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Registration No. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------
HEALTHGRADES.COM, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 62-1623449
(State or Other Jurisdiction of Incorporation or (I.R.S. Employer Identification
Organization) No.)
</TABLE>
44 UNION BOULEVARD
SUITE 600
LAKEWOOD, COLORADO 80228
(303) 716-0041
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's Principal Executive Offices)
--------------------
KERRY R. HICKS
CHIEF EXECUTIVE OFFICER
HEALTHGRADES.COM, INC.
44 UNION BOULEVARD
SUITE 600
LAKEWOOD, COLORADO 80228
(303) 716-0041
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
---------------------
COPIES TO:
ALAN SINGER, ESQ.
MORGAN, LEWIS & BOCKIUS LLP
1701 MARKET STREET
PHILADELPHIA, PENNSYLVANIA 19103-2921
(215) 963-5000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As
soon as practicable after the effective date of this registration statement.
If the only securities being registered on this form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box. [ ]
If this form is filed to register additional securities for an offering
pursuant to Rule 426(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of earlier effective
registration statement for the same offering.[ ]__________
If this form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [ ]__________
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [ ]
<PAGE> 2
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
Title of Each Class Proposed Maximum Proposed Maximum
of Securities to be Amount to be Aggregate Price Per Aggregate Offering Amount of
Registered Registered(1) Share(2) Price Registration Fee
-------------------------------- ---------------------- ---------------------- ----------------------- --------------------
<S> <C> <C> <C> <C>
Common Stock, par value $.001
per share 12,465,000 $1.55 $19,320,750 $5,101.00
-------------------------------- ---------------------- ---------------------- ----------------------- --------------------
</TABLE>
(1) Includes 9,165,000 outstanding shares of common stock and 3,300,000
shares of common stock underlying warrants.
(2) Based on the average of the reported high and low sales prices of our
common stock on Nasdaq on June 16, 2000 for the purpose of calculating
the registration fee in accordance with Rule 457(c) under the
Securities Act of 1933.
The Registrant hereby amends this Registration Statement on such date
or dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933, or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
<PAGE> 3
The information in this prospectus is not complete and may be changed.
We may not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and is not soliciting an offer to buy these securities
in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED JUNE 19, 2000
12,465,000 Shares
HealthGrades.com, Inc.
Common Stock
----------------------------------------
The shares offered hereby (the "Shares") consist of up to 12,465,000
shares of our common stock, including up to 3,300,000 shares underlying
warrants. The Shares may be offered from time to time by the selling
stockholders identified in this prospectus.
We will not receive any part of the proceeds from the sale of the
Shares. We will bear all expenses relating to registration of the Shares.
The selling stockholders have not advised us of any specific plans for
the distribution of the Shares covered by this prospectus, but it is anticipated
that the Shares will be sold from time to time in negotiated transactions and in
transactions (which may include short sales and block transactions) on Nasdaq at
the market price then prevailing, although sales may also be made as described
in this prospectus under "Plan of Distribution." The selling stockholders and
the brokers and dealers through whom sale of the Shares may be made may be
deemed to be "underwriters" within the meaning of the Securities Act of 1933, as
amended (the "Securities Act"), and commissions or discounts paid to brokers and
dealers in connection with such sales and other compensation may be regarded as
underwriter's compensation. See "Plan of Distribution."
THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE "RISK FACTORS"
BEGINNING ON PAGE 3 OF THIS PROSPECTUS.
Our common stock is quoted on Nasdaq under the symbol HGRD. On June 16,
2000, the last reported sale price of our common stock was $1.5625 per share.
----------------------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
-----------------------------------------
Prospectus dated ________, 2000
<PAGE> 4
TABLE OF CONTENTS
Page
Prospectus Summary 1
Risk Factors 2
Disclosure Regarding Forward-Looking Statements 9
Use of Proceeds 10
Market for Our Common Stock and Related Stockholder Matters 11
Selected Financial Data 12
Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
Business 21
Management 35
Certain Transactions 40
Principal and Selling Stockholders 44
Description of Capital Stock 46
Plan of Distribution 48
Legal Matters 50
Experts 50
Where You Can Find Additional Information 50
Index to Financial Statements F-1
i
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PROSPECTUS SUMMARY
The following highlights information contained elsewhere in this
prospectus. You should read the entire prospectus carefully.
We are principally engaged in the operation of two Internet healthcare
sites: HealthGrades.com and ProviderWeb.net. HealthGrades.com provides ratings
and other information on healthcare providers and facilities. ProviderWeb.net is
a subscription-based website that provides tools and resources for physician
practice administrators and managers.
HealthGrades.com is a comprehensive healthcare information website that
provides rating and other profile information regarding a variety of providers
and facilities. This information is provided through several "report card"
sections that rate hospitals, health plans, nursing homes and home health
agencies on a scale from one to five stars. The ratings are based upon the
application of proprietary algorithms or other statistical analysis to data that
we obtain from several sources. In addition, our HealthGrades.com website also
provides information on physicians in numerous specialties including detailed
profiles, as well as the ability to refine a physician search based on criteria
including practice experience, board certification and absence of sanctions. In
addition, we provide detailed data on hospices, including the ability to refine
searches based on the nature of core and non-core services provided. We also
furnish detailed provider profiles for providers and facilities such as
dentists, assisted living residences and mammography facilities. We obtain the
data that is the basis of report card ratings and provider profiles from a
number of public and private sources. Our goal is to provide comprehensive,
objective health care ratings and profiles to assist consumers in making the
most informed decisions regarding their health and that of their families.
We seek to obtain revenue through our HealthGrades.com website by
licensing our content to other websites, licensing our data and trademark rights
to highly rated hospitals, nursing homes and health plans, licensing our health
plan information to payors and employers and selling advertising space on our
website.
ProviderWeb.net is a subscription-based service that provides financial
and administrative tools, articles and resources covering a broad range of
matters relating to practice administration including, among other areas,
financial, human resources, compliance and patient satisfaction. We believe that
these tools and resources cover the wide array of needs of a typical physician
practice. We market subscriptions to practice administrators and others involved
in the financial and operational performance of physician practices.
We seek to obtain revenue through our ProviderWeb.net website by
subscription fees, revenue sharing arrangements with other health-related
websites that can be accessed from our website, advertising and promotional
activities.
We also provide limited physician practice management services to five
musculoskeletal practices under management services agreements that have terms
expiring through September 2002.
Our principal executive offices are located at 44 Union Boulevard,
Suite 600, Lakewood, Colorado, 80228 and our telephone number is (303) 716-0041.
Our website is www.HealthGrades.com. THE INFORMATION IN OUR WEBSITE IS NOT PART
OF THIS PROSPECTUS.
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SUMMARY FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1998 1999 1999 2000
---------------- --------------- -------------- ------------
(unaudited)
<S> <C> <C> <C> <C>
Revenue:
Physician practice management
revenue $ 79,181,302 $ 31,178,171 $ 14,398,838 $ 1,579,430
Internet revenue -- 407,577 74,040 433,283
Other -- -- -- 2,719
---------------- --------------- -------------- ------------
79,181,302 31,585,748 14,472,878 2,015,432
Costs and expenses:
Physician practice management costs
and expenses:
Clinic expenses 55,188,411 15,234,416 9,575,632 --
Impairment loss on service
agreements 94,582,227 -- -- --
Impairment loss on intangible
assets and other long-lived assets 3,316,651 -- -- --
Litigation and other costs 3,564,392 5,309,168 1,107,700 369,223
Internet costs and expenses:
Production, content and product
development -- 1,217,917 62,280 618,827
Sales and marketing -- 1,853,191 -- 392,059
General and administrative 14,468,537 10,570,223 3,491,697 2,174,166
---------------- --------------- -------------- ------------
Total costs and expenses 171,120,218 34,184,915 14,237,309 3,554,275
---------------- --------------- -------------- ------------
(Loss) income from operations (91,938,916) (2,599,167) 235,569 (1,538,843)
Other:
Loss on sale of assets and other -- -- -- (336,653)
Gain on sale of assets, practice
disputes, and amendment and
restatement of service agreements -- 2,766,284 -- --
Gain on sale of equity investment 1,240,078 127,974 -- --
Gain on sale of subsidiary -- 221,258 221,258 --
Interest income 187,450 312,447 63,338 51,154
Interest expense (3,741,089) (2,489,427) (1,007,243) (316,075)
---------------- --------------- -------------- ------------
(Loss) income before income taxes (94,252,477) (1,660,631) (487,078) (2,140,417)
Income tax benefit (expense) 32,466,391 2,625,561 194,254 --
---------------- --------------- -------------- ------------
Net income (loss) $ (61,786,086) $ 964,930 $ (292,824) $(2,140,417)
================ =============== ============== ============
Net income (loss) per common share (basic) $ ( 3.39) $ ( 0.07) $ ( 0.02) $ (0.16)
================ =============== ============== ============
Weighted average number of common shares
used in computation (basic) 18,237,827 14,202,748 16,494,704 13,504,008
================ =============== ============== ============
Net income (loss) per common share
(diluted) $ (3.39) $ 0.07 $ (0.02) $ ( 0.16)
================ =============== ============== ============
Weighted average number of common shares
and common share equivalents used in
computation (diluted) 18,237,827 14,817,732 16,494,704 13,504,008
================ =============== ============== ============
</TABLE>
Balance Sheet Data
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1999 MARCH 31, 2000
----------------- ----------------- --------------
(unaudited)
<S> <C> <C> <C>
Working capital (deficit) $(21,457,105) $ 1,383,945 $ 8,885,436
Total assets 70,179,278 20,393,968 27,730,052
Total long-term debt 680,152 8,803,283 1,811,065
Total short-term debt 53,514,615 7,702,005 6,813,149
</TABLE>
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RISK FACTORS
Risks Related to Our Business
OUR INTERNET HEALTH CARE BUSINESS HAS NOT BEEN PROFITABLE AND MAY NEVER BECOME
PROFITABLE.
We began developing Internet operations in 1998. For the year ended
December 31, 1999 and the three months ended March 31, 2000, net losses before
income taxes for our Internet business were $5,558,935 and $1,096,899,
respectively. We expect to continue to incur operating losses for the
foreseeable future as we fund operating and capital expenditures to expand the
content on our websites, market our websites, upgrade our technology and
continue to build our brand. Our business model assumes that, with respect to
HealthGrades.com, consumers will be attracted to and use the health care 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
other Internet sites, payors, employers, hospitals and other providers and sell
advertising on our website. With regard to ProviderWeb.net, our business model
assumes that physician practice administrators and managers will be willing to
pay a subscription fee to have online access to practice tools and other
information and to purchase additional products and services made available on
the website. 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.
SINCE WE RECENTLY CHANGED OUR PRINCIPAL BUSINESS FOCUS, WE ARE ESSENTIALLY A NEW
COMPANY AND ACCORDINGLY ARE SUBJECT TO THOSE RISKS ASSOCIATED WITH A NEW
COMPANY.
We were founded in 1995, but have only been engaged in the Internet
health care information business since 1998. As a result, our company is
essentially a new venture. Therefore, we do not have a significant operating
history upon which you can evaluate us or our prospects, and you should not rely
upon our past performance to predict our future performance. In making the
transition from a physician practice management company to an Internet health
care company, we substantially changed our business operations and management
focus. We are also facing new challenges, including a lack of meaningful
historical financial data upon which to plan future budgets, a radically
different competitive environment and other risks described below. We cannot
assure you that our new model will be successful.
WE MAY NEED ADDITIONAL CAPITAL TO CONTINUE OUR BUSINESS IF WE DO NOT GENERATE
SUFFICIENT REVENUES OVER THE NEXT TWELVE MONTHS.
We believe that as a result of our recent financing, 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 financings. 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, 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 RATINGS AND PROFILE INFORMATION.
To provide our rating and profile information, we must be able to
receive comprehensive, reliable data. We currently seek this data from a number
of public and private sources. Our business could suffer if some of these
sources were to cease to make such information available and suitable
alternative sources could not be identified on a timely basis. Moreover, our
ability to attract and retain consumer interest is dependent on the reliability
of the information that we purchase. If our information is inaccurate or
otherwise erroneous, our reputation and consumer following could be damaged.
Recently, The National Committee on Quality Assurance ("NCQA") advised us that
our agreement (the "NCQA Agreement") with them enabling us to license their data
which we use for our HMO Report Cards component of our Health Plan Report Cards
page, is terminated because we have distributed or otherwise disclosed this data
to a third party in alleged breach of the NCQA Agreement. We believe the NCQA's
position is erroneous and in breach of the NCQA's obligations to us. We intend
to take prompt action to bring this dispute to resolution. In addition, an
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information content company that provides data for one of our pages has alleged
that we are in default under an agreement between us and the company because of
the manner in which we make our content available to users of the websites of
other Internet health care information companies. We believe this assertion is
unfounded and have filed a complaint against the company alleging breach of
contract for failure to deliver information required to be delivered under the
terms of the agreement. Our failure to obtain suitable information, if needed to
use in place of information provided by these sources, could hurt our business.
OUR PLAN FOR REVENUE GENERATION MAY NOT BE VIABLE.
Our business plan contemplates that we will obtain revenues on our
HealthGrades.com website principally by:
o licensing access to our ratings content through linking agreements to
other companies that operate Internet health care sites;
o licensing our data, HealthGrades.com name and trademarks to
highly-rated hospitals, nursing homes and health plans for use in
connection with their marketing programs;
o directly or indirectly licensing our data to payors and employers; and
o selling banner advertisements and sponsorships.
With regard to ProviderWeb.net, we are seeking to generate revenues
through practice subscriptions, revenue sharing arrangements with providers of
services on our website and corporate sponsorships for subscriptions to our
website. We do not know if this plan will be successful. Specifically, while we
have licensed access to our HealthGrades.com content to several health care
information websites, these contracts generally have a relatively short term or
can be terminated on short notice. We do not know if the Internet information
companies that have licensed our data will view it as helpful in connection with
their own businesses, and they may determine not to continue to license our
services. Moreover, many of the Internet health care companies that license our
data are recently formed entities that do not have a history of financial
viability and may not have the resources to continue licensing arrangements with
us, even if they view such arrangements to be helpful. In addition, the use of
Internet information in conjunction with hospital, nursing home, and health plan
marketing campaigns is a new, unproven concept that may not achieve acceptance
by hospitals and nursing homes. We also cannot predict whether payors and
employers will view our rating and profile information as useful in connection
with their operations. With regard to our ProviderWeb.net service, we have only
achieved limited penetration in our physician practice market. As of June 1,
2000, we have received subscriptions from 38 practices, only 22 of which are
paying subscribers. In connection with the initial marketing of ProviderWeb.net
we gave 16 practices a free annual subscription. While our marketing efforts
were hampered by severe cash constraints that were rectified only upon
completion of a financing in March 2000, we do not know if additional marketing
efforts will enable us to achieve a level of subscriptions that will make the
website profitable. Moreover, although we have entered into two revenue-sharing
arrangements with companies that will provide services through our
ProviderWeb.net website, we have not yet begun to offer the services, and cannot
predict whether any meaningful revenues will be derived from these services. In
addition, we have only recently begun a marketing effort to obtain corporate
sponsorships for subscriptions, and do not know whether pharmaceutical companies
and other entities we intend to approach will deem subscriptions to our service
to be useful for their own marketing purposes. We may not be successful in
obtaining meaningful corporate sponsorships for our ProviderWeb.net website.
WE MAY BE SUED FOR INFORMATION RETRIEVED FROM OUR WEBSITES.
We may be subjected to claims for defamation, negligence, copyright or
trademark infringement, personal injury or other legal theories relating to the
information we publish on our websites. These types of claims have been brought,
sometimes successfully, against online services as well as other print
publications in 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 also alleged that our
use of our rating system constitutes a business practice that violates state law
and may also be a basis for product disparagement, negligent misrepresentation
and other claims. The provider threatened to institute legal action if we do not
remove reference to the provider from our website. We have filed a complaint
against the provider seeking a judgment that, among other things, we did not
violate state or federal law as a result of our rating of the provider and our
ratings are protected by the free speech protections of the United States
Constitution and relevant state constitutions. Moreover, 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 on our website, or doctors who are identified on our website. In addition,
a court or government agency may take the position that our delivery of
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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 health care services or
erroneous health information. The amount of insurance we maintain with insurance
carriers may not be sufficient to cover all of the losses we might incur from
these claims and legal actions. In addition, insurance for some risks is
difficult, impossible or too costly to obtain, and as a result, we may not be
able to purchase insurance for some types of risks.
IF WE DO NOT ESTABLISH, MAINTAIN AND STRENGTHEN OUR BRANDS, OUR ABILITY TO
ATTRACT USERS TO OUR WEBSITES AND GENERATE LICENSES, SUBSCRIPTIONS AND
SPONSORSHIPS WILL BE IMPAIRED.
To expand our audience of users and increase our online traffic, as
well as subscriptions on our ProviderWeb.net website, we must establish,
maintain and strengthen our brands. For us to be successful in establishing our
brands, consumers must perceive us as a trusted source of health care
information, practice administrators must perceive us as a valuable source of
tools and information for the operation of physician practices, and hospitals,
nursing homes and other health care information websites must perceive us as an
effective marketing and sales channel for their services and products. We expect
that we will need to increase substantially our marketing budget in our efforts
to establish brand recognition and brand loyalty. Our business will suffer if
our marketing efforts are not productive or if we cannot strengthen our brands.
OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO ATTRACT, RETAIN AND MOTIVATE HIGHLY
SKILLED EMPLOYEES.
Our ability to execute our business plan and be successful depends upon
our continuing ability to attract, retain and motivate highly skilled employees.
We rely on the continued services of our senior management and other personnel.
As we continue to grow, we will need to hire additional personnel to support our
operations. Competition for personnel in Internet-related industries is intense.
We may be unable to retain our key employees or attract, assimilate or retain
other highly qualified employees in the future. If we do not succeed in
attracting new personnel and retaining and motivating our current personnel, our
business will suffer.
IF OUR ABILITY TO EXPAND OUR NETWORK INFRASTRUCTURE IS CONSTRAINED, WE COULD
LOSE CONSUMER USERS OR SUBSCRIBERS, AND OUR BUSINESS COULD BE IMPAIRED.
A growing number of consumers use our HealthGrades.com website, and
only a limited number of practices subscribe to our ProviderWeb.net website. We
must continue to expand and adapt our network infrastructure to accommodate
additional users, changing consumer and subscriber requirements and increasing
transaction volumes. We may not be able to accurately project the rate or timing
of increases, if any, in the use of our websites or expand and upgrade our
systems and infrastructure to accommodate such increases. If our systems do not
accommodate increased use while maintaining overall performance, our users may
determine to use the online services of our competitors.
WE MAY EXPERIENCE SYSTEM FAILURES THAT COULD INTERRUPT OUR SERVICES.
The success of our business 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 increasingly depend on providers of
online content and services for some of the content and applications that we
make available through HealthGrades.com and ProviderWeb.net. Any significant
interruptions in our services or an increase in response time could result in
the loss of potential or existing users and subscribers, licensees, sponsors and
advertisers. Although we maintain insurance for our business, we cannot
guarantee that our insurance will be adequate to compensate us for losses that
may occur or to provide for costs associated with business interruptions.
To succeed, we must be able to operate our websites 24 hours a day, 7
days a week, without material interruption. To operate without interruption, we
and our content providers must guard against:
o damage from fire, power loss and other natural disasters;
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o communications failures;
o software and hardware errors, failures or crashes;
o security breaches, computer viruses and similar disruptive problems;
and
o other potential interruptions.
Our websites may be required to accommodate a high volume of traffic
and deliver frequently updated information. Our users and subscribers may
experience slower response times or system failures due to increased traffic on
our website or for a variety of other reasons. We will also increasingly depend
on content and applications providers to furnish information and data feeds on a
timely basis. 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 a number of trademarks for which we are seeking or will seek
registration with the U.S. Patent and Trademark office but cannot assure that
the registrations will be forthcoming. We also have a patent pending on our
hospital rating system and methodology, but we can give no assurance that the
patent will be issued. In addition, we require some of our employees to enter
into a confidentiality and invention assignment agreement 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 by others or may be subject to challenge by others. Furthermore, our
ability to protect our proprietary rights is uncertain since legal standards
relating to the validity, enforceability and scope of intellectual property
rights in Internet related industries is uncertain and is 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. In connection with allegation that we have breached the NCQA
Agreement, the NCQA has alleged that our actions appear to constitute copyright
infringement. We believe that this assertion is erroneous. See "Our business
will suffer if we are not able to obtain reliable data as a basis for our
ratings and information." 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 property ownership, copyrights and other
intellectual property rights. A claim of intellectual property infringement may
cause us to incur significant expenses in defending against the claim, which
could adversely affect our business, financial condition and results of
operations. 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,
subscribers, licensees, sponsors and advertisers, which would reduce 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 performance, 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
services or infrastructure, which might negatively affect our ability to become
or remain profitable.
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OUR BUSINESS WILL SUFFER IF WE ARE NOT ABLE TO COMPETE SUCCESSFULLY.
The market for Internet content, services, product and advertising is
new, rapidly evolving and intensely competitive. We expect this competition to
increase significantly, and our business will be adversely affected if we are
unable to compete successfully. We currently compete, or potentially compete,
with many providers of web content, information services and products, as well
as traditional media and promotional efforts, for audience attention and
advertising and sponsorship expenditures. We expect competition to intensify in
the future. Barriers to entry are not significant, and current and new
competitors may be able to launch new websites at a relatively low cost. We
compete, directly and indirectly, for consumers, subscribers, licensees and
advertisers with:
o companies or organizations providing or maintaining online services or
websites targeted to consumers, physician practices and practice
administrators within the health care industry;
o companies and organizations providing or maintaining general purpose
consumer online services that provide access to health care content and
services;
o companies and organizations providing or maintaining public sector and
non-profit websites that provide health care information and services
without advertising or commercial sponsorships;
o companies and organizations providing or maintaining web search and
retrieval services and other high-traffic websites;
o publishers and distributors of traditional media, including those
targeted to practice administrators, some of which have established or
may establish websites;
o other websites that offer products and services to improve the
efficiency of administrative and communication tasks of the health care
providers; and
o vendors of health care information, products and services distributed
through other means, including direct sales, mail and fax messaging.
One of ProviderWeb.net's competitors has sold a large number of
subscriptions to a major corporation, which, as part of its own promotional
efforts, is distributing the subscriptions free of charge to physician
practices. This may affect our ability to market our ProviderWeb.net service to
some practices.
Competition for subscribers, users, licensees, sponsors and
advertisers, as well as competition in the electronic commerce market, is
intense and expected to increase significantly.
Risks Related to Online Health Care Services and the Internet
HEALTH CARE REFORMS AND THE COST OF REGULATORY COMPLIANCE COULD NEGATIVELY
AFFECT OUR BUSINESS.
The health care industry is heavily regulated. Various laws,
regulations and guidelines promulgated by government, industry and professional
bodies affect, among other matters, the provision, licensing, labeling,
marketing, promotion and reimbursement of health care services and products. Our
failure or the failure of our subscribers, licensees, sponsors or advertisers to
comply with any applicable regulatory requirements or industry guidelines could:
o result in limitation or prohibition of business activities;
o subject us or subscribers, licensees, sponsors or advertisers to
adverse publicity; or
7
<PAGE> 12
o increase the costs of regulatory compliance or subject us or our
subscribers, licensees, sponsors or advertisers to monetary fines or
other penalties.
A federal law commonly known as the Medicare/Medicaid anti-kickback
law, and several similar state laws, prohibit payments that are intended to
induce physicians or others either to refer patients or to acquire or arrange
for or recommend the acquisition of health care products or services, including
pharmaceuticals. Another federal law, commonly known as the "Stark" law,
prohibits physicians from referring Medicare and Medicaid patients for
designated health services to entities with which they have a financial
relationship, unless that relationship qualifies for an explicit exception to
the referral ban. 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 sponsors and licensees,
including hospitals and nursing homes. It is possible that additional or changed
laws, regulations or guidelines could be adopted in the future.
In addition, implementation of government health care reform may
adversely affect promotional and marketing expenditures by pharmaceutical
companies, which could decrease the business opportunities available to us.
While we do not presently have any promotional agreements with pharmaceutical
companies, we are pursuing such agreements.
THE INTERNET IS SUBJECT TO MANY LEGAL UNCERTAINTIES AND POTENTIAL GOVERNMENT
REGULATIONS THAT MAY DECREASE DEMAND FOR OUR SERVICES, 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 demand for our
services, 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. Numerous federal and state laws and
regulations govern collection, dissemination, use and confidentiality of
patient-identifiable health information, including:
o state privacy and confidentiality laws;
o state laws regulating health care professionals, such as physicians,
pharmacists and nurse practitioners;
o Medicaid laws;
o the Health Insurance Portability and Accountability Act of 1996 and
related rules proposed by the Health Care Financing Administration; and
o Health Care Financing Administration standards for Internet
transmission of health data.
8
<PAGE> 13
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 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 may 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.
FDA AND FTC REGULATIONS ON LABELING, ADVERTISING AND PROMOTION MAY BE BURDENSOME
AND MAY NEGATIVELY AFFECT OUR ABILITY TO PROVIDE SOME APPLICATIONS OR SERVICES,
WHICH COULD LEAD TO HIGHER THAN ANTICIPATED COSTS OR LOWER THAN ANTICIPATED
REVENUES.
Complying with Food and Drug Administration and Federal Trade
Commission regulations may be time consuming, burdensome and expensive and could
negatively affect our ability to continue providing some applications or
services, or to introduce new applications or services in a timely manner. This
may result in higher than anticipated costs or lower than anticipated revenues.
In addition, because part of our business may in the future involve
direct-to-consumer advertising of prescription drugs, any increase in FDA or FTC
regulation of these advertisements or the enforcement of these regulations or
policies could make it more difficult for us to provide existing or future
applications or services to our users and subscribers or obtain the necessary
corporate sponsorship to do so.
Any current or future regulatory requirements that the FDA or the FTC
imposes on us or our advertisers and sponsors could harm us by:
o making it harder for pharmaceutical, biotechnology and medical device
companies to advertise or promote their products on our websites, or
imposing additional limitations on such promotion;
o restricting our ability to continue to provide some of our services or
content, or to introduce new services or content in a timely manner;
o damaging our relationships with pharmaceutical, biotechnology and
medical device companies, particularly if programs we recommend or
endorse result in FDA or FTC enforcement action directed against us or
these companies; or
o making it more expensive and time-consuming to comply with new
requirements.
As a consequence of these events, we might lose advertising or
sponsorship revenue, spend significant amounts of our limited resources on
regulatory experts in the area of FDA or FTC compliance, or receive adverse
publicity that negatively affects our business. In addition to the effect of
existing FDA and FTC regulation of advertising and promotion by pharmaceutical,
biotechnology and medical device companies, our business faces a potential risk
of increased FDA and FTC regulation of these activities in an online context.
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 websites, 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 and will be
increasingly important as we expand our services. 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 services.
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, like 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.
9
<PAGE> 14
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.
Other Risks
OUR OFFICERS, DIRECTORS AND MAJOR STOCKHOLDERS MAINTAIN SIGNIFICANT CONTROL OF
HEALTHGRADES.COM.
Our officers, directors and two major stockholders own approximately
50.7% of our outstanding common stock. If our officers, directors and the
stockholders act together, they will be able to control the management and
affairs of HealthGrades.com 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. Under an agreement among
us, the two major stockholders, and our principal executive officers, the
parties other than us have agreed to vote their shares for the election of a
designee of each of the major stockholders.
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.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Various statements made in this prospectus under the captions
"Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Business" and elsewhere in this
prospectus are "forward-looking statements." Forward-looking statements include,
without limitation, statements about the following:
o changes to our HealthGrades.com website;
o fee-based services to be introduced on our ProviderWeb.net website;
o proposed revenue sharing arrangements;
10
<PAGE> 15
o planned advertising and marketing activities;
o anticipated losses;
o costs relating to further development of our websites;
o anticipated legal fees relating to litigation;
o sufficiency of available resources to fund operations; and
o anticipated pay down of principal amounts due under our term loan.
When used in this prospectus, the words "may," "will," "expect,"
"anticipate," "believe," "estimate," and similar expressions are generally
intended to identify forward looking statements, but are not the exclusive
expressions of forward-looking statements. Because forward-looking statements
involve risks and uncertainties, there are important factors that could cause
actual results to differ materially from those expressed or implied by these
forward-looking statements, including, but not limited to:
o technical difficulties in effecting improvements to our websites;
o lack of market acceptance by physician practices of our ProviderWeb.net
basic subscription or value added services;
o inability to enter into additional revenue sharing agreements with
respect to our websites;
o unanticipated cash requirements to support current operations or
expansion of our websites;
o advertising and marketing activities and other expenditures;
o inability to appropriately match personnel to our business needs;
o the creation of new websites by our competitors that encompass rating
or other attributes that are attractive to hospitals, licensees,
sponsors, and others seeking to promote their products or services on
the Internet;
o increased competition;
o enactment of new legislation or administrative regulation;
o application to our business of court decisions and regulatory
interpretations;
o adverse developments in our pending litigation; and
o claims that exceed our insurance coverage.
In addition, other factors that could cause actual events or results to differ
materially from those expressed or implied by forward-looking statements section
are addressed in the Risk Factors section of this prospectus.
USE OF PROCEEDS
We will not receive any proceeds from the sale of Shares by the selling
stockholders. This offering will fulfill our contractual obligations to some of
the selling stockholders to register certain Shares held by those selling
stockholders. Some of the Shares offered under this prospectus are issuable in
the future upon the exercise of outstanding warrants, and we will receive the
exercise prices payable upon any exercise of warrants. We cannot assure you that
all or any of the warrants will be exercised.
11
<PAGE> 16
MARKET FOR OUR 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 Stock Market.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Year Ended December 31, 1998
First Quarter................................ $ 13 3/8 $ 11 1/8
Second Quarter............................... 12 1/2 5 3/4
Third Quarter................................ 6 5/8 1 1/32
Fourth Quarter............................... 2 7/32 3/4
Year Ended December 31, 1999
First Quarter................................ 1 7/8 5/8
Second Quarter............................... 3 3/8
Third Quarter................................ 5 7/8 1 27/32
Fourth Quarter............................... 4 7/8 1 7/16
Year Ended December 31, 2000
First Quarter................................ 3 1/2 2
Second Quarter (through June 16, 2000)....... 2 9/16 15/16
</TABLE>
Since November 24, 1999, our common stock has been traded on the Nasdaq
Small Cap Market. Our common stock previously traded on the Nasdaq National
Market.
On June 16, 2000 the closing price per share of our common stock was
$1 9/16. On June 15, 2000 we had approximately 136 stockholders of record.
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. Our credit facility with a
bank syndicate prohibits the payment of any dividends without written approval
from the bank syndicate.
12
<PAGE> 17
Item 6. Selected Financial Data
Statement of Operations Data
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
Revenue: 1996(1) 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Physician practice management revenue $ 4,392,050 $ 49,655,921 $ 79,181,302
Internet revenue -- -- --
Other -- -- --
------------- ------------- -------------
4,392,050 49,655,921 79,181,302
------------- ------------- -------------
Costs and expenses:
Physician practice management costs and expenses:
Clinic expenses 2,820,743 31,644,618 55,188,411
Impairment loss on service agreements -- -- 94,582,227
Impairment loss on intangible assets and
other long-lived assets -- -- 3,316,651
Litigation and other costs -- -- 3,564,392
Internet costs and expenses:
Production, content and product development -- -- --
Sales and marketing -- -- --
General and administrative 3,770,263 7,861,015 14,468,537
------------- ------------- -------------
Total costs and expenses 6,591,006 39,505,633 171,120,218
------------- ------------- -------------
(Loss) income from operations (2,198,956) 10,150,288 (91,938,916)
Other:
Loss on sale of assets and other -- -- --
Gain on sale of assets, practice disputes, and
amendment and restatement of service
agreements -- -- --
Gain on sale of equity investment -- -- 1,240,078
Gain on sale of subsidiary -- -- --
Interest income 11,870 536,180 187,450
Interest expense (90,368) (942,144) (3,741,089)
------------- ------------- -------------
(Loss) income before income taxes (2,277,454) 9,744,324 (94,252,477)
Income tax benefit (expense) 506,071 (3,873,926) 32,466,391
------------- ------------- -------------
Net income (loss) $ (1,771,383) $ 5,870,398 $ (61,786,086)
============= ============= =============
Net income (loss) per common share (basic) $ (0.16) $ (0.38) $ (3.39)
============= ============= =============
Weighted average number of common shares
used in computation (basic) 11,422,387 15,559,368 18,237,827
============= ============= =============
Net income (loss) per common share (diluted) $ (0.14) $ 0.37 $ (3.39)
============= ============= =============
Weighted average number of common
shares and common share equivalents
used in computation (diluted) 12,454,477 16,071,153 18,237,827
============= ============= =============
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31
1999 1999 2000
------------- ------------- -------------
(unaudited)
<S> <C> <C> <C>
Physician practice management revenue $ 31,178,171 $ 14,398,838 $ 1,579,430
Internet revenue 407,577 74,040 433,283
Other -- -- 2,719
------------- ------------- -------------
31,585,748 14,472,878 2,015,432
------------- ------------- -------------
Costs and expenses:
Physician practice management costs and expenses:
Clinic expenses 15,234,416 9,575,632 --
Impairment loss on service agreements -- -- --
Impairment loss on intangible assets and
other long-lived assets -- -- --
Litigation and other costs 5,309,168 1,107,700 369,223
Internet costs and expenses:
Production, content and product development 1,217,917 62,280 618,827
Sales and marketing 1,853,191 -- 392,059
General and administrative 10,570,223 3,491,697 2,174,166
------------- ------------- -------------
Total costs and expenses 34,184,915 14,237,309 3,554,275
------------- ------------- -------------
(Loss) income from operations (2,599,167) 235,569 (1,538,843)
Other:
Loss on sale of assets and other -- -- (336,653)
Gain on sale of assets, practice disputes, and
amendment and restatement of service
agreements 2,766,284 -- --
Gain on sale of equity investment 127,974 -- --
Gain on sale of subsidiary 221,258 221,258 --
Interest income 312,447 63,338 51,154
Interest expense (2,489,427) (1,007,243) (316,075)
------------- ------------- -------------
(Loss) income before income taxes (1,660,631) (487,078) (2,140,417)
Income tax benefit (expense) 2,625,561 194,254 --
------------- ------------- -------------
Net income (loss) $ 964,930 $ (292,824) $ (2,140,417)
============= ============= =============
Net income (loss) per common share (basic) $ (0.07) $ (0.02) (0.16)
============= ============= =============
Weighted average number of common shares
used in computation (basic) 14,202,748 16,494,704 13,504,008
============= ============= =============
Net income (loss) per common share (diluted) $ 0.07 $ (0.02) $ (0.16)
============= ============= =============
Weighted average number of common
shares and common share equivalents
used in computation (diluted) 14,817,732 16,494,704 13,504,008
============= ============= =============
</TABLE>
Balance Sheet Data
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1999 MARCH 31, 2000
----------------- ----------------- ----------------- ----------------- --------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Working capital (deficit) $ 7,637,724 $ 21,924,386 $ (21,457,105) $ 1,383,945 $ 8,885,436
Total assets 16,013,125 140,301,650 70,179,278 20,393,968 27,730,052
Total long-term debt 5,142,450 33,885,141 680,152 8,803,283 1,811,065
Total short-term debt -- -- 53,514,615 7,702,005 6,813,149
</TABLE>
(1) The 1996 net income (loss) per share and weighted average share amounts
have been restated to comply with Statement of Financial Accounting
Standards No. 128, Earnings Per Share.
13
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
We operate two health care Internet sites and provide practice
management services to physicians. Our HealthGrades.com website provides ratings
or "report cards" on hospitals, health plans, nursing homes and home health
agencies. Additionally, we provide a database of physicians and hospices from
which a user can perform a customized search based upon criteria selected by the
user. We also offer profiles of specialty health care providers in the United
States. Our Provider Web.net website is a subscription service for physician
practice administrators and managers that provides online tools and information.
MODIFICATION OF ARRANGEMENTS AND RESTRUCTURING TRANSACTION
As a result of transactions with 13 practices that restructured our
management service arrangements (six of which were later terminated) and other
agreements, including litigation settlements terminating our management services
arrangements with four other practices, our physician practice management
services have been substantially reduced. Therefore, our results of operations
for the year ended December 31, 1999 and the three months ended March 31, 2000,
are not comparable to our results of operations for the respective periods of
the prior year. In an effort to enhance the comparability and presentation of
our financial statements, beginning in 2000, we identify in our financial
statements the revenues and the costs and expenses that relate directly to our
Internet and physician practice management operations, respectively, and
segregated them in our Statements of Operations. As a result, we have made
certain reclassifications to the Statements of Operations for all prior periods
presented in this registration statement in order to conform to our revised
presentation.
Effective December 31, 1998, we entered into transactions with four of
our affiliated practices. In these transactions, we sold to each of the
practices accounts receivable, fixed assets and certain other assets relating to
the respective practices and replaced the original management service
arrangements with new arrangements under which we provide substantially reduced
services to the practices and the practices pay significantly reduced service
fees. We have since terminated three of these revised arrangements. The
remaining revised management services agreement terminates in March 2002. As a
result of the completion of these four transactions, we reacquired 2,124,959
shares of our common stock and reduced our outstanding indebtedness at December
31, 1998 by approximately $5.5 million through the cancellation of a convertible
note previously issued to one of the practices. Additionally, in 1999, we used
the cash proceeds from the completion of these four transactions to reduce the
amount outstanding under our credit facility by approximately $8.5 million.
Effective June 15, 1999, we closed a restructuring transaction through
ten separate restructuring agreements involving the following nine practices:
Floyd R. Jaggears, Jr., M.D., P.C., II; Riyaz H. Jinnah, M.D., II, P.A.; The
Orthopaedic and Sports Medicine Center, II, P.A.; Orthopaedic Associates of West
Florida, P.A.; Orthopaedic Institute of Ohio, Inc.; Orthopaedic Surgery Centers,
P.C. II; Princeton Orthopaedic Associates, II, P.A.; Reconstructive Orthopaedic
Associates, II, P.C.; and Steven P. Surgnier, M.D., P.A., II. (See Note 2 to the
Consolidated Financial Statements for information regarding this transaction.)
We have received to date approximately $16.3 million in payment for the
restructuring transaction. Most of these funds were used to reduce indebtedness.
In addition, we reacquired 3,254,519 shares of our common stock.
OTHER TRANSACTIONS
Effective June 14, 1999, we entered into a termination agreement with
Ortho-Associates, P.A. d/b/a Park Place Therapeutic Center ("PPTC"), which
terminated the affiliation of PPTC with us. The consideration paid to us
consisted of payment for PPTC practice assets that we transferred to PPTC and
payment for the termination of the service agreement. In connection with the
termination agreement, we received a cash payment of $8,775,217. Additionally,
approximately 545,000 warrants were canceled in connection with the PPTC
termination agreement.
Effective June 16, 1999, we entered into a settlement agreement with
TOC Specialists, PL ("TOC") that resolved all legal disputes and litigation
between us and TOC. In connection with the settlement agreement, we
14
<PAGE> 19
received a cash payment of $3,500,000 and 762,128 shares of our common stock in
consideration for the TOC practice assets that we transferred to TOC and the
termination of the service agreement.
Effective November 12, 1999, we entered into a settlement and release
agreement with The Specialists Orthopaedic Medical Corporation and The
Specialists Surgery Center (collectively, "The Specialists") that resolved all
legal disputes and litigation between us and The Specialists. In connection with
the settlement agreement, we received cash payments during 1999 of $500,000, a
note receivable in the amount of $1,500,000 and 165,987 shares of our common
stock in consideration for The Specialists practice assets that we transferred
to The Specialists and the termination of the Specialists service agreements.
Effective December 31, 1999, we entered into a settlement and release
agreement with Associated Orthopaedics & Sports Medicine, P.A., Associated
Arthroscopy Institute, Inc. Access Medical Supply, Inc. d/b/a Associated
Physical Therapy, Allied Health Services, P.A., d/b/a Associated Occupational
Rehabilitation, Neal C. Small, M.D. and Alexander I. Glogau, M.D. (collectively,
"Plano") that resolved all legal disputes and litigation between us and Plano.
In connection with the settlement agreement, we received a cash payment of
$778,848 in December 1999 and an additional cash payment in the amount of
$1,536,384 in January 2000 in consideration for the Plano practice assets that
we transferred to Plano and the termination of the Plano service agreements.
ACQUISITION OF MINORITY INTERESTS AND OFFICER NOTES
In June 1999, we entered into an agreement with the former stockholders
of Provider Partnerships, Inc. ("PPI") to resolve certain issues raised by the
former stockholders of PPI relating to the transaction in which we acquired PPI.
Under the agreement, we formed HG.com, Inc. (formerly known as HealthGrades.com,
Inc.) ("HG.com") and transferred to HG.com certain assets that were developed by
us into one of our websites (formerly HealthCareReportCards.com, currently
HealthGrades.com) and other related Internet products. The remaining
non-internet related assets of PPI were transferred to us, and PPI was
subsequently liquidated. Additionally, one of our employees and Venture5 LLC,
whose members consist of the former PPI stockholders, owned minority interests
in HG.com. We owned the majority interest. In September 1999, we entered into an
agreement with Venture5 under which we agreed to purchase a number of shares of
our majority-owned subsidiary, HG.com, Inc. which would increase our ownership
in HG.com, Inc. to 90%. On December 31, 1999, we purchased the shares from
Venture5 (the "Minority Interest Purchase") for $4,000,000 and the cancellation
of $172,000 in indebtedness owed to us by the former PPI stockholders. We
financed the Minority Interest Purchase by borrowing $3,550,000 from some of our
officers (the "Officers") and issued notes to the officers totaling $3,550,000
(hereafter, the "Officer Notes"). The Officer Notes bear interest at prime plus
two percentage points and are payable on December 31, 2000. The remainder of the
purchase price was financed with our working capital.
In an effort to raise the funding to comply with our commitments
described above, during November and December 1999, we pursued various financing
alternatives. On December 29, 1999, our Board of Directors approved a term sheet
relating to an equity investment (the "Proposed Financing") in us by a venture
capital firm (hereafter, the "VC firm"). On December 30, 1999, we executed the
term sheet. In March 2000, we consummated an equity financing which raised $18
million. This financing (the "Revised Financing") superceded the Proposed
Financing. Under the terms of the Revised Financing, in March 2000, the Officers
converted $3.2 million of the Officer Notes into an aggregate of 1.6 million
shares of common stock and five year warrants to purchase 560,000 shares of
common stock at $4.00 per share.
Effective February 3, 2000, we merged our majority-owned subsidiary,
HG.com, Inc., into a recently formed, wholly-owned subsidiary, Healthcare
Ratings, Inc. (hereafter, the "Merger Transaction"). In order to effect the
Merger Transaction, we gave the remaining minority shareholders of HG.com
800,000 shares of Company common stock. In connection with the Merger
Transaction, we recorded goodwill in the amount of $1,850,000 based on the fair
value of the stock issued as of the transaction date. The goodwill is being
amortized over an estimated useful life of seven years.
15
<PAGE> 20
ACCOUNTING TREATMENT
Commencing January 1, 1999, costs of obtaining long-term service
agreements for practices affiliated with us that were not a party to the
restructuring transaction are amortized using the straight-line method over
estimated lives of five years from January 1, 1999.
Goodwill, which is stated at cost, was acquired in connection with the
Minority Interest Purchase described above and is being amortized on a
straight-line basis over a seven-year period. (See Note 7 to the Consolidated
Financial Statements for further discussion of this transaction.) In addition,
the additional goodwill acquired in February 2000 in connection with the Merger
Transaction described above is also being amortized over an estimated useful
life of seven years.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2000 Compared to Three Months Ended March 31, 1999
Physician practice management revenue. Physician practice management revenue
includes service fees and other revenue derived from our physician practice
management business. For the three months ended March 31, 2000, physician
practice management revenue includes a non-recurring payment of approximately
$850,000 related to the termination of a management services agreement with one
of our affiliated practices. Physician practice management revenue for the three
months ended March 31, 1999 was approximately $14.4 million, reflecting the much
larger scope of our physician practice management operations during that period.
Internet revenue. Internet revenue includes all revenues derived from our
Internet health care business. We derive these revenues primarily from marketing
arrangements with providers, fees related to the licensing of access to our
content (including set-up fees) and advertising. Marketing revenues are derived
from annual fees from hospitals, nursing homes and health plans in return for
our serving banner advertisements and providing other marketing services to the
hospitals. Revenue related to these arrangements is recognized on a
straight-line basis over the term of the agreement. Revenue related to the
licensing of content and initial set-up fees are recognized on a straight-line
basis over the term of the agreement. In conjunction with certain of our
licensing agreements, we have entered into promotional agreements under which
the licensees may offset their cash obligations to us by providing significant
HealthGrades.com branding on their web sites, or by providing certain other
services to us. For these arrangements, we record the value of the content
licensing as revenue in our Statement of Operations, and a corresponding expense
for the value of the branding or other services we receive. For the three months
ended March 31, 2000, we recorded approximately $123,000 in revenue and
corresponding expense related to these types of arrangements. Advertising
revenue relates to advertisements served on both our sites and our share of
advertising revenue derived from advertisements delivered on sites of other
online health care companies that provide access to our content. Revenues
derived from advertising arrangements where we contract directly with the
advertiser are recorded at the gross contract amount and commissions and other
revenue sharing splits with other online health care companies under those
contracts are recorded as general and administrative expenses. Advertising
revenues earned under revenue sharing arrangements from other web sites are
recorded net of commissions because the commissions are not contractual
obligations of ours.
Clinic expenses. Previously, under our long-term service agreements with
physician practices, we provided, among other things, facilities and management,
administrative and development services to the affiliated practices, and
employed most non-physician personnel of the affiliated practices, in return for
specified service fees. The operating expenses incurred by us included the
salaries, wages and benefits of personnel (other than physician owners and
certain technical medical personnel), supplies, expenses involved in
administering the clinical aspects of the affiliated practices and depreciation
and amortization of assets. We did not incur any clinic expenses for the three
months ended March 31, 2000 as we are no longer obligated to pay clinic expenses
under our management services arrangements with physician practices.
Litigation and other costs. We continue to be involved in litigation with
certain of our former affiliated practices. For the three months ended March 31,
2000, we incurred approximately $290,000 in legal fees directly related to these
disputes. Litigation and other costs decreased by approximately $738,000 from
the same period in 1999. This
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decrease reflects our entry into settlement agreements in late 1999 with several
of the practices with which we were previously involved in litigation.
Production, content and product development costs. Beginning in 1999, we began
incurring production, content and product development costs related to the
development and support of our HealthGrades.com and ProviderWeb.net web sites.
These costs (which consist primarily of salaries and benefits, consulting fees
and other costs related to software development, application development and
operations expense) are expensed as incurred. Compared with the three months
ended March 31, 1999, these costs increased by approximately $560,000 during the
three months ended March 31, 2000. This increase is primarily due to the launch
and expansion of both the HealthGrades.com and ProviderWeb.net web sites.
Sales and marketing expenses. Sales and marketing expenses are costs incurred to
sell, market and advertise for our two Internet sites. We incurred approximately
$392,000 in sales and marketing costs for the three months ended March 31, 2000.
Of this amount, approximately $123,000 related to expenses incurred in
connection with a content licensing arrangement whereby we received advertising
services in return for access to our content. There were no corresponding costs
for the three months ended March 31, 1999.
Loss on sale of assets and other. For the three months ended March 31, 2000, the
loss consists primarily of a loss of approximately $275,000 on the sale of two
MRI units.
Interest expense. During the three months ended March 31, 2000, we incurred
interest expense of approximately $316,000 compared to interest expense of
approximately $1.0 million for the same period of 1999. This decrease reflects
the reduction of our indebtedness with our bank syndicate from a balance of
approximately $44.4 million as of March 31, 1999 to a balance of approximately
$8.1 million as of March 31, 2000. Subsequent to March 31, 2000, we have further
reduced our indebtedness to our bank syndicate to approximately $2.1 million, as
discussed below under "Liquidity and Capital Resources".
Year Ended December 31, 1999 Compared To Year Ended December 31, 1998
Physician practice management revenue
Physician practice management revenue was $31.2 million for the year ended
December 31, 1999, compared to $79.2 million for the same period in 1998. The
decrease was primarily the result of the reduced service fees received by us due
to the modification of arrangements with four practices beginning January 1,
1999 and as a result of the restructuring transaction. In connection with the
restructuring transaction, management services obligations and service fees were
reduced commencing April 1, 1999.
During the year ended December 31, 1999, we terminated our management services
agreements with several of our affiliated practices. As a result of those
terminations, we are no longer required to provide management services to these
practices. Included in physician practice management revenue for the year ended
December 31, 1999 is $2.7 million related to revenue recognized as a result of
those terminations.
Internet revenue
Internet revenue was approximately $408,000 for the year ended December 31,
1999. There was no corresponding revenue during 1999
Clinic expenses
For the year ended December 31, 1999, total clinic expenses were $15.2 million
compared to $55.2 million for the same period of 1998. This decrease was
primarily the result of the elimination of our obligation to pay clinic expenses
with respect to practices that were party to the transactions described above
Physician Practice Management Revenue."
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Litigation and other costs
As a result of litigation with some of our affiliated practices, we recorded a
charge of approximately $3.4 million for the year ended December 31, 1999 to
reserve for service fee revenues that have not been paid by these practices. For
the year ended December 31, 1999, we incurred approximately $1.1 million in
expenses directly related to these disputes. In addition, we incurred legal and
other consulting fees associated with the negotiation of the restructuring
transaction with nine of our affiliated practices of approximately $750,000
during 1999.
Production, content and product development costs
Beginning in 1999, we began incurring production, content and product
development costs related to the development and support of our HealthGrades.com
and ProviderWeb.net Internet sites. These costs, which consist primarily of
salaries and benefits, consulting fees and other costs related to software
development, application development and operations expense, are expensed as
incurred. Total costs for the year ended December 31, 1999 were $1.2 million.
Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," requires
the capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based upon our product development
process, technological feasibility is established upon the completion of a
working model. Costs incurred by us between completion of a working model and
the launch of our websites have not been significant.
Sales and marketing expenses
Sales and marketing expenses are costs incurred to sell, market and advertise
for our two Internet web sites. For the year ended December 31, 1999, we
incurred $1.9 million in sales and marketing expenses primarily in relation to
our initial marketing campaign with respect to our HealthGrades.com website.
General and administrative
General and administrative expenses were $10.6 million for the year ended
December 31, 1999, compared to $14.5 million for the same period in 1998. The
decrease in general and administrative expenses is primarily the result of the
reduction in corporate overhead due to the transactions described above.
Gain on sale of assets, practice disputes and amendment and restatement of
service agreements
Effective June 15, 1999, we closed the restructuring transaction with nine
practices. Additionally, we terminated our relationship with two practices and
entered into litigation settlements with several practices that resulted in
termination of our affiliation with these practices. We recorded a pre-tax gain
on these transactions of approximately $2.8 million for the year ended December
31, 1999.
Gain on sale
During 1998, we funded, through our wholly-owned subsidiary, Ambulatory
Services, Inc. ("ASI"), the purchase of a lease for, and improvements to, a
surgery center in Lutherville, Maryland. The surgery center was the only asset
of SCN of Maryland, LLC (the "LLC"), which was wholly owned by ASI. In March
1999, the LLC issued to ASI a promissory note in the amount of $2,120,619 with
respect to advances made by ASI to cover development of the surgery center. This
promissory note bore interest at 8% and was payable in sixty monthly
installments beginning July 1, 1999. In March 1999, we sold 68% of our interest
in the LLC to certain physician owners of a practice affiliated with us for
$360,505. The sale resulted in a pre-tax gain of $221,258. In September 1999, we
sold our remaining interest in the LLC to the affiliated practice for $169,650.
In addition, we received $2,212,445, in full payment of the obligation,
including accrued interest, of the LLC to us and $502,633 to repay working
capital advances made by ASI to the LLC. This sale resulted in a pre-tax gain of
$127,974. We used approximately $1.6 million of the proceeds from this sale to
reduce the amount outstanding under our credit facility.
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Income taxes
For the year ended December 31, 1999, our effective income tax rate was negative
158%. The effective income tax rate for the year ended December 31, 1999
reflects reductions in the valuation allowance for deferred tax assets due to
our restructuring and other transactions. The reduction in the valuation
allowance for the year ended December 31, 1999 was partially offset by our
inability to record a future income tax benefit for our deferred tax assets due
to the uncertainty regarding our ability to produce sufficient taxable income in
future periods necessary to realize such benefits.
Year Ended December 31, 1998 Compared To Year Ended December 31, 1997
Physician practice management revenue
Physician practice management revenue increased by $29.5 million to $79.2
million for the twelve months ended December 31, 1998 compared to $49.7 million
for the same period in 1997. This increase primarily reflects affiliation
transactions that occurred during the latter part of 1997 and in the first
quarter in 1998.
Clinic expenses
For the year ended December 31, 1998, total clinic expenses were $55.2 million
compared to $31.6 million for the same period of 1997. Clinic expenses reflected
costs incurred by us, in accordance with service agreements then in effect, on
behalf of the affiliated practices for which they were obligated to reimburse
us. Reimbursement of clinic expenses is a component of the service fee revenue
recorded by us.
Impairment losses, litigation and other costs
Due to the then pending restructuring transaction, as well as numerous other
factors in the physician practice management industry in general, we undertook
during the fourth quarter of 1998 an evaluation of the carrying amount of our
management service agreements pursuant to the provisions of Statement of
Financial Accounting Standards No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of. As a result of
this evaluation, we recorded an impairment loss on our management service
agreements of approximately $94.6 million in December 1998. (See Note 2 to the
Consolidated Financial Statements for further discussion of this impairment
charge.)
As a result of disputes with certain of our affiliated practices, we recorded a
charge of approximately $2.7 million to reserve for service fees recorded for
these practices. In addition, as of December 31, 1998, we incurred approximately
$200,000 in legal fees directly related to these disputes. In connection with
the restructuring transaction described above, we also incurred expenses of
approximately $700,000 for financial advisors and legal consultation.
During 1998, we were engaged in negotiations to resolve certain issues raised by
the former stockholders of Provider Partnerships, Inc. ("PPI"), a corporation
acquired by us in August 1998. PPI was a company engaged in providing consulting
services to hospitals, and it also provided certain assets that were developed
by us into the HealthCareReportCards.com website. Because of the dispute with
the former PPI stockholders, we recorded an impairment loss in December 1998 of
approximately $1.2 million on the intangible asset created with the acquisition
of PPI. In addition, as a result of the proposed restructuring transaction, we
performed a review of the carrying amount of our other long-lived assets, which
resulted in an impairment loss of approximately $2.1 million during the fourth
quarter of 1998.
General and administrative
For the year ended December 31, 1998, general and administrative expenses were
$14.5 million compared to $7.9 million for the same period of 1997. This
increase was primarily due to increased amortization expense related to the
additional long-term service agreements we entered into with affiliated
practices in the latter part of 1997 and first quarter 1998. In addition, we
shortened the lives over which the service agreements are amortized effective
June 1998.
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Gain on sale of equity investment
In March 1998, we sold our entire interest in West Central Ohio Group, Ltd., an
Ohio limited liability company, for a pre-tax gain of approximately $1.2
million.
Interest expense
During the year ended December 31, 1998, we incurred interest expense of $3.7
million compared to $.9 million for the same period of 1997. This increase was
primarily the result of additional borrowings under our bank credit facility
which were made to fund our affiliation transactions and to fund our purchase of
ancillary equipment for installation at affiliated practices.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2000, we had working capital of approximately $8.9 million, an
increase of $7.5 million from approximately $1.4 million as of December 31,
1999.
Effective September 1999, we entered into an amendment to our credit facility,
which converted the existing credit facility to a term loan. The term loan
provided for monthly principal and interest payments through November 2000, with
interest payable at a floating rate based on the lead bank's prime lending rate
plus .75%. At December 31, 1999, the effective interest rate was 9.25%. The
monthly principal payments under the term loan were as follows: $167,000 for the
months of October 1999 through December 1999, $200,000 for the months of January
2000 through March 2000, $233,000 for the months of April 2000 through June
2000, $267,000 for the months of July 2000 through October 2000 and a final
payment of the balance on the loan in November 2000. The term loan does not
contain any financial covenants other than a requirement that we pay principal
and interest on a timely basis. The term loan is secured by substantially all of
our assets.
Effective March 2000, we entered into an amendment to the term loan. The
amendment extends the final payment on the loan to November 2001. The revised
term loan provides for monthly principal and interest payments through November
2001, with interest payable at a floating rate based on the lead bank's prime
lending rate plus .75%. The monthly principal payments under the term loan are
$50,000 per month beginning April 2000, with the final payment for any remaining
balance on the loan due November 2001. The amounts of the required principal
payments are subject to increase if we have not paid down the loan to certain
levels throughout the term of the loan. Based upon payments made on the term
loan in January 2000 of approximately $3.2 million from settlements we entered
into in the fourth quarter of 1999, the estimate of a federal tax refund (which
was received in May 2000) and scheduled principal payments in 2000 of
approximately $1.1 million, we classified approximately $6.3 million of the term
loan as a current liability in the consolidated balance sheet as of December 31,
1999. Our two wholly-owned subsidiaries, Healthcare Ratings, Inc. and
ProviderWeb.net, Inc. are guarantors of the loan. We issued 165,000 shares of
our common stock to the bank syndicate in connection with the amendment as a
financing fee.
During the year ended December 31, 1999, we received an income tax refund of
approximately $4.0 million related to the overpayment of 1998 estimated taxes
and the carryback of 1998 net operating losses being applied towards taxable
income for 1997 on which we paid income taxes. In May 2000, we received an
additional $2.3 million of tax refunds related to carryback of 1999 net
operating losses being applied towards taxable income for 1997 on which we paid
income taxes. We applied this refund to the balance on our term loan. As of June
1, 2000, the remaining balance on our term loan is approximately $2.1 million.
Based upon the payments we made on our term loan in 2000, our future principal
payments will remain fixed at $50,000 per month and are no longer subject to
increase.
We anticipate incurring costs in excess of revenues in 2000 to further develop
and market our Internet sites HealthGrades.com and ProviderWeb.net. Although we
have settled much of the litigation between our former affiliated practices and
us, we continue to incur legal fees and other costs related to the remaining
litigation with some former affiliated practices.
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On March 17, 2000, we closed on the Revised Financing, which raised $18 million.
Under the terms of the Revised Financing, certain investors paid us $14.8
million in return for 7,400,000 shares of our common stock. Additionally, we
issued warrants to the investors to purchase 2,590,000 shares of our common
stock at an exercise price of $4.00 per share. The warrants have a five-year
term. We also issued five-year warrants to purchase 150,000 shares of our common
stock to officers of a company that served as a financial advisor for the
Revised Financing with an exercise price of $3.45 per share. In connection with
the Revised Financing, certain of our officers exchanged $3.2 million in notes
for an aggregate of 1.6 million shares of our common stock and five-year
warrants to purchase 560,000 shares of our common stock at $4.00 per share. In
accordance with the provisions of EITF 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios, upon the exchange of the notes payable, we recorded an
expense of $347,200 based upon the estimated fair market value of the warrants
issued to the officers. This expense is included in general and administrative
expenses in our Consolidated Statement of Operations for the three months ended
March 31, 2000. As a result of the cash raised under the Revised Financing
transaction, we anticipate that we have sufficient funds available to support
ongoing operations and future development and marketing efforts for at least the
next twelve months.
YEAR 2000
To date, we have not experienced Year 2000 issues with regard to our internal
systems or any third-party systems. Our expenditures related to Year 2000
compliance have not been material. Despite the fact that the Year 2000 has
commenced and we have experienced no problems to date, we cannot assure that the
risks posed by Year 2000 issues will not adversely affect our business in the
future, either as a result of unanticipated difficulties related to our own
systems or to third parties.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Amounts outstanding under our term loan bear interest at the prime lending rate
of our bank syndicates' leading bank plus .75%. As a result, this debt is
subject to fluctuations in the market which affect the prime rate.
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BUSINESS
OVERVIEW
We are principally engaged in the operation of two health care Internet
sites. HealthGrades.com(TM) provides quality ratings and other information on
health care providers and facilities. ProviderWeb.net(TM) is a
subscription-based website that provides articles, tools and other resources to
physician practice administrators and managers.
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
generally, and with respect to our affiliated physician practices in particular,
we terminated or restructured our arrangements with various physician practices,
beginning in late 1998 and continuing thereafter. As a result, the scope of our
physician practice management business has become far more limited, particularly
after a restructuring of our arrangements with nine practices in June 1999.
During 1998, we began our Internet business, and we launched our present
HealthGrades.com and ProviderWeb.net Internet sites in August 1999. In January
2000, we changed our name to HealthGrades.com, Inc.
HEALTHGRADES.COM INTERNET SITE
HealthGrades.com is a comprehensive health care information website
that provides rating and other profile information regarding a variety of
providers and facilities. We make this information available through several
health care "report card" sections and provider profile modules. Our goal is to
provide comprehensive, objective health care ratings and profiles to assist
consumers in making the most informed decisions regarding their health and that
of their families. Our website is available to consumers for free. We license
access to our information to hospitals, nursing homes, other Internet sites and
other groups.
We distinguish ourselves from most other health care information
websites based on the nature of the information we provide. Most other health
care 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 websites.
We provide information on our HealthGrades.com website through the
following sections:
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:
o cardiac;
o orthopaedics;
o neurosciences;
o pulmonary/respiratory;
o obstetrics; and
o 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 five star rating system (five
stars is the highest rating; one star is the lowest) with regard to the
performance of all 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 Health Care Financing
Administration, known as HCFA. For our obstetrics ratings, which also are
subject to the five star rating system, we use data from 14 individual states
derived from the inpatient records of persons who utilize hospitals in those
states. We believe that the 14 states are the only states with sufficient data
for use on our website. We apply proprietary algorithms to the MEDPAR and state
data to account for variations in risk in order to make the data comparable from
hospital to hospital. Generally, approximately 70% 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 15% of hospitals are rated four and five
stars, which means that their performance is better than expected on
statistically significant basis. Approximately 15% of hospitals are rated 1 or 2
stars, meaning that their performance was worse than expected on a statistically
significant basis. We have applied for a patent with respect to our hospital
rating system and methodology.
Health Plan Report Cards(TM) - We provide two ratings pages on health
plans. The first, HMO Report Cards(TM), addresses managed care organizations,
including health maintenance organizations (HMOs), and HMOs with point of
service plans (POSs). HMO report cards provides information on an aggregate of
297 HMOs and HMO/POS plans administered by 216 organizations across the United
States. Our ratings are based on data we purchase from the National Committee on
Quality Assurance (NCQA), a private, not-for-profit organization dedicated to
assessing and reporting on the quality of managed care organizations. The
Company is currently engaged in a dispute with NCQA regarding the use of data
obtained from NCQA see "Our business will suffer if we are not able to obtain
reliable data as a basis for our ratings and profit information." The data
provided to us from the NCQA is a subset of HEDIS (Health Plan Employer Data and
Information Set). We base our ratings on 28 HEDIS measures that we believe
capture the quality of service and care provided by a managed care organization,
which we group into the following six categories:
o Access and Services (4 measures);
o Child and Adolescent Health (5 measures);
o Getting Better/Living with Illness (4 measures);
o Women's Health (4 measures);
o Member's Satisfaction (4 measures); and
o Qualified Providers (7 measures).
We apply a statistical analysis designed to obtain a weighted average
of the six rating categories that explains the greatest percentage of the
overall variation between categories across all managed care organizations. The
overall scores are then sorted and star grades are assigned (five stars is
highest rating). The top 10% of all managed care organizations nationally
receive five stars. The next 20% of managed care organizations are assigned four
stars. The middle 40% of managed care organizations analyzed receive three
stars. The next 20% of managed care organizations are assigned two stars, and
the bottom 10% receive one star. HMO Report Cards also supplies NCQA
accreditation status for each plan on the website.
The second set of ratings on health plans is provided under the Health
Plan Report Cards page. Health Plan Report Cards ranks the performance of health
plans across the United States based on customer satisfaction studies provided
by the HCIA Sachs. HCIA Sachs advised us that it commissioned Scarborough
Research Organization, a local market media and consumer research organization,
to perform an enrollee satisfaction survey. Comprehensive questionnaires were
completed and analyzed for every health plan rated on the website (currently 244
health care plans from 39 major U.S. metropolitan markets). We apply a
statistical analysis to assign weights to nine performance ratings derived from
the questionnaires. An overall general score for each health plan analyzed is
derived from a weighted average
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of the nine performance ratings. These scores are displayed on the website. A
five star rating system is used in conjunction with the overall score. The
distribution between the best and worst performing health plans is allocated in
the same manner as on the HMO Report Cards page.
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 during 1996 through 1999, using data provided by HCFA in the
Online Survey Certification and Reporting (OSCAR) database. The OSCAR database
contains information on nursing homes, including survey dates, survey results,
resident characteristics and staffing distribution. This information is derived
from individual state agencies, which enter the information into the OSCAR
database. In preparing the ratings, we reviewed four years of nursing home
survey information for nursing homes that were active in the Medicare and/or
Medicaid programs. Specifically, we analyzed the following elements to rate the
quality of care provided by each nursing home:
o recent survey deficiencies;
o past survey deficiencies;
o repeating deficiencies found in all surveys not related to quality of
care; and
o repeating deficiencies found in all surveys related to quality of care.
Working with a group of health care professionals whose expertise is in
nursing home care, we developed a proprietary scoring system that translates the
scope and severity of each deficiency into numerical points. Our website
provides a three tier rating system under which five stars were awarded to the
top 30% of all nursing homes by state, three stars are awarded to the middle 40%
of all nursing homes by state and one star is awarded to the bottom 30% of all
nursing homes by state. 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 website provides
specific information with regard to particular deficiencies found in the
surveys.
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 HCFA in the OSCAR database. The
OSCAR database contains information on home health agencies, including licensing
survey dates, complaint surveys and survey results. As is the case with nursing
homes, this information is derived from individual state agencies, which enter
the information into the OSCAR database. 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. These surveys
generally occur every 36 months but may occur more frequently based on the
results of the previous survey. In preparing the ratings, we reviewed survey
information from the four most recent licensing 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:
o Complaint surveys (two elements)
o Number of complaint surveys within the last four years
o Number of complaint surveys dated within six months of each
other
o 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
o 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
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o Condition level deficiencies reported on both the most recent and
prior surveys
o Standard level deficiencies reported on both the most recent and prior
surveys
o Surveyor's summary score on the quality of care during the most recent
survey
o Years in operation
o Ownership changes as compared to years in operation
Working with a group of health care professionals whose area of expertise is
home health care, we developed a proprietary weighting system that translates
the fifteen 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.
Physician Report Cards(TM) - This page differs from most of our other
report card pages in that it does not provide ratings. Instead, it provides
users with the means to assess physicians across the United States. Using data
obtained from a number of publicly and privately available sources, we provide
information regarding physicians practicing in 59 medical and surgical
specialties. Our page provides users with a list of physicians in each specialty
and enables users to refine their search based upon the following criteria:
o whether a physician is board certified in the specialty he or she is
practicing;
o whether the physicians have had any state medical board or Medicare
sanctions within the past five years;
o whether the physician practices in a hospital that is ranked by
HealthGrades.com as at least a three, four or five star hospital on our
Hospital Report Cards page;
o whether the physician has been in practice for at least two, ten,
twenty or thirty years; and
o whether the physician is male or female.
For example, a user may refine the list of orthopaedic surgeons to only include
female board certified surgeons who have been in practice for at least ten
years, are affiliated with a hospital that has at least a four star rating and
have had no state medical board or Medicare sanctions in the past five years.
Hospice Report Cards(TM) - Like our Physician Report Card page, 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 hospice programs
across the United States that participate in Medicare. The data on our Hospice
Report Card site is purchased from HCFA, 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 "core services" or
"non-core services." Core services, as defined in the POS file, are important,
basic elements of hospice care which are crucial to virtually every hospice
patient and their family. These services include the following:
o Nursing care provided by or under the supervision of a registered nurse
(R.N.);
o medical social services provided under the direction of a physician;
o Physician services; and
o Counseling
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Non-core services, such as physical therapy, homemaker services and short-term
inpatient care, are also important to high-quality hospice care, but are not
appropriate or necessary for every hospice patient.
Hospice report cards provide users with a list of hospices from which they can
refine their search based upon the following criteria:
o whether the program provides nursing care directly by hospice
employees;
o whether the program provides medical social services directly by
hospice employees;
o whether the program provides physician services directly by hospice
employees;
o whether the program provides counseling directly by hospice employees;
and
o whether the program provides all non-core hospice services
Other Provider Profiles - In addition to the report card sections, we
provide profiles containing information with regard to the following providers
or facilities. The approximate number of providers or facilities addressed in
each profile is indicated in parenthesis:
o Hospitals (5,000);
o Dentists (150,000);
o Chiropractors (60,000);
o Assisted living residences (21,000);
o Fertility clinics (300);
o Mammography facilities (10,000);
o Acupuncturists (8,000);
o Naturopathic physicians (700); and
o Birth centers (75)
Licensing Activities
Information on our website is free to consumers. We seek to obtain
revenues on a business to business basis as follows:
Licensing Links to HealthGrades.com Content to Other Websites - We
provide linking arrangements that permit other companies operating health care
websites to provide their users access to HealthGrades.com from their locations.
As of June 1, 2000, we have licensed nine companies that pay a cash fee to us
for the provision of such
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access, and five additional companies that either provide their on-line content
to us or share advertising revenue derived from their websites with us or both.
License Data and Trademark Rights to Highly Rated Hospitals, Nursing
Homes and Health Plans - After our ratings are objectively determined, we
contact hospitals, nursing homes and health plans that have received four or
five star ratings and seek to have them license our data and trademark rights in
connection with their own marketing programs. As of June 1, 2000, we have
entered into agreements with 21 hospitals, two health plans and one nursing
home.
We approach potential licensees only after our ratings have been
compiled because we believe that the success of our business is largely
dependent on the credibility of our ratings. We do not adjust our ratings based
on whether a hospital, nursing home or health plan is willing to license with
us.
License Data to Payors/Employers - Through an arrangement with
XCare.net, we provide customized health care ratings and profile services to
payor organizations, provider groups and medical suppliers.
Advertising
We generate advertising revenue through banner advertisements that are
served on our website. We also receive a percentage of advertising revenue
derived from banner advertisements delivered on websites of other online health
care companies that display our content.
Advertisements displayed on our website are primarily served by a
consulting company, which retains a percentage of the advertising revenue
generated as a commission fee.
Marketing and Public Relations Activities
We market our website through relationships with other companies that
operate health care websites and an aggressive public relations campaign. As
noted above under "Licensing Links to HealthGrades.com Content to Other
Websites," several of the companies pay a fee to us to license access to our
information. We pay a fee to one of the companies for including links to our
website and for users who access our site. The websites through whom we provide
access to our information include the following:
o iVillage.com;
o Onhealth.com;
o HealthAnswers.com;
o VitalRX.com;
o MediZine.com;
o WeMedia.com;
o Healthpick.com;
o Newsweek.com;
o Washingtonpost.com;
o Vivius.com (formerly, BuyMed Direct.com);
o SimplyHealth.com;
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o WebHealthy.com;
o Gazoontite.com;
o Healthtrends.com;
o eLocal.com and affiliated sites; and
o DiscoveryHealth.com
These arrangements provide additional exposure to our website and an
increased number of users. As a result, we believe our marketing to health care
providers, payors and others is enhanced because of the increased user
population that we can make available to those entities who wish to advertise on
our website, or license our data in connection with their own marketing
programs.
In addition, we have engaged in an aggressive public relations
campaign, which includes references to our website in connection with our
licensing of data to hospitals, appearances on national television and radio
programs and coverage in newspapers and periodicals.
Competition
We believe that HealthGrades.com is the most comprehensive source of
health care ratings and provider profiles on the Internet. Moreover, we believe
our provider profiles include more extensive information than directories or
other websites. Other sources publish lists of top hospitals, but do not provide
ratings of all hospitals, by procedure/diagnosis, as we do. NCQA has recently
established a health plan ratings page on its website.
PROVIDERWEB.NET INTERNET SITE
ProviderWeb.net is a subscription based, online physician practice
management resource. ProviderWeb.net provides financial and administrative
tools, articles and resources covering a broad range of matters relating to
practice administration. We market subscriptions to our website to practice
administrators and others involved in the financial and operational performance
of physician practices.
ProviderWeb.net provides tools and information in the following areas:
Finance and Accounting - In addition to articles on various aspects of financial
management of a practice, we provide the following tools:
o an extensive budget template with multiple worksheets that can be
utilized to create a detailed practice budget;
o an application that calculates key practice financial ratios; and
o an application that creates graphs and charts comparing year-to-year
practice results.
Human Resources - Our human resources section contains the following information
and tools:
o a complete, downloadable employee handbook;
o employment contract templates;
o human resource forms covering a variety of issues from patient
dismissal to reference checks; and
o an anti-harassment and nondiscrimination policy.
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Marketing - We provide articles dealing with various aspects of marketing
including medical practice advertising and steps a practice should take when
developing a marketing plan. In addition, our tools include the following:
o a Web Builder feature that enables a practice to design and build its
own web page and
o a marketing plan template that can be utilized to develop a detailed
practice marketing plan.
Planning - We provide several articles to assist practices with respect to
strategic planning, as well as the following tools:
o strategic planning tools that include forms designed to enable a
practice to gather and evaluate detailed internal and external planning
information and
o an operational assessment template designed to enable the practice
administrator to perform an objective evaluation of the practice's
day-to-day operations.
Billing and Collections - In addition to an article designed to assist the
practice in evaluating billing problems, we provide the following tools and
applications:
o a payor mix application that enables a practice to track revenues from
various sources and display results in graphs and charts;
o a business office assessment tool that enables a practice to evaluate
the effectiveness of its business office functions;
o a payment preparation policy;
o an aged accounts receivable application that enables a practice to
track and display results in graphs and charts; and
o downloadable information supplementing an article that explains in
detail the HCFA 1500 Form, a universal form used for billing physician
services.
Coding and Compliance - We provide information and tools to assist practice
administrators in providing a billing code that correctly relates to procedures
performed by physicians in the practice. Among the tools we offer are the
following:
o documentation tools for insuring proper coding and accurate billing for
ten different specialty areas and
o a guide to proper use of CPT (Current Procedural Terminology) code
modifiers, which are used to more accurately reflect, on a claim form,
the level of service performed by physician than would be the case if
only a standard CPT code is used; the proper use of CPT code modifiers
can facilitate appropriate reimbursement to providers.
Policies and Procedures - We provide 25 downloadable policies and procedures
covering various aspects of the physician practice, including accounting,
patient registration and collection.
Credentials File - We provide articles containing information with respect to
credentialing and the completion of hospital and insurance applications as well
as the verification of credentials. In addition, we offer the following
features:
o a downloadable universal credentialing application;
o a downloadable malpractice claims/suit history form; and
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<PAGE> 34
o a credential reminder application designed to result in our
transmission of reminder e-mails after the practice inputs information
regarding renewal dates for certificates, licensing and insurance
policies with respect to each physician.
Patient Satisfaction - In addition to information with regard to improving
customer service for patients, we provide a patient satisfaction survey form
with instructions for use. Once the survey form has been completed and sent to
us, we provide the results of the survey online to the practice.
Other Areas - We provide information and in some cases tools in other areas,
including legal matters, insurance, reimbursement, imaging, front desk,
information systems and managed care.
Sales
We seek to derive revenues from three separate sources:
Subscription fees - Users of our website pay an annual user license fee
for access to our website, information and tools. As of June 1, 2000, we had a
subscriber base of 38 practices. Of the 38 practices, 22 are paying subscribers.
In connection with the initial marketing of ProviderWeb.net, we gave 16
practices a free annual subscription. User license fees are paid by the
practices based on the number of users of our service. We also provide fee based
web page development services, and are planning to introduce additional fee
based services in the future, including online access to financial management
reporting for the practice, online help in determining appropriate CPT codes,
online supply purchasing, online malpractice insurance applications and other
services.
Revenue Sharing Arrangements - We will seek to derive revenues through
revenue sharing arrangements with other companies. We have recently entered into
an agreement with Global HealthNet, Inc. under which we will provide our
subscribers access to Global HealthNet's online claim eligibility and referral
service. This service provides online communication with payors to confirm
patient eligibility for coverage and to receive payor approval for referrals to
physicians for the provision of services. We will receive a portion of any fee
Global HealthNet receives from subscribers who access their service through our
website. In addition, we have entered into an agreement with FirstNet Learning,
Inc. under which we will offer FirstNet's online training and education programs
to our subscribers. Under the agreement, we will receive a portion of any
training fee received by First Net Learning in connection with our subscribers
who access the online training course through our website. In addition, we will
seek to enter into similar arrangements with companies that provide medical
supplies, coding assistance and malpractice and life insurance online. To date,
we have not entered into any revenue sharing agreements other than those
specifically referenced above.
Other Activities - Ultimately, as our subscriber base grows, we hope to
obtain additional revenues through the sale of banners, links and other forms of
advertising by other companies, including the sale of promotional subscriptions
for use by the companies in their own marketing programs.
Marketing
We currently market our ProviderWeb.net website by a direct sales
effort to large physician organizations, including independent practice
organizations, physician/hospital organizations and management services
organizations. We also use a direct sales approach to larger physician group
practices. In addition, we telemarket to individual practices. Our sales force
consists of two direct sales personnel and one telemarketer. In addition, we
have commission arrangements with several independent sales consultants.
We also have commenced and intend to expand a program of appearances at
conferences of organizations that include members who we believe would be
interested in our website, including the Medical Group Management Association
and the Professional Association of Health care Office Managers. In addition, we
intend to begin a print advertising campaign in several journals directed toward
practice administrators and a direct mail program.
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Competition
There are many Internet based products and services directed to the physician
practice market. We believe that our two principal online competitors are WebMD
and CyBear. While these websites both offer some administrative tools, they are
also focused on providing clinical (disease management) information. WebMD also
provides consumer information. We believe that the principal competitive factors
in the provision of online services to physician practices is the breadth of
information and tools available, ease of use and price. We believe that
ProviderWeb.net provides a more comprehensive array of administrative tools and
resources for physician practice administrators than any other website. We also
compete with traditional private consulting firms that provide services to
physician practices.
PHYSICIAN PRACTICE MANAGEMENT OPERATIONS
We provide services under management services agreements to six
musculoskeletal physician practices under management services agreements. We
provide the following services:
o assessment of the financial performance, organizational structure,
wages and strategic plan of the practice
o advice with respect to current and future marketing and contracting
plans with third-party payors and managed care plans
o negotiation of malpractice insurance coverage
o provision of access to our patient information databases
o analysis of annual performance on a comparative basis with other
practices that have contracted with us
o analysis of coding and billing practices
We provide these services under management services agreements that
have terms expiring through September 2002. The scope of our physician practice
management business has contracted significantly as a result of the transactions
described under "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Modification of arrangements and restructuring
Transaction."
GOVERNMENT REGULATION
The delivery of health care services has become one of the most highly
regulated of professional and business endeavors in the United States. Both the
federal government and the individual state governments are responsible for
overseeing the activities of individuals and businesses engaged in the delivery
of health care services. Federal law and regulations are based primarily upon
the Medicare and Medicaid programs. Each of these programs is financed, at least
in part, with federal funds. State jurisdiction is based upon the state's
interest in regulating the quality of health care in the state, regardless of
the source of payment.
We believe our Internet service activities and physician practice
management operations materially comply with applicable laws. However, we have
not received or sought a legal opinion from counsel or from any federal or state
judicial or regulatory authority with respect to our Internet service activities
or our practice management operations. Additionally, many aspects of our
business have not been the subject of state or federal regulatory
interpretation. The laws applicable to us and the practices that contract with
us are subject to evolving interpretations. If we, or these practices, are
reviewed by a government authority, we may receive a determination that could be
adverse to us or the practices. Furthermore, the laws applicable to either us or
the practices may be amended in a manner that could adversely affect us.
Federal Anti-kickback Law. A federal law commonly known as the
"Anti-kickback Law" prohibits the knowing or willful solicitation, receipt,
offer or payment of any remuneration which is made in return for:
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o the referral of patients covered under Medicare, Medicaid and other
federally-funded health care programs; or
o the purchasing, leasing or ordering of any good, facility, item or
service reimbursable under those programs.
The law also prohibits remuneration that is made for the recommendation
of, or the arranging for, the purchasing, leasing, or ordering of any good,
facility, item or service reimbursable under those programs. The law has been
broadly interpreted by a number of courts to prohibit remuneration that is
solicited, received, offered or paid for otherwise legitimate purposes if one
purpose of the arrangement is to induce referrals or the other prescribed
activities. The penalties for violations of this law include:
o civil monetary penalties;
o criminal sanctions;
o exclusion from further participation in federally-funded health care
programs (mandatory exclusion in certain cases);
o the ability of the Secretary of Health and Human Services to refuse to
enter into or terminate a provider agreement; and
o debarment from participation in other federal programs.
In 1991, the federal government published regulations that provide
exceptions or "safe harbors," to the Anti-kickback Law. Subsequently, in
November 1999, final regulations were issued establishing additional safe harbor
provisions under the Anti-kickback Law, as well as clarifying the original 1991
safe harbor regulation. The failure of an activity to qualify under a safe
harbor provision, while potentially leading to greater regulatory scrutiny, does
not render the activity illegal.
There are several aspects of our activities to which the Anti-kickback
Law may be relevant. For example, the Anti-kickback Law has been construed to
apply to referral services, where a consumer group, professional society or some
other organization charges a health care provider a fee or other payment in
exchange for referring such health care provider to a prospective patient. The
Anti-kickback Law, and the safe harbor regulations promulgated thereunder, are
unclear as to whether activities such as our activities with respect to our
HealthGrades.com website would be construed as "referral services." Since, under
certain circumstances, hospitals, nursing homes and other health care providers
achieving a four-star or five-star rating may pay us a fee in exchange for
banner advertisements on our website and the use of our name and logo in
marketing the health care provider's services, it is possible that we could be
deemed to be engaged in referral services in such a manner so as to implicate
the Anti-kickback Law. Although a referral services safe harbor was adopted in
1991, we do not believe that our current activities with respect to our
HealthGrades.com website would qualify under the referral services safe harbor.
Additionally, the Office of Inspector General has stated on a number of
occasions that any compensation arrangement between a health care provider and
another party for the purpose of marketing health care items or services that
are directly or indirectly reimbursable by a federal health care program
potentially implicates the Anti-kickback Law, irrespective of the methodology
used to compensate the party providing the marketing services. Generally, the
Office of Inspector General takes the position that marketing services fall
under the category of a "recommendation" of a good, facility, item or service
reimbursable under the federal health care program. To the extent that certain
health care providers pay a flat fee payment to us in exchange for placing a
banner ad on our websites or in exchange for other activities by us which could
be construed as marketing services, the Anti-kickback Law may be implicated. In
addressing this issue, the Office of Inspector General has identified several
characteristics of arrangements among health care providers and sales agents
that appear to be associated with an increased potential for program abuse.
These suspect characteristics include:
o compensation to the sales agent based on a percentage of sales;
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o direct billing of a health care program by the health care provider for
the item or services sold by the sales agent;
o direct contact between a sales agent and physicians in a position to
order items or services;
o direct contact between the sales agent and federal health care program
beneficiaries;
o the use of sales agents who are health care professionals or persons in
a similar position to exert undue influence over purchases or patients;
or
o the marketing of items or services that are separately reimbursable by
a Federal health care program (whether on the basis of charges or
costs).
We do not believe that our activities with respect to certain health
care providers who achieve a four-star or five-star rating on the
HealthGrades.com website involve any of these suspect characteristics, or other
characteristics which the Office of Inspector General would consider abusive or
likely to lead to federal health care program abuse. Fees paid to us by health
care providers are not in any manner determined based on the amount of revenue
or other financial benefit generated by our activities, we are not marketing
specific services or items with respect to hospitals or other health care
providers, and our HealthGrades.com website is not directed to physicians, other
health care professionals or federal health care program beneficiaries.
Finally, we provide, on a limited basis, certain management services to
physician practices. These management services are provided through our
ProviderWeb.net website and under short-term management services agreements with
a limited number of physician practices.
In at least one advisory opinion, the Inspector General of the
Department of Health and Human Services has stated that under certain
circumstances, payments by a physician practice to a medical practice management
company in exchange for certain marketing services, billing and collection
services, and managed care contract negotiation services could constitute
illegal remuneration as defined in the Anti-kickback Law, especially where the
fee paid by the medical practice to the management company is based on a
percentage of medical practice revenue. We do not believe that the limited
management services we provide to physician practices or the practice management
information and tools we provide to physician practices under our
ProviderWeb.net website are the types of services to which this advisory opinion
is directed, and our fees under our management services arrangements are no
longer based on a percentage of medical practice revenue.
We do not provide billing and collection services, marketing services
or managed care contracting services under any of our current physician practice
management operations. Although our HealthGrades.com activities (to the extent
they may be deemed "referral services") and general marketing activities do not
qualify for protection under the safe harbor regulations, we believe that our
activities are not the type of activities and arrangements the Anti-kickback Law
prohibits. We are not aware of any legal challenge or proceeding pending against
similar activities under the Anti-kickback Law. A determination that we violated
the Anti-kickback Law would be detrimental to us.
State Anti-kickback Laws. Many states have laws that prohibit payment
of kickbacks in return for the referral of patients. Some of these laws apply
only to services reimbursable under state Medicaid programs. A number of these
laws apply to all health care services in the state, regardless of the source of
payment for the service. Based on court and administrative interpretation of the
federal Anti-kickback Law, we believe that most of these laws prohibit payments
to referral sources where a purpose for the payment is for a referral. Most
state anti-kickback laws have received limited judicial and regulatory
interpretation. 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.
Fee-Splitting Laws. Most states prohibit a physician from splitting
fees with a referral source. Some states have a broader prohibition against any
splitting of a physician's fees, regardless of whether the other party is a
referral source. In most states, we believe that a management fee payment made
by a physician to a management company
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would not be considered fee-spitting if the payment constitutes reasonable
payment for services rendered to the physician or physician's medical practice.
We are paid by physicians (and their medical practices) for whom we
provide management services. Although we believe that our ProviderWeb.net
practice management services and our management service agreements comply with
applicable state laws relating to fee-splitting, a state authority may
nevertheless determine that we and the practices that contract with us are
violating the state's fee-splitting laws. Such a determination could render any
of our service agreements in such state unenforceable or subject to modification
in a manner that is adverse to us.
Health Care Reform. In recent years, a variety of legislative proposals
designed to change access to and payment for health care 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 health
care reform legislation or similar legislation will be enacted or, if enacted,
its effect on us.
POTENTIAL GOVERNMENT REGULATION OF THE INTERNET
Any new law or regulation pertaining to the Internet, or the
application or interpretation of existing laws, could decrease demand for our
services, 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.
INTELLECTUAL PROPERTY
We regard the protection of our intellectual property rights to be
important. We rely on a combination of trademark, patent, 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 and, in more limited cases, 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 are
seeking or will seek registration of a number of our trademarks with the U.S.
Patent and Trademark Office. We also have a patent pending on our health care
rating system and methods. We cannot assure that registrations will be
forthcoming or that this patent will be issued, or that, even if registered or
issued, the trademarks or patent will adequately protect our intellectual
property or otherwise result in commercial advantage to us.
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.
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 other."
EMPLOYEES
As of June 1, 2000, we had sixty-two employees, most of whom were
located at our corporate offices.
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PROPERTIES
We have a lease for our approximately 15,000 sq. foot headquarters
facility in Lakewood, Colorado, which expires on March 15, 2001. Our annual
rental for this facility is approximately $253,000.
LEGAL PROCEEDINGS
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES
On October 27, 1999, Reconstructive Orthopaedic Associates II, P.C.,
("ROA"), filed a complaint against us in the U.S. District Court for the Eastern
District of Pennsylvania. The complaint asserts that, during negotiations
between ROA and us related to the restructure agreement by and between ROA and
us, we agreed that if we entered into a similar restructuring agreement with any
other affiliated practice on financial terms more favorable to the other
affiliated practice than those extended to ROA under its restructure agreement,
we would modify and adjust the terms of their restructure agreement to ensure
that ROA received financial terms as favorable as those extended to the other
affiliated practice. The complaint further alleges that one or more lawsuits or
other adversary proceedings between us and one or more other affiliated
practices have been settled, in fact or in principle, on financial terms
materially more favorable to the other affiliated practices than the terms
extended to ROA under its restructure agreement. ROA seeks compensatory,
consequential and incidental damages in excess of $75,000, punitive damages in
excess of $1,000,000 and attorneys fees. Additionally, ROA seeks a declaratory
judgment that if any of the alleged settlements were entered into between us and
any other affiliated practices on terms materially more favorable than those
extended to ROA, we would be required to modify and adjust the terms of their
restructure agreement to ensure that ROA received financial terms as favorable
as those extended to such other affiliated practices.
On November 8, 1999, we filed a complaint in the U.S. District Court
for the District of Colorado against ROA. The complaint asserts that ROA has
taken actions in direct contravention of our management services agreement with
ROA, including trying to terminate the agreement in a manner not allowed by the
contract, threatening to withhold payments due under the agreement, and filing
suit in another jurisdiction in violation of the agreement. We seek a
declaration and adjudication of both parties' contractual rights and obligations
in order to terminate this dispute. We also seek injunctive relief and damages.
By letter dated April 28, 2000, our counsel raised certain concerns
with ROA's counsel that may become the subject of an amended complaint in the
Colorado action. In response to that letter, on May 11, 2000, three individual
doctors practicing at ROA, Richard H. Rothman, Todd J. Albert and Alexander R.
Vaccaro, filed a complaint against us in Pennsylvania for declaratory and
injunctive relief and damages. The April 28, 2000 letter, which is attached to
the Complaint, questions whether Dr. Rothman and/or other doctors practicing at
ROA improperly purchased shares of our common stock on the basis of material
non-public information he/they acquired in a position of trust. ROA seeks
declaratory judgment that none of the plaintiffs violated any fiduciary,
contractual or common law duty to us and did not violate section 10(b) or
section 16(b) of the Securities and Exchange Act of 1934. ROA also brings fraud
and negligent misrepresentation claims against us, contending that the stock
purchases by the individual doctors were acceptable to us and not otherwise in
violation of any legal duty. On or before June 27, 2000, we will file a motion
to dismiss or answer and assert counterclaims.
We believe we have strong legal and factual defenses to ROA's claims.
We intend to vigorously defend against ROA's lawsuits and aggressively pursue
our claims.
ORTHOPAEDIC INSTITUTE OF OHIO
On November 1, 1999, we filed a complaint in the U.S. District Court
for the District of Colorado against the Orthopaedic Institute of Ohio, Inc.
("OIO"). The complaint asserts that, prior to the closing of the restructure
agreement between OIO and us, OIO, its physician owners and the administrator of
OIO diverted over $470,000 from our bank account and deposited such funds into a
bank account held by OIO and the physician owners. The complaint further asserts
that OIO and the physician owners are continuing to withhold from us amounts
that remain due under the restructure agreement of over $720,000. OIO
subsequently filed a Motion for Stay of Proceedings and
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a Motion to Dismiss. Essentially, OIO has argued that all claims made by us are
subject to the arbitration clause of the Restructure Agreement by and between us
and OIO. We filed a response to OIO's Motions and oral arguments occurred in
March 2000. On March 27, 2000, the Court entered an order staying the litigation
and ordering the parties to resolve their disputes through arbitration. The
parties are in the process of finalizing the terms under which an arbitrator
will be retained. We seek to use the arbitration to resolve all claims raised by
us in the District Court Complaint.
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth information regarding our executive
officers and directors:
<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
Kerry R. Hicks.......................... 40 Chief Executive Officer
Patrick M. Jaeckle...................... 41 President and Secretary
D. Paul Davis........................... 42 Executive Vice President - Finance, Chief
Financial Officer and Treasurer
David G. Hicks.......................... 41 Executive Vice President - Information
Technology
Timothy D. O'Hare....................... 47 Senior Vice President - ProviderWeb.net
Frank W. Riesenecker.................... 42 Senior Vice President - Corporate Operations
Peter A. Fatianow....................... 36 Senior Vice President - Business Development
Sarah Loughran.......................... 35 Senior Vice President - Content
Peter H. Cheesbrough(1)(2).............. 48 Director
Leslie S. Matthews, M.D. ............... 48 Director
Mats Wahlstrom(1)....................... 45 Director
Parag Saxena(1)......................... 45 Director
Marc S. Sandroff(2)..................... 42 Director
</TABLE>
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
HealthGrades.com, Inc., Messrs. Kerry Hicks, Jaeckle, David Hicks, Davis and
Fatianow and Ms. Loughran have agreed to take such actions (including in the
case of the individuals, voting their shares) as are in their control so that
(1) our Board of Directors is comprised of no more than eight members and (2)
one designee of each of Chancellor V, L.P. and Essex Woodlands Health Ventures
Fund IV, L.P is elected to the Board of Directors. See "Certain Transactions."
In addition, we have agreed that, at the option of Chancellor V, L.P. and Essex
Woodlands Health Ventures Fund IV, L.P., their respective designees may serve on
both the Audit Committee and the Compensation Committee of the Board of
Directors. Chancellor V, L.P. has designated Mr. Saxena and Essex Woodlands
Health Ventures Fund IV, L.P. has designated Mr. Sandroff. Mr. Saxena serves on
the Audit Committee and Mr. Sandroff serves on the Compensation Committee. The
agreement remains in effect as to each of the director designees until the later
of March 17, 2005 or the date on which the respective designating entity fails
to own in the aggregate more than five percent of our issued and outstanding
common stock.
KERRY R. HICKS, one of our founders, has served as our Chief Executive
Officer and as a director since our inception in December 1995. He also served
as our President from our inception until November 1999. From 1985 to March
1996, Mr. Hicks served as Senior Vice President of LBA Healthcare Management.
PATRICK M. JAECKLE, one of our founders, has served as our President
since November 1999. From July 1998 to November 1999, Mr. Jaeckle served as
Executive Vice President - Corporate Development. Mr. Jaeckle served as our
Executive Vice President - Finance/Development and Chief Financial Officer from
December 1995 to July 1998, and as a director since our inception in December
1995. From February 1994 through March 1996, Mr.
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<PAGE> 41
Jaeckle served as Director of Healthcare Corporate Finance at Morgan Keegan &
Co., Inc. Previously, Mr. Jaeckle was a member of the health care groups at both
Credit Suisse First Boston and Smith Barney. Prior to his career in investment
banking, Mr. Jaeckle was a member of the International Business Development
Group at Merck & Company.
D. PAUL DAVIS has served as Executive Vice President - Finance for
HealthGrades.com, Inc. since November 1999. He also has been our Chief Financial
Officer since August 1998. He was our Senior Vice President - Finance from March
1997 until November 1998, and from March 1996 until March 1997 he was Vice
President - Finance. From January 1993 to March 1996, Mr. Davis served as Vice
President of Finance for Surgical Partners of America, Inc. He served as Chief
Financial Officer for Anesthesia Service Medical Group, Inc., from April 1987 to
January 1993. From January 1982 to April 1987, Mr. Davis was employed by
Intermountain Health Care, Inc., as Corporate Accountant. Mr. Davis is a
Certified Public Accountant and a Certified Management Accountant.
DAVID G. HICKS has served as our Executive Vice President - Information
Technology since November 1999. He was our Senior Vice President - Information
Technology from May 1999 to November 1999 and Vice President - Management
Information Systems from March 1996 until May 1999. From 1994 to March 1996, Mr.
Hicks worked as Manager of Information Technology for the Association of
Operating Room Nurses. From 1992 to 1994, He worked as Manager of Financial
Systems for Coors Brewing Company. From 1982 to 1992, Mr. Hicks served as
Manager of Internal Systems for Martin Marietta Data Systems.
TIMOTHY D. O'HARE has served as our Senior Vice President -
ProviderWeb.net since November 1999. He was our Vice President - Operations from
August 1996 until November 1999. From 1987 to 1994, Mr. O'Hare served as Vice
President and Executive Director of CIGNA Health Care of North Carolina. From
1994 to 1996, Mr. O'Hare served as Executive Director of Kaiser Foundation
Health Plan of North Carolina.
FRANK W. RIESENECKER has served as our Senior Vice President -
Corporate Operations since September 1999. From March 1997 to August 1999, Mr.
Riesenecker served as President of Chums, Inc., a manufacturer of sports and
safety products for consumer and industrial markets worldwide. Previously, Mr.
Riesenecker served as President of Tundra, Inc. an industrial and commercial
construction project management company.
SARAH P. LOUGHRAN has served as our Senior Vice President - Content
since March 2000 and as Senior Vice President - Content of HG.com and its
successor, Healthcare Ratings, Inc. since 1998. From 1996 to 1997, Ms. Loughran
worked as Assistant Vice President for Product Development for HCIA, where she
developed a number of information application products. From 1994 to 1996, Ms.
Loughran served as a Senior Consultant at LBA Healthcare Management. In this
role, she consulted with more than 35 different hospitals on managing cost by
clinical specialty. Prior to this, she was Assistant Vice President for Clinical
Support Services in the Rush Presbyterian St. Lukes Medical Center system.
PETER A. FATIANOW has served as our Senior Vice President - Business
Development since March 2000. He has served in several capacities for HG.com and
its successor, Healthcare Ratings, Inc. since July 1998, most recently as Senior
Vice President - Operations. He was previously our Vice President - 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. From July 1994 to February 1996, Mr. Fatianow
worked as an Associate Vice President in Healthcare Corporate Finance with
Morgan Keegan & Company, Inc. Previously, he spent two years in Credit Suisse
First Boston's health care group in New York.
PETER H. CHEESBROUGH has served as one of our directors since December
1996. Since August 1999, Mr. Cheesbrough has been Chief Financial Officer of
XCare.net, a company providing electronic commerce architecture and business to
business applications solutions for health care. From June 1993 to August 1999,
Mr. Cheesbrough was the Senior Vice President-Finance and Chief Finance Officer
of Echo Bay Mines Ltd., a company engaged in precious metals mining. From April
1988 to June 1993, he was Echo Bay Mines' Vice President and Controller. Mr.
Cheesbrough is a Fellow of the Institute of Chartered Accountants of England and
Wales and is also a chartered accountant in Canada.
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<PAGE> 42
LESLIE S. MATTHEWS, M.D. has served as one of our directors since
December 1996. Since October 1994, Dr. Matthews has been an orthopaedic surgeon
at Greater Chesapeake Orthopaedic Associates, LLC, and since 1990, he has been
the Chief of Orthopaedic Surgery at Union Memorial Hospital in Baltimore,
Maryland. From July 1982 to October 1994, Dr. Matthews was also engaged in
private practice.
MATS WAHLSTROM has served as one of our directors since March 1997. In
May 2000, Mr. Wahlstrom was appointed as an Executive Vice President for
Securitas AB, a multinational corporation engaged in guard services, alarm
system design, installation and monitoring and cash-in-transit services. From
1990 until February 2000, Mr. Wahlstrom served in various capacities for Gambro
AB and its affiliated companies, which are engaged in the manufacture of
equipment for hemodialysis, cardiovascular surgery and blood component analysis
and in the provision of health care services. He was President of Gambro
Healthcare, Inc. from 1993 until February 2000, Executive Vice President of
Gambro AB from 1990 until February 2000 and President of COBE Laboratories,
Inc., a subsidiary of Gambro AB engaged in the development and manufacture of
hemodialysis products and the operation of dialysis centers from 1991 until
February 2000.
PARAG SAXENA has served as one of our directors since March 2000. Mr.
Saxena has served in various capacities at INVESCO Private Capital, Inc. or its
predecessor since May 1983, most recently as Chief Executive Officer.
MARC S. SANDROFF has served as one of our directors since March 2000.
Mr. Sandroff has been a general partner and/or Managing Director of Essex
Woodlands Health Venture Funds since 1987. From 1984 to 1987, he was one of nine
professionals responsible for managing the venture capital portfolio for
Allstate Insurance. Prior to entering the venture capital industry, he was a
founder of and had direct operating responsibilities of several rehabilitation
and long-term care facilities.
Kerry R. Hicks and David G. Hicks are brothers.
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<PAGE> 43
EXECUTIVE COMPENSATION
Summary of Cash and Other Compensation. The following table sets forth
information concerning the compensation we paid to our Chief Executive Officer
and the four other most highly paid executive officers during 1999, 1998 and
1997. We refer to these persons in this prospectus as the "named executive
officers."
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
------------
AWARDS
------
NAME AND PRINCIPAL POSITION ANNUAL COMPENSATION SECURITIES ALL
-------------------- UNDERLYING OTHER
YEAR SALARY BONUS OPTIONS COMPENSATION(1)
---- -------- ----- ---------- ---------------
<S> <C> <C> <C> <C> <C>
Kerry R. Hicks.................................. 1999 $253,606 - 475,000 $7,137
Chief Executive Officer 1998 $248,923 - 500,000 $4,197
1997 $214,260 - 172,622 $8,226
Patrick M. Jaeckle.............................. 1999 $253,606 - 475,000 $4,800
President 1998 $250,400 - 500,000 --
1997 $214,259 - 172,622 $6,572
D. Paul Davis................................... 1999 $174,391 - 200,000 $6,392
Executive Vice President - Finance 1998 $166,442 - 305,310 $6,402
1997 $135,519 - 60,217 $8,236
David G. Hicks.................................. 1999 $162,377 - 200,000 $6,070
Executive Vice President - Information Technology 1998 $139,615 - 183,659 $5,584
1997 $121,731 - 50,181 $7,110
Timothy D. O'Hare............................... 1999 $146,077 - 200,000 $5,728
Senior Vice President - ProviderWeb.net 1998 $143,402 - 183,659 $5,736
1997 $124,717 - 50,181 $4,552
</TABLE>
(1) Includes amounts that we contributed for the accounts of the executive
officers under our Retirement Savings Plan. The 1997 amount also
includes, for each executive officer, $692 distributed upon termination
of medical savings accounts that we initially established for all
employees.
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<PAGE> 44
Stock Options. The following table sets forth information regarding
stock options granted during 1999 to the named executive officers.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
NUMBER OF PERCENT OF
SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED TO EXERCISE
OPTIONS EMPLOYEES IN PRICE EXPIRATION GRANT DATE
NAME GRANTED(1) FISCAL YEAR PER SHARE DATE PRESENT VALUE (2)
---------- ------------- --------- ---------- -----------------
<S> <C> <C> <C> <C> <C>
Kerry R. Hicks............... 475,000 20.25% $0.5625 4/28/09 $ 223,250
Patrick M. Jaeckle........... 475,000 20.25% $0.5625 4/28/09 $ 223,250
D. Paul Davis................ 200,000 8.53% $0.5625 4/28/09 $ 94,000
David G. Hicks............... 200,000 8.53% $0.5625 4/28/09 $ 94,000
Timothy D. O'Hare............ 200,000 8.53% $0.5625 4/28/09 $ 94,000
</TABLE>
(1) On April 29, 1999, we granted options to a number of our employees,
including our executive officers. The options each have an exercise
price of $0.5625, which was the closing price per share of our common
stock on the date of grant. The options fully vested on October 29,
1999 and terminate ten years from the date of grant.
(2) These amounts represent the estimated fair value of stock options,
measured at the date of grant using the Black-Scholes option pricing
model. There are four underlying assumptions used in developing the
grant valuations: an expected volatility of 1.55; an expected term to
exercise of 3 years; risk-free interest rate over the life of the
option of 6%; and an expected dividend yield of zero. The actual value,
if any, an officer may realize will depend on the amount by which the
stock price exceeds the exercise price on the date the option is
exercised. Consequently, there is no assurance the value realized by an
officer will be at or near the value estimated above. These amounts
should not be used to predict stock performance.
The following table sets forth information regarding stock options held
as of December 31, 1999 by the named executive officers. The named executive
officers did not exercise any stock options in 1999.
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL YEAR-END(#) FISCAL YEAR-END($)(1)
------------------------------- -------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Kerry R. Hicks.................. 769,766 452,856 $920,313 --
Patrick M. Jaeckle.............. 769,766 452,856 $920,313 --
D. Paul Davis................... 311,997 283,530 $387,500 --
David G. Hicks.................. 286,006 177,834 $387,500 --
Timothy D. O'Hare............... 388,007 195,833 $387,500 --
</TABLE>
----------------------------
(1) Based on $2.50, the closing price of our common stock as reported on the
Nasdaq Small Cap Market on December 31, 1999.
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<PAGE> 45
EMPLOYMENT AGREEMENTS
We have employment agreements with each of Mr. Kerry Hicks and Mr.
Jaeckle dated as of April 1, 1996. Each agreement has an initial term of five
years and is renewable automatically for one-year periods unless terminated by
one of the parties. The agreements provide for an annual salary rate to each
officer of $187,500 for 1996, $215,000 for 1997 and $250,000 for 1998, with cost
of living increases for the years following 1998. In addition, the agreements
provide for annual incentive compensation to each officer equal to up to 100% of
his base salary based on performance targets established by the Board of
Directors.
We have employment agreements with Mr. Davis, Mr. David Hicks and Mr.
O'Hare, dated as of February 22, 1996, March 1, 1996, and August 12, 1996,
respectively. Each agreement has an initial term of five years and is renewable
automatically for one-year periods unless terminated by one of the parties. The
agreements provide for an annual salary rate to each officer of $108,000 for
1996, $125,000 for 1997 and $144,000 for 1998, with cost of living increases for
the years following the third year. In addition, the agreements provide for
annual incentive compensation to each officer equal to up to 75% of his base
salary based on performance targets established by the Board of Directors. In
connection with Mr. Davis' appointment as Senior Vice President in 1997, his
base salary was increased to $150,000 per annum on April 1, 1997 and $172,500
per annum effective on April 1, 1998. In connection with Mr. David Hicks'
appointment as Senior Vice President in 1999, his base salary was increased to
$172,500 per annum effective May 5, 1999.
Under all of the employment agreements described above, in the event
that the officer is terminated without cause and there has been no change of
control of the Company, we will pay such officer his base salary for the
remaining term of the agreement and any earned but unpaid salary and incentive
compensation. In the event the officer is terminated with cause, regardless of
whether there has been a change of control, we will pay such officer his base
salary for 60 days following such termination. If the officer is terminated
without cause upon a change of control, he is entitled to receive a lump sum
payment upon such termination equal to 300% of his base salary plus 300% of his
annual incentive compensation for the prior year. Each agreement contains
certain confidentiality covenants.
COMPENSATION OF DIRECTORS
Effective January 1, 1999, Messrs. Cheesbrough and Wahlstrom are
entitled to receive $20,000 per annum for their services on our board of
directors and board committees.
On May 5, 1999, we granted options to our non-employee directors to
purchase the following numbers of shares: Mr. Cheesbrough, 23,345 shares: Dr.
Matthews, 27,236 shares; and Mr. Wahlstrom, 20,010 shares. The options have an
exercise price of $.5313 per shares (the closing price per share of our Common
Stock at the date of grant) and terminate on May 4, 2009. The options fully
vested on November 5, 1999.
CERTAIN TRANSACTIONS
During 1997 and 1998, and in some cases part of 1999, we had
service agreements with a number of medical practices (the "Director Affiliated
Practices") and their respective physician owners, including our physician
directors. Under the service agreements, we, among other things, provided
facilities and management, administrative and development services, and employed
most non-medical personnel of the Director Affiliated Practices in return for
management service fees. Such fees were payable monthly and consisted of the
following: (i) service fees based on a percentage ranging from 20% to 33% of the
Adjusted Pre-Tax Income of the Director Affiliated Practices (defined generally
as revenue of the Director Affiliated Practices related to professional services
less amounts equal to certain clinic expenses of the Director Affiliated
Practices, not including physician owner compensation or most benefits to
physician owners ("Clinic Expenses," as defined more fully in the service
agreements)) and (ii) amounts equal to Clinic Expenses. However, under the
service agreements, for the first three years following affiliation (which
included the entire period prior to the modifications or restructurings
described below), our service fees were to be equal to the greater of the amount
payable as described under clauses (i) and (ii) above or a specified fixed
dollar amount plus Clinic Expenses. In addition, with respect to our management
of ancillary facilities and services
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<PAGE> 46
for certain of the Director Affiliated Practices, we received fees based on net
revenue related to such facilities and services.
In December 1998, we entered into transactions (collectively, the
"Modification Transactions") with four of our affiliated practices, including
Greater Chesapeake Orthopaedic Associates, LLC ("GCOA"). Dr. Leslie S. Matthews,
one of our directors, is a physician owner of GCOA. Under the terms of the
Modification Transaction with GCOA, we sold to GCOA accounts receivable and
other assets relating to the practice and revised the original service agreement
through entry into a new management services agreement. Under the new management
services agreement with GCOA, which, as described below, was terminated in
September 1999, we provided substantially reduced services to the practice, and
the practice paid significantly reduced service fees. In addition, the term of
the new management services agreement was shortened to November 2001. We
received $2,747,000 and 1,176,692 shares of our common stock in return for the
repurchase by GCOA of its practice assets and for the execution of the new
management services agreement. In addition, GCOA pre-paid its service fee
obligation with a lump sum payment of $1,185,271.
In September 1999, we agreed to terminate the management services
agreement with GCOA. In connection with this termination, we retained the
prepaid service fee. Additionally, we entered into agreements to lease certain
fixed assets to GCOA, commencing on October 1, 1999 and terminating at various
dates through August 31, 2003. Under the terms of the leases, GCOA was required
to pay to us a fixed fee of approximately $5,849 per month and an additional fee
equal to 7.5 percent of Ancillary Services Revenue, as defined more fully in the
lease agreements. In December 1999, we terminated the lease agreements with GCOA
and sold the fixed assets previously under lease to GCOA. We received $200,000
from GCOA in consideration for the fixed assets.
Effective June 15, 1999, we restructured our relationship with ten
affiliated practices, including Princeton Orthopaedic Associates, II, P.A.
("POA") (collectively, the "Restructuring Transaction"). Dr. Richard E. Fleming,
Jr., one of our directors until November 18, 1999, is a physician owner of POA.
The Restructuring Transaction provided for the repurchase by each of the
participating affiliated practices of accounts receivable and other assets
relating to the practice and revision of the original service agreement with the
practice through entry into a new management services agreement. In return, we
received cash and, in most cases, our common stock. Under the new management
services agreement, the management services provided by us to the practice and
the term of the agreement were substantially reduced. In addition, service fees
paid to us by the practices were also reduced. Under the new management services
agreement with POA, which terminated in June 2000, we provided substantially
reduced services to the practice, and the practice paid significantly reduced
service fees. We received $3,126,000 and 533,131 shares of our common stock from
POA in return for the repurchase by POA of its practice assets and for the entry
into the new management services agreement. In addition, POA pre-paid its
service fee obligation with a lump sum payment of $972,155.
During 1998, we funded, through a wholly-owned subsidiary, Ambulatory
Services, Inc. ("ASI"), the purchase of a lease for, and improvements to, a
surgery center in Lutherville, Maryland. The surgery center was the only asset
of a limited liability company (the "LLC") which was owned by ASI. We also
entered into a service agreement with GCOA and its physician owners with respect
to our management of the surgery center. In March 1999, the LLC issued a
promissory note in the amount of $2,120,619 to ASI in respect of advances made
by ASI to cover development of the surgery center. This promissory note bore
interest at 8% and was payable in sixty monthly installments beginning July 1,
1999. We sold to GCOA a 68% interest in the LLC in March 1999 for $360,505. In
September 1999, we sold our remaining interest in the LLC to GCOA for $169,650.
In addition, we received $2,212,445, in full payment of the obligation of the
LLC to us, and $502,633 in full payment of working capital advances made by ASI
to the LLC.
Other transactions involving a Director Affiliated Practice that
occurred while a physician owner of the Director Affiliated Practice served on
our Board of Directors are summarized below:
GCOA paid service fees of approximately $4,100,000 (including
approximately $2,200,000 in respect of unreimbursable Clinic Expenses) to us in
1997. GCOA also paid service fees of approximately $5,900,000 (including
approximately $4,400,000 in respect of reimbursed Clinic Expenses) to us in
1998. Prior to the Modification Transaction with GCOA, we leased the facilities
utilized by GCOA from an entity of which Dr. Matthews is a part owner. We paid
approximately $300,000 under the lease in 1997 and approximately $500,000
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<PAGE> 47
under the lease in 1998. These payments were included in reimbursed Clinic
Expenses.
POA paid service fees of approximately $7,500,000 (including
approximately $6,100,000 in respect of unreimbursable Clinic Expenses) to us in
1997. POA also paid $7,700,000 (including approximately $6,200,000 in respect of
reimbursed Clinic Expenses) to us in 1998. Prior to the Restructuring
Transaction, POA paid service fees of approximately $1,100,000 (including
approximately $600,000 in respect of reimbursed clinic expenses) to us in 1999.
Additionally, we leased the facilities utilized by POA from an entity of which
Dr. Fleming is a partial owner. We paid approximately $1,300,000 under the lease
in 1997, approximately $500,000 under the lease in 1998 and approximately
$57,000 under the lease in 1999. These payments were included in reimbursed
Clinic Expenses.
Reconstructive Orthopaedic Associates II, P.C. ("ROA"), whose owners
include Dr. Richard H. Rothman, Chairman of our Board of Directors until
December 14, 1998, and, through July 1997, Dr. Robert Booth, one of our
directors until October 12, 1998, paid service fees of approximately $8,600,000
(including approximately $5,400,000 in respect of reimbursed Clinic Expenses) to
us in 1997. POA also paid us service fees of approximately $7,000,000 (including
approximately $5,000,000 in respect of reimbursed Clinic Expenses) in 1998.
Effective July 1997, Dr. Booth became a physician owner of 3B
Orthopaedics, Inc. ("3B Orthopaedics"). 3B Orthopaedics paid service fees of
approximately $900,000 to us in 1997 and paid service fees of approximately
$1,000,000 to us for the ten months ended October 31, 1998. Total service fees
incurred by 3B Orthopaedics for the ten months ended October 31, 1998 were
approximately $1,500,000. We relinquished our claim to these fees under the
terms of the January 2000 settlement agreement with 3B Orthopaedics, under which
the practice surrendered 850,000 shares of our common stock.
TOC Specialists, P.L. ("TOC"), whose owners include Dr. Thomas C.
Haney, one or our directors until June 5, 1998, paid service fees of
approximately $6,200,000 (including approximately $4,800,000 in respect of
reimbursable Clinic Expenses) to us in 1997. TOC also paid $3,500,000 (including
approximately $2,900,000 in respect of reimbursed Clinic Expenses) to us for the
six months ended June 30, 1998. We leased the facilities utilized by TOC from an
entity of which Dr. Haney is a partial owner. We paid approximately $700,000
under the lease in 1997 and $400,000 under the lease for the six months ended
June 30, 1998. These payments were included in reimbursed Clinic Expenses.
Vero Orthopaedics II, P.A. ("VO"), whose owners include Dr. James L.
Cain, one of our directors until August 31, 1998, paid service fees of
approximately $2,200,000 (including approximately $1,300,000 in respect of
reimbursable Clinic Expenses) to us in 1997. VOA also paid $1,500,000 (including
approximately $1,000,000 in respect of reimbursed Clinic Expenses) to us for the
eight months ended August 31, 1998. We leased certain of the facilities utilized
by VO from an entity of which Dr. Cain is a partial owner. We paid approximately
$100,000 under the lease in 1997 and $100,000 under the lease for the eight
months ended August 31, 1998. The expenses were included in reimbursed Clinic
Expenses.
In 1997, we purchased 50 percent of the outstanding membership
interests in West Central Ohio Group, Ltd. ("WCOG"), an Ohio limited liability
company that was formed to construct an ambulatory surgery center in Lima, Ohio,
from the physician owners of a practice affiliated with us (the "Ohio Physician
Owners") for $400,000. In addition, we agreed to pay an amount equal to 25% of
WCOG's first $6,000,000 of net income as contingent consideration (the
"Contingent Consideration"). Our obligation to pay the Contingent Consideration
was to terminate on September 2002. In March 1998, after the ambulatory surgery
center received a permit to begin operations, we sold our one-half of our
interest in WCOG to the Ohio Physician Owners for consideration of approximately
$875,000 and the remaining one-half of our interest to Specialty Solutions, Inc.
for consideration of $1,075,000. In connection with the sale, the Ohio Physician
Owners also forgave our obligation to pay the Contingent Consideration. Kevin J.
Hicks, who was one of our executive officers during 1998 and 1999 and is a
brother of Kerry R. Hicks and David G. Hicks, two of our executive officers, is
an officer and 50 percent stockholder of Specialty Solutions, Inc.
In August 1998, we acquired Provider Partnerships, Inc. ("PPI") in
exchange for 420,000 shares of our common stock. PPI was a recently formed
company that provided consulting services to hospitals. In addition, PPI had
begun development of an Internet site designed to rate hospitals on quality of
care indicators. Kevin J. Hicks, a brother of two of our executive officers, was
one of the principals of PPI and was elected to serve as our Executive Vice
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<PAGE> 48
President-Provider Businesses following that transaction. Kevin Hicks'
employment with us terminated in 1999. Sarah P. Loughran, who became our Senior
Vice President - Content in March 2000, was a shareholder of PPI.
During the latter part of 1998, the former stockholders of PPI raised
certain issues relating to the transaction in which we acquired PPI. In June
1999, we entered into agreements with the former PPI stockholders and Venture5,
LLC ("Venture5"), an entity formed by the former PPI stockholders, to resolve
these matters. Under the agreements:
o We formed a new company ("HG.com") that owned certain aspects of our
Internet health care business. In substance, we owned 70 percent of
HG.com, Venture5 owned 25 percent of the company and Peter A. Fatianow
owned five percent of the company.
o We entered into a stockholders agreement under which we agreed to place
representatives of Venture5 on the HG.com Board of Directors, and
provide to Venture5 certain preemptive rights, voting rights,
registration rights and rights to participate in some sales with
respect to HG.com stock.
o We agreed, under the stockholders agreement, to facilitate financing to
fund the operations of HG.com. Under the agreement, if we were unable
to facilitate financing of at least $4 million by December 31, 1999, we
would be required to transfer sufficient shares of HG.com stock that we
owned so that the former PPI stockholders would become the majority
stockholders of HG.com.
o We sold most of the assets of PPI to the former PPI stockholders for
notes receivable totaling approximately $172,000 (the "PPI Notes"). The
PPI Notes bore interest at the greater of 4.8 percent per annum or the
"Applicable Federal Rate," as defined in Section 1274(d) of the
Internal Revenue Code of 1986. We also funded approximately $500,000 in
expenses of PPI from July 1, 1999 through December 31, 1999.
o The former PPI stockholders waived their options to purchase 760,000
shares of our common stock that they previously held.
o We and the former PPI stockholders mutually released each other from
claims relating to our acquisition of PPI.
In December 1999, in exchange for $4,000,000 and our cancellation of
the PPI Notes, we purchased from Venture5 a number of shares of HG.com that
increased our ownership interest in HG.com to 90 percent. Sarah Loughran, a
member of Venture5, did not participate in the transaction and retained a five
percent interest in HG.com.
In December 1999, Kerry Hicks, our Chief Executive Officer, Patrick
Jaeckle, our President, D. Paul Davis, our Executive Vice President - Finance
and Chief Financial Officer and David Hicks, our Executive Vice President -
Information Technology, made loans to HealthGrades.com in the principal amounts
of $2 million, $1 million, $100,000 and $100,000, respectively. Mr. Kerry Hicks
and Mr. Jaeckle also jointly loaned an additional $350,000 to HealthGrades.com.
We used the proceeds of those loans to purchase the HG.com shares held by the
members of Venture5 other than Ms. Loughran. We issued notes (the "Officer
Notes") to those officers in connection with those loans. The notes bore
interest at 10.5% per annum and were payable on December 31, 2000.
In February 2000, through a series of transactions, we acquired the
remaining minority interests in HG.com from Peter A. Fatianow and Sarah
Loughran, each of whom owned five percent of the outstanding stock of HG.com. We
issued 400,000 shares of our common stock to each of Mr. Fatianow and Ms.
Loughran in exchange for their minority interests. In March 2000, Mr. Fatianow
became our Senior Vice President - Business Development and Ms. Loughran became
our Senior Vice President - Content.
On March 17, 2000, we closed a private placement of our securities. In
connection with the offering, we sold 4,215,000 shares of our common stock and
warrants to purchase 1,475,250 shares of our common stock to Chancellor V, L.P.
for $8,430,000. Parag Saxena, who became one of our directors following the
transaction, is an affiliate of Chancellor V, L.P. We also sold 3,000,000 shares
of our common stock and warrants to purchase 1,050,000 shares to Essex Woodlands
Health Ventures Fund IV, L.P. for $6,000,000. Marc Sandroff, who became
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<PAGE> 49
one of our directors following the transaction, is an affiliate of Essex
Woodlands Health Ventures Fund IV, L.P. In addition, the holders of $3,200,000
principal amount of Officer Notes surrendered their notes in exchange for our
common stock and warrants as follows: Mr. Kerry Hicks surrendered $2,000,000
principal amount of Officer Notes for 1,000,000 shares and warrants to purchase
350,000 shares; Mr. Jaeckle surrendered $1,000,000 principal amount of Officer
Notes for 500,000 shares and warrants to purchase 175,000 shares; and each of
Mr. Davis and Mr. David Hicks surrendered $100,000 principal amount of Officer
Notes for 50,000 shares and warrants to purchase 17,500 shares. The warrants
issued in the transaction each have an exercise price of $4.00 per share and
have a term of five years.
PRINCIPAL AND SELLING STOCKHOLDERS
The Shares being offered under this prospectus include shares currently
held by the selling stockholders as well as shares issuable upon exercise of
warrants held by some of the selling stockholders. The selling stockholders
obtained the shares in various transactions. Chancellor V, L.P., Essex Woodlands
Health Ventures Fund IV, L.P., Punk, Ziegel & Company Investors, L.L.C. and
William J. Punk (collectively, "the Investors") acquired their securities in
connection with a private financing in March 2000. The Investors paid an
aggregate of $14.8 million for their securities. Neil Grossman, Irwin J. Newman
and Alan S. Frankel, who are officers of Triton Capital, Inc. received warrants
to purchase an aggregate of 150,000 shares in consideration of services rendered
by Triton Capital in connection with the private financing. Bank of America
Corporation, AmSouth Bank Corporation, Paribas North America, Inc. and Key
Corporate Capital, Inc., our lending banks, received their shares as a financing
fee in connection with certain modifications to our credit facility. Kerry R.
Hicks, Patrick M. Jaeckle, D. Paul Davis and David G. Hicks, who are some of our
executive officers, received the shares and warrants covered by this Prospectus
in March 2000 in exchange for their surrender of $3.2 million of notes that we
issued to them in December 1999. We issued the notes in connection with loans
that the executive officers made to us in December 1999 to enable us to acquire
a portion of the minority interest in a subsidiary that operated our
HealthGrades.com website. See "Certain Transactions" for additional information
concerning some of these transactions.
The following table sets forth certain information with respect to
beneficial ownership of our common stock as of May 8, 2000 by (i) each person
known to us to own beneficially more than five percent of our common stock
(including such person's address); (ii) our executive officers listed in the
Summary Compensation Table under "Management - Executive Compensation"; (iii)
each of our directors; (iv) all directors and executive officers as a group; and
(v) other selling stockholders. Some of this information is based on information
provided by or on behalf of the selling stockholders and, with regard to the
beneficial holdings of the selling stockholders, is accurate only to the extent
beneficial holdings information was disclosed to us by or on behalf of the
selling stockholders. The selling stockholders and any of their transferees,
pledgees, donees or successors to these persons, may, from time to time offer
and sell, pursuant to this prospectus and any subsequent prospectus supplement,
any and all of these shares.
The amounts shown under "Shares Beneficially Owned After Offering"
assume that the selling stockholders will sell all shares owned by them,
including all shares issuable upon the exercise of warrants held by them.
However, because each of the selling stockholders may offer all, some or none of
his or its respective Shares, we cannot provide a definitive estimate as to the
amount and percentage of common stock that each of the selling stockholders will
hold upon the termination of any sales. In addition, because the warrants held
by some of the selling stockholders have "net exercise" provisions, the actual
number of shares issued upon exercise of the warrants may be less than indicated
in the footnotes to the table. Generally, a "net exercise" provision enables a
holder of a warrant to surrender a warrant and receive, without any cash
payment, a number of shares based upon a formula that takes into account the
excess of the market value of the shares underlying the warrant over the
exercise price of such shares.
45
<PAGE> 50
<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially
Owned Prior to Owned After
Offering (1) Offering
Number Percent Number of Number Percent
of of Shares Being of of
Name Shares Total Offered Total Total
---- --------- ------- ------------ --------- -------
<S> <C> <C> <C> <C> <C>
DIRECTORS AND OFFICERS:
Kerry R. Hicks(2) 2,578,436 11.4 1,350,000 1,228,436 5.4
Patrick M. Jaeckle(3) 2,028,142 9.0 675,000 1,353,142 6.0
D. Paul Davis(4) 462,352 2.1 67,500 394,852 1.8
David G. Hicks(5) 439,286 2.0 67,500 371,786 1.7
Timothy D. O'Hare(6) 397,505 1.9 -- 397,505 1.8
Parag Saxena(7) 5,690,250 24.7 5,690,250 -- --
Marc S. Sandroff(8) 4,050,000 17.9 4,050,000 -- --
Leslie S. Matthews, M.D.(9) 85,116 * -- 85,116 *
Peter H. Cheesbrough(10) 54,345 * -- 54,345 *
Mats Wahlstrom(11) 46,677 * -- 46,677 *
All Directors and Officers as a
group (13 persons) (12) 16,982,490 61.3 11,900,250 4,911,604 22.8
FIVE PERCENT STOCKHOLDERS:
Chancellor V, L.P.(13) 5,690,250 24.7 5,690,250 -- --
Essex Woodlands
Health 4,050,000 17.9 4,050,000 -- --
Ventures Fund IV, L.P.(14)
OTHER SELLING STOCKHOLDERS:
Bank of America Corporation(15) 66,000 * 66,000 -- --
AmSouth Bancorporation(15) 33,000 * 33,000 -- --
Paribas North America, Inc.(15) 33,000 * 33,000 -- --
Key Corporate Capital, Inc.(15) 33,000 * 33,000 -- --
Punk, Ziegel & Company
Investors, L.L.C.(16) 216,000 1.0 216,000 -- --
William J. Punk(17) 33,750 * 33,750 -- --
Neil Grossman(18) 90,000 * 90,000 -- --
Irwin J. Newman(18) 30,000 * 30,000 -- --
Alan S. Frankel(18) 30,000 * 30,000 -- --
</TABLE>
* Less than one percent
(1) Applicable percentage of ownership is based on 21,516,468 shares of
common stock outstanding on May 8, 2000. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and means voting and investment power with respect to
securities. Shares of common stock issuable upon the exercise of stock
options or warrants exercisable currently or within 60 days of May 8,
2000 are deemed outstanding and to be beneficially owned by the person
holding such option for purposes of computing such person's percentage
ownership, but are not deemed outstanding for the purpose of computing
the percentage ownership of any other person. Except for shares jointly
held with a person's spouse or subject to applicable community property
laws, or as indicated in the footnotes to this table, each stockholder
identified in the table possesses sole voting and investment power with
respect to all shares of common stock shown as beneficially owned by
such stockholder.
(2) Includes 10,000 shares of common stock held by The David G. Hicks
Irrevocable Children's Trust, 350,000 shares underlying warrants and
813,018 shares underlying stock options. Does not include 60,000 shares
of common stock held by The Hicks Family Irrevocable Trust, for which
shares Mr. Kerry Hicks
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<PAGE> 51
disclaims beneficial ownership. Mr. Kerry Hicks is our Chief Executive
Officer and one of our directors. Mr. Hicks' address is
HealthGrades.com, Inc., 44 Union Boulevard, Suite 600, Lakewood, CO
80228.
(3) Includes 175,000 shares underlying warrants and 813,018 shares
underlying stock options. Does not include 100,000 shares of common
stock held by The Patrick M. Jaeckle Family Irrevocable Children's
Trust, for which shares Mr. Jaeckle disclaims beneficial ownership. Mr.
Jaeckle is our President and one of our directors. Mr. Jaeckle's
address is HealthGrades.com, Inc., 44 Union Boulevard, Suite 600,
Lakewood, CO 80228.
(4) Includes 17,500 shares underlying warrants and 337,853 shares
underlying stock options. Mr. Davis is our Executive Vice President -
Finance and our Chief Financial Officer.
(5) Includes 17,500 shares underlying warrants and 295,505 shares
underlying stock options. Mr. David Hicks is our Executive Vice
President - Information Technology.
(6) Includes 397,505 shares underlying stock options.
(7) Includes 4,215,000 shares and 1,475,250 shares underlying warrants held
by Chancellor V, L.P. Mr. Saxena is a Managing Director of INVESCO
Private Capital, Inc., the Managing Member of IPC Direct Associates V,
L.L.C., which is the General Partner of Chancellor V, L.P. Mr. Saxena's
address is INVESCO Private Capital, Inc., 1166 Avenue of the Americas,
New York, NY 10036.
(8) Includes 3,000,000 shares and 1,050,000 shares underlying warrants held
by Essex Woodlands Health Ventures Fund IV, L.P. (the "Fund"). Mr.
Sandroff is a Managing Director of Essex Woodlands Health Ventures Fund
IV, L.L.C. (the "LLC"), which is the General Partner of the Fund. Mr.
Sandroff's address is Essex Woodlands Health Ventures IV, L.L.C., 190
South LaSalle Street, Suite 2800, Chicago, IL 60603.
(9) Includes 43,333 shares underlying stock options.
(10) Includes 53,345 shares underlying stock options.
(11) Includes 46,677 shares underlying stock options.
(12) Includes 3,085,250 shares underlying warrants and 2,800,254 shares
underlying stock options.
(13) Includes 1,475,250 shares underlying warrants. See note 7. The address
of Chancellor V, L.P. is 1166 Avenue of the Americas, New York, NY
10036.
(14) Includes 1,050,000 shares underlying warrants. See note 8. The address
of Essex Woodlands Health Ventures Fund IV, L.P. is 190 South LaSalle
Street, Suite 2800, Chicago, IL 60603.
(15) The stockholder is one of our lending banks.
(16) Includes 56,000 shares underlying warrants.
(17) Includes 8,750 shares underlying warrants.
(18) All shares listed are underlying warrants. Messrs. Grossman, Newman and
Frankel are officers of Triton Capital, Inc., which provided financial
advisory services to us in connection with a private placement in March
2000.
DESCRIPTION OF THE CAPITAL STOCK
Our authorized capital stock consists of 50,000,000 shares of common
stock, $.001 par value per share, and 2,000,000 shares of preferred stock, $.001
par value per share. As of May 8, 2000, there were 21,516,468 shares of common
stock outstanding. No shares of preferred stock are currently outstanding.
COMMON STOCK
The holders of our common stock are entitled to one vote per share on
each matter to be decided by our stockholders and do not have cumulative voting
rights. Accordingly, the holders of a majority of common stock entitled to vote
in any election of directors may elect all of the directors standing for
election. Our common
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<PAGE> 52
stockholders will be entitled to receive ratably such dividends, if any, as the
Board of Directors may declare from time to time out of funds legally available
for that purpose. In the event of liquidation, dissolution or winding up of our
affairs, after payment or provision for payment of all of our debts and
obligations and any preferential distributions to holders of preferred stock, if
any, the holders of the common stock will be entitled to share ratably in our
remaining assets. The holders of our common stock have no preemptive, redemption
or conversion rights. All outstanding shares of common stock are validly issued,
fully paid and non-assessable.
PREFERRED STOCK
Our Board of Directors is authorized, without further action by the
stockholders, to provide for the issuance of shares of preferred stock as a
class without series or in one or more series, to establish the number of shares
in each class or series and to fix the designation, powers, preferences and
rights of each such class or series and the qualifications, limitations or
restrictions thereof. Because the Board of Directors has the power to establish
the preferences and rights of each class or series of preferred stock, the Board
of Directors may afford the holders of any class or series of preferred stock
preferences, powers and rights, voting or otherwise, senior to the rights of
holders of common stock. The issuance of preferred stock could have the effect
of delaying or preventing a change in control in HealthGrades.com. As of the
date of this prospectus, we have not authorized the issuance of any preferred
stock and there are no plans, agreements or understandings for the issuance of
any shares of preferred stock.
WARRANTS TO PURCHASE OUR COMMON STOCK
Warrants to purchase 3,300,000 shares of our common stock were
outstanding on May 8, 2000. Warrants to purchase 3,150,000 shares are all
currently exercisable at a price of $4.00 per share and warrants to purchase
150,000 shares are currently exercisable at $3.45 per share. The warrants expire
on March 17, 2005.
CERTAIN PROVISIONS OF DELAWARE LAW AND OUR CERTIFICATE OF INCORPORATION AND
BYLAWS
We are subject to Section 203 of the Delaware General Corporation Law,
which regulates acquisitions of some Delaware corporations. In general, Section
203 prohibits a publicly-held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years
following the date the person becomes an interested stockholder, unless:
o the corporation's board of directors approved the business combination
or the transaction in which the person became an interested stockholder
prior to the date the person attained this status;
o upon consummation of the transaction that resulted in the person
becoming an interested stockholder, the person owned at least 85% of
the voting stock of the corporation outstanding at the time the
transaction commenced, excluding shares owned by persons who are
directors and also officers and some types of employee stock plans; or
o at or subsequent to the date the person became an interested
stockholder, the corporation's board of directors approved the business
combination, and the stockholders, by the affirmative vote of 66 2/3%
of the outstanding voting stock not owned by the interested
stockholder, authorized the transaction at an annual or special meeting
of stockholders.
A "business combination" generally includes a merger, asset or stock
sale or other transaction resulting in a financial benefit to the interested
stockholder. In general, an "interested stockholder" is a person who, together
with the person's affiliates and associates, owns 15% or more of a corporation's
voting stock.
Our Certificate of Incorporation provides that liability of our
directors is eliminated to the fullest extent permitted under Section 102(b)(7)
of the Delaware General Corporation Law. As a result, none of our directors will
be liable to us or our stockholders for monetary damages for breach of fiduciary
duty as a director, except for liability:
o for any breach of the director's duty of loyalty to us or our
stockholders;
48
<PAGE> 53
o for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
o for any willful or negligent payment of an unlawful dividend, stock
purchase or redemption; or
o for any transaction from which the director derived an improper
personal benefit.
Our Bylaws generally provide that we will indemnify our directors, employees and
other agents to the fullest extent provided by Delaware law.
Our Amended and Restated Certificate of Incorporation requires the vote
of 66 2/3% of the outstanding voting securities to effect certain actions,
including a sale of substantially all of our assets, certain mergers and
consolidations, and the dissolution and liquidation of HealthGrades.com, unless
those actions have been approved by a majority of our directors. These
supermajority voting rights could have the effect of making it more difficult
for a third party to acquire, or discouraging a third party from seeking to
acquire, control of HealthGrades.com.
Our Bylaws provide that stockholders must follow an advance
notification procedure for certain stockholder nominations of candidates for the
Board of Directors and for certain other stockholder business to be conducted at
an annual meeting. These provisions could, under certain circumstances, operate
to delay, defer or prevent a change in control of the Company.
PLAN OF DISTRIBUTION
The shares of common stock covered by this prospectus may be offered and sold
from time to time by the selling stockholders, including donees, transferees,
pledgees or other successors in interest that receive such shares as a gift,
partnership distribution or other non-sale related transfer. Each of the selling
stockholders will act independently of HealthGrades.com in making decisions with
respect to the timing, manner and size of any sale. Each of the selling
stockholders may sell the Shares on the Nasdaq Stock Market, or otherwise, at
market prices then prevailing, at prices related to the then current market
price or at negotiated prices. The shares may be sold by one or more of the
following means of distribution:
o a block trade in which the broker-dealer so engaged will attempt to
sell shares as agent, but may position and resell a portion of the
block as principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its own account pursuant to this prospectus;
o an over-the-counter distribution in accordance with the rules of the
National Association of Securities Dealers, Inc.;
o ordinary brokerage transactions and transactions in which the broker
solicits purchasers; and
o in privately negotiated transactions.
To the extent required, this prospectus may be amended or supplemented from time
to time to describe a specific plan of distribution. In connection with
distributions of the Shares or otherwise, each of the selling stockholders may
enter into hedging transactions with broker-dealers or other financial
institutions. In connection with these transactions, broker-dealers or other
financial institutions may engage in short sales of HealthGrades.com common
stock in the course of hedging the positions they assume with such selling
stockholder. Each of the selling stockholders may also sell HealthGrades.com
common stock short or redeliver the shares to close out such short positions.
Each of the selling stockholders may also enter into option or other
transactions with broker-dealers or other financial institutions which require
the delivery to the broker-dealer or other financial institution of Shares
offered hereby, which the broker-dealer or other financial institution may
resell pursuant to this prospectus (as supplemented and amended, if required, to
reflect such transaction). Each of the selling stockholders also may pledge
shares to a broker dealer or other financial institution, and, upon a default,
the broker-dealer or other financial institution may effect sales of the pledged
shares pursuant to this prospectus (as supplemented or amended, if
49
<PAGE> 54
required, to reflect such transaction). In addition, any Shares that qualify for
sale pursuant to Rule 144 may be sold under Rule 144 rather than through this
prospectus.
Broker-dealers or agents may receive compensation in the form of
commissions, discounts or concessions from the selling stockholders.
Broker-dealers or agents may also receive compensation from the purchasers of
Shares for whom they act as agents or to whom they sell as principals, or both.
Compensation as to a particular broker-dealer may be in excess of customary
commissions and will be in amounts to be negotiated in connection with the sale.
The Selling Stockholders and any broker-dealers that act in connection with the
sale of Shares might be deemed to be "underwriters" within the meaning of
Section 2(11) of the Securities Act, and any commissions received by such
broker-dealers and any profit on the resale of the Shares sold by them while
acting as principals might be deemed to be underwriting discounts or commissions
under the Securities Act. Because selling stockholders may be deemed to be
"underwriters" within the meaning of Section 2(11) of the Securities Act, the
selling stockholders will be subject to the prospectus delivery requirements of
the Securities Act. We have informed the selling stockholders that the
anti-manipulative provisions of Regulation M promulgated under the Exchange Act
may apply to their sales in the market.
In order to comply with the securities laws of certain states, if
applicable, the Shares must be sold in such jurisdictions only through
registered or licensed brokers or dealers. In addition, in certain states the
Shares may not be sold unless they have been registered or qualified for sale in
the applicable state or an exemption from the registration or qualification
requirements is available and is complied with.
The selling stockholders have advised the Company that they have not
entered into any agreements, understandings or arrangements with any
underwriters or broker-dealers regarding the sale of their securities, nor is
there any underwriter or coordinating broker acting in connection with the
proposed sale of Shares by the selling stockholders.
We will file a supplement to this prospectus, if required, under Rule
424(b) under the Securities Act upon being notified by the selling stockholders
that any material arrangement has been entered into with a broker-dealer for the
sale of Shares through a block trade, special offering, exchange distribution or
secondary distribution or a purchase by a broker or dealer. This supplement will
disclose:
o the name of the selling stockholders and of participating brokers and
dealer(s);
o the number of Shares involved;
o the price at which the Shares were sold;
o the commissions paid or the discounts or concessions allowed to the
broker-dealer(s), where applicable;
o that the broker-dealer(s) did not conduct any investigation to verify
the information set out or incorporated by reference in this
prospectus; and
o other facts material to the transaction.
In addition, upon being notified by any selling stockholder that a donee or
pledgee intends to sell more than 500 Shares, we will file a supplement to this
prospectus.
We will bear all costs, expenses and fees in connection with the registration of
the Shares. The selling stockholders will bear all commissions and discounts, if
any, attributable to their respective sales of Shares. The selling stockholders
may agree to indemnify any broker-dealer or agent that participates in
transactions involving the sales of Shares against some liabilities, including
liabilities arising under the Securities Act. We and the Investors have agreed
to indemnify each other against some liabilities in connection with the offering
of the Shares, including liabilities arising under the Securities Act.
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<PAGE> 55
LEGAL MATTERS
The legality of the common stock offered by this prospectus has been
passed upon for us by Morgan, Lewis & Bockius LLP, Philadelphia, Pennsylvania.
Certain health care regulatory matters will be passed upon for us by Baker,
Donelson, Bearman & Caldwell PC, Jackson, Mississippi.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated financial
statements and schedule at December 31, 1999 and 1998 and for each of the three
years in the period ended December 31, 1999, as set forth in their report. We
have included our financial statements and schedule in the prospectus and
elsewhere in the registration statement in reliance on Ernst & Young LLP's
report, given their authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a
registration statement on Form S-1 under the Securities Act with respect to the
shares of common stock being offered. Portions of the registration statement are
not included in this prospectus and the exhibits and schedules to the
registration statement contain additional relevant information about us and our
common stock. In addition, we file reports, proxy statements and other
information with the SEC as required by the Securities Exchange Act of 1934 (the
"Exchange Act"). You may read and copy this information at the following
locations of the SEC:
<TABLE>
<S> <C> <C>
Public Reference Room Northeast Regional Office Midwest Regional Office
Room 1024 7 World Trade Center West Madison Street
450 Fifth Street, N.W. 14th Floor Suite 1400
Washington, DC 20549 New York, NY 10048 Chicago, IL 60661
</TABLE>
You may obtain information about the operation of the SEC's Public
Reference Room by calling the SEC at 1-800-SEC-0330. Our SEC filings are also
available on the SEC's Internet site at: www.sec.gov.
51
<PAGE> 56
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
HEALTHGRADES.COM, INC. AND SUBSIDIARIES:
Report of Independent Auditors.................................... F-1
Consolidated Balance Sheets....................................... F-2
Consolidated Statements of Operations............................. F-3
Consolidated Statements of Stockholders' Equity (Deficit)......... F-4
Consolidated Statements of Cash Flows............................. F-5
Notes to Consolidated Financial Statements........................ F-7
</TABLE>
<PAGE> 57
Report of Independent Auditors
Board of Directors and Stockholders of HealthGrades.com, Inc.
We have audited the accompanying consolidated balance sheets of
HealthGrades.com, Inc. and subsidiaries (collectively the "Company") as of
December 31, 1999 and 1998, and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for each of the three
years in the period ended December 31, 1999. Our audits also included the
financial statement schedule listed in the Index at Item 16(b). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of HealthGrades.com,
Inc. and subsidiaries at December 31, 1999 and 1998, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
-----------------------------
Ernst & Young LLP
Denver, Colorado
March 17, 2000
F-1
<PAGE> 58
HealthGrades.com, Inc. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31 MARCH 31
1998 1999 2000
------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 1,418,201 $ 316,767 $ 12,759,950
Restricted cash -- 1,178,848 --
Accounts receivable, net 22,281,471 2,744,912 806,133
Due from affiliated practices in litigation, net 4,747,940 2,745,413 2,745,413
Receivables from sales of affiliated practices assets
and execution of new service agreements 7,953,068 -- --
Loans to physician stockholders 521,355 -- --
Prepaid expenses, inventories and other 1,500,382 205,665 258,797
Current portion notes receivable -- 3,531,099 551,922
Prepaid and recoverable income taxes 4,258,102 1,838,589 1,715,918
------------ ------------ ------------
Total current assets 42,680,519 12,561,293 18,838,133
Property and equipment, net 11,050,365 1,656,613 1,148,920
Goodwill, net of accumulated amortization of $-- and
$187,435 in 1999 and 2000, respectively -- 4,000,000 5,662,565
Intangible assets, net of accumulated amortization of
$64,241 in 1998 134,319 -- --
Management service agreements, net of accumulated
amortization of $4,675,892 and in 1998 13,153,048 --
Advances to affiliates and other 944,520 --
Notes receivable, less current portion -- 1,512,242 1,416,880
Other assets 2,216,507 662,720 663,554
------------ ------------ ------------
Total assets $ 70,179,278 $ 20,392,868 $ 27,730,052
============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31 MARCH 31
1998 1999 2000
------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current portion of capital lease obligations $ 244,446 $ -- $ --
Accounts payable 785,649 520,767 638,877
Accrued payroll, incentive compensation and related
expenses 2,453,653 278,474 288,066
Accrued expenses 2,730,069 1,531,550 1,273,877
Line-of-credit 52,925,000 -- --
Notes payable -- 7,352,005 6,463,149
Notes payable to officers -- 350,000 350,000
Due to affiliated practices 3,326,014 -- --
Deferred income -- 1,144,552 938,728
Deferred income taxes 1,083,178 -- --
Convertible debentures 589,615 -- --
------------ ------------ ------------
Total current liabilities 64,137,624 11,177,348 9,952,697
Capital lease obligations, less current portion 680,152 -- --
Note payable, less current portion -- 5,603,283 1,811,065
Notes payable to officers, less current portion -- 3,200,000 --
Deferred income -- 646,847 548,807
------------ ------------ ------------
Total liabilities 64,817,776 20,627,478 12,312,569
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, $0.001 par value, 2,000,000
shares authorized, no shares issued or outstanding -- -- --
Common stock, $0.001 par value, 50,000,000
shares authorized, and 18,618,873, 18,738,686
and 28,786,664 issued and outstanding in 1998,
1999 and 2000 respectively 18,619 18,739 28,787
Additional paid-in capital 66,993,627 67,509,276 87,310,488
Accumulated deficit (57,687,071) (56,722,141) (58,862,558)
Treasury stock (3,963,673) (11,040,484) (13,059,234)
------------ ------------ ------------
Total stockholders' equity (deficit) 5,361,502 (234,610) 15,417,483
------------ ------------ ------------
Total liabilities and stockholders' equity (deficit) $ 70,179,278 $ 20,392,868 $ 27,730,052
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE> 59
HealthGrades.com, Inc. and Subsidiaries
Consolidated Statements of Operations
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
1997 1998 1999 1999 2000
------------ ------------ ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Revenue:
Physician practice management revenue $ 49,655,921 $ 79,181,302 $ 31,178,171 $ 14,398,838 $ 1,579,430
Internet revenue -- -- 407,577 74,040 433,283
Other -- -- -- -- 2,719
------------ ------------ ------------ ------------ ------------
49,655,921 79,181,302 31,585,748 14,472,878 2,015,432
------------ ------------ ------------ ------------ ------------
Costs and expenses:
Physician practice management costs and expenses:
Clinic expenses 31,644,618 55,188,411 15,234,416 9,575,632 --
Impairment loss on service agreements -- 94,582,227 -- -- --
Impairment loss on intangible assets and
other long-lived assets -- 3,316,651 -- -- --
Litigation and other costs -- 3,564,392 5,309,168 1,107,700 369,223
Internet costs and expenses:
Production, content and product development -- -- 1,217,917 62,280 618,827
Sales and marketing -- -- 1,853,191 -- 392,059
General and administrative 7,861,015 14,468,537 10,570,223 3,491,697 2,174,166
------------ ------------ ------------ ------------ ------------
Total costs and expenses 39,505,633 171,120,218 34,184,915 14,237,309 3,554,275
------------ ------------ ------------ ------------ ------------
(Loss) income from operations 10,150,288 (91,938,916) (2,599,167) 235,569 (1,538,843)
Other:
Loss on sale of assets and other -- -- -- -- (336,653)
Gain on sale of assets, practice disputes, and
amendment and restatement of service
agreements -- -- 2,766,284 -- --
Gain on sale of equity investment -- 1,240,078 127,974 -- --
Gain on sale of subsidiary -- -- 221,258 221,258 --
Interest income 536,180 187,450 312,447 63,338 51,154
Interest expense (942,144) (3,741,089) (2,489,427) (1,007,243) (316,075)
------------ ------------ ------------ ------------ ------------
(Loss) income before income taxes 9,744,324 (94,252,477) (1,660,631) (487,078) (2,140,417)
Income tax benefit (expense) (3,873,926) 32,466,391 2,625,561 194,254 --
------------ ------------ ------------ ------------ ------------
Net income (loss) $ 5,870,398 $(61,786,086) $ 964,930 $ (292,824) $ (2,140,417)
============ ============ ============ ============ ============
Net income (loss) per common share (basic) $ 0.38 $ (3.39) $ 0.07 $ (0.02) $ (0.16)
============ ============ ============ ============ ============
Weighted average number of common shares
used in computation (basic) 15,559,368 18,237,827 14,202,748 16,494,704 13,504,008
============ ============ ============ ============ ============
Net income (loss) per common share (diluted) $ 0.37 $ (3.39) $ 0.07 $ (0.02) $ (0.16)
============ ============ ============ ============ ============
Weighted average number of common
shares and common share equivalents
used in computation (diluted) 16,071,153 18,237,827 14,817,732 16,494,704 13,504,008
============ ============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 60
HealthGrades.com, Inc. and Subsidiaries
Consolidated Statements of Stockholders'
Equity (Deficit)
<TABLE>
<CAPTION>
COMMON STOCK (ACCUMULATED
$0.001 PAR VALUE ADDITIONAL DEFICIT)
--------------------------- PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL EARNINGS STOCK TOTAL
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997 11,045,015 $ 11,045 $ 6,465,205 ($ 1,771,383) $ -- $ 4,704,867
Shares issued in connection with
an initial public offering of
common stock, including the
underwriters' overallotment 3,208,338 3,208 22,188,283 -- -- 22,191,491
Shares and other equity
instruments issued in
connection with the
acquisitions of net assets of
affiliated practices 3,222,891 3,223 31,147,368 -- -- 31,150,591
Exercise of employee stock options 227,049 227 265,160 -- -- 265,387
Tax benefit related to employee
stock options -- -- 717,140 -- -- 717,140
Non-cash compensation expense
related to employee stock
options -- -- 212,021 -- -- 212,021
Net income -- -- -- 5,870,398 -- 5,870,398
------------ ------------ ------------ ------------ ------------ ------------
Balances at December 31, 1997 17,703,293 17,703 60,995,177 4,099,015 -- 65,111,895
Shares and other equity
instruments issued in
connection with the
acquisitions of net assets of
affiliated practices and
Provider Partnerships, Inc. 879,480 880 5,561,101 -- -- 5,561,981
Exercise of employee stock options 36,100 36 231,314 -- -- 231,350
2,237,644 shares acquired as
treasury stock -- -- -- -- (3,963,673) (3,963,673)
Tax benefit related to employee
stock options -- -- 86,863 -- -- 86,863
Non-cash compensation expense
related to employee stock
options -- -- 119,172 -- -- 119,172
Net loss -- -- -- (61,786,086) -- (61,786,086)
------------ ------------ ------------ ------------ ------------ ------------
Balances at December 31, 1998 18,618,873 18,619 66,993,627 (57,687,071) (3,963,673) 5,361,502
Non-cash compensation expense
related to employee stock options -- -- 448,374 -- -- 448,374
Exercise of employee stock options 119,813 120 67,275 -- -- 67,395
4,182,634 shares acquired as
treasury stock -- -- -- -- (7,076,811) (7,076,811)
Net income -- -- -- 964,930 -- 964,930
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1999 18,738,686 18,739 67,509,276 (56,722,141) (11,040,484) (234,610)
Non-cash compensation expense
related to employee stock options
(unaudited) -- -- 9,644 -- -- 9,644
Exercise of employee stock options
(unaudited) 82,978 83 45,742 -- -- 45,825
850,000 shares acquired as treasury
stock (unaudited) -- -- -- -- (2,018,750) (2,018,750)
Equity financing, net (unaudited) 7,565,000 7,565 14,351,026 -- -- 14,358,591
Cancellation of officer notes
(unaudited) 1,600,000 1,600 3,198,400 -- -- 3,200,000
Non-cash compensation expense
related to officer note cancellation
(unaudited) -- -- 347,200 -- -- 347,200
Acquisition of minority interest
(unaudited) 800,000 800 1,849,200 -- -- 1,850,000
Net loss (unaudited) -- -- -- (2,140,417) -- (2,140,417)
------------ ------------ ------------ ------------ ------------ ------------
Balance at March 31, 2000 (unaudited) 28,786,664 $ 28,787 $ 87,310,488 $(58,862,558) $(13,059,234) $ 15,417,483
============ ============ ============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 61
HealthGrades.com, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 5,870,398 $(61,786,086) $ 964,930
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Non-cash compensation expense related to
employee stock options 212,021 119,172 448,374
Depreciation expense 965,492 2,227,101 1,757,700
Amortization expense 1,377,746 4,374,607 1,567,352
Bad debt expense -- -- 33,570
Gain on sale of equity investment -- (1,240,078) (127,973)
Gain on sale of subsidiary -- -- (221,258)
Officer notes financing fee -- -- --
Loss on disposal of assets -- -- 181,251
Gain on sale of assets, practice disputes,
and amendment and restatement of
service agreements -- -- (2,766,284)
Impact of termination agreement -- -- (1,073,777)
Equity in investee -- -- 23,852
Impairment loss on service agreements, non-cash -- 94,582,227 --
Impairment loss on intangible assets and
other long-lived assets, non-cash -- 3,316,651 --
Litigation and other costs, non-cash -- 3,431,734 --
Deferred income tax benefit (1,279,497) (31,520,026) (1,083,178)
Changes in operating assets and liabilities, net
of the effects of the non-cash acquisitions of
net assets of affiliated physician practices and
Provider Partnerships, Inc., sale of assets
and execution of new service agreements
and practice disputes:
Accounts receivable, net (9,313,152) (9,092,730) (259,264)
Due from affiliated practices in litigation -- -- (1,360,023)
Prepaid expenses and other assets (1,572,849) (1,265,926) 600,456
Prepaid and recoverable income taxes -- (4,170,177) 2,419,513
Accounts payable and accrued expenses (1,171,896) 1,420,027 962,440
Accrued payroll, incentive compensation
and related expenses 876,369 735,390 (1,270,994)
Income taxes payable 432,497 (944,632) --
Deferred income -- -- 1,791,399
Due to affiliated physician practices, net 1,798,545 734,676 (3,326,014)
------------ ------------ ------------
Net cash (used in) provided by operating activities (1,804,326) 921,930 (737,928)
INVESTING ACTIVITIES
Purchases of property and equipment (1,568,795) (9,141,785) (1,140,438)
Proceeds from sale of medical equipment -- -- 1,001,856
Proceeds from sale of majority interest in a subsidiary
and equity investments, net of cash -- 1,075,000 3,208,397
Repayments of advances to affiliates and
notes receivable -- 1,022,621 --
Increases in goodwill and intangible assets (1,111,257) (116,048) (4,000,000)
Increase in other assets -- -- --
Repayments from (advances to) affiliates (922,022) (1,753,742) 131,233
Advances to investee -- -- (991,386)
Acquisitions of physician practices and Provider
Partnerships, Inc., net of cash acquired (44,452,105) (12,636,948) --
------------ ------------ ------------
Net cash used in investing activities (48,054,179) (21,550,902) (1,790,338)
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
1999 2000
------------ ------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ (292,824) $ (2,140,417)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Non-cash compensation expense related to
employee stock options -- 9,644
Depreciation expense 721,205 241,486
Amortization expense 892,543 187,435
Bad debt expense -- 99,015
Gain on sale of equity investment -- --
Gain on sale of subsidiary (221,258) --
Officer notes financing fee -- 347,200
Loss on disposal of assets 29,604 336,653
Gain on sale of assets, practice disputes,
and amendment and restatement of
service agreements -- --
Impact of termination agreement -- --
Equity in investee (14,884) --
Impairment loss on service agreements, non-cash -- --
Impairment loss on intangible assets and -- --
other long-lived assets, non-cash -- --
Litigation and other costs, non-cash -- --
Deferred income tax benefit (334,119) --
Changes in operating assets and liabilities, net
of the effects of the non-cash acquisitions of
net assets of affiliated physician practices and
Provider Partnerships, Inc., sale of assets
and execution of new service agreements
and practice disputes:
Accounts receivable, net (360,191) (178,986)
Due from affiliated practices in litigation (1,722) --
Prepaid expenses and other assets (34,366) (68,399)
Prepaid and recoverable income taxes --
Accounts payable and accrued expenses 518,480 49,883
Accrued payroll, incentive compensation
and related expenses (1,085,319) 9,592
Income taxes payable 2,826,518 122,671
Deferred income 1,550,457 (303,864)
Due to affiliated physician practices, net (582,438) --
------------ ------------
Net cash (used in) provided by operating activities 3,611,686 (1,288,087)
INVESTING ACTIVITIES
Purchases of property and equipment (701,625) (133,351)
Proceeds from sale of medical equipment -- 125,000
Proceeds from sale of majority interest in a subsidiary
and equity investments, net of cash 322,812 --
Repayments of advances to affiliates and
notes receivable -- --
Increases in goodwill and intangible assets -- --
Increase in other assets (15,847) (834)
Repayments from (advances to) affiliates 77,511 --
Advances to investee (252,434) --
Acquisitions of physician practices and Provider
Partnerships, Inc., net of cash acquired -- --
------------ ------------
Net cash used in investing activities (569,583) (9,185)
</TABLE>
F-5
<PAGE> 62
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1998 1999
------------- ------------- -------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Proceeds from sale of assets, practice disputes
and amendment and restatement of service agreements $ -- $ -- $ 39,416,313
Proceeds from initial public offering, net of
period offering costs 22,939,338 -- --
Cash restricted for repayment of note payable -- -- (1,178,848)
Proceeds from line-of-credit agreement 35,500,000 20,325,000 --
Proceeds from officer notes -- -- 3,550,000
Principal repayments on line-of-credit agreement (6,677,681) (400,000) --
Net proceeds from equity financing -- -- (41,030,000)
Principal repayments on capital lease obligations (229,711) (221,757) (48,805)
Purchases of treasury stock -- (921,491) --
Exercise of employee stock options 265,387 231,350 67,395
Principal payments from loans to physician
stockholders 1,026,419 78,427 124,756
Repayments of notes receivable -- -- 556,569
Loans to physician stockholders (964,737) (488,873) (30,548)
Exercise of common stock options -- -- --
------------- ------------- -------------
Net cash provided by (used in) financing activities 51,859,015 18,602,656 1,426,832
Net increase (decrease) in cash and cash equivalents 2,000,510 (2,026,316) (1,101,434)
Cash and cash equivalents at beginning of period 1,444,007 3,444,517 1,418,201
------------- ------------- -------------
Cash and cash equivalents at end of period $ 3,444,517 $ 1,418,201 $ 316,767
============= ============= =============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 910,000 $ 3,509,592 $ 2,393,289
============= ============= =============
Income taxes paid (received) $ 4,720,926 $ 4,169,506 $ (3,961,898)
============= ============= =============
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING ACTIVITIES
Effects of the acquisitions of net assets of
affiliated physician practices:
Assets acquired $ 110,952,707 $ 23,196,873 $ --
Liabilities assumed (2,429,726) (294,042) --
Income tax liabilities assumed (32,920,285) -- --
Convertible note payable issued -- (6,044,054) --
Less: Cash paid for acquisitions (44,452,105) (12,400,360) --
------------- ------------- -------------
$ 31,150,591 $ 4,458,417 $ --
============= ============= =============
Realized loss on four affiliated practice restructurings in
1998:
Assets disposed of $ -- $ 29,909,279 $ --
Liabilities transferred -- (1,361,040) --
Convertible debentures payable forgiven -- (5,454,439) --
Treasury stock acquired -- (2,656,199) --
Less: Receivable from affiliated practices -- (7,953,068) --
------------- ------------- -------------
Pretax impairment loss on four restructurings closed in 1998 $ -- $ 12,484,533 $ --
============= ============= =============
Gain on sale of assets, practice disputes and amendment
and restatement of service agreements:
Assets disposed of $ -- $ -- $ 43,069,171
Liabilities transferred -- -- (3,859,015)
Treasury stock acquired -- -- (7,076,811)
Less: Notes receivable -- -- (3,436,384)
Cash received -- -- (31,463,245)
------------- ------------- -------------
Gain on sale of assets, practice disputes and amendment
and restatement of service agreements $ -- $ -- $ (2,766,284)
============= ============= =============
Sale of subsidiary
Assets disposed of $ -- $ -- $ 9,619
Liabilities assumed -- -- 343,832
Note receivable -- -- (172,200)
------------- ------------- -------------
Loss on sale of assets $ -- $ -- $ 181,251
============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 2000
------------- -------------
(Unaudited)
<S> <C> <C>
FINANCING ACTIVITIES
Proceeds from sale of assets, practice disputes
and amendment and restatement of service agreements $ 7,953,068 $ --
Proceeds from initial public offering, net of
period offering costs -- --
Cash restricted for repayment of note payable -- --
Proceeds from line-of-credit agreement -- --
Proceeds from officer notes -- --
Principal repayments on line-of-credit agreement --
Principal repayments on note payable (8,547,623) (3,691,672)
Net proceeds from equity financing -- 14,358,591
Principal repayments on capital lease obligations (46,289) --
Purchases of treasury stock -- --
Exercise of employee stock options -- --
Principal payments from loans to physician
stockholders -- --
Repayments of notes receivable -- 3,027,711
Loans to physician stockholders (48,178) --
Exercise of common stock options -- 45,825
------------- -------------
Net cash provided by (used in) financing activities (689,022) 13,740,455
Net increase (decrease) in cash and cash equivalents 2,353,081 12,443,183
Cash and cash equivalents at beginning of period 1,418,201 316,767
------------- -------------
Cash and cash equivalents at end of period $ 3,771,282 $ 12,759,950
============= =============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 825,000 $ 259,000
============= =============
Income taxes paid (received) $ 123,000 $ (2,700,000)
============= =============
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Effects of the acquisitions of net assets of
affiliated physician practices:
Assets acquired $ -- $ --
Liabilities assumed -- --
Income tax liabilities assumed -- --
Convertible note payable issued -- --
Less: Cash paid for acquisitions -- --
------------- -------------
$ -- $ --
============= =============
Realized loss on four affiliated practice restructurings in -- --
1998: -- --
Assets disposed of $ -- $ --
Liabilities transferred -- --
Convertible debentures payable forgiven -- --
Treasury stock acquired -- --
Less: Receivable from affiliated practices -- --
------------- -------------
Pretax impairment loss on four restructurings closed in 1998 $ -- $ --
============= =============
Gain on sale of assets, practice disputes and amendment
and restatement of service agreements:
Assets disposed of $ -- $ --
Liabilities transferred -- --
Treasury stock acquired -- --
Less: Notes receivable -- --
Cash received -- --
------------- -------------
Gain on sale of assets, practice disputes and amendment
and restatement of service agreements $ -- $ --
============= =============
Sale of subsidiary
Assets disposed of $ -- $ --
Liabilities assumed -- --
Note receivable -- --
------------- -------------
Loss on sale of assets $ -- $ --
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 63
HealthGrades.com, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Information subsequent to December 31, 1999 is unaudited)
1. DESCRIPTION OF BUSINESS
Effective January 4, 2000, Specialty Care Network, Inc. changed its name to
HealthGrades.com, Inc. (hereafter, "the Company"). Simultaneously, the Company
changed the name of its majority-owned subsidiary, HealthGrades.com, Inc. to
HG.com, Inc. Effective February 3, 2000, the Company merged its majority-owned
subsidiary, HG.com, Inc. into a recently formed, wholly-owned subsidiary,
HealthCare Ratings, Inc. (See Note 20 for further discussion of this merger
transaction). Additionally, in February 2000, a new, wholly-owned subsidiary of
the Company, ProviderWeb.net was formed. The Company operates two healthcare
Internet sites. HealthGrades.com provides quality ratings and other information
on healthcare providers and facilities. ProviderWeb.net, is a subscription-based
site focused on providing articles, tools and other resources to physician
practice administrators and managers.
2. RESTRUCTURING AND OTHER TRANSACTIONS
Effective June 15, 1999, the Company closed its previously announced
restructuring transaction through ten separate restructuring agreements
involving the following nine practices: Floyd R. Jaggears, Jr., M.D., P.C., II;
Riyaz H. Jinnah, M.D., II, P.A.; The Orthopaedic and Sports Medicine Center, II,
P.A.; Orthopaedic Associates of West Florida, P.A.; Orthopedic Institute of
Ohio, Inc.; Orthopaedic Surgery Centers, P.C. II; Princeton Orthopaedic
Associates, II, P.A.; Reconstructive Orthopaedic Associates, II, P.C.; and
Steven P. Surgnier, M.D., P.A., II.
Under the restructure agreements, the Company transferred, with respect to each
practice, all of the accounts receivable relating to the practice; tangible and
intangible assets purchased or acquired by the Company in respect of the
practice, other than those disposed of in the ordinary course of business since
the date the Company affiliated with the practice; all prepaid expenses relating
to the practice; all inventory relating to the practice; and all other assets
relating to the practice. The amount received by the Company from each practice
and its physician owners for the assets sold to the practice generally equals
the sum of (1) the book value of the accounts receivable relating to the
practice on the effective date of closing; (2) the book value of all fixed
assets and other capital assets relating to the practice on the effective date
of closing; (3) the book value of all prepaid expenses relating to the practice
on the effective date of closing; (4) the book value of all notes and other
receivables the physician owners of the practice owe to the Company on the
effective date of closing; and (5) the cash balance of the practice's deposit
account on the effective date of closing, reduced by the book value of the
liabilities and obligations relating to the practice on the effective date of
closing.
In addition, the Company and each of the practices and their physician owners
entered into a management services agreement to replace the existing service
agreement. As consideration for the Company's agreement to enter into the
management services agreement, the practices and their physician owners paid to
the Company an additional amount of cash, or paid cash and returned to the
Company shares of its common stock.
Under the management services agreements, the Company provides only limited
services to the practices. In addition, the terms of the management services
arrangements were reduced, generally from forty year terms to five year terms
beginning from the initial affiliation date of the affected practice; the
management services agreements expire at various times between one year after
closing of the restructuring transaction and March 2003. In addition, the
practices pay reduced service fees to the Company under the management services
agreements. Six of the practices pay monthly service fees, while three paid a
lump sum fee in connection with the closing of the restructuring transaction, in
lieu of the monthly fee obligation.
With respect to the restructuring transaction, the Company has received to date
approximately $16.3 million and expects to receive approximately an additional
$760,000. Most of the funds received were used to reduce indebtedness. In
addition, shares outstanding were reduced by 3,254,519 shares.
During the latter part of 1999, the Company terminated the revised management
services arrangements with two of the restructured practices and two practices
which were not party to the restructuring transaction, but entered into
transactions during 1998 which resulted in revised management service
arrangements. (See Modification of Arrangements with Four Practices below). In
connection with these terminations, the Company is no longer required to provide
management services to the practices. Included in physician practice management
revenue for the year ended December 31, 1999 is approximately $2.7 million
related to revenue recognized as a result of these terminations.
F-7
<PAGE> 64
OTHER TRANSACTIONS
Effective June 14, 1999, the Company entered into a termination agreement with
Ortho-Associates, P.A. d/b/a Park Place Therapeutic Center ("PPTC"), which
terminated the affiliation of PPTC with the Company. The consideration paid to
the Company consisted of payment for PPTC practice assets that the Company
transferred to PPTC and payment for the termination of the service agreement. In
connection with the termination agreement, the Company received a cash payment
of $8,775,217. Additionally, approximately 545,000 warrants were canceled in
connection with the PPTC termination agreement.
Effective June 16, 1999, the Company entered into a settlement agreement with
TOC Specialists, PL ("TOC") that resolved all legal disputes and litigation
between the Company and TOC. In connection with the settlement agreement, the
Company received a cash payment of $3,500,000 and 762,128 shares of the
Company's common stock in consideration for the TOC practice assets that the
Company transferred to TOC and the termination of the service agreement.
Effective November 12, 1999, the Company entered into a settlement and release
agreement with The Specialists Orthopaedic Medical Corporation and The
Specialists Surgery Center (collectively, "The Specialists") that resolved all
legal disputes and litigation between the Company and The Specialists. In
connection with the settlement agreement, the Company received cash payments
during 1999 of $500,000, a note receivable in the amount of $1,500,000 and
165,987 shares of the Company's common stock in consideration for the
Specialists practice assets that the Company transferred to the Specialists and
the termination of the Specialists service agreements.
Effective December 31, 1999, the Company entered into a settlement and release
agreement with Associated Orthopaedics & Sports Medicine, P.A., Associated
Arthroscopy Institute, Inc. Access Medical Supply, Inc. d/b/a Associated
Physical Therapy, Allied Health Services, P.A., d/b/a Associated Occupational
Rehabilitation, Neal C. Small, M.D. and Alexander I. Glogau, M.D. (collectively,
"Plano") that resolved all legal disputes and litigation between the Company and
Plano. In connection with the settlement agreement, the Company received a cash
payment of $778,848 in December 1999, and an additional cash payment in the
amount of $1,536,384, in January 2000 in consideration for the Plano practice
assets that the Company transferred to Plano assets and the termination of the
Plano service agreements.
Modification of Arrangements with Four Practices
On December 31, 1998, the Company entered into transactions with four of its
affiliated practices. In these transactions, the Company sold to each of the
practices accounts receivable, fixed assets and certain other assets relating to
the respective practices and replaced the original service agreements with new
agreements. Under the new agreements, which terminate at certain dates between
November 2001 and March 2003, the Company provides substantially reduced
services to the practices and the practices pay significantly reduced service
fees. As a result of the completion of these four transactions, the Company
reacquired 2,124,959 shares of its common stock and reduced its outstanding
indebtedness at December 31, 1998 by approximately $5.5 million through the
cancellation of a convertible note previously issued to one of the affiliated
practices. Additionally, in 1999, the Company used additional proceeds from
these four transactions to reduce the amount outstanding under its credit
facility by approximately $8.5 million.
IMPAIRMENT LOSSES, LITIGATION AND OTHER COSTS
Impairment Loss on Management Service Agreements
Based on the restructuring transaction, as well as numerous other factors in the
physician practice management industry in general, during the fourth quarter of
1998, management of the Company undertook an evaluation of the carrying amount
of its management service agreements pursuant to the provisions of Statement of
Financial Accounting Standards No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of. As a result of
this evaluation, the Company recorded an impairment loss on its management
service agreements of approximately $94.6 million in December 1998. This
impairment loss consisted of approximately $12.5 million related to the
management service agreements on the four transactions which closed effective
December 31, 1998, approximately $53.6 million related to the management service
agreements for practices which were party to the restructuring transaction,
approximately $9.0 million related to the management service agreements for
practices which were involved in litigation with the Company and approximately
$19.5 million related to the management service agreements for practices which
were maintaining their long-term agreements with the Company. (See Note 16 for
further discussion of legal proceedings involving the Company's Affiliated
Practices).
Litigation and Other Costs
During the years ended December 31, 1999 and 1998, the Company was involved in
litigation with several of its affiliated practices. As a result of these
disputes, the Company recorded a charge of approximately $3.4 million and $2.7
million for the years ended December 31, 1999 and 1998, respectively, to reserve
for service fee revenue for these practices. (See Note 16 for further discussion
F-8
<PAGE> 65
related to these legal proceedings). In addition, for the years ended December
31, 1999 and 1998, the Company incurred approximately $1.1 million and $0.2
million, respectively, in legal fees directly related to these disputes.
In connection with the restructuring transaction described above, the Company
also incurred expenses of approximately $750,000 and $660,000, for the years
ended December 31, 1999 and 1998, respectively, for financial advisors and legal
consultation.
Impairment Loss on Intangible Assets and Other Long-Lived Assets
During 1998, the Company became involved in negotiations to resolve certain
issues raised by the former stockholders of Provider Partnerships, Inc. ("PPI"),
a corporation acquired by the Company in August 1998. PPI was a company engaged
in providing consulting services to hospitals, and it also provided certain
assets that were developed by the Company into one of its web sites. Because of
this dispute, the Company recorded an impairment loss in December 1998 of
approximately $1.2 million on the intangible asset created with the acquisition
of PPI.
Additionally, as a result of the restructuring transaction, management of the
Company performed a review of the carrying amount of its other long-lived
assets, which resulted in an impairment loss of approximately $2.1 million
during the fourth quarter of 1998.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the Company and its subsidiaries.
All significant intercompany balances and transactions have been eliminated in
consolidation. The Company uses the equity method of accounting to account for
investments in entities in which it exhibits significant influence, but not
control, and generally does not have an ownership interest in excess of 50%.
PRINCIPLES OF ACQUISITION ACCOUNTING AND CHANGE IN ACCOUNTING ESTIMATE
The accompanying financial statements give effect to the acquisitions of
substantially all of the assets of five physician practices on November 12,
1996, through asset purchases, a share exchange and mergers, at their historical
cost basis in accordance with the accounting treatment prescribed by Securities
and Exchange Commission Staff Accounting Bulletin No. 48, Transfers of
Non-monetary Assets by Promoters or Shareholders. In connection with all
subsequent affiliations with physician practices, a substantial portion of the
consideration paid to the physician owners of the practice was restricted
securities and cash, and is allocated to the management service agreement (the
"Service Agreements"). Hereinafter, all physician practices that have affiliated
with the Company, including the initial five physician practices, are referred
to collectively as the "Affiliated Practices." The Company also recognizes the
income tax effects of temporary differences related to all identifiable
acquisition intangible assets, including the Service Agreements.
Beginning June 1, 1998, the Company reduced the amortizable lives of its Service
Agreements to a range of 5 to 30 years by assigning specific lives to each
management service agreement based on factors such as practice market share,
length of operating history and other factors. Previously, the Company amortized
such service agreements over the term of the underlying agreements, which is
generally forty years. This action was taken in response to viewpoints expressed
by the Securities and Exchange Commission regarding the amortization periods
used by the physician practice management industry. The change in accounting
estimate resulted in additional amortization expense of approximately $870,000
for the period June 1, 1998 through December 31, 1998, or $0.03 per common share
for the year ended December 31, 1998 after consideration of the related income
tax effect.
In addition, as a result of the Company's evaluation of the carrying amount of
its management service agreements (as more fully described in Note 2), effective
January 1, 1999, the Company reduced the estimated useful lives of its
management service agreements to lives ranging from 3 to 5 years.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The accompanying balance sheet at March 31, 2000 and the statements of
operations, stockholders' equity (deficit) and cash flows for the three month
periods ended March 31, 2000 and March 31, 1999 are unaudited and have been
prepared on the same basis as the audited financial statements included herein.
In the opinion of management, such unaudited financial statements include all
adjustments necessary to present fairly the information set forth therein, which
consist solely of normal recurring adjustments. The results of operations for
such interim periods are not necessarily indicative of results for the full
respective year.
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<PAGE> 66
RECLASSIFICATIONS
Certain amounts in the Consolidated Balance Sheets as of December 31, 1999 and
1998 and certain amounts in the Statements of Operations and the Consolidated
Statement of Cash Flows for the year ended December 31, 1999 and the three
months ended March 31, 1999 have been reclassified in order to conform to the
current presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and footnotes. Although
these estimates are based on management's knowledge of current events and
actions they may undertake in the future, actual results could differ from those
estimates.
REVENUE RECOGNITION AND ACCOUNTS RECEIVABLE
Physician practice management revenue
Physician practice management revenue consists primarily of service fees
revenue, which is recognized based upon the contractual arrangements of the
underlying Service Agreements between the Company and the Affiliated Practices.
The five largest Affiliated Practices represented 49%, 48%, and 39%, of total
management service fee revenue for the years ended December 31, 1999, 1998 and
1997, respectively. See Note 14 for further discussion of such contractual
arrangements, including certain guaranteed minimum management fees.
Internet revenue
The Company derives its Internet revenue primarily from marketing arrangements
with hospitals, fees related to the licensing of access to its content
(including set-up fees) and advertising.
Marketing revenues are derived from annual fees paid by hospitals in return for
the Company serving banner advertisements and providing other marketing services
to the hospitals. Revenue related to these arrangements is recognized
straight-line over the term of the agreement.
Revenue related to the licensing of access to the Company's content and initial
set-up fees are recognized straight-line over the term of the agreement.
Advertising revenue relates to advertisements served on both the Company's sites
and the Company's share of advertising revenue derived from advertisements
delivered on sites of other healthcare companies which display the Company's
content. Revenues derived from advertising arrangements where the Company
contracts directly with the advertiser are recorded at the gross contract amount
and commissions and other revenue-sharing splits with other on-line healthcare
companies are recorded as general and administrative expenses. Advertising
revenues earned under revenue sharing arrangements from other websites are
recorded net of commissions as the commissions are not contractual obligations
of the Company.
PRODUCTION, CONTENT AND PRODUCT DEVELOPMENT COSTS
Beginning in 1999, the Company began incurring production, content and product
development costs related to the development and support of its HealthGrades.com
and ProviderWeb.net web sites. These costs (which consist primarily of salaries
and benefits, consulting fees and other costs related to software development,
application development and operations expense) are expensed as incurred.
Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," requires
the capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based upon the Company's product
development process, technological feasibility is established upon the
completion of a working model. Costs incurred by the Company between completion
of a working model and the launch of its web sites have not been significant.
F-10
<PAGE> 67
EARNINGS PER SHARE
In 1997, Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"),
Earnings Per Share, was issued. SFAS No. 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to fully diluted earnings per share under the
previous method of reporting earnings per share. All earnings per share amounts
for all periods have been presented in conformity with SFAS No. 128
requirements.
RESTRICTED CASH
At December 31, 1999, the Company had $1,178,848 in cash received related to
settlements of practice disputes which was restricted for the paydown of its
indebtedness. In January 2000, the Company used this cash to reduce amounts
outstanding under its note payable with the bank syndicate.
FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments as reported in the accompanying
balance sheets approximate their fair value primarily due to the short-term
and/or variable-rate nature of such financial instruments.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, including assets acquired from the
Affiliated Practices. Equipment held under capital leases is stated at the
present value of minimum lease payments at inception of the related lease. Costs
of repairs and maintenance are expensed as incurred. Depreciation is computed
using the straight-line method over the estimated useful lives of the underlying
assets. Amortization of capital lease assets and leasehold improvements are
computed using the straight-line method over the shorter of the lease term or
the estimated useful lives of the underlying assets. The estimated useful lives
used are as follows:
<TABLE>
<S> <C>
Computer equipment and software 3-5 years
Furniture and fixtures 5-7 years
Leasehold improvements 5 years
</TABLE>
GOODWILL AND INTANGIBLE ASSETS
Goodwill, which is stated at cost, was acquired in connection with the Company's
purchase of a number of shares of its majority-owned subsidiary, HG.com, Inc.
which increased the Company's ownership in HG.com, Inc. to 90%. Goodwill is
being amortized on a straight-line basis over a seven-year period. (See Note 7
for further discussion of this transaction.)
Pursuant to the provisions of Statement of Financial Accounting Standards No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, the carrying value of long-lived assets, including
goodwill and management service agreements, is reviewed quarterly to determine
if any impairment indicators are present. If it is determined that such
indicators are present and the review indicates that the assets will not be
recoverable, based on undiscounted estimated cash flows over the remaining
amortization and depreciation period, the carrying value of such assets are
reduced to estimated fair market value. Impairment indicators include, among
other conditions, cash flow deficits; historic or anticipated decline in revenue
or operating profit; adverse legal, regulatory or reimbursement developments;
accumulation of costs significantly in excess of amounts originally expected to
acquire the asset; or a material decrease in the fair market value of some or
all of the assets.
The Company reviews its long-lived assets separately for each physician practice
because the cash flows and operations of each individual physician practice are
largely independent of each other and of other aspects of the Company's
business. Intangible and other long-lived assets are allocated to each physician
practice based on the specific identification methodology. During the years
ended December 31, 1997 and 1999, no impairment charges were recognized by the
Company. However, during the fourth quarter of 1998, based on the circumstances
described in Note 2, the Company recorded impairment losses of approximately
$94.6 million on its service agreements, $1.2 million on the intangible asset
created with the acquisition of PPI and $2.1 million on its other long-lived
assets, including deferred debt issuance costs.
STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation arrangements under the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees ("APB No. 25"). In 1995, Financial Accounting Standards
Board Statement No. 123, Accounting for
F-11
<PAGE> 68
Stock-Based Compensation ("SFAS No. 123"), was issued, whereby companies may
elect to account for stock-based compensation using a fair value based method or
continue measuring compensation expense using the intrinsic value method
prescribed in APB No. 25. SFAS No. 123 requires that companies electing to
continue to use the intrinsic value method make pro forma disclosure of net
income and net income per share as if the fair value based method of accounting
had been applied.
REPORTING COMPREHENSIVE INCOME
Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"), Reporting
Comprehensive Income, was issued in June 1997. SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
(e.g., revenue, expenses, gains, losses, etc.) in a full set of general purpose
financial statements. This accounting pronouncement requires that all items that
are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements and display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of the balance sheet. SFAS No.
130 was effective for the Company's year ended December 31, 1999; however, as
the Company currently has no comprehensive income items, there was no impact on
the Company's financial statement presentation. If the Company has items of
comprehensive income in future periods, these items will be reported and
displayed in accordance with SFAS No. 130.
OPERATING SEGMENTS
During 1998, the Company adopted Statement of Financial Accounting Standards No.
131, Disclosures About Segments of an Enterprise and Related Information, ("SFAS
No. 131") which requires reporting of summarized financial results for operating
segments and establishes standards for related disclosures about products and
services, geographic areas and major customers. The Company evaluates
performance based on two different operating segments: physician practice
management and Internet services. For 1998 and 1997, physician practice
management was the only significant operating segment.
FUTURE ACCOUNTING PRONOUNCEMENTS
Accounting for Derivative Instruments and Hedging Activities
In June 1998, Statement of Financial Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities ("SFAS No. 133") was issued.
SFAS No. 133 requires the recording of all derivative instruments as assets or
liabilities, measured at fair value. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. In June 1999, SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133 was issued, which deferred the effective date of SFAS
No. 133 to fiscal years beginning after June 15, 2000. Therefore, the Company
will adopt the new requirement effective January 1, 2001. Management has
completed its review of SFAS No. 133 and does not expect there to be any
material impact on its financial position or results of operations from the
implementation of this statement.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1998 and 1997 financial
statements to conform with the 1999 presentation.
4. ACCOUNTS RECEIVABLE AND MANAGEMENT FEE REVENUE
Accounts receivable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER, 31
1999 1998
------------ ------------
<S> <C> <C>
Gross patient accounts receivable
purchased from the affiliated physician practices $ 168,858 $ 41,779,935
Less allowance for contractual adjustments
and doubtful accounts -- 22,161,082
------------ ------------
168,858 19,618,853
Management fees, including reimbursement
of clinic expenses (net of an allowance of
$1,010,419 in 1999) 2,348,600 2,501,628
Other receivables 227,454 160,990
------------ ------------
$ 2,744,912 $ 22,281,471
============ ============
</TABLE>
F-12
<PAGE> 69
Management fee revenue, exclusive of reimbursed clinic expenses, was
approximately $11.6 million, $21.5 million and $14.3 million for the years ended
December 31, 1999, 1998 and 1997, respectively. One of the Affiliated Practices
exceeded 20% of management fee revenue in 1997.
An integral component of the computation of management fees earned by the
Company is net patient revenue of the Affiliated Practices. The Affiliated
Practices recognize net patient revenue for medical services at established
rates reduced by allowances for contractual adjustments and doubtful accounts.
Contractual adjustments arise due to the terms of certain reimbursement and
managed care contracts. Such adjustments represent the difference between
charges at established rates and estimated recoverable amounts and are
recognized by the Affiliated Practices in the period the services are rendered.
Any differences between estimated contractual adjustments and actual final
settlements under reimbursement and managed care contracts are reported as
contractual adjustments in the year the final settlements are made. Net patient
revenue is not recognized as revenue in the accompanying financial statements.
The Company's Affiliated Practices derived approximately 19.4% and 21.9% of
their net revenue from services provided under the Medicare program for the
years ended December 31, 1998 and 1997, respectively. Laws and regulations
governing the Medicare program are complex and subject to interpretation. The
Company believes that the Affiliated Practices are in compliance, in all
material respects, with all applicable laws and regulations and is not aware of
any pending or threatened investigations involving allegations of potential
wrongdoing. Such laws and regulations can be subject to future government review
and interpretation. Violation of such laws could result in significant
regulatory action including fines, penalties and exclusion from the Medicare
program. Other than the Medicare program, no single payor provided more than 10%
of aggregate net clinic revenue or 5% of accounts receivable as of and for the
years ended December 31, 1998 and 1997.
Due from Affiliated Practices in litigation represent amounts due from
Affiliated Practices with which the Company is currently involved in disputes.
See Note 16 for further discussion of legal proceedings involving the Company's
Affiliated Practices. Gross accounts receivable for these practices were
$4,008,099 and $12,145,102, as of December 31, 1999 and 1998, respectively, net
of an allowance for contractual adjustments and doubtful accounts of $1,262,686
and $7,397,144, respectively. Gross accounts receivable include patient accounts
receivable purchased from the related Affiliated Practice, management fees and
reimbursement of clinic expenses.
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER, 31
1999 1998
------------ ------------
<S> <C> <C>
Furniture and fixtures $ 1,481,130 $ 10,455,889
Computer equipment and software 1,477,896 2,851,399
Leasehold improvements and other 10,832 770,717
Construction in progress -- 1,749,731
------------ ------------
2,969,858 15,827,736
Accumulated depreciation and (1,313,245) (4,777,371)
amortization ------------ ------------
Net property and equipment $ 1,656,613 $ 11,050,365
============ ============
</TABLE>
Included in the above are assets recorded under capital leases which consist of
the following:
<TABLE>
<CAPTION>
DECEMBER, 31
1999 1998
---------- ----------
<S> <C> <C>
Furniture and fixtures $ -- $1,234,383
Computer equipment -- 178,693
---------- ----------
-- 1,413,076
Accumulated amortization -- 917,336
========== ==========
Net assets under capital leases $ -- $ 495,740
========== ==========
</TABLE>
6. DEBT
Line-of-Credit
On November 1, 1996, the Company entered into a $30 million Revolving Loan and
Security Agreement (the "Credit Facility") with a bank, which provided certain
amounts necessary to effectuate acquisitions of Affiliated Practices. Through
October 31, 1997, the Credit Facility interest rates ranged from 7.2% to 7.4%,
primarily based on a LIBOR rate plus an applicable margin.
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<PAGE> 70
In November 1997, the Credit Facility was restated to permit maximum borrowings
of $75 million, subject to certain limitations. Prior to the loan covenant
violations described below, the Credit Facility could be used (i) to fund the
cash portion of affiliation transactions, and (ii) for the development of
musculoskeletal focused surgery centers. The Company could elect to borrow on
the Credit Facility at a floating rate based on the prime rate plus an
adjustable applicable margin of 0% to 0.75% or at a rate based on LIBOR plus an
adjustable applicable margin of 1.0% to 2.25%.
As of December 31, 1998, the Company was not in compliance with certain of the
financial ratio covenants required by the Company's Credit Facility. As a result
of the non-compliance, the Company was in default under the terms of the Credit
Facility. In the event of default, the terms of the Credit Facility provided
that the bank syndicate could immediately terminate its obligation to make
further advances under the respective commitments and/or declare the Company's
outstanding debt under the Credit Facility to be immediately due and payable.
Accordingly, the total amount outstanding under the Credit Facility of
approximately $52.9 million has been included in the Company's Consolidated
Balance Sheet as a current liability at December 31, 1998.
Effective September 1999, the Company entered into an amendment to its Credit
Facility, which converted the existing credit facility to a term loan. The term
loan provided for monthly principal and interest payments through November 2000,
with interest payable at a floating rate based on the bank syndicate's prime
lending rate plus .75%. At December 31, 1999, the effective interest rate was
9.25%. The monthly principal payments under the term loan were as follows:
$167,000 for the months of October 1999 through December 1999, $200,000 for the
months of January 2000 through March 2000, $233,000 for the months of April 2000
through June 2000, $267,000 for the months of July 2000 through October 2000 and
a final payment of the balance on the loan in November 2000. The term loan does
not contain any financial covenants other than timely principal and interest
payments. The term loan is secured by substantially all of the assets of the
Company.
Effective March 2000, the Company entered into an amendment to its term loan.
The amendment extends the final payment on the loan to November 2001. The
revised term loan provides for monthly principal and interest payments through
November 2001, with interest payable at a floating rate based on the bank
syndicate's prime lending rate plus .75%. The monthly principal payments under
the term loan are $50,000 per month beginning April 2000, with the final payment
for any remaining balance on the loan due November 2001. The amounts of the
required principal payments are subject to increase if the Company has not paid
down the loan to certain levels throughout the term of the loan. The Company's
federal tax refund for the year ended December 31, 1999, which is currently
anticipated to be approximately $2.0 million is pledged for application to the
balance of the term loan. Based upon payments made on the term loan in January
2000 of approximately $3.2 million from settlements entered into by the Company
in the fourth quarter of 1999, the estimate of a federal tax refund (which was
received in May 2000) and scheduled principal payments in 2000 of approximately
$1.1 million, the Company has classified approximately $6.3 million of the term
loan as a current liability in the consolidated balance sheet as of December 31,
1999. Based upon the payments the Company made on its term loan in 2000, the
Company's future principal payments will remain fixed at $50,000 per month and
are no longer subject to increase. The Company's two wholly-owned subsidiaries,
HealthCare Ratings, Inc. and ProviderWeb.net, Inc. are guarantors of the loan.
(See Note 20 for further discussion of the formation of these subsidiaries.) The
Company issued 165,000 shares of Company common stock to the bank syndicate in
connection with the amendment as a financing fee.
Convertible Debentures Issued in 1998
In connection with an acquisition of an Affiliated Practice on March 31, 1998,
the Company issued $5,454,439 of convertible debentures; however, such
convertible debentures and the related accrued interest totaling $205,479 were
subsequently canceled contemporaneous with a restructuring of the related
Affiliated Practice's management service agreement on December 31, 1998.
In connection with an affiliation on October 1, 1998 of certain assets of two
physicians who were made party to one of the Company's service agreements with
an Affiliated Practice, the Company issued $589,615 of convertible debentures.
The 2% convertible debentures were convertible into Company common stock at a
conversion price of $10 per share. No debt was converted in 1998. The debentures
were canceled in connection with the restructuring transactions described in
Note 2.
7. ACQUISITION OF MINORITY INTERESTS AND OFFICER NOTES
In June 1999, the Company entered into an agreement with the former PPI
stockholders to resolve certain issues raised by the former stockholders of PPI
relating to the transaction in which the Company acquired PPI. Under the
agreement, the Company formed HG.com, Inc. (f/k/a HealthGrades.com, Inc.,
hereafter, "HG.com") and transferred to HG.com one of the Company's websites
(formerly HealthCareReportCards.com, currently HealthGrades.com) and other
related Internet products. The remaining non-internet related assets of PPI were
transferred into the Company and PPI was subsequently liquidated. Additionally,
Venture5 LLC, whose members consist of the former PPI stockholders and an
employee of the Company, owned a minority interest in HG.com. The Company owned
a majority interest. In September 1999, the Company entered into an agreement
with Venture5 under which the Company agreed to purchase a number of shares of
its majority-owned subsidiary, HG.com, Inc. that would increase the Company's
F-14
<PAGE> 71
ownership in HG.com, Inc. to 90%. On December 31, 1999, the Company purchased
the shares from Venture5 (the "Minority Interest Purchase") for $4,000,000 and
the cancellation of $172,000 in indebtedness owed to us by the former PPI
stockholders. The Company financed the Minority Interest Purchase through the
issuance of notes payable to certain officers (the "Officers") of the Company
totaling $3,550,000 (hereafter, the "Officer Notes"). The Officer Notes bear
interest at prime plus two percentage points and are payable on December 31,
2000. The remainder of the purchase price was financed with the Company's
working capital.
In an effort to raise the funding to comply with the Company's commitments
described above, during November and December 1999, management of the Company
pursued various financing alternatives. On December 29, 1999, the Company's
Board of Directors approved a term sheet relating to an equity investment (the
"Proposed Financing") in the Company by a venture capital firm (hereafter, the
"VC firm"). On December 30, 1999, management of the Company executed the term
sheet. In March 2000, the Company consummated an equity financing which raised
$18 million. This financing (the "Revised Financing") superceded the Proposed
Financing. Pursuant to the terms of the Revised Financing, in March 2000, the
Officers converted $3.2 million of the Officer Notes into an aggregate of 1.6
million shares of common stock and five year warrants to purchase 560,000 shares
of common stock at $4.00 per share. Based on the provisions of EITF 98-5,
Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios, when the Officer Notes were cancelled
in March 2000, the Company recorded an expense of approximately $350,000 based
on the estimated fair market value of the 560,000 warrants issued to the
Officers in connection with the share purchase. Subsequent to year-end, after
further discussion with the VC firm and other potential investors, the Company
entered into a revised financing transaction. (See Note 20 for further
discussion of the Revised Financing.)
8. SALE OF INTEREST IN AMBULATORY SURGERY CENTER
During 1998, the Company funded, through its wholly-owned subsidiary, Ambulatory
Services, Inc. ("ASI"), the purchase of a lease for, and improvements to, a
surgery center in Lutherville, Maryland. The surgery center was the only asset
of SCN of Maryland, LLC, (the "LLC"), which was owned by ASI. In March 1999, a
promissory note in the amount of $2,120,619 was issued to ASI by the LLC with
respect to advances made by ASI to cover development of the surgery center. This
promissory note bore interest at 8% and was payable in sixty monthly
installments beginning July 1, 1999. In March 1999, the Company sold 68% of its
interest in the LLC to certain physician owners of a practice affiliated with
the Company for $360,505. The sale resulted in a pre-tax gain of $221,258. In
September 1999, the Company sold its remaining interest in the LLC to the
affiliated practice for $169,650. In addition, ASI received $2,212,445, in full
payment of the obligation (including accrued interest) of the LLC to the Company
and $502,633 to repay working capital advances made by ASI to the LLC. This sale
resulted in a pre-tax gain of $127,974. The Company used approximately $1.6
million of the proceeds from this sale to reduce amounts outstanding under its
credit facility. In December 1999, ASI's remaining net assets were transferred
into the parent company, HealthGrades.com, and ASI was liquidated.
9. SEGMENT DISCLOSURES
Management regularly evaluates the operating performance of the Company by
reviewing results on a product or service provided basis. The Company's
reportable segments are Physician Practice Management ("PPM") and Internet
Services. PPM derives its revenue primarily from management services provided to
physician practices. Internet Services revenue is derived primarily from
marketing arrangements with hospitals, fees related to the licensing of its
content (including set-up fees) and advertising. The Company's other segment
represents ambulatory surgery center services and health care consulting for the
year ended December 31, 1999. Both of the Company subsidiaries, which generated
revenue for the "other" segment, were liquidated during 1999.
The Company uses net (loss) income before income taxes for purposes of
performance measurement. The measurement basis for segment assets includes
intangible assets.
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<PAGE> 72
<TABLE>
<CAPTION>
AS OF AND FOR THE AS OF AND FOR THE AS OF AND FOR THE
THREE MONTHS ENDED YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1999 1998 1999 1998 2000 1999
------------- ------------- ------------- ------------- ------------- -------------
(Unaudited)
<S> <C> <C> <C> <C> <C> <C>
PPM
Revenue from external customers $ 1,969,446 $ 20,685,788 $ 29,513,863 $ 76,649,778 $ 1,579,430 $ 14,415,325
Interest income 63,202 46,095 220,621 187,450 51,154 63,338
Interest expense 283,875 1,042,421 2,489,427 3,741,089 (316,075) 1,007,243
Segment net income before income taxes 201,415 (100,971,377) 5,029,937 (94,252,477) (1,043,518) (291,095)
Segment assets 26,854,149 70,179,278 26,854,149 70,179,278 35,706,643 62,173,448
Segment asset expenditures 18,461 8,187,565 794,258 9,141,785 7,812 678,075
INTERNET SERVICES
Revenue from external customers $ 127,738 $ -- $ 407,577 $ -- $ 433,283 $ 74,040
Segment net loss before income taxes (2,681,559) -- (5,558,935) -- (1,096,899) (135,814)
Segment assets 4,634,979 -- 4,634,979 -- 6,668,203 140,919
Segment asset expenditures 167,757 -- 346,180 -- 125,539 21,137
OTHER
Revenue from external customers $ -- $ -- $ 132,831 $ -- $ -- $ 132,831
Interest income -- -- 91,826 -- -- 14,884
Equity in net loss of investee -- -- (23,852) -- -- (58,317)
Segment net loss before income taxes -- -- (1,023,633) -- -- 111,138
Segment assets -- -- -- -- -- 2,413
</TABLE>
<TABLE>
<CAPTION>
AS OF AND FOR THE AS OF AND FOR THE AS OF AND FOR THE
THREE MONTHS ENDED YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, DECEMBER 31, MARCH 31
1999 1998 1999 1998 2000 1999
------------- ------------- ------------- ------------- ------------- -------------
(Unaudited)
<S> <C> <C> <C> <C> <C> <C>
REVENUE
Total for reportable segments $ 2,097,184 $ 20,685,788 $ 30,054,271 $ 76,649,778 $ 2,012,713 $ 14,472,878
Other revenue 1,719,531 -- 1,531,477 -- 2,719 --
------------- ------------- ------------- ------------- ------------- -------------
Total consolidated revenue $ 3,816,715 $ 20,685,788 $ 31,585,748 $ 76,649,778 $ 2,015,432 $ 14,472,878
============= ============= ============= ============= ============= =============
LOSS BEFORE INCOME TAXES
Total net loss before tax for
reportable segments $ (2,480,144) $(100,971,377) $ (1,552,631) $ (94,252,477) $ (2,140,417) $ (426,909)
Other net loss -- -- -- -- -- (58,317)
Adjustment 2,471 -- (108,000) -- -- (1,852)
------------- ------------- ------------- ------------- ------------- -------------
Income (loss) before income taxes $ (2,477,673) $(100,971,377) $ (1,660,631) $ (94,252,477) $ (2,140,417) $ (487,078)
============= ============= ============= ============= ============= =============
ASSETS
Total assets for reportable segments $ 31,489,128 $ 70,179,278 $ 31,489,128 $ 70,179,278 $ 42,374,846 $ 62,995,523)
Other assets -- -- -- -- -- 111,138
Elimination of advances to
subsidiaries (5,095,805) -- (5,095,805) -- (6,849,774) (575,007)
Elimination of investment in
subsidiaries (5,943,205) -- (5,943,205) -- (7,795,020) (1,210,436)
------------- ------------- ------------- ------------- ------------- -------------
Consolidated total assets $ 20,450,118 $ 70,179,278 $ 20,450,118 $ 70,179,278 $ 27,730,052 $ 61,215,069
============= ============= ============= ============= ============= =============
</TABLE>
For each of the years presented, the Company's primary operations and
assets were within the United States.
F-16
<PAGE> 73
10. COMMON STOCK
On February 6, 1997, the Company's initial public offering of its common stock
became effective. In connection therewith, 3,208,338 shares of common stock were
issued at $8.00 per share, including 208,338 common shares issued upon exercise
of the underwriters' overallotment option.
In connection with the acquisition, through merger, of substantially all of the
assets and certain liabilities of Orthopaedic Surgery, Ltd. ("OSL"), on July 1,
1997, the Company granted one physician associated with OSL the option to
require the Company to purchase 74,844 shares of common stock issued to such
physician as consideration for the OSL merger at a purchase price equal to
approximately $11.21 per share. In addition, in connection with the acquisition,
by asset purchase, of substantially all of the assets and certain liabilities of
Steven P. Surgnier, M.D., P.A., the Company granted Dr. Surgnier the option to
require the Company to purchase 37,841 shares of common stock at a purchase
price equal to approximately $12.38 per share. During the year ended December
31, 1998, the above mentioned options were exercised. The Company paid $921,491
and canceled a loan to a physician stockholder in the amount of $385,983 as
consideration for the repurchase of shares and has included this amount as
treasury stock in its consolidated balance sheet at December 31, 1998.
The Company records treasury stock at cost with regard to monetary transactions
(e.g., settlement of put options). With regard to non-monetary transactions, the
common stock transferred to the Company is record at estimated fair value.
As of December 31, 1999, the Company had the following common shares reserved
for future issuance:
<TABLE>
<S> <C> <C>
Awards under the 1996 Equity Compensation Plan 5,532,812
Awards under the 1996 Incentive and Non-Qualified Stock Option Plan 3,500
------------
Total shares reserved for future issuance 5,536,312
============
</TABLE>
The Company issued 9,165,000 shares of Company common stock in March 2000 in
connection with an equity financing transaction. (See further discussion in
Note 20.)
11. STOCK OPTION PLANS
On March 22, 1996, the Company adopted the 1996 Incentive and Non-Qualified
Stock Option Plan (the "Plan") pursuant to which nontransferable options to
purchase up to 5,000,000 shares of common stock of the Company were available
for award to eligible directors, officers, advisors, consultants and key
employees. On January 10, 1997, the Board of Directors voted to terminate the
Plan. The exercise price for incentive stock options awarded during the year
ended December 31, 1996 was not less than the fair market value of each share at
the date of the grant, and the options granted thereunder had a term of ten
years. Options, which are generally contingent on continued employment with the
Company, could be exercised only in accordance with a vesting schedule
established by the Company's Board of Directors. Options to purchase 553,500
shares were granted during the year ended December 31, 1996 at an exercise price
of $1.00 per share, of which options to purchase 3,500 shares remain outstanding
and exercisable at December 31, 1999. The other options were forfeited or
exercised during 1997.
On October 15, 1996, the Company's Board of Directors approved the 1996 Equity
Compensation Plan (the "Equity Plan"), which provides for the granting of
options to purchase up to 2,000,000 shares of the Company's common stock. The
total number of shares authorized by the Equity Plan increased to 6,000,000 in
1998. Both incentive stock options and non-qualified stock options may be issued
under the provisions of the Equity Plan. Employees of the Company and any future
subsidiaries, members of the Board of Directors and certain advisors are
eligible to participate in this plan, which will terminate no later than October
14, 2006. The granting and vesting of options under the Equity Plan are
authorized by the Company's Board of Directors or a committee of the Board of
Directors.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that accounting
pronouncement. The fair value for options awarded during the years ended
December 31, 1999, 1998 and 1997 were estimated at the date of grant using an
option pricing model with the following weighted-average assumptions: risk-free
interest rate over the life of the option of 6.0%; no dividend yield; and
expected two to eight year lives of the options. The estimated fair value for
these options was calculated using the minimum value method in 1996 and may not
be indicative of the future impact since this model does not take into
consideration volatility and the commencement of public trading in the Company's
common stock on February 7, 1997. The Black-Scholes model was utilized to
calculate the value of the options issued during 1999, 1998 and 1997. The
volatility factors utilized in 1999, 1998 and 1997 were 1.55, 0.36 and 0.47,
respectively.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions,
F-17
<PAGE> 74
including the expected stock price volatility. Because the Company's employee
stock options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
For purposes of pro forma disclosure, the estimated fair value of the options is
amortized to expense over the options' vesting period. Because compensation
expense associated with an award is recognized over the vesting period, the
impact on pro forma net (loss) income as disclosed below may not be
representative of compensation expense in future years.
The Company's pro forma information for the years ended December 31 is as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------- -------------- --------------
<S> <C> <C> <C>
Pro forma net (loss) income $ (404,224) $ (64,073,357) $ 5,354,571
Pro forma net (loss) income per common
share (basic) (0.03) (3.51) 0.34
Pro forma net (loss) income per common
share (diluted) (0.03) (3.51) 0.33
</TABLE>
A summary of the Company's stock option activity and related information for the
years ended December 31 is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------- -------------------------- --------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at Beginning of Year 5,277,665 $ 8.41 2,365,007 $ 9.57 1,758,748 $ 5.25
Granted
Exercise price equal to
fair value of common stock 2,345,692 0.91 3,625,572 7.89 1,073,751 12.07
Exercise price greater than
fair value of common stock -- -- -- -- 160,000 10.00
Exercised (119,813) 0.56 (36,100) 6.41 (227,049) 1.17
Forfeited (1,967,232) 6.43 (676,814) 9.82 (400,443) 2.26
---------- ---------- ---------- ---------- ---------- ----------
Outstanding at end of year 5,536,312 6.10 5,277,665 8.40 2,365,007 $ 9.57
========== ========== ========== ==========
Exercisable at end of year 3,130,383 4.52 644,341 9.75 231,537 $ 7.38
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Weighted-Average Fair Value of Options:
Exercise price equal to fair value of
common stock $ .72 $ 2.56 $ 4.62
Exercise price greater than fair value
of common stock -- -- 4.35
</TABLE>
Exercise prices for options outstanding and the weighted-average remaining
contractual lives of those options at December 31, 1999 are as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------------------ --------------------------
WEIGHTED
AVERAGE WEIGHTED- WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
-------------------- ---------------- ------------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C>
$ 0.50 - $ 0.99 1,886,508 9.33 $ 0.56 1,833,508 $ 0.56
1.00 - 1.99 41,000 9.22 1.69 3,500 1.00
3.00 - 4.99 220,000 9.76 3.99 -- 3.99
6.00 - 6.99 1,010,287 8.05 6.55 103,487 6.36
8.00 526,000 6.93 8.00 372,000 8.00
9.00 - 9.99 833,460 8.34 9.86 286,687 9.85
10.00 - 12.99 741,321 7.87 12.23 346,046 12.14
13.00 - 13.25 277,736 7.87 13.25 185,155 13.25
--------- ----------
0.50 - 13.25 5,536,312 8.46 6.10 3,130,383 4.52
========= ==========
</TABLE>
12. LEASES
The Company is obligated under operating leases for its offices. Future minimum
payments under the operating leases with terms in excess of one year are
summarized as follows for the years ending December 31:
<TABLE>
<S> <C>
2000 $196,131
2001 49,033
2002 --
2003 --
2004 --
--------
Totals $245,164
========
</TABLE>
F-18
<PAGE> 75
Rent expense for the years ended December 31, 1999, 1998 and 1997 under all
operating leases was approximately $2,100,000, $7,800,000 and $4,800,000,
respectively. Approximately $1,900,000, $7,600,000 and $4,600,000, respectively,
of such amounts were charged directly to the Affiliated Practices as clinic
expenses. Excluded from total minimum operating lease payments are approximately
$1.5 million in total future payments related to Affiliated Practices currently
in disputes with the Company. These Affiliated Practices are currently paying
these leases directly.
13. INCOME TAXES
The Company is a corporation subject to federal and certain state and local
income taxes. The provision for income taxes is made pursuant to the liability
method as prescribed in Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes. The liability method requires recognition of
deferred income taxes based on temporary differences between the financial
reporting and income tax bases of assets and liabilities, using currently
enacted income tax rates and regulations.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities at December 31, 1999 and 1998
are as follows:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Deferred start-up expenditures $ 404,360 $ 678,515
Allowance for doubtful accounts 366,422 389,062
Accrued liabilities 283,775 307,603
Web development costs 166,449 --
Financing fees 88,147 293,697
Property and equipment, net 24,948 421,654
Management service agreements -- 4,510,554
Net operating loss carryforwards 2,025,411 --
----------- -----------
3,359,512 6,601,085
Valuation allowance for deferred
tax assets (3,011,642) (5,498,609)
----------- -----------
Net deferred tax asset 347,870 1,102,476
----------- -----------
Deferred tax liabilities:
Deferred gain on installment sale 196,362 218,976
Prepaid expenses 75,899 483,399
Net cash basis assets assumed in
Physician practice affiliations 59,324 1,483,279
Management service agreements 16,285 --
----------- -----------
347,870 2,185,654
----------- -----------
Net deferred tax liability $ -- $ 1,083,178
=========== ===========
</TABLE>
The Company has established a $3,011,642 valuation allowance as of December 31,
1999. The valuation allowance results from uncertainty regarding the Company's
ability to produce sufficient taxable income in future periods necessary to
realize the benefits of the related deferred tax assets. During 1999, the
valuation allowance was reduced by $2,486,967 due to tax benefits recognized in
connection with the Company's restructuring and other transactions.
The income tax (benefit) expense for the years ended December 31, 1999, 1998 and
1997 is summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Current:
Federal $ (1,662,165) $ (1,071,968) $ 4,074,033
State 119,782 125,603 1,079,390
------------ ------------ ------------
(1,542,383) (946,365) 5,153,423
------------ ------------ ------------
Deferred:
Federal (839,331) (24,424,176) (991,430)
State (243,847) (7,095,850) (288,067)
------------ ------------ ------------
(1,083,178) (31,520,026) (1,279,497)
------------ ------------ ------------
Total $ (2,625,561) $(32,466,391) $ 3,873,926
============ ============ ============
</TABLE>
The income tax (benefit) expense differs from amounts currently payable because
certain revenues and expenses are reported in the statement of operations in
periods that differ from those in which they are subject to taxation. The
principal differences relate to asset impairment charges that are not deductible
for income tax purposes until the related asset is disposed, business
acquisition and start-up
F-19
<PAGE> 76
expenditures that are capitalized for income tax purposes and expensed for
financial statement purposes, and the amortization of certain cash basis net
assets included in taxable income in periods subsequent to the date of
affiliation with physician practices.
A reconciliation between the statutory federal income tax rate of 34% and the
Company's (158.1%), (34.4%) and 39.8% effective tax rates for the years ended
December 31, 1999, 1998 and 1997, respectively, is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Federal statutory income tax rate (34.0)% (34.0)% 34.0%
State income taxes, net of federal (4.9) (5.8) 5.1
benefit
Nondeductible business acquisition and
other costs 5.3 -- 0.7
Miscellaneous 3.4 (0.4) --
Deferred tax asset valuation allowance (127.9) 5.8 --
-------- -------- --------
Effective income tax rates (158.1)% (34.4)% 39.8%
======== ======== ========
</TABLE>
The Company has approximately $4,900,000 in net operating loss carryforwards,
which expire in 2019. Approximately $4,500,000 of the net operating loss
carryforwards relate to the Company's majority-owned subsidiary, HG.com, Inc.,
and are subject to Separate Return Limitation Year ("SRLY") limitations. The
SRLY limitations permit an offset to consolidated taxable income only to the
extent of taxable income attributable to the member with the SRLY loss.
14. PHYSICIAN PRACTICE NET ASSET ACQUISITIONS AND SERVICE AGREEMENTS
1997 ACTIVITY
During 1997, the Company acquired substantially all of the assets and certain
liabilities of additional physician practices through a combination of asset
purchases and mergers as detailed in the table below:
<TABLE>
<CAPTION>
AFFILIATION AFFILIATED ACQUISITION HEADQUARTERS
DATE PRACTICE(1) TYPE LOCATION
-------------------- ------------------------------------ ------------ -----------------
<S> <C> <C> <C>
March 1997 Medical Rehabilitation Merger Tallahassee, Florida
Specialists II, P.A., Riyaz H. Baltimore, Maryland
Jinnah, M.D., II, P.A., Floyd Thomasville, Georgia
R. Jaggears, Jr., M.D., P.C.,
II
April 4, 1997 The Orthopaedic and Sports Merger Annapolis, Maryland
Medicine Center, II, P.A.
July 1, 1997 Southeastern Neurology Group Asset Portsmouth, Virginia
II, P.C. Purchase/
Merger
July 1, 1997 Orthopaedic Surgery Centers, Merger Portsmouth, Virginia
P.C. II
July 3, 1997 Associated Orthopaedics & Merger Plano, Texas
Sports Medicine, P.A.
July 3, 1997 Associated Arthroscopy Asset Plano, Texas
Institute, Inc. Purchase
July 3, 1997 Access Medical Supply, Inc. Asset Plano, Texas
d/b/a Associated Physical Purchase
Therapy
July 3, 1997 Allied Health Services, P.A. Asset Plano, Texas
d/b/a Associated Occupational Purchase
Rehabilitation
July 7, 1997 Ortho-Associates P.A. d/b/a Asset Plantation, Florida
Park Place Therapeutic Center Purchase
July 16, 1997 Mid-Atlantic Orthopaedic Asset Hagerstown, Maryland
Specialists. Cirincione, Purchase
Milford, Stowell, and
Amalfitano, P.C.
August 29, 1997 Northeast Florida Merger Orange Park, Florida
Orthopaedics, Sports Medicine
and Rehabilitation II, P.A.
August 29, 1997 Steven P. Surgnier, M.D., Asset Mariana, Florida
P.A., II Purchase
</TABLE>
F-20
<PAGE> 77
<TABLE>
<CAPTION>
AFFILIATION AFFILIATED ACQUISITION HEADQUARTERS
DATE PRACTICE(1) TYPE LOCATION
-------------------- ------------------------------------ ------------ -----------------
<S> <C> <C> <C>
September 1, 1997 Orthopaedic Associates of Merger Clearwater, Florida
West Florida, P.A.
September 10, 1997 Orthopedic Institute of Ohio, Merger Lima, Ohio
Inc.
November 14, 1997 The Specialists Orthopaedic Merger/ Fairfield, California
Medical Corporation Asset
Purchase
November 14, 1997 The Specialists Surgery Center Asset Fairfield, California
Purchase
</TABLE>
(1) Some of the Affiliated Practices listed are successors to entities acquired
by the Company.
Total consideration for the 1997 merger and asset acquisitions was 3,222,891
shares of the Company's common stock and $44,452,105 in cash. As part of the
consideration in three of the mergers, the Company issued an aggregate 13,322
shares of common stock and paid an aggregate $189,000 in cash to Michael E.
West, who served as a consultant to three of the predecessors to the Affiliated
Practices. Mr. West subsequently became Senior Vice President of Operations of
the Company in August 1997 and terminated his employment with the Company in
March 1999. Furthermore, the Company granted one physician associated with
Orthopaedic Surgery Centers, P.C. II the right, until June 30, 1998, to require
the Company to re-purchase 74,844 shares of common stock issued to such
physician in the merger at a purchase price equal to $11.21 per share and, in
connection therewith, such shares were put to the Company in 1998 (see Note 10).
Additionally, in connection with the asset purchase of Ortho-Associates P.A.
d/b/a Park Place Therapeutic Center, the Company issued to the physician owners
warrants to purchase, in the aggregate, 544,681 shares of common stock at an
exercise price of $14.69 per share, which were canceled in connection with the
PPTC termination agreement (see Note 2). The Company also had an escrowed
deposit of approximately $900,000 in cash and 113,393 shares which was released
as additional consideration in the restructuring transaction described in Note
2.
Effective September 10, 1997, the Company acquired, by purchase from the
physician owners of Orthopedic Institute of Ohio, Inc., one-half of the
outstanding membership interests of West Central Ohio Group, Ltd., an Ohio
limited liability company ("WCOG"). WCOG constructed an orthopaedic institute in
Lima, Ohio (the "Institute"), which commenced operations in February 1998. In
connection with the acquisition, the Company paid $400,000 in cash for its
investment in WCOG, which consisted of a $180,000 equity investment and $220,000
of goodwill. Included in advances to affiliates and other in the accompanying
financial statements at December 31, 1997 is the $400,000 investment in WCOG and
$522,022 in advances to WCOG. Additionally, the Company agreed to pay an amount
equal to 25% of WCOG's first $6,000,000 of net income as contingent
consideration.
1998 ACTIVITY
In March 1998, the Company sold its entire interest in WCOG to the physician
owners of Orthopedic Institute of Ohio, Inc. and a company (the "Acquiring
Company") for total consideration of approximately $1,950,000. In addition, the
Company was relieved of its obligation to pay an amount equal to 25% of WCOG's
first $6,000,000 of net income as contingent consideration. The sale resulted in
a pre-tax gain of $1,240,078 which has been included in the accompanying
consolidated financial statements for the year ended December 31, 1998. The
Company maintains long-term advances receivable from WCOG in the aggregate
amount of $813,287 and $944,520, as of December 31, 1999 and 1998, respectively.
An officer and 50% stockholder of the Acquiring Company is the brother of the
Chief Executive Officer of the Company.
Effective March 31, 1998, in connection with the acquisition, by asset purchase,
of substantially all of the assets and certain liabilities of Orlin & Cohen
Associates LLP ("OCOA"), the Company issued to OCOA 459,562 shares of common
stock and a promissory note (convertible debenture) in the principal amount of
$5,454,539 and paid cash in the amount of $11,375,000. In addition, the Company
paid a finder's fee of $114,000 in connection with the acquisition. The
convertible debenture was canceled pursuant to one of the transactions described
in Note 2.
MANAGEMENT SERVICE AGREEMENT DISCUSSION
Concurrent with its acquisitions, the Company simultaneously entered into
long-term service agreements with the Affiliated Practices. Pursuant to the
terms of the Service Agreements, the Company, among other things, provided
facilities and management, administrative and development services, including
assistance in the negotiations of contracts signed between the affiliate
practice and third party payors, in return for service fees. Such fees were
payable monthly and consisted of the following: (i) service fees based on a
percentage ranging from 20%-50% of the adjusted pre-tax income of the Affiliated
Practices (generally defined as revenue of the Affiliated Practices related to
professional services less amounts equal to certain clinic expenses but not
including physician owner compensation or most benefits to physician owners)
plus (ii) reimbursement of certain clinic expenses.
F-21
<PAGE> 78
Typically, for the first three years following affiliation, however, the portion
of the service fees described under clause (i) were specified to be the greater
of the amount payable as described under clause (i) above or a fixed dollar
amount (the "Base Service Fee"), which was generally calculated by applying the
respective service fee percentage to adjusted pre-tax income of the predecessors
to the Affiliated Practices for the twelve months prior to affiliation. In
addition, with respect to its management of certain facilities and ancillary
services associated with certain of the Affiliated Practices, the Company
received fees ranging from 2%-8% of net revenue.
The Service Agreements had terms of forty years, with automatic extensions
(unless specified notice is given) of additional five-year terms. A Service
Agreement could be terminated by either party if the other party (i) filed a
petition in bankruptcy or other similar events occur or (ii) defaulted on the
performance of a material duty or obligation, which default continued for a
specified term after notice. In addition, the Company could terminate the
agreement if the Affiliated Practice's Medicare or Medicaid number was
terminated or suspended as a result of some act or omission of the Affiliated
Practice or the physicians, and the Affiliated Practice could terminate the
agreement if the Company misapplied funds or assets or violated certain laws.
Upon termination of a Service Agreement by the Company for one of the reasons
set forth above, the Company generally had required the Affiliated Practice to
purchase and assume the assets and liabilities related to the Affiliated
Practice at the fair market value thereof. In addition, upon termination of a
Service Agreement by the Company during the first five years of the term, the
physician owners of the Affiliated Practice would have been required to pay the
Company or return to the Company an amount of cash or stock of the Company equal
to one-third of the total consideration received by such physicians in
connection with the Company's affiliation with the practice.
Under the Service Agreements, each physician owner was required to give the
Company twelve months notice of an intent to retire from the Affiliated
Practice. If a physician gave such notice during the first five years of the
agreement, the physician would also have been required to locate a replacement
physician or physicians acceptable to a Joint Policy Board and pay the Company
an amount based on a formula relating to any loss of service fee for the first
five years of the term. Furthermore, the physician would have been required to
pay the Company an amount of cash or stock of the Company equal to one-third of
the total consideration received by such physician in connection with the
Company's affiliation with the practice. The agreement also provides that after
the fifth year no more than 20% of the physician owners at an Affiliated
Practice may retire within a one-year period.
NEW MANAGEMENT SERVICE AGREEMENT DISCUSSION
As discussed in Note 2, the Company completed restructuring agreements with nine
of the Company's Affiliated Practices and a modification of arrangements with
four of the Affiliated Practices. The purchase price paid to the Company
consisted of payment equal to the book value of the assets to be purchased by
the practices, less the practice liabilities as of the closing date of the
transaction and payment for the execution of a new management services agreement
to replace the existing service agreement.
Under the new management service agreements, the Company reduced the level of
services previously provided to the practices participating in the
restructuring. The following services are currently provided to each practice:
o Assessing the financial performance, organizational structure, wages and
strategic plan of the practice;
o Advising with respect to current and future marketing and contracting plans
with third party payors and managed care plans;
o Negotiating malpractice insurance coverage;
o Providing access to patient information databases;
o Analyzing annual performance on a comparative basis with other practices
that have contracted with the Company; and
o Analyzing of coding and billing practices.
As a result of the reduced services offered, the service fees under the new
management service agreements were substantially reduced; and are paid for a
period ending five years from the initial practice affiliation date.
15. ACQUISITION OF PROVIDER PARTNERSHIPS, INC. ("PPI")
During the third quarter of 1998, the Company acquired PPI as a wholly-owned
subsidiary in exchange for 420,000 shares of Company common stock. PPI was
formed to provide consulting services to hospitals to increase their operating
performance, with a specific focus on the cardiac areas. Pursuant to an
agreement with the former PPI stockholders to resolve certain issues raised by
the
F-22
<PAGE> 79
former stockholders of PPI relating to the transaction in which the Company
acquired PPI, the subsidiary was liquidated during 1999. (See further discussion
in Note 7).
16. LEGAL PROCEEDINGS
Reconstructive Orthopaedic Associates
On October 27, 1999, Reconstructive Orthopaedic Associates II, P.C., ("ROA"),
filed a complaint against the Company in the U.S. District Court for the Eastern
District of Pennsylvania. The complaint asserts that, during negotiations
between ROA and the Company related to the restructure agreement by and between
ROA and the Company, the Company agreed that if the Company entered into a
similar restructuring agreement with any other affiliated practice on financial
terms more favorable to such affiliated practice than those extended to ROA
under its restructure agreement, the Company would modify and adjust the terms
of their restructure agreement to ensure that ROA received financial terms as
favorable as those extended to such other affiliated practice. The complaint
further alleges that one or more lawsuits or other adversary proceedings between
the Company and one or more other affiliated practices have been settled, in
fact or in principle, on financial terms materially more favorable to the other
affiliated practices than the terms extended to ROA under its restructure
agreement. ROA seeks compensatory, consequential and incidental damages in
excess of $75,000, punitive damages in excess of $1,000,000 and attorneys fees.
Additionally, ROA seeks a declaratory judgment that if any of the alleged
settlements were entered into between the Company and any other affiliated
practices on terms materially more favorable than those extended to ROA, the
Company would be required to modify and adjust the terms of their restructure
agreement to ensure that ROA received financial terms as favorable as those
extended to such other affiliated practices.
On November 8, 1999, the Company filed a complaint in the U.S. District Court
for the District of Colorado against ROA. The complaint asserts that ROA has
taken actions in direct contravention of our management service agreement with
ROA, including trying to terminate the agreement in a manner not allowed by the
contract, threatening to withhold payments due under the agreement, and filing
suit in another jurisdiction in violation of the agreement. The Company seeks a
declaration and adjudication of both parties' contractual rights and obligations
in order to terminate this dispute. The Company also seeks injunctive relief and
damages.
The Company believes it has strong legal and factual defenses to ROA's claims.
The Company intends to vigorously defend against ROA's lawsuit and aggressively
pursue its claims.
Orthopaedic Institute of Ohio
On November 1, 1999, the Company filed a complaint in the U.S. District Court
for the District of Colorado against the Orthopaedic Institute of Ohio, Inc.
("OIO"). The compliant asserts that, prior to the closing of the restructure
agreement between OIO and the Company, OIO, the physician owners and the
administrator of OIO diverted over $470,000 from the Company's bank account and
deposited such funds into a bank account held by OIO and the physician owners.
The compliant further asserts that OIO and the physician owners are continuing
to withhold from the Company amounts that remain due under the restructure
agreement of over $720,000. OIO subsequently filed a Motion for Stay of
Proceedings and a Motion to Dismiss. Essentially, OIO has argued that all claims
made by the Company are subject to the arbitration clause of the Restructure
Agreement by and between the Company and OIO. The Company has filed a response
to OIO's Motions and currently oral arguments have been set for March 2000 in
this case.
17. COMMITMENTS AND CONTINGENCIES
The Company has entered into employment agreements that provide key executives
and employees with minimum base pay, annual incentive awards and other fringe
benefits. The Company expenses all costs related to the agreements in the period
that the services are rendered by the employee. In the event of death,
disability, termination with or without cause, voluntary employee termination,
change in ownership of the Company, etc., the Company may be partially or wholly
relieved of its financial obligations to such individuals. However, under
certain circumstances, a change in control of the Company may provide
significant and immediate enhanced compensation to the employees possessing
employment contracts. At December 31, 1999, the Company was contractually
obligated for the following base pay compensation amounts (summarized by years
ending December 31):
<TABLE>
<S> <C>
2000 $1,053,000
2001 477,167
----------
$1,530,167
==========
</TABLE>
F-23
<PAGE> 80
18. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share for the years ended December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Numerator for both basic and diluted earnings per share:
Net income (loss) $ 964,930 $(61,786,086) $ 5,870,398
============ ============ ============
Denominator:
Weighted average shares outstanding 14,202,748 18,237,827 15,559,368
Cheap stock shares:
Employee stock options -- -- 118,761
------------ ------------ ------------
Denominator for basic net income (loss) per
common share--weighted average shares 14,202,748 18,237,827 15,678,129
Effect of dilutive securities:
Employee stock options 614,984 -- 393,024
------------ ------------ ------------
Denominator for diluted net income (loss) per
common share--adjusted weighted average
shares and assumed conversion 14,817,732 18,237,827 16,071,153
============ ============ ============
Net (loss) income per common share (basic) $ 0.07 $ (3.39) $ 0.38
============ ============ ============
Net (loss) income per common share (diluted) $ 0.07 $ (3.39) $ 0.37
============ ============ ============
</TABLE>
For additional disclosures regarding employee stock options, puts and warrants,
see Notes 10, 11 and 14.
Outstanding options to purchase 3,608,804 and 943,251 shares of common stock
were outstanding during 1999 and 1997, respectively, but were not included in
the computation of diluted earnings per share for the years then ended because
the options' exercise price was greater than the average market price of the
common shares and, therefore, the effect would be antidilutive.
Options to purchase 5,261,165 shares of common stock were outstanding during
1998 but were not included in the computation of diluted earnings per common
share for 1998 because the effect would be antidilutive based on the Company's
net loss for the year.
Warrants to purchase 544,681 shares of common stock were outstanding during 1997
but were not included in the computation of diluted earnings per share because
the warrants' exercise price was greater than the average market price of the
common shares and, therefore, the effect would be anti-dilutive.
The Company used a portion of the proceeds from the initial public offering of
its common stock to repay borrowings under the Company's Credit Facility. If
shares issued to repay amounts outstanding under the Company's Credit Facility
were outstanding for the year ended December 31, 1997, the net income per common
share would not have changed from the amount reported.
19. EMPLOYEE BENEFIT PLAN
Effective May 1, 1997, the Company adopted a defined contribution employee
benefit plan covering substantially all employees of the Company, most
affiliated physicians and other employees of the affiliated practices.
Participants must have attained age 21 and completed one year of service with
either the Company or one of the Affiliated Practices in order to participate in
the plan. The plan is designed to qualify under Section 401(k) of the Internal
Revenue Code of 1986, as amended. The plan includes a matching contribution
equal to up to 4% of eligible employee salaries and a discretionary defined
contribution (5.5% in 1997). There was no discretionary contribution made for
the year ended December 31, 1998. Although the Company's Board of Directors has
until the filing of the 1999 employee benefit plan financial statements to
determine whether or not a discretionary contribution will be made, management
currently anticipates that there will not be a discretionary contribution made
for the 1999 plan year.
Effective January 1, 1999, the matching contribution component of the employee
benefit plan was eliminated and replaced with a Qualified Non-Elective
Contribution equal to 3% of annual compensation. The employer contribution is
applicable to all eligible participants, regardless of whether or not the
participant contributes to the employee benefit plan. Additionally, effective
April 1, 1999, the age and service requirements of the employee benefit plan
were eliminated.
Expense under this plan, including the discretionary defined contributions,
aggregated approximately $612,000, $1,611,000 and $711,000 for 1999, 1998 and
1997, respectively, of which approximately $540,000, $1,445,000 and $654,000 was
charged directly to the Affiliated Practices as clinic expenses.
20. SUBSEQUENT EVENTS
In January 2000, the Company terminated its revised management services
arrangement with one of the affiliated practices. Pursuant to the termination,
the Company received approximately $850,000 and will no longer be required to
provide management services to the practice.
F-24
<PAGE> 81
Effective February 3, 2000, the Company merged its majority-owned subsidiary,
HG.com, Inc. into a recently formed, wholly-owned subsidiary, HealthCare
Ratings, Inc. (hereafter, the "Merger Transaction"). In order to effectuate the
Merger Transaction, the remaining minority shareholders of HG.com were given
800,000 shares of Company common stock. In connection with the Merger
Transaction, the Company recorded goodwill in the amount of $1,850,000 based on
the fair value of the stock issued as of the transaction date. The goodwill is
being amortized over an estimated useful life of seven years.
On March 7, 2000, the Company entered into a binding agreement as to material
terms with Mid-Atlantic Orthopedic Specialists, et. al. ("MAOS") that resolves
all legal disputes and litigation between the Company and MAOS. On April 21,
2000, the Company received a payment of $1,500,000 in consideration for the
tangible book value of the MAOS assets and the termination of the MAOS service
agreement.
Effective March 17, 2000, the Company closed on an equity financing transaction
(the "Revised Financing") which raised $18 million. Pursuant to the terms of the
Revised Financing, certain investors funded $14.8 million to the Company in
return for 7,400,000 shares of Company common stock. Additionally, the Company
issued warrants to the investors to purchase 2,590,000 shares of Company common
stock at an exercise price of $4.00 per share. The warrants have a five-year
term. The Company also issued warrants to purchase an aggregate of 150,000
shares of Company common stock to officers of a company that served as a
financial advisor to the Revised Financing. Upon the closing of the Revised
Financing, the Officers exchanged $3.2 million of the Officer Notes into an
aggregate of 1.6 million shares of common stock and five-year warrants to
purchase 560,000 shares of common stock at $4.00 per share. (See further
discussion of Officer Notes in Note 7.)
In April 2000, we terminated our revised management services arrangement with
one of our former affiliated practices. Pursuant to the termination, we received
approximately $1.7 million and will no longer be required to provide management
services to the practice.
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<PAGE> 82
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth all expenses, that we will pay in connection
with the common stock and warrants being registered. All of the amounts shown
are estimates except for the registration fee.
<TABLE>
<S> <C>
Registration fee $ 5,101
Legal fees and expenses
Accounting fees and expenses
Printing
Nasdaq filing fee
Miscellaneous
-------------
Total $
=============
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 102(b)(7) of the Delaware General Corporation Law (the "DGCL")
permits a corporation, in its certificate of incorporation, to limit or
eliminate, subject to certain statutory limitations, the liability of directors
to the corporation or its stockholders for monetary damages for breaches of
fiduciary duty, except for liability (a) for any breach of the director's duty
of loyalty to the corporation or its stockholders, (b) for acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation of
law, (c) for any willful or negligent payment of an unlawful dividend, stock
purchase or redemption, or (d) for any transaction from which the director
derived an improper personal benefit. Article 7 of our Certificate of
Incorporation provides that the personal liability of our directors is
eliminated to the fullest extent permitted by Section 102(b)(7) of the DGCL.
Under Section 145 of the DGCL, a corporation has the power to indemnify
directors and officers under certain prescribed circumstances and subject to
certain limitations against certain costs and expenses, including attorney's
fees actually and reasonably incurred in connection with any action, suit or
proceeding, whether civil, criminal, administrative or investigative, to which
any of them is a party by reason of being a director or officer of the
corporation if it is determined that the director or officer acted in accordance
with the applicable standard of conduct set forth in such statutory provision.
Article VI of our Bylaws provides that we will indemnify any person who was or
is a party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding by reasons of the fact that he or she is or
was our director, officer and, if designated by our Board of Directors as an
authorized representative, our employee or agent, against certain liabilities,
costs and expenses. Article VI further permits us to purchase and maintain
insurance on behalf of any person who is or was our director, officer, employee
or agent, or is or was serving at our request as a director, officer, employee
or agent of another entity, against any liability asserted against such person
and incurred by such person in any such capacity or arising out of his status as
such, whether or not we would have the power to indemnify such person against
such liability under the DGCL.
We have purchased directors and officers liability insurance.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
On July 1, 1997, in connection with our acquisition, through merger, of
substantially all of the assets and certain liabilities of Southeastern
Neurology Group, P.C. ("SNG"), the common stock of SNG was exchanged for
consideration of 120,155 shares of our common stock and approximately $1,995,000
in cash. In addition to the consideration paid to the SNG shareholders, we also
issued 4,102 shares of our common stock and paid $69,000 in cash to a consultant
of the practice as consideration for services rendered to SNG by such consultant
in connection with the transaction.
On July 1, 1997, in connection with our acquisition, through merger, of
substantially all of the assets and certain liabilities of Orthopaedic Surgery,
Ltd. ("OSL"), the common stock of OSL was exchanged for consideration of 339,839
shares of our common stock and approximately $2,158,000 in cash. In addition to
the consideration paid to the OSL shareholders, we also issued 6,920 shares of
our common stock and paid $120,000 in cash to a
II-1
<PAGE> 83
consultant of OSL, as consideration for services rendered to OSL by the
consultant in connection with the transaction. Furthermore, we granted one
physician associated with OSL the right, until June 30, 1998, to require us to
purchase 74,844 of the 159,643 shares of our common stock issued to such
physician in connection with the OSL merger at a purchase price equal to $11.21
per share. The physician subsequently exercised his right.
On July 3, 1997, in connection with our acquisition: (i) by merger (the
"NCS&A Merger") of substantially all of the assets and certain liabilities of
Neal C. Small, M.D. & Associates, P.A. ("NCS&A"); (ii) by merger (the "NCS
Merger") of substantially all of the assets and certain liabilities of Neal C.
Small, M.D., P.A. ("NCS"); and (iii) by merger (the "AIG Merger") of
substantially all of the assets and certain liabilities of Alexander I. Glogau,
M.D., P.A. ("AIG"), we issued in each of the NCS&A Merger and AIG Merger 90,780
shares of our common stock and paid approximately $405,000 in cash, and in the
NCS Merger, 90,780 shares of our common stock.
On July 7, 1997, in connection with our acquisition, by asset purchase, of
certain assets of Ortho-Associates, P.A. d/b/a/ Park Place Therapeutic Center
("PPTC"), we issued to the physician owners warrants to purchase, in the
aggregate, 544,681 shares of our common stock at an exercise price of $14.69 per
share.
On July 16, 1997, in connection with our acquisition, by asset purchase, of
substantially all of the assets and certain liabilities of Mid-Atlantic
Orthopaedic Specialists, P.C. ("MAOS"), the common stock of MAOS was exchanged
for consideration of 146,520 shares of our common stock and approximately
$1,792,000 in cash.
On July 22, 1997, in connection with our acquisition, through merger, of
substantially all of the assets and certain liabilities of Drs. Howell, Ryder,
Kells & Persons, Inc. ("HRKP"), the common stock of HRKP was exchanged for
90,492 shares of our common stock and approximately $1,141,000 in cash. In
addition to the consideration paid to HRKP shareholders, we also issued 2,318
shares of our common stock to a consultant of the practice, as consideration for
services rendered to HRKP by that consultant in connection with the HRKP merger.
On August 29, 1997, in connection with our acquisition, through merger, of
substantially all of the assets and certain liabilities of Northeast Florida
Orthopaedics, Sports Medicine & Rehabilitation, P.A. ("NFO"), the common stock
of NFO was exchanged for 31,319 shares of our common stock and approximately
$802,000 in cash.
On August 29, 1997, in connection with our acquisition, by asset purchase,
of substantially all of the assets and certain liabilities of Steven P.
Surgnier, M.D., P.A. ("Surgnier"), the common stock of Surgnier was exchanged
for 48,994 shares of our common stock.
On September 1, 1997, in connection with our acquisition, through merger,
of substantially all of the assets and certain liabilities of Orthopaedic
Associates of West Florida, P.A. ("OAWF"), the common stock of OAWF was
exchanged for 332,983 shares of our common stock and approximately $3,799,000 in
cash.
On September 10, 1997, in connection with the acquisition: (i) by merger
(the "OSAL Merger"), of substantially all of the assets and certain liabilities
of Orthopedic Surgeons Associated of Lima, Inc. ("OSAL"); (ii) by merger (the
"BJCL Merger"), of substantially all of the assets and certain liabilities of
Bone & Joint Center of Lima, Inc. ("BJCL"); (iii) by merger (the "LOI Merger"),
of substantially all of the assets and certain liabilities of Lima Orthopedics,
Inc. ("LOI"), we issued 498,244 shares of our common stock and approximately
$1,115,000 in cash in the OSAL Merger; 97,473 shares of our common stock in the
BJCL Merger and 77,670 shares of our common stock and approximately $255,000 in
cash in the LOI Merger.
On November 14, 1997, in connection with the acquisition of substantially
all of the assets of the Specialists Medical Orthopaedic Corporation and the
Specialists Surgery Center (together, "Specialists"), we issued a total of
226,181 shares of our common stock and approximately $5,408,000 in cash to the
equity owners of these entities.
Effective March 31, 1998, in connection with the acquisition, by asset
purchase, of substantially all of the assets and certain liabilities of Orlin &
Cohen Associates LLP ("OCOA"), we issued 470,094 shares of common stock, a
promissory note in the principal amount of $5,579,000 and cash in the amount of
$11,125,000.
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<PAGE> 84
In December 1999, Kerry R. Hicks, our Chief Executive Officer, Patrick M.
Jaeckle, our President, D. Paul Davis, our Executive Vice President - Finance
and Chief Financial Officer and David G. Hicks, our Executive Vice President -
Information Technology, made loans to HealthGrades.com in the principal amounts
of $2 million, $1 million, $100,000 and $100,000, respectively. Mr. Kerry Hicks
and Mr. Jaeckle also jointly loaned an additional $350,000 to HealthGrades.com.
We issued promissory notes (the "Officer Notes") to these executive officers in
principal amounts equal to the amounts of their loans.
In February 2000, we issued 400,000 shares of our common stock to each of
Peter A. Fatianow and Sarah P. Loughran in exchange for each of their five
percent interest in our majority-owned subsidiary, HG.com.
On March 17, 2000, we closed a private placement of our securities. We sold
4,215,000 shares of our common stock and warrants to purchase 1,475,250 shares
of our common stock to Chancellor V, L.P. for $8,430,000. We also sold 3,000,000
shares of our common stock and warrants to purchase 1,050,000 shares to Essex
Woodlands Health Ventures Fund IV, L.P. for $6,000,000. In addition, we sold
160,000 shares of our common stock and warrants to purchase 56,000 shares to
Punk, Ziegel & Company Investors, L.L.C. for $320,000 and 25,000 shares of our
common stock and warrants to purchase 8,750 shares to William J. Punk for
$50,000. In connection with the private placement, we paid to Triton Capital,
Inc. $300,000 and issued to its warrants to purchase an aggregate of 150,000
shares in exchange for Triton Capital Inc.'s services in connection with the
private financing.
Concurrently with our private placement, the holders of $3,200,000
principal amount of Officer Notes surrendered their notes in exchange for our
common stock and warrants as follows: Kerry R. Hicks surrendered $2,000,000
principal amount of Officer Notes for 1,000,000 shares and warrants to purchase
350,000 shares; Patrick M. Jaeckle surrendered $1,000,000 principal amount of
Officer Notes for 500,000 shares and warrants to purchase 175,000 shares; and
each of D. Paul Davis and David G. Hicks surrendered $100,000 principal amount
of Officer Notes for 50,000 shares and warrants to purchase 17,500 shares.
All of the securities issued in the transactions described above were
issued in reliance on the exemption provided under Section 4(2) of the
Securities Act. In this regard, the Registrant believes that each of the
transactions complied with Rule 506 under the Act.
II-3
<PAGE> 85
ITEM 16. EXHIBITS AND FINANCIAL STATEMENTS
The following is a list of exhibits filed as part of this registration
statement. The file number for filings on Forms 10-K or 10-Q with respect to
which some of the documents are incorporated by reference is 0-22019.
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
3.1 Certificate of Amendment of Amended and Restated Certificate
of Incorporation and Amended and Restated Certificate of
Incorporation (incorporated by reference to Exhibit 3.1 to
the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1999)
3.2 Amended and Restated Bylaws (incorporated by reference to
Exhibit 3.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999)
*5 Opinion of Morgan, Lewis & Bockius LLP
10.1 1996 Equity Compensation Plan, as amended (incorporated by
reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2000)
10.2.1 Second Amended and Restated Revolving Loan and Security
Agreement dated as of November 21, 1997 among Specialty Care
Network, Inc., SCN of Princeton, Inc., NationsBank of
Tennessee N.A., AmSouth Bank, Banque Paribas, Key Corporate
Capital Inc. and NationsBank of Tennessee, N.A., as Agent
("Second Amended and Restated Loan Agreement") (incorporated
by reference to Exhibit 10.2 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1997)
10.2.2 Amendment No. 3 to the Second Amended and Restated Loan
Agreement, dated as of September 16, 1999 (incorporated by
reference to Exhibit 10.8 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1999)
10.2.3 Amendment No. 4 to the Second Amended and Restated Loan
Agreement, dated as of March 8, 2000 (incorporated by
reference to Exhibit 10.9 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1999)
10.3 Employment Agreement dated as of April 1, 1996 by and
between Specialty Care Network, Inc. and Kerry R. Hicks
(incorporated by reference to Exhibit 10.3 to the
Registrant's Registration Statement on Form S-1 (File No.
333-17627))
10.4 Employment Agreement dated as of April 1, 1996 by and
between Specialty Care Network, Inc. and Patrick M. Jaeckle
(incorporated by reference to Exhibit 10.4 to the
Registrant's Registration Statement on Form S-1 (File No.
333-17627))
10.5.1 Employment Agreement dated as of February 22, 1996 by and
between Specialty Care Network, Inc. and Paul Davis
(incorporated by reference to Exhibit 10.6 to the
Registrant's Registration Statement on Form S-1 (File No.
333-17627)).
10.5.2 Amendment to Employment Agreement between Specialty Care
Network, Inc. and D. Paul Davis dated December 5, 1997
(incorporated by reference to Exhibit 10.6.1 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997)
10.6.1 Employment Agreement dated as of March 1, 1996 by and
between Specialty Care Network, Inc. and David Hicks
(incorporated by reference to Exhibit 10.8 of the
Registrant's Registration Statement on Form S-1 (File No.
333-17627))
10.6.2 Amendment to Employment Agreement between Specialty Care
Network, Inc. and David Hicks, dated December 2, 1997
(incorporated by reference to Exhibit 10.8.1 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997)
II-4
<PAGE> 86
EXHIBIT
NUMBER DESCRIPTION
10.7 Amended and Restated Stock Purchase Agreement dated as of
March 3, 2000 among HealthGrades.com, Inc. and Essex
Woodlands Health Ventures Fund IV, L.P., Chancellor V, L.P.,
PaineWebber, as custodian for William J. Punk, I.R.A. and
Punk, Ziegel & Company Investors, L.L.C. (incorporated by
reference to Exhibit 10.2 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2000)
10.8.1 Restructure Agreement by and Among Specialty Care Network,
Inc., Medical Rehabilitation Specialists II, P.A. and Kirk
J. Mauro, M.D. dated as of December 31, 1998 (incorporated
by reference to Exhibit 2.1 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1998)
10.8.2 Management Services Agreement by and Among Specialty Care
Network, Inc., Medical Rehabilitation Specialists II, P.A.,
and Kirk J. Mauro, M.D. dated as of January 1, 1999
(incorporated by reference to Exhibit 2.11 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1998)
10.9.1 Restructure Agreement by and Among Specialty Care Network,
Inc., Greater Chesapeake Orthopaedic Associates, L.L.C.,
Paul L. Asdourian, M.D., Frank R. Ebert, M.D., Leslie S.
Matthews, M.D., Stewart D. Miller, M.D., Mark S. Myerson,
M.D., John B. O'Donnell, M.D. and Lew C. Schon, M.D., dated
as of December 31, 1998 (incorporated by reference to
Exhibit 2.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998)
10.9.2 Management Services Agreement by and Among Specialty Care
Network, Inc., Greater Chesapeake Orthopaedic Associates,
L.L.C., Paul L. Asdourian, M.D., Frank R. Ebert, M.D.,
Leslie S. Matthews, M.D., Stewart D. Miller, M.D., Mark S.
Myerson, M.D., John B. O'Donnell, M.D. and Lew C. Schon,
M.D., dated as of January 1, 1999 (incorporated by reference
to Exhibit 2.21 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1998)
10.10.1 Restructure Agreement by and Among Specialty Care Network,
Inc., Vero Orthopaedics II, P.A., James L. Cain, M.D., David
W. Griffin, M.D., George K. Nichols, M.D. and Peter G.
Wernicki, M.D. dated as of December 31, 1998 (incorporated
by reference to Exhibit 2.3 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1998)
10.10.2 Management Services Agreement by and Among Specialty Care
Network, Inc., Vero Orthopaedics II, P.A., James L. Cain,
M.D., David W. Griffin, M.D., George K. Nichols, M.D. and
Peter G. Wernicki, M.D. dated as of January 1, 1999
(incorporated by reference to Exhibit 2.31 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1998)
10.11.1 Restructure Agreement by and Among Specialty Care Network,
Inc., Orlin & Cohen Orthopedic Associates, LLP, Harvey
Orlin, M.D., Isaac Cohen, M.D., John M. Feder, M.D., Gregory
Lieberman, M.D., Sebastian Lattuga, M.D., Harvey Orlin,
M.D., P.C. and Rockville Centre Arthroscopic Associates,
P.C. dated as of December 31, 1998 (incorporated by
reference to Exhibit 2.4 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1998)
10.11.2 Management Services Agreement by and Among Specialty Care
Network, Inc., Orlin & Cohen Orthopedic Associates, LLP,
Harvey Orlin, M.D., Isaac Cohen, M.D., John M. Feder, M.D.,
Gregory Lieberman, M.D., Sebastian Lattuga, M.D., Harvey
Orlin, M.D., P.C. and Rockville Centre Arthroscopic
Associates, P.C. dated as of January 1, 1999 (incorporated
by reference to Exhibit 2.41 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1998)
10.12.1(1) Form of Restructure Agreement (incorporated by reference to
Exhibit 2.1 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999)
10.12.2(1) Form of Management Services Agreement (incorporated by
reference to Exhibit 2.11 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1999)
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<PAGE> 87
EXHIBIT
NUMBER DESCRIPTION
21 Subsidiaries of the Registrant (incorporated by reference to
Exhibit 21 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999)
23.1 Consent of Ernst & Young LLP
23.2 Consent of Morgan, Lewis & Bockius LLP (included in
Exhibit 5)
------------
* To be filed by amendment.
(1) Effective June 15, 1999, the Registrant closed a restructuring transaction
through ten separate restructure agreements involving the following nine
practices: Floyd R. Jaggears, Jr., M.D., P.C., II; Riyaz H. Jinnah, M.D.,
II, P.A.; The Orthopaedic and Sports Medicine Center, II, P.A.; Orthopaedic
Associates of West Florida, P.A.; Orthopaedic Institute of Ohio, Inc.;
Orthopaedic Surgery Centers, P.C. II; Princeton Orthopaedic Associates, II,
P.A.; Reconstructive Orthopaedic Associates, II, P.C.; and Steven P.
Surgnier, M.D., P.A., II. Simultaneously, the Registrant executed revised
Management Services Agreements with these practices. The Registrant has
attached a generic form of these agreements to this Registration Statement
as the terms of the agreements between the Registrant and the individual
practices are substantially equivalent.
(b) Financial statement schedules
We have furnished Schedule II - Valuation and Qualifying Accounts on
Page II-9.
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes:
(1) To file during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:
(i) to include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;
(ii) to reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or
the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the registration
statement; and
(iii) to include any material information with respect to the
plan of distribution not previously disclosed in the
registration statement or any material change to such
information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall
be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain
unsold at the termination of the offering.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provision, or otherwise, the
registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment
by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any
action, suit or
II-6
<PAGE> 88
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will,
unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
questions whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
II-7
<PAGE> 89
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of Lakewood, state of
Colorado, on June 19, 2000.
HEALTHGRADES.COM, INC.
By: /s/ Kerry R. Hicks
------------------------------
Kerry R. Hicks
Chief Executive Officer
POWER OF ATTORNEY
Know all persons by these presents, that each person whose signature
appears below in so signing also makes, constitutes and appoints Kerry R. Hicks,
Patrick M. Jaeckle and D. Paul Davis, and each of them, his true and lawful
attorneys-in-fact and agents, with full power of substitution and
re-substitution, for him and in his name, place and stead, in any and all
capacities, to execute and cause to be filed with the Securities and Exchange
Commission any and all amendments and post-effective amendments to this
registration statement and a related registration statement that is to be
effective upon filing pursuant to rule 462(b) under the Securities Act of 1933,
and in each case to file the same, with all exhibits thereto and other documents
in connection therewith, and hereby ratifies and confirms all that said
attorneys-in-fact and agents or their substitute or substitutes may do or cause
to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
<S> <C> <C>
/s/ Kerry R. Hicks Chief Executive Officer June 19, 2000
-------------------------------
Kerry R. Hicks
/s/ D. Paul Davis Principal Financial and Accounting Officer June 19, 2000
-------------------------------
D. Paul Davis
/s/ Patrick M. Jaeckle Director June 19, 2000
-------------------------------
Patrick M. Jaeckle
/s/ Peter H. Cheesbrough Director June 19, 2000
-------------------------------
Peter H. Cheesbrough
/s/ Leslie S. Matthews, M.D. Director June 19, 2000
-------------------------------
Leslie S. Matthews, M.D.
/s/ Mats Wahlstrom Director June 19, 2000
-------------------------------
Mats Wahlstrom
Director June , 2000
-------------------------------
Marc S. Sandroff
/s/ Parag Saxena Director June 19, 2000
-------------------------------
Parag Saxena
</TABLE>
II-8
<PAGE> 90
HealthGrades.com, Inc. and Subsidiaries
Schedule II -- Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
--------------------------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1999
Reserves and allowances deducted
from asset accounts:
Allowance for contractual
adjustments and doubtful
accounts on patient
accounts receivable $ 22,161,082 $ -- $ 29,670,283(1) (21,862,431)(6) $ --
(29,968,934)(3)
Allowance for contractual
adjustments and doubtful
accounts on receivables
due from affiliated
Physician practices in
litigation $ 7,397,144 $ 2,407,848 $ 762,686(10) $ (6,706,068)(6) $ 1,262,686
(1,719,532)(4) -- (879,392)(9)
Allowance for doubtful
accounts on management fee
receivables $ -- $ 1,040,428 $ 879,392(9) $ (146,715)(6) $ 1,010,419
Year ended December 31, 1998 (762,686)(10)
Reserves and allowances deducted
from asset accounts:
Allowance for contractual
adjustments and doubtful
accounts on patient
accounts receivable $ 26,225,860 $ 1,210,126(8) 125,086,140(1) (12,454,506)(6) $ 22,161,082
(592,659)(4) 6,816,751(2) (119,406,005)(3)
Allowance for contractual (4,724,624)(7)
adjustments and doubtful
accounts on receivables
due from affiliated
physician practices
in litigation $ -- $ 2,672,520(5) $ 4,724,624(7) $ -- $ 7,397,144
Year ended December 31, 1997
Reserves and allowances deducted
from asset accounts:
Allowance for contractual
adjustments and doubtful
accounts on patient
accounts receivable $ 15,719,542 $ 100,380 $ 87,199,182(1) $ (84,589,217)(3) $ 26,225,860
(1,542,354)(4) 9,338,327(2)
</TABLE>
(1) Contractual adjustments recognized in the purchase of monthly net accounts
receivable balances for the periods presented.
(2) Acquired in conjunction with acquisition of affiliated practices.
(3) Represents actual amounts charged against the allowance for the periods
presented.
(4) Recoveries of amounts previously reserved, included in other revenue in
the consolidated financial statements.
(5) Charged to litigation and other costs in the consolidated statements of
operations.
(6) Sold in conjunction with disposition of assets of restructured affiliated
practices.
(7) Transferred from allowance for contractual adjustments and doubtful
accounts for patient accounts receivable to allowance for contractual
adjustments and doubtful accounts due from affiliated practices in
litigation.
(8) Charged to impairment loss on service agreements in the consolidated
statements of operations.
(9) Transferred from allowance for contractual adjustments and doubtful
accounts due from affiliated practices in litigation to allowance for
doubtful accounts on management service fee receivables.
(10) Transferred from allowance for doubtful accounts on management fee
receivables to allowance for contractual adjustments and doubtful accounts
on receivables due from affiliation physician practices in litigation.
II-9
<PAGE> 91
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
3.1 Certificate of Amendment of Amended and Restated Certificate
of Incorporation and Amended and Restated Certificate of
Incorporation (incorporated by reference to Exhibit 3.1 to
the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1999)
3.2 Amended and Restated Bylaws (incorporated by reference to
Exhibit 3.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999)
*5 Opinion of Morgan, Lewis & Bockius LLP
10.1 1996 Equity Compensation Plan, as amended (incorporated by
reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2000)
10.2.1 Second Amended and Restated Revolving Loan and Security
Agreement dated as of November 21, 1997 among Specialty Care
Network, Inc., SCN of Princeton, Inc., NationsBank of
Tennessee N.A., AmSouth Bank, Banque Paribas, Key Corporate
Capital Inc. and NationsBank of Tennessee, N.A., as Agent
("Second Amended and Restated Loan Agreement") (incorporated
by reference to Exhibit 10.2 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1997)
10.2.2 Amendment No. 3 to the Second Amended and Restated Loan
Agreement, dated as of September 16, 1999 (incorporated by
reference to Exhibit 10.8 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1999)
10.2.3 Amendment No. 4 to the Second Amended and Restated Loan
Agreement dated as of March 8, 2000 among Specialty Care
Network, Inc, SCN of Princeton, Inc., NationsBank of
Tennessee N.A., AmSouth Bank, Banque Paribas, Key Corporate
Capital Inc. and NationsBank of Tennessee, N.A., as Agent
(incorporated by reference to Exhibit 10.9 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1999)
10.3 Employment Agreement dated as of April 1, 1996 by and
between Specialty Care Network, Inc. and Kerry R. Hicks
(incorporated by reference to Exhibit 10.3 to the
Registrant's Registration Statement on Form S-1 (File No.
333-17627))
10.4 Employment Agreement dated as of April 1, 1996 by and
between Specialty Care Network, Inc. and Patrick M. Jaeckle
(incorporated by reference to Exhibit 10.4 to the
Registrant's Registration Statement on Form S-1 (File No.
333-17627))
10.5.1 Employment Agreement dated as of February 22, 1996 by and
between Specialty Care Network, Inc. and Paul Davis
(incorporated by reference to Exhibit 10.6 to the
Registrant's Registration Statement on Form S-1 (File No.
333-17627)).
10.5.2 Amendment to Employment Agreement between Specialty Care
Network, Inc. and D. Paul Davis dated December 5, 1997
(incorporated by reference to Exhibit 10.6.1 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997)
10.6.1 Employment Agreement dated as of March 1, 1996 by and
between Specialty Care Network, Inc. and David Hicks
(incorporated by reference to Exhibit 10.8 of the
Registrant's Registration Statement on Form S-1 (File No.
333-17627))
10.6.2 Amendment to Employment Agreement between Specialty Care
Network, Inc. and David Hicks, dated December 2, 1997
(incorporated by reference to Exhibit 10.8.1 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997)
</TABLE>
<PAGE> 92
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
10.7 Amended and Restated Stock Purchase Agreement dated as of
March 3, 2000 among HealthGrades.com, Inc. and Essex
Woodlands Health Ventures Fund IV, L.P., Chancellor V, L.P.,
PaineWebber, as custodian for William J. Punk, I.R.A. and
Punk, Ziegel & Company Investors, L.L.C. (incorporated by
reference to Exhibit 10.2 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2000)
10.8.1 Restructure Agreement by and Among Specialty Care Network,
Inc., Medical Rehabilitation Specialists II, P.A. and Kirk
J. Mauro, M.D. dated as of December 31, 1998 (incorporated
by reference to Exhibit 2.1 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1998)
10.8.2 Management Services Agreement by and Among Specialty Care
Network, Inc., Medical Rehabilitation Specialists II, P.A.,
and Kirk J. Mauro, M.D. dated as of January 1, 1999
(incorporated by reference to Exhibit 2.11 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1998)
10.9.1 Restructure Agreement by and Among Specialty Care Network,
Inc., Greater Chesapeake Orthopaedic Associates, L.L.C.,
Paul L. Asdourian, M.D., Frank R. Ebert, M.D., Leslie S.
Matthews, M.D., Stewart D. Miller, M.D., Mark S. Myerson,
M.D., John B. O'Donnell, M.D. and Lew C. Schon, M.D., dated
as of December 31, 1998 (incorporated by reference to
Exhibit 2.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998)
10.9.2 Management Services Agreement by and Among Specialty Care
Network, Inc., Greater Chesapeake Orthopaedic Associates,
L.L.C., Paul L. Asdourian, M.D., Frank R. Ebert, M.D.,
Leslie S. Matthews, M.D., Stewart D. Miller, M.D., Mark S.
Myerson, M.D., John B. O'Donnell, M.D. and Lew C. Schon,
M.D., dated as of January 1, 1999 (incorporated by reference
to Exhibit 2.21 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1998)
10.10.1 Restructure Agreement by and Among Specialty Care Network,
Inc., Vero Orthopaedics II, P.A., James L. Cain, M.D., David
W. Griffin, M.D., George K. Nichols, M.D. and Peter G.
Wernicki, M.D. dated as of December 31, 1998 (incorporated
by reference to Exhibit 2.3 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1998)
10.10.2 Management Services Agreement by and Among Specialty Care
Network, Inc., Vero Orthopaedics II, P.A., James L. Cain,
M.D., David W. Griffin, M.D., George K. Nichols, M.D. and
Peter G. Wernicki, M.D. dated as of January 1, 1999
(incorporated by reference to Exhibit 2.31 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1998)
10.11.1 Restructure Agreement by and Among Specialty Care Network,
Inc., Orlin & Cohen Orthopedic Associates, LLP, Harvey
Orlin, M.D., Isaac Cohen, M.D., John M. Feder, M.D., Gregory
Lieberman, M.D., Sebastian Lattuga, M.D., Harvey Orlin,
M.D., P.C. and Rockville Centre Arthroscopic Associates,
P.C. dated as of December 31, 1998 (incorporated by
reference to Exhibit 2.4 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1998)
10.11.2 Management Services Agreement by and Among Specialty Care
Network, Inc., Orlin & Cohen Orthopedic Associates, LLP,
Harvey Orlin, M.D., Isaac Cohen, M.D., John M. Feder, M.D.,
Gregory Lieberman, M.D., Sebastian Lattuga, M.D., Harvey
Orlin, M.D., P.C. and Rockville Centre Arthroscopic
Associates, P.C. dated as of January 1, 1999 (incorporated
by reference to Exhibit 2.41 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1998)
10.12.1(1) Form of Restructure Agreement (incorporated by reference to
Exhibit 2.1 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999)
10.12.2(1) Form of Management Services Agreement (incorporated by
reference to Exhibit 2.11 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1999)
</TABLE>
<PAGE> 93
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
21 Subsidiaries of the Registrant (incorporated by reference to
Exhibit 21 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999)
23.1 Consent of Ernst & Young LLP
23.2 Consent of Morgan, Lewis & Bockius LLP (included in
Exhibit 5)
</TABLE>
------------
* To be filed by amendment.
(1) Effective June 15, 1999, the Registrant closed a restructuring transaction
through ten separate restructure agreements involving the following nine
practices: Floyd R. Jaggears, Jr., M.D., P.C., II; Riyaz H. Jinnah, M.D.,
II, P.A.; The Orthopaedic and Sports Medicine Center, II, P.A.; Orthopaedic
Associates of West Florida, P.A.; Orthopaedic Institute of Ohio, Inc.;
Orthopaedic Surgery Centers, P.C. II; Princeton Orthopaedic Associates, II,
P.A.; Reconstructive Orthopaedic Associates, II, P.C.; and Steven P.
Surgnier, M.D., P.A., II. Simultaneously, the Registrant executed revised
Management Services Agreements with these practices. The Registrant has
attached a generic form of these agreements to this Registration Statement
as the terms of the agreements between the Registrant and the individual
practices are substantially equivalent.
