HEALTHSTREAM INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   Special Cautionary Notice Regarding Forward ‑ Looking Statements   You should read the following discussion and analysis in conjunction with our Condensed Consolidated Financial Statements and related Notes included elsewhere in this report and our audited Consolidated Financial Statements and the Notes thereto for the year ended December 31, 2022, appearing in our Annual Report on Form 10-K that was filed with the Securities and Exchange Commission (“SEC”) on February 28, 2023 (the “2022 Form 10-K”). Statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements that the Company intends to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Statements that are predictive in nature, that depend on or refer to future events or conditions, or that include words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” and similar expressions are forward-looking statements.   The Company cautions that forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements.   In evaluating any forward-looking statement, you should specifically consider the information regarding forward-looking statements set forth above and the risks set forth under the caption Part I, Item 1A. Risk Factors in our 2022 Form 10-K and other disclosures in our 2022 Form 10-K, earnings releases, and other filings with the SEC from time to time, as well as other cautionary statements contained elsewhere in this report, including our critical accounting policies and estimates as discussed in this report and our 2022 Form 10-K. We undertake no obligation to update or revise any forward-looking statements. You should read this report and the documents that we reference in this report and have filed as exhibits to this report completely and with the understanding that our actual future results may be materially different from what we currently expect.   Business Overview   HealthStream provides primarily SaaS based applications for healthcare organizations—all designed to improve business and clinical outcomes by supporting the people who deliver patient care. We are focused on helping healthcare organizations meet their ongoing clinical development, talent management, training, education, assessment, competency management, safety and compliance, scheduling, and provider credentialing, privileging, and enrollment needs.   Our business is managed and organized around a single platform strategy, also referred to as our One HealthStream approach. At the center of this single platform strategy is our hStream technology platform. By facilitating interoperability among our applications, as well as third party applications, we believe that our hStream technology platform is allowing stand-alone applications to leverage each other to more efficiently and effectively empower our customers to manage their business and improve their outcomes.   As indicated in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, filed on February 28, 2023, the Company has reached an inflection point in its efforts to operate according to its One HealthStream approach. As of January 1, 2023, the Company’s business is now organized and managed around a consolidated, enterprise approach, including with regard to technology, operations, accounting, internal reporting (including the nature of information reviewed by our key decision maker), organization structure, compensation, performance assessment, and resource allocation.   11 Table of Contents   As the result of these developments, the Company determined that Workforce Solutions and Provider Solutions were no longer separate operating segments or separate reportable segments as of January 1, 2023, such that the Company would no longer present two reportable segments for periods beginning on and after this date. As such, beginning January 1, 2023, the Company has a single reportable segment, such that the Company is presenting historical financial information on a single segment basis beginning with this Quarterly Report on Form 10-Q for the three months ending March 31, 2023.   Significant financial metrics for the first quarter of 2023 are set forth in the bullets below.   • Revenues of $68.9 million in the first quarter of 2023, up 5% from $65.4 million in the first quarter of 2022, attributable primarily to growth in several of our subscription-based product categories, including contributions from recent acquisitions.   • Operating income of $2.9 million in the first quarter of 2023, down 28% from $4.0 million in the first quarter of 2022, which comparison was negatively impacted in the amount of $1.0 million by the severance charge in the first quarter of 2023 associated with the consolidation of HealthStream's business under a single platform strategy, as further discussed below.   • Net income of $2.6 million in the first quarter of 2023, down 9% from $2.9 million in the first quarter of 2022, which comparison was negatively impacted in the amount of $0.8 million by the severance charge in the first quarter of 2023 associated with HealthStream’s consolidation referenced above.   • Earnings per share (“EPS”) of $0.09 per share (diluted) in both the first quarters of 2023 and 2022, which comparison was negatively impacted in the amount of $0.03 per share (diluted) by the severance charge in the first quarter of 2023 associated with HealthStream’s consolidation referenced above.   • Adjusted EBITDA 1  of $13.7 million in the first quarter of 2023, down 2% from $14.0 million in the first quarter of 2022, which comparison was negatively impacted in the amount of $1.0 million by the severance charge in the first quarter of 2023 associated with HealthStream’s consolidation referenced above.   1 Adjusted EBITDA is a non-GAAP financial measure. A reconciliation of adjusted EBITDA to net income and disclosure regarding why we believe adjusted EBITDA provides useful information to investors is included later in this report.   12 Table of Contents   COVID-19 Pandemic and Other Recent Developments   The impact of the COVID-19 pandemic continues to cause uncertainty and potential economic volatility, including with regard to our healthcare customers and our business. However, the impact of the pandemic itself on public health and economic conditions has significantly lessened and conditions have normalized since the height of the pandemic in 2020 and 2021, potentially to the point of reaching an endemic stage.   Our business is focused on providing solutions to healthcare organizations, and as such the pandemic’s adverse impact on healthcare organizations has resulted in an adverse impact on our Company. We believe that certain developments related to the pandemic negatively impacted our business in 2021 and to a lesser extent in 2022 and the three months ended March 31, 2023. In particular, sales cycles in 2021 and 2022 were delayed or postponed such that declines in sales bookings by customers over this period resulted in a negative impact to revenue and earnings in 2022 and the three months ended March 31, 2023 and may continue to result in a negative impact (to a lesser extent) to revenue and earnings for a portion of the remainder of 2023. Earlier in the pandemic, such impacts on our healthcare organization customers were more frequently associated with the need to focus on providing critical care to pandemic victims and the negative economic impact many of our healthcare organization customers experienced from being forced to temporarily reduce or discontinue services, like elective surgeries, from which they derive revenue. More recently, such impacts on healthcare customers appear to be associated with the cessation of or significant reduction in governmental funds such customers have received or anticipate receiving through earlier federal stimulus and relief measures, including the Public Health Emergency Fund, the Paycheck Protection Program, and the Provider Relief Fund.   Macroeconomic conditions in the U.S. continue to be challenging in various respects, including as the result of ongoing inflationary pressures, elevated interest rate levels, disruptions to global supply networks, challenging labor market conditions, and instability in the banking system. Such negative macroeconomic conditions have adversely affected, and may continue to adversely affect, us and our customers in the healthcare industry. In particular, we have experienced, and believe that some of our customers have experienced, increased labor, supply chain, capital, and other expenditures associated with current inflationary pressures and labor market conditions.   Key Business Metrics   Our management utilizes the following financial and non-financial metrics in connection with managing our business.     • Revenues, net . Revenues, net, reflect income generated by the sales of goods and services related to our operations and, for businesses acquired prior to the adoption of ASU 2021-08 on January 1, 2022, reflects deferred revenue write-downs associated with fair value accounting for such acquired businesses. Revenues, net, were $68.9 million for the three months ended March 31, 2023, compared to $65.4 million for the three months ended March 31, 2022. Management utilizes revenue in connection with managing our business and believes that this metric provides useful information to investors as a key indicator of the growth and success of our products.     • Adjusted EBITDA . Adjusted EBITDA, calculated as set forth below under “Reconciliation of Non-GAAP Financial Measures,” is utilized by our management in connection with managing our business and provides useful information to investors because adjusted EBITDA reflects net income adjusted for certain GAAP accounting, non-cash, and/or non-operating items, as more specifically set forth below, which may not fully reflect the underlying operating performance of our business. We also believe that adjusted EBITDA is useful to investors to assess the Company’s ongoing operations. Additionally, short-term cash incentive bonuses and performance-based equity award grants are based on the achievement of adjusted EBITDA targets (as defined in applicable bonus and equity grant documentation). Adjusted EBITDA was $13.7 million for the three months ended March 31, 2023, compared to $14.0 million for the three months ended March 31, 2022, which comparison was negatively impacted in the amount of $1.0 million by the severance charge in the first quarter of 2023 associated with HealthStream's consolidation referenced above.     • hStream Subscriptions . hStream subscriptions are determined as the number of subscriptions under contract for hStream, our proprietary technology platform that enables healthcare organizations and their respective workforces to connect to and gain value from the HealthStream ecosystem of applications, tools, and content. Management utilizes hStream subscriptions in connection with managing our business and believes that this metric provides useful information to investors as a measure of our progress in growing the value of our customer base. At March 31, 2023, we had approximately 5.52 million contracted subscriptions to hStream, compared to 5.13 million as of March 31, 2022.   13 Table of Contents   Critical Accounting Policies and Estimates   The Company’s Condensed Consolidated Financial Statements are prepared in accordance with US GAAP. These accounting principles require us to make certain estimates, judgments, and assumptions during the preparation of our Financial Statements. We believe the estimates, judgments, and assumptions upon which we rely are reasonable based upon information available to us at the time they are made. These estimates, judgments, and assumptions can affect the reported amounts of assets and liabilities as of the date of the Financial Statements, as well as the reported amounts of revenues and expenses during the periods presented and related disclosures. To the extent there are material differences between these estimates, judgments, or assumptions and actual results, our Financial Statements will be affected.   The accounting policies and estimates that we believe are the most critical in fully understanding and evaluating our reported financial results include the following:     • Revenue recognition     • Accounting for income taxes     • Goodwill   In many cases, the accounting treatment of a particular transaction is specifically dictated by US GAAP and does not require management’s judgment in its application. There are also areas where management’s judgment in selecting among available alternatives would not produce a materially different result. See Notes to the Consolidated Financial Statements in our 2022 Form 10-K and the Notes to the Condensed Consolidated Financial Statements herein which contain additional information regarding our accounting policies and other disclosures required by US GAAP. There have been no changes in our critical accounting policies and estimates from those reported in our 2022 Form 10-K.   Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022   Revenues, net. Revenues increased approximately $3.5 million, or 5%, to $68.9 million for the three months ended March 31, 2023 from $65.4 million for the three months ended March 31, 2022. The revenue growth was attributable to growth in several product categories, including contributions from our recent acquisitions. Subscription revenues increased $3.9 million, or six percent, but were partially offset by $0.4 million of declines from professional services revenues.   A comparison of revenues by revenue source is as follows (in thousands):       Three Months Ended March 31,       2023     2022     Percentage Change   Subscription services   $ 66,015     $ 62,075       6 % Professional services     2,931       3,292       -11 % Total revenues, net   $ 68,946     $ 65,367       5 %                           % of Revenues                         Subscription services     96 %     95 %         Professional services     4 %     5 %           Cost of Revenues (excluding Depreciation and Amortization). Cost of revenues increased $1.9 million, or 8%, to $23.9 million for the three months ended March 31, 2023, from $22.0 million for the three months ended March 31, 2022. Cost of revenues as a percentage of revenues were 35% and 34% for the three months ended March 31, 2023 and 2022, respectively. The increase is primarily associated with personnel costs, including severance costs associated with the elimination of 33 job roles as part of the consolidation of HealthStream's business under a single platform strategy. In addition, we experienced higher costs for contract labor, software expenses, royalties, and cloud hosting.    14 Table of Contents   Product Development. Product development expenses increased $1.3 million, or 12%, to $11.7 million for the three months ended March 31, 2023, from $10.4 million for the three months ended March 31, 2022. Product development expenses as a percentage of revenues were 17% and 16% for the three months ended March 31, 2023 and 2022, respectively. The increase is primarily due to increased personnel costs, including severance costs as noted above, and an increase in contract labor, which were partially offset by an increase in labor capitalized for internally developed software.   Sales and Marketing. Sales and marketing expenses, including personnel costs, increased $1.3 million, or 13%, to $11.7 million for the three months ended March 31, 2023, from $10.4 million for the three months ended March 31, 2022. Sales and marketing expenses were 17% and 16% of revenues for the three months ended March 31, 2023 and 2022, respectively. The increase is primarily due to increased personnel costs, including severance costs as noted above, as well as higher travel expense and higher software costs, which were partially offset by a decrease in general marketing expenses.   Other General and Administrative Expenses. Other general and administrative expenses decreased $0.3 million, or 3%, to $8.9 million for the three months ended March 31, 2023, from $9.2 million for the three months ended March 31, 2022. Other general and administrative expenses were 13% and 14% of revenues for the three months ended March 31, 2023 and 2022, respectively. The decrease is primarily due to lower employee recruitment expenses, professional service fees, and software.   Depreciation and Amortization. Depreciation and amortization expense increased $0.6 million, or 6%, to $9.9 million for the three months ended March 31, 2023, from $9.3 million for the three months ended March 31, 2022. This increase is primarily a result of an increase in amortization associated with capitalized software but was partially offset by lower depreciation expense.   Other Income (Loss), Net . Other income (loss), net was income of $0.3 million for the three months ended March 31, 2023, compared to a loss of $0.3 for the three months ended March 31, 2022. The increase is primarily the result of interest income earned on cash and investments during the three months ended March 31, 2023 compared to the prior year period.   Income Tax Provision. The Company recorded a provision for income taxes of $0.5 million for the three months ended March 31, 2023, compared to $0.9 million the three months ended March 31, 2022. The Company’s effective tax rate was 16% for the three months ended March 31, 2023, compared to 23% for the three months ended March 31, 2022. The Company’s effective tax rate primarily reflects the statutory corporate income tax rate, the net effect of state taxes, foreign income taxes, the effect of various permanent tax differences, and recognition of discrete tax items. During the three months ended March 31, 2023, the Company recorded discrete tax benefits of $53,000, which consisted primarily of a $133,000 tax benefit associated with stock-based awards. This tax benefit was partially offset by $80,000 of discrete tax expense related to uncertain tax positions. During the three months ended March 31, 2022, the Company recorded discrete tax expense of $0.1 million, primarily related to tax deficiencies associated with stock-based awards.    Net Income. Net income was $2.6 million and $2.9 million for the three months ended March 31, 2023 and 2022, respectively. Earnings per share (EPS) was $0.09 per share (diluted) for both the three months ended March 31, 2023 and 2022.    Adjusted EBITDA was $13.7 million for the three months ended March 31, 2023, compared to $14.0 million for the three months ended March 31, 2022. See “Reconciliation of Non-GAAP Financial Measures” below for our reconciliation of adjusted EBITDA to the most directly comparable measure under US GAAP and disclosure regarding why we believe adjusted EBITDA provides useful information to investors.   15 Table of Contents     Reconciliation of Non-GAAP Financial Measures   This Quarterly Report on Form 10-Q presents adjusted EBITDA, which is a non-GAAP financial measure used by management in analyzing our financial results and ongoing operational performance.   In order to better assess the Company’s financial results, management believes that net income excluding the impact of the deferred revenue write-downs associated with fair value accounting for acquired businesses (as discussed in greater detail below) and before interest, income taxes, stock-based compensation, depreciation and amortization, and changes in fair value of, including gains (losses) on the sale of, non-marketable equity investments (“adjusted EBITDA”) is a useful measure for evaluating the operating performance of the Company because adjusted EBITDA reflects net income adjusted for certain GAAP accounting, non-cash, and/or non-operating items which may not, in any such case, fully reflect the underlying operating performance of our business. We also believe that adjusted EBITDA is useful to investors to assess the Company’s ongoing operating performance and to compare the Company’s operating performance between periods. Additionally, short-term cash incentive bonuses and performance-based equity awards are based on the achievement of adjusted EBITDA targets (as defined in applicable bonus and equity grant documentation).   As noted above, the definition of adjusted EBITDA includes an adjustment for the impact of the deferred revenue write-downs associated with fair value accounting for acquired businesses. Prior to the Company early adopting ASU 2021-08 effective January 1, 2022, following the completion of any acquisition by the Company, the Company was required to record the acquired deferred revenue at fair value as defined in GAAP, which typically resulted in a write-down of the acquired deferred revenue. When the Company was required to record a write-down of deferred revenue, it resulted in lower recognized revenue, operating income, and net income in subsequent periods. Revenue for any such acquired business was deferred and was typically recognized over a one-to-two year period following the completion of any particular acquisition, so our GAAP revenues for this one-to-two year period would not reflect the full amount of revenues that would have been reported if the acquired deferred revenue was not written down to fair value. Management believes that including an adjustment in the definition of adjusted EBITDA for the impact of the deferred write-downs associated with fair value accounting for businesses acquired prior to the January 1, 2022 effective date of the Company's adoption of ASU 2021-08 provides useful information to investors because the deferred revenue write-down recognized in periods after an acquisition may, given the nature of this non-cash accounting impact, cause our GAAP financial results during such periods to not fully reflect our underlying operating performance and thus adjusting for this amount may assist in comparing the Company’s results of operations between periods. Following the adoption of ASU 2021-08, contracts acquired in an acquisition completed on or after January 1, 2022 are measured as if the Company had originated the contract (rather than the contract being measured at fair value) such that, for such acquisitions, the Company no longer records deferred revenue write-downs associated with acquired businesses (for acquisitions completed prior to January 1, 2022, the Company continues to record deferred revenue write-downs associated with fair value accounting for periods on and after January 1, 2022 consistent with past practice). At the current time, the Company intends to continue to include an adjustment in the definition of adjusted EBITDA for the impact of deferred revenue write-downs from business acquired prior to January 1, 2022 given the ongoing impact of such deferred revenue on our financial results.   Adjusted EBITDA is a non-GAAP financial measure and should not be considered as a measure of financial performance under GAAP. Because adjusted EBITDA is not a measurement determined in accordance with GAAP, adjusted EBITDA is susceptible to varying calculations. Accordingly, adjusted EBITDA, as presented, may not be comparable to other similarly titled measures of other companies and has limitations as an analytical tool.    A reconciliation of adjusted EBITDA to the most directly comparable GAAP measure is set forth below (in thousands).       Three Months Ended March 31,       2023     2022   GAAP net income   $ 2,623     $ 2,893   Deferred revenue write-down     50       94   Interest income     (363 )     (15 ) Interest expense     33       32   Income tax provision     518       866   Stock-based compensation expense     945       774   Depreciation and amortization     9,926       9,322   Adjusted EBITDA   $ 13,732     $ 13,966     16 Table of Contents   Liquidity and Capital Resources   Net cash provided by operating activities decreased by $0.1 million to $20.5 million during the three months ended March 31, 2023, from $20.7 million during the three months ended March 31, 2022. Our days sales outstanding ("DSO") was 51 days for the first quarter of 2023 compared to 45 days for the first quarter of 2022. The Company calculates DSO by dividing the average accounts receivable balance for the quarter by average daily revenues for the quarter. The Company’s primary sources of cash were receipts generated from the sales of our products and services. The primary uses of cash to fund operations included 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.   Net cash used in investing activities was $16.9 million for the three months ended March 31, 2023, compared to $4.0 million for the three months ended March 31, 2022. During the three months ended March 31, 2023, the Company spent $6.6 million for the acquisition of substantially all of the assets of Electronic Education Documentation System, LLC ("eeds") (note: the eeds acquisition was consummated on December 31, 2022, but was funded in January 2023 such that the purchase price for eeds impacted net cash used in investing activities during the three months ended March 31, 2023), invested in marketable securities of $2.9 million, made payments for capitalized software development of $7.6 million, and purchased property and equipment of $0.9 million. These uses of cash were partially offset by $1.0 million in maturities of marketable securities. During the three months ended March 31, 2022, the Company spent $22,000 related to a post-closing adjustment for a prior acquisition, invested in marketable securities of $2.0 million, made payments for capitalized software development of $6.3 million, and purchased property and equipment of $0.6 million. These uses of cash were partially offset by $5.0 million in maturities of marketable securities.    Net cash used in financing activities was approximately $0.8 million for the three months ended March 31, 2023, compared to $20.2 million for the three months ended March 31, 2022. The uses of cash for the three months ended March 31, 2023 included $0.8 million for the payment of employee payroll taxes in relation to the vesting of restricted share units. The uses of cash for the three months ended March 31, 2022 included $19.7 million for repurchases of common stock and $0.5 million for the payment of employee payroll taxes in relation to the vesting of restricted share units.   Our balance sheet reflects positive working capital of $4.1 million at March 31, 2023, compared to negative working capital of $2.8 million at December 31, 2022. The increase in working capital is primarily a result of an increase in cash and cash equivalents despite the use of cash to fund the acquisition of eeds during the quarter as a result of strong collections coupled with an increase in accounts receivable. The Company’s primary source of liquidity as of March 31, 2023 was $48.8 million of cash and cash equivalents and $9.8 million of marketable securities. The Company also has a $65.0 million revolving credit facility, all of which was available for additional borrowing at March 31, 2023. The revolving credit facility expires on October 28, 2023, unless earlier renewed or amended.   On November 30, 2021, the Company announced a share repurchase program approved by the Company’s Board of Directors under which the Company was authorized to purchase up to $20.0 million of its common stock. This share repurchase program concluded on March 8, 2022, when the maximum dollar amount authorized under the program was expended. During the three months ended March 31, 2022 the Company repurchased 649,739 shares of common stock pursuant to this share repurchase program at an aggregate fair value of $14.9 million, reflecting an average price per share of $22.92 (excluding the cost of broker commissions).   On March 14, 2022, the Board approved an expansion of the Company's share repurchase program by authorizing the repurchase of up to an additional $10.0 million of the Company's outstanding shares of common stock. The share repurchase program expired on March 13, 2023, and no repurchases occurred during the three months ended March 31, 2023. Under this program, the Company repurchased a total of 402,050 shares at an aggregate fair value of $8.1 million, based on an average price per share of $20.19 (excluding the cost of broker commissions), including 242,647 shares purchased during the three months ended March 31, 2022, at an aggregate fair value of $5.0 million, based on an average per share price of $20.52 (excluding the cost of broker commissions). We may elect in the future to adopt a new share repurchase program.   On February 20, 2023, we announced that our Board approved a dividend policy under which we intend to pay quarterly cash dividends on our common stock, at an initial rate of $0.025 per share per fiscal quarter. We also announced that our Board declared the initial quarterly dividend under the new policy in the amount of $0.025 per share, which will be payable on April 28, 2023 to the holders of record of all of the issued and outstanding shares of common stock as of the close of business on April 17, 2023. This marks the first quarterly cash dividend policy adopted by the Company.   On April 24, 2023, the Board approved the Company's second quarterly cash dividend of $0.025 per share, payable on June 23, 2023 to holders of record on June 12, 2023. Further, the Company intends to declare and pay two more quarterly cash dividends in 2023.   The dividend policy and the declaration and payment of each quarterly cash dividend will be subject to our Board’s continuing determination that the policy and the declaration of dividends thereunder are in the best interests of our stockholders and are in compliance with applicable law and our credit agreement. Our Board retains the power to modify, suspend, or cancel the dividend policy in any manner and at any time that our Board may deem necessary or appropriate.   We believe that our existing cash and cash equivalents, marketable securities, cash generated from operations, and available borrowings under our revolving credit facility will be sufficient to meet anticipated working capital needs, new product development, and capital expenditures for at least the next 12 months and for the foreseeable future thereafter.   17 Table of Contents   In addition, the Company’s growth strategy includes acquiring businesses or making strategic investments in businesses that complement or enhance our business. It is anticipated that future acquisitions or strategic investments, if any, would be effected through cash consideration, stock consideration, or a combination of both. The issuance of our stock as consideration for an acquisition or to raise additional capital could have a dilutive effect on earnings per share and could adversely affect our stock price. Our revolving credit facility contains financial covenants and availability calculations designed to set a maximum leverage ratio of outstanding debt to adjusted EBITDA and an interest coverage ratio of adjusted EBITDA to interest expense. Therefore, the maximum borrowings against our revolving credit facility would be dependent on the covenant calculations at the time of borrowing. As of March 31, 2023, we were in compliance with all covenants. There can be no assurance that amounts available for borrowing under our revolving credit facility will be sufficient to consummate any possible acquisitions, and we cannot assure you that if we need additional financing that it will be available on terms favorable to us, or at all. 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.