Business Combinations | 7. BUSINESS COMBINATIONS HealthLine Systems On March 16, 2015, the Company acquired all of the membership interests of HealthLine Systems, LLC (“HLS”), a San Diego, California based company that specializes in credentialing, privileging, call center, and quality management solutions for the healthcare industry. The acquisition of HLS enables the Company to provide a comprehensive solution set for healthcare provider credentialing, privileging, enrollment, referral, onboarding, and analytics in support of HealthStream’s approach to talent management for healthcare organizations. The consideration paid for HLS consisted of approximately $90.3 million in cash (taking into account an estimated closing working capital adjustment and amounts due to the seller as of June 30, 2016). The Company incurred approximately $1.3 million in transaction costs associated with the acquisition, of which $965,000 were incurred during the three months ended March 31, 2015 and $329,000 were incurred during the year ended December 31, 2014. The transaction costs were recorded in other general and administrative expenses in the condensed consolidated statement of income for such periods. The results of operations for HLS have been included in the Company’s condensed consolidated financial statements from the date of acquisition, and are also included in the HealthStream Provider Solutions segment. A summary of the purchase price is as follows (in thousands): Cash paid at closing $ 81,379 Consideration due to the seller 2,180 Cash held in escrow 6,750 Total consideration paid $ 90,309 The following table summarizes the fair value of the assets acquired and liabilities assumed as of the date of acquisition (in thousands): Cash $ 54 Accounts receivable, net 3,052 Prepaid assets 546 Property and equipment 200 Deferred tax assets 2,523 Goodwill 43,798 Intangible assets 47,200 Accounts payable and accrued liabilities (1,085 ) Deferred revenue (5,979 ) Net assets acquired $ 90,309 The excess of purchase price over the fair values of net tangible and intangible assets has been recorded as goodwill. The fair values of tangible and identifiable intangible assets, deferred tax assets, deferred revenue, and other liabilities are based on management’s estimates and assumptions. Included in the assets and liabilities assumed is an estimated indemnification asset of $300,000 and a contingent liability of $700,000, both of which are associated with tax liabilities. The contingent liability is measured based on management’s estimate of a range of probable outcomes. The goodwill balance is primarily attributed to the assembled workforce, additional market opportunities from offering HLS’s products, and expected synergies from integrating HLS with other products or other combined functional areas within the Company. During the three months ended March 31, 2016, the Company received notice of an indemnification claim from the former owners of HLS pursuant to the terms of the membership purchase agreement. The terms of such agreement require the Company to indemnify such owners for incremental taxes incurred as the result of the structure of the acquisition, which had favorable tax aspects to the Company. Although the amount of such claim has not been agreed to by the Company, the Company recorded a measurement period adjustment in relation to the claim that increased goodwill by approximately $2.2 million during the three months ended March 31, 2016. This additional goodwill will be deductible for U.S. income tax purposes when any amounts underlying the indemnification claim are paid. Accordingly, this measurement period adjustment has no effect on current or prior period earnings. The goodwill balance excluding such measurement period adjustment is also deductible for U.S. income tax purposes. The Company surpassed the one year measurement period as of the period ended March 31, 2016; therefore, in accordance with requisite accounting guidance, at such time that the amount of the indemnification claim is agreed to by the Company, the difference, if any, of the agreed to indemnification amount in comparison to the $2.2 million measurement period adjustment noted above will be reflected in net income, thus impacting the Company’s results of operations in the period of settlement. The net tangible assets include deferred revenue, which was adjusted down from a book value at the acquisition date of $15.0 million to an estimated fair value of $6.0 million. The $9.0 million write-down of deferred revenue will result in lower revenues than would have otherwise been recognized for such services. The following table sets forth the components of identifiable intangible assets and their estimated useful lives as of the acquisition date (in thousands): Fair value Useful life Customer relationships $ 42,600 13 years Developed technology 3,700 5 years Trade names 900 6 years Total intangible assets subject to amortization $ 47,200 The amounts of revenue and operating income (loss) of HLS included in the Company’s condensed consolidated statement of income from the date of acquisition of March 16, 2015 to the period ending June 30, 2015 are as follows (in thousands): Total revenues $ 2,606 Operating loss $ (1,170 ) The following unaudited pro forma financial information summarizes the combined results of operations of the Company and HLS as though the companies were combined as of January 1, 2014 (in thousands, except per share data): Three Months Ended Six Months Ended 2016 2015 2016 2015 Total revenues $ 55,231 $ 54,604 $ 110,265 $ 106,213 Net income $ 1,656 $ 2,909 $ 3,730 $ 6,840 Basic earnings per share $ 0.05 $ 0.10 $ 0.12 $ 0.24 Diluted earnings per share $ 0.05 $ 0.10 $ 0.12 $ 0.24 These unaudited pro forma combined results of operations include certain adjustments arising from the acquisition such as adjustment for amortization of intangible assets, depreciation of property and equipment, fair value adjustments of acquired deferred revenue balances, and interest expense associated with borrowings under a revolving credit facility by the Company to partially fund the acquisition. The unaudited pro forma combined results of operations is for informational purposes only and is not indicative of what the Company’s results of operations would have been had the transaction occurred at the beginning of the period presented or to project the Company’s results of operations in any future period. The unaudited pro forma financial information for the three and six months ended June 30, 2016 and 2015 combines the historical results of the Company and HLS for the three and six months ended June 30, 2016 and 2015, and the pro forma adjustments listed above. Other Business Combination On June 30, 2016, the Company completed the acquisition of Performance Management Services, Inc. (“PMSI”), a Company based in Tustin, California focused on competency-based performance development for nurses, for $4.0 million in cash and up to an additional $500,000 of contingent consideration. The acquisition, including associated transaction costs, is not considered material to the Company’s financial statements. The Company accounted for the acquisition as a business combination and has allocated purchase consideration based on preliminary estimates of fair value. The Company expects to finalize estimates of fair value as soon as practicable, but not later than one year from the date of acquisition. The results of operations for PMSI are included in the Company’s condensed consolidated financial statements from the date of acquisition and are included in the HealthStream Workforce Solutions segment. Goodwill The changes in the carrying amount of goodwill for the six months ended June 30, 2016 are as follows (in thousands): Workforce Patient Experience Provider Total Balance at January 1, 2016 $ 12,336 $ 24,154 $ 46,583 $ 83,073 Other business combinations 3,375 — — 3,375 Acquisition of HealthLine Systems, LLC — — 2,180 2,180 Balance at June 30, 2016 $ 15,711 $ 24,154 $ 48,763 $ 88,628 During the three months ended March 31, 2016, the Company recorded approximately $2.2 million of additional goodwill in relation to the March 2015 acquisition of HealthLine Systems, LLC. Such amount relates to the measurement period adjustment previously discussed under the above caption “ HealthLine Systems. |