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 Form 10-Q and our audited Consolidated Financial Statements and the Notes thereto for the year ended December 31, 2023, appearing in our Annual Report on Form 10-K that was filed with the Securities and Exchange Commission (“SEC”) on February 26, 2024 (the “2023 Form 10-K”). Statements contained in this 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 2023 Form 10-K and other disclosures in our 2023 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 Form 10-Q, including our critical accounting policies and estimates as discussed in this Form 10-Q and our 2023 Form 10-K. We undertake no obligation to update or revise any forward-looking statements. You should read this Form 10-Q and the documents that we reference in this Form 10-Q and have filed as exhibits to this Form 10-Q 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 individuals and organizations in healthcare meet their ongoing learning, clinical development, credentialing, and scheduling needs. We also provide our solutions to nursing schools and nursing students. 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 enabling our applications through hStream, we believe that stand-alone applications, which already provide a powerful value proposition on their own, are beginning to leverage each other to more efficiently and effectively empower our customers to manage their business and improve their outcomes. Further, the Company’s internal structure and executive leadership are likewise shaped by the organizing principle of a single platform, including with regard to technology, operations, accounting, internal reporting (including the nature of information reviewed by our key decision makers), organizational structure, compensation, performance assessment, and resource allocation. Significant financial metrics for the first quarter of 2024 are set forth in the bullets below. • Revenues of $72.8 million in the first quarter of 2024, up 6% from $68.9 million in the first quarter of 2023 • Operating income of $5.7 million in the first quarter of 2024, up 97% from $2.9 million in the first quarter of 2023 • Net income of $5.2 million in the first quarter of 2024, up 99% from $2.6 million in the first quarter of 2023 • Earnings per share (“EPS”) of $0.17 per share (diluted) in the first quarter of 2024, up from $0.09 per share (diluted) in the first quarter of 2023 • Adjusted EBITDA 1 of $17.1 million in the first quarter of 2024, up 24% from $13.7 million in the first quarter of 2023 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 Form 10-Q. 12 Table of Contents Recent Developments 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, challenging labor market conditions, and uncertain geopolitical conditions. In this regard, we have experienced in certain recent periods, and believe that many of our customers have experienced, increased labor, supply chain, capital, and other expenditures associated with current inflationary pressures. These conditions impacting the U.S. economy and our customers in the healthcare industry have adversely affected, and may continue to adversely impact, our business and results of operations. While the COVID-19 pandemic continues to cause some level of uncertainty, the impact of the pandemic itself on public health and economic conditions has significantly lessened and normalized to the point of reaching an endemic stage. As our business is focused on providing solutions to healthcare organizations, we continue to closely monitor any developments related to COVID-19 and remain prepared to modify our operating approaches to address COVID 19-related developments or other public health related events as they may arise. Key Financial Metrics Our management utilizes the following 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 $72.8 million for the three months ended March 31, 2024, compared to $68.9 million for the three months ended March 31, 2023. 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, certain short-term cash incentive bonuses and performance-based equity award grants are based on the achievement of adjusted EBITDA (as defined in applicable bonus and equity grant documentation) targets. Adjusted EBITDA was $17.1 million for the three months ended March 31, 2024, compared to $13.7 million for the three months ended March 31, 2023. • Capital Expenditures . Capital expenditures represent cash payments incurred for purchases of property and equipment and during the development phase for projects to develop software and content. Capital expenditures were $7.8 million for the three months ended March 31, 2024 compared to $8.4 million for the three months ended March 31, 2023. Management utilizes this metric in connection with managing the allocation of capitalized expenditures in which the Company invests related to the development of its products and believes that this metric is a key indicator of investment in products relative to their current and expected performance. • Net Income . Net income represents revenues, net less all expenses. Net income was $5.2 million for the three months ended March 31, 2024, compared to $2.6 million for the three months ended March 31, 2023. Management utilizes net income in connection with managing our business, including with regard to our capital deployment strategies. 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 2023 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 2023 Form 10-K. Three Months Ended March 31, 2024 Compared to Three Months Ended March 31, 2023 Revenues, net. Revenues increased $3.8 million, or 6%, to $72.8 million for the three months ended March 31, 2024 from $68.9 million for the three months ended March 31, 2023. Subscription revenues increased $4.2 million, or 6%, 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, 2024 2023 Percentage Change Subscription services $ 70,205 $ 66,015 6 % Professional services 2,555 2,931 -13 % Total revenues, net $ 72,760 $ 68,946 6 % % of Revenues Subscription services 96 % 96 % Professional services 4 % 4 % Cost of Revenues (excluding Depreciation and Amortization). Cost of revenues increased $0.7 million, or 3%, to $24.6 million for the three months ended March 31, 2024, from $23.9 million for the three months ended March 31, 2023. Cost of revenues as a percentage of revenues were 34% and 35% for the three months ended March 31, 2024 and 2023, respectively. The increase in expense is primarily associated with higher costs for cloud hosting, royalties, and software, which were partially offset by a reduction in labor costs. Labor costs recognized during the three months ended March 31, 2023 included severance costs incurred in connection with the Company's previously disclosed restructuring under a single platform strategy. 14 Table of Contents Product Development. Product development expenses increased $0.3 million, or 3%, to $12.0 million for the three months ended March 31, 2024, from $11.7 million for the three months ended March 31, 2023. Product development expenses as a percentage of revenues were 17% for both the three months ended March 31, 2024 and 2023. The increase in expense is primarily due to an increase in labor costs, partially offset by an increase in labor capitalized for internally developed software. Sales and Marketing. Sales and marketing expenses, including personnel costs, increased $45,000 to $11.8 million for the three months ended March 31, 2024, from $11.7 million for the three months ended March 31, 2023. Sales and marketing expenses were 16% and 17% of revenues for the three months ended March 31, 2024 and 2023, respectively. The increase in expense is primarily due to increases in general marketing expenses, travel expenses, and commissions, which were partially offset by a decrease in labor costs. Other General and Administrative Expenses. Other general and administrative expenses decreased $0.6 million, or 6%, to $8.3 million for the three months ended March 31, 2024, from $8.9 million for the three months ended March 31, 2023. Other general and administrative expenses were 11% and 13% of revenues for the three months ended March 31, 2024 and 2023, respectively. The decrease is primarily due to lower labor costs and professional service fees, which were partially offset by higher software expenses. Depreciation and Amortization. Depreciation and amortization expense increased $0.4 million, or 4%, to $10.3 million for the three months ended March 31, 2024, from $9.9 million for the three months ended March 31, 2023. This increase is primarily a result of an increase in amortization associated with capitalized software. Other Income, Net . Other income, net was $0.9 million for the three months ended March 31, 2024, compared to $0.3 million for the three months ended March 31, 2023. The increase is primarily the result of an increase in interest income earned on cash and investments during the three months ended March 31, 2024. Income Tax Provision. The Company recorded a provision for income taxes of $1.3 million for the three months ended March 31, 2024, compared to $0.5 million for the three months ended March 31, 2023. The Company’s effective tax rate was 20% for the three months ended March 31, 2024, compared to 16% for the three months ended March 31, 2023. 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, 2024, the Company recorded discrete tax benefits of $17,000, which consisted primarily of a $129,000 tax benefit associated with stock-based awards, partially offset by $112,000 of discrete tax expense related to reserves for uncertain tax positions. 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. Net Income. Net income was $5.2 million and $2.6 million for the three months ended March 31, 2024 and 2023, respectively. EPS was $0.17 per share (diluted) and $0.09 per share (diluted) for the three months ended March 31, 2024 and 2023, respectively. Adjusted EBITDA was $17.1 million for the three months ended March 31, 2024, compared to $13.7 million for the three months ended March 31, 2023. 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 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 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. In addition, as discussed below, for periods ended on or prior to December 31, 2023, adjusted EBITDA excludes the impact of deferred revenue write-downs associated with fair value accounting for acquired businesses. We 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, certain short-term cash incentive bonuses and performance-based equity awards are based on the achievement of adjusted EBITDA (as defined in applicable bonus and equity grant documentation) targets. As previously disclosed, 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. In connection therewith, management determined that including an adjustment in the definition of adjusted EBITDA for the impact of the deferred revenue 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 (the “Pre-2022 Acquisitions”) provided useful information to investors because the deferred revenue write-down recognized in periods after any such Pre-2022 Acquisition could, 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. Following the adoption of ASU 2021-08, contracts acquired in an acquisition completed on or after January 1, 2022 have been 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. With respect to periods ended on or prior to December 31, 2023, the Company has included an adjustment in the calculation of adjusted EBITDA for the impact of deferred revenue write-downs associated with the Pre-2022 Acquisitions consistent with this prior accounting standard, given the ongoing impact of such deferred revenue on the Company's financial results under GAAP over this time period. With respect to periods beginning on or after January 1, 2024, the Company is no longer recognizing any deferred revenue write-downs associated with the Pre-2022 Acquisitions under GAAP, and accordingly such deferred revenue write-downs are no longer an adjustment in connection with the calculation of adjusted EBITDA for periods beginning on and after January 1, 2024. 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, net income, is set forth below (in thousands). Three Months Ended March 31, 2024 2023 Net income $ 5,227 $ 2,623 Deferred revenue write-down — 50 Interest income (904 ) (363 ) Interest expense 24 33 Income tax provision 1,316 518 Stock-based compensation expense 1,060 945 Depreciation and amortization 10,336 9,926 Adjusted EBITDA $ 17,059 $ 13,732 16 Table of Contents Liquidity and Capital Resources Net cash provided by operating activities increased by $0.4 million to $20.9 million during the three months ended March 31, 2024, from $20.5 million during the three months ended March 31, 2023. The increase in net cash provided by operating activities is primarily due to higher cash collections compared to the prior year period. Our days sales outstanding ("DSO") was 46 days for the first quarter of 2024 compared to 51 days for the first quarter of 2023. 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, income tax payments, and general corporate expenses. Net cash used in investing activities was $7.1 million for the three months ended March 31, 2024, compared to $16.9 million for the three months ended March 31, 2023. During the three months ended March 31, 2024, the Company invested in marketable securities of $14.1 million, made payments for capitalized software development of $7.0 million, and purchased property and equipment of $0.7 million. These uses of cash were partially offset by $14.0 million in maturities of marketable securities and $0.8 million received upon the settlement and release of escrowed proceeds related to a prior sale of a non-marketable equity investment. 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. Net cash used in financing activities was approximately $1.7 million for the three months ended March 31, 2024, compared to $0.8 million for the three months ended March 31, 2023. The uses of cash for the three months ended March 31, 2024 included $0.8 million for the payment of cash dividends and $0.9 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, 2023 included $0.8 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 $21.3 million at March 31, 2024, compared to positive working capital of $11.8 million at December 31, 2023. The increase in working capital is primarily a result of an increase in cash and cash equivalents. The Company’s primary source of liquidity as of March 31, 2024 was $52.4 million of cash and cash equivalents and $31.3 million of marketable securities. On October 6, 2023, the Company entered into a new revolving credit facility, which amended and replaced our prior revolving credit facility. There currently are no outstanding borrowings under our revolving credit facility. For additional information regarding our revolving credit facility, see Note 8 to the Condensed Consolidated Financial Statements included herein. On September 13, 2023, the Company announced a share repurchase program approved by the Company's Board under which the Company was authorized to purchase up to $10.0 million of the Company's outstanding shares of common stock. The share repurchase program expired according to its terms on March 31, 2024, and no repurchases occurred during the three months ended March 31, 2024. During the term of this program, the Company repurchased a total of 404,188 shares under this program at an aggregate fair value of $8.9 million, based on an average price per share of $22.07 (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 quarterly dividend policy. Under this dividend policy, our Board declared, and the Company paid, quarterly cash dividends on our common stock at the rate of $0.025 per share during the year ended December 31, 2023. In addition, on February 19, 2024, our Board approved a quarterly dividend under this dividend policy at a rate of $0.028 per share, which was paid on March 22, 2024 to the holders of record of our common stock on March 11, 2024. Moreover, on April 22, 2024, the Board approved a quarterly cash dividend of $0.028 per share, which will be payable on May 17, 2024 to holders of record of our common stock on May 6, 2024. T he 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 and payment 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 and quarterly dividends thereunder 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, dividend payments, any repurchases of shares we may elect to make under any future share repurchase program, 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 new revolving credit facility would be dependent on the covenant calculations at the time of borrowing. As of March 31, 2024, we were in compliance with all covenants under our revolving credit facility. 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 provide assurance 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.