HEALTHGATE DATA CORP - 10-Q Quarterly Report

HealthGate Data Corp.
(Exact name of registrant as specified in its charter)

Delaware		04-3220927
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
25 Corporate Drive, Suite 310, Burlington, Massachusetts		01803
(Address of principal executive offices)		(Zip 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 at least the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

The number of shares outstanding of the registrant's common stock as of October 31, 2002 was 6,014,676.

HEALTHGATE DATA CORP.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

HEALTHGATE DATA CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Increase (Decrease) in Cash and Cash Equivalents

(unaudited)

HealthGate Data Corp. ("HealthGate" or the "Company") is a provider and electronic publisher of healthcare information to healthcare institutions, corporations and government agencies for professionals, patients, and consumers. HealthGate currently provides access to this content on an individual resource basis to customers that prefer to choose specific content elements. HealthGate also provides its CHOICE products which consist of content and related services on a pre-packaged basis. The Company's XML-based content can be delivered electronically to its customers or built into clinical software systems.

HealthGate has recently developed additional proprietary content and has tagged this content along with portions of its other proprietary content using one of the standardized medical coding vocabularies. The Company anticipates marketing this content to healthcare institutions and related healthcare organizations for use in a variety of clinical applications. HealthGate was an early adopter of Microsoft's.NET XML services platform which enables applications to communicate and share data regardless of operating system, device, or programming language. During the third quarter of 2002, HealthGate released HealthGate OnSite™ which enables customers to download HealthGate's content files and host them on their own servers.

HealthGate's consolidated financial statements have been presented on the basis that it is a going concern, which contemplates the continuity of business, realization of assets and the satisfaction of liabilities in the ordinary course of business. At September 30, 2002, the Company had $5,025,000 of cash and cash equivalents, and $479,000 of working capital. The Company has incurred substantial losses and negative cash flows from operations in every fiscal year since inception. For the nine months ended September 30, 2002, the Company incurred a net loss of $3,461,000 and negative cash flows from operations of $2,766,000. Additionally as of September 30, 2002, the Company had an accumulated deficit of $97,192,000.

The Company has taken numerous actions to substantially reduce operating cash outflows. These actions included workforce reductions, terminating the Company's agreement with NBC Internet, Inc. ("NBCi"), and amending or canceling several content arrangements. Many of these cost savings were made possible through process improvements, development of proprietary content and focusing on content sales and service. Management believes that these actions have not impaired the Company's ability to invest in its core business. If the Company does not achieve its forecasted revenue levels in the future, management is prepared to implement additional cost reductions.

Based on HealthGate's forecasted cash flows and its cash and cash equivalents on hand, the Company expects to have sufficient cash to finance its operations for at least the next twelve months. The Company's future beyond the next twelve months is dependent upon its ability to achieve break-even or positive cash flow, or raise additional financing. There can be no assurances that the Company will be able to do so.

HealthGate is subject to risks and uncertainties common to technology-based companies, including rapid technological developments, reliance on continued development and acceptance of the Internet, intense competition and a limited operating history.

The accompanying unaudited condensed consolidated interim financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements, and should be read in conjunction with the audited financial statements included in HealthGate's Form 10-K for the year ended December 31, 2001. However, in the opinion of management, the accompanying interim financial statements have been prepared on the same basis as

the audited financial statements, and include all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full fiscal year or any future period. Certain amounts in the prior period condensed consolidated financial statements have been reclassified to conform to the current period presentation.

Net loss per share is computed in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). Basic net loss per share is computed by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding. Diluted net loss per share does not differ from basic net loss per share since potential common shares from the assumed exercise of stock options and warrants are anti-dilutive for all periods presented. As of September 30, 2002, options to purchase 601,429 shares of the Company's stock and warrants to purchase 1,110,279 shares of the Company's common stock were outstanding.

HealthGate primarily derives revenue from licensing access to its content repository and other content services, including Web site development and hosting arrangements such as CHOICE® Web sites. In 2002, HealthGate began entering into publishing agreements with print publishers. HealthGate has also generated revenue from activePress™ services and online advertising, sponsorships and e-commerce, including user subscription and transaction based fees.

HealthGate records revenue in accordance with Staff Accounting Bulletin No. 101 ("SAB 101"). Revenue from services arrangements is recognized ratably over the terms of the underlying agreement between HealthGate, the customer, and if applicable, HealthGate's authorized reseller, which generally ranges from one to three years. HealthGate typically does business with its customers using standard contracts and does not begin to recognize revenue until such contract is signed by both parties. For any arrangement in which HealthGate guarantees advertising commissions to the customer, HealthGate records fees paid by the customer as a customer deposit, up to the amount of the applicable guarantee. Payments made to customers under these guarantees are recorded as reductions of the related customer deposit. The excess of the fee paid by the customer to HealthGate over guaranteed advertising and sponsorship commissions, if any, is recognized as revenue ratably over the term of the underlying agreement. For those arrangements in which HealthGate guarantees advertising and sponsorship commissions in excess of the fees paid by the customer, the excess is recorded as expense upon signing the agreement. For arrangements in which HealthGate sells through a reseller, HealthGate does not recognize any revenue until an agreement has been finalized between HealthGate, its customer, and its authorized reseller, and the content has been delivered. Revenue is not recognized in any circumstances unless collectability is deemed probable.

If consideration, including equity instruments, is given to a customer or reseller for which the Company does not receive a separate identifiable benefit with a determinable fair value, the Company characterizes the recognition of such consideration as a reduction in revenue, to the extent there is cumulative revenue from such customer or reseller. Any excess recognition of such consideration is recorded as an expense.

Revenue from licensing electronic content to print publishers for print distribution, including minimum royalties, is recognized upon delivery of the content as long as HealthGate has no material future obligations.

HealthGate rarely enters into multi-element service arrangements. When HealthGate does enter into such an arrangement, each element is accounted for separately over its respective service period, provided that there is objective evidence of fair value, such as the price charged for each element when sold separately. If the fair value of each element cannot be objectively determined, the total value of the arrangement is recognized ratably over the entire service period. For all multi-element service arrangements to date, the fair value of each element has not been objectively determinable. Therefore, all revenue under these contracts has been recognized ratably over the related service period. For arrangements under which HealthGate receives equity instruments in exchange for services, HeathGate determines the value of the arrangement based on the fair value of the equity received or services provided, whichever is more readily determinable.

HealthGate leases approximately 32,000 square feet of office space under a lease, which expires in June 2005. HealthGate's annual cost for this space is at a rate of approximately $28 per square foot per year. During the fourth quarter of 2001, the Company committed to an exit plan to vacate approximately 20,000 square feet of excess space at its headquarters building. HealthGate finalized a sublease for a portion of this excess space in February 2002.

HealthGate's results of operations for the year ended December 31, 2001 included a charge of $1,880,000 as a result of these activities. This charge represents accrual of expenses relating to HealthGate's continued liability under its lease and is included in liabilities on HealthGate's balance sheet at December 31, 2001. The activity for the nine months ended September 30, 2002 relating to this accrual are as follows:

Payments	$	(516,613	)
Payments received from tenant		148,377
Depreciation on leasehold improvements		(32,317	)

Liability at September 30, 2002		1,479,175
Less: current portion		(401,987	)

Other long-term liabilities	$	1,077,188

The charge and accrual included certain significant estimates and assumptions which will be monitored for changes in facts and circumstances. It is reasonably possible that changes in circumstances and evaluation of assumptions may require adjustment to this charge in future periods, and the amount could be material.

On February 12, 2002, HealthGate acquired from Random House, Inc. the assets of The Natural Pharmacist ("TNP"), a publisher of comprehensive evidence-based alternative and natural health content for consumers and healthcare professionals. The total purchase price of $393,000 consisted of $350,000 in cash and $43,000 in direct transactional costs. In accordance with the provisions of

Statement of Financial Accounting Standards No. 141, the purchase price was allocated to the assets acquired based on their value at the date of acquisition, with $48,000 of the purchase price being allocated to accounts receivable and $345,000 allocated to purchased content. This purchased content asset is being amortized on a straight-line basis over the estimated three-year life of the underlying asset. The pro forma effect of this acquisition in the three and nine months ended September 30, 2001 and 2002 would not have been significant.

HealthGate has entered into agreements to license content for its services from various unrelated third parties. Future minimum license payments under these agreements as of September 30, 2002 totaled approximately $537,000.

In July 1999, HealthGate received a letter alleging that HealthGate's Web site induces users to infringe a patent held by a company (the "Holder"). In lieu of pursuing a patent infringement claim against HealthGate, the Holder offered to provide HealthGate with a license for unlimited use of the patent for a one-time payment of between $50,000 and $150,000. There has been no recent activity on this matter and at this time, HealthGate is unable to predict its outcome.

From time to time HealthGate becomes subject to legal proceedings and claims arising in connection with its business. HealthGate does not believe that there were any asserted claims at September 30, 2002 that, if adversely decided, would have a material adverse effect on its results of operations, financial condition or liquidity.

Through the Company's activePress service, HealthGate developed the technology platform for Web distribution of a collection of approximately 320 full text journals for Blackwell Science. The Company's agreement with Blackwell Science expired in January 2002. HealthGate's results of operations for the nine months ended September 30, 2002 and 2001 include $116,000 and $1,259,000 of revenue relating to this agreement. HealthGate does not expect to have significant revenues from Blackwell Science for the remainder of 2002. Blackwell Science is a stockholder of HealthGate.

In June 1999, HealthGate entered into a development and distribution agreement with GE Medical Systems ("GEMS"). The agreement, as amended, runs through June 2003. Under the terms of this agreement, GEMS may sell HealthGate's standard CHOICE product and GEMS' branded enhanced versions of HealthGate's CHOICE product through its worldwide sales force into its worldwide customer base of hospitals and other patient care facilities. HealthGate's results of operations for the three and nine months ended September 30, 2002 include no revenue from GEMS. HealthGate's results of operations for the three and nine months ended September 30, 2001 include $13,000 and $852,000, respectively of revenue from GEMS.

In connection with this agreement, HealthGate issued a warrant to General Electric Company for the purchase of up to 396,600 shares of HealthGate's common stock. Affiliates of General Electric Company also purchased shares of HealthGate stock in April 1999 and January 2000. General Electric Company is currently a principal stockholder of HealthGate.

name, the www.healthgate.com Web site, enterprise-based CHOICE Web sites and the products and services HealthGate offers. In exchange for the services provided to HealthGate by NBCi during the first year of the agreement, HealthGate issued to NBCi 166,666 shares of its common stock in November 1999. In January 2000, HealthGate paid NBCi a minimum cash fee of $10,000,000 plus a $250,000 production and content integration fee. In September 2000, HealthGate amended this agreement. One of the provisions of the revised agreement was that HealthGate agreed to redirect its user traffic from www.healthgate.com to the Health Channel section of NBCi's consumer Internal portal at www.nbci.com so that NBCi could count all user traffic as part of its total user base.

In March 2001, HealthGate further amended its agreement with NBCi. Under the amended agreement, HealthGate issued a warrant to purchase 66,666 shares of HealthGate common stock at $0.5625 per share, the then current market price of HealthGate's stock. The Company ascribed a value of approximately $38,000 to the warrant, which was recorded as prepaid advertising and was being amortized over the remaining term of the amended agreement. HealthGate was also to pay NBCi $2,100,000 in cash in 2001 and $2,800,000 in cash in 2002, and was to provide content to NBCi through October 2004. In return, NBCi was to feature HealthGate as the anchor tenant on the men's health, women's health and drugs and medications sections of the Health Channel of the NBCi portal through October 2002 and share advertising and sponsorship revenue derived from the co-branded www.healthgate.nbci.com Web site with HealthGate through October 2004.

In June 2001, HealthGate negotiated to end its contract with NBCi. In connection with this termination agreement HealthGate paid NBCi $831,000 during the third quarter of 2001. HealthGate also paid $592,000 in 2001 under the March 2001 amended agreement.

NBCi is wholly owned by National Broadcasting Company, a subsidiary of General Electric Company.

Costs incurred in the research and development of HealthGate's content and products are expensed as incurred, except for certain software development costs. In accordance with the American Institute of Certified Public Accountants' Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"), HealthGate capitalizes costs incurred during the application development stage of software developed for internal use. During the three and nine months ended September 30, 2002 development costs of approximately $29,000 and $145,000, respectively, were capitalized. These costs will be amortized to cost of revenue on a straight-line basis over the expected one-year life of the related software, once the software is complete and ready for its intended use.

In June 2002, The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities. SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. SFAS 146 also established that fair value is the objective for initial measurement of the liability. The provisions of SFAS 146 are effective for exit and disposal activities that are initiated after December 31, 2002. HealthGate is currently evaluating the impact, if any, of SFAS 146 on its financial statements.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This report on Form 10-Q contains certain statements that are forward-looking and actual results may differ materially from those contemplated by the forward-looking statements. These forward-looking statements reflect management's current expectations, are based on many assumptions and are subject to certain risks and uncertainties. Factors that might cause or contribute to such differences are described further below and in the periodic reports and registration statements HealthGate files from time to time with the Securities and Exchange Commission, including HealthGate's most recent Form 10-K. Investors are cautioned not to place undue reliance on the forward-looking statements, which appear elsewhere in this report on Form 10-Q. HealthGate does not intend to update or publicly release any revisions to the forward-looking statements.

HealthGate Data Corp. ("HealthGate" or the "Company") is a market-leading provider and electronic publisher of healthcare information. HealthGate offers customers a comprehensive content repository of healthcare information. HealthGate's authoritative content has been chosen by more than 600 hospitals in the United States to provide the capability to drive down costs through clinician and patient education, more effective research, improved treatment and regulatory compliance. The Company's XML-based content can be delivered electronically to its customers or built into clinical software systems.

In the second half of 2000, HealthGate began its Project Intellect strategic initiative in order to design a content repository architecture and data management system capable of enabling the Company's content assets to be dynamically integrated into a wide range of clinical and administrative applications. The prototype of the content repository was completed in December 2001 and the Company decided to implement the software technology into its production systems. Also in December 2001, the Company entered into a Beta agreement with HCA—Information Technology & Services, Inc. ("HCA-Information"), formerly known as Columbia Information Systems, Inc., a subsidiary of HCA, Inc., formerly known as Columbia/HCA Healthcare Corporation to test Project Intellect's content tagging techniques for delivering content from the new data repository architecture. In the second quarter of 2002 the Company launched its newly-enhanced, multi-dimensional content repository. Content in the repository is now being tagged using Clinical Classification Software ("CCS") codes developed by the Agency for Healthcare Research and Quality.

On February 12, 2002, HealthGate acquired from Random House, Inc. the assets of The Natural Pharmacist ("TNP"), a publisher of comprehensive evidenced-based alternative and natural health content for consumers and healthcare professionals. HealthGate paid approximately $393,000 ($350,000 in cash and approximately $43,000 in direct transactional costs) to acquire the assets of TNP. These assets consisted primarily of complementary and alternative health content and trademarks. HealthGate has applied the purchase accounting provisions of Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141") in recording this transaction. See Note 5 to the financial statements.

During the third quarter of 2002, HealthGate applied for URAC Health Web Site Accreditation. URAC's accreditation assures that a company's Web site is trustworthy and conforms to more than fifty demanding quality standards. HealthGate anticipates receiving notification of its success in gaining accreditation during the fourth quarter of 2002.

HealthGate's management believes it has developed a scalable and sustainable business model. The Company's limited operating history makes an evaluation of the business and its prospects difficult. Investors should not use the Company's past results as a basis to predict future performance. The

Company intends to continue to invest in its content repository. The Company plans to manage its expenses based on its anticipated revenue. However, HealthGate cannot assure investors that it will achieve significant revenue or profitability or, if significant revenue or profitability is achieved, that the Company will be able to sustain them.

At September 30, 2002, the Company had $5,025,000 of cash and cash equivalents and $479,000 of working capital. The Company has incurred substantial losses and negative cash flows from operations in every fiscal year since inception. In the nine months ended September 30, 2002, the Company incurred a net loss of $3,461,000 and negative cash flows from operations of $2,766,000. Additionally, as of September 30, 2002, the Company had an accumulated deficit of $97,192,000.

HealthGate's discussion and analysis of its financial condition and results of operations are based upon HealthGate's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. HealthGate evaluates its estimates on an on-going basis. HealthGate bases its estimates on assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

A complete description of critical accounting policies and significant judgments used in the preparation of HealthGate's consolidated financial statements can be found in the Company's most recent Form 10-K. The following critical accounting policies and significant judgments and estimates represent selected updates to those discussed in the Form 10-K.

Revenue Recognition. HealthGate primarily derives revenue from licensing access to its content repository and other content services, including Web site development and hosting arrangements such as CHOICE® Web sites. In 2002, HealthGate also began entering into publishing agreements with print publishers. HealthGate has also generated revenue from providing activePress™ services, online advertising, sponsorships and e-commerce, including user subscription and transaction based fees. In order to focus on being a provider and electronic publisher of healthcare information, HealthGate chose to phase out its advertising, sponsorship and e-commerce offerings in November 2000. Accordingly, there is limited revenue from these activities in 2001 and 2002. HealthGate's activePress agreement with Blackwell Science terminated in January 2002. HealthGate no longer provides activePress services.

ranges from one to three years. HealthGate typically does business with its customers using standard contracts and does not begin to recognize revenue until such contract is signed by both parties. For any arrangement in which HealthGate guarantees advertising commissions to the customer, HealthGate records fees paid by the customer as a customer deposit, up to the amount of the applicable guarantee. Payments made to customers under these guarantees are recorded as reductions of the related customer deposit. The excess of the fee paid by the customer to HealthGate over guaranteed advertising and sponsorship commissions, if any, is recognized as revenue ratably over the term of the underlying agreement. For those arrangements in which HealthGate guarantees advertising and sponsorship commissions in excess of the fees paid by the customer, the excess is recorded as expense upon signing the agreement. For arrangements in which HealthGate sells through a reseller, HealthGate does not recognize any revenue until an agreement has been finalized between HealthGate, its customer, and its authorized reseller, and the content has been delivered. Revenue is not recognized under any circumstances unless collectability is deemed probable.

Effective January 1, 2002, HealthGate adopted Emerging Issues Task Force Issue No. 01-09, "Accounting for Consideration Given by a Vendor to a Customer" ("EITF 01-09"). EITF 01-09 addresses whether a vendor should recognize consideration given to a customer as an expense or as an offset to revenue being recognized from that same customer. Consideration given to a customer is presumed to be a reduction in revenue unless both of the following conditions are met:

If both conditions are met, consideration paid to the customer may be recognized as expense.

Upon adopting EITF 01-09, HealthGate reviewed its agreements with both vendor and customer components that might be impacted. As a result, HealthGate has reclassified $179,000 of amortization of marketing and distribution rights relating to the warrant issued to CIS Holdings, Inc. in November 1999 from expense to a reduction in revenue for each of the three months ended September 30, 2002 and 2001 and reclassified amortization of $538,000 relating to this warrant for each of the nine months ended September 30, 2002 and 2001 from expense to a reduction in revenue. Identifying transactions that are within the scope of EITF 01-09, and determining whether those transactions meet the criteria for recognition as expense, requires HealthGate to make significant judgments. If HealthGate reached different conclusions, reported revenues could be materially different.

In November 1999, HealthGate entered into a three year development agreement with Columbia Information Systems, Inc., now known as HCA-Information Technology & Services, Inc. ("HCA-Information"), a subsidiary of HCA, Inc., formerly known as Columbia/HCA Healthcare Corporation ("HCA"), to design, develop and maintain customized, co-branded CHOICE Web sites for up to 280 HCA hospitals and affiliates. The agreement provided for an annual license fee of $3,500,000 to be paid by HCA-Information for all products and services that HealthGate provides under the agreement. The agreement could be terminated without cause by HCA-Information on June 1, 2001, upon payment of a $1,000,000 termination fee to HealthGate. HealthGate began delivering customized co-branded CHOICE Web sites pursuant to this agreement in December 1999.

In March 2001, HealthGate and HCA-Information amended the development agreement. The term of the amended agreement is from March 2001 to November 2002 and calls for HCA-Information to pay license fees to HealthGate of approximately $1,417,000 in both 2001 and 2002. The amendment significantly reduced the content and services that will be made available to HCA-Information, increased the maximum number of authorized users covered to 330 and eliminated HCA-Information's

option to terminate the Agreement on June 1, 2001. The annual license fees from this agreement are recognized ratably over the term of the amended agreement. As of September 30, 2002, the Company had delivered 302 customized co-branded CHOICE Web sites to HCA hospitals.

In October 2002, HealthGate and HCA-Information entered into a new content agreement. The term of the new agreement is from November 2002 through October 2004 and calls for HCA-Information to pay annual license fees to HealthGate of $1.1 million. The agreement covers up to 400 authorized users and can be terminated by HCA-Information at any time with 60 days prior notice. The annual license fees will be recognized ratably over the term of the agreement.

E-commerce revenue has been derived principally from individual user online subscriptions and from transaction fees for the fee based access to portions of the HealthGate Web sites. Revenue from user subscriptions is recognized ratably over the subscription period, and revenue from transactional based fees is recognized when the related service is provided.

HealthGate rarely enters into multi-element service arrangements. When HealthGate does enter into such an arrangement, each element is accounted for separately over its respective service period, provided that there is objective evidence of fair value, such as the price charged for each element when sold separately. If the fair value of each element cannot be objectively determined, the total value of the arrangement is recognized ratably over the entire service period. For all multi-element service arrangements to date, the fair value of each element has not been objectively determinable. Therefore all revenue under these contracts has been recognized ratably over the related service period.

Software Development and Content Development Costs. Costs incurred in the research and development of HealthGate's products are expensed as incurred, except for certain software development costs. In accordance with the American Institute of Certified Public Accountants' Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"), HealthGate capitalizes certain costs, primarily internal labor, incurred during the application development stage of software developed for internal use. These costs are amortized to cost of revenue on a straight-line basis over the expected one-year life of the related software, once the software is complete and ready for its intended purpose. During the nine months ended September 30, 2002, $145,000 of software development costs were capitalized. During the three months ended March 31, 2002 approximately $66,000 of software development costs were capitalized relating to HealthGate's Project Intellect initiative. HealthGate began amortizing these expenses to cost of revenue in April 2002. During the three months ended June 30, 2002, HealthGate capitalized approximately $50,000 of software development costs related to development of a new product, HealthGate On-Site which was placed in service during the third quarter of 2002. During the three months ended September 30, 2002, HealthGate capitalized approximately $29,000 on development of a new product which is not yet ready for its intended use. HealthGate expects to capitalize additional software development costs during the remainder of 2002. HealthGate has made significant judgments in estimating the useful life of the capitalized software to be one year. Operating results would be materially different if a different useful life were used.

Costs incurred in the research and development of HealthGate's content and products, except for certain software development costs as described above, are expensed as incurred. The cost to develop proprietary content and update existing content is expensed as research and development costs in the period the costs are incurred. Operating results would be materially different if such costs were capitalized and amortized over the expected benefit period.

Marketing and Distribution Rights. In June 1999, HealthGate entered into a development and distribution agreement with GE Medical Systems ("GEMS"), an affiliate of a General Electric Company. Under the terms of this agreement, GEMS may sell HealthGate's standard CHOICE product and GEMS' branded enhanced versions of HealthGate's CHOICE product through its worldwide sales force into its worldwide customer base of hospitals and other patient care facilities. In connection with this agreement, HealthGate issued a warrant to General Electric Company for the purchase of up to 396,600 shares of HealthGate's common stock. The warrant has a term of five years, was immediately exercisable and had an original exercise price of $28.47 per share, which exercise price was adjusted to $10.38 per share on January 1, 2000. The fair value of this warrant was determined to be $10,300,000 at the time of issuance using the Black-Scholes option pricing model, based on the following assumptions: 100% volatility, a term of 5 years, and an interest rate of 5.6%. This amount was recorded as marketing and distribution rights, and was amortized on a straight-line basis over the one year contractual term of the related development and distribution agreement. In connection with the exercise price adjustment to $10.38 per share on January 1, 2000, the value of the marketing and distribution rights increased by approximately $1,243,000. This incremental value was amortized over the remaining term of the development and distribution agreement. The warrant was fully amortized in 2000.

In November 1999, HealthGate entered into a three-year marketing and reseller agreement with Columbia Information Systems, Inc., now known as HCA-Information Technology & Services, Inc. ("HCA-Information"), a subsidiary of HCA, Inc., formerly known as Columbia/HCA Healthcare Corporation ("HCA"), under which HCA-Information agreed to endorse HealthGate as the preferred provider of patient and consumer oriented health content for Web sites owned or operated by HCA hospitals and affiliates. The agreement provides HealthGate, among other things, the right to make a first offer to provide services for adding content to the HCA-Information's health portal site and any site owned or operated by or affiliated with HCA-Information or HCA. Further, HCA-Information may, for a commission, market and sell HealthGate's CHOICE products to entities unaffiliated with HCA, subject to HealthGate's approval. In connection with this agreement HealthGate issued a warrant to CIS Holdings, Inc., an affiliate of HCA and HCA-Information, for the purchase of up to 647,012 shares of HealthGate's common stock. The warrant has a term of three years, an exercise price per share of $33.00 and became exercisable in January 2000 upon HealthGate's initial public offering. The fair value of this warrant was determined to be $13,500,000 using the Black-Scholes option pricing model, based on the following assumptions: 100% volatility, a term of 3 years, and an interest rate of 6.6%. This amount was recorded as marketing and distribution rights, and is being amortized on a straight-line basis over the three-year contractual term of the related agreement.

When issued, HealthGate concluded that it was appropriate to record the value of the warrants to General Electric Company and CIS Holdings, Inc. as assets and amortize the assets over the contractual term of the related agreements rather than record one-time charges, because the Company believed there was value to being associated with these partners that would lead to future revenues to HealthGate from third parties. If the Company had reached a different conclusion it would have yielded materially different results. The valuations of the warrants required certain significant judgments and estimates, including the term, volatility and interest rates that were used in the Black-Scholes valuation model. If different assumptions and estimates had been made the amount capitalized and the related amortization could have been materially different.

Upon adoption of EITF 01-09 on January 1, 2002, HealthGate reviewed its agreements to determine whether the Company's accounting would be impacted. HealthGate determined that it could not reasonably estimate the fair value of the services received from HCA-Information and that, accordingly, the warrant granted to CIS Holdings, Inc. did not meet the criteria in EITF 01-09 for classification as an expense. As a result HealthGate reclassified $179,000 of amortization of marketing and distribution rights relating to the warrant issued to CIS Holdings, Inc. from expense to a reduction

in revenue for each of the three months ended September 30, 2002 and 2001 and reclassified amortization of $538,000 relating to this warrant from expense to a reduction in revenue for each of the nine months ended September 30, 2002 and 2001.

Identifying transactions that are within the scope of EITF 01-09, and determining whether those transactions meet the criteria for recognition as expense, requires HealthGate to make significant judgments. If HealthGate reached different conclusions, reported revenues could be materially different.

Impairments of Long-Lived Assets. HealthGate periodically evaluates its long-lived assets for potential impairment under Statement of Financial Accounting Standards No.144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). The Company performs such evaluations when events or changes in circumstance suggest that the carrying value of an asset or group of assets is not recoverable. Indicators of potential impairment include:

Determining whether an indicator of potential impairment exists requires significant judgment on the part of the Company.

If an indicator of potential impairment is believed to exist, the Company tests to determine whether the impairment recognition criterion of SFAS 144 has been met. The Company tests this by preparing a projection of future undiscounted cash flows expected to be generated by the asset, and determining whether those cash flows are less than the carrying amount of the asset. In this assessment, assets are grouped at the lowest level for which cash flows are identifiable and largely independent of cash flows of other asset groups. The projection of expected future cash flows includes the Company's best estimate of all applicable cash inflows from operations, any cash outflows necessary to obtain those cash inflows, and any residual value of the asset. If the projected undiscounted cash flows are less than the carrying amount of the asset or group of assets, an impairment is determined to exist.

Once an impairment is determined to exist, the amount of the impairment loss is measured by the excess of the carrying amount of the asset over its fair value. HealthGate generally estimates the fair value of the asset using a discounted cash flow analysis. In this analysis, the Company discounts expected cash flows using a discount rate that it believes is commensurate with the risks involved. The fair value then becomes the asset's new cost basis.

In evaluating long-lived assets for potential impairment, the Company makes several significant estimates and judgments, including: determining the appropriate grouping of assets at the lowest level for which cash flows are available, estimating future cash flows associated with the asset or group of assets, and determining an appropriate discount rate to use in the analysis. Use of different estimates and judgments could yield materially different results in the Company's analysis, and could result in materially different asset impairment charges.

HealthGate recorded deferred compensation of $2,307,000 in 1999, representing the difference between the exercise price of stock options granted and the fair market value of the underlying common stock at the date of grants. The difference is recorded as a reduction of stockholders' equity and is being amortized over the vesting period of the applicable options, typically three years. Of the

total deferred compensation amount, approximately $9,000 and $114,000 was amortized during the nine months ended September 30, 2002 and 2001, respectively. There are no remaining amounts of deferred compensation as of September 30, 2002.

On November 27, 2001, HealthGate commenced an offer to exchange certain options to purchase shares of its common stock, par value $0.03 per share, upon the terms and subject to the conditions described in the Offer to Exchange dated November 27, 2001, as amended (the "Offer"). Under the Offer, employees (including executive officers) were given the opportunity to elect to cancel outstanding stock options held by them in exchange for an equal number of new options to be granted at a future date. Acceptance of the Offer required the employee to exchange any other options granted to him or her during the six months prior to the commencement of the Offer. The Offer expired on Thursday, December 27, 2001. Pursuant to the terms and conditions described in the Offer, HealthGate accepted for exchange options to purchase 552,290 shares of common stock, which were cancelled on December 28, 2001. On July 8, 2002, HealthGate granted new options to purchase an aggregate of 322,141 shares of common stock in exchange for such tendered options. The exercise price of the new options was equal to the fair market value of HealthGate's common stock on the date of grant. The exchange program was designed to comply with Financial Accounting Standards Board Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation," and Emerging Issues Task Force Issue No. 00-23, "Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44," and did not result in any additional compensation charges or variable plan accounting.

In October 1999, HealthGate entered into a three-year strategic alliance agreement with Snap! LLC and Xoom.com, Inc. The rights of Snap! LLC and Xoom.com, Inc. were subsequently assigned to NBCi. Under the original agreement, NBCi was to provide various services to promote HealthGate's name, the www.healthgate.com Web site, enterprise-based CHOICE Web sites and the products and services HealthGate offers. In exchange for the services provided to HealthGate by NBCi during the first year of the agreement, HealthGate paid NBCi a minimum cash fee of $10,000,000 plus a $250,000 production and content integration fee, and in November 1999 HealthGate issued to NBCi 166,666 shares of its common stock. The value of these shares was $4,500,000 at the time of issuance, which was recorded as prepaid advertising. The value of 83,333 shares was amortized as sales and marketing expense on a straight-line basis in 2000, and the value of the other 83,333 shares was recognized based on the delivery of advertising impressions in the first year of the agreement. In September 2000, HealthGate amended this agreement. One of the provisions of the revised agreement was that HealthGate agreed to redirect its user traffic from www.healthgate.com to the Health Channel section of NBCi's consumer Internal portal at www.nbci.com so that NBCi could count all user traffic as part of its total user base.

In March 2001, HealthGate further amended its agreement with NBCi. Under the amended agreement, HealthGate issued a warrant to NBCi for the purchase of up to 66,666 shares of HealthGate common stock at $0.5625 per share, the then current market price of HealthGate's stock. The Company ascribed a value of approximately $38,000 to the warrant. This amount was being recognized over the remaining term of the amended agreement. HealthGate was also to pay NBCi $2,100,000 in cash in 2001 and $2,800,000 in cash in 2002, and was to provide content to NBCi through October 2004. In return, NBCi was to feature HealthGate as the anchor tenant on the men's health, women's health and drugs and medications sections of the Health Channel of the NBCi portal through October 2002 and share advertising and sponsorship revenue derived from the co-branded www.healthgate.nbci.com Web site with HealthGate through October 2004.

In June 2001, HealthGate negotiated to end its contract with NBCi. In connection with this termination agreement HealthGate paid NBCi $831,000 during the third quarter of 2001. HealthGate also paid NBCi $592,000 in 2001, under the March 2001 amendment.

NBCi is wholly owned by National Broadcasting Company, a subsidiary of General Electric Company. General Electric Company is a principal stockholder of HealthGate.

Comparison of the Three Months Ended September 30, 2002 with the Three Months Ended September 30, 2001

Total revenue for the three months ended September 30, 2002 decreased by $244,000 or 14% compared to the three months ended September 30, 2001. Substantially all of the revenue in both periods was derived from content services. The revenue decrease is primarily related to the expiration of HealthGate's agreement with Blackwell Science in January 2002.

In March 2001, HealthGate and HCA-Information amended their development agreement. The term of the amended agreement is from March 2001 to November 2002 and calls for HCA-Information to pay license fees to HealthGate of approximately $1,400,000 in both 2001 and 2002. The amendment significantly reduced the content and services available to HCA-Information, increased the maximum number of authorized users covered to 330 and eliminated HCA-Information's option to terminate the agreement on June 1, 2001. Revenue relating to this agreement was $246,000 during each of the three months ended September 30, 2002 and September 30, 2001. In accordance with EITF 01-09, revenue in each period has been reduced by $179,000 related to the reclassification of amortization of marketing and distribution rights from operating expense.

The three months ended September 30, 2002 included revenue of $246,000 (16%) from HCA-Information. The three months ended September 30, 2001 included revenue of $246,000 (14%) from HCA-Information, and related party revenue of $333,000 (19%) from Blackwell Science and $13,000 (1%) from GEMS. HealthGate's agreement with Blackwell Science expired in January 2002. No other customer accounted for more than 10% of the Company's revenue for the periods.

Cost of Revenue. Cost of revenue consists primarily of editorial costs to refresh and update existing proprietary content and build new proprietary content as well as royalties associated with licensed content, amortization of capitalized content related software projects, and related equipment and software costs. Cost of revenue increased to $759,000 in the three months ended September 30, 2002 from $707,000 in the three months ended September 30, 2001. The current quarter includes savings for content royalties resulting from continued cost containment measures and savings for contract writers. Savings on contract writers were made possible through process improvements. These savings are partially offset by approximately $67,000 more in depreciation and amortization expense in the current quarter, primarily relating to amortization of capitalized software development costs for software placed in service in the second quarter of 2002. Cost of revenue for the three months ended September 30, 2001 included benefits of approximately $200,000 as a result of negotiated settlements with several of the Company's content vendors As a percentage of total revenue, cost of revenue increased from 40% for the three months ended September 30, 2001 to 50% for the three months ended September 30, 2002.

Research and Development. Research and development expenses consist primarily of salaries and related costs associated with the development and support of the Company's Web-based content

offerings. Research and development expenses decreased to $566,000 for the three months ended September 30, 2002 from $673,000 for the three months ended September 30, 2001, due primarily to savings in salaries and related costs for technical and development personnel and consultants made possible through operating efficiencies. During the three months ended September 30, 2001, software development costs totaling $214,000 were capitalized. These costs began being amortized into cost of revenue over the one-year estimated life of the related software in April 2002. During the three months ended September 30, 2002, approximately $29,000 of software development costs were capitalized. These costs will be amortized into cost of revenue over the one-year estimated life of the related software, once that software is complete and ready for its intended use.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions, and related costs for sales and marketing personnel, as well as the cost of advertising, marketing and promotional activities. Sales and marketing expenses decreased to $302,000 in the three months ended September 30, 2002 from $605,000 in the three months ended September 30, 2001. This decrease was primarily due to savings in salaries and related costs for marketing management personnel and promotional activities resulting from continued cost containment measures.

General and Administrative. General and administrative expense consists primarily of salaries and related costs for executive and administrative personnel, as well as legal, accounting and insurance costs. General and administrative expenses decreased to $996,000 in the three months ended September 30, 2002 from $1,187,000 in the three months ended September 30, 2001. This decrease primarily relates to savings in salaries and occupancy costs resulting from cost containment measures.

Interest and Other Income, Net. Interest and other income (net) includes interest income, interest expense, and other income. Interest income for the three months ended September 30, 2002 was $18,000 compared to $67,000 for the three months ended September 30, 2001. The decrease is the result of lower invested cash balances and lower interest rates in the current period. Interest expense for the three months ended September 30, 2002 was $3,000 compared to $15,000 for the three months ended September 30, 2001. Other income, net for the three months ended September 30, 2002 was $2,000 compared to $44,000 for the three months ended September 30, 2001.

Income Taxes. HealthGate has incurred significant losses for all periods from inception through September 30, 2002. A valuation allowance has been recorded for the entire deferred tax asset as a result of uncertainties regarding the utilization of the asset due to the Company's lack of earnings history.

Comparison of the Nine Months Ended September 30, 2002 with the Nine Months Ended September 30, 2001

Total revenue for the nine months ended September 30, 2002 decreased by $2,121,000 or 31% compared to the nine months ended September 30, 2001. Substantially all of the revenue in both periods was derived from content services. The revenue decrease is primarily related to the amendment of HealthGate's agreement with HCA-Information, ($300,000) the expiration of the Company's agreement with Blackwell Science ($1,143,000) and decreases in revenue under the Company's agreement with GEMS ($852,000).

In March 2001, HealthGate and HCA-Information amended their development agreement. The term of the amended agreement is from March 2001 to November 2002 and calls for HCA-Information to pay license fees to HealthGate of approximately $1,400,000 in both 2001 and 2002. The amendment significantly reduced the content and services available to HCA-Information, increased the maximum number of authorized users covered to 330 and eliminated HCA-Information's option to terminate the agreement on June 1, 2001. Revenue relating to this agreement was $737,000 and $1,037,000 during the nine months ended September 30, 2002 and September 30, 2001, respectively. In accordance with EITF 01-09, revenue in each period has been reduced by $538,000 related to the reclassification of amortization of marketing and distribution rights from operating expense.

The nine months ended September 30, 2002 included revenue of $737,000 (16%) from HCA-Information and included related party revenue of $116,000 (2%) from Blackwell Science. The nine months ended September 30, 2001 included revenue of $1,037,000 (15%) from HCA-Information, and related party revenue of $1,259,000 (19%) from Blackwell Science and $852,000 (13%) from GEMS. HealthGate's agreement with Blackwell Science expired in January 2002. No other customer accounted for more than 10% of the Company's revenue for the periods.

Cost of Revenue. Cost of revenue decreased to $1,973,000 in the nine months ended September 30, 2002 from $2,333,000 in the nine months ended September 30, 2001, due in part to decreased royalty expenses for licensed content resulting from the replacement of several licensed sources of content with proprietary content. The nine months ended September 30, 2002 includes savings for content royalties resulting from continued cost containment measures and savings for contract writers. Savings on contract writers were made possible through process improvements. These savings are partially offset by approximately $57,000 more in depreciation and amortization expense in the current year, primarily relating to amortization of capitalized software development costs for software placed in service in the second quarter of 2002. As a percentage of total revenue, cost of revenue increased from 34% for the nine months ended September 30, 2001 to 42% for the nine months ended September 30, 2002.

Research and Development. Research and development expenses decreased to $1,871,000 for the nine months ended September 30, 2002 from $2,364,000 for the nine months ended September 30, 2001, due primarily to savings in salaries and related costs for technical and development personnel and consultants made possible through operating efficiencies. During the nine months ended September 30, 2002, software development costs totaling $145,000 were capitalized. These costs are amortized into cost of revenue over the one-year estimated life of the related software, once that software is complete and ready for its intended use. The costs capitalized in the first six months have already been placed in service. The Company anticipates that software development costs of $28,000 capitalized in the third quarter will be placed in service in the fourth quarter of 2002.

Sales and Marketing. Sales and marketing expenses decreased to $1,200,000 in the nine months ended September 30, 2002 from $4,886,000 in the nine months ended September 30, 2001. A significant portion of this decrease was due to expenses relating to the Company's relationship with NBCi of $1,620,000 for the nine months ended September 30, 2001. No similar amounts were incurred in the nine months ended September 30, 2002 as a result of the termination of the Company's agreement with NBCi in June 2001. This decrease was also due to savings in salaries and related costs for marketing management personel and promotional activities resulting from cost containment measures throughout 2001 and the first nine months of 2002.

General and Administrative. General and administrative expenses decreased to $3,211,000 in the nine months ended September 30, 2002 from $4,436,000 in the nine months ended September 30, 2001.

This decrease primarily relates to savings in salaries and occupancy costs resulting from cost containment measures and realignment of personnel.

Interest and Other Income, Net. Interest income for the nine months ended September 30, 2002 was $72,000 compared to $379,000 for the nine months ended September 30, 2001. The decrease is the result of lower invested cash balances and lower interest rates in the current period. Interest expense for the nine months ended September 30, 2002 was $18,000 compared to $55,000 for the nine months ended September 30, 2001. Other income, net for the nine months ended September 30, 2002 was $87,000 compared to $49,000 for the nine months ended September 30, 2001.

Since inception and prior to HealthGate's January 2000 initial public offering and concurrent private sale of common stock, operations were primarily financed by the private placement of debt and equity securities. In January 2000, HealthGate completed its initial public offering of common stock and a concurrent private placement of common stock and realized net proceeds of approximately $44,472,000. A portion of the net proceeds was used to repay a $2,000,000 long-term note payable, which was secured by substantially all of the Company's tangible and intangible assets. In addition, in connection with the conversion of then outstanding preferred stock, the Company paid cash for accrued dividends on Series E preferred stock totaling $465,000.

For the nine months ended September 30, 2002, cash used in operations was $2,766,000. The Company's net loss of $3,461,000, reduced for non-cash expenses including depreciation and amortization of $2,257,000 and stock-based compensation of $9,000 was a net use of $1,195,000. Decreases in accounts receivable due to improved collection efforts resulted in an increase in operating cash of $182,000. Increases in prepaid expenses and other assets resulting from pre-payment of an insurance policy resulted in a use of $237,000 of operating cash and decreases in accounts payable, accrued expenses and other long-term liabilities resulted in a use of approximately $503,000 of operating cash. Decreases in deferred revenue resulted in a use of operating cash of $1,013,000.

For the nine months ended September 30, 2001, cash used in operating activities was $5,755,000. The Company's net loss of $6,872,000, reduced for non-cash expenses including depreciation and amortization of $2,652,000, stock-based compensation of $114,000 and a loss on sale of fixed assets of $23,000, was a net use of $4,083,000. During the first nine months of 2001, HealthGate's net accounts receivable balance decreased, creating a net increase in operating cash of $2,746,000. This decrease in net accounts receivable was primarily the result of increased collection efforts. Decreases in accounts payable and accrued expenses resulted in a use of $3,776,000 of operating cash. Payments were primarily for liabilities recorded at December 31, 2000. Decreases in deferred revenue resulted in a use of operating cash of $736,000. Net changes in all other operating assets and liabilities resulted in a net decrease in operating cash of approximately $93,000 for the nine months ended September 30, 2001.

Net cash used in investing activities for the nine months ended September 30, 2002 was $602,000, consisting of $393,000 of cash used to acquire certain assets of The Natural Pharmacist, $145,000 used for capitalized software development costs and $64,000 to purchase fixed assets. Net cash provided by investing activities for the nine months ended September 30, 2001 was $6,815,000 resulting from proceeds from the sale and maturity of marketable securities of $15,654,000, less cash used to purchase marketable securities of $8,331,000 and refunds on purchases of fixed assets of $248,000. In the nine months ended September 30, 2001, HealthGate used $113,000 to purchase fixed assets and used $642,000 for capitalized software costs.

Cash used in financing activities in the nine months ended September 30, 2002 was $136,000, which consisted of the payment of obligations under capital lease arrangements. Cash used in financing activities in the nine months ended September 30, 2001 was $151,000 which consisted primarily of the payment of obligations under capital lease arrangements.

Contractual Obligations	October 1, 2002 to December 31, 2002	2003-2004	Thereafter	Total
Operating leases	387,000	2,038,000	462,000	2,887,000
Capital lease obligations	19,000	6,000	—	25,000
Content licensing obligations	175,000	522,000	—	697,000

	581,000	2,566,000	462,000	3,609,000

At September 30, 2002, the Company has $5,025,000 of cash and marketable securities and $479,000 of working capital. The Company has incurred substantial losses and negative cash flows from operations in every fiscal year since inception. In the nine months ended September 30, 2002, the Company incurred a net loss of $3,461,000 and negative cash flows from operations of $2,766,000. Additionally, as of September 30, 2002, the Company had an accumulated deficit of $97,192,000.

The Company has taken numerous actions to substantially reduce operating cash outflows. These actions included workforce reductions, terminating the Company's agreement with NBCi, and amending or canceling several content arrangements. If the Company does not achieve its forecasted revenue levels in the future, management is prepared to implement additional cost reductions.

Based on the Company's current forecasted cash flows and its cash and cash equivalents on hand, the Company expects to have sufficient cash to finance its operations through at least the next twelve months. The Company's future beyond the next twelve months is dependent on its ability to achieve break even or positive cash flow, or raise additional financing. There can be no assurance that the Company will be able to do so.

HealthGate's business involves significant risks and uncertainties. HealthGate operates in a highly competitive and rapidly evolving Internet industry. The risks and uncertainties described below are some of those that HealthGate currently believe may affect the Company.

Failure to generate sufficient revenues, or raise additional capital will have a material adverse effect on HealthGate's long-term viability and its ability to achieve its intended business objectives. At September 30, 2002, the Company had $5,025,000 of cash and cash equivalents and $479,000 of working capital. The Company has incurred substantial losses and negative cash flows from operations in every fiscal period since inception. For the nine months ended September 30, 2002, the Company incurred a net loss of $3,461,000 and negative cash flow from operations of $2,766,000. The Company had an accumulated deficit of $97,192,000 at September 30, 2002.

HealthGate has taken numerous actions to substantially reduce operating cash outflows. These actions included workforce reductions, terminating the Company's agreement with NBCi and amending or canceling several content arrangements. Many of these cost savings were made possible through process improvements, development of additional proprietary content and focusing on content sales and services. If the Company does not achieve its forecasted revenue levels in the future, management is prepared to implement additional cost reductions.

The Company's future liquidity and capital requirements will depend upon numerous factors, including the success of existing and new content service offerings, and continued cost containment. Based on the Company's current forecasted cash flows and its cash and marketable securities on hand, the Company currently anticipates its cash resources will be sufficient to finance its operations for at least the next twelve months. The Company's future beyond the next twelve months is dependent on its ability to maintain break-even or positive cash flow, or raise additional financing. The Company may need to raise additional funds to support expansion, develop new or enhanced applications and

services, respond to competitive pressures, acquire complementary businesses or technologies, or take advantage of unanticipated opportunities. The Company may be required to raise additional funds through public or private financing, strategic relationships or other arrangements. There can be no assurance that additional funding, if needed, will be available on terms acceptable to the Company, or at all.

The success of the Company's business will depend on HealthGate's ability to sell its content products and services and develop new products and services. HealthGate's products and services include licensing content on both an individual resource basis and on a pre-packaged basis. HealthGate licenses access to portions of its content on an individual content resource basis to customers that prefer to choose specific content resources. HealthGate sells its CHOICE Web site products consisting of content and related services on a pre-packaged basis.

A key element of the Company's strategy is to continue sales and licensing into the hospital market as well as to expand sales and licensing into other healthcare markets, such as payors and pharmaceutical companies and to continue entering into agreements with print publishers. HealthGate continually evaluates its products and services and looks to develop new products and services that meet the needs of its customers. HealthGate's ability to sell its existing products and services and develop new products and services is necessary for the Company to increase its sales and licensing. If HealthGate is unable to increase sales and licensing, the Company's business prospects, results of operations and the market price of the Company's common stock could be adversely affected.

HealthGate's business prospects may suffer if the Company is not able to keep up with the rapid technological developments in the electronic healthcare content industry. The electronic healthcare content industry is characterized by rapid technological developments, evolving industry standards, changes in user and customer requirements and frequent new service and product introductions and enhancements. The introduction of new technology or the emergence of new industry standards and practices could render the Company's systems and, in turn, its products and services, obsolete and unmarketable or require the Company to make significant unanticipated investments in research and development to upgrade its systems in order to maintain the marketability of its products. To be successful, in addition to maintaining the depth and breadth of its content repository, the Company must continue to license or develop leading technology, enhance its existing products and services and respond to emerging industry standards and practices on a timely and cost-effective basis. If the Company is unable to successfully respond to these developments, particularly in light of the rapid technological changes in the electronic healthcare content industry generally and the highly competitive market in which it operates, the Company's business, results of operations and the market price of the Company's common stock could be adversely affected.

A significant portion of HealthGate's revenue has historically been derived from a few customers and the loss of any of these customers could adversely affect the Company's business unless the Company finds other significant customers. Historically, HealthGate has generated a substantial portion of its revenue from a few customers. In the nine months ended September 30, 2002, one customer, HCA-Information (an affiliate of a HealthGate warrant holder), accounted for 16% of the Company's total revenue.

In October 2002, HealthGate and HCA-Information entered into a new agreement. The term of the new agreement is from November 2002 through October 2004 and calls for HCA-Information to pay annual license fees to HealthGate of $1.1 million. The agreement covers up to 400 authorized users and can be terminated by HCA-Information at any time with 60 days prior notice. The annual license fees will be recognized ratably over the term of the agreement.

Blackwell Science (a stockholder) that has historically accounted for a significant portion of HealthGate's revenue, accounted for 2% of HealthGate's total revenue for the nine months ended

September 30, 2002. HealthGate's agreement with Blackwell Science terminated on January 31, 2002. HealthGate will not derive significant revenue from Blackwell Science in the remainder of 2002.

HealthGate's agreement with GEMS, as amended, runs through June 2003. Revenues derived under this agreement were significant prior to 2002. No revenue was recognized from GEMS in the nine months ended September 30, 2002 and no significant revenue from GEMS is expected in the remainder 2002.

An agreement with a customer that represents 8% of revenue for the nine months ended September 30, 2002 is scheduled to terminate in January 2003. HealthGate has initiated discussions concerning a new agreement with this customer to be effective January 2003. There is no assurance that the customer will agree to continue to license content from HealthGate or the amount of revenue, if any, that will be obtained from this customer after January 2003.

The loss of HCA-Information or any other significant customer or HealthGate's failure to obtain new significant customers and sources of revenues to replace the revenue previously derived from Blackwell Science and GEMS could adversely affect the Company's business.

HealthGate's quarterly operating results may fluctuate, which could affect the market price of HealthGate's common stock in a manner unrelated to the Company's long-term performance. The Company's quarterly revenue, expenses and operating results may fluctuate in the future, which could affect the market price of the common stock in a manner unrelated to the Company's long-term operating performance. Quarterly fluctuations could result from a number of factors, including:

Although HealthGate does not plan a major increase in spending related to operations, the expense levels are in part based on the Company's expectations concerning future revenue and these expense levels are predominately fixed in the short-term. If the Company has lower revenue than expected, HealthGate may not be able to reduce spending in the short-term in response. Any shortfall in revenue would have a direct impact in HealthGate's results of operations. In this event, the price of the Company's common stock may fall.

HealthGate faces intense competition in licensing its electronic healthcare information products and services and may not be able to compete effectively. The market for healthcare content products and services provided electronically is relatively new, intensely competitive and rapidly changing. With only moderate barriers to entry in a rapidly evolving industry, there are now several content providers offering users similar healthcare content, products and services, and there are many other companies that provide general healthcare content. The Company expects that competition will continue to grow. HealthGate competes, directly and indirectly, for customers, consumers, content and service providers, and acquisition candidates with other electronic healthcare content companies. Some of the Company's competitors may enjoy competitive advantages including: greater resources that can be devoted to the development, promotion and sale of their products and services, longer operating histories, greater brand recognition and larger customer bases.

The performance of HealthGate's Web sites and computer systems is critical to its business and the business will suffer if the Company experiences system failures. The performance of HealthGate's Web sites and computer systems is critical to the Company's reputation and ability to attract and retain users, customers, advertisers and subscribers. HealthGate provides products and services based on sophisticated computer and telecommunications software and systems, which often experience development delays and may contain undetected errors or failures when introduced into the Company's existing systems. HealthGate experienced a minor unscheduled service interruption of approximately

four hours in 1998 and a minor unscheduled service interruption of approximately 1 hour in 2002. In April 2001, HealthGate's activePress service experienced an unscheduled service interruption of approximately six hours. The Company cannot guarantee that it will not experience more significant service interruptions in the future. The Company is also dependent upon Web browsers and Internet service providers to provide Internet users access to its Web sites. Many of them have experienced significant outages in the past and could experience outages, delays and other difficulties in the future due to system failures. The Company also depends on certain information providers to deliver information and data feeds to it on a timely basis. HealthGate Web sites could experience disruptions or interruptions in service due to the failure or delay in the transmission or receipt of this information. System errors or failures that cause a significant interruption in the availability of the Company's content or an increase in response time on the Company's Web sites could cause it to lose potential or existing users, customers, advertisers or subscribers and could result in damage to its reputation and brand name or a decline in the Company's stock price.

In March 1999, HealthGate entered into an Internet Data Center Services Agreement with Exodus Communications, Inc. to house all of the Company's central computer facility servers at Exodus's Internet Data Center in Waltham, Massachusetts. In September 2001, Exodus filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code and in December 2001 was purchased by Cable and Wireless. HealthGate does not presently maintain fully redundant systems at separate locations, so the Company's operations depend on Exodus's ability to protect the systems in its data center against damage from fire, power loss, water damage, telecommunications failure, vandalism and similar events. Although Exodus provides comprehensive facilities management services, including human and technical monitoring of all production servers, neither Exodus nor Cable & Wireless guarantees that HealthGate's Internet access will be uninterrupted, error-free or secure.

During the third quarter, HealthGate decided to outsource the monitoring of its production Web performance in order to reduce operating costs. HealthGate began using Coradiant's "OutSight" services to find critical events and fix them before there is service interruption.

HealthGate has also developed a disaster recovery plan to respond to system failures. HealthGate cannot guarantee that its disaster recovery plan is capable of being implemented successfully. HealthGate cannot guarantee that the Company's insurance will be adequate to compensate it for all losses that may occur as a result of any system failure.

HealthGate's business prospects may suffer if it is not able to successfully retain key personnel. HealthGate has 35 employees as of September 30, 2002. HealthGate's future success depends on the Company's ability to retain, train, motivate, identify, attract, and hire highly skilled technical, managerial, editorial, sales and customer service personnel. Competition for highly skilled personnel is intense, and the Company cannot guarantee that it will be able to retain or attract skilled personnel.

HealthGate may be subject to liability for information retrieved from the Company's content repository. As a publisher and distributor of online information, HealthGate may be subject to third party claims for defamation, negligence, copyright or trademark infringement or other theories based on the nature and content of information supplied by the Company. These types of claims have been brought, sometimes successfully, against online service providers in the past. HealthGate could be subject to liability with respect to content that may be accessible through the Company's content repository or client Web sites. For example, claims could be made against HealthGate if material deemed inappropriate for viewing by children could be accessed through its Web site or if a professional, patient or consumer relies on healthcare information accessed through HealthGate to their detriment. Even if any of the kinds of claims described above do not result in liability to the Company, HealthGate could incur significant costs in investigating and defending against them and in implementing measures to reduce its exposure to this kind of liability. The Company's insurance may

not cover potential claims of this type or may not be adequate to cover all costs incurred in defense of potential claims or to indemnify HealthGate for all liability that may be imposed.

HealthGate's business depends on its ability to provide a comprehensive library of healthcare information. A significant portion of HealthGate's content is proprietary. HealthGate licenses the rest of its content from third parties. These licenses are generally non-exclusive, have an initial term of one year and are renewable. In addition, a number of these licenses permit cancellation by the content provider upon 30 to 90 days notice. HealthGate cannot guarantee that it will be able to continue to license its present content or be able to develop or license sufficient additional content to provide a diverse and comprehensive library.

HealthGate's business may be adversely affected if the Company is not able to effectively protect its intellectual property rights. HealthGate regards its trademarks, service marks, copyrights, trade secrets and similar intellectual property as important to its business, and the Company relies upon trademark and copyright law, trade secret protection and confidentiality and/or license agreements with its employees, customers, strategic partners and others to protect its rights in this property. HealthGate has registered the Company's "HealthGate," "HealthGate Data," "CHOICE," "MedGate," "ReADER," "activePress," and its HealthGate logo trademarks in the United States. On February 12, 2002, HealthGate acquired the U.S. registered trademark for "The Natural Pharmacist" along with the trademark registration for "TNP.com". Effective trademark, copyright and trade secret protection may not be available in every country in which HealthGate products and services are distributed or made available through the Internet. Therefore, HealthGate cannot guarantee that the steps it has taken to protect its proprietary rights will be adequate to prevent infringement or misappropriation by third parties or will be adequate under the laws of some foreign countries, which may not protect HealthGate's proprietary rights to the same extent, as do the laws of the United States.

Although HealthGate believes that its proprietary rights do not infringe on the intellectual property rights of others, other parties may assert infringement claims against the Company or claim that the Company has violated a patent or infringed a copyright, trademark or other proprietary rights belonging to them. These claims, even if they are without merit, could result in HealthGate spending a significant amount of time and money to dispose of them. In July 1999, HealthGate received a letter from a company (the "Holder") claiming ownership of a patent that claims exclusive rights to all electronic methods of on-demand remote retrieval of graphic and audiovisual information. The letter asserted that the use of HealthGate's Web site, www.healthgate.com, induces users to infringe the patent. In the letter, the Holder offered to license the patent perpetually and retroactively to HealthGate for a one-time fee of between $50,000 and $150,000 depending upon the number of "hits" per day on the Company's web site. There has been no recent activity on this matter and at this time, HealthGate is unable to predict its outcome.

HealthGate's business may be adversely affected if the Company is unable to continue to license software that is necessary for the development of product and service enhancements. HealthGate relies on a variety of technologies that are licensed from third parties, including the Company's database software and Internet server software, which is used in HealthGate's computer network to perform key functions. These third party licenses may not be available to HealthGate on commercially reasonable terms in the future. The loss of or inability to maintain any of these licenses could delay the introduction of software enhancements, interactive tools and other features until equivalent technology could be licensed or developed.

Government regulation of the Internet may result in increased costs of using the Internet, which could adversely affect HealthGate's business. Currently, there are a number of laws that regulate communications or commerce on the Internet. Several telecommunications carriers have petitioned the Federal Communications Commission to regulate Internet service providers and online service providers in a manner similar to long distance telephone carriers and to impose access fees on these

providers. Regulation of this type, if imposed, could substantially increase the cost of communicating on the Internet and adversely affect the Company's business, results of operations and the market price of the Company's common stock.

Tax treatment of companies engaged in Internet commerce may adversely affect the Internet industry and HealthGate. Tax authorities on the federal, state, and local levels are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. New state tax regulations may subject HealthGate to additional state sales, income and other taxes. In November 2001, the federal law that placed a temporary moratorium on certain types of taxation on Internet commerce was extended through November 2003. HealthGate cannot predict the effect of current attempts at taxing or regulating commerce over the Internet. It is also possible that the governments of other states and foreign countries also might attempt to regulate HealthGate's transmission of content. Any new legislation, regulation or application or interpretation of existing laws would likely increase HealthGate's cost of doing business and may adversely affect its results of operations and the market price of the Company's common stock.

HealthGate may be subject to liability for claims that the distribution of medical information constitutes practicing medicine over the Internet. States and other licensing and accrediting authorities prohibit the unlicensed practice of medicine. HealthGate does not believe that its publication and distribution of healthcare information online constitutes practicing medicine. However, HealthGate cannot guarantee that one or more states or other governmental bodies will not assert claims contrary to its belief. Any claims of this nature could result in HealthGate spending a significant amount of time and money to defend and dispose of them.

HealthGate is not subject to any meaningful market risks related to currency, commodity prices or similar matters. HealthGate is sensitive to short-term interest rate fluctuations to the extent that such fluctuations impact the interest income HealthGate receives from its investments. To minimize this risk, HealthGate maintains its portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, other short-term debt securities and money market funds. In general, money market funds are not subject to market-risk because the interest paid on such funds fluctuates with the prevailing interest rate. In addition, HealthGate invests in relatively short-term securities. HealthGate does not use derivative financial instruments in its investment portfolio. HealthGate limits its default risk by purchasing only investment grade securities. As of September 30, 2002, all of HealthGate's investments were in money market funds. Cash and cash equivalents were approximately $5,025,000 at September 30, 2002.

For several years HealthGate has had internal controls and disclosure procedures in place to ensure that HealthGate's periodic reports as filed with the U.S. Securities and Exchange Commission are accurate. Following enactment of the Sarbanes-Oxley Act of 2002, HealthGate has focused on further improving and clarifying (including documenting) its disclosure controls and procedures. Among the recent revisions to HealthGate's disclosure controls and procedures are written certifications from employees at the end of each quarter, the adoption of a Code of Ethics for all senior financial employees, the establishment of a Disclosure Committee and written notice to all employees of their ability to make confidential reports to HealthGate's counsel concerning HealthGate's operations.

Management of HealthGate, including HealthGate's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a-14(c)) during the 90 days prior to the filing date of this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that HealthGate's disclosure controls and procedures are effective. The Company did not conclude that any significant changes in the Company's internal controls were necessary subsequent to the date of their evaluation.

No reports on Form 8-K were filed by HealthGate during the three months ended September 30, 2002.

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.

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets at September 30, 2002 (unaudited) and December 31, 2001	3
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2001 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001 (unaudited)	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
Item 4.	Controls and Procedures	27
PART II. OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K	28
Signatures		29
Certifications		30

			September 30, 2002			December 31, 2001
			(unaudited)
Assets
Current assets:
	Cash and cash equivalents		$	5,024,745		$	8,588,708
	Accounts receivable, including receivables from related parties of $0 and $7,250 at September 30, 2002 and December 31, 2001, respectively, and net of allowance for doubtful accounts $9,050 and $20,740 at September 30, 2002 and December 31, 2001, respectively			261,595			443,622
	Prepaid expenses and other current assets			530,882			324,921

		Total current assets		5,817,222			9,357,251
Fixed assets, net				2,055,636			3,492,271
Marketing and distribution rights, net				59,788			597,736
Other assets				673,062			322,260

		Total assets	$	8,605,708		$	13,769,518

Liabilities and Stockholders' Equity
Current liabilities:
	Current portion of capital lease obligation		$	24,069		$	213,733
	Accounts payable			882,216			1,001,232
	Accrued expenses			1,890,052			1,925,798
	Deferred revenue			2,541,670			3,555,234

		Total current liabilities		5,338,007			6,695,997
Long-term portion of capital lease obligation				—			5,823
Other long-term liabilities				1,077,188			1,425,435

		Total liabilities		6,415,195			8,127,255

Stockholders' equity:
	Common stock, $.03 par value;
		Authorized: 100,000,000 shares
		Issued and outstanding: 6,014,676 shares at September 30, 2002 and December 31, 2001		180,440			180,440
	Additional paid in capital			99,202,276			99,202,276
	Accumulated deficit			(97,192,203	)		(93,730,988	)
	Deferred compensation			—			(9,465	)

		Total stockholders' equity		2,190,513			5,642,263
Commitments and contingencies (Notes 4 and 6)				—			—

		Total liabilities and stockholders' equity	$	8,605,708		$	13,769,518

			Three Months Ended September 30, 2002			Three Months Ended September 30, 2001			Nine Months Ended September 30, 2002			Nine Months Ended September 30, 2001
Revenue, including revenue from related parties of $0 and $346,215 for the three months ended September 30, 2002 and 2001, respectively and $115,583 and $2,110,435 for the nine months ended September 30, 2002 and 2001, respectively			$	1,508,363		$	1,752,461		$	4,653,634		$	6,774,408
Costs and expenses:
	Cost of revenue			759,496			707,360			1,973,057			2,333,385
	Research and development			566,193			673,278			1,870,957			2,364,182
	Sales and marketing			302,432			604,634			1,200,300			4,885,643
	General and administrative			996,233			1,186,780			3,211,105			4,436,191

		Total costs and expenses		2,624,354			3,172,052			8,255,419			14,019,401

	Loss from operations		$	(1,115,991	)	$	(1,419,591	)	$	(3,601,785	)	$	(7,244,993	)
Interest and other income, net				16,936			96,273			140,570			373,249

	Net loss		$	(1,099,055	)	$	(1,323,318	)	$	(3,461,215	)	$	(6,871,744	)

Basic and diluted net loss per share			$	(0.18	)	$	(0.22	)	$	(0.58	)	$	(1.14	)
Shares used in computing basic and diluted net loss per share				6,014,676			6,013,540			6,014,676			6,002,618

			Nine Months Ended September 30, 2002			Nine Months Ended September 30, 2001
Cash flows from operating activities:
	Net loss		$	(3,461,215	)	$	(6,871,744	)
		Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization		2,257,358			2,652,400
		Stock based compensation		9,465			113,816
		Loss on sales of fixed assets		—			22,958
	Changes in assets and liabilities:
		Accounts receivable		182,027			2,746,393
		Prepaid expenses and other current assets		(205,961	)		211,694
		Other assets		(31,333	)		(118,760	)
		Accounts payable		(119,016	)		(2,016,767	)
		Accrued expenses		(35,746	)		(1,759,073	)
		Deferred revenue		(1,013,564	)		(736,332	)
		Other long-term liabilities		(348,247	)		—

Net cash used in operating activities				(2,766,232	)		(5,755,415	)

Cash flows from investing activities:
	Proceeds from sales and maturities of marketable securities			—			15,653,643
	Purchases of marketable securities			—			(8,331,492	)
	Purchases of fixed assets			(64,221	)		(113,058	)
	Acquisition of assets of TNP			(393,200	)		—
	Expenditures for capitalized software			(144,823	)		(641,880	)
	Refund on purchase of fixed assets			—			247,735

Net cash provided by (used in) investing activities				(602,244	)		6,814,948

Cash flows from financing activities:
	Payment of capital lease obligation			(195,487	)		(217,648	)
	Proceeds from issuance of common stock			—			6,351

Net cash used in financing activities				(195,487	)		(211,297	)

Net increase (decrease) in cash and cash equivalents				(3,563,963	)		848,236
Cash and cash equivalents, beginning of period				8,588,708			4,594,167

Cash and cash equivalents, end of period			$	5,024,745		$	5,442,403

Supplemental disclosure of cash flow information:
	Cash paid for interest		$	18,000		$	55,000

	HEALTHGATE DATA CORP.
Dated: November 7, 2002	By:	/s/ WILLIAM S. REECE William S. Reece Chairman of the Board of Directors and Chief Executive Officer
Dated: November 7, 2002	By:	/s/ VERONICA ZSOLCSAK Veronica Zsolcsak Chief Financial Officer