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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2002

OR

Commission file number 0-28701

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

Registrant's telephone number, including area code: (781) 685-4000

        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

        The number of shares outstanding of the registrant's common stock as of July 22, 2002 was 6,014,676.

HealthGate Data Corp.
FORM 10-Q
For the Quarter Ended June 30, 2002

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HEALTHGATE DATA CORP.

CONDENSED CONSOLIDATED BALANCE SHEET

The accompanying notes are an integral part of these financial statements.

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HEALTHGATE DATA CORP.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(unaudited)

The accompanying notes are an integral part of these financial statements.

4

HEALTHGATE DATA CORP.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

Increase (Decrease) in Cash and Cash Equivalents

(unaudited)

The accompanying notes are an integral part of these financial statements.

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HEALTHGATE DATA CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation and Financial Condition

        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 including information that is tagged using the most popular medical coding vocabularies. The Company anticipates marketing this content to healthcare institutions and related healthcare organizations for use in a variety of clinical systems. In 2002, 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 second quarter, HealthGate began development of HealthGate OnSite which will enable 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 June 30, 2002, the Company had $5,570,000 of cash and cash equivalents, and $871,000 of working capital. The Company has incurred substantial losses and negative cash flows from operations in every fiscal year since inception. For the six months ended June 30, 2002, the Company incurred a net loss of $2,362,000 and negative cash flows from operations of $2,374,000. Additionally as of June 30, 2002, the Company had an accumulated deficit of $96,093,000.

        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. 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

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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.

2. Net Loss Per Share

        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 exercise of stock options and warrants are anti-dilutive for all periods presented. As of June 30, 2002, options to purchase 249,816 shares of the Company's stock and warrants to purchase 1,110,279 shares of the Company's common stock were outstanding.

3. 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 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 a expense.

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        Revenue from licensing electronic content to print publishers for print distribution, including minimum royalties, is recognized upon delivery of the content as long 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.

4. Lease Exit Costs

        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 six months ended June 30, 2002 relating to this accrual are as follows:

        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.

5. Acquisition

        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

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$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 six months ended June 30, 2001 and 2002 would not have been significant.

6. Other Commitments and Contingencies

        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 June 30, 2002 totaled approximately $564,000.

        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 June 30, 2002 that, if adversely decided, would have a material adverse effect on its results of operations, financial condition or liquidity.

7. Related Party Transactions

        Through the Company's activePress service, HealthGate was the developer on the Web of a collection of approximately 320 full text journals for Blackwell Science. The Company's agreement with Blackwell Science, as amended, expired in January 2002. HealthGate's results of operations for the six months ended June 30, 2002 and 2001 include $116,000 and $926,000 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 principal 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 six months ended June 30, 2002 include no revenue from GEMS. HealthGate's results of operations for the three and six months ended June 30, 2001 include $397,000 and $839,000, respectively of revenue from GEMS.

        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

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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. General Electric Company is a principal stockholder of HealthGate.

8. Research and Development and Software 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 costs incurred during the application development stage of software developed for internal use. During the three and six months ended June 30, 2002 development costs totaling $51,000 and $116,000, 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.

        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.

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

Forward-Looking Statements

        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.

Overview

        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.

        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, consisting of $350,000 in cash and approximately $43,000 in direct transactional costs, to acquire the assets of TNP, consisting 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.

        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 in line with its revenue growth. 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 June 30, 2002, the Company had $5,570,000 of cash and cash equivalents and $871,000 of working capital. The Company has incurred substantial losses and negative cash flows from operations in every fiscal year since inception. In the six months ended June 30, 2002, the Company incurred a net loss of $2,362,000 and negative cash flows from operations of $2,374,000. Additionally, as of June 30, 2002, the Company had an accumulated deficit of $96,093,000.

        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. 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.

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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.

Critical Accounting Policies and Significant Judgments and Estimates

        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 disclosed 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. HealthGate's activePress agreement with Blackwell Science terminated in January 2002. HealthGate no longer provides activePress services.

        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 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

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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:

(a)

HealthGate receives an identifiable benefit in exchange for the consideration and the identifiable benefit is sufficiently separable from the customer's purchase of HealthGate's products that HealthGate could have purchased the products or services from a third party.



(b)

HealthGate can reasonably estimate the fair value of the benefit received.

        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 June 30, 2002 and 2001 and reclassified amortization of $359,000 relating to this warrant for each of the six months ended June 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 that will be made available on the customized HCA-Information CHOICE Web sites, increased the maximum number of hospitals 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 June 30, 2002, the Company had delivered 287 customized co-branded CHOICE Web sites to HCA hospitals.

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

        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

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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 six months ended June 30, 2002, $116,000 of software development costs were capitalized. During the three months ended March 31, 2002 $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 $50,000 of software development costs related to a new development project. HealthGate expects to capitalize additional software development costs during the remainder of 2002. HealthGate has made a significant judgment 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

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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 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 June 30, 2002 and 2001 and reclassified amortization of $359,000 relating to this warrant from expense to a reduction in revenue for each of the six months ended June 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:

•

A significant change in the manner in which an asset is used;



•

A significant decrease in the market value of an asset;



•

A significant adverse change in the Company's business or its industry; or



•

A current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the asset.

        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

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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.

Non-Cash Expenses

        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 $77,000 was amortized during the six months ended June 30, 2002 and 2001, respectively. There are no remaining amounts of deferred compensation as of June 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

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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.

Results of Operations

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

Revenue

        Total revenue for the three months ended June 30, 2002 decreased by $750,000 or 33% compared to the three months ended June 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 and decreases in revenue under the Company's agreement with GEMS.

        In March 2001, HealthGate and HCA-Information amended their Co-Branded CHOICE Web Site 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 available on the customized HCA-Information CHOICE Web sites, increased the maximum number of hospitals 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 June 30, 2002 and June 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 June 30, 2002, included revenue of $246,000 (16%) from one customer. The three months ended June 30, 2001 included revenue of $246,000 (11%) from one customer, and related party revenue of $325,000 (14%) from Blackwell Science and $397,000 (18%) from GEMS. HealthGate's agreement with Blackwell Science expired in January 2002.

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Costs and Expenses

        Cost of Revenue.    Cost of revenue consists primarily of editorial costs to refresh 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 decreased to $741,000 in the three months ended June 30, 2002 from $838,000 in the three months ended June 30, 2001, due primarily to decreased royalty expenses for licensed content resulting from the replacement of several licensed sources of content with proprietary content and savings for technical and development services resulting from cost containment measures taken throughout 2001 and the first six months of 2002. These decreases were partially offset by increased amortization relating to 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 37% for the three months ended June 30, 2001 to 49% for the three months ended June 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 enhancement initiatives. Research and development expenses decreased to $605,000 for the three months ended June 30, 2002 from $775,000 for the three months ended June 30, 2001, due primarily to savings in salaries and related costs for technical and development personnel and consultants resulting from cost containment measures taken throughout 2001 and the first six months of 2002. During the three months ended June 30, 2001, software development costs totaling $428,000 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 June 30, 2002, approximately $50,000 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 $388,000 in the three months ended June 30, 2002 from $2,459,000 in the three months ended June 30, 2001. A significant portion of this decrease was due to expenses relating to the Company's relationship with NBCi of $1,290,000 for the three months ended June 30, 2001. No similar amounts were incurred in the three months ended June 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 and promotional activities resulting from cost containment measures taken in the fourth quarter of 2000 and throughout 2001.

        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 $1,098,000 in the three months ended June 30, 2002 from $1,607,000 in the three months ended June 30, 2001. This decrease primarily relates to savings in salaries and related 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 June 30, 2002 was $24,000 compared to $121,000 for the three months ended June 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 June 30, 2002 was $6,000 compared to $18,000 for the three months ended June 30, 2001. Other income, net for the three months ended June 30, 2002 was $65,000 compared to $5,000 for the three months ended June 30, 2001.

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        Income Taxes.    HealthGate has incurred significant losses for all periods from inception through June 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 Six Months Ended June 30, 2002 with the Six Months Ended June 30, 2001

Revenue

        Total revenue for the six months ended June 30, 2002 decreased by $1,877,000 or 37% compared to the six months ended June 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, the expiration of the Company's agreement with Blackwell Science and decreases in revenue under the Company's agreement with GEMS.

        In March 2001, HealthGate and HCA-Information amended their Co-Branded CHOICE Web Site 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 available on the customized HCA-Information CHOICE Web sites, increased the maximum number of hospitals covered to 330 and eliminated HCA-Information's option to terminate the Agreement on June 1, 2001. Revenue relating to this agreement was $491,000 and $791,000 during the six months ended June 30, 2