HEALTH GRADES INC - 10-Q Quarterly Report

Back to GetFilings.com

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

----------

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

For the quarterly period ended JUNE 30, 2002
-------------

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 of (I.R.S. Employer
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
--------------

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 registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

On July 31, 2002, 36,406,731 shares of the Registrant's common stock, $.001
par value, were outstanding.

Health Grades, Inc. and Subsidiaries

INDEX

2

PART I. FINANCIAL INFORMATION
Health Grades, Inc. and Subsidiaries
Consolidated Balance Sheets

See accompanying notes to consolidated financial statements

3

Health Grades, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)

See accompanying notes to consolidated financial statements.

4

Health Grades, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)

See accompanying notes to consolidated financial statements.

5

Health Grades, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

June 30, 2002

NOTE 1 - BASIS OF PRESENTATION

The accompanying unaudited consolidated condensed financial statements of Health
Grades, Inc. and subsidiaries (collectively the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and the instructions to Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, these statements include all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation of the results
of the interim periods reported herein. Operating results for the three and six
months ended June 30, 2002 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2002. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

DESCRIPTION OF BUSINESS

HealthGrades is a healthcare quality ratings, information and advisory services
company. The Company rates, or provides information to assess and compare the
quality or qualifications of, various types of healthcare providers. The Company
also provides profile information for a variety of providers and facilities.

The Company offers services to hospitals that are either attempting to build a
brand name reputation based upon quality of care or are working to identify
areas to improve quality. For hospitals that have received high ratings, the
Company offers the opportunity to license its ratings and trademarks and provide
assistance in hospital's marketing programs. For providers who have not received
high ratings, the Company offers quality improvement services.

The Company provides basic and expanded profile information for a variety of
providers and facilities. This information is made available to consumers,
employers and health plans to assist them in selecting healthcare providers. The
basic profile information is available free of charge on the Company's website,
www.healthgrades.com. For certain providers, the Company offers healthcare
quality reports. These reports provide more detailed information than is
available free of charge on the healthgrades.com website. Report pricing and
content varies based upon the type of provider and whether the user is a
consumer or a healthcare professional.

All significant intercompany balances and transactions have been eliminated in
consolidation.

NEW ACCOUNTING PRONOUNCEMENTS

Business Combinations. In June 2001, the Financial Accounting Standards Board
(the "FASB") issued Statement of Financial Accounting Standards No. 141,
Business Combinations ("Statement 141"), which requires the use of the purchase
method of accounting for all business combinations initiated after June 30,
2001, establishes specific criteria for the recognition of intangible assets
separately from goodwill and requires unallocated negative goodwill to be
written off immediately as an extraordinary gain. The adoption of this
accounting pronouncement on January 1, 2002 had no effect on the Company's
financial position or results of operations.

Goodwill and Other Long-Lived Assets. In June 2001, the FASB issued Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets
("Statement 142"), which prohibits the amortization of goodwill and intangible
assets with indefinite useful lives. Statement 142 also requires that these
assets be reviewed for impairment at least annually. Under Statement 142,
intangible assets with finite lives continue to be to be amortized over their
estimated useful lives. The Company adopted Statement 142 on January 1, 2002.

Statement 142 also requires companies to perform a transitional test of goodwill
for impairment, and the Company completed its test during the second quarter of
2002. Based upon the results of the test, the Company recorded a charge of
approximately $1.1 million in

6

its consolidated statement of operations for the quarter ended June 30, 2002, as
a cumulative effect of change in accounting principle (See Note 3 - GOODWILL
IMPAIRMENT).

In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets ("Statement
144"), which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions
of Accounting Principles Board Opinion No. 30, Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, as
far as they relate to the disposal of a segment of a business. The Company
adopted Statement 144 on January 1, 2002. The adoption of Statement 144 did not
have a material effect on the Company's results of operations or financial
position.

CONSOLIDATED STATEMENT OF OPERATIONS PRESENTATION

In light of the Company's completed transition from a physician practice
management company to a healthcare quality ratings, information and advisory
services company, management is currently evaluating its operating statement
presentation. Although the Company believes that the current presentation has
been the most relevant presentation to investors over the past few years, the
Company believes that modifying this presentation to focus on the Company's only
reporting unit, its ratings and advisory business will provide an enhanced
presentation to investors. The Company anticipates it will complete this
modification for its Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002 and anticipates it will result in reclassifications to prior
periods in order to make them consistent with the modified presentation.

NOTE 2 - RECEIVABLES FROM OFFICERS

One of the Company's officers has a note with the Company with a principal
balance of $12,726, bearing interest at 9.75% per annum. The note is currently
due upon demand by the Company.

NOTE 3 - GOODWILL IMPAIRMENT

As a result of the adoption of Statement 142, the Company discontinued the
amortization of goodwill effective January 1, 2002. Statement 142 also requires
companies to perform a transitional test of goodwill for impairment, and the
Company completed its test during the second quarter of 2002. Based upon the
results of the test, the Company recorded a charge of approximately $1.1 million
in its consolidated statement of operations for the quarter ended June 30, 2002,
as a cumulative effect of change in accounting principle.

Statement 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, etc. Statement 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 the Company consists of only one reporting unit, ratings and advisory revenue
and is publicly traded, management utilized the Company's market capitalization,
multiplying the number of actual shares outstanding by an average market price
and applying an additional premium of 30% to give effect to the Company's best
estimate of a "control premium".

As the Company's shares are very thinly traded, management also determined to
utilize an approach using the present value of expected future cash flows. Due
to the inherent uncertainty involved in projecting cash flows, 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.

7

The Company then applied an equal weighting to market capitalization and
expected cash flow valuations to derive its overall fair value estimate. This
fair value amount was then compared to the carrying amount of goodwill to arrive
at the final impairment loss calculation of approximately $1.1 million.

Through December 31, 2001, the Company had recorded accumulated goodwill
amortization of $1.7 million. Application of the non-amortization provisions of
Statement 142 is expected to result in a reduction of operating expenses of
approximately $839,000 ($0.02 per share) for the year ending December 31, 2002.

Net loss and net loss per share, adjusted to exclude amortization of goodwill,
and the cumulative effect change in accounting principle are as follows:

Under Statement 142, the Company is required to perform additional tests for
impairment of its goodwill annually, beginning with the year ending December 31,
2002. The Company anticipates that this test will be performed in the fourth
quarter of 2002 and future years. Any impairment identified during the annual
impairment tests will be recorded as an operating expense in the Company's
consolidated statement of operations. The Company anticipates that it will
continue to utilize the combined market capitalization and expected cash flow
approach described above, to perform its annual impairment analysis.

NOTE 4 - INCOME TAX REFUND

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
extends 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, the Company did not have the ability to utilize its
2001 tax loss to reduce prior year taxable income because the Company had no
taxable income in 2000 or 1999. With the passage of the JCWA Act, the Company
was able to carryback its 2001 tax loss to reduce taxable income in 1997. The
tax refund, which amounted to approximately $1.0 million, was received in May
2002.

NOTE 5 - STOCK PURCHASE PLAN

In February 2002, the Company's stockholders approved the Health Grades, Inc.
Stock Purchase Plan (the "Plan"). The Plan enables participating employees (the
"Participants") to purchase shares of Company 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 share price for shares purchased under the Plan was $0.1195
per share, based upon the average of the last reported sales price on each of
the 20 trading days ending on, and including February 15, 2002, as reported on
the OTC Bulletin Board. Participants purchased a total of 1,799,973 shares with
an aggregate purchase price of approximately $215,000. Shares purchased under
the Plan are voting shares and are restricted from sale until December 31, 2002.
Under the terms of the Plan, if a Participant terminates employment with the
Company prior to December 31, 2002, no further salary reduction will be made and
the Participant will forfeit a number of shares equal to the number of shares
that would have been purchased by the employee for the

8

period beginning on the employee's termination date and ending on December 31,
2002. The amount remaining to be paid from future salary reductions by the
Participants for the purchase of shares under the Plan has been shown as a
reduction to stockholders' equity in the Company's consolidated balance sheet.

NOTE 6 - STOCK OPTION PLAN

Effective February 7, 2002, the Company granted options to purchase 5,782,759
shares to Company employees. The options have an exercise price of $0.10 per
share, which was the closing price per share of the Company's common stock on
the OTC Bulletin Board on the date of grant. Of the total options granted,
options to purchase 4,893,104 shares of Company common stock were granted to
certain Company officers and options to purchase 889,655 shares of Company
common stock were granted to other Company employees. Of the options granted to
certain Company officers, 13.6% of the shares underlying stock options fully
vest six months following the date of grant; 13.6% of the shares underlying
stock options fully vest 12 months following the date of grant; 54.6% of the
shares underlying stock options vest two years following the date of grant,
subject to acceleration if certain cash flow targets were met; and 18.2% of the
shares underlying stock options vest two years following the date of grant,
subject to acceleration if certain market price targets are met with respect to
the Company's common stock. As of June 30, 2002, the above-mentioned cash flow
targets were met and the shares underlying such stock options have fully vested.

NOTE 7 - BANK LINE OF CREDIT

On May 13, 2002, the Company entered into a line of credit arrangement (the
"Agreement") with Silicon Valley Bank. Under the terms of the Agreement, the
Company may request advances not to exceed an aggregate amount of $1.0 million
over the one-year term of the Agreement. In addition, advances under the
Agreement are limited to 75% of Eligible Accounts receivable (as defined in the
Agreement) plus 50% of the Company's cash deposited with Silicon Valley Bank.
Amounts borrowed under the Agreement bear interest at Silicon Valley Bank's
prime rate plus .75%. Interest is due monthly on amounts outstanding and the
principal balance is due at the end of the Agreement term. The Company's ability
to request advances under the Agreement is subject to certain financial and
other covenants. The Company currently has no advances outstanding under the
Agreement.

NOTE 8 - SUPPLEMENTAL CASH FLOW INFORMATION

Cash interest paid amounted to approximately $0 and $78,000 for the six months
ended June 30, 2002 and 2001, respectively. Refunds received from income taxes
amounted to approximately $1,000,000 and $2,000 for the six months ended June
30, 2001 and 2000, respectively.

For the six months ended June 30, 2002, Participants in the Plan paid $86,040
for shares purchased through payroll deductions. This amount has been included
in cash received from financing activities in the Company's consolidated
statement of cash flows. In addition, the remaining receivable from stock
purchase plan purchases of $129,059 will be included in cash received from
financing activities in the Company's consolidated statement of cash flows as
the payroll deductions occur for the remainder of 2002.

Note 9 -- INCOME FROM SALE OF ASSETS AND OTHER

During the second quarter 2002, the Company received a payment of approximately
$150,000 related to the termination of a multi-year license and content
agreement. Approximately $142,000 of this payment was recorded as income from
sale of assets and other in the Company's Consolidated Statement of Operations.

Note 10 -- SUBSEQUENT EVENT

In July 2002, the Company received a threatened, but unasserted claim from the
owner of two buildings in which one of the Company's former affiliated practices
is leasing office space. As part of a restructuring with the practice in 1999,
the practice and the individual physician owners agreed to indemnify the Company
in connection with the leasehold obligations. The Company and its counsel are
currently investigating this matter.

Based on information currently available to the Company, the leases run through
July 7, 2007 and the total base rental obligations for both properties from June
1, 2002, the date on which the practice allegedly discontinued lease payments,
through July 7, 2007 are approximately $2.8 million, excluding any rental
increases during such term or common area maintenance charges. The Company
cannot, at this time give an estimate of the potential exposure related to this
contingency. Nonetheless, if a claim is asserted against the Company, management
intends to vigorously deny its responsibility for any rental obligations and to
pursue other available legal rights.

9

ITEM 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Statements in this section, including statements concerning the sufficiency of
available funds, anticipated future revenues, anticipated costs to further
develop and market our Internet sites are "forward looking statements." Actual
events or results may differ materially from those discussed in forward looking
statements as a result of various factors, including failure to achieve revenue
increases, unanticipated expenditures, adverse litigation developments and other
factors discussed below and in the Company's Annual Report on Form 10-K for the
year ended December 31, 2001, particularly under "Risk Factors" in Item 1.

GENERAL

HealthGrades is a healthcare quality ratings, information and advisory services
company. We grade, or provide the means to assess and compare the quality or
qualifications of, various types of healthcare providers. We also provide
profile information for a variety of providers and facilities.

We offer services to hospitals that are either attempting to build a brand name
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 its ratings and trademarks and provide assistance in
their marketing programs. For providers who have not received high ratings, we
offer quality improvement services.

We provide basic and expanded profile information for a variety of providers and
facilities. This information is made available to consumers, employers and
health plans to assist them in selecting healthcare providers. The basic profile
information is available free of charge on our website, www.healthgrades.com.
For certain providers, we offer healthcare quality reports. These reports
provide more detailed information than what is available free of charge on the
healthgrades.com website. Report pricing and content varies based upon the type
of provider and whether the user is a consumer or a healthcare professional.

CRITICAL ACCOUNTING POLICIES

In accordance with the Securities and Exchange Commission financial reporting
release FR-60, Cautionary Advice Regarding Disclosure About Critical Accounting
Policies, we performed an analysis of our financial statements to identify our
Critical Accounting Policies. FR-60 defines Critical Accounting Policies as
those most important to the financial statement presentation and that require
the most difficult, subjective, complex judgments. As facts, circumstances and
financial position are subject to change at each reporting period, we will
review our Critical Accounting Policies on a quarterly basis to determine which
policies should be included. Currently, we have identified revenue recognition
(with respect to our ratings and advisory revenue) and goodwill as our two
Critical Accounting Policies.

Revenue Recognition - Ratings and Advisory Revenue

We currently derive our ratings and advisory revenue principally from annual
fees from hospitals that participate in our Strategic Quality Initiative (SQI)
program. The SQI program provides business development tools to hospitals that
are highly rated on our website. Under our SQI program, we license the Health
Grades 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,
Neurosciences and Orthopaedics.) 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 this program is a
detailed comparison of the data underlying a hospital's rating to local and
national benchmarks.

We recognize revenue related to these arrangements in a straight-line manner
over the term of the agreement (typically one year). We follow this method
because the primary deliverable under the agreement is the license to utilize
our rating over the contract term. In addition, consulting services are
performed as requested by the client as needed over the term of the agreement.
As we typically receive a non-refundable payment for the contract term upon
execution of the agreement, we record the cash payment as deferred revenue that
is then amortized to revenue over the contract term.

10

Currently, the Emerging Issues Task Force ("EITF") is working to reach a final
consensus regarding EITF 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables, which addresses how to account for multiple-deliverable
revenue arrangements and focuses on when a revenue arrangement should be
separated into different revenue-generating deliverables or "units of
accounting" and if so, how the arrangement considerations should be allocated to
the different deliverables or units of accounting. We continue to follow the
status of the EITF and, based on the tentative conclusions reached by the EITF,
do not believe the final consensus will have an impact on how we currently
account for our SQI agreements.

Goodwill

In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets,
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill is no longer amortized but is subject to annual impairment
testing. Statement 142 also requires companies to perform a transitional test of
goodwill for impairment, and the Company completed its test during the second
quarter of 2002. Based upon the results of the test, the Company recorded a
charge of approximately $1.1 million in its consolidated statement of operations
for the quarter ended June 30, 2002, as a cumulative effect of change in
accounting principle (See Note 3 to our Consolidated Financial Statements).

Statement 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, etc. As described in Note 3 to
our Consolidated Financial statements, management utilized a market
capitalization and expected cash flow valuation approach, giving equal weighting
to each method, to derive its overall fair value estimate of goodwill. This fair
value amount was then compared to the carrying amount of goodwill to arrive at
the final impairment loss calculation of approximately $1.1 million. The process
of determining the fair value of goodwill involved significant judgments
relating to the methodologies available for determining fair value (including
market capitalization, present value analysis, techniques based on multiples of
earnings, revenue, etc.), assumptions imbedded in our cash flow analysis,
weighting given to the various cash flow analyses generated, as well as overall
weighting given to the final combined market capitalization and expected cash
flow approach utilized by management.

Although management believes its approach of applying equal weighting to both
the market capitalization and expected cash flow valuations was reasonable,
applying different weightings to the valuations could have resulted in a range
of no impairment charge recorded to an impairment charge of approximately $2.2
million.

CONSOLIDATED STATEMENT OF OPERATIONS PRESENTATION

In light of the Company's completed transition from a physician practice
management company to a healthcare quality ratings, information and advisory
services company, management is currently evaluating its operating statement
presentation. Although the Company believes that the current presentation has
been the most relevant presentation to investors over the past few years, the
Company believes that modifying this presentation to focus on the Company's only
reporting unit, its ratings and advisory business will provide an enhanced
presentation to investors. The Company anticipates it will complete this
modification for its Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002 and anticipates it will result in reclassifications to prior
periods in order to make them consistent with the modified presentation.

RESULTS OF OPERATIONS

Ratings and advisory revenue. For the three and six months ended June 30, 2002,
ratings and advisory revenue was approximately $1.2 million and $2.2 million,
respectively, compared to ratings and advisory revenue of approximately $661,000
and $1.2 million, for the three and six months ended June 30, 2001,
respectively. These increases are primarily the result of an increase in the
number of hospitals under our strategic quality initiative program. For the
second quarter of 2002, approximately 79% of our ratings and advisory revenue
was derived from our strategic quality initiative services, compared to 78% for
the same period of 2001. In addition, approximately 11% of our ratings and
advisory revenue was derived from our quality assessment and improvement
services, compared to 8% for the same period of 2001. Finally, 10% of our
ratings and advisory revenue was derived from licensing access to our data base
of healthcare information and other services, compared to 14% for the same
period of 2001.

Physician practice service fee revenue. Physician practice service fee revenue
is recognized based upon the service agreements between the Company and the
physician practices. For the six months ended June 30, 2002, physician practice
service fee revenue was approximately $195,000, compared to revenue of $272,000
for the six months ended June 30, 2001. As of July 2002, all service agreements
have expired, we are no longer providing any practice services and we will no
longer have any revenue from practice service fees.

11

Litigation and other costs. For the six months ended June 30, 2001, we incurred
approximately $369,000 in legal fees related to disputes with two of our former
affiliated practices. All disputes with our former affiliated practices have
been settled.

General and administrative expenses. For the three and six months ended June 30,
2002, employee salaries, wages, benefits and taxes accounted for approximately
69% and 68%, respectively of total general and administrative expenses. Employee
salaries include company executives, information technology and client service
personnel. In addition, travel expenses, commercial insurance, facility costs
and professional fees accounted for approximately 19% of total general and
administrative expenses for the three and six months ended June 30, 2002. For
the three months ended June 30, 2002, general and administrative expenses were
approximately $1.2 million, a decrease of $1.3 million, or 52%, over general and
administrative expenses of $2.5 million for the three months ended June 30,
2001. Contributing to this decrease was a reduction in salaries and wages
expenses of approximately $278,000, due to certain employee reductions made
during 2001. In addition, due to the non-amortization provisions of Statement of
Financial Accounting Standards No. No. 142, Goodwill and Other Intangible
Assets, we did not record amortization expense related to goodwill for the three
months ended June 30, 2002, while we incurred approximately $210,000 in
amortization expense for the same period of 2001. Professional fees decreased
over $300,000 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 $146,000. Finally, we decreased
costs in several additional areas as a result of a cost reduction effort
initiated during 2001.

Income on sale of assets and other. For the three months ended June 30, 2002, we
recorded a gain of approximately $142,000 resulting from our receipt of a
payment related to the termination of a multi-year license and content
agreement.

Cumulative effect of change in accounting principle. Based upon the results of
the transitional impairment test performed on our goodwill as required by
Statement 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.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2002, we had working capital of approximately $652,000, an increase
of approximately $491,000 from $161,000 as of December 31, 2001. For the first
six months of 2002, cash flow provided by operations was approximately $188,000
compared to $1.9 million utilized in operations for the same period of 2001.
Included in cash flow provided by operations for the six months ended June 30,
2002 was an income tax refund received of approximately $1.0 million (See Note 4
to our Consolidated Financial Statements).

On May 13, 2002, we entered into 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 one-year
term of the Agreement. In addition, advances under the Agreement are limited to
75% of Eligible Accounts receivable (as defined in the Agreement) plus 50% of
our cash deposited with Silicon Valley Bank. Amounts borrowed under the
Agreement bear interest at Silicon Valley Bank's prime rate plus .75%. Interest
is due monthly on amounts outstanding and the principal balance is due at the
end of the Agreement term. Our ability to request advances under the Agreement
is subject to certain financial and other covenants. We currently have no
advances outstanding under the Agreement.

During the second quarter of 2002, we resolved a dispute with respect to one of
our license and content agreements. In exchange for the termination of the
agreement, we received a payment of $150,000 during the second quarter.

See Note 10 to our Consolidated Financial Statements for information regarding a
threatened, but unasserted claim against us.

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 draw on the credit line available under the Agreement described above, and/or
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, we typically receive a non-refundable
payment for the contract term upon execution of our strategic quality initiative
agreements. As a result, our operating cash flow is substantially dependent upon
our ability to continue to sign new agreements. Our current operating plan
includes growth in new sales from our strategic quality initiative and quality
assessment and improvement agreements. Therefore, failure to achieve our current
operating plan would have a material negative impact on our financial position
and cash flow.

12

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

None.

PART II. OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On June 25, 2002, the Company held its annual meeting of stockholders. At the
meeting, the stockholders voted on the election of six members of the Board of
Directors.

The voting results are set forth below.

13

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits - The following is a list of exhibits filed as part of this
quarterly report on Form 10-Q.

10.1 - Loan and Security Agreement Health Grades, Inc., Healthcare
Ratings, Inc. and ProviderWeb.net, Inc.

99.1 - Certificate of the CEO of Health Grades, Inc. pursuant to
Title 18, Section 1350 of the United States Code.

99.2 - Certificate of the CFO of Health Grades, Inc. pursuant to
Title 18, Section 1350 of the United States Code.

(b) Reports on Form 8-K. During the period covered by this report, the
Company did not file any reports on Form 8-K with the Commission.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

HEALTH GRADES, INC.

Date: August 14, 2002 By: /s/ Allen Dodge
------------------------------------
Allen Dodge
Senior Vice President - Finance and
Chief Financial Officer

14

EXHIBIT INDEX