. Management is currently evaluating the impact that adoption of
this new standard will have on Company’s financial position, results of operations or cash flows.
2. BUSINESS COMBINATION
On March 12, 2007, the Company acquired all of the stock of The Jackson Organization, Research
Consultants, Inc. (TJO). TJO provides healthcare organizations a wide range of quality and
satisfaction surveys, data analyses of survey results, and other research-based measurement tools.
The acquisition of TJO complements our existing research business and expands our service
offerings to the healthcare industry. Consideration paid to the seller of TJO included
approximately $11.5 million in cash and 252,616 shares of our common stock. The Company also
incurred direct, incremental expenses associated with the acquisition of approximately $680,000
through December 31, 2007, which are included in the table below in “purchase price in excess of
net tangible assets acquired” and “cash paid.” Total cash paid of $12.2 million includes cash paid
for TJO and direct expenses associated with the acquisition. All of the common stock shares issued
in the acquisition 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. Of the
cash consideration portion, approximately $1.6 million is being held in escrow pending
satisfaction of certain items pursuant to the stock purchase agreement. During the fourth quarter
of 2007, management completed its valuation analysis associated with acquired intangible assets,
which resulted in a revision to the allocation of purchase price associated with intangible
assets. The Company reduced the valuation to customer-related intangibles by $1.9 million and
non-competition agreements by $200,000. The allocation of purchase price is as follows:
Estimated fair value of tangible assets acquired |
$ | 2,856,480 | ||
Estimated fair value of liabilities assumed |
(4,419,409 | ) | ||
Purchase price in excess of net tangible assets acquired |
14,704,471 | |||
Less fair value of stock issued |
(960,170 | ) | ||
Cash paid |
12,181,372 | |||
Less cash acquired |
(97,094 | ) | ||
Net cash paid for acquisition, including expenses |
$ | 12,084,278 | ||
The purchase price in excess of the net tangible assets acquired was allocated as follows:
Goodwill |
$ | 10,829,471 | ||
Customer
related intangibles (estimated life of eight years) |
3,575,000 | |||
Non-compete
agreement (estimated life of four years) |
300,000 |
The results of operations for TJO have been included in the Company’s statement of income
beginning March 13, 2007.
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. BUSINESS COMBINATION (continued)
The following unaudited combined results of operations give effect to the operations of TJO as if
the acquisition had occurred as of January 1, 2006. These unaudited combined results of operations
include certain adjustments arising from the acquisition such as adjustment for TJO shareholder
compensation, amortization of intangible assets, elimination of acquisition costs incurred by TJO,
and the elimination of interest income associated with cash paid for TJO by the Company. The pro
forma combined 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.
| Year Ended December 31, | ||||||||
| 2007 | 2006 | |||||||
Revenues, net |
$ | 46,499,403 | $ | 42,619,996 | ||||
Net income |
$ | 4,366,948 | $ | 1,992,765 | ||||
Net income per share: |
||||||||
Basic |
$ | 0.20 | $ | 0.09 | ||||
Diluted |
$ | 0.19 | $ | 0.09 | ||||
3. SHAREHOLDERS’ EQUITY
Common Stock
We are authorized to issue up to 75 million shares of common stock. The number of common shares
issued and outstanding as of December 31, 2007 and 2006 was 22,315,485 and 21,928,687,
respectively. During September 2007, our Board of Directors authorized the Company to purchase up
to $3.0 million of its common stock. Share repurchases under this program may be made through open
market or privately negotiated transactions in accordance with all applicable securities laws,
rules, and regulations. The transactions may be made at times and in such amounts as management
deems appropriate and will be funded from available working capital. The number of shares to be
purchased and the timing of purchases will be based on several factors, including the market price
of the Company’s common stock, general business and market conditions, and other investment
opportunities. The share repurchase program expires one year from its initiation and may be
limited or terminated at any time without prior notice. As of December 31, 2007, the Company had
repurchased 27,200 shares for approximately $79,967, excluding broker commissions.
Preferred Stock
We are authorized to issue up to 10 million shares of preferred stock in one or more series,
having the relative voting powers, designations, preferences, rights and qualifications,
limitations or restrictions, and other terms as the Board of Directors may fix in providing for
the issuance of such series, without any vote or action of the shareholders. During 2000, all
outstanding shares of preferred stock were converted into common stock in connection with our IPO.
There have been no shares of preferred stock outstanding since our IPO.
Warrants
In connection with a distribution agreement we entered into during 1999, we provided a business
partner with a warrant to purchase 245,032 shares of our common stock at $4.06 per share. The
warrant expires in June 2009, and no portion of the stock warrant has been exercised as of
December 31, 2007.
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net income per share:
| Year Ended December 31, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Numerator: |
||||||||||||
Net income |
$ | 4,087,209 | $ | 2,499,680 | $ | 1,912,928 | ||||||
Denominator: |
||||||||||||
Weighted-average shares outstanding: |
||||||||||||
Basic |
21,998,845 | 21,576,553 | 21,051,373 | |||||||||
Employee stock options and escrowed shares |
702,151 | 782,095 | 890,809 | |||||||||
Diluted |
22,700,996 | 22,358,648 | 21,942,182 | |||||||||
Net income per share: |
||||||||||||
Basic |
$ | 0.19 | $ | 0.12 | $ | 0.09 | ||||||
Diluted |
$ | 0.18 | $ | 0.11 | $ | 0.09 | ||||||
For the years ended December 31, 2007, 2006, and 2005, the calculation of weighted average and
equivalent shares excluded options and warrants that were
anti-dilutive. The equivalent common shares related to such options and warrants were 1,915,641 in 2007, 1,964,460 in 2006, and
1,447,561 in 2005.
5. INVESTMENTS IN MARKETABLE SECURITIES
The Company maintained no investments in marketable securities as of December 31, 2007.
At December 31, 2006, investments in marketable securities, which were all classified as
available-for-sale and considered to be short-term based on management’s intent of holding such
securities for less than 12 months, included the following:
| Amortized | Unrealized | Fair | ||||||||||||||
| Cost | Losses | Unrealized Gains | Value | |||||||||||||
Auction Rate Securities |
$ | 1,700,000 | $ | — | $ | — | $ | 1,700,000 | ||||||||
6. GOODWILL
We account for goodwill under the provisions of Statement 142, which specifies the approach and
timing for evaluating impairment of intangible assets, and also requires that goodwill be tested
for impairment at least annually using a fair value method. 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 additional 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. During our annual
impairment evaluation in the fourth quarter of 2007 and 2006, the results of our goodwill
impairment analysis indicated the fair value of our reporting units exceeded their carrying
values. Therefore no impairment existed at December 31, 2007 and 2006.
On March 12, 2007 we acquired TJO. We recorded goodwill of $10,829,471 in connection with this
acquisition. The changes in the carrying amount of goodwill for the years ended December 31, 2007
and 2006 are as follows:
| Learning | Research | Total | ||||||||||
Balance at January 1, 2007 |
$ | 3,306,688 | $ | 7,010,705 | $ | 10,317,393 | ||||||
Changes in carrying value of goodwill |
— | 10,829,471 | 10,829,471 | |||||||||
Balance at December 31, 2007 |
$ | 3,306,688 | $ | 17,840,176 | $ | 21,146,864 | ||||||
| Learning | Research | Total | ||||||||||
Balance at January 1, 2006 |
$ | 3,306,688 | $ | 7,010,705 | $ | 10,317,393 | ||||||
Changes in carrying value of goodwill |
— | — | — | |||||||||
Balance at December 31, 2006 |
$ | 3,306,688 | $ | 7,010,705 | $ | 10,317,393 | ||||||
45
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. INTANGIBLE ASSETS
All intangible assets have been evaluated in accordance with Statement 142 and are considered to
have finite useful lives. Customer related intangible assets include
contract rights, customer lists, and customer relationships
associated with our acquisitions of DMR and TJO. Other intangible
assets include non-competition agreements associated with the same
acquired entities. The intangibles are being amortized over their estimated useful lives,
ranging from one to eight years. Amortization of intangible assets was approximately $926,000,
$508,000, and $552,000, for the years ended December 31, 2007, 2006 and 2005, respectively.
Identifiable intangible assets are comprised of the following:
| As of December 31, 2007 | As of December 31, 2006 | |||||||||||||||||||||||
| Accumulated | Accumulated | |||||||||||||||||||||||
| Gross Amount | Amortization | Net | Gross Amount | Amortization | Net | |||||||||||||||||||
Customer related |
$ | 9,915,000 | $ | (4,470,224 | ) | $ | 5,444,776 | $ | 6,340,000 | $ | (3,687,243 | ) | $ | 2,652,757 | ||||||||||
Content |
3,500,000 | (3,500,000 | ) | — | 3,500,000 | (3,500,000 | ) | — | ||||||||||||||||
Other |
972,142 | (712,331 | ) | 259,811 | 672,142 | (568,918 | ) | 103,224 | ||||||||||||||||
Total |
$ | 14,387,142 | $ | (8,682,555 | ) | $ | 5,704,587 | $ | 10,512,142 | $ | (7,756,161 | ) | $ | 2,755,981 | ||||||||||
Estimated amortization expense for the years ending December 31, is as follows:
2008 |
$ | 966,766 | ||
2009 |
946,875 | |||
2010 |
946,875 | |||
2011 |
886,794 | |||
2012 |
871,875 | |||
Thereafter |
1,085,402 | |||
Total |
$ | 5,704,587 | ||
8. CONTENT RIGHTS AND DEFERRED SERVICE CREDITS
During 2007 and 2006, we completed updates and maintenance required to publish certain courseware
owned by one of our customers and were provided the right to distribute and resell such courseware
to our Internet-based customers. In exchange for receipt of an exclusive license to distribute and
resell this courseware, we provided the customer with service credits that can be used to make
future purchases of our products and services. We accounted for this transaction in accordance
with Accounting Principles Board Opinion No. 29 “Accounting for Nonmonetary Transactions” as
amended by SFAS No. 153, “Exchanges of Nonmonetary Assets.” The initial value assigned to the
content rights and the deferred service credits was $191,667 in 2007 and $904,167 in 2006, which
represents the estimated fair value of the assets relinquished. The content rights are classified
within prepaid development fees and other assets, and the service credits are classified within
accrued liabilities and other long term liabilities on our consolidated balance sheet as of
December 31, 2007 and 2006.
The service credits will be issued annually through May 2008, and expire twenty-four months after
issuance. Any unused credits will be forfeited. As of December 31, 2007, we were obligated to
provide remaining credits of $795,209 which expire on various dates through May 2010. Additional
service credits may be provided in the future if the customer provides additional courseware
rights to us. The content rights are being amortized on a straight-line basis through December 31,
2008. Revenues for services provided in exchange for service credits will be recognized in
accordance with our revenue recognition policies.
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. BUSINESS SEGMENTS
We provide our services to healthcare organizations, pharmaceutical and medical device companies,
and other members within the healthcare industry. Our services are primarily focused on the
delivery of education and training products and services (HealthStream Learning), as well as
survey and research services (HealthStream Research). HealthStream Learning products and services
include our Internet-based HealthStream Learning Center®, authoring tools, courseware
subscriptions, online training and content development, online sales training courses, live
events, HospitalDirect® and other products focused on education and training to serve
professionals that work within healthcare organizations.
Effective with the acquisition of TJO in March 2007, we launched HealthStream
ResearchTM. HealthStream Research reflects the combination of DMR and TJO, which
collectively provide a wide range of quality and satisfaction surveys, data analyses of survey
results, and other research-based measurement tools focused on patients, employees, physicians,
and members of the community. In addition, at that time, we changed our organizational structure,
appointing a President of HealthStream Research who reports to our Chief Executive Officer (CEO).
Our CEO is also our chief operating decision maker. During the first quarter of 2007, we began
reporting and measuring performance based on the delivery of learning services and research
services. Accordingly, we began disclosing segment performance under the Learning and Research
segments.
Our historical segments consisted of services provided to healthcare organizations and
professionals (HCO) and services provided to pharmaceutical and medical device companies (PMD). We
no longer manage our business based on the markets of our customer base. We have, therefore,
reclassified prior period segment disclosures to conform to the current year presentation.
The following is our business segment information as of and for the years ended December 31, 2007,
2006 and 2005. 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. The unallocated component below includes corporate functions, such as accounting,
human resources, legal, marketing, administrative, and executive personnel, as well as
depreciation, a portion of amortization, and certain other expenses, which are not currently
allocated in measuring segment performance.
| Year ended December 31, 2007 | ||||||||||||||||
| Learning | Research | Unallocated | Consolidated | |||||||||||||
Revenues, net |
$ | 27,461,507 | $ | 16,487,757 | $ | — | $ | 43,949,264 | ||||||||
Cost of revenues (excluding depreciation
and amortization) |
9,272,559 | 6,889,946 | — | 16,162,505 | ||||||||||||
Product development |
3,668,651 | 515,605 | 123,482 | 4,307,738 | ||||||||||||
Sales and marketing |
6,362,109 | 2,735,565 | 114,731 | 9,212,405 | ||||||||||||
Depreciation and amortization |
1,627,564 | 926,393 | 1,949,223 | 4,503,180 | ||||||||||||
Other general and administrative |
392,616 | 2,364,937 | 5,090,505 | 7,848,058 | ||||||||||||
Segment income (loss) from operations |
$ | 6,138,008 | $ | 3,055,311 | $ | (7,277,941 | ) | $ | 1,915,378 | |||||||
*Segment assets |
$ | 17,270,540 | $ | 26,284,097 | $ | 9,806,820 | $ | 53,361,457 | ||||||||
Purchases of property and equipment |
$ | 807,450 | $ | 46,702 | $ | 410,413 | $ | 1,264,565 | ||||||||
Payments associated with capitalized software
feature enhancements |
$ | 2,460,254 | $ | 106,184 | $ | — | $ | 2,566,438 | ||||||||
| Year ended December 31, 2006 | ||||||||||||||||
| Learning | Research | Unallocated | Consolidated | |||||||||||||
Revenues, net |
$ | 25,069,651 | $ | 6,713,818 | $ | — | $ | 31,783,469 | ||||||||
Cost of revenues (excluding depreciation
and amortization) |
8,979,456 | 1,889,847 | — | 10,869,303 | ||||||||||||
Product development |
2,988,862 | 369,682 | 144,246 | 3,502,790 | ||||||||||||
Sales and marketing |
5,948,316 | 883,973 | 187,762 | 7,020,051 | ||||||||||||
Depreciation and amortization |
973,859 | 508,332 | 1,406,977 | 2,889,168 | ||||||||||||
Other general and administrative |
524,632 | 633,190 | 4,435,204 | 5,593,026 | ||||||||||||
Segment income (loss) from operations |
$ | 5,654,526 | $ | 2,428,794 | $ | (6,174,189 | ) | $ | 1,909,131 | |||||||
*Segment assets |
$ | 15,167,472 | $ | 10,620,782 | $ | 15,220,232 | $ | 41,008,486 | ||||||||
Purchases of property and equipment |
$ | 865,416 | $ | 24,341 | $ | 510,880 | $ | 1,400,637 | ||||||||
Payments associated with capitalized software
feature enhancements |
$ | 2,274,684 | $ | — | $ | — | $ | 2,274,684 | ||||||||
47
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. BUSINESS SEGMENTS (continued)
| Year ended December 31, 2005 | ||||||||||||||||
| Learning | Research | Unallocated | Consolidated | |||||||||||||
Revenues, net |
$ | 22,878,412 | $ | 4,480,994 | $ | — | $ | 27,359,406 | ||||||||
Cost of revenues (excluding depreciation
and amortization) |
8,252,664 | 1,492,806 | — | 9,745,470 | ||||||||||||
Product development |
2,397,961 | 275,275 | 254,876 | 2,928,112 | ||||||||||||
Sales and marketing |
4,754,973 | 482,537 | 214,658 | 5,452,168 | ||||||||||||
Depreciation and amortization |
745,179 | 385,428 | 1,547,833 | 2,678,440 | ||||||||||||
Other general and administrative |
348,376 | 438,016 | 4,172,116 | 4,958,508 | ||||||||||||
Segment income (loss) from operations |
$ | 6,379,259 | $ | 1,406,932 | $ | (6,189,483 | ) | $ | 1,596,708 | |||||||
*Segment assets |
$ | 9,996,030 | $ | 10,873,432 | $ | 14,346,678 | $ | 35,216,140 | ||||||||
Purchases of property and equipment |
$ | 447,749 | $ | 14,208 | $ | 290,265 | $ | 752,222 | ||||||||
Payments associated with capitalized software
feature enhancements |
$ | 626,122 | $ | — | $ | — | $ | 626,122 | ||||||||
| * | Segment assets include restricted cash, accounts and unbilled receivables, prepaid and other current assets, other assets, capitalized software feature enhancements, certain property and equipment, and intangible assets. Investments in marketable securities and cash and cash equivalents are not allocated to individual segments, and are included within Unallocated. A significant portion of property and equipment assets are included within Unallocated. |
10. INCOME TAXES
The (benefit) provision for income taxes is comprised of:
| Year Ended December 31, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Current federal |
$ | 44,366 | $ | 28,044 | $ | 21,500 | ||||||
Current state |
— | — | — | |||||||||
Deferred federal |
(1,780,403 | ) | — | — | ||||||||
Deferred state |
(209,459 | ) | — | — | ||||||||
(Benefit) provision for income taxes |
$ | (1,945,496 | ) | $ | 28,044 | $ | 21,500 | |||||
Income tax (benefit) provision differs from the amounts computed by applying the federal statutory
rate of 34% to the income before income taxes as follows:
| Year Ended December 31, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Federal tax provision at the statutory rate |
$ | 728,176 | $ | 859,427 | $ | 657,705 | ||||||
State income tax provision, net of federal benefit |
113,081 | 102,681 | 80,275 | |||||||||
Difference related to warrants |
943,018 | — | — | |||||||||
Other |
197,989 | 254,624 | (32,265 | ) | ||||||||
Decrease in valuation allowance |
(3,927,760 | ) | (1,188,688 | ) | (684,215 | ) | ||||||
(Benefit) provision for income taxes |
$ | (1,945,496 | ) | $ | 28,044 | $ | 21,500 | |||||
During the fourth quarter of 2007 management concluded that a portion of its deferred tax assets
would be realized, and recognized $1,989,862 of deferred tax assets at December 31, 2007 by
reversing a portion of the valuation allowance. The recognition of this asset was recorded as an
income tax benefit in our statement of income for the year ended December 31, 2007, and is shown
net of current tax expense. The balance sheet at December 31, 2007 includes current deferred tax
assets of $360,312 and non current deferred tax assets of $1,629,550.
As a result of prior tax deductions related to stock based
compensation, up to $116,285 of future reductions of the valuation
allowance would be recognized as an increase to common stock. At December 31, 2007, a
valuation allowance exists for the remaining portion of deferred tax assets, due to the
uncertainty of realizing these assets in the future. At December 31, 2006 the Company had
established a full valuation allowance against its deferred tax assets.
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. INCOME TAXES (continued)
Deferred federal and state income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. Significant components of deferred tax assets are as
follows:
| December 31, | ||||||||
| 2007 | 2006 | |||||||
Current deferred tax assets: |
||||||||
Allowance for doubtful accounts |
$ | 23,569 | $ | 42,649 | ||||
Accrued liabilities |
476,325 | 318,201 | ||||||
Deferred revenue |
606,410 | — | ||||||
Net operating loss carryforwards |
755,662 | — | ||||||
Other |
— | 13,541 | ||||||
| 1,861,966 | 374,391 | |||||||
Less: Valuation allowance |
(1,501,654 | ) | (374,391 | ) | ||||
Net Current deferred tax assets |
$ | 360,312 | $ | — | ||||
Noncurrent deferred tax assets: |
||||||||
Depreciation |
$ | 278,212 | $ | 467,503 | ||||
Deductible goodwill |
440,480 | 772,817 | ||||||
Difference related to warrants |
284,370 | 1,227,388 | ||||||
Research and development credits |
285,787 | 285,787 | ||||||
Stock based compensation |
116,285 | 57,006 | ||||||
Alternative minimum tax credits |
93,910 | 49,544 | ||||||
Net operating loss carryforwards |
13,710,318 | 15,041,694 | ||||||
| 15,209,362 | 17,901,739 | |||||||
Less: Valuation allowance |
(12,266,176 | ) | (17,901,739 | ) | ||||
Net Noncurrent deferred tax assets |
$ | 2,943,186 | $ | — | ||||
Noncurrent deferred tax liabilities: |
||||||||
Nondeductible intangible assets |
$ | 1,313,636 | $ | — | ||||
Total Noncurrent deferred tax liabilities |
$ | 1,313,636 | $ | — | ||||
Net Noncurrent deferred tax asset |
$ | 1,629,550 | $ | — | ||||
As of December 31, 2007, we had federal and state net operating loss carryforwards of $38,956,024
and $30,523,309, respectively. These loss carryforwards will expire in years 2012 through 2024. As
of December 31, 2007, $2,652,519 of our net operating loss carryforwards is attributable to the
exercise of stock options, and if realized, the tax benefit will be recorded as an increase to
additional paid-in capital. Our net operating loss carryforwards are subject to annual limitations
under Internal Revenue Code Section 382. The annual limitations could result in the expiration of
a portion of our net operating loss and tax credit carryforwards before they are fully utilized.
During the year, the valuation allowance decreased by $4,508,300, which was comprised of a
$3,927,760 decrease related to current taxes, a decrease of $596,335 related to acquired deferred
tax liabilities associated with the TJO acquisition, and an increase of $15,795 related to the
exercise of stock options.
We have research and development tax credit carryforwards of $285,787 that expire in varying
amounts through 2024. We have alternative minimum tax credit carryforwards of $93,910 that are
available to offset future regular tax liabilities and they do not expire. Federal income tax
payments of $43,000, $21,000, and $15,000 were made during the years ended December 31, 2007,
2006, and 2005, respectively. There were no state income tax payments made during the years ended
December 31, 2007, 2006, and 2005.
As of December 31, 2007 and 2006, the Company’s consolidated balance sheets did not reflect a
liability for uncertain tax positions, nor any accrued penalties or interest associated with
income tax uncertainties. The Company is subject to income taxation at the federal and various
state levels. The Company is subject to U.S. federal tax examinations for tax years through 2007,
subject to the statute of limitations. The Company has no income tax examinations in process.
49
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. STOCK BASED COMPENSATION
Total stock based compensation expense recorded, as a result of adopting Statement 123(R), for the
years ended December 31, 2007 and 2006, which is recorded in our statements of income, is as
follows:
| Years Ended December 31, | ||||||||
| 2007 | 2006 | |||||||
Cost of revenues (excluding depreciation and amortization) |
$ | 48,501 | $ | 53,790 | ||||
Product development |
150,193 | 142,058 | ||||||
Sales and marketing |
171,400 | 127,953 | ||||||
Other general and administrative |
372,250 | 358,267 | ||||||
Total stock based compensation expense |
$ | 742,344 | $ | 682,068 | ||||
Stock Option Plans
Our 2000 Stock Incentive Plan (2000 Plan) and 1994 Employee Stock Option Plan (1994 Plan) (the
2000 Plan and the 1994 Plan are collectively referred to as “the Plan”) authorize the grant of
options or other forms of stock based compensation to employees, officers, directors and others,
and such grants must be approved by the Compensation Committee of the Board of Directors. The
terms of both plans are substantially similar. Options granted under the Plan have terms of no
more than ten years, with certain restrictions. The Plan allows the Compensation Committee of the
Board of Directors to determine the vesting period of each grant. The vesting period of the
options granted ranges from immediate vesting (generally associated with professional consulting
boards and directors’ options) to annual vesting over four years, beginning one year after the
grant date (generally for employee and officer options). As of December 31, 2007, 1,905,437 shares
of unissued common stock remained reserved for future grants under the Plan. The Company issues
new shares of common stock when options are exercised.
The weighted average fair value of options granted was estimated using the Black-Scholes method.
The ranges of assumptions used for these estimates include:
| 2007 | 2006 | 2005 | ||||||||||
Risk-free interest rate |
4.45 – 4.80 | % | 4.55 – 5.07 | % | 3.77 – 4.45 | % | ||||||
Expected dividend yield |
0.0 | % | 0.0 | % | 0.0 | % | ||||||
Expected life (in years) |
5 to 8 | 5 to 8 | 5 to 8 | |||||||||
Expected forfeiture rate |
0-30 | % | 0-20 | % | 0-20 | % | ||||||
Volatility |
75 | % | 75 | % | 75 | % | ||||||
Risk-free interest rate is based on the U.S. Treasury rate in effect at the time of the
option grant having a term equivalent to the expected life of the option.
Expected dividend yield is zero because the Company has not made any dividend payments in
its history and does not plan to pay dividends in the foreseeable future.
Expected life is the period of time the option is expected to remain outstanding, and is
based on historical experience. The contractual option life ranges from eight to ten years. We
estimate the expected life of options granted to members of management to be five years and eight
years for directors.
Expected forfeiture rate is the estimated percentage of options granted that are not
expected to become fully vested. This estimate is based on historical experience, and will be
adjusted as necessary to match the actual forfeiture experience.
Volatility is the measure of the amount by which the price is expected to fluctuate. We
estimate volatility based on the actual historical volatility of our common stock, and we believe
future volatility will be similar to our past experience.
We amortize the fair value of all stock based awards on a straight-line basis over the requisite
service period, which generally is the vesting period.
50
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. STOCK BASED COMPENSATION (continued)
A progression of activity and various other information relative to stock options for the year
ended December 31, 2007 is presented in the table below.
| Weighted- | ||||||||||||
| Common | Average | Aggregate | ||||||||||
| Shares | Exercise Price | Intrinsic Value | ||||||||||
Outstanding – beginning of period |
2,806,679 | $ | 3.52 | |||||||||
Granted |
490,000 | 3.77 | ||||||||||
Exercised |
(123,697 | ) | 2.01 | |||||||||
Expired |
(473,175 | ) | 5.13 | |||||||||
Forfeited |
(161,000 | ) | 3.31 | |||||||||
Outstanding – end of period |
2,538,807 | $ | 3.36 | $ | 2,046,626 | |||||||
Exercisable at end of period |
1,655,557 | $ | 3.38 | $ | 1,773,836 | |||||||
The aggregate intrinsic value in the table above represents the total difference between the
Company’s closing stock price on December 31, 2007 (the last trading day of the year) of $3.50 and
the option exercise price, multiplied by the number of in-the-money options as of December 31,
2007. As of December 31, 2007, total unrecognized compensation expense related to non-vested stock
options was $1,247,528, net of estimated forfeitures, with a weighted average expense recognition
period of 2.6 years.
Other information relative to option activity during the years ended December 31, 2007, 2006, and
2005 is as follows:
| Year Ended December 31, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Weighted average grant date fair value of stock options granted |
$ | 2.46 | $ | 2.01 | $ | 1.97 | ||||||
Total fair value of stock options vested |
$ | 682,084 | $ | 582,189 | $ | 348,032 | ||||||
Total intrinsic value of stock options exercised |
$ | 144,826 | $ | 663,202 | $ | 414,948 | ||||||
Cash proceeds from exercise of stock options |
$ | 248,517 | $ | 490,467 | $ | 654,955 | ||||||
Employee Stock Purchase Plan
Our Employee Stock Purchase Plan (Purchase Plan) incorporates the provisions of Section 423 of the
Internal Revenue Code. Under the Purchase Plan, 1,000,000 shares of common stock have been
reserved for purchase by employees. The Purchase Plan provides for annual offer periods of twelve
months to eligible employees. Under the Purchase Plan, eligible employees can purchase through
payroll deductions, the lesser of up to 15% of their eligible base compensation or 2,500 shares of
common stock, at a price equivalent to 85% of the lesser of the beginning or end of Purchase Plan
year price. During 2007, 37,685 shares were purchased under the plan at $3.23 per share, and
during 2006, 68,102 shares were purchased under the plan at $2.38 per share. There were 586,089
shares available for issuance under the Purchase Plan as of December 31, 2007. In accordance with
the provisions of SFAS No. 123(R), the Company recognized $33,409 and $58,639 of stock based
compensation expense for the Purchase Plan during the years ended December 31, 2007 and 2006,
respectively. No compensation expense was recognized under this plan prior to the adoption of SFAS
No. 123(R).
12. EMPLOYEE BENEFIT PLAN
401(k) Plan
We have a defined-contribution employee benefit plan (401(k) Plan) incorporating provisions of
Section 401(k) of the Internal Revenue Code. Our employees must have attained the age of 21 and
have completed thirty days of service to be eligible to participate in the 401(k) Plan. Under the
provisions of the 401(k) Plan, a plan member may make contributions, on a tax-deferred basis, not
to exceed 20% of compensation, subject to IRS limitations. The Company has not provided matching
contributions through December 31, 2007.
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. DEBT
At December 31, 2007 and 2006, the Company had the following debt outstanding:
| December 31, | ||||||||
| 2007 | 2006 | |||||||
Promissory Note |
$ | 1,737,735 | $ | — | ||||
Less current portion |
(706,698 | ) | — | |||||
Long-term debt (net of current portion) |
$ | 1,031,037 | $ | — | ||||
Note Payable
During 2007, the Company financed the purchase of approximately $2.1 million in multi-year
software licenses. As a result of this transaction, the Company entered into a promissory note
loan agreement which is scheduled to be repaid in 36 payments due on a monthly basis beginning
July 1, 2007. The promissory note bears interest at an annual rate of 2.32%, and is unsecured. The
Company may not prepay the loan without consent from the lender, and if a prepayment request is
granted by the lender, a prepayment fee may be assessed. As of December 31, 2007, the amount
outstanding under this loan agreement was $1,737,735.
Scheduled principal payments for debt outstanding, as of December 31, 2007 for the next five years
and thereafter are as follows:
2008 |
$ | 706,698 | ||
2009 |
724,095 | |||
2010 |
306,942 | |||
2011 |
— | |||
2012 |
— | |||
Thereafter |
— | |||
Total |
$ | 1,737,735 | ||
Revolving Credit Facility
The Company maintains a Loan Agreement (the “Revolving Credit Facility”) with SunTrust Bank
(“SunTrust”) in the aggregate principal amount of $15.0 million, which matures on July 21, 2009.
The obligations under the revolving credit facility are guaranteed by each of the Company’s
subsidiaries. The Company’s borrowings under the revolving credit facility bear interest at a
LIBOR rate generally defined as the sum of (i) a variable rate of interest equal to the 30-Day
LIBOR Rate and (ii) 150 basis points per annum. Principal is payable in full on the maturity date.
The Company is required to pay a commitment fee of 10 basis points per annum of the average daily
unused portion of the revolving credit facility.
The purpose of the revolving credit facility is for general working capital needs, permitted
acquisitions (as defined in the Loan Agreement), and for stock repurchase and/or redemption
transactions that the Company may authorize.
The revolving credit facility contains certain covenants that, among other things, restrict
additional indebtedness, liens and encumbrances, changes to the character of the Company’s
business, acquisitions, asset dispositions, mergers and consolidations, sale or discount of
receivables, creation or acquisitions of additional subsidiaries, and other matters customarily
restricted in such agreements.
In addition, the revolving credit facility requires the Company to meet certain financial tests,
including, without limitation:
| • | a maximum total leverage ratio (consolidated debt/consolidated EBITDA) of 2.0 to 1.0; and | ||
| • | funded debt to total capitalization may not exceed 40% |
As of December 31, 2007, the Company believes it was in compliance with all covenants. There were
no balances outstanding on the revolving credit facility as of December 31, 2007.
52
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HEALTHSTREAM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. LEASES
As of December 31, 2007, we lease office facilities in Nashville, TN, Laurel, MD, Franklin, TN,
and Denver, CO, under agreements that expire before or during March 2012. Some lease agreements
contain provisions for escalating rent payments over the initial terms of the lease. We account
for these leases by recognizing rent expense on the straight-line basis and adjusting the deferred
rent expense liability for the difference between the straight-line rent expense and the amount of
rent paid. The Company also leases certain office equipment under both operating and capital
leases. Total rent expense under all operating leases was approximately $1,410,000, $897,000,
$895,000, for the years ended December 31, 2007, 2006, and 2005, respectively. We also lease
certain computer and office equipment from third parties which are accounted for as capital
leases.
Future rental payment commitments at December 31, 2007 under capital and non-cancelable operating
leases, with initial terms of one year or more, are as follows:
| Capital Leases | Operating Leases | |||||||
2008 |
$ | 131,650 | $ | 990,095 | ||||
2009 |
21,390 | 736,781 | ||||||
2010 |
9,072 | 494,250 | ||||||
2011 |
4,494 | 397,218 | ||||||
2012 |
— | 79,402 | ||||||
Total minimum lease payments |
166,606 | $ | 2,697,746 | |||||
Less amounts representing interest |
(10,017 | ) | ||||||
Present value of minimum lease payments (including $124,099 classified as current) |
$ | 156,589 | ||||||
The carrying value of assets under capital leases, which are included with owned assets in the
accompanying consolidated balance sheets was $128,773 and $279,494 at December 31, 2007 and 2006,
respectively. Amortization of the assets under the capital leases is included in depreciation
expense on the accompanying consolidated statements of income.
15. LITIGATION
In the ordinary course of business, the Company is from time to time involved in various pending
legal actions. The litigation process is inherently uncertain and it is possible that the
resolution of such matters might have a material adverse effect upon the financial condition and /
or results of operations of the Company. However, in the opinion of the Company’s management,
matters currently pending or threatened against the Company are not expected to have a material
adverse effect on the financial position or results of operations of the Company.
16. SUBSEQUENT EVENT
In February 2008, the Company initiated an exit plan and communicated to its employees it would be
closing its Denver, CO satellite office. The purpose of this office closure is to reduce overhead
costs. This office contains fewer than 15 employees, who were all offered the opportunity to
remain an employee of the Company after the office is closed. In addition, the Company provided
notice to terminate its lease in accordance with the office lease agreement. There will be no
penalty to terminate the lease. The Company expects it will take up to three months to complete
the office closure, and does not anticipate any additional costs afterwards.
53
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A(T). Controls and Procedures
Evaluation of Disclosure 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 December 31, 2007. Based on that evaluation, the chief executive officer and
principal financial officer have concluded that HealthStream’s disclosure controls and procedures
were effective to ensure that the information required to be disclosed by the Company in the
reports the Company files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange Commission’s rules and
forms, and the information required to be disclosed in the reports the Company files or submits
under the Exchange Act was accumulated and communicated to the Company’s management, including its
principal executive and principal financial officer, or persons performing similar functions, as
appropriate to allow timely decisions regarding required disclosure.
Management’s Report On Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act
of 1934, and for assessing the effectiveness of internal control over financial reporting. The
Company’s internal control over financial reporting is designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. The Company’s
internal control over financial reporting includes those policies and procedures that: (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the Company
are being made only in accordance with authorizations of management and directors of the Company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the Company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting
as of December 31, 2007. In making this assessment, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework. Management’s assessment included
an evaluation of the design of our
internal control over financial reporting and testing of the operational effectiveness of our
internal control over financial reporting. Management believes that, as of December 31, 2007, the
Company’s internal control over financial reporting was effective based on those criteria.
This annual report does not include an attestation report of the Company’s registered public
accounting firm regarding internal control over financial reporting. Management’s report was not
subject to attestation by the Company’s registered public accounting firm pursuant to temporary
rules of the Securities and Exchange Commission that permit the Company to provide only
management’s report in this annual report.
Changes in Internal Control Over Financial Reporting
There were no changes in HealthStream’s internal control over financial reporting that occurred
during the fourth quarter of 2007 that have materially affected, or that are reasonably likely to
materially affect, HealthStream’s internal control over financial reporting.
Item 9B. Other Information
None.
54
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
Information as to directors of the Company and corporate governance is incorporated by reference
from the information contained in our proxy statement for the 2008 Annual Meeting of Shareholders
that we will file with the Securities and Exchange Commission within 120 days of the end of the
fiscal year to which this report relates. Pursuant to General Instruction G(3), certain
information concerning executive officers of the Company is included in Part I of this Form 10-K,
under the caption “Executive Officers of the Registrant.”
Item 11. Executive Compensation
Incorporated by reference from the information contained in our proxy statement for the 2008
Annual Meeting of Shareholders that we will file with the Securities and Exchange Commission
within 120 days of the end of the fiscal year to which this report relates.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Incorporated by reference from the information contained in our proxy statement for the 2008
Annual Meeting of Shareholders that we will file with the Securities and Exchange Commission
within 120 days of the end of the fiscal year to which this report relates.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Incorporated by reference from the information contained in our proxy statement for the 2008
Annual Meeting of Shareholders that we will file with the Securities and Exchange Commission
within 120 days of the end of the fiscal year to which this report relates.
Item 14. Principal Accounting Fees and Services
Incorporated by reference from the information contained in our proxy statement for the 2008
Annual Meeting of Shareholders that we will file with the Securities and Exchange Commission
within 120 days of the end of the fiscal year to which this report relates.
55
Table of Contents
PART IV
Item 15. Exhibits, Financial Statement Schedules
(a)(1) Financial Statements
Reference is made to the financial statements included in Item 8 to this Report on Form 10-K.
(a)(2) Financial Statement Schedules
All schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or the notes thereto.
(a)(3) Exhibits
| Number | Description | |
| 2.1 (1) | Stock Purchase Agreement, dated as of March 28, 2005, by and among
HealthStream, Inc., Mel B. Thompson and Data Management & Research, Inc. |
|
| 2.2 (2) | Stock Purchase Agreement, dated as of March 12, 2007, by and among
HealthStream, Inc., The Jackson Organization, Research Consultants, Inc., David Jackson and
the Jackson Charitable Remainder Trust |
|
| *3.1 | Form of Fourth Amended and Restated Charter of HealthStream, Inc. |
|
| *3.2 | Form of Amended and Restated Bylaws of HealthStream, Inc. |
|
| *4.1 | Form of certificate representing the common stock, no par value per share, of HealthStream, Inc. |
|
| 4.2 | Reference is made to Exhibits 3.1 and 3.2 |
|
| *4.3 | Warrant to purchase common stock of HealthStream, Inc., dated June 14, 1999, held by GE Medical Systems. |
|
| *4.4 | Common Stock Purchase Agreement between HealthStream, Inc. and Healtheon/WebMD Corporation |
|
| *10.1^ | 1994 Employee Stock Option Plan, effective as of April 15, 1994 |
|
| *10.2^ | 2000 Stock Incentive Plan, effective as of April 10, 2000 |
|
| *10.3^ | Form of Indemnification Agreement |
|
| *10.4^ (3) | Executive
Employment Agreement, dated July 21, 2005, between HealthStream, Inc. and Robert A. Frist, Jr. |
|
| *10.5 | Lease dated March 27, 1995, as amended June 6, 1995 and September 22, 1998, between Cummins Station LLC, as landlord,
and NewOrder Media, Inc., as tenant |
|
| *+10.6 | Development and Distribution Agreement between HealthStream, Inc. and GE Medical Systems |
|
| *+10.7 | Education Services Provider Agreement dated October 1, 2001 between HealthStream, Inc. and HCA Information Technology
& Services, Inc., as amended |
|
| *^10.8 | Form of Employee Stock Purchase Plan |
|
| ^10.9 (4) | Form of Director Stock Option Agreement |
|
| ^10.10 (4) | Form of Employee and Executive Officer Stock Option Agreement |
|
| 10.11 (5) | Loan Agreement dated July 21, 2006 between HealthStream, Inc. and SunTrust Bank |
|
| 10.12 (6) | Amendment to Loan Agreement dated February 16, 2007 between HealthStream, Inc. and SunTrust Bank |
|
| 10.13 (7) | Amendment to Loan Agreement dated July 23, 2007 between HealthStream, Inc. and SunTrust Bank |
|
| ^10.14 | Summary of
Director and Executive Officer Compensation |
|
| 21.1 | Subsidiaries of HealthStream, Inc. |
|
| 23.1 | Consent of Independent Registered Public Accounting Firm |
|
| 31.1 | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
| 31.2 | Certification of the Chief 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 |
|
| + | Confidential treatment was received, with respect to certain portions of this document. Such portions were omitted
and filed separately with the Securities and Exchange Commission. |
|
| * | Incorporated by reference to Registrant’s Registration Statement on Form S-1 (Reg. No.
333-88939). |
|
| ^ | Management contract or compensatory plan or arrangement |
|
| (1) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated March
29, 2005. |
|
| (2) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated March
12, 2007. |
|
| (3) | Incorporated
by reference from exhibit filed on our Current Report on Form 8-K,
dated July 25, 2005. |
|
| (4) | Incorporated
by reference from exhibit filed on our Annual Report on Form 10-K,
dated March 30, 2007. |
|
| (5) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated July
25, 2006. |
|
| (6) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated
February 20, 2007. |
|
| (7) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated July
24, 2007. |
56
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on this 28th day of March 2008.
| HEALTHSTREAM, INC. | ||||
| By: | /s/ Robert A. Frist, Jr. | |||
| Robert A. Frist, Jr. | ||||
| Chief Executive Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by
the following persons on behalf of the registrant and in the capacities and on the dates indicated:
| Signature | Title(s) | Date | ||
| /s/ Robert A. Frist, Jr.
|
President, Chief Executive Officer and Chairman (Principal Executive Officer) |
March 28, 2008 | ||
| /s/ Arthur E. Newman
|
Chief Financial Officer and Executive Vice President (Principal Financial and Accounting Officer) |
March 28, 2008 | ||
| /s/ James Daniell
|
Director | March 28, 2008 | ||
| /s/ Thompson Dent
|
Director | March 28, 2008 | ||
| /s/ Frank Gordon
|
Director | March 28, 2008 | ||
| /s/ Gerard Hayden
|
Director | March 28, 2008 | ||
| /s/ Jeffrey L. McLaren
|
Director | March 28, 2008 | ||
| /s/ Dale Polley
|
Director | March 28, 2008 | ||
| /s/ Linda Rebrovick
|
Director | March 28, 2008 | ||
| /s/ Michael Shmerling
|
Director | March 28, 2008 | ||
| /s/ William Stead
|
Director | March 28, 2008 |
57
Table of Contents
INDEX TO EXHIBITS
| Exhibit | ||
| Number | Description | |
| 2.1 (1) | Stock Purchase Agreement, dated as of March 28, 2005, by and among
HealthStream, Inc., Mel B. Thompson and Data Management & Research, Inc. |
|
| 2.2 (2) | Stock Purchase Agreement, dated as of March 12, 2007, by and among
HealthStream, Inc., The Jackson Organization, Research Consultants, Inc., David Jackson and
the Jackson Charitable Remainder Trust |
|
| *3.1 | Form of Fourth Amended and Restated Charter of HealthStream, Inc. |
|
| *3.2 | Form of Amended and Restated Bylaws of HealthStream, Inc. |
|
| *4.1 | Form of certificate representing the common stock, no par value per share, of HealthStream, Inc. |
|
| 4.2 | Reference is
made to Exhibit 3.1 and 3.2 |
|
| *4.3 | Warrant to purchase common stock of HealthStream, Inc., dated June 14, 1999, held by GE Medical Systems. |
|
| *4.4 | Common Stock Purchase Agreement between HealthStream, Inc. and Healtheon/WebMD Corporation |
|
| *10.1^ | 1994 Employee Stock Option Plan, effective as of April 15, 1994 |
|
| *10.2^ | 2000 Stock Incentive Plan, effective as of April 10, 2000 |
|
| *10.3^ | Form of Indemnification Agreement |
|
| *10.4^ (3) | Executive Employment Agreement, dated July 21, 2005, between HealthStream, Inc. and Robert A. Frist, Jr. |
|
| *10.5 | Lease dated March 27, 1995, as amended June 6, 1995 and September 22, 1998, between Cummins Station LLC, as landlord,
and NewOrder Media, Inc., as tenant |
|
| *+10.6 | Development and Distribution Agreement between HealthStream, Inc. and GE Medical Systems |
|
| *+10.7 | Education Services Provider Agreement dated October 1, 2001 between HealthStream, Inc. and HCA Information Technology
& Systems, Inc., as amended |
|
| *^10.8 | Form of Employee Stock Purchase Plan |
|
| ^10.9 (4) | Form of Director Stock Option Agreement |
|
| ^10.10 (4) | Form of Employee and Executive Officer Stock Option Agreement |
|
| 10.11 (5) | Loan Agreement dated July 21, 2006 between HealthStream, Inc. and SunTrust Bank |
|
| 10.12 (6) | Amendment to Loan Agreement dated February 16, 2007 between HealthStream, Inc. and SunTrust Bank |
|
| 10.13 (7) | Amendment to Loan Agreement dated July 23, 2007 between HealthStream, Inc. and SunTrust Bank |
|
| ^10.14 | Summary of
Director and Executive Officer Compensation |
|
| 21.1 | Subsidiaries of HealthStream, Inc. |
|
| 23.1 | Consent of Independent Registered Public Accounting Firm |
|
| 31.1 | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
| 31.2 | Certification of the Chief 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 |
|
| + | Confidential treatment was received with respect to certain portions of this document. Such portions were omitted and
filed separately with the Securities and Exchange Commission. |
|
| * | Incorporated by reference to Registrant’s Registration Statement on Form S-1 (Reg. No.
333-88939). |
|
| ^ | Management contract or compensatory plan or arrangement |
|
| (1) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated March
29, 2005. |
|
| (2) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated March
12, 2007. |
|
| (3) | Incorporated
by reference from exhibit filed on our Current Report on
Form 8-K, dated July
25, 2005. |
|
| (4) | Incorporated
by reference from exhibit filed on our Annual Report on Form 10-K, dated March
30, 2007. |
|
| (5) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated July
25, 2006. |
|
| (6) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated
February 20, 2007. |
|
| (7) | Incorporated by reference from exhibit filed on our Current Report on Form 8-K, dated July
24, 2007. |