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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, 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 (I.R.S. Employer Identification No.)
of 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
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 28, 2002, the aggregate market value of the Common Stock held by
non-affiliates of the registrant was $724,305. 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 31, 2003 there were 36,406,649 shares of the registrant's Common
Stock outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
None
TABLE OF CONTENTS
PART I
Item 1. Business........................................................... 2
Item 2. Properties......................................................... 20
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......... 28
Item 8. Financial Statements and Supplementary Data........................ 28
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................... 28
PART III
Item 10. Directors and Executive Officers of the Registrant................. 29
Item 11. Executive Compensation............................................. 29
Item 12. Security Ownership of Certain Beneficial Owners and Management..... 29
Item 13. Certain Relationships and Related Transactions..................... 29
Item 14. Controls and Procedures............................................ 30
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, 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 "Item 1-Risk Factors" and matters
set forth in the Report generally. We undertake no obligation to update publicly
any forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.
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PART I
Item 1. Business.
BUSINESS
OVERVIEW
Health Grades, Inc. ("HealthGrades") provides healthcare ratings, advisory
services and other healthcare information. We grade, or provide the means to
assess and compare the quality or qualifications of, various types of healthcare
providers. Our customers include healthcare providers, employees, health plans,
insurance companies and consumers.
We provide ratings or profile information relating to the following
healthcare providers:
- 5,000 hospitals according to specialty (cardiac surgery,
cardiology, orthopedic surgery, neurosciences, pulmonary,
vascular surgery and obstetrics);
- 620,000 physicians in over 70 specialties;
- 17,000 nursing homes;
- 7,800 home health agencies;
- 3,000 hospice programs; and
- 300 fertility clinics that provide assisted reproductive
technology (ART) services.
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 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 a fee, we offer healthcare quality reports with
respect to certain healthcare providers. 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,
health plans and other organizations that license access to our database of
healthcare providers.
We have also entered into strategic arrangements with other service
providers, including GeoAccess and J.D. Power & Associates, in an effort to
increase our name recognition and market presence, as well as enhance our
service offerings.
HEALTHCARE INFORMATION; HEALTHGRADES.COM
We compile comprehensive information regarding various healthcare providers
and distill the information to meet the requirements of consumers, employers,
health plans and other customers. We provide certain information for no charge
on our healthgrades.com Internet site. Our revenues are generated, in part,
through the provision of healthcare information derived from our database in a
manner that can be useful to employers, health plans and others.
Healthgrades.com 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 the most informed decisions
regarding their health and that of their families.
We distinguish the 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 quality care or a quality
provider, using our rating and profile information. However, we do not endorse
any particular provider or facility. We strive to provide unbiased ratings
regarding the quality of providers and facilities by developing proprietary
algorithms or 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 page provides a list of hospitals and
ratings for the hospitals with respect to different medical procedures or
diagnoses chosen by the user. Information with regard to procedures and
diagnoses is provided in the following areas:
- cardiac;
- orthopaedics;
- neurosciences;
- neurosurgery;
- pulmonary/respiratory;
- obstetrics; and
- vascular surgery.
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For each particular diagnosis or procedure chosen by the user, other than
those relating to obstetrics, we provide a rating system of five stars, three
stars or one star (five stars is the highest rating; one star is the lowest)
with regard to the performance of the majority of hospitals in the United
States. We base all of our ratings, except ratings on obstetrics, 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. Generally, approximately 70% to 80% of hospitals studied
are classified as three stars. The three star rating is applied when there is
very little 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 better than expected on a
statistically significant basis. Approximately 10% to 15% of hospitals are rated
one star, meaning that their performance was worse than expected on a
statistically significant basis.
For our obstetrics ratings, which also are subject to the five star rating
system, we use state all-payor 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,
Illinois, Maryland, Massachusetts, Nevada, New Jersey, New York, North Carolina,
Pennsylvania, Texas, Utah, Vermont, Virginia, Washington, and Wisconsin. We
believe that these 18 states are the only states with sufficient data for use on
our website. This data represents all discharges for the 18 states over a
three-year period set from 1998-2000, with the exception of Iowa (2000 only),
Illinois (1999 and 2000 only), North Carolina (1999 and 2000 only) and Texas
(1999 and 2000 only). We analyzed the following factors for each hospital within
the 18 all-payor states:
- Actual complication rates from vaginal and cesarean section single
birth deliveries;
- Volume of vaginal and cesarean single birth deliveries; and
- Presence of neonatal intensive care unit (NICU).
Hospitals are assigned a score in respect of each of the factors. Volume
for vaginal and cesarean single birth deliveries was ordered into tenth
percentile groups by state with the highest volume percentile group in each
state receiving a value of 10 and the lowest volume percentile group in each
state receiving a value of 1. Complication rates were placed into tenth
percentile groups by state. The highest complication rate percentile group in
each state received a value of 1 while the lowest complication rate percentile
group in each state received a value of 10. The presence of a NICU was assigned
a value of 10 while no NICU was assigned a value of 1. We then developed a
system that assigned a weight to each factor based on its importance to the
quality of obstetric care in the hospital. These weightings were developed by
interviewing a group of obstetricians who had an average of 17 years of practice
experience. Each factor's score was multiplied by its percentage weight and then
summed to create an overall score. The top 30% of hospitals (in the 18 states)
receive five stars, the middle 40% receive three stars and the bottom 30%
receive one star.
Nursing Home Report Cards(TM) - This page provides rankings of the performance
of nursing homes across the United States that were Medicare or Medicaid
certified and active in these programs. In preparing the ratings, we analyzed
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 were not included in the
analysis. Stand-alone Medicare and/or Medicaid nursing homes were analyzed apart
from Medicare, hospital-based nursing homes. We did 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 were not included in our analysis. The ratings were 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 in the states' survey process and results.
In conjunction with a group of nursing home professionals (which included
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 (involved 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 received five stars, and the middle 40% of nursing homes received
three stars.
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Home Health Report Cards(TM) - This page provides rankings of the performance of
Medicare certified home health agencies across the United States. Home health
agencies provide health and social services to persons at their homes. These
persons are recovering from an illness or injury or require assistance with
daily needs such as eating, dressing and bathing. We rate home health agencies
based upon data provided by CMS. Information is derived from complaint surveys
and licensing surveys. Complaint surveys are conducted by a state survey team in
response to one or more complaints about a home health agency. Licensing surveys
are surveys completed for Medicare certification. The licensing survey
information is derived from individual state agencies, which enter the
information into the OSCAR database. These surveys generally occur every 36
months, but may occur more frequently based on the results of the previous
survey. Home Health Report Cards(TM) is updated annually, and currently reflects
May 2002 OSCAR data (the next data update will occur mid-2003). In preparing the
ratings, we reviewed survey information from the most recent licensing surveys
and a maximum of four complaint surveys of home health agencies. Only home
health agencies that were active in the Medicare program during this time period
were included in the analysis. Specifically, we utilized the following elements
to capture the quality of care and operational stability of each home health
agency:
- Complaint surveys (two elements):
- Number of complaint surveys within the last four years
- Number of complaint surveys dated within six months of each
other;
- Condition level deficiencies (very serious deficiencies that may give
cause for penalties or de-certification by Medicare) (four elements) -
Number of condition level deficiencies on each of the past four
surveys;
- Standard level deficiencies (non-serious deficiencies that require a
plan for correction) (four elements) - Number of standard level
deficiencies on each of the last four surveys;
- Condition level deficiencies reported on both the most recent and
prior survey;
- Standard level deficiencies reported on both the most recent and prior
survey;
- Surveyor's summary score on the quality of care during the most recent
survey;
- Years in operation; and
- Ownership changes as compared to years in operation.
Working with a group of healthcare professionals whose area of expertise is
home healthcare; we developed a proprietary weighting system that translates the
elements detailed above into numeric scores. Home health agencies were sorted by
state based upon the overall score. The top 30% of home health agencies in each
state received five stars, the middle 60% received three stars and the bottom
10% received one star. As is the case with nursing homes, the ratings were
assigned on a state-by-state basis, rather than nationally, because the surveys
from which information is derived on the OSCAR database are conducted by state
agencies, and there may be variations in the states' survey process and results.
In addition, our site provides specific information with regard to particular
deficiencies found in the surveys.
Hospice Report Cards(TM) - This page differs from some of our other report card
pages in that it does not provide ratings. Instead, it provides users with the
means to assess hospice programs across the United States that participate in
Medicare. The data on our Hospice Report Card site is purchased from CMS, and is
derived from their Provider of Service ("POS") file. The POS file contains data
on every hospice program that participates in Medicare. Hospice services are
categorized as "provided by staff" and "provided under arrangement." "Provided
by staff" refers to a hospice service that is performed by an employee or staff
member of the hospice, whereas "provided under arrangement" refers to a service
that is delegated to a healthcare provider other than a hospice employee or
staff member. For example, if a hospice program does not employ a physical
therapist, but a patient requires physical therapy, the organization might
contract with an independent physical therapist to provide this service. In
addition, hospice services are categorized as "core services" or "non-core
services." Core services, as defined in the POS file, are important, basic
elements of hospice care that are crucial to virtually every hospice patient and
their family. These services include the following:
- nursing care provided by or under the supervision of a registered
nurse;
- medical social services provided under the direction of a physician;
- physician services; and
- counseling.
Non-core services are also important to high-quality hospice care, but each
non-core service may be inappropriate or unnecessary for every hospice patient.
Non-core hospice services, as defined in the POS file, include:
- physical therapy;
- occupational therapy;
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- speech pathology;
- home health aide;
- homemaker services;
- medical supplies; and
- short-term inpatient care.
Hospice report cards provide users with a list of hospices from which they
can refine their search based upon the following criteria:
- whether the program provides nursing care directly by hospice
employees;
- whether the program provides medical social services directly by
hospice employees;
- whether the program provides physician services directly by hospice
employees;
- whether the program provides counseling directly by hospice employees;
and
- whether the program provides all non-core hospice services.
Fertility Clinic Report Cards(TM) - Like our Hospice Report Card pages,
this page differs from our other report card pages in that it does not provide
ratings. Instead, it provides users with the means to assess fertility clinics
across the United States. Information on healthgrades.com presently represents
one year of assisted reproductive technology ("ART") data. ART is defined as any
clinical treatment or procedure that involves the handling of human eggs and
sperm to help a woman become pregnant. Types of ART include IVF (in vitro
fertilization), GIFT (gamete intrafallopian transfer), ZIFT (zygote
intrafallopian transfer), egg or embryo donation and surrogate birth.
The ART data on the healthgrades.com website is acquired from an annual
report published by the National Center for Chronic Disease Prevention and
Health Promotion of the Centers for Disease Control and Prevention ("CDC"), the
American Society of Reproductive Medicine, the Society for Assisted Reproductive
Technology ("SART") and RESOLVE, a national consumer group for men and women
facing infertility. Fertility clinics in the United States are required to
provide ART data to SART, and information for over 300 fertility clinics are
represented in the CDC/SART report.
Each fertility clinic profile consists of the following five elements:
- General information (contact information for each facility);
- Program characteristics, including whether the clinic accepts single
women and gestational carriers (women who carry children for other
women), whether the clinic utilizes a donor egg program and whether
the clinic is a member of SART;
- Percentage of facilities nationwide that have designated program
characteristics;
- Type of ART (each fertility clinic's ART procedures (e.g., % of
procedures using IVF) compared to the national average);
- Patient diagnosis (individual clinic patient diagnoses compared to the
national average); and
- Pregnancy success rates (individual clinic pregnancy success rates in
four age categories compared to the national average). For each age
category, success rates are provided for three types of ART cycles:
cycles that utilize fresh embryos from non-donor eggs, cycles that
utilize frozen embryos from non-donor eggs, and cycles that utilize
donor eggs.
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. Physician
information provided by HealthGrades includes primary and secondary
specialty areas, medical school attended, years since medical school,
address, telephone number, and maps. For a fee, we also provide 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;
- Children's Hospitals -- The children's hospital profile database is an
online directory of every Medicare-licensed children's hospital in the
U.S. The directory contains detailed profiles and maps for more than
70 children's hospitals;
- Chiropractors - HealthGrades Chiropractor Profiles is an online
directory that contains detailed profiles and maps for more than
60,000 chiropractors in the United States;
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- Assisted living residences - HealthGrades Assisted Living Profiles is
on online directory that contains detailed profiles (including
accreditation information) and maps for more than 21,000 residences in
the United States;
- Mammography facilities - HealthGrades Mammography Facility Profiles is
an online directory that contains detailed profiles and maps for more
than 10,000 facilities in the United States;
- Acupuncturists - HealthGrades Acupuncturist Profiles is an online
directory that contains detailed profiles and maps for more than 800
acupuncturists in the United States;
- Naturopathic physicians - HealthGrades Naturopathic Physician Profiles
is an online directory that contains detailed profiles and maps for
more than 700 naturopathic physicians in the United States;
- Birth centers - HealthGrades Birth Center Profiles is on online
directory that contains detailed profiles (including accreditation
information) and maps for more than 70 facilities in the United
States;
- Emergency Centers -HealthGrades Emergency Services Profiles includes
detailed profiles of over 10,000 hospital emergency rooms, rural
health clinics and federally-qualified community health centers;
- Cancer Centers - HealthGrades Cancer Center Profiles is an online
directory of cancer facilities designated by the National Cancer
Institute as comprehensive or clinical cancer centers. The directory
contains detailed profiles that include contact information, disease
specializations, clinical trials, patient support programs, screenings
and prevention programs and maps for over 50 cancer centers.
INFORMATION AND RELATED SERVICES FOR HOSPITALS, EMPLOYERS, HEALTH PLANS,
PROFESSIONALS AND CONSUMERS
The information provided on our 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, health plans and consumers as described below:
SERVICES FOR HOSPITALS - We offer a Strategic Quality Initiative(TM) (SQI)
program, a Quality Assessment and Improvement(TM) (QAI) program and a Ratings
Quality Analysis Program(TM) (RQA) for hospitals. As our programs are targeted
toward specific areas (for example, Cardiac, Neurosciences, etc.) some of our
hospital customers choose to work with us utilizing our SQI programs for their
higher rated areas and utilizing our QAI and RQA programs for their lower rated
areas. As of March 22, 2003, over 130 hospitals have joined our SQI program, QAI
program or RQA program.
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.
Marketing. 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 o 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;
- Marketing messages developed and approved by HealthGrades; and
- Ratings comparisons developed and approved by HealthGrades.
The license may be in a single service line (for example, Cardiac) or multiple
service lines (for example, Cardiac, Neuroscience and Orthopaedics). In
addition, the SQI program provides ongoing access to HealthGrades' marketing
service and resources, tailored to the hospital's specific needs, and includes:
- Assistance in the creation and distribution of marketing/public
relations communications;
- Communication tools, such as press releases, that are customized as
needed;
- A comprehensive reference guide with sample client marketing material,
template letters, electronic artwork and detailed descriptions of our
ratings methodology;
- "Award" certificates and posters recognizing the client as a Five Star
provider of services; and
- Customized web site ("Quality Net") for access to HealthGrades'
library, which includes case studies regarding HealthGrades' clients;
sample marketing materials, including print, television and radio ad
samples; and direct access to HealthGrades logos which can be
downloaded for immediate use and Ratings Quality Analysis for the
licensed service line(s), described below.
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RQA Programs. We also assist hospitals in measuring the success of their
quality efforts utilizing our team of in-house healthcare consultants. Either
purchased as a stand-alone product, or as part of the SQI program, HealthGrades
provides an on-site presentation to administrative, physician and quality
improvement staff regarding an annual comprehensive quality analysis of the
hospital's identified weaknesses and potential areas for improvement within the
service line(s) 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;
- Summary analysis presenting key observations and recommendations for
overall improvement; and
- An annual regional performance comparison to assist hospitals in
identifying competitive trends.
QAI Program. 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. 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. Under our QAI program, hospitals will receive the following
services with respect to the service line(s) licensed from us:
- - detailed analysis of the last two years of the hospital's Medicare and all
payer-data, including risk adjusted analysis and comparison of the
hospital's:
- annual actual and predicted mortality data for various hospital
procedures;
- documented and coded risk factors for various hospital
procedures; and
- documented and coded complications for various hospital
procedures;
- - comparison of all data by physician and physician group when appropriate;
- - provision of updated data on a quarterly basis;
- - consultation with key administrative and hospital staff, key physicians and
quality improvement team and implementation groups during every on-site
visit
SERVICES FOR EMPLOYERS, HEALTH PLANS AND OTHERS - We license access to, and
customize our database for employers, health plans and others. Depending on the
client's needs, we can customize our content for the intended users (for
example, health plan members who are affiliated with the health plan). Some of
the healthcare quality information available to our customers and their web
users includes:
Physicians
Profiles of over 620,000 practicing physicians in the nation that include:
- Sanction database for every state except HI, SD, DC;
- Board certification status by specialty;
- Hospital affiliations; and
- Medical school.
Hospitals
Profiles of every hospital in the nation that include:
- Ratings based on outcomes for the most current three-year data set;
and
- Ratings by procedure or diagnosis in the six areas addressed by our
Hospital Report Cards.
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Nursing Homes
Profiles of every Medicare/Medicaid - licensed nursing home in the nation
that include:
- Ratings based on health and complaint surveys over the last four years
- Benchmark data to help evaluate risk; and
- Detailed deficiency information.
HEALTHCARE QUALITY REPORTS FOR PROFESSIONALS - 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 three
categories of reports on nursing homes. 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 is a three-page
report, which summarizes this information. Our Risk Assessment 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:
- Risk and severity-adjusted performance measures for cardiac,
neuroscience, vascular, orthopaedics, pulmonary and obstetrics
procedures and diagnoses;
- 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 - 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(TM) - Our Hospital Quality Reports
for Consumers include:
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- All procedures and diagnoses rated by HealthGrades for the hospital;
- Survey data prepared in connection with The Leapfrog Group (described
below); 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:
- Board certification information;
- State and federal sanction information within the last 5 years (if
any);
- Name and address of hospital affiliation(s);
- Name of health plan affiliation(s);
- National comparative statistics in board certification and sanction
activity about 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 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
"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. 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.
GeoAccess/HealthGrades Quality Rating Suite. We have developed a suite of
web-based decision support tools for consumers referred to as our Quality
Ratings Suite. Included in this product offering are our Hospital, Physician and
Nursing Home Quality Reports for Professionals, which provide online
applications designed to help users select the best healthcare provider to suit
their needs. We have entered into an arrangement with GeoAccess, Inc., a company
affiliated with Ingenix, Inc., to market our Quality Ratings Suite to managed
care organizations, health plans, employers and benefit management companies
through GeoAccess' sales and marketing teams. GeoAccess 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
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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
GeoAccess/HealthGrades Quality Rating Suite, customers are offered project
management, information technology, user support and communications services
(for example, materials to inform users of the GeoAccess/HealthGrades Quality
Rating Suite and how to access the information). The Quality Rating Suite also
includes the following applications:
- integrated search within online physician and hospital directory;
- 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;
- leading physician ratings; and
- additional customization (user interface or additional data, such as
state and local data).
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. Through March 31, 1998, we entered into comprehensive
affiliation arrangements with 21 practices including 164 physicians. 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.
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,
health plans, 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, SelectQualityCare and Doctor
Quality. 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.
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
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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 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", formerly HCFA) 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 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 harbor
provides 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. Outside of a statutory
exception or a safe harbor, the government could attempt to draw an inference
that at least one purpose of the remuneration is to induce referrals.
Nevertheless, 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.
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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. In recent years, a variety of legislative proposals designed
to change access to and payment for healthcare services in the United States
have been introduced. Although no major health reform proposals have been passed
by Congress to date, such legislation has been and may be considered by Congress
and state legislatures. We can make no prediction as to whether healthcare
reform legislation or similar 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 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 complied by
our systems in connection with services we offer to employers and other health
plans. 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. 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 -- health plans,
healthcare clearinghouses, and certain healthcare providers. However, most
healthcare providers and health plans 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 health plans 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.
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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, 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 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 March 22, 2003, we had 48 employees, most of whom were located at our
corporate offices.
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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, 2002, substantially all of our operations related to
this business. Our loss before income taxes and cumulative effect of a change in
accounting principle for the year ended December 31, 2002, was approximately
$1.6 million. Despite our efforts in 2001 and 2002 to reduce expenditures, 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, 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, health
plans, 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. 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, healthgrades.com 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, health plans 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;
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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 health plans, or our quality
reports. In addition, we do not know whether employers or health plans 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 new, unproven concept. We may not be
able to expand or retain acceptance by hospitals and other providers.
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. One provider has brought a claim in Washington state alleging that our
use of our rating system constitutes a business practice that violates state
consumer protection and defamation laws and may also be a basis for product
disparagement, negligent misrepresentation and other claims. That case was
dismissed for lack of personal jurisdiction, but the dismissal was reversed on
appeal. We have filed a petition seeking review of the jurisdictional issue
before the United States Supreme Court.
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.
We could be adversely affected if the provider were to prevail in this
litigation.
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, health plans,
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.
During 2001, we reduced the size of our employee base in order to lower
expenses. Nevertheless, 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.
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,
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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 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,
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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 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.
18
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 its customers, there could be 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 health
plans. 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
- - 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, health plans
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.
19
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.
Our current officers and directors and entities with which they are
affiliated beneficially own approximately 31.6% of our outstanding common stock.
In addition, Essex Woodlands Health Ventures Fund IV, L.P. holds approximately
38.5% 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.
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 12,200-sq. foot headquarters facility
in Lakewood, Colorado, which expires on February 15, 2005. Our annual lease
payments for this facility are approximately $215,000.
20
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
is seeking damages against HealthGrades in the amount of approximately $4.7
million.
The basis of the allegation against HealthGrades is 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 alleges that, notwithstanding the
assignment of our leasehold interests to Park Place, HealthGrades remains liable
for all lessee obligations under the leases.
We have filed a response to the initial complaint instituted by SPF-II,
denying all liability with respect to the subject leases. In addition, we have
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 have 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 have 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.
The parties are currently engaged in a mediation process in an attempt to
resolve this matter. If the mediation is not successful, we intend to contest
our obligations under the Assignment, Assumption and Release Agreement, fully
explore SPF-II's obligations to mitigate damages and vigorously pursue our
rights against Park Place and the individual physician owners.
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:
NAME AGE POSITION
Kerry R. Hicks.......................... 43 President, Chief Executive Officer
David G. Hicks.......................... 45 Executive Vice President-Information Technology
G. Allen Dodge.......................... 35 Senior Vice President-Finance, CFO & Treasurer
Peter A. Fatianow....................... 39 Senior Vice President-Corporate Services
Sarah Loughran.......................... 38 Senior Vice President-Provider Services
Michael D. Phillips..................... 45 Senior Vice President-Provider Sales
John R. Morrow.......................... 43 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.
21
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.
G. 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 as our Senior Vice President -- Business
Development since March 2000. He has served in several capacities for our
subsidiary, HG.com and its successor Healthcare Ratings, Inc. since July 1998,
most recently as Senior Vice President -- Operations. He was previously our Vice
President of Business Development from our inception until July 1998. From July
1998 until February 1999, he was a partner of Consolidation Capital Partners
LLC, which provided consulting services to us in connection with our
restructuring transaction with our former affiliated practices.
SARAH LOUGHRAN has served as our Senior Vice President -- Provider Services
since December 2001 and as Senior Vice President -- Content of our subsidiary,
HG.com and its successor, Healthcare Ratings, Inc. since 1998. She was our
Senior Vice President -- Content from March 2000 to December 2001.
MICHAEL D. PHILLIPS has served as Senior Vice President -- Provider Sales since
December 2001. He was previously Vice President of Provider Sales since April
2000. Prior to joining HealthGrades, Mr. Phillips was Vice President of Sales at
HCIA-Sachs and LBA Healthcare Management as well as National Sales Manager for
HPI Health Care Services.
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 HCIASachs 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 on the Nasdaq Small Cap Market
through the first quarter of 2001. Subsequent to the first quarter of 2001, the
high and low sales prices for our Common Stock for the quarters indicated are as
reported by the OTC Bulletin Board (OTCBB).
HIGH LOW
Year Ended December 31, 2001
First Quarter.................................... $ .81 $ .22
Second Quarter .................................. .31 .10
Third Quarter.................................... .22 .08
Fourth Quarter................................... .10 .04
Year Ended December 31, 2002
First Quarter.................................... $ .17 $ .05
Second Quarter .................................. .10 .04
Third Quarter.................................... .09 .05
Fourth Quarter................................... .10 .02
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.
22
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,
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
Ratings and advisory revenue 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 76,649,778
Loss from operations (1,770,555) (7,620,773) (7,355,737) (2,599,167) (91,938,916)
(Loss) income before cumulative effect of a
change in accounting principle (562,482) (7,367,243) (7,544,746) 964,930 (61,786,086)
Net (loss) income $ (1,650,793) $ (7,367,243) $ (7,544,746) $ 964,930 $(61,786,086)
============ ============ ============ ============ ============
Net (loss) income per common share (basic) $ (0.05) $ (0.30) $ (0.39) $ 0.07 $ (3.39)
============ ============ ============ ============ ============
Weighted average number of common shares
used in computation (basic) 36,189,748 24,399,699 19,535,841 14,202,748 18,237,827
============ ============ ============ ============ ============
Net (loss) income per common share (diluted) $ (0.05) $ (0.30) $ (0.39) $ 0.07 $ (3.39)
============ ============ ============ ============ ============
Weighted average number of common
shares and common share equivalents
used in computation (diluted) 36,189,748 24,399,699 19,535,841 14,817,732 18,237,827
============ ============ ============ ============ ============
Balance Sheet Data
DECEMBER 31, 2002 DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
----------------- ----------------- ----------------- ----------------- -----------------
Working capital (deficit) $ 44,207 $ 161,324 $ 4,292,698 $ 1,383,945 $(21,457,105)
Total assets 7,117,551 7,747,904 14,371,174 20,392,868 70,179,278
Total long-term debt -- -- -- 8,803,283 680,152
Total short-term debt -- -- 1,559,213 7,702,005 53,514,615
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 2002, our increased
revenues reflected our success in adding new hospital customers to our
Strategic Quality Initiative (SQI) and Quality Assessment and
Improvement (QAI) programs and obtaining renewals from hospitals
already enrolled in these programs. Furthermore, because we typically
receive payment in advance for the annual terms of these agreements,
the addition of new customers could significantly affect our liquidity.
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.
- - Cost control -- We have been successful in substantially reducing
expenses, due largely to personnel reductions in 2001. We do not
anticipate that further expense reductions are feasible or advisable,
particularly because we want to be positioned to accommodate increased
business if our efforts to increase revenues are successful. Moreover,
we believe it is important to provide incentives to our remaining
employees, who have been willing to accommodate our expense control
initiatives as we have attempted to preserve our resources during the
past two years. Specifically, we believe it is important to provide
appropriate compensation and incentives to those employees who
contribute to the further growth of our company. Management recognizes,
however, 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.
23
- - Liquidity -- We believe that current economic conditions and our
depressed market price provides a very challenging environment for
external financing, although we have a maximum of $1,000,000
availability under line of credit with a bank. Therefore, we believe
that our focus must be devoted to generating cash flow from operations.
During 2002, we benefited from significantly reduced losses from
operations, as well as a $1,000,000 tax refund resulting from tax
legislation enacted last year. We believe our cash resources are
sufficient to support ongoing operations for the next twelve months,
but we confront the risk that our inability to generate revenues as
expected could compel us to seek additional financing. Moreover, as
noted elsewhere in this report, we are engaged in litigation relating
to property leased by a former affiliated practice. While we do not
currently anticipate an outcome that would fundamentally affect our
liquidity, an unanticipated result could be materially harmful to our
financial position.
- - Subsequent Events - Effective March 11, 2003, we executed an amendment
to our agreement with a bank noted above. 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, 2004. To date, we have not borrowed
any funds under the line of credit. In addition, the amendment provides
for a term loan of $500,000. The term loan accrues interest at 5.94%
and requires us to pay twenty-four equal installments of principal and
interest over the term, beginning on April 1, 2003. We have the
ability, at our option, to prepay all, but not less than all, of the
term loan without penalty after August 21, 2003, provided we give the
bank at least thirty days written notice prior to such repayment. In
addition, we entered into a Stock and Warrant Repurchase Agreement,
dated March 11, 2003, with Chancellor V, L.P. ("Chancellor"). Under the
terms of the Stock and Warrant Repurchase Agreement, we repurchased
from Chancellor 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. Chancellor initially acquired the common stock and
warrants from us in two private transactions in 2000 and 2001.
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 the our total outstanding common stock
(assuming full exercise of the warrants held by Chancellor, but
assuming no exercise of any other warrants or options).
CRITICAL ACCOUNTING POLICIES
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 are most significant in
connection with our critical accounting policies, namely those of our accounting
policies that are most important to the presentation of financial condition and
results of operations and that require the most difficult, subjective, complex
judgments. These judgments often result from the need to make estimates about
the effects of matters that are inherently uncertain. For the 2002 year, we have
identified evaluation of goodwill impairment and revenue recognition as our
critical accounting policies.
Goodwill Impairment
As a result of the adoption of Statement of Financial Accounting Standards
No. 142 (SFAS 142), we discontinued the amortization of goodwill effective
January 1, 2002. Statement 142 also requires companies to perform a transitional
test of goodwill for impairment, 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. Goodwill, net in the accompanying consolidated balance sheet is shown
net of the impairment charge described above as of December 31, 2002. As of
December 31, 2001, accumulated amortization was approximately $1.7 million.
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
24
capitalist investors (we subsequently repurchased the shares owned by one of the
venture capital investors), we believe a premium of 30% was reasonable to give
effect to additional benefits a purchaser would derive from control of Health
Grades, Inc.
As our shares are very thinly traded, management believes that any analysis
of HealthGrades' fair value should include valuation techniques in addition to
the 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 P/E 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.
We utilized a five-year period for examination of cash flows and expect to
utilize this time period in our subsequent annual impairment valuations absent
evidence to the contrary. Based upon the inherent uncertainty in future cash
flows in particular for a growth company, we feel the utilization of a longer
time period would not be appropriate. As we utilized the expected future cash
flow approach for our present value measurements, 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, these assumptions should not be taken into account again in our
discount rate. As the 5-year treasury maturity rate as of December 31, 2002, was
3.03%, this is the rate we utilized.
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. Subsequent to this valuation, we
compared the implied fair value of goodwill to the carrying amount of goodwill
to arrive at the final impairment loss calculation of approximately $1.1
million.
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.
As required under SFAS 142, we performed our annual test for impairment of
our goodwill during the fourth quarter of 2002. This test resulted in no
additional impairment to our goodwill balance. 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 approach described above
to perform our annual impairment analysis and interim tests if necessary.
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
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,
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.
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
25
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 20, Accounting Changes. We have not determined the effect of adoption of
EITF 00-21 on our financial statements or the method of adoption that we will
use.
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, cost of physician practice management revenue and to make certain
reclassifications from general and administrative expenses to both sales and
marketing and product development.
RESULTS OF OPERATIONS
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 82% of our ratings and advisory revenue was
derived from our strategic quality initiative (SQI) services. Approximately 9%
of our ratings and advisory revenue was derived from our quality assessment and
improvement (QAI) services.
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 will 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 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 delivers our services.
Cost of physician practice management revenue
In 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