UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2011

March 31, 2012

Commission File No.: 000-27701

HealthStream, Inc.

(Exact name of registrant as specified in its charter)

Tennessee 
Tennessee62-1443555
(State or other jurisdiction of
incorporation or organization)		 (I.R.S. Employer
Identification No.)

209 10th Avenue South, Suite 450

Nashville, Tennessee

 37203
(Address of principal executive offices) (Zip Code)

(615) 301-3100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yesþx    Noo¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yesþx    Noo¨

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨  Accelerated filer x
Large acceleratedNon-accelerated filero Accelerated filero¨Non-accelerated filero(Do  (Do not check if a smaller reporting company)  Smaller reporting companyþ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso¨ Noþx

As of October 27, 2011, 22,211,085April 23, 2012, 26,108,635 shares of the registrant’s common stock were outstanding.

 

Index to Form 10-Q

HEALTHSTREAM, INC.

    
Page
Number		 
Part I. Number
Part I. Financial Information
 
Item 1. 
Item 1. Financial Statements
 
 
Condensed Consolidated Balance Sheets — September 30, 2011– March 31, 2012 (Unaudited) and December 31, 20102011
  1  
Condensed Consolidated Statements of Income (Unaudited) —- Three Months ended September 30,March 31, 2012 and 2011 and 2010  2  
Condensed Consolidated Statements of Comprehensive Income (Unaudited)— NineThree Months ended September 30,March 31, 2012 and 2011 and 2010  3  
Condensed Consolidated Statement of Shareholders’ Equity (Unaudited)— NineThree Months ended September 30, 2011March 31, 2012  4  

Condensed Consolidated Statements of Cash Flows (Unaudited) — Nine- Three Months ended September 30,March  31, 2012 and 2011 and 2010

 

5

 
Notes to Condensed Consolidated Financial Statements
  6  
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations  9  
Item 3.Quantitative and Qualitative Disclosures About Market Risk  1513  
Item 4.Controls and Procedures  1613  
Part II.Other Information
Item 6.Exhibits  13  
Item 6. ExhibitsSignature  1714  
Signature
18
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

         
  September 30,  December 31, 
  2011  2010 
  (Unaudited)     
ASSETS        
Current assets:        
Cash and cash equivalents $30,236  $17,868 
Investments in short-term marketable securities  —   5,703 
Restricted cash  15   85 
Interest receivable  —   51 
Accounts receivable, net of allowance for doubtful accounts of $152 and $157 at September 30, 2011 and December 31, 2010, respectively  13,141   11,069 
Accounts receivable — unbilled  1,117   1,314 
Deferred tax assets, current  3,437   3,437 
Prepaid royalties, net of amortization  1,913   3,145 
Other prepaid expenses and other current assets  1,844   1,599 
       
Total current assets  51,703   44,271 
Property and equipment:        
Equipment  16,088   14,348 
Leasehold improvements  4,048   2,738 
Furniture and fixtures  2,384   2,027 
       
   22,520   19,113 
Less accumulated depreciation and amortization  (16,386)  (15,288)
       
   6,134   3,825 
         
Capitalized software development, net of accumulated amortization of $7,673 and $5,887 at September 30, 2011 and December 31, 2010, respectively  7,746   4,333 
Goodwill  21,147   21,147 
Intangible assets, net of accumulated amortization of $8,712 and $8,043 at September 30, 2011 and December 31, 2010, respectively  2,175   2,844 
Deferred tax assets, noncurrent  2,445   5,347 
Other assets  85   244 
       
Total assets $91,435  $82,011 
       
         
LIABILITIES AND SHAREHOLDERS’ EQUITY        
Current liabilities:        
Accounts payable $1,302  $2,375 
Accrued liabilities  4,123   4,121 
Accrued compensation and related expenses  1,499   1,506 
Deferred revenue  20,488   16,740 
Capital lease obligations  —   4 
       
Total current liabilities  27,412   24,746 
         
Other long-term liabilities  458   474 
Commitments and contingencies  —   — 
         
Shareholders’ equity:        
Common stock, no par value, 75,000 shares authorized; 22,211 and 21,805 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively  98,844   97,227 
Accumulated deficit  (35,279)  (40,431)
Accumulated other comprehensive loss  —   (5)
       
Total shareholders’ equity  63,565   56,791 
       
Total liabilities and shareholders’ equity $91,435  $82,011 
       

   March 31,  December 31, 
   2012  2011 
   (Unaudited)    

ASSETS

   

Current assets:

   

Cash and cash equivalents

  $24,268   $76,904  

Marketable securities – short-term

   61,284    6,552  

Accounts receivable, net of allowance for doubtful accounts of $149 and $149
at March 31, 2012 and December 31, 2011, respectively

   16,324    16,014  

Accounts receivable - unbilled

   1,046    1,316  

Deferred tax assets, current

   4,140    5,080  

Prepaid royalties, net of amortization

   1,859    3,409  

Other prepaid expenses and other current assets

   1,980    1,804  
  

 

 

  

 

 

 

Total current assets

   110,901    111,079  

Property and equipment:

   

Equipment

   16,472    16,362  

Leasehold improvements

   4,193    4,170  

Furniture and fixtures

   2,642    2,545  
  

 

 

  

 

 

 
   23,307    23,077  

Less accumulated depreciation and amortization

   (17,078)   (16,990) 
  

 

 

  

 

 

 
   6,229    6,087  

Marketable securities – long-term

   6,002    5,996  

Capitalized software development, net of accumulated amortization of $8,982
and $8,344 at March 31, 2012 and December 31, 2011, respectively

   8,302    7,940  

Goodwill

   21,147    21,147  

Intangible assets, net of accumulated amortization of $9,148 and $8,930
at March 31, 2012 and December 31, 2011, respectively

   1,739    1,957  

Other assets

   31    31  
  

 

 

  

 

 

 

Total assets

  $154,351   $154,237  
  

 

 

  

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

   

Current liabilities:

   

Accounts payable

  $1,426   $2,585  

Accrued liabilities

   3,904    5,492  

Accrued compensation and related expenses

   672    1,612  

Deferred revenue

   24,233    22,759  
  

 

 

  

 

 

 

Total current liabilities

   30,235    32,448  

Deferred tax liabilities, noncurrent

   323    323  

Other long term liabilities

   620    551  

Commitments and contingencies

   —      —    

Shareholders’ equity:

   

Common stock, no par value, 75,000 shares authorized; 26,098 and 25,896
shares issued and outstanding at March 31, 2012 and
December 31, 2011, respectively

   155,247    154,409  

Accumulated deficit

   (32,067)   (33,487) 

Accumulated other comprehensive loss

   (7)   (7) 
  

 

 

  

 

 

 

Total shareholders’ equity

   123,173    120,915  
  

 

 

  

 

 

 

Total liabilities and shareholders’ equity

  $154,351   $154,237  
  

 

 

  

 

 

 

See accompanying notes to the condensed consolidated financial statements.

1

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(In thousands, except per share data)

         
  Three Months Ended September 30, 
  2011  2010 
Revenues, net $20,618  $16,616 
Operating costs and expenses:        
Cost of revenues (excluding depreciation and amortization)  7,915   6,274 
Product development  1,946   1,750 
Sales and marketing  3,810   3,358 
Other general and administrative expenses  2,782   2,401 
Depreciation and amortization  1,471   1,143 
       
Total operating costs and expenses  17,924   14,926 
         
Income from operations  2,694   1,690 
         
Other income (expense):        
Interest and other income  5   4 
Interest and other expense  (13)  (9)
       
Total other expense, net  (8)  (5)
       
         
Income before income tax provision  2,686   1,685 
Income tax provision  890   889 
       
Net income $1,796  $796 
       
         
Net income per share:        
Basic $0.08  $0.04 
       
Diluted $0.08  $0.04 
       
         
Weighted average shares of common stock outstanding:        
Basic  22,164   21,807 
       
Diluted  23,496   22,511 
       

   Three Months Ended March 31, 
   2012   2011 

Revenues, net

  $23,674    $18,506  

Operating costs and expenses:

    

Cost of revenues (excluding depreciation and amortization)

   9,575     7,070  

Product development

   1,869     1,786  

Sales and marketing

   5,536     3,508  

Other general and administrative expenses

   2,819     2,542  

Depreciation and amortization

   1,534     1,043  
  

 

 

   

 

 

 

Total operating costs and expenses

   21,333     15,949  

Income from operations

   2,341     2,557  

Other income (expense), net

   19     20  
  

 

 

   

 

 

 

Income before income tax provision

   2,360     2,577  

Income tax provision

   940     1,051  
  

 

 

   

 

 

 

Net income

  $1,420    $1,526  
  

 

 

   

 

 

 

Earnings per share:

    

Basic

  $0.05    $0.07  
  

 

 

   

 

 

 

Diluted

  $0.05    $0.07  
  

 

 

   

 

 

 

Weighted average shares of common stock outstanding:

    

Basic

   25,999     21,837  
  

 

 

   

 

 

 

Diluted

   27,335     22,969  
  

 

 

   

 

 

 

See accompanying notes to the condensed consolidated financial statements.

2

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In thousands, except per share data)

         
  Nine Months Ended September 30, 
  2011  2010 
Revenues, net $60,175  $48,114 
Operating costs and expenses:        
Cost of revenues (excluding depreciation and amortization)  22,623   17,643 
Product development  5,644   4,999 
Sales and marketing  11,674   9,369 
Other general and administrative expenses  8,009   6,885 
Depreciation and amortization  3,868   3,769 
       
Total operating costs and expenses  51,818   42,665 
         
Income from operations  8,357   5,449 
         
Other income (expense):        
Interest and other income  43   13 
Interest and other expense  (35)  (31)
       
Total other income (expense), net  8   (18)
       
         
Income before income tax provision  8,365   5,431 
Income tax provision  3,213   2,481 
       
Net income $5,152  $2,950 
       
         
Net income per share:        
Basic $0.23  $0.14 
       
Diluted $0.22  $0.13 
       
         
Weighted average shares of common stock outstanding:        
Basic  22,001   21,759 
       
Diluted  23,272   22,358 
       
thousands)

   Three Months Ended March 31, 
   2012   2011 

Net income

  $1,420    $1,526  

Other comprehensive income, net of taxes:

    

Unrealized gain on marketable securities

   —       4  
  

 

 

   

 

 

 

Total other comprehensive income

   —       4  
  

 

 

   

 

 

 

Comprehensive income

  $1,420    $1,530  
  

 

 

   

 

 

 

See accompanying notes to the condensed consolidated financial statements.

3

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
NINE

THREE MONTHS ENDED SEPTEMBER 30, 2011
MARCH 31, 2012

(In thousands)

                     
              Accumulated Other  Total 
  Common Stock  Accumulated  Comprehensive  Shareholders’ 
  Shares  Amount  Deficit  (Loss)  Equity 
Balance at December 31, 2010  21,805  $97,227  $(40,431) $(5) $56,791 
                     
Net income  —   —   5,152   —   5,152 
                     
Unrealized gain on investments in marketable securities  —   —   —   5   5 
                     
Stock based compensation expense  —   597   —   —   597 
                     
Exercise of stock options  406   1,020   —   —   1,020 
                
                     
Balance at September 30, 2011  22,211  $98,844  $(35,279) $—  $63,565 
                

   Common Stock   Accumulated  Accumulated
Other
Comprehensive		  Total
Shareholders’		 
   Shares   Amount   Deficit  (Loss)  Equity 

Balance at December 31, 2011

   25,896    $154,409    $(33,487)  $(7)  $120,915  

Net income

   —       —       1,420    —      1,420  

Other comprehensive income

   —       —        —      —    

Stock based compensation expense

   —       242     —      —      242  

Exercise of stock options

   202     596     —      —      596  
  

 

 

   

 

 

   

 

 

  

 

 

  

 

 

 

Balance at March 31, 2012

   26,098    $155,247    $(32,067)  $(7)  $123,173  
  

 

 

   

 

 

   

 

 

  

 

 

  

 

 

 

See accompanying notes to the condensed consolidated financial statements.

4

HEALTHSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

         
  Nine Months Ended September 30, 
  2011  2010 
OPERATING ACTIVITIES:        
Net income $5,152  $2,950 
Adjustments to reconcile net income to net cash provided by operating activities:        
Depreciation and amortization  3,868   3,769 
Stock based compensation expense  597   498 
Deferred income taxes  2,902   2,338 
Provision for doubtful accounts  45   20 
Changes in operating assets and liabilities:        
Accounts and unbilled receivables  (1,920)  (1,366)
Restricted cash  70   23 
Prepaid royalties  1,233   314 
Other prepaid expenses and other current assets  (356)  (402)
Other assets  243   134 
Accounts payable  (1,073)  (730)
Accrued liabilities and accrued compensation and related expenses and other long-term liabilities  (21)  (600)
Deferred revenue  3,748   4,869 
       
Net cash provided by operating activities  14,488   11,817 
       
         
INVESTING ACTIVITIES:        
Proceeds from maturities of investments in marketable securities  10,351   — 
Purchases of investments in marketable securities  (4,728)  — 
Payments associated with capitalized software development  (5,199)  (1,586)
Purchases of property and equipment  (3,560)  (850)
       
Net cash used in investing activities  (3,136)  (2,436)
       
         
FINANCING ACTIVITIES:        
Proceeds from exercise of stock options  1,020   469 
Repurchase of common stock  —   (380)
Payments on note payable  —   (307)
Payments on capital lease obligations  (4)  (7)
       
Net cash provided by (used in) financing activities  1,016   (225)
       
         
Net increase in cash and cash equivalents  12,368   9,156 
Cash and cash equivalents at beginning of period  17,868   12,287 
       
Cash and cash equivalents at end of period $30,236  $21,443 
       

   Three Months Ended March 31, 
   2012  2011 

OPERATING ACTIVITIES:

   

Net income

  $1,420   $1,526  

Adjustments to reconcile net income to net cash provided by operating activities:

   

Depreciation and amortization

   1,534    1,043  

Stock based compensation expense

   242    190  

Deferred income taxes

   940    1,051  

Changes in operating assets and liabilities:

   

Accounts and unbilled receivables

   (40)   (2,075) 

Prepaid royalties

   1,550    741  

Other prepaid expenses and other current assets

   (232)   (186) 

Other assets

   146    91  

Accounts payable

   (1,160)   (1,000) 

Accrued liabilities and accrued compensation and related expenses and other long-term liabilities

   (2,460)   (1,180) 

Deferred revenue

   1,474    3,342  
  

 

 

  

 

 

 

Net cash provided by operating activities

   3,414    3,543  
  

 

 

  

 

 

 

INVESTING ACTIVITIES:

   

Proceeds from maturities of investments in marketable securities

   3,500    2,135  

Purchases of investments in marketable securities

   (58,383)   (4,728) 

Payments associated with capitalized software development

   (1,000)   (4,086) 

Purchases of property and equipment

   (763)   (708) 
  

 

 

  

 

 

 

Net cash used in investing activities

   (56,646)   (7,387) 
  

 

 

  

 

 

 

FINANCING ACTIVITIES:

   

Proceeds from exercise of stock options

   596    199  

Payments on capital lease obligations

   —      (2) 
  

 

 

  

 

 

 

Net cash provided by financing activities

   596    197  
  

 

 

  

 

 

 

Net decrease in cash and cash equivalents

   (52,636)   (3,647) 

Cash and cash equivalents at beginning of period

   76,904    17,868  
  

 

 

  

 

 

 

Cash and cash equivalents at end of period

  $24,268   $14,221  
  

 

 

  

 

 

 

See accompanying notes to the condensed consolidated financial statements.

5

HEALTHSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, condensed consolidated financial statements do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant intercompany transactions have been eliminated in consolidation. Operating results for the three and nine months ended September 30, 2011March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

2012.

The balance sheet at December 31, 20102011 is consistent with the audited financial statements at that date but does not include all of the information and footnotes required by US GAAP for a complete set of financial statements. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 20102011 (included in the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 23, 2011 and as amended on August 10, 2011)February 28, 2012).

2. INCOME TAXES

Income taxes are accounted for using the asset and liability method, whereby 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.

During the ninethree months ended September 30,March 31, 2012 and 2011, and 2010, the Company recorded a provision for income taxes of $3.2 million$940,000 and $2.5$1.1 million, respectively. The Company’s effective tax rate for the ninethree months ended September 30,March 31, 2012 and 2011 was 39.8% and 2010 was 38.4% and 45.7%40.8%, respectively. The Company’s effective tax rate primarily reflects the statutory corporate income tax rate, the net effect of state taxes, and the effect of various immaterial permanent tax differences.

3. STOCK BASED COMPENSATION

The Company maintains two stock incentive plans. The Company accounts for its stock based compensation plans using the fair-value based method for costs related to share-based payments, including stock options.options and restricted share units. During the ninethree months ended September 30,March 31, 2012, the Company issued 69,950 restricted share units with a grant date fair value of $23.00 per share, measured based on the closing fair market value of the Company’s stock on the date of grant. During the three months ended March 31, 2011, the Company granted 362,750219,750 stock options with a weighted average grant date fair value of $4.67. During the nine months ended September 30, 2010, the Company granted 319,000 stock options with a weighted average grant date fair value of $2.07.$3.51. The fair value of stock based awardsoptions granted during the ninethree months ended September 30,March 31, 2011 and 2010 was estimated using the Black Scholes option pricing model, with the assumptions as follows:

         
  Nine Months Ended 
  September 30, 
  2011  2010 
Risk-free interest rate  1.05 — 2.39%  2.39 — 2.49%
Expected dividend yield  0.0%  0.0%
Expected life 5 — 7 years 5 — 7 years
Expected forfeiture rate  0–5%  0–10%
Volatility  50%  55%

Three Months Ended
March 31, 2011

Risk-free interest rate

2.37% 

Expected dividend yield

0.0% 

Expected life

5 years

Expected forfeiture rate

5% 

Volatility

50% 

Total stock based compensation expense recorded for the three and nine months ended September 30,March 31, 2012 and 2011, and 2010, which is recorded in the condensed consolidated statements of income, is as follows (in thousands):

                 
  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
  2011  2010  2011  2010 
Cost of revenues (excluding depreciation and amortization) $9  $9  $29  $28 
Product development  34   32   110   96 
Sales and marketing  35   40   117   126 
Other general and administrative  145   85   341   248 
             
Total stock based compensation expense $223  $166  $597  $498 
             

6

   

Three Months Ended

March 31,

 
   2012   2011 

Cost of revenues (excluding depreciation and amortization)

  $10    $11  

Product development

   34     40  

Sales and marketing

   38     48  

Other general and administrative

   160     91  
  

 

 

   

 

 

 

Total stock based compensation expense

  $242    $190  
  

 

 

   

 

 

 

HEALTHSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

4. NET INCOMEEARNINGS PER SHARE

Basic net incomeearnings 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 incomeearnings 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 sharesshare units subject to vesting are included in diluted net incomeearnings per share only 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. The total number of common equivalent shares excluded from the calculations of diluted net incomeearnings per share, due to their anti-dilutive effect, was approximately 0.10.2 million and 0.3 million for the three and nine months ended September 30,March 31, 2012 and 2011, respectively, and approximately 0.3 million and 0.5 million for the three and nine months ended September 30, 2010, respectively.

The following table sets forth the computation of basic and diluted net incomeearnings per share for the three and nine months ended September 30,March 31, 2012 and 2011 and 2010 (in thousands, except per share data):

                 
  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
  2011  2010  2011  2010 
Numerator:                
Net income $1,796  $796  $5,152  $2,950 
             
                 
Denominator:                
Weighted average shares outstanding:                
Basic  22,164   21,807   22,001   21,759 
Employee stock options  1,332   704   1,271   599 
             
Diluted  23,496   22,511   23,272   22,358 
             
                 
Net income per share:                
Basic $0.08  $0.04  $0.23  $0.14 
             
Diluted $0.08  $0.04  $0.22  $0.13 
             

   

Three Months Ended

March 31,

 
   2012   2011 

Numerator:

    

Net income

  $1,420    $1,526  
  

 

 

   

 

 

 

Denominator:

    

Weighted-average shares outstanding

   25,999     21,837  

Effect of dilutive shares

   1,336     1,132  
  

 

 

   

 

 

 

Weighted-average diluted shares

   27,335     22,969  
  

 

 

   

 

 

 

Basic earnings per share

  $0.05    $0.07  
  

 

 

   

 

 

 

Diluted earnings per share

  $0.05    $0.07  
  

 

 

   

 

 

 

5. COLLABORATIVE ARRANGEMENT

On June 23, 2010, the Company announced the formation of SimVentures, a collaborative arrangement between HealthStreamMARKETABLE SECURITIES

At March 31, 2012 and Laerdal Medical Corporation (Laerdal Medical). The Company receives 50 percent of the profits or losses generated from this collaborative arrangement. The parties did not form a separate legal entity as part of the collaborative arrangement; therefore, the Company accounts for SimVentures as a collaborative arrangement in accordance with applicable accounting guidance. During the first quarter ofDecember 31, 2011, the Company acquired a fifty percent ownership interestfair value of marketable securities, which were all classified as available for sale, included the following (in thousands):

   March 31, 2012 
   Adjusted Cost   Unrealized
Gains		   Unrealized
Losses		  Fair Value 

Level 1:

       

Mutual funds

  $5,011    $12    $—     $5,023  
  

 

 

   

 

 

   

 

 

  

 

 

 

Level 2:

       

Corporate debt securities

   16,171     —       (7)   16,164  

U.S. government securities

   46,111     1     (13)   46,099  
  

 

 

   

 

 

   

 

 

  

 

 

 

Subtotal

   62,282     1     (20)   62,263  
  

 

 

   

 

 

   

 

 

  

 

 

 

Total

  $67,293    $13    $(20)  $67,286  
  

 

 

   

 

 

   

 

 

  

 

 

 

   December 31, 2011 
   Adjusted Cost   Unrealized
Gains		   Unrealized
Losses		  Fair Value 

Level 1:

       

Mutual funds

  $2,504    $—      $—     $2,504  
  

 

 

   

 

 

   

 

 

  

 

 

 

Level 2:

       

Corporate debt securities

   2,038     —       (1)   2,037  

U.S. government securities

   8,013     —       (6)   8,007  
  

 

 

   

 

 

   

 

 

  

 

 

 

Subtotal

   10,051     —       (7)   10,044  
  

 

 

   

 

 

   

 

 

  

 

 

 

Total

  $12,555    $—      $(7)  $12,548  
  

 

 

   

 

 

   

 

 

  

 

 

 

The carrying amounts reported in Laerdal Medical’s Advanced Video System (AVS) product for $3.5 million in cash. AVS is a product that enables users of advanced patient simulators to easily capture video, audio, data logs, and “patient” responses. The AVS product is now jointly owned through SimVentures. During the second quarter of 2011, SimVentures launched SimStore™, one of the components of SimCenter™ that offers healthcare providers an opportunity to sample and purchase simulation scenarios to use in their simulation training activities. During the nine months ended September 30, 2011, the Company recorded approximately $0.5 million of revenues and $0.9 million of expenses related to the collaborative arrangement. The expenses are primarily recorded in the product development, sales and marketing and depreciation and amortization categories within the condensed consolidated statements of income.balance sheet approximate the fair value based on quoted market prices or alternative pricing sources and models utilizing market observable inputs. The Company also recorded approximately $4.0 million of capitalized software development for SimVentures during 2011, comprisedmaturities of the $3.5 million paid forCompany’s long-term marketable securities are less than two years. As of March 31, 2012, the AVS product and $0.5 million associated with SimStoreTM.

Company does not consider any of its marketable securities to be other than temporarily impaired.

HEALTHSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

6. BUSINESS SEGMENTS

The Company primarily provides services to healthcare organizations and to a lesser extent, to pharmaceutical and medical device companies and other members within the healthcare industry. The Company’s 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). The accounting policies of the segments are the same as those described in the summary of significant accounting policies in the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2010.

7

2011.

HEALTHSTREAM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6. BUSINESS SEGMENTS (continued)
The Company measures segment performance based on operating income before income taxes and prior to the allocation of certain corporate overhead expenses, interest income, interest expense, and depreciation. The following is the Company’s business segment information as of and for the three and nine months ended September 30,March 31, 2012 and 2011 and 2010 (in thousands).
                 
  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
Revenues 2011  2010  2011  2010 
HealthStream Learning $14,805  $11,527  $42,248  $33,070 
HealthStream Research  5,813   5,089   17,927   15,044 
             
Total net revenue $20,618  $16,616  $60,175  $48,114 
             
                 
Income from operations                
HealthStream Learning $4,649  $3,686  $13,124  $11,033 
HealthStream Research  504   39   1,977   665 
Unallocated  (2,459)  (2,035)  (6,744)  (6,249)
             
Total income from operations $2,694  $1,690  $8,357  $5,449 
             
         
Segment assets * September 30, 2011  December 31, 2010 
HealthStream Learning $23,670  $18,731 
HealthStream Research  25,256   26,702 
Unallocated  42,509   36,578 
       
Total assets $91,435  $82,011 
       

   

Three Months Ended

March 31,

 
   2012  2011 
Revenues   

Learning

  $17,798   $12,987  

Research

   5,876    5,519  
  

 

 

  

 

 

 

Total net revenue

  $23,674   $18,506  
  

 

 

  

 

 

 

Income from operations

   

Learning

  $4,757   $4,267  

Research

   279    327  

Unallocated

   (2,695)   (2,037) 
  

 

 

  

 

 

 

Total income from operations

  $2,341   $2,557  
  

 

 

  

 

 

 

    March 31, 2012   December 31, 2011 

Segment assets *

    

Learning

  $25,990    $27,322  

Research

   25,743     26,088  

Unallocated

   102,618     100,827  
  

 

 

   

 

 

 

Total assets

  $154,351    $154,237  
  

 

 

   

 

 

 

*Segment assets include restricted cash, accounts and unbilled receivables, prepaid and other current assets, other assets, capitalized software development, certain property and equipment, and intangible assets. Cash and cash equivalents and investments in marketable securities are not allocated to individual segments, and are included within Unallocated. A significant portion of property and equipment assets are included within Unallocated.

8

7. COLLABORATIVE ARRANGEMENT

On June 23, 2010, the Company announced the formation of SimVenturesTM, a collaborative arrangement between HealthStream and Laerdal Medical A/S (Laerdal Medical). The Company receives 50 percent of the profits or losses generated from this collaborative arrangement. For the three months ended March 31, 2012, the Company recorded approximately $0.4 million of revenues and $0.5 million of expenses related to the collaborative arrangement. For the three months ended March 31, 2011, the Company recorded no revenues and $0.1 million of expenses related to the collaborative arrangement. The Company also recorded approximately $0.4 million of capitalized software development for SimVentures during 2012.

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, 2010,2011, appearing in our Annual Report on Form 10-K that was filed with the Securities and Exchange Commission (“SEC”) on March 23, 2011 as amended on August 10, 2011February 28, 2012, (the “2010“2011 Form 10-K”). Statements contained in this Quarterly Report on Form 10-Q that are not historical fact 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 and the information set forth under the caption “Item 1A. Risk Factors” in our 20102011 Form 10-K and the information regarding forward-looking statements in our earnings releases, as well as other cautionary statements contained elsewhere in this report, including the matters discussed in “Critical Accounting Policies and Estimates.” We undertake no obligation beyond that required by law to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. 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 expect.

Overview

HealthStream provides servicesInternet-based learning and research solutions for healthcare organizations—all designed to assess and develop the people that deliver patient care which, in turn, supports the improvement of business and clinical outcomes. Our learning products are used by healthcare organizations to meet a broad range of their training, certification, and development needs, while our research products provide our customers information about patients’ experiences, workforce engagement, physician relations, and community perceptions of their services. HealthStream’s customers include healthcare organizations, pharmaceutical and medical device companies, and other participants withinin 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® (HLC), authoring tools, courseware subscriptions, implementation and consulting services, content development, online sales training courses (RepDirect™), HospitalDirect®, SimVentures, and other products focused on education and training to serve professionals that work within healthcare organizations. HealthStream Research provides 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 patients, employees, physicians, and members of the community.

Key financial indicators for the thirdfirst quarter of 2012 include:

Revenues of $23.7 million in the first quarter of 2012, up 28% over the first quarter of 2011

Operating income of $2.3 million in the first quarter of 2012, compared to $2.6 million in the first quarter of 2011: annual customer Summit net costs of approximately $520,000 incurred in the first quarter of 2012 versus the second quarter of 2011

Net income of $1.4 million in the first quarter of 2012, compared to net income of $1.5 million in the first quarter of 2011, include:and earnings per share (EPS) of $0.05 per share in the first quarter of 2012, compared to EPS of $0.07 per share in the first quarter of 2011

 • Revenues

Adjusted EBITDA(1) of $20.6$4.1 million in the thirdfirst quarter of 2011,2012, up 24% over the third quarter of 2010

•Operating income of $2.78% from $3.8 million in the thirdfirst quarter of 2011 up 59% over the third quarter

(1)- Adjusted EBITDA is a non-GAAP financial measure. A reconciliation of 2010
•Net income of $1.8 million, up 126% fromadjusted EBITDA to net income of $796,000is included in the third quarter of 2010, and earnings per share (EPS) of $0.08 per share (diluted) in the third quarter of 2011, up 100% from EPS of $0.04 per share (diluted) in the third quarter of 2010
•Adjusted EBITDA of $4.4 million in the third quarter of 2011, up 46% from $3.0 million in the third quarter of 2010this report.

Critical Accounting Policies and Estimates

Our

The Company’s condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (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. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected.

9

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

•Revenue recognition
•Accounting for income taxes
•Product development costs and related capitalization
•Goodwill, intangibles, and other long-lived assets
•Allowance for doubtful accounts
•Accrual for service credits
•Stock based compensation
•Nonmonetary exchange of content rights and deferred service credits

Accounting for income taxes

Software development costs

Goodwill, intangibles, and other long-lived assets

Allowance for doubtful accounts

Accrual for service credits

Stock based compensation

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 in which management’s judgment in selecting among available alternatives would not produce a materially different result. See Notes to Consolidated Financial Statements in our 20102011 Form 10-K, which contains 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 20102011 Form 10-K.

Revenues and Expense Components
The following descriptions of the components of revenues and expenses apply to the comparison of results of operations.
Revenues, net.Revenues for our HealthStream Learning business segment primarily consist of the following products and services: provision of services through our Internet-based HLC, authoring tools, a variety of courseware subscriptions, implementation and consulting services, content development, online sales training courses (RepDirect™), HospitalDirect®, SimVentures, and a variety of other educational activities to serve professionals that work within healthcare organizations. 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 patients, employees, physicians, and other members of the community.
Cost of Revenues (excluding depreciation and amortization).Cost of revenues (excluding depreciation and amortization) 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 consists primarily of salaries and employee benefits, contract labor, 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, application development, and quality assurance teams, product managers, and other personnel associated with content and product development.
Sales and Marketing.Sales and marketing consists primarily of salaries, commissions and employee benefits, stock based compensation, employee travel and lodging, advertising, trade shows, promotions, and related marketing costs. We host a national customer conference in Nashville known as “The Summit,” a portion of the costs of which are included in sales and marketing expenses. Personnel costs within sales and marketing include our HealthStream Learning and HealthStream Research sales teams, strategic account management, consultants, and marketing personnel, as well as our account management group.
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.
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 development.

10

Other Income (Expense).The primary component of other income is interest income related to interest earned on cash, cash equivalents and investments in marketable securities. The primary component of other expense is interest expense related to capital leases and our revolving credit facility.
Three Months Ended September 30, 2011March 31, 2012 Compared to Three Months Ended September 30, 2010
March 31, 2011

Revenues, net.Revenues increased approximately $4.0$5.2 million, or 24.1%27.9%, to $20.6$23.7 million for the three months ended September 30, 2011March 31, 2012 from $16.6$18.5 million for the three months ended September 30, 2010.March 31, 2011. Revenues for 20112012 consisted of $14.8$17.8 million, or 72%75% of total revenue, for HealthStream Learning and $5.8$5.9 million, or 28%25% of total revenue, for HealthStream Research. In 2010,2011, revenues consisted of $11.5$13.0 million, or 69%70% of total revenue, for HealthStream Learning and $5.1$5.5 million, or 31%30% of total revenue, for HealthStream Research.

Revenues for HealthStream Learning increased $3.3$4.8 million, or 28.4%37.0%, over the thirdfirst quarter of 2010.2011. Revenues from our Internet-based subscription learning products increased by $3.2$3.5 million, or 28.1% over the prior year third quarter, and were comprised of revenue increases from the HLC of $1.1 million and from courseware subscriptions of $2.0 million. Revenues from our Internet-based subscription products increased 29.4% over the prior year thirdfirst quarter due to a higher number of subscribers and more courseware consumption by subscribers. Our HLC subscriber base increased to 2,536,0002,659,000 fully-implemented subscribers and 2,653,0002,790,000 contracted subscribers at September 30, 2011March 31, 2012 compared to 2,175,0002,400,000 fully-implemented subscribers and 2,365,0002,523,000 contracted subscribers at September 30, 2010.March 31, 2011. “Contracted subscribers” include both those already implemented (2,536,000(2,659,000 and 2,175,0002,400,000 at September 30,March 31, 2012 and 2011, and 2010, respectively) and those in the process of implementation (117,000(131,000 and 190,000123,000 at September 30,March 31, 2012 and 2011, and 2010, respectively). Revenues from SimVentures, our collaborative arrangement with Laerdal Medical, Corporation, were approximately $321,000$374,000 during the thirdfirst quarter of 2012 while there were no revenues during the first quarter of 2011. Revenues from project-based services declinedincreased by $251,000$595,000 compared to the prior year thirdfirst quarter.

Revenues for the first quarter of 2012 also include approximately $300,000 of registration fees from our customer Summit.

Revenues for HealthStream Research increased $724,000,$357,000, or 14.2%6.5%, over the thirdfirst quarter of 2010.2011. Revenues from Patient Insights™ surveys, our survey research product that generates recurring revenues, increased by $949,000,$556,000, or 26.4%13.1%, over the prior year thirdfirst quarter. Revenues from other surveys, which are conducted on annual or bi-annual cycles, declined by $225,000,$199,000, or 15.1%15.8%, compared to the prior year thirdfirst quarter due to fewer survey engagements.

Cost of Revenues (excluding depreciation and amortization).Cost of revenues increased approximately $1.6$2.5 million, or 26.1%35.4%, to $7.9$9.6 million for the three months ended September 30, 2011March 31, 2012 from $6.3$7.1 million for the three months ended September 30, 2010.March 31, 2011. Cost of revenues as a percentage of revenues was 38.4%40.4% of revenues for the three months ended September 30, 2011March 31, 2012 compared to 37.8%38.2% of revenues for the three months ended September 30, 2010.March 31, 2011. Cost of revenues for HealthStream Learning increased approximately $1.3$2.2 million to $4.8$6.4 million and approximated 32.5%35.7% and 30.2%32.0% of revenues for HealthStream Learning for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively. The increase is primarily associated with increased royalties paid by us resulting from growth in courseware subscription revenues.revenues and increased costs associated with project-based services. Cost of revenues for HealthStream Research increased approximately $318,000$310,000 to $3.1$3.2 million and approximated 53.5%54.8% and 54.9%52.8% of revenues for HealthStream Research for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively. The increase in amount is primarily the result of additional costs associated with the growth in patient survey volume over the prior year thirdfirst quarter.

Product Development.Product development expenses increased approximately $196,000,$82,000, or 11.2%4.6%, to $1.9 million for the three months ended September 30, 2011March 31, 2012 from $1.7$1.8 million for the three months ended September 30, 2010.March 31, 2011. Product development expenses as a percentage of revenues were 9.4%7.9% and 10.5%9.7% of revenues for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively.

Product development expenses for HealthStream Learning increased approximately $158,000$62,000 and approximated 10.3%8.3% and 11.8%10.9% of revenues for HealthStream Learning for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively. The decrease as a percentage of revenue is the result of the growth in revenues over the prior year thirdfirst quarter, while the increase in amount is due to additional personnel expenses associated with the maintenance of our platform, maintenance andas well as working on new product development initiatives, including the Company’s share of SimVentures expenses.initiatives. Product development expenses for HealthStream Research increased approximately $38,000$20,000 and approximated 7.3%6.7% and 7.6%6.8% of revenues for HealthStream Research for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively.

Sales and Marketing.Sales and marketing expenses, including personnel costs, increased approximately $452,000,$2.0 million, or 13.5%57.8%, to $3.8$5.5 million for the three months ended September 30, 2011March 31, 2012 from $3.4$3.5 million for the three months ended September 30, 2010.March 31, 2011. Approximately $870,000 of the increase resulted from our customer Summit, which occurred during the first quarter of 2012, but was held during the second quarter of 2011. Sales and marketing expenses approximated 18.5%23.4% and 20.2%19.0% of revenues for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively.

Sales and marketing expenses for HealthStream Learning increased $550,000$1.8 million and approximated 18.0%22.9% and 18.3%17.3% of revenues for HealthStream Learning for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively. This expense increase is primarily due to the costs associated with our customer Summit, as well as, additional personnel and related expenses, increased marketing spending, and increased commissions associated with better sales performance compared to the prior year. Sales and marketing expenses for HealthStream Research decreasedincreased approximately $83,000,$181,000, and approximated 18.2%23.0% and 22.4%21.2% of revenues for HealthStream Research for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively. The expense decrease isincrease was primarily a result of lower commissions.

11

due to the costs associated with our customer Summit.

Other General and Administrative Expenses.Other general and administrative expenses increased approximately $381,000,$277,000, or 15.8%10.9%, to $2.8 million for the three months ended September 30, 2011March 31, 2012 from $2.4$2.5 million for the three months ended September 30, 2010.March 31, 2011. Other general and administrative expenses as a percentage of revenues approximated 13.5%11.9% and 14.5%13.7% for the three months ended September 30,March 31, 2012 and 2011, and 2010, respectively.

Other general and administrative expenses for HealthStream Learning increased $48,000$41,000 over the prior year thirdfirst quarter due to employee recruiting costs, while other general and administrative expenses for HealthStream Research increased slightlydecreased $91,000 compared to the prior year third quarter.first quarter due to lower personnel costs. The unallocated corporate portion of other general and administrative expenses increased $328,000$327,000 over the prior year thirdfirst quarter, primarily associated with software maintenance renewal fees, personnel expenses, professional fees, and stock based compensation expense.

expense, and other general expenses.

Depreciation and Amortization.Depreciation and amortization increased approximately $328,000,$491,000, or 28.7%47.1%, to $1.5 million for the three months ended September 30, 2011March 31, 2012 from $1.1$1.0 million for the three months ended September 30, 2010.March 31, 2011. The increase primarily resulted from amortization of capitalized software development assets within HealthStream Learning and depreciation expense associated with leasehold improvements to our Nashville, Tennessee office space.

Other Income (Expense), netNet. Other expense, net was approximately $8,000$19,000 for three months ended September 30, 2011March 31, 2012 compared to $6,000$20,000 for the three months ended September 30, 2010.

March 31, 2011.

Provision for Income Taxes.Tax Provision.The Company recorded a provision for income taxes of $890,000$940,000 for the three months ended September 30, 2011March 31, 2012 compared to $889,000$1.1 million for the three months ended September 30, 2010.March 31, 2011. The Company’s effective tax rate was 33.1%39.8% for the thirdfirst quarter of 20112012 compared to 52.8%40.8% for the thirdfirst quarter of 2010. We expect the full year 2011 effective tax rate to range between 38 and 39 percent, compared to the full year 2010 effective tax rate of 41%.2011. Actual tax payments will be substantially less than our income tax provision until we utilize our federal and state net operating loss carry-forwards of approximately $18.0$14.5 million and $14.0$12.6 million, respectively, at September 30,December 31, 2011, to offset taxable income.

Net Income.Net income increaseddecreased approximately $1.0 million,$106,000, or 125.7%6.9%, to $1.8$1.4 million for the three months ended September 30, 2011March 31, 2012 from $796,000$1.5 million for the three months ended September 30, 2010. Net incomeMarch 31, 2011. Earnings per diluted share was $0.08$0.05 per share for the three months ended September 30, 2011,March 31, 2012, compared to $0.04$0.07 per diluted share for the three months ended September 30, 2010.

March 31, 2011. Key factors impacting EPS (diluted) for the first quarter of 2012 were the effect of additional shares outstanding that were issued during the Company’s fourth quarter 2011 follow-on stock offering and the timing of our customer Summit. The impact of the follow-on stock offering increased the outstanding share count by approximately 3.6 million shares for the three months ended March 31, 2012.

Adjusted EBITDA (which we define as net income before interest, income taxes, stock-based compensation, and depreciation and amortization) improvedincreased by 46.3%8.4% to approximately $4.4$4.1 million for the three months ended September 30, 2011March 31, 2012 compared to $3.0$3.8 million for the three months ended September 30, 2010.March 31, 2011. This improvement is consistent with the factors mentioned in management’s discussion and analysis of financial condition and results of operations herewith.

See Reconciliation of Non-GAAP Financial Measures in Management’s Discussion and Analysis of Financial Condition and Results of Operations for our reconciliation of this calculation to measures under US GAAP.

Reconciliation of Non-GAAP Financial Measures

In order to better assess the Company’s financial results, management believes that adjusted EBITDA is an appropriate measure for evaluating the operating performance of the Company at this stage in its life cycle because adjusted EBITDA reflects net income adjusted for non-cash and non-operating items. Adjusted EBITDA is also used by many investors and securities analysts to assess the Company’s results from current operations. Adjusted EBITDA is a non-GAAP financial measure and should not be considered as a measure of financial performance under US GAAP. Because adjusted EBITDA is not a measurement determined in accordance with US GAAP, it is susceptible to varying calculations. Accordingly, adjusted EBITDA, as presented, may not be comparable to other similarly titled measures of other companies.

The Company understands that, although adjusted EBITDA is frequently used by investors and securities analysts in their evaluation of companies, this measure has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for an analysis of the Company’s results as reported under US GAAP. For example, adjusted EBITDA does not reflect cash expenditures, or future requirements for capital expenditures or contractual commitments; it does not reflect non-cash components of employee compensation; it does not reflect changes in, or cash requirements for, our working capital needs; and due to the Company’s utilization of federal and state net operating loss carryforwards in 20102011 and 2011,2012, actual cash income tax payments have been significantly less than the tax provision recorded in accordance with US GAAP, and income tax payments will continue to be less than the income tax provision until our existing federal and state net operating loss carryforwards have been fully utilized or have expired.

Management compensates for the inherent limitations associated with using adjusted EBITDA through disclosure of such limitations, presentation of our financial statements in accordance with US GAAP, and reconciliation of adjusted EBITDA to net income, the most directly comparable US GAAP measure.

Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010
Revenues, net.Revenues increased approximately $12.1 million, or 25.1%, to $60.2 million for the nine months ended September 30, 2011 from $48.1 million for the nine months ended September 30, 2010. Revenues for 2011 consisted of $42.3 million, or 70% of total revenue, for HealthStream Learning and $17.9 million, or 30% of total revenue, for HealthStream Research. In 2010, revenues consisted of $33.1 million, or 69% of total revenue, for HealthStream Learning and $15.0 million, or 31% of total revenue, for HealthStream Research.
Revenues for HealthStream Learning increased $9.2 million, or 27.8%, over 2010. Revenues from our Internet-based subscription learning products increased by $9.1 million over the prior year, and were comprised of revenue increases from the HLC of $3.2 million and from courseware subscriptions of $5.8 million. Revenues from our Internet-based subscription products increased 29.5% over the prior year due to a higher number of subscribers and more courseware consumption by subscribers. Revenues from SimVentures, our collaborative arrangement with Laerdal Medical Corporation, were $469,000 during 2011. Project-based revenues declined by $431,000 compared to the prior year due to fewer engagements.
Revenues for HealthStream Research increased $2.9 million, or 19.2%, over 2010. Revenues from Patient Insights™ surveys, our survey research product that generates recurring revenues, increased by $2.8 million, or 26.4%, over the prior year. Revenues from other surveys, which are conducted on annual or bi-annual cycles, increased by $123,000, or 2.7%, over the prior year.
Cost of Revenues (excluding depreciation and amortization).Cost of revenues increased approximately $5.0 million, or 28.2%, to $22.6 million for the nine months ended September 30, 2011 from $17.6 million for the nine months ended September 30, 2010. Cost of revenues as a percentage of revenues was 37.6% of revenues for the nine months ended September 30, 2011 compared to 36.7% of revenues for the nine months ended September 30, 2010. Cost of revenues for HealthStream Learning increased approximately $3.7 million to $13.5 million and approximated 32.0% and 29.6% of revenues for HealthStream Learning for the nine months ended September 30, 2011 and 2010, respectively. The increase is primarily associated with increased royalties paid by us resulting from growth in courseware subscription revenues and from additional personnel expenses. Cost of revenues for HealthStream Research increased

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approximately $1.3 million to $9.1 million and approximated 50.9% and 52.1% of revenues for HealthStream Research for the nine months ended September 30, 2011 and 2010, respectively. The increase in amount is primarily the result of costs associated with the growth in patient survey volume over the prior year.
Product Development.Product development expenses increased approximately $645,000, or 12.9%, to $5.6 million for the nine months ended September 30, 2011 from $5.0 million for the nine months ended September 30, 2010. Product development expenses as a percentage of revenues were 9.4% and 10.4% of revenues for the nine months ended September 30, 2011 and 2010, respectively.
Product development expenses for HealthStream Learning increased approximately $582,000 and approximated 10.6% and 11.8% of revenues for HealthStream Learning for the nine months ended September 30, 2011 and 2010, respectively. The decrease as a percentage of revenue is the result of the growth in revenues over the prior year, while the increase in amount is due to additional personnel expenses associated with platform maintenance and new product development initiatives, including SimVentures. Product development expenses for HealthStream Research increased approximately $63,000 and approximated 6.5% and 7.3% of revenues for HealthStream Research for the nine months ended September 30, 2011 and 2010, respectively. The decrease as a percentage of revenue is the result of the growth in revenues over the prior year.
Sales and Marketing.Sales and marketing expenses, including personnel costs, increased approximately $2.3 million, or 24.6%, to $11.7 million for the nine months ended September 30, 2011 from $9.4 million for the nine months ended September 30, 2010. Approximately $627,000 of the increase resulted from the Summit, which occurred during the second quarter of 2011, but did not occur during 2010. Sales and marketing expenses approximated 19.4% and 19.5% of revenues for the nine months ended September 30, 2011 and 2010, respectively.
Sales and marketing expenses for HealthStream Learning increased $2.0 million and approximated 18.6% and 17.7% of revenues for HealthStream Learning for the nine months ended September 30, 2011 and 2010, respectively. This expense increase is primarily due to the Summit, additional personnel and related expenses, increased marketing spending, and increased commissions associated with better sales performance compared to the prior year. Sales and marketing expenses for HealthStream Research increased approximately $249,000, and approximated 19.5% and 21.6% of revenues for HealthStream Research for the nine months ended September 30, 2011 and 2010, respectively. The expense increase for HealthStream Research resulted from the Summit and additional personnel and related expenses.
Other General and Administrative Expenses.Other general and administrative expenses increased approximately $1.1 million, or 16.3%, to $8.0 million for the nine months ended September 30, 2011 from $6.9 million for the nine months ended September 30, 2010. Other general and administrative expenses as a percentage of revenues approximated 13.3% and 14.3% for the nine months ended September 30, 2011 and 2010, respectively.
Other general and administrative expenses for HealthStream Learning increased $245,000 over the prior year, primarily associated with increased rent expense and recruiting costs for new employees, while other general and administrative expenses for HealthStream Research were comparable to the prior year. The unallocated corporate portion of other general and administrative expenses increased $875,000 over the prior year, primarily associated with software maintenance renewal fees, personnel expenses, professional fees, stock based compensation expense and rent expense.
Depreciation and Amortization.Depreciation and amortization increased approximately $99,000, or 2.6%, to $3.9 million for the nine months ended September 30, 2011 from $3.8 million for the nine months ended September 30, 2010. The increase primarily resulted from an increase from amortization of capitalized software development, but was partially offset by lower depreciation expense associated with certain assets reaching the end of their useful lives.
Other Income (Expense), net. Other income, net was approximately $8,000 for the nine months ended September 30, 2011 compared to a net expense of $18,000 for the nine months ended September 30, 2010. The improvement over the prior year was associated with higher interest income resulting from both higher invested balances and higher yields on cash and investments in marketable securities.
Provision for Income Taxes.The Company recorded a provision for income taxes of approximately $3.2 million for the nine months ended September 30, 2011 compared to $2.5 million for the nine months ended September 30, 2010. The Company’s effective tax rate was 38.4% for 2011 compared to 45.7% for 2010.
Net Income.Net income increased approximately $2.2 million, or 74.6%, to $5.2 million for the nine months ended September 30, 2011 from $3.0 million for the nine months ended September 30, 2010. Net income per diluted share was $0.22 per share for the nine months ended September 30, 2011, compared to $0.13 per diluted share for the nine months ended September 30, 2010.
Adjusted EBITDA improved by 32.0% to approximately $12.8 million for the nine months ended September 30, 2011 compared to $9.7 million for the nine months ended September 30, 2010. This improvement is consistent with the factors mentioned in management’s

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discussion and analysis of financial condition and results of operations herewith. Our reconciliation of Adjusted EBITDA to net income is listed in the table below.
Income before interest, income tax provision, stock based compensation expense, depreciation and amortization, or adjusted EBITDA (in thousands):
                 
  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
  2011  2010  2011  2010 
Net income $1,796  $796  $5,152  $2,950 
Interest income  (5)  (4)  (36)  (11)
Interest expense  13   10   35   31 
Income tax provision  890   889   3,213   2,481 
Stock based compensation expense  223   166   597   498 
Depreciation and amortization  1,471   1,143   3,868   3,769 
             
Adjusted EBITDA $4,388  $3.000  $12,829  $9,718 
             

   

Three Months Ended

March 31,

 
   2012  2011 

Net income

  $1,420   $1,526  

Interest income

   (31)   (22) 

Interest expense

   12    9  

Income tax provision

   940    1,051  

Stock based compensation expense

   242    190  

Depreciation and amortization

   1,534    1,043  
  

 

 

  

 

 

 

Adjusted EBITDA

  $4,117   $3,797  
  

 

 

  

 

 

 

Liquidity and Capital Resources

Net cash provided by operating activities was approximately $14.5$3.4 million and $11.8$3.5 million during the ninethree months ended September 30,March 31, 2012 and 2011, and 2010, respectively. The Company’s primary sources of cash were receipts generated from the sales of our products and services. Days sales outstanding (“DSO”) which is calculated by dividing the accounts receivable balance, excluding unbilled and other receivables, by average daily revenues for the quarter, approximated 5963 days for both the thirdfirst quarter of 2011 compared to 61 days for the third quarter of 2010.2012 and 2011. 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 approximately $3.1$56.6 million and $2.4$7.4 million for the ninethree months ended September 30,March 31, 2012 and 2011, and 2010, respectively. During 2011,2012, the Company purchased $4.7$58.4 million of investments in marketable securities, spent $5.2$1.0 million for capitalized software development, and purchased $3.6$0.8 million of property and equipment. Approximately $1.8 million of the property and equipment purchases during 2011 were associated with the expansion of our Nashville, Tennessee office space, while the remainder is associated with hardware and software to support our business operations. Approximately $3.5 million of the capitalized software development spending related to the acquisition of a 50 percent ownership stake in Laerdal Medical’s AVS product. These uses of cash were partially offset by maturities and sales of investments in marketable securities of $10.4$3.5 million. During 2010,2011, the Company purchased $4.7 million of marketable securities, spent $1.6$4.1 million for capitalized software development, and purchased $850,000$0.7 million of property and equipment.

These uses of cash were partially offset by maturities of marketable securities of $2.1 million.

Cash provided by financing activities was approximately $1.0$0.6 million and $0.2 million for the ninethree months ended September 30,March 31, 2012 and 2011, while $225,000 was used by financing activities during the nine months ended September 30, 2010.respectively. The primary source of cash from financing activities for

14

2011 2012 and 20102011 resulted from proceeds associated with the exercise of employee stock options. The primary uses of cash for 2011 related to payments under capital lease obligations, and for 2010 related to repurchases of common stock and payments under a promissory note and capital lease obligations.

Revenues increased and operating income improved over the prior year period, and our balance sheet reflects positive working capital of $24.3$80.7 million at September 30, 2011March 31, 2012 compared to $19.5$78.6 million at December 31, 2010.2011. The increase in working capital was primarily due to the cash generated from operations. The Company’s primary source of liquidity is $30.3$91.6 million of cash and cash equivalents and restricted cash.marketable securities. The Company also has a $20.0 million revolving credit facility loan agreement, all of which was available at September 30, 2011.

March 31, 2012.

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 cash needs for working capital, new product development and capital expenditures for at least the next 12 months. Additionally,Over the past seven years, we have utilized our shelf registration statement on Form S-3, which was declared effective on August 12, 2011, provides us withfederal and state net operating loss carryforwards to offset taxable income. We anticipate our remaining net operating loss carryforwards could become fully utilized within the ability to raise additional capital of up to $75 million throughnext 24 months. Our actual tax payments may increase significantly once the issuance of shares of common stock, subject to market conditions.net operating loss carryforwards are fully utilized. As part of our growth strategy, we review 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 could have a dilutive effect on earnings per share and could adversely affect our stock price. Because we have no material debt or outstanding borrowings under our revolving credit facility, our balance sheet is unleveraged. Our revolving credit facility contains financial covenants and availability calculations designed to set a maximum leverage ratio of outstanding debt to equity. Therefore, if we were to borrow against our revolving credit facility, our debt capacity would be dependent on the covenant values at the time of borrowing. As of March 31, 2012, we believe we were in compliance with all covenants. The credit markets have been experiencing extreme volatility and disruption, and we cannot assure youprovide assurances 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.

Item 3.Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to market risk from changes in interest rates. The Company doesWe do not have any foreign currency exchange rate risk or commodity price risk. As of September 30, 2011,March 31, 2012, the Company had no outstanding indebtedness.debt. We may become subject to interest rate market risk associated with any future borrowings under our revolving credit facility. The interest rate under the revolving credit facility is based on 30 Day LIBOR plus a margin of either 175 or 200 basis points determined in accordance with a pricing grid. We are also exposed to market risk with respect to our cash and investment balances. At September 30, 2011, the Company had cash and cash equivalents and restricted cash totaling approximately $30.3 million. Our current investment rates of return approximate 0.08%.balances, which approximated $91.6 million at March 31, 2012. Assuming a 0.08% rate of return on $30.3 million, a hypothetical 10% decrease in interest rates, would decrease interest income from cash and investments would decrease net income on an annualized basis by approximately $2,400.

$16,000.

The Company manages itsCompany’s investment risk bypolicy and strategy is focused on investing in corporate debt securities, foreign corporate debt, secured corporate debt, and municipal debthighly rated securities, with minimum acceptablethe objective of minimizing the potential risk of principal loss. The Company’s policy limits the amount of credit ratings. For certificates of depositexposure to any single issuer and corporate obligations, ratings must be A1/A, BBB, FDIC insured or better; A1/P1 or better for commercial paper, and MIG 1/S, P/1 or better for municipal debt securities. The Company also requires that all securities must mature within 24 months from the original settlement date,sets limits on 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.

maturity.

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 4.Controls and Procedures

Evaluation of Controls and Procedures

HealthStream’s chief executive officer and principal financial officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report. Based on that evaluation, the chief executive officer and principal financial officer have concluded that HealthStream’s disclosure controls and procedures 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 chief executive and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There was no change in HealthStream’s internal control over financial reporting that occurred during the period covered by this Quarterly Report that has materially affected, or that is reasonably likely to materially affect, HealthStream’s internal control over financial reporting.

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PART II —- OTHER INFORMATION

Item 6.Exhibits

 (a)Exhibits

10.14^ - Form of HealthStream Inc. Restricted Share Unit Agreement (Officer)

10.15^ - Form of HealthStream Inc. Restricted Share Unit Agreement (Non-Employee Director)

31.1 – Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 – Certification of the Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1 – Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of

2002

32.2 – Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of

2002

101.1 INS* – XBRL Instance Document

101.1 SCH* – XBRL Taxonomy Extension Schema

101.1 CAL* – XBRL Taxonomy Extension Calculation Linkbase

101.1 DEF* – XBRL Taxonomy Extension Definition Linkbase

101.1 LAB* – XBRL Taxonomy Extension Label Linkbase

101.1 PRE* – XBRL Taxonomy Extension Presentation Linkbase

^ - Exhibits

31.1 — CertificationManagement contract or compensatory plan or arrangement

* - The XBRL-related information in Exhibit No. 101 to this Quarterly Report on Form 10-Q is furnished and not filed for purposes of Sections 11 and 12 of the Chief Executive Officer Pursuant toSecurities Act of 1933 and Section 30218 of the Sarbanes-OxleySecurities Exchange Act of 2002

31.2 — Certification of the Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1 — Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2 — Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.1 INS* — XBRL Instance Document

101.1 SCH* — XBRL Taxonomy Extension Schema

101.1 CAL* — XBRL Taxonomy Extension Calculation Linkbase

101.1 DEF* — XBRL Taxonomy Extension Definition Linkbase

101.1 LAB* — XBRL Taxonomy Extension Label Linkbase

101.1 PRE* — XBRL Taxonomy Extension Presentation Linkbase1934.
*- The XBRL-related information in Exhibit No. 101 to this Quarterly Report on Form 10-Q is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

17

SIGNATURE

SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 HEALTHSTREAM, INC.
:
April 30, 2012 
October 31, 2011 By:  /s/ Gerard M. Hayden, Jr. By:/s/ GERARD M. HAYDEN, JR.
 Gerard M. Hayden, Jr.
 
  Chief Financial Officer

18

HEALTHSTREAM, INC.

EXHIBIT INDEX

10.14^  Form of HealthStream, Inc. Restricted Share Unit Agreement (Officer)
10.15^  Form of HealthStream, Inc. Restricted Share Unit Agreement (Non-Employee Director)
HEALTHSTREAM, INC.
EXHIBIT INDEX
31.1  Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2  Certification of the Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1  Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.1 INS*XBRL Instance Document
101.1 SCH*XBRL Taxonomy Extension Schema
101.1 CAL*XBRL Taxonomy Extension Calculation Linkbase
101.1 DEF*XBRL Taxonomy Extension Definition Linkbase
101.1 LAB*XBRL Taxonomy Extension Label Linkbase
101.1 PRE*XBRL Taxonomy Extension Presentation Linkbase
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.1 INS* XBRL Instance Document
101.1 SCH* XBRL Taxonomy Extension Schema
101.1 CAL* XBRL Taxonomy Extension Calculation Linkbase
101.1 DEF* XBRL Taxonomy Extension Definition Linkbase
101.1 LAB* XBRL Taxonomy Extension Label Linkbase
101.1 PRE* XBRL Taxonomy Extension Presentation Linkbase
*- The XBRL-related information in Exhibit No.101 to this Quarterly Report on Form 10-Q is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

19

^ -Management contract or compensatory plan or arrangement
* -The XBRL-related information in Exhibit No. 101 to this Quarterly Report on Form 10-Q is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.