HEALTHGATE DATA CORP - 10-Q Quarterly Report

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

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 August 1, 2003 was 4,261,606.

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 an electronic publisher of healthcare information. HealthGate offers customers a comprehensive content repository of healthcare information on a wide range of medical conditions, drug interactions, complementary and alternative health remedies, medical procedures and current information on emerging health issues and medical developments. The Company currently licenses access to this content on an individual resource basis which allows HealthGate's customers to select only those content resources and databases that are desired for that customer's purpose or constituents. HealthGate continues to generate revenue from customers who license HealthGate's content on a pre-packaged basis, such as the Company's CHOICE Web site products, which offer customers a generalized selection of HealthGate's more popular content resources. The Company's XML-based content can be delivered electronically to its customers or built into clinical software systems. During 2002, HealthGate released HealthGate OnSite^TM which enables customers to download HealthGate's content files and host them on their own servers. In March 2003, HealthGate released The HealthGateWay^TM, a web-based newsletter service that allows customers to publish a customized electronic newsletter integrating the content they license from HealthGate with the customer's own news items and announcements.

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, 2003, the Company had $3,333,000 of cash and cash equivalents, and negative working capital of $118,000. The Company has incurred net losses in every fiscal year since inception. For the six months ended June 30, 2003, the Company incurred a net loss of $754,000, and negative cash flows from operations of $958,000. Additionally, as of June 30, 2003, the Company had an accumulated deficit of $98,920,000.

The Company continues to take numerous actions to substantially reduce operating cash outflows. These actions included settling amounts owed under development and distribution agreements, workforce reductions, 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 some of the risks and uncertainties common to electronic healthcare publishing companies, including rapid technological developments, ability to sell content products and services and develop new content products and services and intense competition.

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, 2002. 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 June 30, 2003, options to purchase 1,182,709 shares of the Company's common stock were outstanding. No warrants to purchase shares of the Company's common stock were outstanding.

HealthGate primarily derives revenue from licensing access to its content repository. HealthGate also enters into publishing agreements with print publishers.

HealthGate records revenue in accordance with Staff Accounting Bulletin No. 101 ("SAB 101"). Revenue from fixed fee services arrangements is recognized ratably over the term of the underlying agreement between HealthGate, the customer, and if applicable, HealthGate's authorized reseller, which generally ranges from one to three years. Revenue from usage fees is recognized when the service has been provided and the usage reporting has been received by HealthGate. 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 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 collectibility is deemed probable. Accounts are evaluated for collectibility based on HealthGate's past collections experience, the customer's payment history and evaluation of the customer's financial condition. If collection is not deemed probable, revenue recognition does not begin until cash is received.

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.

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.

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 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 approximately $1,729,000 of expenses relating to HealthGate's continued liability under its lease and approximately $151,000 for the impairment of leasehold improvements on the space the Company vacated.

During the quarter ended June 30, 2003, the Company's tenant defaulted on the sublease. As a result, the Company reevaluated the assumptions underlying the accrual and recorded additional lease exit costs of approximately $106,000 in the current period. The activity for the six months ended June 30, 2003 relating to the accrual is as follows:

Liability at December 31, 2002	$	1,250,939
Payments		(149,841	)
Payments received from tenant		76,703

Liability at March 31, 2003		1,177,801
Payments		(149,525	)
Payments received from tenant		65,135
Additional lease exit costs accrued		105,861

Liability at June 30, 2003		1,199,272
Less: current portion (included in accrued expenses)		(599,636	)

Other long-term liabilities	$	599,636

The charges and accruals 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 six months ended June 30, 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 June 30, 2003 totaled approximately $627,000.

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, 2003 that, if adversely decided, would have a material adverse effect on its results of operations, financial condition or liquidity.

HealthGate indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was serving, at the Company's request in such capacity. The maximum potential amount of future payments that the Company could be required to make under these indemnification agreements is unlimited; however, HealthGate has a Director and Officer insurance policy that limits its exposure and enables the Company to recover a portion of any future amounts paid. As a result of the insurance policy coverage, HealthGate believes the estimated fair value of these indemnification agreements is minimal.

HealthGate warrants that the content that the Company licenses to its customers shall operate in accordance with the written specifications and documentation provided by HealthGate. If the licensed content failed to operate as specified, a customer would be entitled to refund of a pro rata portion of the license fees paid to HealthGate. Since HealthGate recognizes such fees on a pro rata basis it is unlikely that the Company would experience significant claims under its product or services warranties in excess of amounts recorded as deferred revenue. As a result, the Company believes the estimated fair value of these warranties is minimal.

HealthGate enters into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to HealthGate's products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The amount of future payments required under these indemnification agreements is generally limited to the amount of fees paid by the customer pursuant to the agreement. HealthGate has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these warranties is minimal.

In June 1999, HealthGate entered into a development and distribution agreement with GE Medical Systems ("GEMS"). The agreement, as amended, was terminated in June 2003. Under the terms of this agreement, GEMS could have sold 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 February 2003, HealthGate entered into a settlement agreement that established commissions due under this development and distribution agreement relating to fiscal years 1999 through 2002. The settlement amount was approximately $818,000 less than HealthGate had previously accrued. This amount is included in other income in the six months ended June 30, 2003. HealthGate's results of operations for the three and six months ended June 30, 2002 and 2003 include no revenue from GEMS. In connection with this agreement, in June 1999, 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.

In May 2003, HealthGate acquired 1,153,667 of its shares of common stock from GE Capital Equity Investments, Inc. and National Broadcasting Company, Inc. (NBC). General Electric Company and NBC also agreed to cancel without exercise warrants for the purchase of up to 463,266 shares of HealthGate common stock. As consideration for these shares and cancellation of the warrants, HealthGate transferred to NBC all HealthGate's rights to its general unsecured claim against Medical SelfCare, Inc. ("SelfCare"). In December 2000 SelfCare had made an assignment for the benefit of creditors. HealthGate had previously determined that a material recovery of its claim in the SelfCare liquidation was remote. At the time of the settlement, NBC was involved in litigation with SelfCare. In the quarter ended June 30, 2003, HealthGate's recorded a gain of approximately $92,000 in connection with this transaction. The gain was determined based on the fair value of HealthGate's stock based on the closing price on the Over-the-Counter Bulletin Board ("OTC-BB") on the date of the transaction. These shares of stock were retired.

In May 2003, HealthGate purchased 599,403 shares of its common stock from Computer Sciences Corporation ("CSC"). As consideration for these shares, the Company paid CSC $47,952.24 or $0.08 per share, the fair market value of the stock based on the closing price of HealthGate's stock on the OTC-BB on the date of the transaction. These shares of stock were retired.

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 six months ended June 30, 2002 include $116,000 of revenue relating to this agreement. HealthGate's results of operations for the three months ended June 30, 2002 and the three and six months ended June 30, 2003 include no revenue relating to this agreement. Blackwell Science is a stockholder of HealthGate.

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 months ended June 30, 2003 and 2002, development costs of approximately $36,000 and

$51,000, respectively, were capitalized. During the six months ended June 30, 2003 and 2002, development costs of approximately $65,000 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.

HealthGate accounts for stock-based awards to employees using the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB 25") and related interpretations. HealthGate has adopted the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123") and Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation," ("SFAS 148") for disclosure purposes only. All stock-based awards to non-employees are accounted for at their fair value in accordance with SFAS 123 and related interpretations.

The following table illustrates the effect on net loss and net loss per share if HealthGate had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation:

		For the three months ended		For the six months ended
		June 30, 2003		June 30, 2002		June 30, 2003		June 30, 2002
	Net loss as reported		$	(550,369	)	$	(1,246,364	)	$	(754,164	)	$	(2,362,158	)
	Add: stock-based compensation expense recognized			—			9,465			—			9,465
	Less: SFAS 123 Pro forma stock compensation			(13,822	)		(22,228	)		(33,700	)		28,942

	Pro forma net loss			(564,191	)		(1,259,127	)		(787,864	)		(2,323,751	)
Basic and diluted net loss per share attributable to common stockholders
	As reported		$	(0.11	)	$	(0.21	)	$	(0.14	)	$	(0.39	)
	Pro forma			(0.11	)		(0.21	)		(0.14	)		(0.39	)

In December 1999, HealthGate entered into an e-commerce/sponsorship agreement with Medical Self Care, Inc. ("SelfCare"), a privately held provider of health related products and services. Under the agreement, HealthGate developed a co-branded HealthGate/SelfCare Web site, and agreed to provide promotions for this co-branded site over the 37-month term of the agreement. The agreement provided for SelfCare to make annual cash payments to HealthGate of approximately $1,000,000 in the first year, $7,100,000 in the second year and $8,400,000 in the third year. In addition, for the first year services under the agreement, SelfCare issued 996,348 shares of its Series H preferred stock to HealthGate on February 2, 2000.

In August 2000, HealthGate filed suit against SelfCare in US District Court in Boston, Massachusetts, seeking damages due to SelfCare's breaches of the agreement based on SelfCare's failure to pay fees due under the agreement, and the filing of an action by SelfCare against HealthGate in California state court seeking a declaratory judgment that SelfCare is entitled to rescind the

agreement and that HealthGate is not entitled to terminate the agreement and is not entitled to post-contract remedies. The lawsuit filed by SelfCare in California was later dismissed.

On December 1, 2000, the rights and obligations of SelfCare were assumed by Development Specialists, Inc. ("DSI"). HealthGate reached agreement with DSI in February 2001 to settle HealthGate's litigation against SelfCare for a claim in the liquidation and a release of all of SelfCare's claims against HealthGate. The Company was uncertain what amount, if any, it would ultimately realize on this settlement.

HealthGate continued to monitor the liquidation of SelfCare throughout 2001. Based on the information provided to HealthGate by DSI during the fourth quarter of 2001, such as the value of assets currently available for distribution, the likelihood and timing of additional recoveries, and the amount of total claims against the SelfCare estate, HealthGate determined that the likelihood of a material recovery of its claim in the SelfCare liquidation was remote. HealthGate's balance sheets at December 31, 2002 and June 30, 2003 do not include any amounts relating to the Company's relationship with SelfCare.

In May 2003, HealthGate transferred to National Broadcasting Company, Inc. (NBC) all HealthGate's rights to its general unsecured claim against SelfCare in exchange for 1,153,667 shares of HealthGate's common stock, and the cancellation of warrants to purchase 463,266 shares of HealthGate's common stock. At the time of the settlement, NBC was involved in litigation with SelfCare. In the quarter ended June 30, 2003, HealthGate's recorded a gain of approximately $92,000 in connection with this transaction. The gain was determined based on the fair value of HealthGate's stock based on the closing price on the Over-the-Counter Bulletin Board ("OTC-BB") on the date of the transaction. These shares of stock were retired.

In November 2002, the Emerging Issues Task Force issued Issue No. 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables" ("EITF 00-21"). EITF 00-21 addresses how to determine whether a revenue arrangement involving multiple deliverables contains more than one unit of accounting for the purposes of revenue recognition and how the revenue arrangement consideration should be measured and allocated to the separate units of accounting. EITF 00-21 applies to all revenue arrangements that the Company enters into after June 30, 2003. HealthGate does not expect the adoption of EITF 00-21 to have a material impact on the Company's financial condition or results of operations.

In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity ("SFAS 150"). This statement establishes standards for classifying certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003. The adoption of SFAS 150 is not expected to have a material impact on the Company's financial condition or results of operations.

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 under the caption "Risk Factors" 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'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. 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, 2003, the Company had $3,333,000 of cash and cash equivalents and negative working capital of $118,000. 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, 2003, the Company incurred a net loss of $754,000 and negative cash flows from operations of $958,000. Additionally, as of June 30, 2003, the Company had an accumulated deficit of $98,920,000.

The Company continues to take actions to reduce operating cash outflows. These actions included settling commissions owed under a development and distribution agreement, workforce reductions, and amending or canceling several content arrangements. 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 maintain 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'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.

The following critical accounting policies and significant judgments and estimates were used in the preparation of HealthGate's condensed consolidated financial statements.

Revenue Recognition. HealthGate primarily derives revenue from licensing access to its content repository. HealthGate also enters into publishing agreements with print publishers.

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., an affiliate of HCA, Inc., formerly known as Columbia/HCA Healthcare Corporation, in November 1999 from expense to a reduction in revenue for each of the three and six months ended June 30, 2002. Amortization of the marketing and distribution rights was completed in October 2002. 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 have been 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 provided under the agreement. 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 was from March 2001 to November 2002 and called 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 were made available to HCA-Information and increased the maximum number of authorized users covered to 330. The annual license fees from this agreement were recognized ratably over the term of the amended agreement.

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 $1,100,000. 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 are being recognized ratably over the term of the agreement. As of June 30, 2003, the Company was providing access to its content to 256 authorized users under this agreement.

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, HealthGate determines the value of the arrangement based on the fair value of the equity received or services provided, whichever is more readily determinable.

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 three months ended June 30, 2003 and 2002, development costs of approximately $36,000 and $51,000, respectively, were capitalized. During the six months ended June 30, 2002, development costs of $116,000 were capitalized. The underlying software was placed in service during 2002 and these costs are being amortized into cost of revenue over the estimated life of the related software. During the six months ended June 30, 2003, development costs totaling $65,000 were capitalized. These costs are being

amortized into cost of revenue over the estimated life of the related software. 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.

Marketing and Distribution Rights. 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 provided 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 could, 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 had 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 was amortized on a straight-line basis over the three-year contractual term of the related agreement, which expired in October 2002.

When issued, HealthGate concluded that it was appropriate to record the value of the warrant as an asset and amortize the asset over the contractual term of the related agreement rather than record a one-time charge, 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 valuation of the warrant required certain significant judgments and estimates, including the term, volatility and interest rate 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.

Lease Exit Costs. HealthGate leases approximately 32,000 square feet of office space under a lease that expires in June 2005. HealthGate's annual cost for this space is 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, and began negotiating a sublease for a portion of this excess space that was finalized in February 2002. The sublease was initially for approximately 10,800 square feet, and increased to approximately 14,000 square feet after the first year. The sublease was for the remaining term of HealthGate's lease with its landlord.

For purposes of calculating exit costs, HealthGate included the difference between the rate the Company is currently obligated to pay and the rate that the subtenant has agreed to pay for the space it is renting. The Company also included an impairment of leasehold improvements on the space being vacated, taxes and utilities related to the subleased space. HealthGate also estimated the amount of sublease payments that will ultimately be collected. Additionally, HealthGate assumed that it would not be able to locate a subtenant for its remaining unused space and included the rent expense for that space for the remainder of the lease. HealthGate's charge also included the estimated cost of building out the space for its subtenant and legal and professional costs of completing the sublease.

HealthGate's calculations include significant estimates, including HealthGate's inability to rent the remaining excess space, the amount of charges that will actually be incurred and the rate that HealthGate would be charged for taxes and utilities by its landlord over the remaining term of its lease. If HealthGate had made different assumptions, it could have resulted in different charges being recorded in 2001 and in the second quarter of 2003. Also, these estimates and assumptions will continue to require monitoring on a quarterly basis for changes in circumstances. As a result, assumptions may require adjustment, which could affect the amount accrued and generate a future charge or credit to this line item in future periods, and the amount could be material.

Comparison of the Three Months Ended June 30, 2003 with the Three Months Ended June 30, 2002

Total revenue for the three months ended June 30, 2003 increased by $35,000 or 2% compared to the three months ended June 30, 2002. Substantially all of the revenue in both periods was derived from content services. This increase occurred because revenues from new customers and renewals offset the loss of revenues from the expiration of a contract that represented 8% of revenue for the second quarter ended June 30, 2002.

In March 2001, HealthGate and HCA-Information amended their development agreement. The term of the amended agreement was from March 2001 to November 2002 and called 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 available to HCA-Information, increased the maximum number of authorized users covered to 330. In accordance with EITF 01-09, revenue for the three months ended June 30, 2002 was reduced by $179,000 related to the reclassification of amortization of marketing and distribution rights from operating expense. Amortization of the marketing and distribution rights was completed in October 2002.

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 $1,100,000. 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 are being recognized ratably over the term of the agreement. Revenue from HCA-Information was $275,000 and $246,000 during the three months ended June 30, 2003 and 2002, respectively.

The three months ended June 30, 2003 included revenue of $275,000 (18%) from HCA-Information and $212,000 (14%) from Integic/MHS. The three months ended June 30, 2002 included revenue of $246,000 (16%) from HCA-Information. 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 decreased to $606,000 in the three months ended June 30, 2003 from $741,000 in the three months ended June 30, 2002. The current quarter includes approximately $182,000 less in depreciation and amortization expense, primarily relating to amortization of capitalized software development costs for software which was completed in the first quarter of 2003, and approximately $92,000 less in costs for contract writers, offset by approximately $145,000 more in royalties for additional licensed content purchased by customers. As a percentage of total revenue, cost

of revenue decreased from 49% for the three months ended June 30, 2002 to 39% for the three months ended June 30, 2003. The Company does not expect cost of revenue as a percentage of total revenue to increase materially for the remainder of 2003.

Research and Development. Research and development expenses consist primarily of salaries and related costs associated with the development and support of the Company's content offerings. Research and development expenses decreased to $469,000 for the three months ended June 30, 2003 from $605,000 for the three months ended June 30, 2002, due primarily to savings in salaries and related costs for technical and development personnel made possible through operating efficiencies. During the three months ended June 30, 2003, approximately $36,000 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. During the three months ended June 30, 2002, software development costs totaling $51,000 were capitalized. These costs began being amortized into cost of revenue over the one-year estimated life of the related software in the fourth quarter of 2002.

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. Sales and marketing expenses decreased to $278,000 in the three months ended June 30, 2003 from $388,000 in the three months ended June 30, 2002. This decrease was primarily due to lower commission accruals related to a settlement agreement executed in February 2003.

General and Administrative. General and administrative expenses consist 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 $739,000 in the three months ended June 30, 2003 from $1,098,000 in the three months ended June 30, 2002. This decrease primarily relates to savings in salaries, hosting services, investor relations, and occupancy costs resulting from cost containment measures.

Lease Exit Costs. During the quarter ended June 30, 2003, HealthGate was informed by its tenant that it would not be fulfilling its obligations under the sublease agreement. As a result, HealthGate reevaluated its assumptions relative to the lease exit accrual and determined that an additional liability was needed. HealthGate's results of operations for the three months ended June 30, 2003 include a charge of $106,000 as a result of this evaluation.

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, 2003 was $9,000 compared to $24,000 for the three months ended June 30, 2002. 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. There was no interest expense for the three months ended June 30, 2003. Other income, net for the three months ended June 30, 2003 was $100,000 compared to $65,000 for the three months ended June 30, 2002. In May 2003, HealthGate transferred to National Broadcasting Company, Inc. ("NBC") all HealthGate's rights to its general unsecured claim against Medical SelfCare, Inc. in exchange for 1,153,667 shares of HealthGate's common stock, and the cancellation of warrants to purchase 463,266 shares of HealthGate's common stock. HealthGate recorded a gain of approximately $92,000 on this on this transaction which is included in other income for the three months ended June 30, 2003.

Income Taxes. HealthGate has incurred significant losses for all periods from inception through June 30, 2003. 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, 2003 with the Six Months Ended June 30, 2002

Total revenue for the six months ended June 30, 2003 decreased by $219,000 or 7% compared to the six months ended June 30, 2002. Substantially all of the revenue in both periods was derived from content services. New revenues from new customers and renewals were less than the revenues lost due to the expiration of HealthGate's agreement with Blackwell Science in January 2002 and the termination of an agreement in January 2003 with a customer that represented 8% of revenue for the six months ended June 30, 2002.

The six months ended June 30, 2003 included revenue of $550,000 (18%) from HCA-Information. The six months ended June 30, 2002 included revenue of $491,000 (16%) from HCA-Information, and related party revenue of $116,000 (4%) from Blackwell Science. 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 increased to $1,440,000 in the six months ended June 30, 2003 from $1,214,000 in the six months ended June 30, 2002. The six months ended June 30, 2003 includes approximately $71,000 in additional depreciation and amortization expense, primarily relating to amortization of capitalized software development costs for software placed in service in the second quarter of 2002, and approximately $252,000 more in royalties paid to third parties for additional licensed content requested by customers, offset by lower costs for contract writers in the current year. As a percentage of total revenue, cost of revenue increased from 39% for the six months ended June 30, 2002 to 49% for the six months ended June 30, 2003.

Research and Development. Research and development expenses decreased to $978,000 for the six months ended June 30, 2003 from $1,305,000 for the six months ended June 30, 2002, due primarily to savings in salaries and related costs for technical and development personnel made possible through operating efficiencies. During the six months ended June 30, 2003, approximately $65,000 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. During the six months ended June 30, 2002, software development costs totaling $116,000 were capitalized. These costs began being amortized into cost of revenue over the one-year estimated life of the related software beginning in the fourth quarter of 2002.

Sales and Marketing. Sales and marketing expenses decreased to $511,000 in the six months ended June 30, 2003 from $898,000 in the six months ended June 30, 2002. This decrease was primarily due to savings in salaries and related costs for sales personnel and promotional activities resulting from continued cost containment measures, and lower commission accruals related to a settlement agreement executed in February 2003.

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 $1,618,000 in the three months ended June 30, 2003 from $2,215,000 in the six months ended June 30, 2002. This decrease primarily relates to savings in salaries, hosting, investor relations, and occupancy costs resulting from cost containment measures.

Lease Exit Costs. During the quarter ended June 30, 2003, HealthGate was informed by its tenant that it would not be fulfilling its obligations under the sublease agreement. As a result, HealthGate reevaluated its assumptions relative to the lease exit accrual and determined that an additional liability was needed. HealthGate's results of operations for the six months ended June 30, 2003 include a charge of $106,000 as a result of this evaluation.

Interest and Other Income, Net. Interest and other income (net) includes interest income, interest expense, and other income. Interest income for the six months ended June 30, 2003 was $22,000 compared to $54,000 for the six months ended June 30, 2002. The decrease is the result of lower invested cash balances and lower interest rates in the current period. Interest expense for the six months ended June 30, 2003 was $1,000 compared to $15,000 for the six months ended June 30, 2002. Other income, net for the six months ended June 30, 2003 was $952,000 compared to $86,000 for the six months ended June 30, 2002. In February 2003, HealthGate entered into a settlement agreement that established commissions due under a development and distribution agreement related to fiscal years 1999 through 2002. The settlement amount was approximately $818,000 less than HealthGate had previously accrued. In May 2003, HealthGate transferred to NBC all HealthGate's rights to its general unsecured claim against Medical SelfCare, Inc. in exchange for 1,153,667 shares of HealthGate's common stock, and the cancellation of warrants to purchase 463,266 shares of HealthGate's common stock. HealthGate recorded a gain of approximately $92,000 on this transaction which is included in other income for the six months ended June 30, 2003.

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 six months ended June 30, 2003, cash used in operating activities was $958,000. The Company's net loss of $754,000, reduced for non-cash expenses including depreciation and amortization of $980,000 and a gain on reacquisition of stock of $92,000, was a net source of operating cash of $134,000. Decreases in accounts payable, accrued expenses and other long-term liabilities primarily related to the settlement of commissions owed under a development and distribution agreement resulted in a use of approximately $1,190,000 of operating cash. Net changes in other operating assets and liabilities resulted in a net decrease in operating cash of $98,000.

For the six months ended June 30, 2002, cash used in operations was $2,374,000. The Company's net loss of $2,362,000, reduced for non-cash expenses including depreciation and amortization of $1,415,000 and stock-based compensation of $9,000, was a net use of $938,000. Decrease in accounts receivable due to improved collection efforts resulted in an increase in operating cash of $260,000. Increases in prepaid expenses and other assets resulting from pre-payment of an insurance policy resulted in a use of $280,000 of operating cash, and decreases in accounts payable, accrued expenses and other long-term liabilities resulted in a use of $604,000 of operating cash. Decreases in deferred revenue resulted in a use of operating cash of $812,000.

Net cash used in investing activities for the six months ended June 30, 2003 was $104,000. The Company used $65,000 for capitalized software development costs and used $39,000 to purchase fixed assets. Net cash used in investing activities for the six months ended June 30, 2002 was $509,000,

consisting of $393,000 of cash used to acquire certain assets of The Natural Pharmacist, and $116,000 for capitalized software development costs.

Cash used in financing activities in the six months ended June 30, 2003 was $54,000, which consisted of $6,000 for the payment of obligations under capital lease arrangements and $48,000 used to repurchase shares of the Company's common stock. Cash used in financing activities in the six months ended June 30, 2002 was $136,000, which consisted of the payment of obligations under capital lease arrangements.

Contractual Obligations		Jul-Dec 2003		1-3 years		More than 3 years		Total
Operating leases		$	561,000		$	1,384,000		$	—		$	1,945,000
Content licensing obligations		$	257,000		$	370,000		$	—		$	925,000

At June 30, 2003, the Company has $3,333,000 of cash and cash equivalents and negative working capital of $118,000. 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, 2003, the Company incurred a net loss of $754,000 and negative cash flows from operations of $958,000. Additionally, as of June 30, 2003, the Company had an accumulated deficit of $98,920,000.

The Company has taken numerous actions to substantially reduce operating cash outflows. These actions included terminating the Company's agreement with NBCi, settling amounts owed under distribution agreements, workforce reductions, and amending or canceling several content arrangements. Further, 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 June 30, 2003, the Company has $3,333,000 of cash and cash equivalents and negative working capital of $118,000. 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, 2003, the Company incurred a net loss of $754,000 and negative cash flows from operations of $958,000. Additionally, as of June 30, 2003, the Company had an accumulated deficit of $98,920,000.

HealthGate continues to take actions to reduce operating cash outflows. These actions include settling commissions owed under development and distribution agreements, workforce reductions and amending or canceling several content arrangements. Other 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 cash equivalents 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 licenses content on an individual resource basis so that customers can choose specific content elements that meet their needs. HealthGate continues to support its CHOICE Web site products consisting of content and related services on a pre-packaged basis. HealthGate is currently working on delivering three new product initiatives: customized print-on-demand patient education materials (including brochures and fact sheets); Content Centers of Excellence; and customizable electronic newsletter. In March 2003, HealthGate released The HealthGateWay^TM, a web-based newsletter service that allows customers to publish a customized electronic newsletter integrating the content they license from HealthGate with the customer's own news items and announcements. The Company believes that these products will allow HealthGate's customers to provide their patients with complete, consistent and up-to-date healthcare information. New product initiatives involve some initial investment with no assurance of success.

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. The Company has been able to effectively adopt and implement new technologies to date, however, there can be no assurances that the Company could continue to do so. 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 six months ended June 30, 2003, one customer, HCA-Information, accounted for 18% 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 $1,100,000. 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 are being recognized ratably over the term of the agreement.

An agreement with a customer that represented 8% of revenue for the six months ended June 30, 2002 terminated in 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 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 healthcare information products and services and may not be able to compete effectively. The market for healthcare content products and services is 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 4 hours in 1998 and a minor unscheduled service interruption of approximately 1 hour in 2002. These interruptions represent 0.05% and 0.01%, respectively, of the service time for each of those years. 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 or a decline in the Company's stock price.

HealthGate has an Internet Data Center Services Agreement with Cable and Wireless to house all of the Company's central computer facility servers at Cable and Wireless's Internet Data Center in Waltham, Massachusetts. HealthGate does not presently maintain fully redundant systems at separate locations, so the Company's operations depend on Cable & Wireless' ability to protect the systems in its data center against damage from fire, power loss, water damage, telecommunications failure, vandalism and similar events. Although Cable & Wireless provides comprehensive facilities management services, including human and technical monitoring of all production servers, Cable & Wireless does not guarantee that HealthGate's Internet access will be uninterrupted, error-free or secure.

During 2002, 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. However, Coradiant does not guarantee that HealthGate's Internet access will be uninterrupted, error-free or secure.

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 had 34 employees as of June 30, 2003. 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. 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. Although HealthGate currently considers its relationships with its third party content vendors to be good, the Company 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," "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." HealthGate has pending applications for "HealthGate OnSite," and "The HealthGateWay." 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. In order to limit unauthorized use of its intellectual property, HealthGate began conducting regular external Web audits in 2002. 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.

Recent regulations from the U.S. Department of Health and Human Services concerning The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") may impact how HealthGate collects data about its sites and reports this information to these sites. The Federal Trade Commission and government agencies in some states and countries have been investigating certain Internet companies regarding their use of personal information. Although HealthGate does not currently collect or use personal information, any additional regulations imposed to protect the privacy of Internet users may affect HealthGate.

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 June 30, 2003, approximately $2,818,000 of the Company's investments were in money market funds. Cash and cash equivalents were approximately $3,333,000 at June 30, 2003.

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-15(e)) as of the period ending June 30, 2003. 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.

HealthGate's annual meeting of stockholders was held on June 24, 2003 in Boston, Massachusetts.

The vote to elect two persons as Class I Directors of HealthGate was as follows:

	Number of Shares
Nominee	For	Withheld Authority
David Friend	3,995,278	274,518
William G. Nelson, Ph.D.	4,259,678	10,118

Accordingly. Mr. Friend and Dr. Nelson were elected as Class I Directors to serve for a three-year term until the 2006 Annual Meeting of Stockholders and until their successors are elected and qualified. Class II directors (Gerald E. Bisbee, Jr., Ph.D., Jonathan J.G. Conibear and Thomas O. Pyle) whose terms are scheduled to expire at the 2004 Annual Meeting of Stockholders, and Class III directors (Edson D. de Castro and William S. Reece) whose terms are scheduled to expire at the 2005 Annual Meeting of Stockholders, have terms as directors that continue after the June 2003 Annual Meeting.

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.

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Delaware (State or other jurisdiction of incorporation or organization)		04-3220927 (I.R.S. Employer Identification No.)
25 Corporate Drive, Suite 310, Burlington, Massachusetts (Address of principal executive offices)		01803 (Zip Code)
Registrant's telephone number, including area code: (781) 685-4000

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets at June 30, 2003 and December 31, 2002 (unaudited)	3
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002 (unaudited)	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
Item 4.	Controls and Procedures	27
PART II. OTHER INFORMATION
Item 4.	Submission of Matters to a Vote of Security Holders	28
Item 6.	Exhibits and Reports on Form 8-K	28
Signatures		29

			June 30, 2003			December 31, 2002
Assets
Current assets:
	Cash and cash equivalents		$	3,332,823		$	4,449,086
	Accounts receivable, net of allowance for doubtful accounts of $4,815 and $3,781 at June 30, 2003 and December 31, 2002, respectively.			235,932			128,113
	Prepaid expenses and other current assets			302,982			378,131

		Total current assets		3,871,737			4,955,330
Fixed assets, net				536,138			1,355,241
Other assets				504,160			582,039

		Total assets	$	4,912,035		$	6,892,610

Liabilities and Stockholders' Equity
Current liabilities:
	Current portion of capital lease obligation		$	—		$	5,821
	Accounts payable			278,110			797,694
	Accrued expenses			1,436,322			1,899,148
	Deferred revenue			2,275,448			2,165,893

		Total current liabilities		3,989,880			4,868,556
Other long-term liabilities				599,636			807,124

		Total liabilities		4,589,516			5,675,680

Stockholders' equity:
	Common stock, $.03 par value;
		Authorized: 100,000,000 shares
		Issued and outstanding: 4,261,606 and 6,014,676 shares at June 30, 2003 and December 31, 2002, respectively.		127,848			180,440
	Additional paid in capital			99,114,621			99,202,276
	Accumulated deficit			(98,919,950	)		(98,165,786	)

		Total stockholders' equity		322,519			1,216,930
		Total liabilities and stockholders' equity	$	4,912,035		$	6,892,610

			Three Months Ended June 30, 2003			Three Months Ended June 30, 2002			Six Months Ended June 30, 2003			Six Months Ended June 30, 2002
Revenue, including revenue from related parties of $115,583 for the six months ended June 30, 2002			$	1,538,728		$	1,503,261		$	2,925,999		$	3,145,272
Costs and expenses:
	Cost of revenue			605,854			740,515			1,439,768			1,213,560
	Research and development			469,257			605,067			977,827			1,304,765
	Sales and marketing			277,978			388,349			511,009			897,868
	General and administrative			738,968			1,098,436			1,618,481			2,214,872
	Lease exit costs			105,861			—			105,861			—

		Total costs and expenses		2,197,918			2,832,367			4,652,946			5,631,065

	Loss from operations		$	(659,190	)	$	(1,329,106	)	$	(1,726,947	)	$	(2,485,793	)
Interest and other income, net				108,821			82,742			972,783			123,635

	Net loss		$	(550,369	)	$	(1,246,364	)	$	(754,164	)	$	(2,362,158	)

Basic and diluted net loss per share			$	(0.11	)	$	(0.21	)	$	(0.14	)	$	(0.39	)
Shares used in computing basic and diluted net loss per share				5,060,022			6,014,676			5,534,711			6,014,676

			Six Months Ended June 30, 2003			Six Months Ended June 30, 2002
Cash flows from operating activities:
	Net loss		$	(754,164	)	$	(2,362,158	)
		Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization		980,298			1,415,059
		Gain on reacquisition of stock		(92,294	)		—
		Stock based compensation		—			9,465
	Changes in assets and liabilities:
		Accounts receivable		(107,819	)		259,698
		Prepaid expenses and other current assets		75,149			(186,566	)
		Other assets		20,833			(93,833	)
		Accounts payable		(519,584	)		(91,506	)
		Accrued expenses		(462,826	)		(269,110	)
		Deferred revenue		109,555			(811,507	)
		Other long-term liabilities		(207,488	)		(243,328	)

Net cash used in operating activities				(958,340	)		(2,373,786	)

Cash flows from investing activities:
	Purchases of fixed assets			(39,209	)		—
	Acquisition of assets of TNP			—			(393,200	)
	Expenditures for capitalized software			(64,940	)		(116,261	)

Net cash used in investing activities				(104,149	)		(509,461	)

Cash flows from financing activities:
	Payment of capital lease obligation			(5,821	)		(135,917	)
	Purchase of common stock			(47,953	)		—

Net cash used in financing activities				(53,774	)		(135,917	)

Net decrease in cash and cash equivalents				(1,116,263	)		(3,019,164	)
Cash and cash equivalents, beginning of period				4,449,086			8,588,708

Cash and cash equivalents, end of period			$	3,332,823		$	5,569,544

Supplemental disclosure of cash flow information:
	Cash paid for interest		$	1,000		$	15,000

	HEALTHGATE DATA CORP.
Dated: August 12, 2003	By:	/s/ WILLIAM S. REECE William S. Reece Chairman of the Board of Directors and Chief Executive Officer
Dated: August 12, 2003	By:	/s/ VERONICA ZSOLCSAK Veronica Zsolcsak Chief Financial Officer