Special caution 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, 2020, appearing in our Annual Report on
Form 10-K that was filed with the Securities and Exchange Commission ("SEC") on
February 25, 2021 (the "2020 Form 10-K"). Statements contained in this Quarterly
Report on Form 10-Q that are not historical facts are forward-looking statements
that the Company intends to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995. Statements that are predictive in nature, that depend on or refer
to future events or conditions, or that include words such as "anticipates,"
"believes," "could," "estimates," "expects," "intends," "may," "plans,"
"potential," "predicts," "projects," "should," "will," "would," and similar
expressions are forward-looking statements.



The Company cautions that forward-looking statements involve known and unknown
risks, uncertainties, and other factors that may cause actual results,
performance, or achievements to be materially different from any future results,
performance, or achievements expressed or implied by the forward-looking
statements. Forward-looking statements reflect our current views with respect to
future events and are based on assumptions and subject to risks and
uncertainties. Given these uncertainties, you should not place undue reliance on
these forward-looking statements.



In evaluating any forward-looking statement, you should specifically consider
the information regarding forward-looking statements set forth above and the
risks set forth under the caption Part I, Item 1A. Risk Factors in our 2020 Form
10-K and other disclosures in our 2020 Form 10-K, earnings releases and other
filings with the SEC from time to time, as well as other cautionary statements
contained elsewhere in this report, including our critical accounting policies
and estimates as discussed in this report and our 2020 Form 10-K. We undertake
no obligation to update or revise any forward-looking statements. You should
read this report and the documents that we reference in this report and have
filed as exhibits to this report completely and with the understanding that our
actual future results may be materially different from what we currently expect.



Business Overview



HealthStream provides workforce and provider solutions for healthcare
organizations-all designed to support the people that deliver patient care,
which, in turn, supports the improvement of business and clinical outcomes. Our
solutions include multiple Software-as-a-Service (SaaS) applications, and focus
on some of the most significant challenges facing the healthcare workforce and
healthcare organizations today, including the need to effectively manage,
retain, engage, schedule, and develop healthcare workforce talent; meet rigorous
compliance requirements; and efficiently manage ongoing medical staff
credentialing and privileging processes. HealthStream's customers include
healthcare organizations, pharmaceutical and medical device companies, and other
participants in the healthcare industry. At September 30, 2021, we had
approximately 4.92 million contracted subscriptions to hStreamTM, our
Platform-as-a-Service technology. hStream technology enables healthcare
organizations and their respective workforces to easily connect to and gain
value from the growing HealthStream ecosystem of applications, tools, and
content.



Important financial metrics for the third quarter of 2021 are shown in the bullet points below.

• Income from $ 64.1 million in the third quarter of 2021, an increase of

5% of $ 60.9 million in the third quarter of 2020, offsetting a $ 9.2 million

  decline in legacy resuscitation revenues.



• Operating result of $ 1.8 million in the third quarter of 2021, down 43% compared to

  $3.1 million in the third quarter of 2020.



• Net result of $ 1.5 million in the third quarter of 2021, down 43% compared to

  $2.6 million in the third quarter of 2020.



• Earnings per share (“EPS”) of $ 0.05 per share (diluted) in the third quarter of

  2021 compared to $0.08 per share (diluted) in the third quarter of 2020.



• Adjusted EBITDA1 of $ 12.5 million in the third quarter of 2021,

up 12% compared to $ 11.2 million in the third quarter of 2020.

1 Adjusted EBITDA is a non-GAAP financial measure. A reconciliation of adjustments

EBITDA on net income and information on why we believe Adjusted EBITDA

provides useful information to investors is included later in this report.




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Impact and response to the COVID-19 pandemic



The COVID-19 pandemic, which spread throughout the world and the United States
during 2020, resulted in a significant economic downturn. As vaccines have
become widely available in the United States, economic conditions have generally
improved in 2021 compared to 2020. However, during the third quarter of 2021,
the number of COVID-19 cases and hospitalizations increased in the United
States in comparison to earlier levels as a result of the Delta variant,
causing restrictive measures to be implemented or reinstituted, including by
many of our healthcare customers. Uncertainty remains regarding the extent,
timing, and duration of the pandemic, including the extent to which the
availability and sustained efficacy of vaccines will positively impact public
health conditions and whether potentially more contagious and/or virulent
strains of the COVID-19 virus, including strains that may be resistant to
currently available vaccines, may pose additional public health risks. The
pandemic continues to cause uncertainty and potential economic volatility,
including with regard to the pandemic's various and unpredictable impacts on our
healthcare customers and our business.



Our business is focused on providing workforce and provider solutions to
healthcare organizations, and as such, the pandemic's adverse impact on
healthcare organizations has resulted in an adverse impact on our Company.
Although COVID-19 did not have a significant negative impact on our revenues or
net income during 2020, we believe that it began to have a negative impact on
our revenues during the nine months ended September 30, 2021. Additionally,
certain developments related to COVID-19 have negatively impacted and are
expected to continue to negatively impact our business during the remainder of
2021 and potentially thereafter. In particular, sales cycles have been delayed
or postponed such that declines in sales bookings by customers during 2020 and
the nine months ended September 30, 2021 will result in a negative impact to
revenue and potentially to earnings during the remainder of 2021 and in 2022.



Our operating results have benefited from a temporary reduction of operating
expenses related to COVID-19 conditions, but the operating expense reduction
itself-despite its positive impact on operating income and adjusted EBITDA-is
indicative of the negative impact the pandemic has had, and may continue to have
on new bookings and renewals. We have experienced, and expect to continue to
experience, delayed and reduced bookings and renewals due to the pandemic. Given
that we sell multiple year subscriptions to our solutions, the revenue impact of
lost or delayed sales in a given period generally does not manifest until future
periods, just as the revenue we recognize in a given period is generally the
result of sales from a prior period. Since mid-March 2020, our sales
organization has had limited opportunities to travel and conduct onsite sales
meetings with existing or prospective customers, and we have also cancelled
in-person tradeshows, which typically generate future sales opportunities. As a
result, operating income and adjusted EBITDA benefitted from a $1.0 million
reduction in operating expense related to travel restrictions during the first
nine months of 2021 compared to the first nine months of 2020.



When travel restrictions lessen and travel resumes at a more normal level, we
expect operating expenses associated with travel to have a negative impact on
operating income and EBITDA, and we do not expect revenue generated from such
activities to begin offsetting such increases to operating expenses at the same
time we incur such expenses. However, the uncertain trajectory of COVID-19 may
impact when and to what extent normal operating expenses, including expenses
related to sales travel and in-person tradeshows, accelerate or remain abated.



We continue to closely monitor developments related to COVID-19 that may have an
adverse impact on our operational and financial performance. We also continue to
take actions focused on the safety and well-being of our employees, assisting
our customers in this time of need, and mitigating operational and financial
impacts to our business. We intend to continue serving our customers both in
their battle to defeat the coronavirus and across the continuum of their other
workforce and provider solution needs.



Additionally, to promote the safety and well-being of our employees, we required
our entire workforce to begin working remotely from home beginning March 16,
2020, and the entire workforce continues to work remotely to date. Although we
previously intended to reopen our offices during the third quarter of 2021, due
to the recent surges in COVID-19 cases as noted above, we have deferred the time
at which our offices will reopen, and are continuing to monitor local public
health conditions before making a decision to reopen.



Many healthcare organizations have been, and may continue to be, substantially
adversely impacted by the COVID-19 pandemic. The period of time over which this
adverse impact continues, the extent to which certain healthcare organizations
continue to receive and/or are eligible to utilize governmental funds as the
result of federal stimulus and relief measures, and ongoing public health
conditions related to the pandemic are important factors that may impact our
business.


In light of the adverse developments regarding healthcare organizations as noted above, we continue to monitor our clients’ ability or willingness to:


  • pay for our solutions in a timely manner, in full, or at all;




  • implement solutions they have purchased from us; and




  • renew existing or purchase new products or services from us.




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We monitor our cash position and credit exposure by evaluating, among other
things, weekly cash receipts, days sales outstanding (DSO), customer requests to
modify payment or contract terms, and bankruptcy notices. We experienced modest
improvements in DSO during the third quarter of 2021 compared to the third
quarter of 2020. However, while we have not experienced any adverse impacts to
customer defaults resulting from COVID-19, we are unable to know whether or to
what extent negative trends related to the pandemic may arise in the future. Any
deterioration in the collectability (or the timing of payments) of our accounts
receivable could adversely impact our financial results.



The timing of implementation of our services is also relevant to our business
because our software solutions do not result in revenue recognition until they
are made available for use. To the extent our customers delay or fail to
implement products they have purchased, our financial results will be adversely
impacted. While we have experienced a negative impact from certain
implementation delays related to COVID-19, these delays have not been consistent
across products or across customers. In fact, we have become more efficient in
implementing certain products during the pandemic, particularly with respect to
certain Workforce Solutions segment products. In contrast, our Provider
Solutions business segment has, in some instances, been more sensitive to
implementation delays as the result of complexities associated with implementing
certain of the solutions offered through that business segment.



Conditions related to the pandemic have caused some customers to delay
purchasing decisions they would have otherwise made. Such conditions also
adversely impacted the ability or willingness of some customers to renew their
contracts with us or to renew contracts at the same levels. Pandemic-related
conditions have also delayed or otherwise adversely impacted our ability to
enter into contracts with new potential customers, as some potential customers
have been focused on dealing with the impact and demands that COVID-19 is having
on their businesses. In addition, the limitations noted above on onsite sales
meetings and in-person trade shows, as well as our customers' ongoing
uncertainties due to COVID-19 have reduced, and may continue to reduce, the
ability of our sales team to make sales they otherwise would likely make but for
the impact of COVID-19. As the pandemic has persisted, we have, however,
continued to evolve our sales approach such that our sales representatives have
been in frequent contact with customers via video conference and other remote
means that do not require physical travel or onsite visits to our customers'
facilities. The timing and extent of the resumption of in-person activities will
be dependent on the prevalence of future COVID-19 outbreaks, including with
regard to new variants that may continue to emerge.



Given the uncertainty surrounding the adverse impacts that COVID-19 could have
on our business, we took certain expense management measures in 2020 as
previously disclosed. We have generally discontinued these expense management
measures taking into account the improved economic environment and current
conditions related to the pandemic, provided that certain expenses such as those
associated with travel and tradeshows remain significantly lower than
pre-pandemic levels due to limitations on our ability to engage in such
activities at the same levels as prior to the pandemic. We are continuing to
monitor developments related to the COVID-19 pandemic and will continue to make
such expense management adjustments as we deem necessary.



Key Business Metrics


Our management uses the following financial and non-financial measures in managing our business.

• Income, net. Income, net, reflects income generated by sales of goods

and services related to our operations and reflects deferred revenues

impairments associated with the recognition at fair value of acquired businesses.

Income, net, was $ 64.1 million and $ 192.4 million for three and nine

months ended September 30, 2021 compared to $ 60.9 million and $ 183.0 million

for the three and nine months ended September 30, 2020. Management uses

income related to the management of our business and considers that this measure

provides useful information to investors as a key indicator of growth and

    success of our products.



• Operating result. Operating profit represents the amount of profit made

of our operations and is calculated as the difference between revenues, net

and operating costs and expenses. The operating result was $ 1.8 million and

$ 8.5 million for the three and nine months ended September 30, 2021 compared

To $ 3.1 million and $ 14.7 million for the three and nine months ended

September 30, 2020. Management uses operating income in connection with

manage our business and believe that our operating results provide

    information to investors as a key indicator of profitability.




  • Adjusted EBITDA. Adjusted EBITDA, calculated as set forth below under

“Reconciliation of non-GAAP financial measures” is used by our management

as part of the management of our business and provides useful information to

investors because adjusted EBITDA reflects adjusted net income for some

non-cash and non-operating items. We also believe that Adjusted EBITDA is

useful for investors to assess the Company’s current operations. Besides,

from 2021, executive bonuses are based on the achievement of

EBITDA targets. Adjusted EBITDA was $ 12.5 million for the three months ended

September 30, 2021, compared to $ 11.2 million for the three months ended

    September 30, 2020.



• hStream subscriptions. HStream subscriptions are determined as the number of

contracted subscriptions for hStream, our Platform-as-a-Service technology

which enables healthcare organizations and their respective workforces to

connect easily and get the value of growth HealthStream ecosystem of

applications, tools and content. Management uses hStream subscriptions in

link with the management of our business and believes that this measure provides

useful information for investors as a measure of our progress in growing the

value of our customer base. TO September 30, 2021, we had about

    4.92 million contracted subscriptions to hStream, compared to 3.82 million as
    of September 30, 2020.




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Critical accounting conventions 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. 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




  • Software development costs




  • Goodwill, intangibles, and other long-lived assets




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 2020 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 2020 Form 10-K.



Impact on the comparability of operating results



The comparability of our operating results for the nine months ended September
30, 2021 to the same period for 2020 are impacted by several factors, including
acquisitions, the reduction of revenues associated with legacy resuscitation
products, and other non-cash items.



Between March 9, 2020 and January 19, 2021, we completed five acquisitions,
which resulted in additional revenues and higher operating expenses during the
three and nine months ended September 30, 2021 compared to the three and nine
months ended September 30, 2020.



Our legacy agreements with Laerdal (Legacy Agreements) for the HeartCode and
Resuscitation Quality Improvement (RQI) products expired pursuant to their terms
on December 31, 2018. Revenues associated with sales of HeartCode and RQI
products pursuant to the Legacy Agreements were significant in past years,
although margins on such products were lower than HealthStream's average margin.
Revenue generated by HeartCode and RQI products pursuant to the Legacy
Agreements was $9.7 million in the third quarter of 2020 compared to
$0.5 million in the third quarter of 2021. For additional information, see below
under "Other Developments."



During the nine months ended September 30, 2021, the Company recorded a $1.0
million non-recurring, non-cash reduction to paid time off (PTO) expense as a
result of modifications to the Company's PTO policy. During the nine months
ended September 30, 2020, the Company recorded a $3.4 million non-cash
contractual adjustment that resulted in a decrease to royalty expense upon the
resolution of a mutual disagreement relating to various elements of a past
partnership.



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Three months ended September 30, 2021 Compared to the three months ended September 30, 2020

Income, net. Income increased by approximately $ 3.2 million, or 5%, to
$ 64.1 million for the three months ended September 30, 2021 of $ 60.9 million
for the three months ended September 30, 2020.

A comparison of revenues by industry is as follows (in thousands):


                                            Three Months Ended September 30,
Revenues by Business Segment:       2021                2020           Percentage Change
Workforce Solutions             $      51,155       $      49,197                       4 %
Provider Solutions                     12,936              11,686                      11 %
Total revenues, net             $      64,091       $      60,883                       5 %

% of Revenues
Workforce Solutions                        80 %                81 %
Provider Solutions                         20 %                19 %




Revenues for Workforce Solutions increased $2.0 million, or 4%, to $51.2 million
for the three months ended September 30, 2021 from $49.2 million for the
three months ended September 30, 2020. The Workforce Solutions segment achieved
this 4% growth while overcoming a $9.2 million decline from the legacy
resuscitation business. In this regard, while revenues from legacy resuscitation
products effectively ceased at the end of 2020, revenues for the three months
ended September 30, 2021 included $0.5 million as we extended, with support from
Laerdal, utilization of these products in 2021 for a small group of customers.
Revenues from recent acquisitions and growth in other solutions more than offset
the decline in legacy resuscitation revenues. Workforce revenues also benefited
from a $0.5 million increase in professional services revenues, primarily
associated with recently acquired businesses.



Revenues for Provider Solutions increased $1.2 million, or 11%, to $12.9 million
for the three months ended September 30, 2021 from $11.7 million for the
three months ended September 30, 2020. Revenue growth was primarily attributable
to new subscription revenues.



Cost of Revenues (excluding Depreciation and Amortization). Cost of revenues
decreased $0.7 million, or 3%, to $22.6 million for the three months ended
September 30, 2021 from $23.3 million for the three months ended September 30,
2020. Cost of revenues as a percentage of revenues was 35% and 38% for the
three months ended September 30, 2021 and 2020, respectively.



Cost of revenues for Workforce Solutions decreased $0.9 million to $18.4 million
for the three months ended September 30, 2021 compared to the prior year period
and approximated 36% and 39% of revenues for Workforce Solutions for the
three months ended September 30, 2021 and 2020, respectively. The decrease is
primarily attributable to a decrease in royalties payable by us related to
legacy resuscitation products, partially offset by increased expenses related to
recent acquisitions coupled with an increase in software expense classified as
cost of revenues during the three months ended September 30, 2021. Cost of
revenues for Provider Solutions increased $0.2 million to $4.2 million for the
three months ended September 30, 2021 compared to the prior year period and
approximated 33% and 34% of Provider Solutions revenues for the
three months ended September 30, 2021 and 2020, respectively. The increase in
amount is primarily associated with an increase in software expense classified
as cost of revenues during the three months ended September 30, 2021.



Product Development. Product development expenses increased $2.1 million, or
26%, to $10.3 million for the three months ended September 30, 2021 from
$8.2 million for the three months ended September 30, 2020. Product development
expenses as a percentage of revenues were 16% and 13% for the three months ended
September 30, 2021 and 2020, respectively.



Product development expenses for Workforce Solutions increased $2.2 million to
$8.7 million for the three months ended September 30, 2021 compared to the prior
year period and approximated 17% and 13% of revenues for Workforce Solutions for
the three months ended September 30, 2021 and 2020, respectively. The
increase is primarily associated with recent acquisitions and increased product
development efforts across other workforce solutions. Product development
expenses for Provider Solutions decreased $0.1 million to $1.6 million for the
three months ended September 30, 2021 compared to the prior year period and
approximated 12% and 15% of revenues for Provider Solutions for the
three months ended September 30, 2021 and 2020, respectively. The decrease in
product development expenses is primarily due to an increase in labor
capitalized for internally developed software related to additional product
investments across the VerityStream product suite.



Sales and Marketing. Sales and marketing expenses, including personnel costs,
increased $1.3 million, or 15%, to $10.2 million for the three months ended
September 30, 2021 from $8.9 million for the three months ended September 30,
2020. Sales and marketing expenses were 16% and 15% of revenues for the
three months ended September 30, 2021 and 2020, respectively.



Sales and marketing expenses for Workforce Solutions increased $1.2 million to
$8.2 million for the three months ended September 30, 2021 compared to the prior
year period and approximated 16% and 14% of revenues for Workforce Solutions for
the three months ended September 30, 2021 and 2020, respectively. The
increase is primarily due to an increase in general marketing expenses
and additional personnel expenses due to recent acquisitions partially offset by
lower sales commissions associated with the decline in legacy resuscitation
revenues. Sales and marketing expenses for Provider Solutions
increased $0.1 million to $1.7 million for the three months ended September 30,
2021 compared to the prior year period and approximated 13% and 14% of revenues
for Provider Solutions for the three months ended September 30, 2021 and 2020,
respectively. The unallocated corporate portion of sales and marketing expenses
increased $70,000 to $0.3 million for the three months ended September 30, 2021
compared to the prior year period.



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Other general and administrative expenses. The other general and administrative expenses were $ 10.0 million for the two months ended September 30, 2021 and September 30, 2020. Other general and administrative expenses represented 16% of sales for the three months ended September 30, 2021 and 2020.



Other general and administrative expenses for Workforce Solutions
decreased $0.5 million to $2.9 million for the three months ended September 30,
2021 compared to the prior year period and approximated 6% and 7% of Workforce
Solutions revenues for the three months ended September 30, 2021 and 2020,
respectively. The decrease is primarily due to a decrease in software expense
classified as general and administrative expenses partially offset by expenses
related to recent acquisitions. Other general and administrative expenses for
Provider Solutions increased $0.1 million to $1.0 million for the
three months ended September 30, 2021 compared to the prior year period and
approximated 8% and 7% of Provider Solutions revenues for the three months ended
September 30, 2021 and 2020, respectively. The increase is primarily due to
increased personnel costs compared to the prior year period. The unallocated
corporate portion of other general and administrative expenses
increased $0.4 million to $6.1 million for the three months ended September 30,
2021 compared to the prior year period primarily due to increased personnel
costs.



Depreciation and Amortization. Depreciation and amortization
expense increased $1.7 million, or 23%, to $9.1 million for the three months
ended September 30, 2021 from $7.4 million for the three months ended September
30, 2020. This increase is primarily a result of increases to amortization
associated with capitalized software and intangible assets from recent
acquisitions.



Other (Loss) Income, Net. Other (loss) income, net was a loss of $99,000 for the
three months ended September 30, 2021 compared to income of $0.1 million for the
three months ended September 30, 2020. The decrease is a result of lower
interest income due to reductions in cash and investment balances and lower
interest rate yields during the three months ended September 30, 2021 compared
to the prior year period.



Income Tax Provision. The Company recorded a provision for income taxes of
$0.2 million for the three months ended September 30, 2021 compared to
$0.6 million for the three months ended September 30, 2020. The Company's
effective tax rate was 11% for the three months ended September 30, 2021
compared to 19% for the three months ended September 30, 2020. 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.



Net Income. Net income was approximately $1.5 million and $2.6 million for the
three months ended September 30, 2021 and 2020, respectively. Earnings per share
(EPS) was $0.05 per share (diluted) and $0.08 per share (diluted) for the
three months ended September 30, 2021 and 2020, respectively.



Adjusted EBITDA was $12.5 million for the three months ended September 30, 2021
compared to $11.2 million for the three months ended September 30, 2020. See
"Reconciliation of Non-GAAP Financial Measures" below for our reconciliation of
adjusted EBITDA to the most directly comparable measures under US GAAP and
disclosure regarding why we believe Adjusted EBITDA provides useful information
to investors.


Nine months ended September 30, 2021 Compared to the nine months ended September 30, 2020



Revenues, net. Revenues increased $9.4 million, or 5%, to $192.4 million for the
nine months ended September 30, 2021 from $183.0 million for the nine months
ended September 30, 2020.


A comparison of revenues by industry is as follows (in thousands):


                                             Nine Months Ended September 30,
Revenues by Business Segment:       2021                2020           Percentage Change
Workforce Solutions             $     154,559       $     147,909                       4 %
Provider Solutions                     37,815              35,099                       8 %
Total revenues, net             $     192,374       $     183,008                       5 %

% of Revenues
Workforce Solutions                        80 %                81 %
Provider Solutions                         20 %                19 %




Revenues for Workforce Solutions increased $6.7 million, or 4%, over the first
nine months of 2020. Contributions from recent acquisitions and growth in other
workforce solutions more than offset the expected decline in revenues from
legacy resuscitation products of $28.3 million. While revenues from legacy
resuscitation products effectively ceased at the end of 2020, revenues for the
nine months ended September 30, 2021 included $3.2 million as we extended, with
support from Laerdal, utilization of these products into 2021 for a small group
of customers. Workforce revenues also benefited from a $1.4 million increase in
professional services revenues, primarily associated with recently acquired
businesses.



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Provider Solutions revenues increased $ 2.7 million, or 8%, in the first nine months of 2020. The growth in revenue is primarily attributable to new subscription revenue.



Cost of Revenues (excluding depreciation and amortization). Cost of revenues
increased $1.5 million, or 2%, to $68.1 million for the nine months ended
September 30, 2021 from $66.6 million for the nine months ended September 30,
2020. Cost of revenues as a percentage of revenues was 35% and 36% for the nine
months ended September 30, 2021 and 2020, respectively. Cost of revenues were
favorably impacted by $0.2 million during the nine months ended September 30,
2021, resulting from the non-cash reduction to PTO expense, and were favorably
impacted in the amount of $3.4 million during the nine months ended September
30, 2020 from the one-time non-cash contractual adjustment to royalty expense.



Cost of revenues for Workforce Solutions increased $1.2 million to $55.9 million
and approximated 36% and 37% of revenues for Workforce Solutions for the nine
months ended September 30, 2021 and 2020, respectively. The increase in amount
is primarily associated with increased expenses related to recent acquisitions,
the one-time contractual adjustment to cost of revenues in the amount of $3.4
million recorded during the nine months ended September 30, 2020, and an
increase in software expense classified as cost of revenues during the nine
months ended September 30, 2021, partially offset by a decline in royalties
related to legacy resuscitation products. Cost of revenues for Provider
Solutions increased $0.3 million to $12.1 million and approximated 32% and
34% of Provider Solutions revenues for the nine months ended September 30, 2021
and 2020, respectively. The increase in amount is primarily associated with an
increase in software expense classified as cost of revenues during the nine
months ended September 30, 2021.



Product Development. Product development expenses increased $6.7 million, or
29%, to $30.2 million for the nine months ended September 30, 2021 from
$23.5 million for the nine months ended September 30, 2020. Product development
expenses as a percentage of revenues were 16% and 13% of revenues for the nine
months ended September 30, 2021 and 2020, respectively. Product development
expenses were favorably impacted in the amount of $0.4 million during the nine
months ended September 30, 2021 from the non-cash reduction to PTO expense.



Product development expenses for Workforce Solutions increased $7.3 million to
$25.8 million and approximated 17% and 13% of revenues for Workforce Solutions
for the nine months ended September 30, 2021 and 2020, respectively. The
increase in amount is primarily associated with recent acquisitions and
increased product development efforts across other workforce solutions. Product
development expenses for Provider Solutions decreased $0.6 million to
$4.4 million and approximated 12% and 14% of revenues for Provider Solutions for
the nine months ended September 30, 2021 and 2020, respectively. The decrease is
primarily due to an increase in labor capitalized for internally developed
software related to additional product investments across the VerityStream
product suite.



Sales and Marketing. Sales and marketing expenses, including personnel costs,
increased $2.4 million, or 9%, to $28.7 million for the nine months ended
September 30, 2021 from $26.3 million for the nine months ended September 30,
2020. Sales and marketing expenses were 15% and 14% of revenues for the nine
months ended September 30, 2021 and 2020, respectively. Sales and marketing
expenses were favorably impacted by $0.2 million during the nine months ended
September 30, 2021 resulting from the non-cash reduction to PTO expense.



Sales and marketing expenses for Workforce Solutions increased $2.1 million to
$22.9 million and approximated 15% and 14% of revenues for Workforce Solutions
for the nine months ended September 30, 2021 and 2020, respectively. The
increase is primarily associated with increases in general marketing expenses
and recent acquisitions, partially offset by lower sales commissions associated
with the decline in legacy resuscitation revenues and decreases in travel
expenses as a result of the COVID-19 pandemic. Sales and marketing expenses for
Provider Solutions increased $0.1 million to $4.9 million and approximated
13% of revenues for Provider Solutions for both the nine months ended September
30, 2021 and 2020. The unallocated portion of sales and marketing expenses
increased $0.2 million to $1.0 million compared to the prior year period.



Other General and Administrative Expenses. Other general and administrative
expenses decreased $0.5 million, or 2%, to $29.4 million for the nine months
ended September 30, 2021 from $29.9 million for the nine months ended September
30, 2020. Other general and administrative expenses as a percentage of revenues
were 15% and 16% of revenues for the nine months ended September 30, 2021 and
2020, respectively. Other general and administrative expenses were favorably
impacted by $0.2 million during the nine months ended September 30, 2021
resulting from the non-cash reduction to PTO expense.



Other general and administrative expenses for Workforce Solutions
decreased $2.3 million to $9.0 million and approximated 6% and 8% of revenues
for Workforce Solutions for the nine months ended September 30, 2021 and 2020,
respectively. The decrease is primarily associated with a decrease in software
expense classified as general and administrative expenses during the nine months
ended September 30, 2021, partially offset by expenses associated with recent
acquisitions. Other general and administrative expenses for Provider Solutions
increased $0.2 million to $2.7 million and approximated 7% of revenues for
Provider Solutions for both the nine months ended September 30, 2021 and 2020.
The unallocated corporate portion of other general and administrative
expenses increased $1.6 million to $17.8 million compared to the first nine
months of 2020 primarily due to increased personnel expenses over the prior year
period.



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Depreciation and amortization. Increased depreciation and amortization $ 5.4 million, or 25%, to $ 27.4 million for the nine months ended
September 30, 2021 of $ 22.0 million for the nine months ended September 30, 2020. The increase is attributable to increases in amortization associated with capitalized software and intangible assets related to recent acquisitions.



Other (Loss) Income, Net. Other (loss) income, net was a loss of $0.3 million
for the nine months ended September 30, 2021 compared to income of $2.0 million
for the nine months ended September 30, 2020. This decrease is driven by the
$1.2 million gain associated with the change in fair value of the non-marketable
equity investment in NurseGrid prior to the acquisition of NurseGrid on March 9,
2020, coupled with lower interest income due to reductions in bond yields and
bank interest rates during the nine months ended September 30, 2021 compared to
the prior year period.



Income Tax Provision. The Company recorded a provision for income taxes of
$2.0 million and $3.5 million for the nine months ended September 30, 2021 and
2020, respectively. The Company's effective tax rate was 25% for the nine months
ended September 30, 2021 compared to 21% for the nine months ended September 30,
2020. The Company's effective tax rate primarily reflects the statutory
corporate income tax rate, the net effect of state taxes, foreign income taxes,
and the effect of various permanent tax differences. During the nine months
ended September 30, 2021, the Company recorded discrete tax expense of $0.2
million, which included purchase accounting adjustments, changes in state tax
rates enacted during the period, and lower research and development tax credits
recognized than previously estimated. During the nine months ended September 30,
2020, the Company recorded a $1.2 million change in fair value of non-marketable
equity investments as a result of the NurseGrid acquisition, which is not a
taxable transaction, resulting in a tax benefit of $0.3 million, and recognized
tax benefits resulting from higher research and development tax credits than
previously estimated.



Net Income. Net income was $6.2 million for the nine months ended September 30,
2021 compared to $13.2 million for the nine months ended September 30, 2020.
Earnings per diluted share were $0.20 and $0.41 per share for the nine months
ended September 30, 2021 and 2020, respectively.



Adjusted EBITDA increased $5.4 million to $40.6 million for the nine months
ended September 30, 2021 compared to $35.2 million for the nine months ended
September 30, 2020. This increase resulted from the factors mentioned above. See
"Reconciliation of Non-GAAP Financial Measures" below for our reconciliation of
Adjusted EBITDA to the most directly comparable measure under US GAAP.



Other Developments



Our legacy agreements with Laerdal (Legacy Agreements) for the HeartCode and
Resuscitation Quality Improvement (RQI) products expired pursuant to their terms
on December 31, 2018. Revenues associated with sales of HeartCode and RQI
products pursuant to the Legacy Agreements were significant in recent years,
although margins on such products have been lower than HealthStream's average
margin. Revenue generated by HeartCode and RQI products pursuant to the Legacy
Agreements was $38.4 million and $58.9 million in 2020 and 2019, respectively.
While revenues from legacy resuscitation products effectively ceased at the end
of 2020, revenues for the nine months ended September 30, 2021 included
$3.2 million as we extended, with Laerdal's support, utilization of these
products for a small group of customers. We expect revenue from legacy products
to be de minimis for the fourth quarter of 2021.



On December 6, 2018, we announced a new agreement with RQI Partners, a joint
venture between Laerdal and the American Heart Association. This agreement with
RQI Partners was not an extension or renewal of the expired Legacy Agreements
with Laerdal and should not be construed as such. Under our agreement with RQI
Partners, HealthStream will neither market nor sell HeartCode or RQI. Our RQI
Partners agreement provides for continuity of service for customers that desire
to purchase HeartCode or RQI from RQI Partners after December 31, 2018 and
receive it via the HealthStream Learning Center. RQI Partners will remit a fee
to us when sales of HeartCode and RQI are delivered via the HealthStream
Learning Center. These fees will not be sufficient to supplant the revenue
runout associated with the Legacy Agreements.



We remain actively engaged in efforts to broaden the scope and utilization of
our simulation-related offerings to include a range of clinical competencies
that extend beyond resuscitation, and we intend to bring to market a broadened
scope of simulation-based offerings, including resuscitation programs. On
January 17, 2019, as part of a seven-year collaboration agreement with the
American Red Cross which spans to 2026, we announced the launch of the American
Red Cross Resuscitation Suite. We are actively engaged in efforts to market,
sell, and deliver our new resuscitation offering, which includes the American
Red Cross Resuscitation Suite and validation of skills through a technology
enabled Innosonian manikin. A growing number of customers have been implemented
on our new resuscitation offering and the solution continues to gain acceptance
in the market. We believe our efforts to market, sell, and deliver the American
Red Cross Resuscitation Suite, along with efforts to bring additional
simulation-related offerings to market, are giving rise to additional and higher
margin opportunities than those that existed under the Legacy Agreements.



Reconciliation of non-GAAP financial measures

This quarterly report on Form 10-Q presents Adjusted EBITDA, which is a non-GAAP financial measure used by management to analyze our financial results and ongoing operating performance.

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In order to better assess the Company's financial results, management believes
that net income excluding the impact of the deferred revenue write-downs
associated with fair value accounting for acquired businesses and before
interest, income taxes, stock based compensation, depreciation and amortization,
changes in fair value of non-marketable equity investments, the de-recognition
of non-cash expense resulting from the paid time off expense reduction in the
first quarter of 2021, and the resolution of a mutual disagreement related to
various elements of a past partnership which resulted in a reduction to cost of
sales in the first quarter of 2020 ("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
non-operating items which may not, in any such case, fully reflect the
underlying operating performance of our business. We also believe that adjusted
EBITDA is useful to many investors to assess the Company's ongoing operating
performance and to compare the Company's operating performance between periods.
Additionally, beginning in 2021, executive bonuses are based on the achievement
of adjusted EBITDA targets.



As noted above, the definition of adjusted EBITDA includes an adjustment for the
impact of the deferred revenue write-downs associated with fair value accounting
for acquired businesses. Following the completion of any acquisition by the
Company, the Company must record the acquired deferred revenue at fair value as
defined in GAAP, which may result in a write-down of deferred revenue. If the
Company is required to record a write-down of deferred revenue, it may result in
lower recognized revenue, operating income, and net income in subsequent
periods. Revenue for any such acquired business is deferred and is typically
recognized over a one-to-two year period following the completion of any
particular acquisition, so our GAAP revenues for this one-to-two year period
will not reflect the full amount of revenues that would have been reported if
the acquired deferred revenue was not written down to fair value. Management
believes that including an adjustment in the definition of adjusted EBITDA for
the impact of the deferred write-downs associated with fair value accounting for
acquired businesses provides useful information to investors because the
deferred revenue write-down recognized in periods after an acquisition may,
given the nature of this non-cash accounting impact, cause our GAAP financial
results during such periods to not fully reflect our underlying operating
performance and thus adjusting for this amount may assist in comparing the
Company's results of operations between periods.



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 analytical tools.



A reconciliation of Adjusted EBITDA to the most directly comparable GAAP measure is presented below (in thousands).



                                             Three Months Ended September 30,           Nine Months Ended September 30,
                                                2021                  2020                2021                  2020
GAAP net income                            $         1,500       $         2,634     $         6,232       $        13,168
Deferred revenue write-down                            805                    75               3,657                   355
Interest income                                        (24 )                 (88 )               (64 )                (919 )
Interest expense                                        33                    26                  99                    76
Income tax provision                                   186                   600               2,033                 3,519
Stock based compensation expense                       861                   557               2,260                 1,665
Depreciation and amortization                        9,141                 7,406              27,443                22,005
Non-cash paid time off expense                           -                     -              (1,011 )                   -
Change in fair value of non-marketable
equity investments                                       -                     -                   -                (1,181 )
Non-cash royalty expense                                 -                     -                   -                (3,440 )
Adjusted EBITDA                            $        12,502       $        11,210     $        40,649       $        35,248



Liquidity and capital resources



Net cash provided by operating activities increased by $5.6 million to
$36.4 million during the nine months ended September 30, 2021 from $30.8 million
during the nine months ended September 30, 2020. Such increase was primarily
driven by higher cash collections. Our DSO was 40 days for the third quarter of
2021 compared to 43 days for the third quarter of 2020. The Company calculates
DSO by dividing the average accounts receivable balance for the quarter by
average daily revenues for the quarter. The Company's primary sources of cash
were receipts generated from the sales of our products and services. The primary
uses of cash to fund operations included personnel expenses, sales commissions,
royalty payments, payments for contract labor and other direct expenses
associated with delivery of our products and services, and general corporate
expenses.



Net cash used in investing activities was $17.0 million for the nine months
ended September 30, 2021 compared to $38.5 million for the nine months ended
September 30, 2020. During the nine months ended September 30, 2021, the Company
spent $0.7 million on business combinations, invested in marketable securities
of $5.2 million, made payments for capitalized software development of
$16.6 million, purchased property and equipment of $2.6 million, and invested
$1.8 million in equity method investments. These uses of cash were partially
offset by $9.9 million in maturities of marketable securities. During the nine
months ended September 30, 2020 the Company paid $21.4 million on business
combinations, invested in marketable securities of $61.2 million, made payments
for capitalized software development of $12.4 million, purchased property and
equipment of $1.7 million, and invested $1.3 million in non-marketable equity
investments. These uses of cash were partially offset by $59.5 million in
maturities of marketable securities.



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Net cash used in financing activities was approximately $0.5 million for the
nine months ended September 30, 2021 compared to $16.8 million for the nine
months ended September 30, 2020. The use of cash for the nine months ended
September 30, 2021 included $0.5 million for the payment of employee payroll
taxes in relation to the vesting of restricted share units. The uses of cash for
the nine months ended September 30, 2020 included $16.4 million for common stock
repurchases and $0.4 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 $10.3 million
at September 30, 2021 compared to negative working capital of $4.7 million at
December 31, 2020. The improvement in working capital is primarily a result of
strong cash collections during the first nine months of 2021. The Company's
primary source of liquidity as of September 30, 2021 was $55.5 million of cash
and cash equivalents and $5.1 million of marketable securities. The Company also
has a $65.0 million revolving credit facility, all of which was available for
additional borrowing at September 30, 2021. The revolving credit facility
expires on October 28, 2023, unless earlier renewed or amended.



We believe that our existing cash and cash equivalents, marketable securities,
cash generated from operations, and available borrowings under our revolving
credit facility will be sufficient to meet anticipated working capital needs,
new product development, and capital expenditures for at least the next 12
months.



In addition, the Company's growth strategy includes acquiring businesses or
making strategic investments in businesses that complement or enhance our
business. It is anticipated that future acquisitions or strategic investments,
if any, would be effected through cash consideration, stock consideration, or a
combination of both. The issuance of our stock as consideration for an
acquisition or to raise additional capital could have a dilutive effect on
earnings per share and could adversely affect our stock price. Our revolving
credit facility contains financial covenants and availability calculations
designed to set a maximum leverage ratio of outstanding debt to adjusted EBITDA
and an interest coverage ratio of adjusted EBITDA to interest expense.
Therefore, the maximum borrowings against our revolving credit facility would be
dependent on the covenant calculations at the time of borrowing. As of September
30, 2021, we were in compliance with all covenants. There can be no assurance
that amounts available for borrowing under our revolving credit facility will be
sufficient to consummate any possible acquisitions, and we cannot assure you
that if we need additional financing that it will be available on terms
favorable to us, or at all. Failure to generate sufficient cash flow from
operations or raise additional capital when required in sufficient amounts and
on terms acceptable to us could harm our business, financial condition, and
results of operations.

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John R.

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