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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, 2004
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 Identification No.)
Incorporation or Organization)
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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
On July 31, 2004, 25,067,511 shares of the Registrant's common stock,
$.001 par value, were outstanding.
Health Grades, Inc. and Subsidiaries
INDEX
PART I. FINANCIAL INFORMATION:
Item 1. Condensed Consolidated Balance Sheets
June 30, 2004 and December 31, 2003............... 3
Condensed Consolidated Statements of Operations -
Three and Six Months Ended June 30, 2004 and 2003. 4
Condensed Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2004 and 2003........... 5
Notes to Condensed Consolidated Financial
Statements........................................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............... 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risk....................................... 12
Item 4. Controls and Procedures .............................. 12
PART II. OTHER INFORMATION:
Item 4. Submission of Matters to a Vote of Security Holders.... 13
Item 6. Exhibits and Reports on Form 8-K...................... 13
2
PART I. FINANCIAL INFORMATION
Health Grades, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited)
JUNE 30, DECEMBER 31,
2004 2003
------------ ------------
ASSETS
Cash and cash equivalents $ 4,412,163 $ 3,559,125
Accounts receivable, net 1,090,136 1,688,336
Prepaid expenses and other 226,807 230,840
------------ ------------
Total current assets 5,729,106 5,478,301
Property and equipment, net 324,245 236,757
Goodwill 3,106,181 3,106,181
------------ ------------
Total assets $ 9,159,532 $ 8,821,239
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 48,635 $ 116,117
Accrued payroll, incentive compensation and related expenses 897,947 1,148,161
Accrued expenses 205,260 175,380
Deferred income 5,392,214 5,785,437
Income taxes payable 72,243 73,343
------------ ------------
Total current liabilities 6,616,299 7,298,438
Long-term liabilities -- --
------------ ------------
Total liabilities 6,616,299 7,298,438
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 44,630,901 and 44,052,153 shares issued in 2004 and
2003, respectively 44,630 44,052
Additional paid-in capital 90,010,715 89,814,939
Accumulated deficit (73,744,532) (74,568,610)
Treasury stock, 19,563,390 shares (13,767,580) (13,767,580)
------------ ------------
Total stockholders' equity 2,543,233 1,522,801
------------ ------------
Total liabilities and stockholders' equity $ 9,159,532 $ 8,821,239
============ ============
See accompanying notes to condensed consolidated financial statements
3
Health Grades, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------- -------
2004 2003 2004 2003
---- ---- ---- ----
Revenue:
Ratings and advisory revenue $ 3,500,314 $ 2,009,311 $ 6,717,737 $ 3,747,052
Other 867 1,444 1,117 1,487
------------ ------------ ------------ ------------
3,501,181 2,010,755 6,718,854 3,748,539
Expenses:
Cost of ratings and advisory revenue 548,103 464,998 1,210,306 905,107
------------ ------------ ------------ ------------
Gross margin 2,953,078 1,545,757 5,508,548 2,843,432
Operating expenses:
Sales and marketing 1,152,999 847,083 2,244,449 1,489,605
Product development 445,232 332,748 910,682 660,178
General and administrative 731,214 811,494 1,534,423 1,401,411
------------ ------------ ------------ ------------
Income (loss) from operations 623,633 (445,568) 818,994 (707,762)
Other:
Gain on sale of assets and other -- 50 -- 75
Interest income 3,233 1,830 5,083 4,015
Interest expense -- (6,888) -- (7,466)
------------ ------------ ------------ ------------
Income (loss) before income taxes 626,866 (450,576) 824,077 (711,138)
Income tax benefit -- -- -- --
------------ ------------ ------------ ------------
Net income (loss) $ 626,866 $ (450,576) $ 824,077 $ (711,138)
============ ============ ============ ============
Net income (loss) per common share (basic) $ 0.03 $ (0.02) $ 0.03 $ (0.02)
============ ============ ============ ============
Weighted average number of common shares
used in computation (basic) 25,030,159 24,402,398 24,932,969 28,978,635
============ ============ ============ ============
Net income (loss) per common share (diluted) $ 0.02 $ (0.02) $ 0.03 $ (0.02)
============ ============ ============ ============
Weighted average number of common shares
used in computation (diluted) 33,023,883 24,402,398 32,545,662 28,978,635
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
4
Health Grades, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
SIX MONTHS ENDED JUNE 30
2004 2003
---- ----
OPERATING ACTIVITIES
Net income (loss) $ 824,077 $ (711,138)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation 63,271 49,199
Bad debt expense -- 11,667
Gain on disposal of assets -- (75)
Non-cash compensation expense related to non-employee
stock options 142,501 15,000
Change in operating assets and liabilities:
Accounts receivable net 598,200 (172,230)
Prepaid expenses and other assets 4,033 40,235
Accounts payable and accrued expenses (37,602) 21,070
Accrued payroll, incentive compensation
and related expenses (250,214) 388,561
Income taxes payable (1,100) (420)
Deferred income (393,223) 467,674
----------- -----------
Net cash provided by operating activities 949,943 109,543
INVESTING ACTIVITIES
Purchase of property and equipment (150,759) (52,088)
Sale of property and equipment -- 75
----------- -----------
Net cash used in investing activities (150,759) (52,013)
FINANCING ACTIVITIES
Proceeds from note payable -- 500,000
Principal repayments on note payable -- (60,959)
Exercise of common stock options 53,854 --
Purchases of treasury stock -- (500,000)
----------- -----------
Net cash provided by (used in) financing activities 53,854 (60,959)
----------- -----------
Net increase (decrease) in cash and cash equivalents 853,038 (3,429)
Cash and cash equivalents at beginning of period 3,559,125 2,947,047
----------- -----------
Cash and cash equivalents at end of period $ 4,412,163 $ 2,943,618
=========== ===========
See accompanying notes to condensed consolidated financial statements.
5
Health Grades, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
June 30, 2004
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Health
Grades, Inc. ("HealthGrades") have been prepared in accordance with accounting
principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America 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, 2004 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2004. 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, 2003.
DESCRIPTION OF BUSINESS
HealthGrades provides proprietary and objective healthcare provider ratings and
quality improvement consulting services. We provide our clients with healthcare
information, including information relating to quality of care 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 tailored to address service areas (e.g.
cardiac, orthopedics, vascular, etc.) that they 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. We also offer physician-led quality improvement
engagements for any hospitals that are seeking to enhance quality.
In addition, we provide basic and detailed 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. Basic profile information for certain providers 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, a medical professional underwriter).
We provide detailed online healthcare quality information for employers,
benefits consulting firms, payers and other organizations that license our
Quality Ratings Suite(TM) of products - Hospital Quality Guide(TM), Physician
Quality Guide(TM), Nursing Home Quality Guide(TM) and Home Health Quality
Guide(TM).
FUTURE EFFECT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
We have reviewed all recently issued, but not yet effective, accounting
pronouncements and do not believe any such pronouncements will have a material
impact on our condensed consolidated financial statements.
NOTE 2 - STOCK-BASED COMPENSATION
We account for our stock-based compensation arrangements using the intrinsic
value method under the provisions of 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 Black-Scholes option valuation model was utilized for the
purpose of this disclosure. The Black-Scholes 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 income (loss) as disclosed below may not be
representative of compensation expense in future years.
For the six months ended June 30, 2004, the fair value of options awarded during
this period were estimated using the Black Scholes model with the following
assumptions: a risk-free interest rate over the life of the options of between
2.44% to 3.16%; no dividend
6
yield; and expected three year lives of the options. The volatility factors
utilized ranged from 1.76 to 1.78.
For the six months ended June 30, 2003, the fair value of options awarded during
this period were estimated using the Black Sholes model with the following
assumptions: a risk-free interest rate over the life of the options of between
1.32% to 2.18%; no dividend yield; and expected three year lives of the options.
The volatility factors utilized ranged from 1.96 to 2.04.
The following table illustrates the effect on net income (loss) and income
(loss) per share if we had applied the fair value recognition provisions of SFAS
123 to our stock-based compensation plan.
Three months ended June 30, Six months ended June 30,
2004 2003 2004 2003
-------- --------- -------- ---------
Net income (loss) as reported $626,866 $(450,576) $824,077 $(711,138)
Add: Stock-based compensation expense included in
reported net income under APB No. 25 -- -- -- --
Less: Total stock-based compensation expense
determined under fair value based method for
awards, net of related tax effects (31,290) (91,702) (65,403) (194,654)
-------- --------- -------- ---------
Pro forma net income (loss) $595,576 $(542,278) $758,674 $(905,792)
======== ========= ======== =========
Income (loss) per share:
Basic as reported $ 0.03 $ (0.02) $ 0.03 $ (0.02)
======== ========= ======== =========
Diluted as reported $ 0.02 $ (0.02) $ 0.03 $ (0.02)
======== ========= ======== =========
Basic pro forma $ 0.02 $ (0.02) $ 0.03 $ (0.03)
======== ========= ======== =========
Diluted pro forma $ 0.02 $ (0.02) $ 0.02 $ (0.03)
======== ========= ======== =========
The following table sets forth the computation of basic and diluted earnings per
share for the three and six months ended June 30, 2004 and 2003.
Three months ended June 30, Six months ended June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Numerator for both basic and diluted earnings per share:
Net income (loss) $ 626,866 $ (450,576) $ 824,077 $ (711,138)
=========== =========== =========== ===========
Denominator:
Denominator for basic net income (loss) per
common share--weighted average shares 25,030,159 24,402,398 24,932,969 28,978,635
Effect of dilutive securities:
Stock options and warrants 7,993,724 -- 7,612,693 --
----------- ----------- ----------- -----------
Denominator for diluted net income (loss) per
common share--adjusted weighted average
shares and assumed conversion 33,023,883 24,402,398 32,545,662 28,978,635
=========== =========== =========== ===========
Net income (loss) per common share (basic) $ 0.03 $ (0.02) $ 0.03 $ (0.02)
=========== =========== =========== ===========
Net income (loss) per common share (diluted) $ 0.02 $ (0.02) $ 0.03 $ (0.02)
=========== =========== =========== ===========
During the six months ended June 30, 2004, the number of our common shares
issued increased by 578,748 shares due to the exercise of stock options by
several individuals. We received approximately $54,000 from these individuals,
which represents the exercise price of the options. As of June 30, 2003, we had
approximately 5.2 million shares underlying options and warrants that were
currently exercisable, but were not included in our calculation of weighted
average common shares outstanding as they were antidilutive.
NOTE 3 - LINE OF CREDIT
In February 2004, we executed an amendment to our line of credit arrangement
with Silicon Valley Bank. The terms of the amendment provide for an extension of
the maturity date of the $1,000,000 line of credit arrangement to February 20,
2005. To date, we have not borrowed any funds under the line of credit.
7
NOTE 4 - LEGAL PROCEEDINGS
In November 2003, we executed a Settlement Agreement and Mutual Release (the
"Settlement Agreement") with Strategic Performance Fund - II ("SPF-II"),
Orthopaedic Associates, P.A. d/b/a Park Place Therapeutic Center ("Park Place")
and four of the physician owners of Park Place, in connection with a legal
proceeding concerning an alleged breach by us of two leases. In consideration
for the dismissal of all claims and mutual releases, we 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 was 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. In April 2004, upon satisfaction of the conditions described
above, the $441,000 in the above mentioned escrow account was released to
SPF-II. In July 2004, we made the final $50,000 payment to SPF-II, and an order
of dismissal was entered on July 30, 2004.
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.
NOTE 5 - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for income taxes amounted to approximately $1,100 and $400 for the six
months ended June 30, 2004 and 2003, respectively.
8
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 and anticipated additional
personnel additions 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, customer turnover and other factors discussed below
and in the Company's Annual Report on Form 10-K for the year ended December 31,
2003, particularly under "Risk Factors" in Item 1.
Introductory Commentary
In evaluating our financial results and financial condition, management has
focused principally on the following:
Revenue Growth and Client Retention - We believe these are key factors affecting
both our results of operations and our liquidity. Revenue growth during the
first six months of 2004 reflects growth across all of our product areas. In
prior years, our revenue growth was principally due to increased sales of our
Strategic Quality Initiative (SQI) program to hospitals. In addition, our sales
were particularly strong in the period following our annual release of our new
ratings, which occurs during the fall for most of the procedures and diagnoses
for which we rate hospitals. However, we believe that additional initiatives
have contributed to increased growth, both generally and during periods where we
have not experienced pronounced growth in the past. In the second quarter of
2003, we announced the winners of our first annual Distinguished Hospital Award
for Clinical Excellence(TM) (DHA). Winners of the DHA represent the
highest-scoring of the nation's full-service hospitals based on a proprietary,
three-year, risk-adjusted analysis of procedures and diagnoses in six major
clinical specialties. In the fourth quarter of 2003, we identified the DHA
winners for the 2004 year and began marketing our services to the winners. Sales
of both our SQI and DHA programs during the third and fourth quarter of 2003
contributed to our 2004 revenue growth due to the fact that we recognize revenue
related to our marketing programs on a straight-line basis over the first year
term of the agreement. In addition, we experienced meaningful growth from the
sales of our quality information to employers, benefits consulting firms,
consumers and others through both our Healthcare Quality Reports and our Quality
Ratings Suite (QRS) as well as increased revenues from our Quality Assessment
and Improvement (QAI) products.
In addition to increasing our revenue base from new sales, a principal objective
for us is to achieve a high rate of retention of our clients. This is
particularly true for our agreements with hospitals, which are typically signed
for three-year terms, subject to a cancellation right by either the client or
us, on each annual anniversary date. We believe one of the obstacles to
maintaining high retention rates is that clients who signed hospital contracts
with us several years ago, when we were developing our provider services and
charging significantly lower fees than we do today, may be unwilling to accept
our current pricing structure. In addition, beginning in January 2004, we no
longer offer exclusivity under our hospital 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 (subject the ability of a
client or us to terminate on each anniversary date), we anticipate that all
exclusivity provisions will expire by the end of 2006. During the six months
ended June 30, 2004, we retained contracts representing approximately 78% of the
annual revenue associated with all contracts that had first or second year
anniversaries during this period.
We typically receive a non-refundable payment from hospital clients 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.
Variable Expense Considerations - During 2003, we added personnel to provide
client consulting and support for our DHA, 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 expand our
revenue base. The additional of personnel, particularly client consultants, will
be dependent on the level and mix of our sales. For example, our QAI programs
entail more consulting services and, therefore, require a higher ratio of
consultants to service these arrangements compared to our other products.
Moreover, we have in place a cash incentive program for 2004, the amount of
which will be dependent upon company performance. Based on company performance
through the first six months of 2004, we have accrued approximately $325,000
related to this incentive plan. Management recognizes that any increases in
expenses to accommodate future 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.
9
Distribution and Other Collaborative Arrangements - As part of our revenue
growth strategy, we seek to enter into arrangements with well recognized
businesses to develop new products such as our Distinguished Hospital Award
Program, which we developed with J.D. Power and Associates, and expand upon
distribution channels through relationships with companies such as Hewitt
Associates, which provides our quality information to over 125 Fortune 1000
corporations throughout the United States. We expect to continue to seek
arrangements such as these to increase the reach of our product offerings as
well as the awareness and market penetration of our QRS and QAI programs. In
June 2004, we announced an arrangement with 3M Health Information Systems (3M)
under which we will offer, pursuant to a program called the "Quality Excellence
Program", their coding expertise and process improvement services in conjunction
with our clinical quality improvement services. This program is designed to
assist hospitals in assessing and improving their performance in the quality of
care delivered and the accuracy of the patient data that is publicly available
and utilized by employers, payers, and consumers to identify the best hospitals.
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 which
may not be available at satisfactory terms.
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. See Part II, Item 7 , "Management's Discussion and Analysis of
Financial Condition and Results of Operations, Critical Accounting Estimates",
in our Annual Report on Form 10-K for the year ended December 31, 2003 for a
discussion of our goodwill impairment analysis. For the six months ended June
30, 2004, no interim impairment test was performed, as no indicators of
impairment were present.
Evolving Accounting Guidance Regarding Revenue Recognition
See Part II, Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations, Evolving Guidance Regarding Revenue
Recognition", in our Annual Report on Form 10-K for the year ended December 31,
2003 for a discussion of this matter.
RESULTS OF OPERATIONS
Revenue Overview
Three months Three months Six months Six months
ended ended ended ended
Product Area June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
- ------------ ------------- ------------- ------------- -------------
Marketing services to hospitals
(SQI and DHP products) $2,079,080 $1,499,285 $4,155,962 $2,826,755
Quality improvement services to hospitals
(QAI products) 455,862 218,637 849,003 419,251
Sales of quality information to employers,
consumers and others
(QRS and Healthcare Quality Reports) 914,558 253,105 1,600,459 428,948
Consultant reimbursed travel 50,814 38,284 112,313 72,098
---------- ---------- ---------- ----------
Total $3,500,314 $2,009,311 $6,717,737 $3,747,052
========== ========== ========== ==========
Ratings and advisory revenue. For the three and six months ended June 30, 2004,
ratings and advisory revenue was approximately $3.5 million and $6.7 million,
respectively, compared to ratings and advisory revenue of $2.0 million and $3.7
million for the three and six months ended June 30, 2003. These increases are
due to continued growth in the sale of our suite of marketing and quality
10
assessment and improvement products to hospitals and the sales of our quality
information to employers, benefits consulting firms, consumers and others. For
the three months ended June 30, 2004 compared to the three months ended June 30,
2003, sales to hospitals accounted for approximately $830,000 or 56% of our
increased revenue while our sales of quality information accounted for
approximately $661,000 or 44% of the increase. For the second quarter of 2004
and 2003, approximately 59% and 75% of our ratings and advisory revenue was
derived from our marketing services to hospitals. In addition, approximately 13%
of our ratings and advisory revenue was derived from the sale of our quality
improvement services to hospitals for the second quarter of 2004 compared to 11%
for the same period of 2003. Sales of our quality information totaled 26% of our
ratings and advisory revenue for the three months ended June 30, 2004 compared
to 13% for the same period of 2003.
Cost of ratings and advisory revenue. For the three months and six months ended
June 30, 2004, cost of ratings and advisory revenue was $548,000 and $1.2
million, respectively, or approximately 16% and 18% of ratings and advisory
revenue, compared to $465,000 and $905,000, respectively, or approximately 23%
and 24% for the same period of 2003. The decrease in cost of ratings and
advisory revenue as a percentage of ratings and advisory revenue is due to the
fact that our revenue growth was principally from our marketing services to
hospitals and sales of quality information, which do not require a substantial
amount of incremental cost to deliver. In addition, one of the significant
components of cost of ratings and advisory revenue is our cost to acquire data,
which has remained relatively fixed for the last year. Moreover, our sales of
our healthcare quality reports do not require any commission costs as these are
sold online directly to consumers. Costs related to our healthcare quality
reports are principally sales and marketing costs related to payments we make
for search engine placement on the internet as well as fees paid to a
consultant. These costs are recorded in sales and marketing in our consolidated
statements of operations.
Sales and marketing costs for the three and six month periods ended June 30,
2004 increased to approximately $1.2 million and $2.2 million, respectively, or
33% of ratings and advisory revenue, from approximately $847,000 and $1.5
million, or 42% and 40% of ratings and advisory revenue for the three and six
months ended June 30, 2003. The decrease as a percentage of ratings and advisory
revenue is primarily due to our increased existing base of business. We pay a
lesser percentage of commissions to our sales group upon renewals of contracts
with hospitals than we pay with respect to new contracts.
General and administrative expenses. For the three months ended June 30, 2004,
general and administrative expenses were approximately $731,000, a decrease of
approximately $80,000 from general and administrative expenses of approximately
$811,000 for the same period of 2003. For the six months ended June 30, 2004,
general and administrative expenses increased by approximately $133,000 to $1.5
million compared to the same period of 2003. The decrease in expenses from the
three months ended June 30, 2003, is principally due to the fact that the second
quarter of 2003 included an accrual of approximately $268,000 related to cash
bonuses paid in July 2003. Because the amount of these bonus payments were not
known as of the end of the first quarter of 2003 and the payments were not
approved until the second quarter of 2003, the entire amount of the bonus payout
was accrued during the second quarter of 2003.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2004, we had a working capital deficit of approximately $887,000, a
decrease of $933,000 from a working capital deficit of approximately $1.8
million as of December 31, 2003. Included in current liabilities are $5.4
million in deferred income, representing contract payments for future services.
These amounts will be reflected in revenue upon provision of the related
services. For the first six months of 2004, cash flow provided by operations was
approximately $950,000 compared to $110,000 for the same period of 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 June 30, 2004, 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 June 30,
2004, we were in compliance with these covenants.
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.
Operating lease obligations relate principally to our office space lease. In
addition to these obligations, we anticipate incurring certain
11
capital expenditures during the remainder of 2004 primarily to upgrade some of
our information technology hardware and software. We expect that total capital
expenditures in 2004 will be less than $300,000. For the six months ended June
30, 2004, capital expenditures totaled approximately $151,000 and relate to
leasehold improvements in connection with the additional office space noted
above as well as planned upgrades to our information technology infrastructure.
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). We record the cash payment as deferred revenue, which is a
current liability on our consolidated balance sheet, which 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
agreements. A significant failure to achieve sales targets in the plan would
have a material negative impact on our financial position and cash flow.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We have certain investments in a treasury obligation fund maintained by Silicon
Valley Bank. As of June 30, 2004, our investment in this fund amounted to
approximately $2.9 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 six
months ended June 30, 2004, interest earned on this balance was $5,083. Any
decrease in interest rates in this investment account would not have a material
impact on our financial position.
ITEM 4. CONTROL PROCEDURES
a) Evaluation of Disclosure Controls and Procedures
Management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of 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.
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PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 23, 2004, we held our annual meeting of stockholders. At the meeting,
the stockholders voted on the election of five members of the Board of
Directors.
The voting results are set forth below.
1. Election of Directors:
NAME OF NOMINEE FOR WITHHELD
- --------------- --- --------
Kerry R. Hicks 23,247,912 38,200
Peter H. Cheesbrough 23,247,912 38,200
Leslie S. Matthews 23,247,912 38,200
John J. Quattrone 23,247,912 38,200
J. D. Kleinke 23,247,912 38,200
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -
3.1 Amended and Restated Certificate of Incorporation, as amended
(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, as amended (Incorporated by reference
to Exhibit 3.2 to our Annual Report on Form 10-K for the year ended
December 31, 2001).
31.1 Certificate of the Chief Executive Officer of Health Grades, Inc.
required by Rule 15d-14(a).
31.2 Certificate of the Chief Financial Officer of Health Grades, Inc.
required by Rule 15d-14(a).
32.1 Certificate of the Chief Executive Officer of Health Grades, Inc.
required by Rule 15d-14(b).
32.2 Certificate of the Chief Financial Officer of Health Grades, Inc.
required by Rule 15d-14(b).
(b) Reports on Form 8-K.
During the quarter ended June 30, 2004, we furnished a report on Form 8-K.
The report, furnished on April 30, 2004 and dated April 29, 2004, provided
information responsive to Item 12 in connection with our second quarter results
of operations.
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 16, 2004 By: /s/ Allen Dodge
-------------------------------------
Allen Dodge
Senior Vice President - Finance and
Chief Financial Officer
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EXHIBIT INDEX
Exhibits
Number Description
- ------ -----------
3.1 Amended and Restated Certificate of Incorporation, as amended
(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, as amended (Incorporated by reference
to Exhibit 3.2 to our Annual Report on Form 10-K for the year ended
December 31, 2001).
31.1 Certificate of the Chief Executive Officer of Health Grades, Inc.
required by Rule 15d-14(a).
31.2 Certificate of the Chief Financial Officer of Health Grades, Inc.
required by Rule 15d-14(a).
32.1 Certificate of the Chief Executive Officer of Health Grades, Inc.
required by Rule 15d-14(b).
32.2 Certificate of the Chief Financial Officer of Health Grades, Inc.
required by Rule 15d-14(b).