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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL
YEAR ENDED DECEMBER 31, 2003 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE
TRANSITION PERIOD FROM ________ TO ________
Commission file number 0-22019
HEALTH GRADES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 62-1623449
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
44 UNION BOULEVARD, SUITE 600
LAKEWOOD, COLORADO 80228
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (303) 716-0041
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
(Title of class)
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 the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy statement incorporated
by reference in Part III of this annual report on Form 10-K or any amendment to
this annual report on Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of June 30, 2003, the aggregate market value of the Common Stock held by
non-affiliates of the registrant was $2,976,257. Such aggregate market value was
computed by reference to the closing sale price of the Common Stock as reported
on the OTC Bulletin Board on such date. For purposes of making this calculation
only, the registrant has defined "affiliates" as including all directors and
beneficial owners of more than five percent of the Common Stock of the Company.
As of March 30, 2004 there were 24,961,159 shares of the registrant's Common
Stock outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
TABLE OF CONTENTS
PART I
Item 1. Business.......................................................... 2
Item 2. Properties........................................................ 21
Item 3. Legal Proceedings................................................. 21
Item 4. Submission of Matters to a Vote of Security Holders............... 21
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters............................................... 22
Item 6. Selected Financial Data........................................... 23
Item 7. Management's Discussion and Analysis of Financial Condition And
Results of Operations............................................. 23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........ 30
Item 8. Financial Statements and Supplementary Data 30
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................. 30
Item 9A. Controls and Procedures........................................... 30
PART III
Item 10. Directors and Executive Officers of the Registrant................ 30
Item 11. Executive Compensation............................................ 30
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholders Matters.................................. 30
Item 13. Certain Relationships and Related Transactions.................... 31
Item 14. Principal Accountant Fees and Services............................ 31
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.. 31
This Report contains forward-looking statements that address, among other
things, the availability of healthcare data, the generation of increased
revenues, addition of personnel, 2004 cash bonus program, continued company
expansion, anticipated capital expenditures, potential equity and/or debt
financing. These statements may be found under "Item 1-Business," "Item 1-Risk
Factors," and "Item 7-Management's Discussion and Analysis of Financial
Condition and Results of Operations" as well as in this Report generally. We
generally identify forward-looking statements in this report using words like
"believe," "intend," "expect," "may," "will," "should," "plan," "project,"
"contemplate," "anticipate" or similar statements. Actual events or results may
differ materially from those discussed in forward-looking statements as a result
of various factors, including: the failure of the Company to generate increased
revenues or the inability of the Company to raise additional financing. In
addition, other factors that could cause actual events or results to differ
materially from those discussed in the forward looking statements are addressed
in "Risk Factors" in Item 1 and matters set forth in the Report generally. We
undertake no obligation to update publicly any forward-looking statements.
PART I
Item 1. Business.
BUSINESS
OVERVIEW
Health Grades, Inc. ("HealthGrades") provides proprietary, objective
healthcare provider ratings and advisory services. We provide our clients with
healthcare information, including information relating to quality of service and
detailed profile information on physicians, that enables them to measure,
assess, enhance and market healthcare quality. Our clients include hospitals,
employers, benefits consulting firms, payers, insurance companies and consumers.
We currently provide ratings or profile information relating to the
following healthcare providers:
- Over 4,700 hospitals with risk-adjusted ratings on twenty-six
procedures and diagnoses and programmatic ratings for obstetrics and
women's health (as further described below);
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- Over 620,000 physicians in over 120 specialties; and
- Over 16,000 nursing homes.
We offer services to hospitals that help them build a reputation based upon
quality of care or assist them in improving the quality of care. For hospitals
that have received high ratings, we offer the opportunity to license our ratings
and trademarks and provide assistance in their marketing programs. For hospitals
that want to improve or maintain their quality of care, we offer quality
improvement services.
We also provide basic and expanded profile information on a variety of
providers and facilities. We make this information available to consumers,
employers, benefits consulting firms and payers to assist them in selecting
healthcare providers. For certain providers, basic profile information is
available free of charge on our website, www.healthgrades.com. For a fee, we
offer healthcare quality reports with respect to hospitals, nursing homes and
physicians. These reports provide more detailed information than is available
free of charge on our website. Report pricing and content varies based upon the
type of provider and whether the user is a consumer or a healthcare professional
(for example, medical professional underwriter).
We provide online integrated healthcare quality services for employers,
benefits consulting firms, payers and other organizations that license access to
our database of healthcare providers.
We have also entered into strategic arrangements with other service
providers, including Ingenix and J.D. Power and Associates, in an effort to
increase our name recognition and market presence, enhance our service offerings
and increase the distribution of our products.
BACKGROUND - THE DEMAND FOR HEALTHCARE INFORMATION
Consumer demand for quality information regarding healthcare providers has
been increasing over the last several years, as evidenced by numerous
publications, web sites and other communications. Recent research also indicates
that the demand for healthcare quality information is increasing rapidly.
According to 2003 J.D. Power and Associates research, 79% of consumers would
probably or definitely use information from an independent source about a
hospital's clinical performance in choosing a hospital.
Employers are seeking to empower employees to make appropriate healthcare
choices utilizing both cost and quality metrics. In addition, a growing number
of employers are implementing corporate intranet sites to assist their employees
in making informed healthcare decisions, which is important in an environment
where employers are increasingly shifting healthcare costs to employees.
Payers (medical insurers) also seek quality information as a valuable
resource for defining their reimbursements to healthcare providers, creating
provider networks and in giving their members useful tools for evaluating and
selecting healthcare providers.
We believe that the growing demand for quality healthcare information
described above provides increasing opportunities to sell our current product
offerings.
HEALTHCARE INFORMATION; HEALTHGRADES.COM
We compile comprehensive information regarding various healthcare providers
and distill the information to meet the requirements of consumers, employers,
payers and other customers. We provide certain information for no charge on our
website. Our revenues are generated, in part, through the provision of
healthcare information derived from our database in a manner that can be useful
to consumers, employers, benefits consulting firms, payers and others.
The www.healthgrades.com website is a comprehensive healthcare information
website that provides rating and other profile information regarding a variety
of providers and facilities. Our goal is to provide comprehensive, objective
healthcare ratings and profiles to assist consumers in making informed decisions
regarding their families' health.
We distinguish the www.healthgrades.com website from most other healthcare
information websites based on the nature of the information we provide. Most
other healthcare information websites provide general information regarding
specific diseases, conditions or procedures. Healthgrades.com, in contrast,
provides information to assist the user in finding a quality facility or a
quality provider, using our rating and profile information. However, we do not
endorse any particular provider or facility. We strive to
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provide objective ratings regarding the quality of providers and facilities by
developing sophisticated statistical processes and other methodologies and
applying them to a number of databases used on our ratings website.
We provide information on our healthgrades.com website through the sections
described below. As noted above, the data used to compile information for our
website also provides the more comprehensive information and reports we make
available for a fee.
Hospital Report Cards(TM) - This section of our website enables users to
search by state and compare hospitals' performance in twenty-six risk-adjusted
procedures/diagnoses, including, among others, coronary bypass surgery, acute
myocardial infarction (heart attack), stroke, total knee or hip replacement and
back and neck surgery. In addition, users can compare hospitals utilizing our
programmatic ratings for obstetrics and women's health. Our programmatic ratings
are currently available in the eighteen states that provide us with all-payer
data as further described below. In general, all ratings are updated each fall
except for our programmatic ratings, which typically are updated every spring.
For each particular diagnosis or procedure chosen by the user, other than
those relating to obstetrics and women's health, we provide a rating system of
five stars, three stars or one star (five stars is the highest rating; one star
is the lowest) for virtually every hospital in the United States. We base all of
our ratings, except ratings on obstetrics and women's health, on three years of
MedPAR (Medicare Provider Analysis and Review) data that we purchase from the
Centers for Medicare and Medicaid Services (formerly Health Care Financing
Administration), known as CMS. The MedPAR database contains the inpatient
records of all Medicare patients. We apply proprietary algorithms to the MedPAR
data to account for variations in risk in order to make the data comparable from
hospital to hospital. In the initial analysis of the data, a separate data set
is created for each group of patients having a specific procedure or diagnosis
(e.g., coronary bypass surgery, total hip replacement), based on ICD-9-CM
coding. The ICD-9-CM (International Classificant of Diseases, Clinical
Modification) is the official system of assigning codes to diagnoses and
procedures associated with hospital utilization in the United States. The ICD-9
is used to code and classify mortality data from death certificates. Each group
of patients is defined by using the information on diagnoses and procedures
coded in the patient records. The quality measure for some procedures or
diagnoses is mortality, while the quality measure for others is major
complications.
Generally, approximately 75% to 80% of hospitals studied are classified as
three stars. The three star rating is applied when there is no difference,
statistically speaking, between a hospital's predicted and actual performance.
Approximately 10% to 15% of hospitals are rated five stars, which means that
their performance is statistically better than expected. Approximately 10% to
15% of hospitals are rated one star, meaning that their performance was
statistically worse than expected.
For our obstetrics ratings, which also are subject to the five star rating
system, we use state all-payer files from 18 individual states derived from the
inpatient records of persons who utilize hospitals in those states. The 18
states represented on the site are: Arizona, California, Florida, Iowa, Maine,
Maryland, Massachusetts, Nevada, New Jersey, New York, North Carolina,
Pennsylvania, Texas, Utah, Vermont, Virginia, Washington and Wisconsin. This
data represents all discharges for the 18 states over a three-year period set
from 1999-2001. We analyzed the following factors for each hospital within the
18 all-payer states:
- Volume of vaginal and cesarean single live-born deliveries;
- Complication rates from vaginal and cesarean section single live-born
deliveries;
- Presence of neonatal intensive care unit (NICU);
- Preplanned first-time cesarean section rate; and
- Newborn mortality rate stratified into six birth weight categories.
We then developed a system that assigned a weight to each factor based on
its importance to the quality of obstetric care. The weightings were developed
by interviewing a focus group of physicians from various specialties including
obstetrics, neonatology, family practice and internal medicine, who had an
average of ten years of practice experience. Based upon the application of this
system, the top 15% of hospitals (in the 18 states) receive five stars, the
middle 70% receive three stars and the bottom 15% receive one star.
For the women's health ratings, which are also subject to the five star
rating system, we use state all-payer files from the same 18 individual states
referenced for our obstetrics ratings. These ratings are based upon outcomes in
obstetric services and cardiac/stroke mortality outcomes for women. The top 15%
of hospitals (in the 18 states) receive five stars, the middle 70% receive three
stars and the bottom 15% receive one star.
Distinguished Hospital Award for Clinical Excellence(TM) - This recently
developed section of our website provides users the ability to review hospitals
across the United States that are recognized by us for their outstanding
clinical excellence. We anticipate that this distinction will be announced on an
annual basis at the beginning of each calendar year. To be considered for the
Distinguished Hospital Award (DHA) for Clinical Excellence, a hospital is
required to have ratings in the following:
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- Inhospital mortality for coronary bypass surgery and stroke; and
- Inhospital mortality or major complication rating in at least 21 of
the 26 procedures/diagnoses that we rate using MedPAR data
In connection with our most recent determination of DHA designees, we created a
list of 869 hospitals that met the criteria set forth above and performed the
following steps:
- Calculated the average star rating for each hospital by averaging all
of their MedPAR-based ratings;
- Ranked hospitals in descending order by their average star rating.
(Ties were broken by total volume for all of the procedures and
diagnoses considered.);
- Selected the top 20% of hospitals from the list (174 hospitals);
- Removed the ten hospitals with the lowest total volume from the list;
and
- Designated the hospitals that remained on the list as the current DHA
winners
From the original list of 869 hospitals considered for the DHA, 164 received the
DHA designation.
Nursing Home Report Cards(TM) - This section of our website provides rankings of
the performance of nursing homes across the United States that were Medicare or
Medicaid certified and active in these programs. These ratings are typically
updated on a monthly basis. In preparing the ratings, we analyze licensing
survey data from CMS's Online Survey Certification and Reporting (OSCAR)
database and complaint data from CMS's Skilled Nursing Facility (SNF) Complaint
database. Licensing surveys are inspections that assess compliance with
standards of patient care such as staffing, quality of care and cleanliness.
Complaint surveys are investigations of complaints and serious problems. Nursing
homes whose most recent survey date was more than 20 months prior to the date
the data was received by HealthGrades are not included in the analysis.
Stand-alone Medicare and/or Medicaid nursing homes are analyzed apart from
Medicare, hospital-based nursing homes. We do not rate Medicare, hospital-based
nursing homes because these facilities are designed for short-term patient care.
In addition, nursing homes with only one licensing survey are not included in
our analysis. The ratings are assigned on a state by state basis, rather than
nationally, because the surveys from which information is derived are conducted
by state agencies, and there may be variations between the states' survey
process and results.
In conjunction with a group of nursing home professionals (which include
nursing home administrators, a physician, long-term care ombudsmen, a nurse
consultant and others), we developed a proprietary scoring system that
translated the scope and severity of each deficiency into a numerical value. A
low numerical value indicated a deficiency that was not severe (no actual harm
to the resident) and isolated (involve very few residents) in scope. A high
numerical value indicated a deficiency that was very severe (actual harm to the
resident) and was widespread throughout the nursing home. Each nursing home
received several scores from the analysis of licensing surveys and complaint
surveys. We then performed a statistical analysis of these scores that produced
a weight for each area. The weighted scores were summed to produce an overall
score for each nursing home. Based upon the overall score, the best 30% of
nursing homes receive five stars, and the middle 40% of nursing homes receive
three stars.
Provider Profiles - In addition to the report card sections, we provide
profiles containing information with regard to the following providers or
facilities:
- Physicians - The physician data provides a list of physicians by
specialty based on geographic criteria selected by the user. For a
fee, we provide detailed profile information including, to the extent
available through our data sources, primary and secondary specialty
areas, medical school attended, years since medical school, address,
telephone number, board certification, hospital affiliation and
federal or state medical board sanction information. The directory
contains detailed profiles for more than 620,000 physicians.
- Hospitals - The hospital profile database includes a directory of
almost every hospital in the U.S. The directory contains detailed
profiles and maps for more than 5,000 hospitals.
INFORMATION AND RELATED SERVICES FOR HOSPITALS, EMPLOYERS, BENEFITS CONSULTING
FIRMS, PAYERS, PROFESSIONALS AND CONSUMERS
The information provided on our www.healthgrades.com website, and the
database from which this information is derived, forms the basis of our
marketing efforts. While certain information is provided free of charge on our
website, we seek to generate revenues from hospitals and other providers, as
well as employers, payers and consumers as described below:
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SERVICES FOR HOSPITALS - We offer a Strategic Quality Initiative(TM) (SQI)
program, a Distinguished Hospital Program (DHP) for Clinical Excellence(TM) and
a Quality Assessment and Improvement(TM) (QAI) program for hospitals. Our SQI
and QAI programs primarily cover the following eight areas:
- - Cardiac;
- - Orthopedics;
- - Vascular;
- - Pulmonary;
- - Stroke;
- - Neurosciences;
- - Obstetrics; and
- - Women's health.
In addition, we also offer SQI and QAI services for the following individual
procedures or diagnoses (typically when a hospital participates with respect to
one of the areas listed above):
- - Cholecystectomy;
- - Prostatectomy;
- - Bowel obstruction;
- - GI Bleed; and
- - Sepsis.
As our programs are targeted toward specific service areas, some of our hospital
customers choose to work with us utilizing our SQI programs for their higher
rated areas and utilizing our QAI programs for their lower rated areas. As of
March 2004, we had 179 contracts to provide services to 153 hospitals.
SQI Program. We offer the SQI program to highly rated providers only after
our ratings are completed; we do not adjust our ratings based on whether a
provider is willing to license with us.
The SQI program provides business development tools to hospitals that are
highly rated on our website. Under our SQI program, we license the commercial
use of the HealthGrades corporate mark, applicable data and multiple marketing
messages that may be used by hospitals to demonstrate third party validation of
excellence, including:
- - HealthGrades' name, logo, stars and current ratings data including
performance score
- - National designation (i.e., Top 5% in the Nation, Top 10% in the Nation) as
applicable;
- - State rank (i.e., Best in State, Best in Region) as applicable (not
available for obstetrics or women's health);
- - Marketing messages developed and approved by HealthGrades; and
- - Ratings comparisons developed and approved by HealthGrades.
The license may be in a single service area (for example, Cardiac) or
multiple areas (for example, Cardiac, Neurosciences and Orthopedics). In
addition, the SQI program provides ongoing access to HealthGrades' marketing
service and resources, including our in-house healthcare consultants, tailored
to the hospital's specific needs.
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In addition our QAI-I program, described below, is made available to a
hospital that has purchased our SQI program with respect to the areas covered by
the SQI program. Our in-house healthcare consultants also provide certain onsite
consulting services.
QAI-I Program (formerly Ratings Quality Analysis or RQA). We also assist
hospitals in measuring the success of their quality efforts utilizing our
in-house healthcare consultants. Whether purchased as a stand-alone product, or
as part of the SQI program, the QAI-I program involves our provision of an
on-site presentation to administrative, physician and quality improvement staff,
including a detailed, quality analysis and report of the last three years of
client's Medicare data within the service areas licensed by the hospital. This
analysis includes:
- National and Five Star performer benchmarks;
- Analysis of the hospital's annual actual and predicted outcome data;
- Risk adjusted analysis and comparison of hospital's documented and
coded risk factors;
- Risk adjusted analysis and comparison of hospital's documented and
coded complications; and
- Summary analysis presenting key observations and recommendations for
overall improvement.
QAI-II Program. Our QAI-II program is principally designed to help a
hospital measure and improve the quality of its care in particular service
areas. Using our database and on-site interviews, we can measure how well the
hospital performs relative to national and regional best practices and help
identify measures to improve quality. Detailed quality comparisons are also
available at the hospital, physician group and individual physician level. Our
consultants work on-site with the hospital staff and physicians to present the
data and assist in the quality analysis and quality improvement. Under our
QAI-II program, with respect to the areas licensed by the hospital, we will
provide services including, but not limited to, the following: periodic onsite
visits; detailed analysis of the last 2 years of client's all-pager data; and
individual quality profiles for high volume physicians.
Distinguished Hospital Award Program (DHP). The DHP recognizes clinical
excellence in hospitals across a range of service areas. Hospitals that contract
with us for DHP services receive all of the SQI features described above with
respect to their licensed service areas. In addition, hospitals can reference
the additional DHA designation. Hospital clients are provided with additional
marketing and planning assistance with respect to the DHA designation as well as
a trophy for display at the hospital. This program was developed in conjunction
with J.D. Power and Associates, as described below under, "Arrangements with
Other Service Providers."
During 2003 and prior years, as part of our DHP and SQI programs, we
provided certain exclusivity rights for client hospitals. In most cases, for the
particular areas subject to license by our hospital clients, we agreed not to
provide similar marketing services to a maximum of three hospitals selected by
the client. However, we did not remove ratings of an "excluded" hospital from
our website or change the ratings in any way. Beginning in January 2004, we no
longer offer exclusivity under our contracts. For hospitals that signed
agreements with us during 2003 and prior years, we will continue to honor the
exclusivity provisions in their contracts solely for the remaining term of the
agreement. As our agreements are typically three years (with the ability to
terminate on an annual basis), we anticipate that all exclusivity provisions
will expire by the end of 2006.
SERVICES FOR EMPLOYERS, BENEFITS CONSULTING FIRMS, PAYERS AND OTHERS - Through
our Quality Ratings Suite(TM) (QRS) we license access to, and customize our
database for, employers, benefits consulting firms, payers and others. Modules
currently available for license are as follows:
- - Hospital Quality Guide(TM)
- - Physician Quality Guide(TM)
- - Nursing Home Quality Guide(TM)
- - Home Health Quality Guide(TM)
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Customers can integrate our QRS modules within their online provider
directories. As noted below, we have entered into an arrangement with Ingenix,
which provides for the marketing of our QRS to managed care organizations,
payers, employers and benefit management companies. In addition, through this
arrangement, our provider quality data can be combined with in- or
out-of-network indicators so that users can search for healthcare providers
within the provider networks available under their current health plans.
Depending on the client's needs, we can customize our content for the intended
users. Some of the healthcare quality information available to our customers and
their users within our modules are as follows:
Hospital Quality Guide
- Easy-to-understand star ratings by procedure or diagnosis and by
service area based on risk-adjusted outcome measures;
- Consumer-friendly navigation and terminology;
- Cost, length of stay, procedure volume and distance to facility;
- Hospital profile information; and
- Leapfrog Group safety measures.
Physician Quality Guide
- Addresses and phone numbers;
- State and federal sanction information within the last 5 years (if
any);
- Board certification;
- Years since medical school;
- Gender;
- Foreign languages; and
- Ratings of affiliated hospitals (hospitals for which the physician has
privileges).
Nursing Home Quality Guide
- Overall star rating based on comparison to other facilities within the
state;
- Details of the last four licensing surveys;
- Complaint investigations;
- Repeat violations; and
- State averages for violations and inspections.
Home Health Quality Guide
- Overall star rating based on comparison to other home health agencies
within an individual state;
- Licensing survey deficiencies;
- Complaint investigations; and
- Repeat violations.
HEALTHCARE QUALITY REPORTS FOR PROFESSIONALS(TM) - We offer comprehensive
quality information to organizations in need of current and historical quality
information on nursing homes and hospitals. In addition, we offer reports on
physicians that contain detailed information with respect to education,
professional licensing history and other items.
Nursing Home Quality Reports for Professionals(TM) - Our primary customers
for our Nursing Home Quality Reports for professionals are medical professional
liability underwriters and other organizations. We currently offer the following
three categories of reports on nursing homes: Nursing Home Quality Report;
Executive Summary Report; and Risk Assessment Report. Our Nursing Home Quality
Report for Professionals contains detailed information on ownership,
certification history, staffing and patient demographics as well as performance
and ranking data from health, complaint and life safety surveys. Our Executive
Summary Report is a three-page report, which summarizes this information. Our
Risk Assessment Report is a two to three page textual analysis of the Nursing
Home Quality Report that highlights potential problem areas within a facility
that require risk management.
Hospital Reports for Professionals(TM) - Our Hospital Reports contain
detailed information on ownership, services provided and clinical performance
outcomes. Some of the features of our reports include:
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- Risk and severity-adjusted performance measures for cardiac,
neurosciences, stroke, vascular, orthopedics and pulmonary;
- Programmatic ratings for women's health and obstetrics;
- Comparative statistics and state/national benchmarks;
- Infections, complication and mortality rates; and
- "Cases At Risk" analysis, which projects how many cases are likely to
have adverse outcomes based upon our proprietary mortality or
complication rate analysis.
In addition to the information contained in our Hospital Reports, we offer
access to a selection of public record reports to further assess risk, such as:
- Business information, including bankruptcies, liens, judgments, credit
reports, corporate records and federal employer identification
numbers;
- Background checks on administrators and officers and directors; and
- Media searches.
Physician Reports for Professionals(TM) - Our Physician Reports contain
detailed information on a physician's demographics, which include:
- Education history;
- Professional licensing history;
- Board certifications;
- State medical board and Medicare sanction history;
- Hospital and health plan affiliations;
- Our quality ratings for each hospital with which the physician is
affiliated; and
- Bankruptcies, liens and judgments.
We also offer credit reports and civil and criminal records checks in
separate reports.
HEALTHCARE QUALITY REPORTS FOR CONSUMERS(TM) - We offer comprehensive quality
information to consumers that provides current and historical quality
information on hospitals and nursing homes in more detail than is available on
our website. In addition, we offer reports on physicians that contain detailed
information with respect to education, professional licensing history and other
items.
Hospital Quality Reports for Consumers - Our Hospital Quality Reports for
Consumers include:
- Ratings for all procedures and diagnoses rated by HealthGrades for the
hospital;
- Survey data prepared in connection with The Leapfrog Group; and
- HealthGrades' methodology and helpful hints for choosing a hospital.
Nursing Home Quality Reports for Consumers(TM) - Our Nursing Home Quality
Reports for Consumers include:
- Our rating for the particular nursing home;
- Health survey history with descriptions and severity of the
deficiencies for the last four licensing surveys;
- Instances of repeated deficiencies;
- How the nursing home compares to others in the state; and
- Our methodology and helpful hints for choosing a nursing home.
Physician Quality Reports for Consumers(TM) - Our Physician Quality Reports
for Consumers include:
- Addresses and phone numbers;
- Board certification information;
- Education information;
- State and federal sanction information within the last 5 years (if
any);
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- Name and address of area hospitals;
- Gender and age;
- National comparative statistics in board certification and sanction
activity regarding physicians in the same specialty field; and
- Information on how to choose a physician with a checklist and guide.
ARRANGEMENTS WITH OTHER SERVICE PROVIDERS
We have also entered into arrangements with other service providers in an
effort to increase our name recognition and market presence, as well as enhance
our service offerings. The following is a summary of our current arrangements
for the provision of joint product offerings.
Distinguished Hospital Program(TM) with J.D. Power and Associates. In
August 2002, we entered into an agreement with J.D. Power and Associates to
offer a Distinguished Hospital Program, which is designed to validate and
recognize hospitals that perform at notably high levels utilizing J.D. Power and
Associates' customer satisfaction data and HealthGrades' clinical quality data.
Under this program, hospitals may be concurrently or separately recognized and
awarded for exceptional clinical performance and for the provision of an
"outstanding patient experience." The first component of this program, clinical
excellence recognition, is provided by HealthGrades and developed thorough
detailed, risk-adjusted analysis of up to three years of actual and predicted
hospital mortality data and documented coded risk factors, in addition to
documented and coded complications in specialty areas, based on our Hospital
Report Cards methodology (described above under "Information and Related
Services For Hospitals, Employers, Benefits Consulting Firms, Payers,
Professionals and Consumers - Distinguished Hospital Program (DHP).") The second
component of the program, service excellence recognition, is provided by J.D.
Power and Associates and is obtained by surveying a random sample of patients
who have recently experienced a hospital stay and comparing the results with
those from a nationally representative patient experience study. The
Distinguished Hospital Performance Program offers hospitals that receive
recognition the ability to enter into a license agreement to reference the
awards in future advertising and marketing efforts. To enhance the visibility,
understanding and appreciation of the available awards, HealthGrades and J.D.
Power and Associates provide the following support:
- onsite strategic marketing and communication consulting;
- advertising and press release samples;
- electronic artwork;
- links to both the J.D. Power and Associates and HealthGrades web
sites; and recognition of the award posted on both the J.D. Power and
Associates and HealthGrades web sites
Ingenix/HealthGrades Quality Rating Suite. We have entered into an
arrangement with Ingenix, Inc., to market our Quality Ratings Suite (described
above under "Services for Employers, Benefits Consulting Firms, Payers and
Others") to managed care organizations, payers, employers and benefits
consulting firms through Ingenix' sales and marketing teams. Ingenix provides
much of the physician data included in our Quality Ratings Suite, which combines
access to HealthGrades quality ratings and The LeapFrog Group Patient Safety
Survey information. (The Leapfrog Group, a consortium of more than 90 Fortune
500 companies and other large private and public healthcare purchasers, began a
national effort in November 2000 to reward hospitals for advances in patient
safety and to educate employees, retirees, and families about the importance of
hospitals' efforts in this area. The Leapfrog Group's Survey assesses the extent
to which urban, acute care hospitals in selected regions of the U.S. currently
meet or are striving to implement three patient safety practices: Computer
Physician Order Entry, Evidence-Based Hospital Referral and ICU Physician
Staffing.) In addition, under the Ingenix/HealthGrades Quality Rating Suite,
customers are offered project management, information technology, user support
and communications services (for example, materials to inform users of the
Ingenix/HealthGrades Quality Rating Suite and how to access the information).
The Quality Rating Suite also includes the following features:
- links to HealthGrades' Hospital Quality Guide from Ingenix' online
physician and hospital directories;
- risk severity adjusted mortality/complication rates by
procedures/diagnoses;
- hospital comparison tools;
- search by geography, procedure/diagnoses and consumer preference;
- downloadable hospital quality reports;
- nursing home ratings;
- physician profiles and sanction information; and
- additional customization (client designed user interface or additional
data, such as state hospital data)
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COMPETITION
With respect to our quality services for hospitals, we face competition
from data providers, such as Solucient and healthcare consulting companies such
as GE Medical Systems and Premier that offer certain consulting services to
hospitals. We believe that the ability to demonstrate the value of marketing and
consulting programs, name brand recognition and cost are the principal factors
that affect competition.
We face competition with respect to our service offerings to employers,
benefits consulting firms, payers, consumers and others from companies that
provide online information and decision support tools regarding healthcare
providers and physicians. There are several companies that currently offer
online healthcare information and support tools such as Subimo and
SelectQualityCare. We believe that the ability to provide accurate and
comprehensive healthcare information in a manner that is cost-effective to the
client is the principal factor that affects competition in this area.
We face competition on our nursing home quality reports with companies such
as CareScout, which provide ratings of nursing homes and charge professionals
and consumers for this information.
COMPANY HISTORY
We were incorporated in Delaware in December 1995 under the name Specialty
Care Network, Inc. Upon commencement of operations in 1996, we were principally
engaged in the management of physician practices engaged in musculoskeletal
care, which is the treatment of conditions relating to bones, joints, muscles
and connective tissues. Due to difficulties in the physician practice management
industry in general, and with respect to our affiliated physician practices in
particular, we terminated or restructured our arrangements with various
physician practices. As a result, the scope of our physician practice management
business became increasingly limited in subsequent years, particularly after a
restructuring of our arrangements with nine practices in June 1999, and ceased
entirely in September 2002.
During 1998, we began to focus on the provision of healthcare information
through the establishment of our healthcare provider quality ratings and profile
information, which we first introduced on our website. Since that time, we have
expanded the scope of our healthcare information services to encompass the
additional services described above.
In January 2000, we changed our name to Healthgrades.com, Inc. In November
2000, we changed our name to Health Grades, Inc.
GOVERNMENT REGULATION
The delivery of healthcare services has become one of the most highly
regulated of professional and business endeavors in the United States. Both the
federal government and the individual state governments are responsible for
overseeing the activities of individuals and businesses engaged in the delivery
of healthcare services. The focus of Federal regulation of healthcare businesses
and professionals is based primarily upon their participation in the Medicare
and Medicaid programs. Each of these programs is financed, at least in part,
with Federal funds. State jurisdiction is based upon its financing of healthcare
as well as the states' authority to regulate and protect the health and welfare
of its citizens.
A provision of the federal Social Security Act, commonly known as the
Medicare/Medicaid Anti-kickback Law, prohibits kickbacks, rebates and bribes in
return for referrals. This law provides an extremely broad base for finding
violations. Indeed, any remuneration, direct or indirect, offered, paid,
solicited, or received, in return for referrals of patients or business for
which payment may be made in whole or in part under Medicare, or a state
healthcare program (Medicaid) could be considered a violation of law. The
language of the Anti-Kickback Law also prohibits payments made to anyone to
induce them to "recommend purchasing, leasing, or ordering any good, facility,
service, or item for which payment may be made in whole or in part" by Medicare.
Similar laws exist in most states.
To provide more direct guidance on the interpretation of the anti-fraud and
abuse provisions, the Office of the Inspector General, or OIG, of the Centers
for Medicare and Medicaid Services ("CMS") has developed regulations regarding
what types of business arrangements are not to be considered violative of the
law and to develop criteria to be applied to any new arrangement to determine
11
whether it is acceptable under the law. The regulations feature certain "Safe
Harbors" addressing activities that may be technically violative of the act, but
are not to be considered as illegal when carried on in conformance with the
proposed regulation. The OIG has also set forth specific procedures by which the
Department of Health and Human Services, through the OIG, in consultation with
the Department of Justice (DOJ), will issue advisory opinions to outside parties
regarding the interpretation and applicability of anti-kickback and certain
other statutes relating to Federal and State healthcare programs.
Whenever an arrangement exists with an entity capable of providing services
reimbursed by Medicare or Medicaid, the arrangement must be analyzed to
determine if the Anti-kickback Law is implicated (i.e., can the arrangement be
characterized as involving remuneration intended to induce referrals or the
provision of covered services). Because our customers will, in some instances,
be healthcare providers, we must be mindful of the anti-kickback laws; that is,
we want to be sure that any payments to us will not be considered a payment for
a referral of patients or business that HealthGrades controls.
The only payments made to us by providers and practitioners will be for
access to information, evaluation and consulting services, not to induce
referrals. Federal courts have interpreted the anti-kickback provisions very
broadly to prohibit even those payments made in return for legitimate services,
if the intent to induce referrals can be inferred from the arrangement. However,
where the payments made under an agreement represent fair market value or
reasonable remuneration for the goods, services or other consideration being
received, there should be no factual support for any inference that payments are
in exchange for referrals. Moreover, HealthGrades does not control patients,
doctors, or others in a position to refer patients or other business covered
under Medicare or Medicaid.
There is a potential that our arrangements could be brought within the
personal services and management agreement safe harbor that is provided by
federal statute. The personal services and management agreement safe harbors
provide that payments under such agreements will not constitute remuneration
under the anti-kickback statute if the payments meet six criteria including that
the payments are set forth is writing and fixed in advance, are consistent with
fair market value and do not take into account the volume or value of any
referrals or business generated between the parties. Unless an arrangement meets
all of the terms of a safe harbor, the government could attempt to draw an
inference that payments made constitute remuneration and that at least one
purpose of the remuneration is to induce referrals. However, failure to meet the
safe harbors does not render an arrangement unlawful. We believe that our
operations comply with applicable legal regulatory requirements of the
anti-kickback laws. However, some of these laws have been applied to payments by
physicians for marketing and referral services and could constrain our
relationships, including financial and marketing relationships with customers
such as hospitals. It is possible that additional or changed laws, regulations
or guidelines could be adopted in the future that could affect our business.
In addition to the anti-kickback laws, false claims are prohibited pursuant
to federal criminal and civil statutes. Criminal provisions prohibit the knowing
filing of false claims, making false statements or causing false statements to
be made by others. Civil provisions prohibit the filing of claims that the
person filing knew or should have known were false. Criminal penalties include
fines and imprisonment. Civil penalties include fines up to $10,000 per claim,
plus treble damages, for each claim filed.
Although we are not filing claims ourselves, liability under the statutes
can extend to those who "cause claims to be presented." To the extent that
consulting advice provided to our customers could be construed as aiding or
abetting the presentation of false claims by our customers, there could be false
claims liability, although we endeavor to provide advice that cannot be so
construed.
Many states have laws that prohibit payment of kickbacks or other payment
of remuneration to those in a position to control the referral of patients.
Therefore, it is possible that our activities may be found not to comply with
these laws. Noncompliance with such laws could subject us to penalties and
sanctions. Nonetheless, to our knowledge, we are not in violation of any legal
requirements under such state laws.
Healthcare Reform. The Medicare Prescription Drug and Modernization Act of 2003
contained no provisions which will have a major impact on our arrangements with
providers. Legislation may be introduced and considered by Congress and state
legislatures that is designed to change access to and payment for healthcare
services in the United States. We can make no prediction as to whether
additional healthcare reform legislation will be enacted or, if enacted, the
effect that such legislation will have on us.
Privacy of Information and HIPAA
Consumers sometimes enter private information about themselves or their
family members when using our services. Also, our systems record use patters
when consumers access our databases that may reveal health related information
or other private information about their user. In addition, information
regarding employee usage of healthcare providers and facilities can also be
12
compiled by our systems in connection with services we offer to employers and
other payers. Numerous federal and state laws and regulations govern collection,
dissemination, use and confidentiality of patient-identifiable health
information, including:
- state privacy and confidentiality laws;
- state laws regulating healthcare professionals, such as physicians,
pharmacists and nurse practitioners;
- Medicaid laws;
- the U.S. Health Insurance Portability and Accountability Act of 1996,
or HIPAA, as described in detail below, and related rules proposed by
the Health Care Financing Administration; and
- CMS standards for Internet transmission of health data
Under HIPAA, Congress set national standards for the protection of health
information. Under the law, and regulations known collectively as the Privacy
Rule, covered entities must implement standards to protect and guard against the
misuse of individually identifiable health information by the compliance
deadline date of April 14, 2003. We believe that as of April 14, 2003, we have
complied with the applicable standards. Failure to timely implement these
standards may, under certain circumstances, trigger the imposition of civil or
criminal penalties.
The Rule does not replace federal, state, or other law that grants
individuals even greater privacy protections, and covered entities are free to
retain or adopt more protective policies or practices.
By law, the Privacy Rule applies only to covered entities - payers,
healthcare clearinghouses, and certain healthcare providers. However, most
healthcare providers and payers do not carry out all of their healthcare
activities and functions by themselves. Instead, they often use the services of
a variety of other persons or businesses. The Privacy Rule allows covered
providers and payers to disclose protected health information to these "business
associates" if the covered entities obtain satisfactory assurances that the
business associate will use the information only for the purposes for which it
was engaged by the covered entity, will safeguard the information from misuse,
and will help the covered entity comply with some of the covered entity's duties
under the Privacy Rule. HealthGrades is not a covered entity, however, it may be
asked to enter into business associate agreements with covered entities, which
may restrict its ability to receive or utilize information from covered
entities.
Covered entities may disclose protected health information to an entity in
its role as a business associate only to help the covered entity carry out its
healthcare functions - not for the business associate's independent use or
purposes, except as needed for the proper management and administration of the
business associate.
If a covered entity finds out about a material breach or violation of the
privacy related provisions of the contract by the business associate, it must
take reasonable steps to cure the breach or end the violation, and, if
unsuccessful, terminate the contract with the business associate. If termination
is not feasible (e.g., where there are no other viable business alternatives for
the covered entity), the covered entity must report the problem to the
Department of Health and Human Services Office for Civil Rights.
GOVERNMENT REGULATION OF THE INTERNET
Any new or revised law or regulation pertaining to the Internet, or the
application or interpretation of existing laws and regulations, could decrease
demand for our services, increase our cost of doing business, decrease the
availability of the data we obtain and use from third parties, increase the
costs of online marketing, or otherwise cause our business to suffer.
Laws and regulations have been adopted in the United States and throughout
the world, and additional laws and regulations may be adopted in the future,
that address Internet-related issues, including online content, privacy, online
marketing, unsolicited commercial e-mail, pricing and quality of products and
services. This legislation could increase our cost of doing business and
negatively affect our business. Moreover, it likely will take many years to
determine the extent to which older laws and regulations governing issues like
property ownership, libel, negligence taxes, and personal privacy are applicable
to the Internet.
Currently, U.S. privacy law consists of numerous disparate state and
federal statutes regulating specific industries that collect personal data, or
particular types or uses of personal data. For example, large portions of the
statutory provisions and regulations under HIPAA, which protects the disclosure,
use, and transfer of personal health information in digital form by providers
and others, are currently taking effect in stages during 2003 and 2004. Several
other privacy laws and regulations predate and therefore do not specifically
address online activities. In addition, a number of comprehensive legislative
and regulatory privacy proposals have taken effect or are now under
consideration by federal, state and local governments in the United States. All
such privacy laws may
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decrease access to the raw data that we use, and may increase our costs of
compliance with such laws and regulations in the conduct of our business.
INTELLECTUAL PROPERTY
We regard the protection of our intellectual property rights to be
important. We rely on a combination of copyright, trademark and trade secret
restrictions and contractual provisions to protect our intellectual property
rights. We require selected employees to enter into confidentiality and
invention assignment agreements as well as non-competition agreements. The
contractual provisions and other steps we have taken to protect our intellectual
property may not prevent misappropriation of our technology or deter third
parties from developing similar or competing technologies.
We own federal trademark registrations for the marks HEALTHGRADES and THE
HEALTHCARE QUALITY EXPERTS.
There is also significant uncertainty regarding the applicability to the
Internet of existing laws regarding matters such as property ownership and other
intellectual property rights. The vast majority of these laws were adopted prior
to the advent of the Internet and, as a result, do not contemplate or address
the unique issues of the Internet and related technologies. In addition, new
laws that regulate activities on the Internet have been passed and may be
passed, which may have unanticipated effects.
For further information, see "Risk Factors - Our propriety rights may not
be fully protected, and we may be subject to intellectual property infringement
claims by others."
EMPLOYEES
As of December 31, 2003 we had 56 employees, most of whom were located at
our corporate offices in Denver, Colorado. Of these employees, 23 were engaged
in sales and marketing, client consulting or client administrative support, 19
in product development (including information technology/web development) and 14
in general and administrative (including finance, accounting, IT infrastructure,
etc.). We are not subject to any collective bargaining agreements.
14
RISK FACTORS
Risks Related to Our Business
OUR HEALTHCARE INFORMATION BUSINESS HAS NOT BEEN PROFITABLE AND MAY NEVER BECOME
PROFITABLE.
We began developing our healthcare information business in 1998. For the
year ended December 31, 2003, substantially all of our operations related to
this business. Our loss from operations for the year ended December 31, 2003,
was approximately $1.3 million. We may continue to incur operating losses as we
fund operating and capital expenditures to expand our healthcare information
database and website, market our healthcare information, develop new products,
upgrade our technology and continue efforts to increase recognition of our brand
name. Our business model assumes that consumers will be attracted to and use the
healthcare ratings and profile information and related content available on our
website, which will, in turn, enable us to license access to the information on
our website to hospitals and other providers. In addition, our business model
assumes that employers, payers, insurance plans, consumers and other potential
customers will seek our healthcare information to help increase the quality and
reduce the cost of healthcare. Our business model is not yet proven, and we
cannot assure you that we will ever achieve or sustain profitability or that our
operating losses will not increase in the future.
WE MAY NEED ADDITIONAL CAPITAL TO CONTINUE OUR BUSINESS IF WE DO NOT GENERATE
SUFFICIENT REVENUES OVER THE NEXT TWELVE MONTHS.
We believe that we have sufficient resources to meet our requirements for
at least the next 12 months. However, if our revenues fall short of our
expectations or our expenses exceed our expectations, we may need to raise
additional capital through public or private debt or equity financing. We may
not be able to secure sufficient funds on terms acceptable to us. If equity
securities are issued to raise funds, our stockholders' equity may be diluted.
If additional funds are raised through debt financing, we may be subject to
significant restrictions.
OUR BUSINESS WILL SUFFER IF WE ARE NOT ABLE TO OBTAIN RELIABLE DATA AS A BASIS
FOR OUR HEALTHCARE INFORMATION.
To provide our healthcare information, we must be able to receive
comprehensive, reliable data. We currently obtain this data from a number of
public and private sources. Currently, the information we utilize to compile
our hospital report cards is acquired from CMS. For the year ended December 31,
2003, revenues derived from our DHP, SQI and QAI products accounted for
approximately 83% of our total ratings and advisory revenue. These products are
based exclusively on our hospital report cards. Moreover, some of our QRS
modules, are based on information acquired from CMS. Our business could suffer
if some of these sources were to begin charging for use or access to this data,
or cease to make such information available, and suitable alternative sources
are not identified on a timely basis. Moreover, our ability to attract and
retain customers is dependent on the reliability of the information that we use
and purchase. If our information is inaccurate or otherwise erroneous, our
reputation and customer following could be damaged. In the past, we have had
disputes with two providers of information who sought to terminate our
arrangements based on allegations, which we denied, that our use of the
information violated the terms of our agreements with the providers. We have
located alternate sources of information or modified the scope of information
provided in response to these disputes. Nevertheless, our failure to obtain
suitable information, if needed to use in place of information provided by a
source that determines to stop providing information, or which charges
substantially more for such data, could hurt our business.
OUR PLAN FOR REVENUE GENERATION MAY NOT BE VIABLE.
Our business plan contemplates that we will generate revenues from our
healthcare information business principally by:
- - licensing our data, Health Grades name and marks to highly-rated hospitals
and other healthcare providers for use in connection with their marketing
programs;
- - advising lower rated hospitals on improving their quality of care;
- - providing employers, payers and others with information for use by
employees or members in selecting providers and facilities available to
employees or members;
- - providing insurance underwriters, consumers and others with provider
quality reports;
15
However, we do not yet know whether we will be able to generate sufficient
revenues from these activities to be profitable. Specifically, we have not yet
generated substantial revenues from employers or payers, or from our quality
reports. In addition, we do not know whether a significant number of employers
or payers will view our rating and profile information as useful in connection
with their operations or whether our quality reports will be accepted by their
target markets. In addition, while we have entered into licensing agreements
with a number of hospitals, the use of Internet information in conjunction with
hospital and other provider marketing campaigns is a recently developed,
unproven concept. We may not be able to expand or retain acceptance by hospitals
and other providers.
FAILURE TO EFFECTIVELY MANAGE THE GROWTH OF OUR OPERATIONS AND INFRASTRUCTURE
COULD DISRUPT OUR OPERATIONS AND PREVENT US FROM BECOMING PROFITABLE
We are currently in an expansion mode as a company to increase our sales
efforts, attract new clients, maintain existing clients and develop new
products. We anticipate continued expansion during 2004, particularly in our
consulting area. To manage our growth, we must successfully attract qualified
consulting personnel to serve our clients as well as appropriately leverage our
consultants among our growing client base. Our existing operational plan may not
be sufficient to support our growth.
WE MAY BE SUED FOR INFORMATION WE OBTAIN OR INFORMATION RETRIEVED FROM OUR
WEBSITES OR OTHERWISE PROVIDED TO EMPLOYERS AND OTHERS.
We may be subjected to claims for defamation, negligence, copyright or
trademark or patent infringement, personal injury or other legal theories
relating to the information we publish on our websites or otherwise provide to
customers. These types of claims have been brought, sometimes successfully,
against online services as well as print publications in the past. We have
received threats from some providers that they will assert defamation and other
claims in connection with the information posted on our healthgrades.com
website.
We have had disputes with certain physicians with respect to the accuracy
of their data that is included in reports we sell to consumers and
professionals. Continuing to improve the accuracy of our data by both internal
process measures and obtaining data from various sources for comparative
purposes will continue to be important for us.
Patients who file lawsuits against providers often name as defendants all
persons or companies with any nexus to the providers. As a result, patients may
file lawsuits against us based on treatment provided by hospitals or other
facilities that are highly rated by us, or doctors who are identified on our
website or through other information that we provide. In addition, a court or
government agency may take the position that our delivery of health information
directly, or information delivered by a third-party website that a consumer
accesses through our website, exposes us to malpractice or other personal injury
liability for wrongful delivery of healthcare services or erroneous health
information. The amount of insurance we maintain with insurance carriers may not
be sufficient to cover all of the losses we might incur from these claims and
legal actions. In addition, insurance for some risks is difficult, impossible or
too costly to obtain, and as a result, we may not be able to purchase insurance
for some types of risks.
IF WE DO NOT STRENGTHEN RECOGNITION OF OUR BRAND NAME, OUR ABILITY TO EXPAND OUR
BUSINESS WILL BE IMPAIRED.
To expand our audience of online users and increase our online traffic and
increase interest in our other healthcare information services, we must
strengthen recognition of our brand name. To be successful in this effort,
consumers must perceive us as a trusted source of healthcare information;
hospitals and other providers must perceive us as an effective marketing and
sales channel for their services and products; and employees, payers, insurers,
consumers and others must perceive us as a source of valuable information that
can be used to enhance the quality and cost-effectiveness of healthcare. We may
be required to increase substantially our marketing budget in our efforts to
strengthen brand name recognition. Our business will suffer if our efforts are
not productive.
OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO ATTRACT, RETAIN AND MOTIVATE HIGHLY
SKILLED EMPLOYEES.
Our ability to execute our business plan and be successful depends upon our
ability to attract, retain and motivate highly skilled employees when needed. We
rely on the continued services of our senior management and other personnel. If
we are able to expand our business, we will need to hire additional personnel to
support our operations. We may be unable to retain our key employees or attract
or retain other highly qualified employees in the future. If we do not succeed
in attracting new personnel as needed and retaining and motivating our current
personnel, our business will suffer.
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WE MAY EXPERIENCE SYSTEM FAILURES THAT COULD INTERRUPT OUR SERVICES.
The success of our healthgrades.com website and activities related to the
website will depend on the capacity, reliability and security of our network
infrastructure. We rely on telephone communication providers to provide the
external telecommunications infrastructure necessary for Internet
communications. We will also depend on providers of online content and services
for some of the content and applications that we make available through
healthgrades.com. Any significant interruptions in our services or an increase
in response time could result in the loss of potential or existing users or
customers. Although we maintain insurance for our business, we cannot guarantee
that our insurance will be adequate to compensate us for losses that may occur
or to provide for costs associated with business interruptions.
We must be able to operate our website 24 hours a day, 7 days a week,
without material interruption. To operate without interruption, we and our
content providers must guard against:
- - damage from fire, power loss and other natural disasters;
- - communications failures;
- - software and hardware errors, failures or crashes;
- - security breaches, computer viruses and similar disruptive problems; and
- - other potential interruptions.
Our website may be required to accommodate a high volume of traffic and
deliver frequently updated information. Our website users may experience slower
response times or system failures due to increased traffic on our website or for
a variety of other reasons. We could experience disruptions or interruptions in
service due to the failure or delay in the transmission or receipt of this
information. Any significant interruption of our operations could damage our
business.
OUR PROPRIETARY RIGHTS MAY NOT BE FULLY PROTECTED, AND WE MAY BE SUBJECT TO
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS BY OTHERS.
Our failure to adequately protect our intellectual property rights could
harm our business by making it easier for our competitors to duplicate our
services. We have three trademarks that have been registered with the U.S.
Patent and Trademark Office. In addition, we require some of our employees to
enter into confidentiality and invention assignment agreements and, in more
limited cases, non-competition agreements. Nevertheless, our efforts to
establish and protect our proprietary rights may be inadequate to prevent
imitation of our services or branding by others or may be subject to challenge
by others. Furthermore, our ability to protect some of our proprietary rights is
uncertain since legal standards relating to the validity, enforceability and
scope of intellectual property rights in Internet related industries are
uncertain and are still evolving.
In addition to the risk of failing to adequately protect our proprietary
rights, there is a risk that we may become subject to a claim that we infringe
upon the proprietary rights of others. Although we do not believe that we are
infringing upon the rights of others, third parties may claim that we are doing
so. The possibility of inadvertently infringing upon the proprietary rights of
another is increased for businesses such as ours because there is significant
uncertainty regarding the applicability to the Internet of existing laws
regarding matters such as copyrights and other intellectual property rights. A
claim of intellectual property infringement may cause us to incur significant
expenses in defending against the claim. If we are not successful in defending
against an infringement claim, we could be liable for substantial damages or may
be prevented from offering some aspects of our services. We may be required to
make royalty payments, which could be substantial, to a party claiming that we
have infringed their rights. These events could damage our business.
WE MAY LOSE BUSINESS IF HOSPITALS AND OTHERS UTILIZE OUR NAME AND RATINGS
WITHOUT OUR PERMISSION
In order for a hospital to use our name and ratings information, we require
them to enter into a marketing agreement with us. However, hospitals, the media
and others may take the position that certain use of our ratings is "fair use"
and not proprietary. We will need to continue to enforce the protection of our
proprietary information and aggressively pursue hospitals and others that
utilize our name and ratings information without our permission.
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WE MAY LOSE BUSINESS IF WE ARE UNABLE TO KEEP UP WITH RAPID TECHNOLOGICAL OR
OTHER CHANGES.
If we are unable to keep up with changing technology and other factors
related to our market, we may be unable to attract and retain users or
customers, which would reduce or limit our revenues. The markets in which we
compete are characterized by rapidly changing technology, evolving technological
standards in the industry, frequent new service and product announcements and
changing consumer demand. Our future success will depend on our ability to adapt
to these changes, and to continuously improve the content, features and
reliability of our services in response to competitive service and product
offerings and the evolving demands of the marketplace. In addition, the
widespread adoption of new Internet networking or telecommunications
technologies or other technological changes could require us to incur
substantial expenditures to modify or adapt our website or infrastructure, which
might negatively affect our ability to become or remain profitable.
OUR BUSINESS WILL SUFFER IF WE ARE NOT ABLE TO COMPETE SUCCESSFULLY.
The market for healthcare information is new, rapidly evolving and
competitive. We expect competition to increase significantly, and our business
will be adversely affected if we are unable to compete successfully. We
currently compete, or potentially compete, with many providers of healthcare
information services and products, both online and through traditional means. We
compete, directly and indirectly, for users and customers principally with:
- - data providers that provide detailed utilization and outcomes information
to hospitals;
- - healthcare consulting companies;
- - companies or organizations providing or maintaining online healthcare
information;
- - vendors of healthcare information, products and services distributed
through other means, including direct sales, mail and fax messaging;
- - companies and organizations providing or maintaining general purpose
consumer online services that provide access to healthcare content and
services;
- - companies and organizations providing or maintaining public sector and
non-profit websites that provide healthcare information and services
without advertising or commercial sponsorships;
- - companies and organizations providing or maintaining web search and
retrieval services and other high-traffic websites; and
- - publishers and distributors of traditional media, some of which have
established or may establish websites
Some of these competitors are larger, have greater resources and have more
experience in providing healthcare information than us.
RISKS RELATED TO HEALTHCARE INFORMATION AND THE INTERNET
HEALTHCARE REFORMS AND THE COST OF REGULATORY COMPLIANCE COULD NEGATIVELY AFFECT
OUR BUSINESS.
The healthcare industry is heavily regulated. In the ordinary course of
business, healthcare entities and companies that do business with them are
subject to state and federal regulatory scrutiny, supervision, oversight and
control. These various laws, regulations and guidelines affect, among other
matters, the provision, licensing, labeling, marketing, promotion and
reimbursement of healthcare services and products. Our failure or the failure of
our customers to comply with any applicable legal or regulatory requirements, or
any investigation or audit of our or our customers' practices could:
- - result in limitation or prohibition of business activities;
- - subject us or our customers to legal fees and expenses and adverse
publicity; or
- - increase the costs of regulatory compliance and, if found by a court of
competent jurisdiction to have engaged in improper
18
practices, subject us or our customers to criminal or civil monetary fines
or other penalties
A federal law commonly known as the Medicare/Medicaid Anti-kickback Law,
prohibits kickbacks, rebates and bribes in return for referrals. This law
provides an extremely broad base for finding violations. Indeed, any
remuneration, direct or indirect, offered, paid, solicited or received in return
for referrals of patients or business for which payment may be made in whole or
in part under Medicare or Medicaid could be considered a violation of law. The
statute also prohibits payments made to anyone to induce them to "recommend
purchasing, leasing or ordering any good, facility, service or item for which
payment may be made in whole or in part" by Medicare. Similar laws exist in some
states.
We believe that our operations comply with applicable legal regulatory
requirements of the anti-kickback laws. Nevertheless, some of these laws have
been applied to payments by physicians for marketing and referral services and
could constrain our relationships, including financial and marketing
relationships with customers such as hospitals. It is possible that additional
or changed laws, regulations or guidelines could be adopted in the future.
Criminal provisions prohibit the knowing filing of false claims or making
false statements or causing false statements to be made by others, and civil
provisions prohibit the filing of claims that one knows or should have known
were false. Criminal penalties include fines and imprisonment. Civil penalties
include fines of up to $10,000 per claim plus treble damages, for each filed
claim. Although we are not filing claims ourself, liability under the statutes
can extend to those who "cause claims to be presented." To the extent that
consulting advice provided to our customers could be construed as aiding or
abetting the presentation of false claims by the customers, we could be subject
to false claims liability.
THE INTERNET IS SUBJECT TO MANY LEGAL UNCERTAINTIES AND POTENTIAL GOVERNMENT
REGULATIONS THAT MAY DECREASE USAGE OF OUR WEBSITE, INCREASE OUR COST OF DOING
BUSINESS OR OTHERWISE HAVE A DAMAGING EFFECT ON OUR BUSINESS.
Any new law or regulation pertaining to the Internet, or the application or
interpretation of existing laws, could decrease usage for our website, increase
our cost of doing business or otherwise cause our business to suffer.
Laws and regulations may be adopted in the future that address
Internet-related issues, including online content, user privacy, pricing and
quality of products and services. This legislation could increase our cost of
doing business and negatively affect our business. Moreover, it may take years
to determine the extent to which existing laws governing issues like property
ownership, libel, negligence and personal privacy are applicable to the
Internet. Currently, U.S. privacy law consists of disparate state and federal
statutes regulating specific industries that collect personal data. Most of them
predate and therefore do not specifically address online activities. In
addition, a number of comprehensive legislative and regulatory privacy proposals
are now under consideration by federal, state and local governments in the
United States.
OUR BUSINESS COULD BE IMPAIRED BY STATE AND FEDERAL LAWS DESIGNED TO PROTECT
INDIVIDUAL HEALTH INFORMATION.
If we fail to comply with current or future laws or regulations governing
the collection, dissemination, use and confidentiality of patient health
information, our business could suffer.
Consumers sometimes enter private information about themselves or their
family members when using our services. Also, our systems record use patterns
when consumers access our databases that may reveal health-related information
or other private information about the user. In addition, information regarding
employee usage of healthcare providers and facilities can also be compiled by
our systems in connection with services we offer to employers and other payers.
Numerous federal and state laws and regulations govern collection,
dissemination, use and confidentiality of patient-identifiable health
information, including:
- - state privacy and confidentiality laws;
- - state laws regulating healthcare professionals, such as physicians,
pharmacists and nurse practitioners;
- - Medicaid laws;
- - the Health Insurance Portability and Accountability Act of 1996 and related
rules proposed by the Health Care Financing Administration; and
19
- - CMS standards for Internet transmission of health data
Congress has been considering proposed legislation that would establish a
new federal standard for protection and use of health information. While we are
not gathering patient health information at this time, other third-party
websites that consumers access through our website and employees, payers and
other customers may not maintain systems to safeguard any health information
they may be collecting. In some cases, we may place our content on computers
that are under the physical control of others, which may increase the risk of an
inappropriate disclosure of information. For example, we contract out the
hosting of our website to a third party. In addition, future laws or changes in
current laws may necessitate costly adaptations to our systems.
ONLINE SECURITY BREACHES COULD HARM OUR BUSINESS.
Our security measures may not prevent security breaches. Substantial or
ongoing security breaches on our system or other Internet-based systems could
reduce user confidence in our website, causing reduced usage that adversely
affects our business. The secure transmission of confidential information over
the Internet is essential to maintain confidence in our websites. We believe
that consumers generally are concerned with security and privacy on the
Internet, and any publicized security problems could inhibit the growth of the
Internet and, therefore, our provision of healthcare information on the
Internet.
We will need to incur significant expense to protect and remedy against
security breaches when we identify a significant business risk. Currently, we do
not store sensitive information, such as patient information or credit card
information, on our websites. If we launch services that require us to gather
sensitive information, our security expenditures will increase significantly.
A party that is able to circumvent our security systems could steal
proprietary information or cause interruptions in our operations. Security
breaches could also damage our reputation and expose us to a risk of loss or
litigation and possible liability. Our insurance policies may not be adequate to
reimburse us for losses caused by security breaches. We also face risks
associated with security breaches affecting third parties conducting business
over the Internet or customers and others who license our data.
OTHER RISKS
OUR OFFICERS AND DIRECTORS MAINTAIN SIGNIFICANT CONTROL OF HEALTH GRADES, INC.
As of December 31, 2003, our current executive officers and directors and
entities with which they are affiliated beneficially own approximately 33.2% of
our outstanding common stock. In addition, Essex Woodlands Health Ventures Fund
IV, L.P. holds approximately 38.4% of our outstanding common stock. If our
officers, directors and Essex Woodlands act together, they will be able to
control the management and affairs of Health Grades, Inc. and will have the
ability to control all matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions. This
concentration of ownership may have the effect of delaying, deferring or
preventing an acquisition of us and may adversely affect the market price for
our common stock.
OUR CERTIFICATE OF INCORPORATION AND BYLAWS INCLUDE ANTI-TAKEOVER PROVISIONS
THAT MAY DETER OR PREVENT A TAKEOVER ATTEMPT.
Some provisions of our certificate of incorporation and bylaws and
provisions of Delaware law may deter or prevent a takeover attempt, including an
attempt that might result in a premium over the market price for our common
stock. Our certificate of incorporation requires the vote of 66 2/3% of the
outstanding voting securities in order to effect certain actions, including a
sale of substantially all of our assets, certain mergers and consolidations and
our dissolution or liquidation, unless these actions have been approved by a
majority of the directors. Our certificate of incorporation also authorizes our
Board of Directors to issue up to 2,000,000 shares of preferred stock having
such rights as may be designated by our Board of Directors, without stockholder
approval. Our bylaws provide that stockholders must follow an advance
notification procedure for certain nominations of candidates for the Board of
Directors and for certain other stockholder business to be conducted at a
stockholders meeting. The General Corporation Law of Delaware restricts certain
business combinations with interested stockholders upon their acquisition of 15%
or more of our common stock.
All of these provisions could make it more difficult for a third party to
acquire, or could discourage a third party from attempting to acquire, control
of us.
20
WE HAVE NO INTENTION TO PAY DIVIDENDS ON OUR COMMON STOCK.
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain all future earnings to finance the expansion of our
business.
Item 2. Properties
We have a lease for our approximately 15,100 square foot headquarters
facility in Lakewood, Colorado, which expires on February 15, 2005. Our annual
lease payments for this facility are approximately $270,000.
Item 3. Legal Proceedings
On or about October 10, 2002, Strategic Performance Fund - II ("SPF-II")
commenced an action in the Circuit Court of the 17th Judicial Circuit in and for
Broward County, Florida against us, alleging breach of two leases. These leases
relate to two buildings in which one of our former affiliated practices,
Orthopaedic Associates, P.A. d/b/a Park Place Therapeutic Center ("Park Place")
leased office space. Park Place ceased the payment of its rental obligations
with respect to the two leases in May 2000, and subsequently filed a petition
for bankruptcy, under Chapter 11 of the Bankruptcy Code, in the United States
Bankruptcy Court, Southern District of Florida, Ft. Lauderdale Division. SPF-II
sought damages against HealthGrades in the amount of approximately $4.7 million.
The basis of the allegation against HealthGrades was that while under the
corporate name of Specialty Care Network, Inc., we entered into an Assignment,
Assumption and Release Agreement dated July 8, 1997, under which we assumed the
obligations of Orthopaedic Management Services, Inc., as lessee, under its Lease
Agreement with the owner and lessor, Park Place Orthopaedic Center II, Ltd. The
agreement was executed in connection with our acquisition of most of the
non-medical assets of the Park Place practice. On October 1, 1997, the owner of
the leased property sold its interests in the leasehold estates to SPF-II, Inc.
On June 10, 1999, we sold the assets of the Park Place practice, including the
leasehold interests, back to Park Place and entered into an Absolute Assignment
and Assumption Agreement with Park Place, under which Park Place agreed to
indemnify us in connection with the leasehold obligations. In addition, we
entered into an Indemnification Agreement with Park Place and its individual
physician owners, under which the individual physician owners (severally up to
their ownership interest in the practice) agreed to indemnify us in connection
with the leasehold obligations. SPF-II claimed that, notwithstanding the
assignment of our leasehold interests to Park Place, HealthGrades remained
liable for all lessee obligations under the leases.
We filed a response to the initial complaint instituted by SPF-II, denying
all liability with respect to the subject leases. In addition, we filed a
third-party complaint against the individual physician owners seeking
indemnification from each of these individuals under the terms of the
Indemnification Agreement. The physician owners filed a response to our
complaint denying their liability under the Indemnification Agreement, and
asserting several affirmative defenses, including, among others, our failure to
mitigate damages, lack of consideration, our assertion of a premature claim as
liability and damages had not been established by SPF-II, rejection of the
leases by the bankruptcy court, and, in the case of one physician owner, a claim
that an "agent" of ours (who was, in fact, an employee of Park Place both before
and after our affiliation with the practice) fraudulently induced the purchase
of the Park Place practice's assets from us. The physician owners also filed a
motion to enjoin further prosecution of the action instituted against them by
HealthGrades and Bank of America, the lender in connection with their repurchase
of the assets of the Park Place practice, pending resolution of the bankruptcy
proceeding.
In November 2003, we executed a Settlement Agreement and Mutual Release
(the "Settlement Agreement") with SPF-II and four of the physician owners. In
consideration for the dismissal of all claims and mutual releases, HealthGrades
paid approximately $441,000 into an escrow account to be released to SPF-II upon
the occurrence, on or before September 25, 2004 of (i) the bankruptcy court
approval of Chapter 11 plans relating to Park Place and the four physician
owners and (ii) the payment of a specified amount to SPF-II pursuant to the
Chapter 11 plans. In addition, HealthGrades agreed to pay $50,000 to SPF-II on
or before September 25, 2004.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Executive Officers of the Registrant
The following table sets forth certain information concerning the executive
officers of the Company:
21
NAME AGE POSITION
Kerry R. Hicks.......................... 44 President, Chief Executive Officer
David G. Hicks.......................... 46 Executive Vice President-Information
Technology
Allen Dodge............................. 36 Senior Vice President-Finance, CFO &
Treasurer
Peter A. Fatianow....................... 40 Senior Vice President-Corporate Services
Sarah Loughran.......................... 39 Senior Vice President-Provider Services
Michael D. Phillips..................... 46 Senior Vice President-Provider Sales
John R. Morrow.......................... 44 Senior Vice President-Strategic Development
KERRY R. HICKS, one of our founders, has served as our Chief Executive Officer
since our inception in 1995. He also served as our President from our inception
until November 1999 and since March 2002.
DAVID G. HICKS has served as our Executive Vice President - Information
Technology since November 1999. He was Senior Vice President of Information
Technology from May 1999 to November 1999 and Vice President of Management
Information Systems from March 1996 until May 1999.
ALLEN DODGE, has served as Senior Vice President - Finance and Chief Financial
Officer since May 2001. He was Vice President - Finance/Controller from March
2000 to May 2001 and Corporate Controller from September 1997 to March 2000. Mr.
Dodge is a Certified Public Accountant.
PETER A. FATIANOW has served us in several capacities since February 1999,
including as our Senior Vice President - Corporate Services since March 2000.
SARAH LOUGHRAN has served us in several capacities since 1998, including as our
Senior Vice President - Provider Services since December 2001.
MICHAEL D. PHILLIPS has served as Senior Vice President - Provider Sales since
December 2001. He was our Vice President of Provider Sales from April 2000 until
December 2001. Prior to joining HealthGrades, Mr. Phillips was Vice President of
Sales at HCIA-Sachs (later named Solucient LLC) from January 1999 to February
2000 and Vice President of Sales for LBA Healthcare Management from October 1986
to December 1998.
JOHN R. MORROW has served as Senior Vice President - Strategic Development since
February 2003. From June 2000 to January 2003, he was a self-employed
consultant. From November 1999 to May 2000, Mr. Morrow served as Senior Vice
President and Publisher for HCIA-Sachs LLC (later named Solucient LLC). From
August 1998 to November 1999 Mr. Morrow served as Senior Vice President and
Publisher for HCIA, Inc. During his term with HCIA and Solucient, Mr. Morrow was
responsible for the Syndicated Products business units and 100 Top Hospitals
Programs and Corporate Channel Relationships.
Kerry R. Hicks and David G. Hicks are brothers.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The following table sets forth the high and low sales prices for our Common
Stock for the quarters indicated as reported by the OTC Bulletin Board (OTCBB).
HIGH LOW
-------- -----
Year Ended December 31, 2002
First Quarter.................................... $ .17 $ .05
Second Quarter .................................. .10 .04
Third Quarter.................................... .09 .05
Fourth Quarter................................... .10 .02
Year Ended December 31, 2003
First Quarter.................................... $ .06 $ .03
Second Quarter .................................. .61 .04
Third Quarter.................................... .45 .20
Fourth Quarter................................... .62 .25
22
We have never paid or declared any cash dividends and do not anticipate paying
any cash dividends in the foreseeable future. We currently intend to retain any
future earnings for use in our business.
Item 6. Selected Financial Data
Statement of Operations Data
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2003 2002 2001 2000 1999
---------------- ---------------- ---------------- ---------------- -------------
Ratings and advisory revenue $ 8,803,929 $ 5,091,891 $ 3,088,451 $ 1,578,979 $ 407,577
Physician practice service fees -- 195,492 551,925 4,249,658 28,948,397
Loss from operations (1,275,850) (1,770,555) (7,620,773) (7,355,737) (2,599,167)
(Loss) income before cumulative effect of a
change in accounting principle (1,283,687) (562,482) (7,367,243) (7,544,746) 964,930
Net (loss) income $(1,283,687) $(1,650,793)(1) $(7,367,243) $(7,544,746) $ 964,930
=========== =========== =========== =========== ===========
Net (loss) income per common share (basic) $ (0.05) $ (0.05)(1) $ (0.30) $ (0.39) $ 0.07
=========== =========== =========== =========== ===========
Weighted average number of common shares
used in computation (basic) 26,679,467 36,189,748 24,399,699 19,535,841 14,202,748
=========== =========== =========== =========== ===========
Net (loss) income per common share (diluted) $ (0.05) $ (0.05)(1) $ (0.30) $ (0.39) $ 0.07
=========== =========== =========== =========== ===========
Weighted average number of common
shares and common share equivalents
used in computation (diluted) 26,679,467 36,189,748 24,399,699 19,535,841 14,817,732
=========== =========== =========== =========== ===========
(1) - Net loss for the year ended December 31, 2002 includes an impairment
charge of approximately $1.1 million related to a cumulative effect of a change
in accounting principle due to our adoption of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets. In addition, net loss
also includes an income tax benefit of approximately $1.0 million related to the
carryback of our 2001 tax loss.
Balance Sheet Data
DECEMBER 31, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 1999
----------------- ----------------- ----------------- ----------------- -----------------
Working capital (deficit) (1,820,137) 44,207 161,324 4,292,698 1,383,945
Total assets 8,821,239 7,117,551 7,747,904 14,371,174 20,392,868
Total long-term debt -- -- -- -- 8,803,283
Total short-term debt -- -- -- 1,559,213 7,702,005
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
In evaluating our financial results and financial condition, management has
focused principally on the following:
- - Revenue Growth - We believe this is the key factor affecting both our
results of operations and our liquidity. In 2003, our increased revenues
reflected our success in adding new hospital customers to our Distinguished
Hospital (DHP), Strategic Quality Initiative (SQI), Quality Assessment and
Improvement (QAI) programs and in retaining clients who enrolled in these
programs in prior years. As our base of hospital clients grows, a principal
goal will be to achieve a high rate of retention of our hospital clients.
We retained agreements with 79% of the hospitals whose contracts had second
or third year anniversary dates in 2003. In addition, 40% of hospitals
where contracts expired during 2003 signed new agreements with us. We
typically receive a non-refundable payment for the first year of the
contract term (which is typically three years, subject to a cancellation
right by either the client or us, on each annual anniversary date) upon
contract execution. Because we typically receive payment in advance for
each year of the term of these agreements, if we cannot continue to attract
new hospital clients and retain a significant portion of our current
clients, our liquidity could be adversely affected. Management is focused
on increasing revenues in other areas of our business as well. We believe
the principal risk we confront in this regard is that we may be unable to
effect market penetration and growth in these other areas.
23
- - Operating Expense Considerations - During 2003, we added personnel to
provide client consulting and support for our DHP, SQI and QAI programs, as
well as personnel in our information technology department who work on
existing and future client services. We anticipate that we will continue to
add client consultants, some information technology personnel and,
possibly, additional administrative support personnel during 2004 as we
continue to grow our revenue base. Moreover, we believe it is important to
provide appropriate compensation and incentives to those employees who
contribute to the further growth of our company. Cash bonuses of
approximately $708,000 are reflected in the consolidated statement of
operations for the year ended December 31, 2003. Approximately $400,000 of
these bonuses were paid in January 2004. We anticipate that we will have a
cash bonus program in 2004, the amount of which will be dependent upon our
company performance. Management recognizes that any increases in expenses
to accommodate such growth must be applied in a disciplined fashion so as
to enable us to obtain meaningful benefits from the standpoint of our
operations and cash flows.
- - Liquidity - Although we continued to incur net losses in 2003, we have made
meaningful advances in cash generation from operations. In 2003, we
generated cash flow from operations of approximately $1,300,000. As noted
above under "Revenue Growth" we typically receive payment in advance for
the annual term of our agreements. As a result of sales efforts during
2003, advance payments received for the annual terms of most of our
agreements contributed substantially to our cash flow. Although we
generated $1,300,000 in cash flow from operations, our working capital
declined from approximately $44,000 at December 31, 2002 to a working
capital deficit of approximately $1,800,000 at December 31, 2003. However,
we believe that the components of our working capital deficit reflect the
growth of our business, rather than a short-term liquidity constraint. In
this regard, approximately 79% of our current liabilities as of December
31, 2003 consist of deferred income, which reflects advance payments under
contracts relating to our DHP, SQI and QAI programs. These amounts will be
amortized into revenues over the terms of the contracts.
As more fully described in Note 7 to our consolidated financial statements
included in this report, in October 2003 we repaid the remaining balance
due under our term loan with Silicon Valley Bank, and in November 2003 we
agreed to pay approximately $491,000 to settle our lawsuit with SPF-II as
further described in Note 13 to our consolidated financial statements. In
December 2003, $441,000 of this amount was paid into escrow and was removed
from our consolidated balance sheet. The remaining $50,000 has been
recorded as an accrued expense in our consolidated balance sheet and will
be paid on or before September 30, 2004 assuming that, as we anticipate,
the conditions to such payment are satisfied. The entire $491,000 was
recorded as an expense in our consolidated statement of operations for the
year ended December 31, 2003.
We believe our cash resources are sufficient to support ongoing operations
for the next twelve months. Nevertheless, we confront the risk that our
inability to generate revenues as expected could compel us to seek
additional financing.
Critical Accounting Estimates
In preparing our financial statements, management is required to make
estimates and assumptions that, among other things, affect the reported amounts
of assets, revenues and expenses. These estimates and assumptions are most
significant where they involve levels of subjectivity and judgment necessary to
account for highly uncertain matters or matters susceptible to change, and where
they can have a material impact on our financial condition and operating
performance. We discuss below the more significant estimates and related
assumptions used in the preparation of our consolidated financial statements,
namely those relating to our goodwill impairment assessment. If actual results
were to differ materially from the estimates made, the reported results could be
materially affected. Our senior management has discussed the application of
these estimates with our Audit Committee.
Goodwill Impairment
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142), requires companies to perform an annual test of
goodwill for impairment. SFAS 142 also states that if a valuation technique is
used that considers multiple sources of information, such as an average of the
quoted market prices of the reporting unit over a specific time period and the
results of a present value technique, the company should apply that technique
consistently period to period (i.e., in the required annual impairment analysis
in subsequent years).
Consistent with the techniques used in prior impairment tests, for our 2003
annual impairment test, we applied an approach that provided equal weight to
market capitalization (adjusted to reflect a 20% "control premium") and a
probability-weighted average of future cash flows. As the majority of our
outstanding shares are owned by management and a venture capitalist investor, we
believe a premium to market of 20% is reasonable to give effect to additional
benefits a purchaser would derive from control of HealthGrades. However, we
reduced this premium from the 30% used in prior tests due to our purchase of
12,004,333 shares in 2003 from another venture capital investor.
24
Consistent with the methodology we used in prior years, we developed a
range of possible cash flows and derived a probability-weighted average of the
range of possible amounts to determine the expected cash flow over a five-year
period. In connection with our utilization of the expected future cash flow
approach for our present value measurements, we believe that the appropriate
discount rate to utilize for application to future cash flow estimates is the
risk-free rate of interest over the time period of the expected cash flows (or
five years in our case). This is due to the fact that in our expected cash
flows, we have already built in our assumptions concerning the uncertainty of
cash flows. Therefore, we believe these risk assumptions should not be taken
into account again in determining our discount rate.
The annual impairment tests performed during the fourth quarters of 2003
and 2002 resulted in no additional impairment to our goodwill balance. In
accordance with the requirements of FAS 142, we will perform the annual
impairment test in the fourth quarter of each year or, if indicators of
impairment arise at an interim date, earlier in the year. Any impairment
identified during the annual impairment tests will be recorded as an operating
expense in our consolidated statement of operations. We expect to continue to
utilize the combined market capitalization and expected cash flow approach
described above to perform our annual impairment analysis and, if necessary,
interim tests.
Evolving Accounting Guidance Regarding Revenue Recognition
Guidance on revenue recognition has and continues to evolve. In order to
assist readers of our financial statements to better understand our results of
operations, we have set forth below an explanation of how we record revenues for
our most significant revenue sources.
We currently derive our ratings and advisory revenue principally from
annual fees paid by hospitals that participate in our Strategic Quality
Initiative (SQI), Distinguished Hospital (DHP) and Quality Assessment and
Improvement (QAI) programs. The SQI program provides business development tools
to hospitals that are highly rated on our website. Under our SQI program, we
license to hospital customers the use of the HealthGrades name and our "report
card" ratings. The license may be in a single area (for example, Cardiac) or
multiple areas (for example, Cardiac, Neurosciences and Orthopedics.) We also
assist hospitals in promoting their ratings and measuring the success of their
efforts utilizing our in-house healthcare consultants. Another key feature of
the SQI program is a detailed comparison of the data underlying a hospital's
rating to local and national benchmarks. Similar to our SQI program, our DHP
program provides Distinguished Hospital Awards (DHA) winners with the
opportunity to enter into a licensing agreement with us so that they can enhance
their marketing efforts by publicizing this award. Our QAI program is
principally designed to help a hospital measure and improve the quality of its
care in particular areas where it has lower ratings. Using our database and
focusing on a particular hospital's information and ratings, we can help
identify areas to improve quality and measure how well the hospital performs
relative to national and regional best practices.
We recognize revenue related to our SQI and DHP arrangements in a
straight-line manner over the term of the agreement. We follow this method
because the primary deliverables under the agreement are the license to utilize
our ratings and consulting services over the contract term. We typically receive
a non-refundable payment for the first year of the contract term (which is
typically three years, subject to a cancellation right by either the client or
us, on each annual anniversary date) upon contract execution. We record the cash
payment as deferred revenue that is then amortized to revenue over the first
year of the term. Annual renewal payments, which are made in advance of the year
to which the payment relates, are treated in the same manner.
In November 2002, the Emerging Issues Task Force (EITF) reached a final
consensus regarding EITF 00-21, Revenue Arrangements with Multiple Deliverables
(EITF 00-21). The consensus provides that revenue arrangements with multiple
deliverables should be divided into separate units of accounting if certain
criteria are met. The consideration for the arrangement should be allocated to
the separate units of accounting based on their relative fair values, subject to
different reporting guidance if the fair value of all deliverables are not known
or if the fair value is contingent on delivery of specified items or performance
conditions. Applicable revenue recognition criteria should be considered
separately for each separate unit of accounting. EITF 00-21 became effective for
revenue arrangements entered into in fiscal periods beginning after June 15,
2003.
During the quarter ended March 31, 2003, we completed our analysis of EITF
00-21. We examined our QAI - Phase I contracts (formerly known as Ratings
Quality Analysis or "RQA"), QAI - Phase II contracts (formerly known as Quality
Assessment and Improvement or "QAI") and SQI contracts to determine if the
adoption of EITF 00-21 would have any impact on our revenue recognition
policies. As our QAI - Phase I contracts consist of a single deliverable (as
defined by EITF 00-21), namely a comprehensive quality analysis, no change was
required with respect to our policy of recognizing revenue under these
arrangements at the point in time that the services are delivered. In addition,
as our QAI - Phase II contracts consist of consulting services provided over the
term of the contract, (typically on a quarterly basis), we determined that no
change was required with respect to our policy of recognizing revenue under
these arrangements over the term of the contract on a straight-line basis.
25
Our SQI and DHP contracts contain both an analysis of quality outcomes data
as well as a license to utilize our name and certain ratings information for an
annual period. Based upon our analysis, we concluded that there was not reliable
and verifiable evidence of fair value with which to allocate, between the two
deliverables, the consideration received. Moreover, one of the primary
deliverables under these agreements is the license to utilize our name and
certain ratings information for an annual term. In this regard, although we do
sell an analysis of quality outcomes data separately via our QAI - Phase I
contracts, these contracts are generally sold to clients that have lower quality
ratings (as rated by us) and thus may be deemed to have a more significant value
than the quality analysis imbedded within our SQI contracts. Furthermore, some
of our SQI clients never choose to receive the quality outcomes analysis
included within our SQI contracts. Based upon these factors, we concluded that
no change is required with respect to our policy of recognizing revenue under
these arrangements over the term of the contract on a straight-line basis.
Were we to recognize revenue for the quality outcomes data analysis in the
period in which the services were delivered, the amount of revenues reported in
any particular period would increase or decrease, depending on the timing of the
provision of these services
CONSOLIDATED STATEMENT OF OPERATIONS PRESENTATION
During 2002, we revised the presentation of our statement of operations by
making certain modifications to the classification of expenses. These
reclassifications have been made to all periods presented in this report. The
primary changes made were to add line items for cost of ratings and advisory
revenue and cost of physician practice management revenue, as well as to make
certain reclassifications from general and administrative expenses to both sales
and marketing and product development.
DILUTED EARNINGS PER SHARE
For each of the three years in the period ending December 31, 2003, our basic
and fully diluted earnings per share were based upon the same number of common
shares outstanding, with no effect given to outstanding options or warrants as
such securities would have had an antidilutive effect based on our net losses in
these years. However, as of December 31, 2003, options to purchase approximately
9.8 million shares of our common stock and warrants to purchase approximately
2.2 million shares of our common stock are currently outstanding. Exercise
prices for these stock options and warrants range from $0.04 to $11.75, as more
fully described in notes 6, 8 and 9 to our consolidated financial statements.
REVENUE AND EXPENSE COMPONENTS
The following descriptions of the components of revenues and expenses apply to
the comparison of results of operations.
Ratings and advisory revenue. We currently operate in one business segment. We
provide proprietary, objective healthcare provider ratings and advisory services
to our clients. We generate revenue by providing our clients with targeted
solutions that enable them to measure, assess, enhance and market healthcare
quality. Our target clients include hospitals, employers, benefits consulting
firms, payers, insurance companies and consumers.
Physician practice service fees. Physician practice service fees include
services fees and other revenue derived from our physician practice management
business. Our last contract to provide management services expired in September
2002. We no longer provide physician practice management services.
Cost of ratings and advisory revenue. Cost of ratings and advisory revenue
consists primarily of the costs associated with the delivery of services related
to our SQI, DHP and QAI programs, as well as the costs incurred to acquire the
data utilized in connection with these and other services. The cost of delivery
of services relates primarily to the client consultants and support staff that
provide our services.
Cost of physician practice management revenue. In 2001 and 2002, cost of
physician practice management revenue primarily consisted of consulting costs
related to the delivery of limited services to physician practices under
agreements that expired at various times through September 2002.
Sales and marketing costs. Sales and marketing costs include salaries, wages and
commission expenses related to our sales efforts, as well as other direct sales
and marketing costs. For our SQI, DHP and QAI agreements, we pay our sales
personnel commissions as we receive payment from our hospital clients. We
typically receive a non-refundable payment for the first year (and subsequent
years on each anniversary date) of the three-year contract term. In addition, we
record the commission expense in the period it is earned, which is typically
upon contract execution for the first year of the agreement and on each
anniversary date for clients that do not cancel in the second or third year of
the contract term. We record the commission expense in this manner because once
a contract is signed, the salesperson has no remaining obligations to perform in
order to earn the commission.
Product development costs. We incur product development costs related to the
development and support of our website and the development of applications to
support data compilation and extraction for our consulting services. These costs
(which consist primarily of salaries and benefits, consulting fees and other
costs related to software development, application development and operations
expense) are expensed as incurred.
General and administrative expenses. General and administrative expenses consist
primarily of salaries, employee benefits and other expenses
26
for employees that support the company infrastructure such as finance and
accounting personnel, certain information technology employees and some of our
support staff, facility costs, professional fees and insurance costs.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
REVENUE:
Ratings and advisory revenue
Ratings and advisory revenue was approximately $8.8 million for the year
ended December 31, 2003, an increase of approximately $3.7 million or 73% from
the year ended December 31, 2002. This increase reflects strong sales of our DHP
and SQI programs during 2003. The revenue growth reflects both new clients as
well as the sale of additional services (upsells) to current clients. Of the
total amount of additional business added during 2003 for the DHP, SQI and QAI
products, approximately 70% reflected sales to new clients and approximately 30%
related to sales of additional services to our existing clients. Our retention
of existing clients also contributed to our increased revenues. For our DHP, SQI
and QAI agreements that had second or third year anniversary dates during 2003,
we retained approximately 79% of these clients. Also contributing to our revenue
growth in 2003 was our sale of Healthcare Quality Reports. We began selling
these reports at the end of 2002.
For the year ended December 31, 2003, approximately 72% of our ratings and
advisory revenue was derived from our DHP and SQI programs. For the same period
of 2002, approximately 79% of our ratings and advisory revenue was derived from
our SQI programs. We had no DHP sales in 2002 as the program did not begin until
early 2003. Sales of our Quality Ratings Suite, Healthcare Quality Reports for
Consumers and Healthcare Quality Reports for Professionals accounted for
approximately 14% of revenues during 2003, compared to approximately 8% for the
same period of 2002. In addition, approximately 11% of our ratings and advisory
revenue for the year ended December 31, 2003 was derived from our QAI services,
compared to 10% for the same period in 2002.
Cost of ratings and advisory revenue
For the year ended December 31, 2003, cost of ratings and advisory revenue
was approximately $2.0 million, or approximately 22% of ratings and advisory
revenue, compared to $1.5 million, or 29% of revenue for the same period of
2002. The decrease is primarily due to a reduction in costs to acquire data.
During 2002, we renegotiated a data purchase agreement with a vendor, which
substantially reduced our cost to acquire certain physician data. In addition,
during 2003, as described above, we had strong sales of our DHP and SQI
programs. These programs do not have significant cost of sales as they are
primarily licensing and marketing arrangements. The costs incurred related to
these programs principally relate to the sales efforts, which are included in
sales and marketing.
Sales and marketing costs
Sales and marketing costs increased from approximately $2.1 million for the
year ended December 31, 2002 to $3.4 million for the year ended December 31,
2003, an increase of approximately 62%. As a percentage of ratings and advisory
revenue, sales and marketing costs decreased from approximately 41% for the year
ended December 31, 2002 to 38% for the same period of 2003. Sales and marketing
costs as a percentage of ratings and advisory revenue has decreased over the
prior year due to an increase in retained clients. We pay a lower percentage of
contract payments as commissions to our sales group upon the retention of
contracts (i.e., non-cancellation of contracts on their anniversary date and
signing of new contracts at the end of their term) than we pay with respect to
new contracts. Therefore, as our business expands, we anticipate that the
overall commission cost as a percentage of ratings and advisory revenue will
decline.
General and administrative expenses
For the year ended December 31, 2003, general and administrative expenses
were approximately $2.8 million, an increase of approximately $712,000 or 34%
over general and administrative expenses of approximately $2.1 million for the
same period of 2002. The increase relates to legal fees incurred during 2003 due
to the SPF-II litigation described in Note 13 to our consolidated financial
statements included in this report. General and administrative expenses do not
include the amount we agreed to pay to settle this litigation, which is reported
in the litigation settlement line item. Also contributing to the increase in
general and administrative expenses were 2003 cash bonuses.
27
Interest expense
For the year ended December 31, 2003, we incurred interest expense of
approximately $15,000 with respect to interest paid on a loan payable of
$500,000 that was outstanding for part of 2003. This note was completely repaid
in 2003.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
REVENUE:
Ratings and advisory revenue
Ratings and advisory revenue was approximately $5.1 million for the year
ended December 31, 2002; an increase of approximately $2.0 million or 65% from
the year ended December 31, 2001. This increase reflects our continued addition
of new customers while maintaining a high renewal rate with respect to current
customers. In 2002, approximately 79% of our ratings and advisory revenue was
derived from our strategic quality initiative (SQI) services. Approximately 10%
of our ratings and advisory revenue was derived from our quality assessment and
improvement (QAI) services.
Sales and marketing
Sales and marketing costs include salaries, wages and commission expenses
related to our sales efforts, as well as other direct sales and marketing costs.
For our SQI and QAI agreements, we pay our sales personnel commissions as we
receive payment from our hospital clients. Although we typically record revenue
earned from our SQI and QAI agreements over the term of the agreement (typically
one year), we record the commission expense in the period it is earned, which is
typically upon contract execution. We record the commission expense in this
manner, because once a contract is signed, the salesperson has no remaining
obligations to perform in order to earn the commission.
Sales and marketing costs decreased from approximately $3.2 million for the
year ended December 31, 2001, to approximately $2.1 million for the same period
of 2002. This decrease is primarily the result of personnel reductions that
occurred during the latter part of 2001.
General and administrative
For the year ended December 31, 2002, general and administrative expenses
were approximately $2.1 million, compared to approximately $3.7 million for the
same period of 2001. Contributing to this 42% decrease was a significant
reduction in salaries and wages expenses in 2001, due to certain voluntary and
involuntary employee reductions during 2001. Professional fees also decreased
substantially as a result of cost reductions in areas such as consulting, legal
and investor relations. During the second quarter of 2001, we also incurred a
non-recurring financing fee of approximately $162,000. Finally, we decreased
costs in several additional areas as a result of a cost reduction effort
initiated during 2001.
Income tax benefit
On March 9, 2002, President Bush signed into law the Job Creation and
Worker Assistance Act of 2002 ("JCWA Act"). One of the provisions of the JCWA
Act extended the net operating loss carryback provisions of the Internal Revenue
Code from two years to five years for losses incurred in 2001 and 2002. Prior to
the passage of the JCWA Act we did not have the ability to utilize our 2001 tax
loss to reduce prior year taxable income because we had no taxable income in
2000 or 1999. However, with the passage of the JCWA Act, we were able to
carryback our 2001 tax loss to reduce taxable income in 1997. In April 2002, we
filed an Application for Tentative Refund for the 1997 tax year. We received the
tax refund, which amounted to approximately $1.0 million, in May 2002.
Cumulative effect of change in accounting principle
Based upon the results of the transitional impairment test performed on our
goodwill as required by SFAS 142, we recorded a charge of approximately $1.1
million in our consolidated statement of operations for the quarter ended June
30, 2002, as a cumulative effect of change in accounting principle. See Note 5
to our consolidated financial statements included in this Form 10-K for further
discussion of the application of SFAS 142.
28
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, we had a working capital deficit of approximately
$1,820,000, a decrease of $1,864,000 from working capital of approximately
$44,000 as of December 31, 2002. For the year ended December 31, 2003, cash flow
provided by operations was approximately $1,333,000, compared to $444,000
provided by operations for the same period of 2002. Included in cash flow
provided by operations for the year ended December 31, 2002 was an income tax
refund of approximately $1,000,000 related to the carryback of our 2001 tax loss
to reduce taxable income in 1997 made possible by the JCWA Act of 2002. This
apparent disparity between the decline in our working capital and increase in
cash flow provided by operations is due to an increase in deferred income of
approximately $2,534,000 (partially offset by an increase in accounts receivable
of approximately $1,013,000), reflecting increased contractual payments that we
received but will be recognized as revenue on a straight-line basis over the
term of the contract. The payments we received significantly offset the effect
of our operating loss on our cash balance. Also contributing to our decrease in
working capital, is our repurchase from our former largest stockholder, in March
2003, of 12,004,333 shares of our common stock and warrants to purchase
1,971,820 shares of our common stock for a total purchase price of $500,000 and
our payment of $441,000 into an escrow account in connection with the settlement
of our lawsuit with SPF-II. These matters are described in more detail in Notes
6 and 7 to our consolidated financial statements. Although we initially financed
the share purchase with the proceeds of a $500,000 term loan, we repaid the loan
during 2003.
We have a line of credit arrangement (the "Agreement") with Silicon Valley Bank.
Under the terms of the Agreement, we may request advances not to exceed an
aggregate amount of $1.0 million over the term of the Agreement, subject to 75%
of Eligible Accounts (as defined in the Agreement) plus 50% of our cash invested
with Silicon Valley Bank. As of December 31, 2003, the entire $1.0 million is
available to us. Advances under the Agreement bear interest at Silicon Valley
Bank's prime rate plus .75% and are secured by substantially all of our assets.
In February 2004, we negotiated an extension of the maturity date of the
Agreement from February 20, 2004 to February 20, 2005. Interest is due monthly
on advances outstanding and the principal balance of any advances taken by us
are due on February 20, 2005. Our ability to request advances under the
Agreement is subject to certain financial and other covenants. As of December
31, 2003, we were in compliance with these covenants.
The following table sets forth our contractual obligations as of December 31,
2003:
-------------------------------------------------------------------
Payments Due by Period
-------------------------------------------------------------------
Less than 1 More then 5
Total year 1-3 years 3-5 years years
------- ----------- --------- --------- -----------
Contractual Obligations
Operating Lease Obligations 364,966 274,757 84,842 5,367 --
------- ------- ------ ----- ------
Total 364,966 274,757 84,842 5,367 --
======= ======= ====== ===== ======
Operating lease obligations relate principally to our office space lease. In
addition to these obligations, we anticipate incurring certain capital
expenditures during 2004 primarily to upgrade certain information technology
hardware and software. We expect that total capital expenditures in 2004 will be
less than $200,000.
In February 2004, we added approximately 2,900 square feet of office space to
our existing lease of 12,200 square feet. Total annual lease costs are now
approximately $270,000. The lease expires in February 2005. We anticipate that
we will begin negotiations in the summer or fall of 2004 on a multi-year
extension to our current lease.
Although we anticipate that we have sufficient funds available to support
ongoing operations for at least the next twelve months, if our revenues fall
short of our expectations or our expenses exceed our expectations, we may need
to raise additional capital through public or private debt or equity financing.
We may not be able to secure sufficient funds on terms acceptable to us. If
equity securities are issued to raise funds, our stockholders' equity may be
diluted. If additional funds are raised through debt financing, we may be
subject to significant restrictions. Furthermore, as noted above upon execution
of our SQI, DHP and QAI agreements, we typically receive a non-refundable
payment for the first year of the contract term (which is typically three years,
subject to a cancellation right by either the client or us on each annual
anniversary date) upon contract execution. We record the cash payment as
deferred revenue, which is a current liability on our consolidated balance
sheet, that is then amortized to revenue over the first year of the term. Annual
renewal payments, which are made in advance of the year to which the payment
relates, are treated in the same manner. As a result, our operating cash flow is
substantially dependent upon our ability to continue to sign new agreements, as
well as continue to maintain a high rate of client retention. Our current
operating plan includes growth in new sales from these agreements. For the
reasons described above, a significant failure to achieve sales targets in the
plan would have a material negative impact on our financial position and cash
flow.
RECENT ACCOUNTING PRONOUNCEMENTS
Variable interest entities
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities. FIN 46 addresses when a company should
consolidate in its financial statements the assets, liabilities and activities
of a variable interest entity (VIE). It defines VIEs as entities that either do
not have any equity investors with a controlling financial interest, or have
equity investors that do not provide sufficient financial resources for the
entity to support its activities without additional subordinated financial
support. FIN 46 also requires disclosures about VIE's that a company is not
required to consolidate, but in which it has a significant variable interest.
The consolidation requirements of FIN 46 applied immediately to variable
interest entities created after January 31, 2003. The Company has not obtained
an interest in a VIE subsequent to that date. A modification to FIN 46 (FIN
46(R)) was released in December 2003. FIN 46(R) delayed the effective date for
VIEs created before February 1, 2003, with the exception of special-purpose
entities, until the first fiscal year or interim period ending after March 15,
2004. FIN 46(R) delayed the effective date for special-purpose entities until
the first fiscal year or interim period after December 15, 2003. The Company is
not the primary beneficiary of any SPEs at December 31, 2003. The Company will
adopt FIN 46(R) for non-SPE entities as of March 31, 2004. The adoption of FIN
46 did not result in the consolidation of any VIEs, nor is the adoption of FIN
46(R) expected to result in the consolidation of any VIEs. The Company does not
anticipate that the adoption of FIN 46(R) will have any impact on its financial
statements.
Financial instruments with characteristics of both liabilities and equity
In May 2003, the FASB issued Statement 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for classifying and measuring certain financial
instruments that have characteristics of both liabilities and equity. The
guidance in Statement 150 became effective June 1, 2003, for all financial
instruments created or modified after May 31, 2003, and otherwise became
effective as of July 1, 2003. In November 2003, the FASB deferred for an
indefinite period the application of the guidance in Statement 150 to
noncontrolling interests that are classified as equity in the financial
statements of a subsidiary but would be classified as a liability in the
parent's financial statements under Statement 150. The deferral is limited to
mandatorily redeemable noncontrolling interests associated with finite-lived
subsidiaries. Management does not believe it has any involvement with such
entities as of December 31, 2003 or with any other entities as a result of FIN
46 (as described above).
29
Item 7a. Quantitative and Qualitative Disclosure about Market Risk
We have certain investments in a treasury obligation fund maintained by Silicon
Valley Bank. As of December 31, 2003, our investment in this fund amounted to
approximately $3.2 million. This amount is included within the cash and cash
equivalent line item of our balance sheet and consists of investments in highly
liquid U.S. treasury securities with maturities of 90 days or less. For the year
ended December 31, 2003, interest earned on this balance was approximately
$7,400. Any decrease in interest rates in this investment account would not have
a material impact on our financial position.
Item 8. Financial Statements and Supplementary Data
See pages 40-61 of this document.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness the our disclosure controls and
procedures as of the end of the period covered by this report. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures as of the end of the period covered
by this report are functioning effectively to provide reasonable assurance that
the information required to be disclosed by us in reports filed under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms. A controls system, no matter how well designed and operated,
cannot provide absolute assurance that the objectives of the controls system are
met, and no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within a company have been
detected.
(b) Change in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred during our
most recent fiscal quarter that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
This information (other than the information relating to executive officers
included in Part I) will be included in an amendment to this Form 10-K, which
will be filed within 120 days after the close of our fiscal year covered by this
report
Item 11. Executive Compensation
This information will be included in an amendment to this Form 10-K, which will
be filed within 120 days after the close of our fiscal year covered by this
report.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Equity Compensation Plan Information
The following table provides information, as of December 31, 2003, regarding
securities issuable under our stock based compensation plans.
30
Number of securities
remaining available
for future issuance
Number of securities under equity
to be issued upon Weighted-average compensation plans
exercise of exercise price of (excluding securities
outstanding options, outstanding options, reflected in column
warrants and rights warrants and rights (a))
Plan category (a) (b) (c)
- -------------------- -------------------- -------------------- -----------------------
Equity compensation
plans approved
by security holders 9,831,408 $0.31 2,794,684
Equity compensation
plans not approved
by security holders 20,000(1) $2.00 N/A
Total 9,851,408 2,794,684
(1) - Represents warrants issued to a company with respect to certain financial
advisory services provided to us.
Other information required to be included in this item will be included in an
amendment to this Form 10-K, which will be filed within 120 days after the close
of our fiscal year covered by this report.
Item 13. Certain Relationships and Related Transactions
This information will be included in an amendment to this Form 10-K, which will
be filed within 120 days after the close of our fiscal year covered by this
report.
Item 14. Principal Accountant Fees and Services
This information will be included in an amendment to this Form 10-K, which will
be filed within 120 days after the close of our fiscal year covered by this
report.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements.
The financial statements listed in the accompanying Index to Financial
Statements and Financial Statement Schedule at page F-1 are filed as part of
this Form 10-K.
(a) 2. Financial Statement Schedules.
The following financial statement schedule is filed as part of this Form 10-K:
Schedule II - Valuation and Qualifying Accounts.
All other schedules have been omitted because they are not applicable, or not
required, or the information is shown in the Financial Statements or notes
thereto.
(a) 3. Exhibits.
31
The following is a list of exhibits filed as part of this annual report on Form
10-K. Where so indicated by footnote, exhibits which were previously filed are
incorporated by reference.
EXHIBIT
NUMBER DESCRIPTION
3.1 Form of Amended and Restated Certificate of Incorporation
(incorporated by reference to Exhibit 3.1 to our Annual Report on
Form 10-K for the year ended December 31, 2001.)
3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.2 to our Annual Report on Form 10-K for the year ended December
31, 2001.)
10.1* 1996 Equity Compensation Plan, as amended (incorporated
by reference to Exhibit 10.1 to our Annual Report on Form 10-K
for the year ended December 31, 2002.)
10.2.1 Loan and Security Agreement dated May 10, 2002 by and between
Health Grades, Inc., Healthcare Ratings, Inc., ProviderWeb.net,
Inc., and Silicon Valley Bank (incorporated by reference to
Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002.)
10.2.2 Loan Modification Agreement dated March 11, 2003 by and between
Health Grades, Inc. and Silicon Valley Bank (incorporated by
reference to Exhibit 10.2.2 to our Annual Report on Form 10-K for
the year ended December 31, 2002.)
10.3 Stock and Warrant Repurchase Agreement dated March 11, 2003
(incorporated by reference to Exhibit 10.3 to our Annual Report
on Form 10-K for the year ended December 31, 2002.)
10.4* Employment Agreement dated as of April 1, 1996 by and between
Specialty Care Network, Inc. and Kerry R. Hicks (incorporated by
reference to Exhibit 10.3 to our Registration Statement on Form
S-1 (File No. 333-17627))
10.5.1* Employment Agreement between Specialty Care Network, Inc. and
David Hicks, dated March 1, 1996 (incorporated by reference to
Exhibit 10.8 to our Registration Statement of Form S-1 (File No.
333-17627))
10.5.2* Amendment to Employment Agreement between Specialty Care Network,
Inc. and David Hicks, dated December 2, 1997. (incorporated by
reference to Exhibit 10.8.1 to our Annual Report on Form 10-K for
the fiscal year ended December 31, 1997)
23.1 Consent of Grant Thornton LLP
23.2 Consent of Ernst & Young LLP
31.1 Certification of the Chief Executive Officer pursuant to Rule
15d-14(a) under the Securities Exchange Act.
31.2 Certification of the Chief Financial Officer pursuant to Rule
15d-14(a) under the Securities Exchange Act.
32.1 Certification of the Chief Executive Officer pursuant to Rule
15d-14(b) under the Securities Exchange Act.
32.2 Certification of the Chief Financial Officer pursuant to Rule
15d-14(b) under the Securities Exchange Act.
* - Constitutes a management contract, compensatory plan or arrangement required
to be filed as an exhibit to this report.
(b) Reports on Form 8-K
32
During the quarter ended December 31, 2003, we furnished a report on Form 8-K.
The report, filed on November 19, 2003, and dated November 13, 2003, provided
information responsive to Item 12 in connection with our press release related
to our results of operations for the quarter ended September 30, 2003.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
HEALTH GRADES, INC.
Date: March 30, 2004
/s/ KERRY R. HICKS
-----------------------
Kerry R. Hicks
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
- ---------------------------- ----------------------------- --------------
/s/ KERRY R. HICKS Chief Executive Officer March 30, 2004
- ---------------------------- (Principal Executive Officer)
Kerry R. Hicks
/s/ ALLEN DODGE Chief Financial Officer March 30, 2004
- ---------------------------- (Principal Financial and
Allen Dodge Accounting Officer)
/s/ PETER H. CHEESBROUGH Director March 30, 2004
- ----------------------------
Peter H. Cheesbrough
/s/ LESLIE S. MATTHEWS, M.D. Director March 30, 2004
- ----------------------------
Leslie S. Matthews, M.D.
/s/ J.D. KLEINKE Director March 30, 2004
- ----------------------------
J.D. Kleinke
/s/ JOHN QUATTRONE Director March 30, 2004
- ----------------------------
John Quattrone
34
SUPPLEMENTAL INFORMATION TO BE FURNISHED
WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE ACT BY
REGISTRANTS WHICH HAVE NOT REGISTERED
SECURITIES PURSUANT TO SECTION 12 OF THE ACT
No annual report covering the Registrant's last fiscal year and no
proxy statement, form of proxy or other soliciting material relating to the
Registrant's 2004 annual meeting of stockholders has been sent to the
Registrant's stockholders. The Registrant intends to send a report to
stockholders for the period covered by this report and a proxy statement and
proxy with respect to the Registrant's next annual meeting of stockholders. The
Registrant will furnish copies of such material when such material is sent to
its stockholders. Such material shall not be deemed to be "filed" with the
Commission or otherwise subject to the liabilities of Section 18 of the
Securities Exchange Act of 1934.
35
INDEX TO FINANCIAL STATEMENTS
HEALTH GRADES, INC. AND SUBSIDIARIES:
Reports of Independent Auditors.................. 37
Consolidated Balance Sheets...................... 39
Consolidated Statements of Operations............ 40
Consolidated Statements of Stockholders' Equity . 41
Consolidated Statements of Cash Flows............ 42
Notes to Consolidated Financial Statements....... 43
36
Report of Independent Certified Public Accountants
Board of Directors and Stockholders of Health Grades, Inc.
We have audited the accompanying consolidated balance sheets of Health Grades,
Inc. and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Health Grades, Inc.
and subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America.
As discussed in Note 5 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" on January 1, 2002.
We have also audited Schedule II for the years ended December 31, 2003 and 2002.
In our opinion, this schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information therein.
/s/ GRANT THORNTON LLP
-------------------------
Grant Thornton LLP
Denver, Colorado
February 4, 2004
37
Report of Independent Auditors
Board of Directors and Stockholders of Health Grades, Inc.
We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows of Health Grades, Inc. and subsidiaries
(collectively the "Company") for the year ended December 31, 2001. Our audit
also included the financial statement schedule listed in the Index at Item 15(a)
for the year ended December 31, 2001. These financial statements and schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedule based on our
audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations, stockholders'
equity, and cash flows of the Company for the year ended December 31, 2001, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
------------------------
Ernst & Young LLP
Denver, Colorado
February 8, 2002
38
Health Grades, Inc. and Subsidiaries
Consolidated Balance Sheets
DECEMBER 31
2003 2002
------------- -------------
ASSETS
Cash and cash equivalents $ 3,559,125 $ 2,947,047
Accounts receivable, net 1,688,336 675,514
Prepaid expenses and other 230,840 284,898
------------- -------------
Total current assets 5,478,301 3,907,459
Property and equipment, net 236,757 103,911
Goodwill, net 3,106,181 3,106,181
------------- -------------
Total assets $ 8,821,239 $ 7,117,551
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 116,117 $ 23,332
Accrued payroll, incentive compensation and related
expenses 1,148,161 396,774
Accrued expenses 175,380 114,798
Deferred income 5,785,437 3,251,625
Income taxes payable 73,343 76,723
------------- -------------
Total current liabilities 7,298,438 3,863,252
Long-term liabilities -- --
------------- -------------
Total liabilities 7,298,438 3,863,252
Commitments and contingencies -- --
Stockholders' equity:
Preferred stock, $0.001 par value, 2,000,000
shares authorized, no shares issued or outstanding -- --
Common stock, $0.001 par value, 100,000,000 shares
authorized, and 44,052,153 and 43,965,706 shares
issued in 2003 and 2002, respectively 44,052 43,966
Additional paid-in capital 89,814,939 89,762,836
Accumulated deficit (74,568,610) (73,284,923)
Treasury stock, 19,563,390 and 7,559,057 shares in
2003 and 2002, respectively (13,767,580) (13,267,580)
------------- -------------
Total stockholders' equity 1,522,801 3,254,299
------------- -------------
Total liabilities and stockholders' equity $ 8,821,239 $ 7,117,551
============= =============
See accompanying notes to consolidated financial statements.
39
Health Grades, Inc. and Subsidiaries
Consolidated Statements of Operations
Years ended December 31,
2003 2002 2001
----------- ----------- ------------
Revenue:
Ratings and advisory revenue $ 8,803,929 $ 5,091,891 $ 3,088,451
Physician practice service fees -- 195,492 551,925
Other 1,551 20,000 4,490
----------- ----------- ------------
8,805,480 5,307,383 3,644,866
----------- ----------- ------------
Expenses:
Cost of ratings and advisory revenue 1,963,949 1,468,097 1,307,925
Cost of physician practice management revenue -- 91,051 757,896
----------- ----------- ------------
Gross margin 6,841,531 3,748,235 1,579,045
Operating expenses:
Sales and marketing 3,357,874 2,074,425 3,227,598
Product development 1,433,965 1,321,511 1,478,071
Litigation settlement 491,000 -- --
General and administrative 2,834,542 2,122,854 3,655,250
Amortization of goodwill -- -- 838,899
----------- ----------- ------------
Loss from operations (1,275,850) (1,770,555) (7,620,773)
Other:
Gain on sale of assets and other 75 147,768 191,915
Interest income 7,393 14,009 90,409
Interest expense (15,305) -- (28,794)
----------- ----------- ------------
Loss before income taxes and cumulative
effect of a change in accounting principle (1,283,687) (1,608,778) (7,367,243)
Income tax benefit -- 1,046,296 --
----------- ----------- ------------
Loss before cumulative effect of a change in
accounting principle (1,283,687) (562,482) (7,367,243)
Cumulative effect of a change in accounting
principle -- (1,088,311) --
----------- ----------- ------------
Net loss $(1,283,687) $(1,650,793) $ (7,367,243)
=========== =========== ============
Net loss per common share (basic and diluted)
Loss before cumulative effect of a change
in accounting principle $ (0.05) $ (0.02) $ (0.30)
----------- ----------- ------------
Cumulative effect of a change in
accounting principle -- (0.03) --
----------- ----------- ------------
Net loss per common share (0.05) (0.05) (0.30)
=========== =========== ============
Weighted average number of common shares
used in computation (basic and diluted) 26,679,467 36,189,748 24,399,699
=========== =========== ============
See accompanying notes to consolidated financial statements.
40
Health Grades, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Years ended
December 31, 2003, 2002 and 2001
COMMON STOCK STOCK
$0.001 PAR VALUE ADDITIONAL PURCHASE
----------------------- PAID-IN PLAN
SHARES AMOUNT CAPITAL RECEIVABLE
---------- --------- ------------ ----------
Balance at January 1, 2001 28,817,400 $ 28,817 $ 87,381,917 $ --
Exercise of employee stock options 15,000 16 8,423 --
250,000 shares acquired as treasury stock -- -- -- --
Retainer warrants - SmallCaps Online -- -- 10,800 --
Non-cash financing fee -- -- 161,731 --
Common stock issued 13,333,333 13,333 1,986,667 --
Net loss -- -- -- --
---------- --------- ------------ ---------
Balance at December 31, 2001 42,165,733 42,166 89,549,538 --
---------- --------- ------------ ---------
Common stock issued 1,799,973 1,800 213,298 (215,098)
Payments made under stock purchase plan -- -- -- 215,098
Net loss -- -- -- --
---------- --------- ------------ ---------
Balance at December 31, 2002 43,965,706 43,966 89,762,836 --
---------- --------- ------------ ---------
12,004,333 shares acquired as treasury
stock -- -- -- --
Option grants to consultant -- -- 42,499 --
Stock option exercise 86,447 86 9,604 --
Net loss -- -- -- --
---------- --------- ------------ ---------
Balance at December 31, 2003 44,052,153 $ 44,052 $ 89,814,939 $ --
========== ========= ============ =========
ACCUMULATED TREASURY
DEFICIT STOCK TOTAL
---------------- ------------ ------------
Balance at January 1, 2001 $ (64,266,887) $(13,080,080) $ 10,063,767
Exercise of employee stock options -- -- 8,439
250,000 shares acquired as treasury stock -- (187,500) (187,500)
Retainer warrants - SmallCaps Online -- -- 10,800
Non-cash financing fee -- -- 161,731
Common stock issued -- -- 2,000,000
Net loss (7,367,243) -- (7,367,243)
--------------- ------------ ------------
Balance at December 31, 2001 (71,634,130) (13,267,580) 4,689,994
--------------- ------------ ------------
Common stock issued -- -- --
Payments made under stock purchase plan -- -- 215,098
Net loss (1,650,793) -- (1,650,793)
--------------- ------------ ------------
Balance at December 31, 2002 (73,284,923) (13,267,580) 3,254,299
--------------- ------------ ------------
12,004,333 shares acquired as treasury
stock -- (500,000) (500,000)
Option grants to consultant -- -- 42,499
Stock option exercise -- -- 9,690
Net loss (1,283,687) -- (1,283,687)
--------------- ------------ ------------
Balance at December 31, 2003 $ (74,568,610) $(13,767,580) $ 1,522,801
=============== ============ ============
See accompanying notes to consolidated financial statements.
41
Health Grades, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended December 31,
2003 2002 2001
------------ ------------ ------------
OPERATING ACTIVITIES
Net loss $(1,283,687) $(1,650,793) $(7,367,243)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Cumulative effect of a change in accounting principle -- 1,088,311 --
Non-cash consulting expense related to
non-employee stock options 42,499 -- --
Retainer warrants -- -- 10,800
Depreciation expense 98,006 249,802 526,111
Amortization expense -- -- 838,899
Bad debt expense 11,667 6,500 59,014
Non-cash financing fee -- -- 161,731
(Gain) loss on sale of assets and other (75) 446 (191,915)
Changes in operating assets and liabilities:
Accounts receivable, net (1,024,489) 96,356 (9,690)
Due from affiliated practices in litigation -- -- 1,944,919
Prepaid expenses and other assets 54,058 (152,317) 73,836
Prepaid and recoverable income taxes (3,380) (207) 1,930
Accounts payable and accrued expenses 153,367 (142,185) (232,661)
Accrued payroll, incentive compensation
and related expenses 751,387 (167,716) (219,819)
Deferred income 2,533,812 1,115,450 778,145
----------- --------- ------------
Net cash provided by (used in) operating activities 1,333,165 443,647 (3,625,943)
INVESTING ACTIVITIES
Purchases of property and equipment (230,852) (19,981) (14,746)
Increase in other assets -- -- 64,747
Sale of property, plant and equipment 75 -- --
----------- --------- ------------
Net cash (used in) provided by investing activities (230,777) (19,981) 50,001
FINANCING ACTIVITIES
Proceeds from stock purchases -- 215,098 --
Net proceeds from equity financing -- -- 2,000,000
Principal repayments on note payable (500,000) -- (1,369,767)
Purchases of treasury stock (500,000) -- (187,500)
Exercise of employee stock options 9,690 -- 8,439
Repayments of notes receivable -- 12,726 622,459
Proceeds from note payable 500,000 -- --
----------- --------- ------------
Net cash (used in) provided by financing activities (490,310) 227,824 1,073,631
----------- --------- ------------
Net increase (decrease) in cash and
cash equivalents 612,078 651,490 (2,502,311)
Cash and cash equivalents at beginning of period 2,947,047 2,295,557 4,797,868
=========== =========== ===========
Cash and cash equivalents at end of period $ 3,559,125 $ 2,947,047 $ 2,295,557
=========== =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 15,305 $ -- $ 38,467
=========== =========== ===========
Income taxes paid (received) $ 3,380 $(1,046,089) $ (1,930)
=========== =========== ===========
See accompanying notes to consolidated financial statements.
42
Health Grades, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
1. DESCRIPTION OF BUSINESS
Health Grades, Inc. ("HealthGrades") provides proprietary, objective healthcare
provider ratings and advisory services. We provide our clients with healthcare
information, including information relating to quality of service and detailed
profile information on physicians, that enables them to measure, assess, enhance
and market healthcare quality. Our clients include hospitals, employers,
benefits consulting firms, payers, insurance companies and consumers.
We offer services to hospitals that are either attempting to build a reputation
based upon quality of care or are working to identify areas to improve quality.
For hospitals that have received high ratings, we offer the opportunity to
license our ratings and trademarks and provide assistance in their marketing
programs. For hospitals that have not received high ratings, we offer quality
improvement services.
We also provide basic and expanded profile information on a variety of providers
and facilities. We make this information available to consumers, employers,
benefits consulting firms and payers to assist them in selecting healthcare
providers. For certain providers, the basic profile information is available
free of charge on our website, www.healthgrades.com. For a fee, we offer
healthcare quality reports with respect to hospitals, nursing homes and
physicians. These reports provide more detailed information than is available
free of charge on our website. Report pricing and content varies based upon the
type of provider and whether the user is a consumer or a healthcare professional
(for example, medical professional underwriter).
We provide online integrated healthcare quality services for employers, benefits
consulting firms, payers and other organizations that license access to our
database of healthcare providers.
We have also entered into strategic arrangements with other service providers,
including Ingenix and J.D. Power and Associates, in an effort to increase our
name recognition and market presence, as well as enhance our service offerings.
In addition to the services noted above, which constitute our ratings and
advisory business, we also provided, through September 2002, limited physician
practice management services to musculoskeletal practices under management
services agreements. As of December 31, 2002, all of these agreements had
expired or had been terminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
Effective December 31, 2002, we liquidated our Healthcare Ratings and
Providerweb.net subsidiaries. This liquidation had no impact on our financial
position or operations. As of and for the year ended December 31, 2003, Health
Grades, Inc. had no subsidiaries. All significant intercompany balances and
transactions for the years ended December 31, 2002 and 2001 have been eliminated
in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and footnotes. These estimates are based on management's current
knowledge of events and actions they may undertake in the future, and actual
results could differ from those estimates.
43
REVENUE RECOGNITION
Ratings and advisory revenue
Strategic Quality Initiative, Distinguished Hospital and Quality Assessment and
Improvement Programs:
Our ratings and advisory revenue is generated principally from annual fees paid
by hospitals that participate in our Strategic Quality Initiative (SQI),
Distinguished Hospital (DHP) and Quality Assessment and Improvement (QAI)
programs. The SQI program provides business development tools to hospitals that
are highly rated on our website. Under the SQI program, we license the
HealthGrades name and our "report card" ratings to hospitals. The license may be
in a single area (for example, Cardiac) or multiple areas (for example, Cardiac,
Neuroscience and Orthopedics.) We also assist hospitals in promoting their
ratings and measuring the success of their efforts utilizing our team of
in-house healthcare consultants. Another key feature of the SQI program is a
detailed comparison of the data underlying a hospital's rating to local and
national benchmarks. DHP recognizes clinical excellence in hospitals among a
range of areas. Hospitals that contract with us for DHP services receive all of
the SQI features described above with respect to their licensed service lines.
In addition, hospitals can reference the additional DHA (Distinguished Hospital
Award) designation. Hospital clients are provided with additional marketing and
planning assistance related to the DHA designation as well as trophies for
display at the hospital.
Our QAI program is principally designed to help hospitals measure and improve
the quality of their care in particular areas where they have lower ratings.
Using our database and focusing on a particular hospital's information and
ratings we can help identify areas to improve quality and measure how well the
hospital performs relative to national and regional best practices. Our
consultants work on-site with the hospital staff and physicians to present the
data and assist in the quality analysis.
We typically receive a non-refundable payment for the first year of the contract
term (which is typically three years, subject to a cancellation right by either
the client or us, on each annual anniversary date) upon contract execution. We
record the cash payment as deferred revenue that is then amortized to revenue
over the first year of the term. Annual renewal payments, which are made in
advance of the year to which the payments relate, are treated in the same
manner.
Quality Ratings Suite:
Through our Quality Ratings Suite (QRS), we license access to, and customize our
database for employers, benefits consulting firms, payers and others. Modules
currently available for license are the Hospital Quality Guide, Physician
Quality Guide, Nursing Home Quality Guide and Home Health Quality Guide. Some of
our revenue for this product is derived through a relationship with Ingenix.
Typically, Ingenix will add the HealthGrades' QRS functionality to services
available to its existing clients who license Ingenix' provider lookup online
application. An additional licensing fee is charged, of which a portion is
payable to us, with Ingenix retaining the remaining part of the fee. We only
recognize the fees that will ultimately be paid to us as revenue from Ingenix,
and not the entire amount of the licensing fee. We recognize revenues related to
these agreements in a straight-line manner over the term of the agreement.
Healthcare Quality Reports:
We offer comprehensive quality information to professionals and consumers that
provides current and historical quality information on hospitals and nursing
homes in more detail than is available on our website. In addition, we offer
reports on physicians that contain detailed information with respect to
education, professional licensing history and other items. As pricing is usually
on a per report basis, we recognize revenue as reports are ordered.
Physician practice service fees:
Physician practice service fees include services fees and other revenue derived
from our former physician practice management business.
PRODUCT DEVELOPMENT COSTS
We incur product development costs related to the development and support of our
website and the development of applications to support data compilation and
extraction for our consulting services. These costs (which consist primarily of
salaries and benefits, consulting fees and other costs related to software
development, application development and operations expense) are expensed as
incurred.
44
CASH AND CASH EQUIVALENTS
Cash and cash equivalents generally consist of cash and overnight investment
accounts that consist of short-term government obligations. These instruments
have original maturity dates not exceeding three months. Such investments are
stated at cost, which approximates fair value and are considered cash
equivalents for purposes of reporting cash flows.
FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments, as reported in the accompanying
balance sheets, approximate their fair value primarily due to the short-term
and/or variable-rate nature of such financial instruments.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Costs of repairs and maintenance are
expensed as incurred. Depreciation is computed using the straight-line method
over the estimated useful lives of the underlying assets. Amortization of
leasehold improvements are computed using the straight-line method over the
shorter of the lease term or the estimated useful lives of the underlying
assets. The estimated useful lives used are as follows:
Computer equipment and software 3-5 years
Furniture and fixtures 5-7 years
Leasehold improvements 5 years
GOODWILL
Goodwill, which is stated at cost, is evaluated annually for impairment in
accordance with the provisions of Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets (SFAS 142). As a result of the
adoption of SFAS 142, we discontinued the amortization of goodwill effective
January 1, 2002. SFAS 142 also requires companies to perform a transitional test
of goodwill for impairment as of January 1, 2002, and we completed this test
during the second quarter of 2002. Based upon the results of the test, we
recorded a charge of approximately $1.1 million in our consolidated statement of
operations for the quarter ended June 30, 2002, as a cumulative effect of a
change in accounting principle. See Note 5 for further discussion of our
adoption of SFAS 142.
Net Loss Per Common Share
We compute net loss per common share following Statement of Financial Accounting
Standards No. 128, Earnings Per share (SFAS 128). Under the provisions of SFAS
128, basic net loss per common share is computed by dividing the net loss for
the period by the weighted average number of common shares outstanding during
the period. Diluted net loss per common share is computed by dividing the net
loss for the period by the weighted average number of common shares and common
share equivalents outstanding during the period. Common share equivalents,
(composed of incremental common shares issuable upon the exercise of common
stock options and warrants) are included in diluted net loss per share to the
extent these shares are dilutive. Common share equivalents are not included in
our computation of diluted net loss per common share for the years ended
December 31, 2003, 2002 and 2001 because the effect on net loss per common share
would be antidilutive. Common share equivalents excluded from our calculation of
diluted net loss per common share because their effect would be antidilutive
totaled 2,017,064, 15,732 and 3,700, for the years ended December 31, 2003, 2002
and 2001, respectively.
STOCK-BASED COMPENSATION
We account for our stock-based compensation arrangements using the intrinsic
value method under the provisions of Accounting Principles Board Opinion (APB)
No. 25, Accounting for Stock Issued to Employees (APB No. 25), and related
interpretations.
Pro forma information regarding net income and earnings per share is required by
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123), and has been determined as if we had accounted for our
employee stock options under the fair value method of that accounting
pronouncement. The fair value for options awarded during the years ended
December 31, 2003, 2002 and 2001 were estimated at the date of grant using the
Black Scholes option pricing model with the following weighted-average
assumptions: risk-free interest rate over the life of the option of 1.32% to
3.62%; no dividend yield; and expected two to eight year lives of the options.
The volatility factors utilized for the year ended December 31, 2003 were 2.04
and 1.95. For the years ended December 31, 2002 and 2001, volatility factors
used were 1.91 and 1.60, respectively.
The Black-Scholes option pricing model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility.
For purposes of pro forma disclosure, the estimated fair value of the options is
amortized to expense over the options' vesting period. Because compensation
expense associated with an award is recognized over the vesting period, the
impact on pro forma net (loss) income as disclosed below may not be
representative of compensation expense in future years. The following table
illustrates the effect on net loss and loss per share if we had applied the fair
value recognition provisions of SFAS 123, using assumptions described in Note 9,
to our stock-based compensation plan:
45
Year ended December 31,
2003 2002 2001
------------ ------------ ------------
Net loss as reported $ (1,283,687) $ (1,650,793) $ (7,367,243)
Add: Stock-based compensation expense included in
reported net income under APB No. 25 - - -
Less: Total stock-based employee compensation expense
determined under fair value based method for awards
granted, modified or settled (343,512) (870,374) (707,091)
------------ ------------ ------------
Pro forma net loss $ (1,627,199) $ (2,521,167) $ (8,074,334)
============ ============ ============
Loss per share:
Basic and diluted as reported $ (0.05) $ (0.05) $ (0.30)
============ ============ ============
Basic and diluted pro forma $ (0.06) $ (0.07) $ (0.33)
============ ============ ============
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Revenue Recognition
At a November 21, 2002 meeting, the Emerging Issues Task Force (EITF) reached a
final consensus regarding EITF 00-21, Revenue Arrangements with Multiple
Deliverables. The consensus provides that revenue arrangements with multiple
deliverables should be divided into separate units of accounting if certain
criteria are met. The consideration for the arrangement should be allocated to
the separate units of accounting based on their relative fair values, with
different provisions if the fair value of all deliverables are not known or if
the fair value is contingent on delivery of specified items or performance
conditions. Applicable revenue recognition criteria should be considered
separately for each separate unit of accounting. EITF 00-21 is effective for
revenue arrangements entered into in fiscal periods beginning after June 15,
2003. Entities may elect to report the change as a cumulative effect adjustment
in accordance with APB Opinion No. 20, Accounting Changes.
During the quarter ended March 31, 2003, we completed our analysis of EITF
00-21. We examined our QAI - Phase I contracts (which we formerly called Ratings
Quality Analysis or "RQA"), QAI - Phase II contracts (which we formerly called
Quality Assessment and Improvement or "QAI") and Strategic Quality Initiative
("SQI") contracts to determine if the adoption of EITF 00-21 would have any
impact on our revenue recognition policies. As our QAI - Phase I contracts
consist of a single deliverable (as defined by EITF 00-21), namely a
comprehensive quality analysis, no change was required with respect to our
policy of recognizing revenue under these arrangements at the point in time that
services are delivered. In addition, as our QAI - Phase II contracts consist of
consulting services provided over the term of the contract, no change was
required with respect to our policy of recognizing revenue under these
arrangements over the term of the contract on a straight-line basis.
Our SQI contracts contain both an analysis of quality outcomes data as well as a
license to utilize our name and certain ratings information for an annual
period. Based upon our analysis, we concluded that there was not reliable and
verifiable evidence of fair value from which to allocate, between the two
deliverables, the consideration received. Moreover, we believe the primary
deliverable under these agreements clearly is the license to utilize our name
and certain ratings information for an annual term. In this regard, although we
sell the analysis of quality outcomes data separately via our QAI - Phase I
contracts, these contracts are generally sold to clients that have lower quality
ratings (as rated by HealthGrades) and thus may be deemed to have a more
significant value than the quality analysis imbedded within our SQI contracts.
Furthermore, some of our SQI clients never choose to receive the quality
outcomes analysis included within our SQI contracts. Based upon these factors,
we concluded that no change is required with respect to our policy of
recognizing revenue under these arrangements over the term of the contract on a
straight-line basis.
Therefore, the adoption of EITF 00-21 did not have any effect on our financial
statements.
46
Derivative Instruments and Hedging Activities
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149 (SFAS 149), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS 149 amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities. The accounting and reporting requirements is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. Currently, we do not have any derivative
instruments and do not anticipate entering into any derivative contracts.
Accordingly, the adoption of SFAS 149 did not have any impact on our financial
statements.
Variable interest entities
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities. FIN 46 addresses when a company should
consolidate in its financial statements the assets, liabilities and activities
of a variable interest entity (VIE). It defines VIEs as entities that either do
not have any equity investors with a controlling financial interest, or have
equity investors that do not provide sufficient financial resources for the
entity to support its activities without additional subordinated financial
support. FIN 46 also requires disclosures about VIE's that a company is not
required to consolidate, but in which it has a significant variable interest.
The consolidation requirements of FIN 46 applied immediately to variable
interest entities created after January 31, 2003. The Company has not obtained
an interest in a VIE subsequent to that date. A modification to FIN 46 (FIN
46(R)) was released in December 2003. FIN 46(R) delayed the effective date for
VIEs created before February 1, 2003, with the exception of special-purpose
entities, until the first fiscal year or interim period ending after March 15,
2004. FIN 46(R) delayed the effective date for special-purpose entities until
the first fiscal year or interim period after December 15, 2003. The Company is
not the primary beneficiary of any SPEs at December 31, 2003. The Company will
adopt FIN 46(R) for non-SPE entities as of March 31, 2004. The adoption of FIN
46 did not result in the consolidation of any VIEs, nor is the adoption of FIN
46(R) expected to result in the consolidation of any VIEs. The Company does not
anticipate that the adoption of FIN 46(R) will have any impact on its financial
statements.
Financial instruments with characteristics of both liabilities and equity
In May 2003, the FASB issued Statement 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for classifying and measuring certain financial
instruments that have characteristics of both liabilities and equity. The
guidance in Statement 150 became effective June 1, 2003, for all financial
instruments created or modified after May 31, 2003, and otherwise became
effective as of July 1, 2003. In November 2003, the FASB deferred for an
indefinite period the application of the guidance in Statement 150 to
noncontrolling interests that are classified as equity in the financial
statements of a subsidiary but would be classified as a liability in the
parent's financial statements under Statement 150. The deferral is limited to
mandatorily redeemable noncontrolling interests associated with finite-lived
subsidiaries. Management does not believe it has any involvement with such
entities as of December 31, 2003 or with any other entities as a result of FIN
46 (as described above).
3. ACCOUNTS RECEIVABLE AND MANAGEMENT FEE REVENUE
Accounts receivable consisted of the following:
DECEMBER 31
2003 2002
---------- ---------
Trade accounts receivable $1,700,003 $ 675,514
Less allowance for doubtful accounts 11,667 --
---------- ---------
$1,688,336 $ 675,514
========== =========
For the years ended December 31, 2003, 2002 and 2001, we derived substantially
pall of our revenue from our ratings and advisory services. Furthermore, our SQI
services accounted for 72%, 79% and 73% of total ratings and advisory revenue
for the years ending December 31, 2003, 2002 and 2001, respectively. During
2003, 2002 and 2001, no individual customer accounted for more the 10% of our
revenues.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31
2003 2002
----------- -----------
Furniture and fixtures $ 847,147 $ 847,147
Computer equipment and software 1,974,276 1,750,141
Leasehold improvements and other 10,784 10,784
----------- -----------
2,832,207 2,608,072
Accumulated depreciation and amortization (2,595,450) (2,504,161)
----------- -----------
Net property and equipment $ 236,757 $ 103,911
=========== ===========
For the years ended December 31, 2003, 2002, and 2001, depreciation expense was
approximately $98,000, $250,000, and $526,000 respectively.
5. GOODWILL
As a result of the adoption of SFAS 142, we discontinued the amortization of
goodwill effective January 1, 2002. SFAS 142 also requires companies to perform
a transitional test of goodwill for impairment as of January 1, 2002, and we
completed this test during the second quarter of 2002. Based upon the results of
the test, we recorded a charge of approximately $1.1 million in our consolidated
47
statement of operations for the quarter ended June 30, 2002, as a cumulative
effect of a change in accounting principle. Goodwill, net in the accompanying
consolidated balance sheets, as of December 31, 2003 and 2002, is shown net of
the impairment charge described above.
SFAS 142 describes various potential methodologies for determining fair value,
including market capitalization (if a public company has one reporting unit),
discounted cash flow analysis (present value technique) and techniques based on
multiples of earnings, revenue, EBITDA, and/or other financial measures. SFAS
142 also states that if a valuation technique is used that considers multiple
sources of information, such as an average of the quoted market prices of the
reporting unit over a specific time period and the results of a present value
technique, the company should apply that technique consistently period to period
(i.e., in the required annual impairment analysis in subsequent years).
As HealthGrades consists of only one reporting unit, and is publicly traded,
management began its fair value analysis with an evaluation of our market
capitalization. We applied a market capitalization approach by multiplying the
number of actual shares outstanding by an average market price. We applied an
additional premium of 30% to this valuation to give effect to management's best
estimate of a "control premium." As the majority of our outstanding shares were
owned by management and two venture capitalist investors, management believed a
premium of 30% was reasonable to give effect to additional benefits a purchaser
would derive from control of HealthGrades. For the impairment test completed in
the fourth quarter of 2003, we reduced the control premium to 20%. This change
was made due to the fact that in the first quarter of 2003, we repurchased
12,004,333 shares of common stock owned by one of the venture capital investors.
As a result, management believed that a reduction in the control premium was
appropriate.
As our shares are very thinly traded, management believes that any analysis of
HealthGrades' fair value should include valuation techniques in addition to
overall market capitalization. We contemplated utilizing cost, market or income
approaches. However, utilization of cost or market approaches was not feasible,
particularly given the fact that HealthGrades does not fall into an easily
identifiable "peer group" of companies from which to compare valuations in the
form of price/earnings ratios, sales of similar companies, etc. Therefore,
management determined to utilize an approach using the present value of expected
future cash flows as an additional valuation technique. Due to the inherent
uncertainty involved in projecting cash flows, in particular for a growth
company, management developed a range of possible cash flows and derived a
probability-weighted average of the range of possible amounts to determine the
expected cash flow.
After deriving the market capitalization and expected cash flow valuations as
described above, we then applied an equal weighting to each model to derive an
overall fair value estimate of HealthGrades. For our transitional impairment
test in 2001, the carrying value of our net assets exceeded the fair value
estimate. We then compared the implied fair value of goodwill to the carrying
amount of goodwill to arrive at the impairment loss calculation of approximately
$1.1 million during the quarter ended June 30, 2002, in connection with the
transitional test for impairment. As required under SFAS 142, we performed our
annual test for impairment of our goodwill during the fourth quarters of 2002
and 2003. These tests resulted in no additional impairment to our goodwill
balance.
Net loss and net loss per share, adjusted to exclude amortization of goodwill,
are as follows:
YEAR ENDED
DECEMBER 31,
----------------------------------------------------
2003 2002 2001
-------------- -------------- --------------
Reported net loss................................... $ (1,283,687) $ (1,650,793) $ (7,367,243)
Add: amortization of goodwill.................. -- -- 838,899
------------- ------------- -------------
Pro forma adjusted net loss......................... $ (1,283,687) $ (1,650,793) $ (6,528,344)
============= ============= =============
Basic and diluted loss per share
Reported net loss.............................. $ (0.05) $ (0.05) $ (0.30)
Add back: amortization of goodwill............. -- -- .03
------------- ------------- -------------
Pro forma adjusted basic and diluted net
loss per share................................. $ (0.05) $ (0.05) $ (0.27)
============= ============= =============
We will perform the annual impairment test in the fourth quarter of subsequent
years, or sooner, if indicators of impairment arise at an interim date. Any
impairment identified during the annual impairment tests will be recorded as an
operating expense in our consolidated statement of operations. We expect to
continue to utilize the combined market capitalization and expected cash flow
48
approach described above to perform our annual impairment analysis and interim
tests if necessary.
6. EQUITY FINANCING AND STOCK AND WARRANT REPURCHASE
On March 17, 2000, we closed an equity financing transaction (the "Equity
Financing") which raised $18 million. Pursuant to the terms of the Equity
Financing, certain investors paid $14.8 million to us in return for 7,400,000
shares of HealthGrades common stock and five-year warrants to purchase 2,590,000
shares of HealthGrades common stock at an exercise price of $4.00 per share. Net
proceeds of the Equity Financing, after payment of certain legal and other
financing fees, were approximately $14.4 million. We also issued a five year
warrant to purchase 150,000 shares of HealthGrades common stock to a company
that served as a financial advisor to us in connection with the Equity
Financing, at an exercise price of $3.45 per share. In connection with the
Equity Financing, certain of our officers exchanged $3.2 million in notes
payable for an aggregate of 1.6 million shares of our common stock and five-year
warrants to purchase 560,000 shares of HealthGrades common stock at $4.00 per
share.
Effective April 16, 2001, we reached an agreement with Chancellor V., L.P.
("Chancellor") and Essex Woodlands Health Ventures Fund IV, L.P. ("Essex"),
regarding a commitment (the "Commitment") to provide us with up to $2.0 million
of equity financing. Chancellor and Essex were the two principal investors in
the Equity Financing described above. In consideration for the commitment, we
issued Chancellor and Essex warrants (the "Commitment Warrants") to purchase an
aggregate of 500,000 shares of our common stock at an exercise price per share
of $0.26, which was the closing market price per share of our common stock as
reported by Nasdaq on April 16, 2001. The Commitment Warrants were to expire on
April 16, 2007. In addition, we repriced warrants to purchase 100,000 shares of
our common stock that were issued to Chancellor and Essex in March 2000 to the
same $0.26 per share exercise price.
Under the terms of the agreement with Chancellor and Essex, we were granted the
option, until December 31, 2001, to sell our common stock to Chancellor and
Essex at an aggregate purchase price of up to $2.0 million. Effective October 9,
2001, we exercised our option to receive the entire $2.0 million. Under the
terms of the Commitment, in exchange for the $2.0 million, we issued an
aggregate of 13,333,333 shares of HealthGrades' common stock to Chancellor and
Essex. In addition, we issued six-year warrants to purchase 350,000 shares of
our common stock at an exercise price per share of $0.15.
Pursuant to a Stock and Warrant Repurchase Agreement, dated March 11, 2003, we
paid Chancellor $500,000 to repurchase all 12,004,333 shares of our common stock
and warrants to purchase 1,971,820 shares of our common stock that Chancellor
acquired in the transactions, in 2000 and 2001 described above. Immediately
prior to the repurchase, Chancellor's ownership of HealthGrades common stock
represented 33% of our outstanding common stock, and Chancellor's ownership of
HealthGrades common stock and warrants represented 36% of our total outstanding
common stock (assuming full exercise of the warrants held by Chancellor, but
assuming no exercise of any other warrants or options).
See also note 8.
7. BANK LINE OF CREDIT AND TERM LOAN
On May 13, 2002, we completed a line of credit arrangement (the "Agreement")
with Silicon Valley Bank. Under the terms of the Agreement, we were entitled to
request advances not to exceed an aggregate amount of $1.0 million over the
one-year term of the Agreement. Effective March 11, 2003, we executed an
amendment to the Agreement. The terms of the amendment provided for an extension
of the maturity date of the Agreement to February 20, 2004. To date, we have not
borrowed any funds under the Agreement. In addition, advances under the
Agreement are limited to 75% of Eligible Accounts (as defined in the Agreement)
plus 50% of our cash invested with Silicon Valley Bank. As of December 31, 2003,
the entire $1.0 million is available to us.
In addition, the amended Agreement provided for a term loan of $500,000, which
carried an interest rate of 5.94% and was due on March 1, 2005. In October 2003,
we repaid the balance of the term loan.
Advances under the Agreement will bear interest at Silicon Valley Bank's prime
rate plus 0.75% and will be secured by substantially all of our assets. Interest
is due monthly on advances outstanding and the principal balance of any advances
taken by us are due at the end of the Agreement term. Our ability to request
advances under the Agreement is subject to certain financial and other
covenants. As of December 31, 2003, we had no advances outstanding. See also
Note 17 for an update of this Agreement.
49
8. COMMON STOCK AND WARRANTS
For the year ended December 31, 2002, participants in our 2002 Stock Purchase
Plan paid approximately $215,000 for shares purchased through payroll
deductions. This amount was included in cash received from financing activities
in our consolidated statement of cash flows. The 2002 Stock Purchase Plan
enabled participating employees to purchase shares of our common stock by
electing to have payroll deductions in 2002 of up to 30 percent of their annual
base rate of pay (excluding bonuses, overtime pay, commissions and severance
pay) as in effect on January 1, 2002. The 2002 Stock Purchase Plan terminated on
December 31, 2002.
We record treasury stock at cost with regard to monetary transactions and at
estimated fair value with regard to non-monetary transactions.
As of December 31, 2003, we had the following common shares reserved for future
issuance:
Awards under the 1996 Equity Compensation Plan 9,827,908
Awards under the 1996 Incentive and Non-Qualified Stock Option Plan 3,500
---------
Total shares reserved for future issuance 9,831,408
=========
In connection with an equity financing in March 2000, we issued a five year
warrant to purchase 150,000 shares of HealthGrades common stock to a company
that served as a financial advisor to us. Additionally, certain of our officers
exchanged $3.2 million in notes payable for an aggregate of 1.6 million shares
of common stock and five-year warrants to purchase 560,000 shares of
HealthGrades common stock at $4.00 per share.
In June 2000, we issued to SmallCaps Online Group, LLC five-year warrants to
purchase 20,000 shares of HealthGrades common stock at $2.00 per share, in
consideration for certain financial advisory services to be rendered to us.
Effective March 29, 2001, a former executive surrendered 250,000 shares of
HealthGrades common stock to us. The cost to us of $187,500 is included as
treasury shares purchased in our consolidated statement of stockholders' equity
for the year ended December 31, 2001.
See also Note 6 for a discussion of warrants issued to certain investors.
9. STOCK OPTION PLANS
On March 22, 1996, we adopted the 1996 Incentive and Non-Qualified Stock Option
Plan (the "Plan") under which nontransferable options to purchase up to
5,000,000 shares of HealthGrades common stock were available for award to
eligible directors, officers, advisors, consultants and key employees. On
January 10, 1997, the Board of Directors voted to terminate the Plan.
The exercise price for incentive stock options awarded during the year ended
December 31, 1996 was not less than the fair market value of each share at the
date of the grant, and the options granted thereunder had a term of ten years.
Options, which were generally contingent on continued employment with
HealthGrades, could be exercised only in accordance with a vesting schedule
established by our Board of Directors. Of the 553,500 shares underlying options
granted during the year ended December 31, 1996 at an exercise price of $1.00
per share, 3,500 shares underlying the options remain outstanding and
exercisable at December 31, 2003. The other 550,000 shares underlying options
were forfeited or exercised during 1997.
On October 15, 1996, our Board of Directors approved the 1996 Equity
Compensation Plan (the "Equity Plan"), which initially provided for the grant of
options to purchase up to 2,000,000 shares of HealthGrades common stock. The
total number of shares authorized for issuance under the Equity Plan increased
to 6,000,000 in 1998, 7,000,000 in 2000, 8,000,000 in 2001 and 13,000,000 in
2002. Our stockholders approved the Equity Plan and each increase in shares
authorized for issuance. Both incentive stock options and non-qualified stock
options may be issued under the provisions of the Equity Plan. Employees of
HealthGrades and any subsidiaries, members of the Board of Directors and certain
consultants and advisors are eligible to participate in the Equity Plan, which
will terminate no later than October 14, 2006. Our Board of Directors or a
committee of the Board of Directors authorizes the granting and vesting of
options under the Equity Plan. As of December 31, 2003, there were 2,794,684
shares available remaining for grant under the Equity Plan.
A summary of HealthGrades' stock option activity and related information for the
years ended December 31 is as follows:
50
2003 2002 2001
----------------------------- ----------------------------- -------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- ------------- ----------- ------------- ---------- -----------
Outstanding at Beginning of Year 9,857,426 $ 0.78 4,814,278 $ 3.68 6,537,083 $ 4.31
Granted
Exercise price equal to
fair value of common stock 1,390,548 $ 0.26 6,640,759 $ 0.09 775,333 $ 0.39
Exercised (86,447) $ 0.11 -- -- (15,000) $ 0.70
Forfeited (1,330,119) $ 3.72 (1,597,611) $ 6.68 (2,483,138) $ 4.32
---------- -------- ---------- ------- ---------- -------
Outstanding at end of year 9,831,408 $ 0.31 9,857,426 $ 0.78 4,814,278 $ 3.68
========== ========== ==========
Exercisable at end of year 7,466,013 $ 0.35 6,601,970 $ 1.07 3,365,928 $ 4.50
========== ========== ==========
2003 2002 2001
------- ------- ------
Weighted-Average Fair Value of Options:
Granted During the Year
Exercise price equal to fair value of
common stock $ 0.24 $ 0.08 $ 0.33
Exercise prices for options outstanding and the weighted-average remaining
contractual lives of those options at December 31, 2003 are as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------- ----------------------------
WEIGHTED
AVERAGE WEIGHTED- WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ----------------- --------------- --------------- ------------ -------------- -----------
$ 0.04 - $0.06 938,000 8.60 $ 0.05 211,005 $ 0.06
0.10 5,589,202 8.10 0.10 5,144,371 0.10
0.17 - 0.38 1,323,570 9.00 0.28 256,466 0.23
0.48 - 0.69 1,346,451 6.04 0.58 1,259,784 0.58
0.75 - 0.88 319,397 6.78 0.83 279,599 0.84
1.00 - 1.81 169,542 6.29 1.55 169,542 1.55
2.00 - 3.56 75,000 6.13 2.91 75,000 2.91
6.00 - 6.75 43,400 3.87 6.47 43,400 6.47
9.75 2,000 3.22 9.75 2,000 9.75
11.25 - 11.75 24,846 3.61 11.61 24,846 11.61
-------------- --------- ---- ------ --------- ------
$ 0.04 -$11.75 9,831,408 7.87 $ 0.31 7,466,013 $ 0.35
========= =========
10. SEGMENT DISCLOSURES
For the years ended December 31, 2003 and 2002, substantially all of our revenue
and operating expenses were derived from our ratings and advisory business.
Therefore, for the years ended December 31, 2003 and 2002, we had only one
reportable segment.
For the year ended December 31, 2001, our reportable segments were Physician
Practice Services ("PPS") and Ratings and Advisory Revenue. PPS derived its
revenue primarily from management services provided to physician practices.
Ratings and Advisory Revenue ("RAR") is derived primarily from marketing
arrangements with hospitals and fees related to the licensing of our content
(including set-up fees).
We used net (loss) income before income taxes for purposes of performance
measurement. The measurement basis for segment assets includes intangible
assets.
For the year ended December 31, 2001, segment information for PPS represents the
operating results for Health Grades, Inc. The RAR segment includes the operating
results for Healthcare Ratings, Inc. (HRI), our only subsidiary with significant
operations in 2001. Effective December 31, 2002, we liquidated the HRI
subsidiary. All operations that were previously recorded in the HRI subsidiary
are now being recorded in Health Grades, Inc. HRI contained the revenue from our
ratings and advisory business. Expenses of HRI include direct salaries and wages
of HRI expenses, disbursements made directly from HRI, and depreciation recorded
on HRI assets. In addition, our goodwill amortization is included in the RAR
segment information. All corporate employees and operating expenses are included
in the PPS segment. We did not perform any expense allocation other than certain
telephone and utilities expense.
51
For the Year
Ended
2001
------------
PPS
Revenue from external
customers $ 551,925
Interest income 33,588
Interest expense 28,794
Depreciation and amortization
expense 292,566
Segment net (loss) income
before income taxes (4,419,192)
Segment asset expenditures 11,042
RAR
Revenue from external
Customers $ 3,088,451
Interest income 56,821
Depreciation and amortization
expense 1,072,444
Segment net loss before
income taxes (2,948,051)
Segment asset expenditures 3,704
REVENUE
Total for reportable segments 3,640,376
Other revenue 4,490
-----------
Total consolidated revenue $ 3,644,866
===========
LOSS BEFORE INCOME TAXES
Total net loss before tax for
reportable segments $(7,367,243)
Adjustment --
-----------
Loss before income taxes $(7,367,243)
===========
For the year presented, our operations and assets were within the United States
of America.
11. LEASES
We are obligated under operating leases for our office space and certain office
equipment.
Future minimum payments under the operating leases with terms in excess of one
year are summarized as follows for the years ending December 31:
2004 $ 274,757
2005 57,994
2006 26,848
2007 2,576
2008 2,576
Thereafter 215
---------
Total $ 364,966
=========
Rent expense for the years ended December 31, 2003, 2002 and 2001 under all
operating leases was approximately $250,000, $278,000 and $272,000,
respectively.
12. INCOME TAXES
We are a corporation subject to federal and certain state and local income
taxes. The provision for income taxes is made pursuant to the liability method
as prescribed in Statement of Financial Accounting Standards No. 109, Accounting
for Income Taxes. This method requires recognition of deferred income taxes
based on temporary differences between the financial reporting and income tax
bases of assets and liabilities, using currently enacted income tax rates and
regulations.
52
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
our deferred tax assets and liabilities at December 31, 2003 and 2002 are as
follows:
2003 2002
----------- ------------
Deferred tax assets:
Property and equipment, net $ 135,421 $ 171,920
Web development costs 21,288 54,578
Accrued liabilities 213,716 10,406
Deferred start-up expenditures -- 13,116
Allowance for doubtful accounts 4,783 --
Net operating loss carryforwards 7,785,597 7,446,211
----------- -----------
8,160,805 7,696,231
Valuation allowance for deferred
tax assets (8,069,571) (7,579,289)
----------- -----------
Gross deferred tax asset 91,234 116,942
----------- -----------
Deferred tax liabilities:
Prepaid expenses 91,234 116,942
----------- -----------
Gross deferred tax liability 91,234 116,942
----------- -----------
Net deferred tax liability $ -- $ --
=========== ===========
The valuation allowance results from uncertainty regarding our ability to
produce sufficient taxable income in future periods necessary to realize the
benefits of the related deferred tax assets. During 2003, the valuation
allowance was increased by $490,282 principally due to our 2003 operating loss.
The income tax (benefit) expense for the years ended December 31, 2003, 2002 and
2001 is summarized as follows:
2003 2002 2001
---------- ---------- --------
Current:
Federal $ -- $ (1,046,296) $ --
State -- -- --
---------- ------------ -------
-- (1,046,296) --
---------- ------------ -------
Deferred:
Federal -- -- --
State -- -- --
---------- ------------ -------
-- -- --
---------- ------------ -------
Total $ -- $ (1,046,296) $ --
========== ============ =======
The income tax (benefit) expense differs from amounts currently payable because
certain revenues and expenses are reported in the statement of operations in
periods that differ from those in which they are subject to taxation. The
principal differences relate to different methods of calculating depreciation
for financial statement and income tax purposes, business acquisition and
start-up expenditures that are capitalized for income tax purposes and expensed
for financial statement purposes and currently non-deductible book accruals and
reserves.
During 2002, the Job Creation and Worker Assistance Act of 2002 ("JCWA Act") was
signed into law. One of the provisions of the JCWA Act extended the net
operating loss carryback provisions of the Internal Revenue Code from two years
to five years for losses incurred in 2001 and 2002. Prior to the passage of the
JCWA Act, we did not have the ability to utilize our 2001 tax loss to reduce
prior year taxable income because we had no taxable income in 2000 or 1999.
However, with the passage of the JCWA Act, we were able to carryback our 2001
tax loss to reduce taxable income in 1997. As a result of the carryback, we
received a tax refund of $1,046,296 which was recorded in 2002, in accordance
with the provisions of Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes.
A reconciliation between the statutory federal income tax rate of 34% and our
0.0%, (38.8%) and 0.0% effective tax rates for the years ended December 31,
2003, 2002 and 2001, respectively, is as follows:
53
2003 2002 2001
------- ------- ------
Federal statutory income tax rate (34.0)% (34.0)% (34.0)%
State income taxes, net of federal
benefit (5.0) (4.8) (5.1)
Non-deductible goodwill amortization
and impairment, business acquisition
and other costs 2.3 24.6 5.3
Miscellaneous (1.5) (1.7) (0.8)
Deferred tax asset valuation allowance 38.2 (22.9) 34.6
----- ----- -----
Effective income tax rate 0.0% (38.8)% 0.0%
===== ===== =====
We have approximately $19,000,000 in net operating loss carryforwards, which
expire from 2019 through 2023. Certain changes in our stock ownership can result
in a substantial limitation on the amount of the net operating loss
carryforwards that can be utilized following an ownership change. We have
determined that we experienced such an ownership change during 2001.
Consequently, future utilization of approximately $15,000,000 of our net
operating loss carryforwards will be subject to these limitations. Additionally,
approximately $4,500,000 of the net operating loss carryforwards relate to our
former wholly-owned subsidiary, Healthcare Ratings, Inc., and are subject to
Separate Return Limitation Year ("SRLY") limitations. The SRLY limitations
permit an offset to consolidated taxable income only to the extent of taxable
income attributable to the member with the SRLY loss.
13. LEGAL PROCEEDINGS
On or about October 10, 2002, Strategic Performance Fund - II ("SPF-II")
commenced an action in the Circuit Court of the 17th Judicial Circuit in and for
Broward County, Florida against us, alleging breach of two leases. These leases
relate to two buildings in which one of our former affiliated practices,
Orthopaedic Associates, P.A. d/b/a Park Place Therapeutic Center ("Park Place")
leased office space. Park Place ceased the payment of its rental obligations
with respect to the two leases in May 2000, and subsequently filed a petition
for bankruptcy, under Chapter 11 of the Bankruptcy Code, in the United States
Bankruptcy Court, Southern District of Florida, Ft. Lauderdale Division. SPF-II
sought damages against us in the amount of approximately $4.7 million.
The basis of the allegation against us was that while under the corporate name
of Specialty Care Network, Inc., we entered into an Assignment, Assumption and
Release Agreement dated July 8, 1997, under which we assumed the obligations of
Orthopaedic Management Services, Inc., as lessee, under its Lease Agreement with
the owner and lessor, Park Place Orthopaedic Center II, Ltd. The agreement was
executed in connection with our acquisition of most of the non-medical assets of
the Park Place practice. On October 1, 1997, the owner of the leased property
sold its interests in the leasehold estates to SPF-II. On June 10, 1999, we sold
the assets of the Park Place practice, including the leasehold interests, back
to Park Place and entered into an Absolute Assignment and Assumption Agreement
with Park Place, under which Park Place agreed to indemnify us in connection
with the leasehold obligations. In addition, we entered into an Indemnification
Agreement with Park Place and its individual physician owners, under which the
individual physician owners (severally up to their ownership interest in the
practice) agreed to indemnify us in connection with the leasehold obligations.
SPF-II alleged that, notwithstanding the assignment of our leasehold interests
to Park Place, HealthGrades remains liable for all lessee obligations under the
leases.
We filed a response to the initial complaint instituted by SPF-II, denying all
liability with respect to the subject leases. In addition, we filed a
third-party complaint against the individual physician owners seeking
indemnification from each of these individuals under the terms of the
Indemnification Agreement. The physician owners filed a response to our
complaint denying their liability under the Indemnification Agreement, and
asserting several affirmative defenses, including, among others, our failure to
mitigate damages, lack of consideration, our assertion of a premature claim as
liability and damages have not been established by SPF-II, rejection of the
leases by the bankruptcy court, and, in the case of one physician owner, a claim
that an "agent" of ours (who was, in fact, an employee of Park Place both before
and after our affiliation with the practice) fraudulently induced the purchase
of the Park Place practice's assets from us. The physician owners also filed a
motion to enjoin further prosecution of the action instituted against them by
HealthGrades and Bank of America, the lender in connection with their repurchase
of the assets of the Park Place practice, pending resolution of the bankruptcy
proceeding.
In November 2003, we executed a Settlement Agreement and Mutual Release (the
"Settlement Agreement") with SPF-II and four of the physician owners. In
consideration for the dismissal of all claims and mutual releases, HealthGrades
paid approximately $441,000 into an escrow account to be released to SPF-II upon
the satisfaction of certain conditions of the Settlement Agreement. As the
payment was made into escrow prior to year end, this cash was removed from our
consolidated balance sheet as of December 31, 2003. Payment out of escrow will
be contingent upon the occurrence, on or before September 25, 2004 of (i) the
bankruptcy court approval of Chapter 11 plans relating to Park Place and the
four physician owners and (ii) the payment of a specified amount to SPF-II
pursuant to the Chapter 11 plans. In addition, HealthGrades agreed to pay an
additional $50,000 to SPF-II on or before September 25, 2004. The aggregate
payment amount of $491,000 was recorded as an expense in our consolidated
statement of operations in the third quarter of 2003.
54
We are subject to other legal proceedings and claims that arise in the ordinary
course of our business. In the opinion of management, these actions are unlikely
to materially affect our financial position.
14. COMMITMENTS
We have entered into employment agreements that provide two executives with
minimum base pay, annual incentive awards and other fringe benefits. We expense
all costs related to the agreements in the period that the services are rendered
by the employee. In the event of death, disability, termination with or without
cause, voluntary employee termination, or change in ownership of HealthGrades,
we may be partially or wholly relieved of our financial obligations to such
individuals. However, under certain circumstances, a change in control of
HealthGrades may provide significant and immediate enhanced compensation to the
executives. At December 31, 2003, we were contractually obligated to pay base
pay compensation to these executives of approximately $493,000 through December
31, 2004.
15. EMPLOYEE BENEFIT PLAN
We maintain a defined contribution employee benefit plan ("the Plan"). The Plan
covers substantially all HealthGrades' employees and includes a Qualified
Non-Elective Contribution equal to 3% of annual compensation, applicable to all
eligible participants, regardless of whether or not the participant contributes
to the plan.
Expense under the benefit plan, including the Qualified Non-Elective
Contribution, aggregated approximately $116,000, $114,000 and $122,000 for 2003,
2002 and 2001, respectively.
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for the years
ended December 31, 2003 and 2002. Certain reclassifications have been made to
previously reported amounts to conform to the current period presentation.
2003 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------ ------------ ------------- -------------
Revenue:
Ratings and advisory $ 1,737,741 $ 2,009,311 $ 2,289,669 $ 2,767,208
Other 43 1,444 32 32
------------ ------------ ------------ ------------
Total revenue 1,737,784 2,010,755 2,289,701 2,767,240
Expenses:
Cost of ratings and
advisory revenue 440,109 464,998 510,428 548,414
------------ ------------ ------------ ------------
Gross margin 1,297,675 1,545,757 1,779,273 2,218,826
Operating expenses:
Sales and marketing 642,522 847,083 817,061 1,051,208
Product development 327,430 332,748 337,284 436,503
Litigation settlement -- -- 491,000 --
General and administrative 589,917 811,494 655,709 777,422
------------ ------------ ------------ ------------
Loss from operations (262,194) (445,568) (521,781) (46,307)
Other:
Gain on sale of assets and other 25 50 -- --
Interest income 2,185 1,830 1,586 1,792
Interest expense (578) (6,888) (6,062) (1,777)
------------ ------------ ------------ ------------
Loss before income taxes (260,562) (450,576) (526,257) (46,292)
Income tax benefit -- -- -- --
------------ ------------ ------------ ------------
Net loss (260,562) (450,576) (526,257) (46,292)
============ ============ ============ ============
Net income (loss) per share (basic
and diluted) $ (0.01) $ (0.02) $ (0.02) $ --
Weighted average shares outstanding
(basic and diluted) 33,605,720 24,402,398 24,404,493 24,431,077
============ ============ ============ ============
55
2002 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------- ---------- ------------- ------------
Revenue:
Ratings and advisory $ 1,084,955 $ 1,196,017 $ 1,287,436 $ 1,523,483
Physician practice service fees 111,831 83,661 -- --
Other 2,021 670 468 16,841
------------ ------------ ------------ ------------
Total revenue 1,198,807 1,280,348 1,287,904 1,540,324
Expenses:
Cost of ratings and advisory revenue 371,237 332,882 393,347 370,631
Cost of physician practice management
revenue 19,812 15,872 16,183 39,184
------------ ------------ ------------ ------------
Gross margin 807,758 931,594 878,374 1,130,509
Operating expenses:
Sales and marketing 469,199 494,203 602,122 508,901
Product development 306,803 318,925 324,475 371,308
General and administrative 538,308 527,154 488,575 568,817
------------ ------------ ------------ ------------
Loss from operations (506,552) (408,688) (536,798) (318,517)
Other:
Gain on sale of assets and other -- 141,668 6,000 100
Interest income 4,106 2,961 3,775 3,167
------------ ------------ ------------ ------------
Loss before income taxes and
cumulative effect of a change in
accounting principle (502,446) (264,059) (527,023) (315,250)
Income tax benefit 1,046,296 -- -- --
------------ ------------ ------------ ------------
Income (loss) before cumulative
effect of a change in accounting
principle 543,850 (264,059) (527,023) (315,250)
------------ ------------ ------------ ------------
Cumulative effect of a change in
accounting principle -- (1,088,311) -- --
------------ ------------ ------------ ------------
Net income (loss) 543,850 (1,352,370) (527,023) (315,250)
============ ============ ============ ============
Net income (loss) per common share
(basic and diluted):
Income (loss) before cumulative
effect of a change in
accounting principle $ 0.02 $ (0.01) $ (0.01) $ (0.01)
------------ ------------ ------------ ------------
Cumulative effect of a change in
accounting principle -- (0.03) -- --
------------ ------------ ------------ ------------
Net income (loss) per common share
(basic and diluted) $ 0.02 $ (0.04) $ (0.01) $ (0.01)
------------ ------------ ------------ ------------
Weighted average shares outstanding
(basic and diluted) 35,526,744 36,406,731 36,406,731 36,406,731
============ ============ ============ ============
17. SUBSEQUENT EVENT (UNAUDITED)
In February 2004, we extended the maturity date of our line of credit
arrangement to February 20, 2005.
56
Health Grades, Inc. and Subsidiaries
Schedule II -- Valuation and Qualifying Accounts
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ----------------------------- ----------- ----------- ----------- ------------- -----------
Year ended December 31, 2003
Allowance for doubtful
accounts on trade
receivables $ -- $ 11,667 $ -- $ -- $ 11,667
Year ended December 31, 2002
Allowance for doubtful
accounts on trade
receivables $ 57,419 $ -- $ -- $ (57,419)(1) $ --
Year ended December 31, 2001
Allowance for doubtful
accounts on management fee
receivables $ 231,895 $ -- $ -- $(231,895)(1) $ --
Allowance for doubtful
accounts on trade
receivables $ 80,183 $ 85,319 $ -- $(108,083)(1) $ 57,419
(1) Represents actual amounts charged against the allowance for the periods
presented.
57
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
3.1 Form of Amended and Restated Certificate of Incorporation
(incorporated by reference to Exhibit 3.1 to our Annual Report on
Form 10-K for the year ended December 31, 2001.)
3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.2 to our Annual Report on Form 10-K for the year ended December
31, 2001.)
10.1* 1996 Equity Compensation Plan, as amended (incorporated
by reference to Exhibit 10.1 to our Annual Report on Form 10-K
for the year ended December 31, 2002.)
10.2.1 Loan and Security Agreement dated May 10, 2002 by and between
Health Grades, Inc., Healthcare Ratings, Inc., ProviderWeb.net,
Inc., and Silicon Valley Bank (incorporated by reference to
Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002.)
10.2.2 Loan Modification Agreement dated March 11, 2003 by and between
Health Grades, Inc. and Silicon Valley Bank (incorporated by
reference to Exhibit 10.2.2 to our Annual Report on Form 10-K for
the year ended December 31, 2002.)
10.3 Stock and Warrant Repurchase Agreement dated March 11, 2003
(incorporated by reference to Exhibit 10.3 to our Annual Report
on Form 10-K for the year ended December 31, 2002.)
10.4* Employment Agreement dated as of April 1, 1996 by and between
Specialty Care Network, Inc. and Kerry R. Hicks (incorporated by
reference to Exhibit 10.3 to the Company's Registration Statement
on Form S-1 (File No. 333-17627))
10.5.1* Employment Agreement between Specialty Care Network, Inc. and
David Hicks, dated March 1, 1996 (incorporated by reference to
Exhibit 10.8 to the Company's Registration Statement of Form S-1
(File No. 333-17627))
10.5.2* Amendment to Employment Agreement between Specialty Care Network,
Inc. and David Hicks, dated December 2, 1997. (incorporated by
reference to Exhibit 10.8.1 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1997)
23.1 Consent of Grant Thornton LLP
23.2 Consent of Ernst & Young LLP
31.1 Certification of the Chief Executive Officer pursuant to Rule
15d-14(a) under the Securities Exchange Act.
31.2 Certification of the Chief Financial Officer pursuant to Rule
15d-14(a) under the Securities Exchange Act.
32.1 Certification of the Chief Executive Officer pursuant to Rule
15d-14(b) under the Securities Exchange Act.
32.2 Certification of the Chief Financial Officer pursuant to Rule
15d-14(b) under the Securities Exchange Act.
* - Constitutes a management contract, compensatory plan or arrangement required
to be filed as an exhibit to this report.