<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended SEPTEMBER 30, 2000
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from to
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Commission file number 0-22019
HEALTH GRADES, INC.
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(Exact Name of Registrant as Specified in its Charter)
DELAWARE 62-1623449
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
44 UNION BOULEVARD, SUITE 600, LAKEWOOD, COLORADO 80228
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (303) 716-0041
-------------------------
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
On October 31, 2000, 28,930,875 shares of the Registrant's common stock,
$.001 par value, were outstanding.
<PAGE> 2
Health Grades, Inc. and Subsidiaries
INDEX
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION:
Item 1. Consolidated Balance Sheets
September 30, 2000 and December 31, 1999............. 3
Consolidated Statements of Operations -
Three Months Ended September 30, 2000 and 1999
Nine Months Ended September 30, 2000 and 1999........ 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2000 and 1999........ 5
Notes to Consolidated Financial
Statements........................................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................................... 8
Item 3. Quantitative and Qualitative Disclosure
About Market Risk.................................... 11
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings.................................... 11
Item 2. Changes in Securities ............................... 11
Item 6. Exhibits and Reports on Form 8-K..................... 12
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Health Grades, Inc. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
2000 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 7,092,283 $ 316,767
Restricted cash -- 1,178,848
Accounts receivable, net 454,928 2,744,912
Due from affiliated practices in litigation, net 1,232,748 2,745,413
Prepaid expenses, inventories and other 227,918 205,665
Current portion notes receivable 285,018 3,531,099
Prepaid and recoverable income taxes -- 1,838,589
------------ ------------
Total current assets 9,292,895 12,561,293
Property and equipment, net 973,279 1,656,613
Goodwill, net of accumulated amortization of
$467,068 and $-- in 2000 and 1999, respectively 5,243,115 4,000,000
Notes receivable, less current portion 1,414,133 1,661,485
Other assets 508,174 513,477
------------ ------------
Total assets $ 17,431,596 $ 20,392,868
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Accounts payable $ 71,040 $ 520,767
Accrued payroll, incentive compensation and related
expenses 386,012 278,474
Accrued expenses 726,668 1,531,550
Income taxes payable 556,792 --
Notes payable 663,149 7,352,005
Notes payable to officers -- 350,000
Deferred income 1,018,269 1,144,552
------------ ------------
Total current liabilities 3,421,930 11,177,348
Note payable, less current portion 1,146,065 5,603,283
Notes payable to officers, less current portion -- 3,200,000
Deferred income 303,560 646,847
------------ ------------
Total liabilities 4,871,555 20,627,478
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 28,817,400 and 18,738,686
issued and outstanding in 2000 and 1999,
respectively 28,817 18,739
Additional paid-in capital 87,349,730 67,509,276
Accumulated deficit (61,759,272) (56,722,141)
Treasury stock (13,059,234) (11,040,484)
------------ ------------
Total stockholders' equity (deficit) 12,560,041 (234,610)
------------ ------------
Total liabilities and stockholders' equity (deficit) $ 17,431,596 $ 20,392,868
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
Health Grades, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------------- ----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUE:
Physician practice management revenue $ 375,923 $ 5,280,185 $ 3,943,734 $ 27,029,889
Internet revenue 909,558 142,986 2,172,125 279,778
Other 1,128 -- 3,847 459,366
------------ ------------ ------------ ------------
1,286,609 5,423,171 6,119,706 27,769,033
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Physician practice management costs and expenses:
Clinic expenses -- 424,236 -- 14,866,690
Litigation and other costs 85,271 906,035 657,106 4,269,295
Internet costs and expenses:
Production content and product development 466,593 477,188 1,672,185 741,732
Sales and marketing 973,273 561,096 2,219,926 680,340
General and administrative 2,260,894 2,433,118 6,323,307 8,436,102
------------ ------------ ------------ ------------
3,786,031 4,801,673 10,872,524 28,994,159
------------ ------------ ------------ ------------
(Loss) income from operations (2,499,422) 621,498 (4,752,818) (1,225,126)
Other:
Gain (loss) on sale of assets and other (61,473) 117,485 (256,252) 3,649,243
Gain on sale of equity investment -- 127,974 -- 127,974
Gain on sale of subsidiary -- -- -- 221,258
Interest income 141,024 88,749 400,380 249,245
Interest expense (52,648) (318,566) (428,441) (2,205,552)
------------ ------------ ------------ ------------
(Loss) income before income taxes (2,472,519) 637,140 (5,037,131) 817,042
Income tax (expense) benefit -- (920,786) -- 775,561
------------ ------------ ------------ ------------
Net (loss) income $ (2,472,519) $ (283,646) $ (5,037,131) $ 1,592,603
============ ============ ============ ============
Net (loss) income per share (basic) $ (0.11) $ (0.02) $ (0.27) $ 0.11
============ ============ ============ ============
Weighted average shares outstanding (basic) 21,536,065 12,429,197 18,863,324 14,817,837
============ ============ ============ ============
Net (loss) income per share (diluted) $ (0.11) $ (0.02) $ (0.27) $ 0.10
============ ============ ============ ============
Weighted average shares outstanding (diluted) 21,536,065 12,429,197 18,863,324 15,637,817
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
Health Grades, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
----------------------------
2000 1999
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net (loss) income $ (5,037,131) $ 1,592,603
Adjustments to reconcile net (loss) income to net
cash provided by operating activities:
Depreciation 537,281 1,491,225
Amortization 606,885 1,425,645
Bad debt expense 199,343 --
Gain on sale of subsidiary -- (221,258)
Gain on sale of equity investment -- (127,974)
Gain on sale of assets, amendment and restatement
of service agreements and litigation settlement -- (3,649,243)
Impact of termination agreements -- (1,073,777)
Equity in loss of unconsolidated affiliate -- 23,852
Officer notes financing fee 347,200 --
Loss (gain) on disposal of assets 256,253 (5,891)
Deferred income taxes -- (1,285,395)
Non-cash compensation expense-stock options 34,331 394,277
Changes in operating assets and liabilities,
net of the non-cash effects of the acquisitions
of the net assets of physician groups:
Accounts receivable, net 71,891 3,294,746
Due from affiliated practices in
litigation 1,654,539 (1,423,324)
Prepaid expenses and other assets (37,520) 168,192
Accounts payable and accrued expenses (1,065,163) (1,926,666)
Accrued payroll, incentive compensation
and related expenses 107,538 7,782
Income taxes payable and prepaid and
recoverable income taxes, net 2,395,381 3,188,703
Due to affiliated physician practices -- (3,121,548)
Deferred income (469,570) 1,946,009
------------ ------------
Net cash (used in) provided by operating activities (398,742) 697,958
INVESTING ACTIVITIES
Purchases of property and equipment (315,179) (954,220)
Proceeds from sales of majority interest in a
subsidiary and equity investments, net of cash -- 3,208,397
Proceeds from sale of medical equipment 125,200 1,001,856
Increase in other assets 5,303 (39,403)
Repayments from affiliates -- 108,815
Advances to investee -- (899,342)
------------ ------------
Net cash (used in) provided by investing activities (184,676) 2,426,103
FINANCING ACTIVITIES
Proceeds from sales of affiliated practices
assets and execution of new service agreements -- 36,693,110
Cash restricted for repayment of line-of-credit -- --
Principal repayments on notes payable (10,156,672) (40,425,000)
Net proceeds from equity financing 14,356,201 --
Repayments from notes receivable 3,446,605 --
Principal repayments on capital lease obligations -- (47,686)
Loans to physician stockholders -- (48,178)
Escrowed payment related to acquisition
of additional interest in majority-owned
subsidiary -- (60,000)
Repayment of Officer notes (350,000) --
Repayment on loans to physician stockholders -- 135,451
Exercise of common stock options 62,800 7,545
------------ ------------
Net cash provided by (used in) financing activities 7,358,934 (3,744,758)
Net increase (decrease) in cash and cash equivalents 6,775,516 (620,697)
Cash and cash equivalents at beginning of period 316,767 1,418,201
------------ ------------
Cash and cash equivalents at end of period $ 7,092,283 $ 797,504
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
Health Grades, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
September 30, 2000
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements of Health
Grades, Inc. and subsidiaries (collectively the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and the instructions to Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, these statements include all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation of the results
of the interim periods reported herein. Operating results for the three and nine
months ended September 30, 2000 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2000. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1999.
DESCRIPTION OF BUSINESS
The Company operates two Internet healthcare sites and provides practice
management services to physicians. Through its wholly-owned subsidiary,
Healthcare Ratings, Inc., the Company operates its HealthGrades.com website,
which provides ratings and other information on health care providers and
facilities. Through its wholly-owned subsidiary, ProviderWeb.net, Inc., the
Company operates its ProviderWeb.net website, which offers a subscription
service for physician practice administrators and managers that provides online
tools and resources. All significant intercompany balances and transactions have
been eliminated in consolidation.
RECLASSIFICATIONS
Certain amounts in the Consolidated Balance Sheet as of December 31, 1999 and
certain amounts in the Statement of Operations and the Consolidated Statement of
Cash Flows for the three and nine months ended September 30, 1999 have been
reclassified in order to conform to the current presentation.
EARNINGS PER SHARE
The calculation of weighted average shares outstanding for the three and nine
months ended September 30, 2000, and for the three months ended September 30,
1999, does not included the impact of certain stock options whose exercise price
was less than the average market price of the common shares because the effect
on loss per share would have be antidilutive. If such options were included in
the calculation, weighted average shares outstanding would have increased by
approximately 1.2 million and 1.3 million shares, for the three and nine months
ended September 30, 2000, respectively, and approximately 1.8 million for the
three months ended September 30, 1999.
NOTE 2 - EQUITY FINANCING
On March 17, 2000, the Company closed on an equity financing transaction (the
"Equity Financing") which raised $18 million. Pursuant to the terms of the
Equity Financing, certain investors paid $14.8 million to the Company in return
for 7,400,000 shares of Company common stock and five-year warrants to purchase
2,590,000 shares of Company common stock at an exercise price of $4.00 per
share. Net proceeds of the Equity Financing, after payment of certain legal and
other financing fees, were approximately $14.4 million. In connection with the
Equity Financing, the Company also issued an aggregate of 165,000 shares to its
bank syndicate as a financing fee. The Company also issued a warrant to purchase
150,000 shares of Company common stock to a company that served as a financial
advisor to the Company in connection with the Equity Financing, at an exercise
price of $4.00 per share. In connection with the Equity Financing, certain
officers of the Company exchanged $3.2 million in notes payable for an aggregate
of 1.6 million shares of Company common stock and five-year warrants to purchase
560,000 shares of Company 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, the Company 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
the Company's Consolidated Statement of Operations.
6
<PAGE> 7
NOTE 3 - 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 for
the three and nine months ended September 30, 1999 represents ambulatory surgery
center services and health care consulting. Both of the Company subsidiaries
that generated revenue for the "other" segment were liquidated during 1999.
The Company uses net loss before income taxes for purposes of performance
measurement. The measurement basis for segment assets includes intangible
assets.
Summary information by segment is as follows:
<TABLE>
<CAPTION>
AS OF AND FOR AS OF AND FOR
THE THREE MONTHS ENDED THE NINE MONT HS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------------- ----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
PPM
Revenue from external customers $ 375,923 $ 5,306,998 $ 3,943,734 $ 27,544,417
Interest income -- 39,619 -- 157,419
Interest expense (52,648) 318,566 (428,441) 2,205,552
Segment net income (loss) before income taxes (1,230,975) 2,970,613 (1,765,933) 4,828,522
Segment assets 27,966,141 21,282,908 27,966,141 21,282,908
Segment asset expenditures 6,010 29,042 13,822 775,797
INTERNET SERVICES
Revenue from external customers $ 909,558 $ 143,047 $ 2,172,125 $ 279,839
Interest income 141,024 -- 400,380 --
Segment net loss before income taxes (1,241,544) (1,946,611) (3,271,198) (2,877,376)
Segment assets 6,091,992 340,539 6,091,992 340,539
Segment asset expenditures 2,855 78,765 301,357 178,423
OTHER
Revenue from external customers $ -- $ -- $ -- $ 132,831
Interest income -- 49,130 -- 91,826
Equity in net loss of unconsolidated affiliate -- (4,874) -- (23,852)
Segment net loss before income taxes -- (385,008) -- (1,023,633)
Segment assets -- -- -- --
Segment asset expenditures -- -- -- --
</TABLE>
A reconciliation of the Company's segment revenue, segment net loss before
income taxes, segment assets and other significant items to the corresponding
amounts in the Consolidated Financial Statements is as follows:
<TABLE>
<CAPTION>
AS OF AND FOR AS OF AND FOR
THE THREE MONTHS ENDED THE NINE MONT HS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------------- ----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUE
Total for reportable segments $ 1,285,481 $ 5,450,045 $ 6,115,859 $ 27,824,256
Other revenue 1,128 (26,874) 3,847 (55,223)
------------ ------------ ------------ ------------
Total consolidated revenue $ 1,286,609 $ 5,423,171 $ 6,119,706 $ 27,769,033
============ ============ ============ ============
LOSS BEFORE INCOME TAXES
Total net loss before tax for
reportable segments $ (2,472,519) $ 1,024,002 $ (5,037,131) $ 1,951,146
Other net loss -- (385,008) -- (1,023,633)
Adjustment -- (1,854) -- (110,471)
------------ ------------ ------------ ------------
Loss before income taxes $ (2,472,519) $ 637,140 $ (5,037,131) $ 817,042
============ ============ ============ ============
ASSETS
Total assets for reportable segments $ 34,058,133 $ 21,623,447 $ 34,058,133 $ 21,623,447
Other assets -- -- -- --
Elimination of advance to subsidiaries (8,831,517) -- (8,831,517) --
Elimination of investment in
subsidiaries (7,795,020) (4,215,224) (7,795,020) (4,215,224)
------------ ------------ ------------ ------------
Consolidated total assets $ 17,431,596 $ 17,408,223 $ 17,431,596 $ 17,408,223
============ ============ ============ ============
</TABLE>
7
<PAGE> 8
For each of the periods presented, the Company's primary operations and
assets were within the United States.
NOTE 4 - SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest paid amounted to approximately $514,000 and $2.2 million for the
nine months ended September 30, 2000 and 1999, respectively. Refunds received
from income taxes amounted to approximately $2,300,000 and $2,700,000 for the
nine months ended September 30, 2000 and 1999, respectively.
Supplemental schedule of noncash investing and financing activities are as
follows:
During the nine months ended September 30, 2000, approximately $1.2 million in
restricted cash was used to pay down the Company's term loan.
In January 2000, the Company received 850,000 shares of its common stock under
the terms of a settlement agreement with one of its former affiliated practices.
In February 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 connection with the Merger
Transaction, the minority shareholders of HG.com were given 800,000 shares of
Company common stock.
ITEM 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Statements in this section, including statements concerning raising debt and/or
equity financing and anticipated costs to further develop and market our
Internet sites are "forward looking statements." Actual events or results may
differ materially from those discussed in forward looking statements as a result
of various factors, including inability to obtain additional financing and other
factors discussed below and in the Company's Annual Report on Form 10-K for the
year ended December 31, 1999, particularly under "Risk Factors" in Item 1.
GENERAL
We operate two Internet healthcare sites and provide practice management
services to physicians. Through our wholly-owned subsidiary, Healthcare Ratings,
Inc., we operate our HealthGrades.com website, which provides ratings and other
information on health care providers and facilities. Through our wholly-owned
subsidiary, ProviderWeb.net, Inc., we operate our ProviderWeb.net website, which
offers a subscription service for physician practice administrators and managers
that provides online tools and resources. Due to the intent of management to
focus its efforts on continuing the development of the Health Grades website, we
are currently exploring strategic alternatives for ProviderWeb.net.
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 three and nine months ended September 30, 2000 are not comparable to our
results of operations for the three and nine months ended September 30, 1999. In
an effort to enhance the presentation of our financial statements, we have
identified those revenues and costs and expenses that relate directly to our
Internet and physician practice management operations, respectively, and
segregated them in the Statements of Operations. As a result, we have made
certain reclassifications to the Statement of Operations for the three and nine
months ended September 30, 1999 in order to conform to the current period
presentation.
ACQUISITION OF MINORITY INTEREST
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 effectuate the Merger
Transaction, we gave the minority shareholders of HG.com 800,000 shares of our
common stock. In connection with the Merger Transaction, we recorded goodwill in
the amount of $1,850,000 based on the fair value of our common stock issued as
of the transaction date. The goodwill is being amortized over an estimated
useful life of seven years.
8
<PAGE> 9
RESULTS OF OPERATIONS
PHYSICIAN PRACTICE MANAGEMENT REVENUE
Physician practice management revenue includes service fees and other revenue
derived from our physician practice management business. For the three and nine
months ended September 30, 2000, physician practice management revenue includes
non-recurring payments of approximately $70,000 and $2.4 million, respectively,
related to the termination of management services agreements with three of our
affiliated practices. Physician practice management revenue for the three and
nine months ended September 30, 1999 was approximately $5.3 million and $27.0
million, respectively, 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 healthcare
business. We derive these revenues primarily from strategic marketing services
provided to hospitals, nursing homes and other healthcare providers, and fees
related to the licensing 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. 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 also 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 and nine months ended September 30, 2000, we recorded approximately
$424,000 and $1.0 million, respectively, in revenue and corresponding expense
related to these type 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 healthcare
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 healthcare 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 and nine months ended
September 30, 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 and nine months ended September 30, 2000, we incurred
approximately $85,000 and $657,000, respectively, in legal fees directly related
to these disputes. Compared with the corresponding periods from 1999, litigation
and other costs decreased approximately $821,000 and $3.6 million, respectively,
for the three and nine months ended September 30, 2000. This decrease is due to
the fact that during the latter part of 1999 and in the first half of 2000, we
reached settlement agreements with several former affiliated practices.
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.
Production, content and product development costs were approximately $500,000
and $1.7 million for the three and nine months
9
<PAGE> 10
ended September 30, 2000, respectively. These expenses increased substantially
during the later part of 1999 and the first half of 2000, due to the expansion
of the HealthGrades.com website during this time period. Since January 1, 2000,
we have enhanced our website by adding directories for naturopathic physicians
and birthing centers and including report card pages for home health agencies
and hospices. Additionally, through a strategic alliance with GeoAccess, we have
enhanced our physician data.
SALES AND MARKETING EXPENSES
We incurred approximately $1 million and $2.2 million in sales and marketing
costs for the three and nine months ended September 30, 2000, respectively. Of
this amount, approximately $424,000 and $1 million for the three and nine months
ended September 30, 2000, respectively, related to expenses incurred in
connection with promotional agreements under which we received advertising and
other services in return for access to our content. There were no corresponding
costs for the three and nine months ended September 30, 1999.
GAIN (LOSS) ON SALE OF ASSETS AND OTHER
During the nine months ended September 30, 2000, we incurred a loss on sale of
assets and other, of approximately $256,000. This amount consisted primarily of
a loss of $275,000 on the sale of two MRI units, a gain of approximately
$142,000 primarily related to a litigation settlement with one of our former
affiliated practices, and a loss of approximately $61,000 related to the
writedown of certain assets.
INTEREST EXPENSE
We incurred interest expense of approximately $53,000 and $428,000 for the three
and nine months ended September 30, 2000, respectively, compared to interest
expense of approximately $319,000 and $2.2 million for the corresponding periods
of 1999. This decrease reflects the reduction of our indebtedness with our bank
syndicate from a balance of approximately $12.5 million as of September 30, 1999
to a balance of approximately $1.6 million as of September 30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2000, we had working capital of approximately $5.9 million, an
increase of $4.5 million from approximately $1.4 million as of December 31,
1999. For the first nine months of 2000, cash flow used in operations was
approximately $399,000 compared to cash flow provided by operations of $698,000
for the same period of 1999.
On March 17, 2000, we closed on an equity financing transaction (the "Equity
Financing") which raised $18 million. Pursuant to the terms of the Equity
Financing, certain investors funded $14.8 million to us in return for 7,400,000
shares of our common stock. Net proceeds of the Equity Financing, after payment
of certain legal and other financing fees, was approximately $14.4 million.
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 a warrant to purchase 150,000 shares of our
common stock to a company that served as a financial advisor to us in connection
with the Equity Financing, at an exercise price of $3.45 per share. In
connection with the Equity Financing, certain of our officers exchanged $3.2
million in notes payable for an aggregate of 1.6 million shares of our common
stock and five-year warrants to purchase 560,000 shares of 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 nine
months ended September 30, 2000.
Effective March 2000, we entered into an amendment to our term loan with our
bank syndicate. The amendment extends the final payment on the loan from
November 2000 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. Our federal tax refund for the year ended December 31, 1999, was
received during the second quarter of 2000 and totaled approximately $2.3
million. This amount was applied to the balance of the term loan in June 2000.
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.
We anticipate incurring costs in excess of revenues for the remainder of 2000
and during 2001 to further develop and market
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our product offerings. Our revenues to date from ProviderWeb.net have not been
material. Due to the intent of management to focus its efforts on continuing the
development of the HealthGrades.com website, we are currently exploring
strategic alternatives for ProviderWeb.net. Additionally, 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. We anticipate that we will
require additional funds to finance our operations over the next twelve months.
Management is currently examining various alternatives to raise debt and/or
equity financing. The availability and terms of any financing will depend on
market and other conditions. We cannot assure that sufficient funds will be
available on terms acceptable to us, if at all.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The amount outstanding under our term loan bears 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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Orthopaedic Institute of Ohio
On March 27, 2000, the Court entered an order staying the litigation and
ordering the parties to resolve their disputes through arbitration. All initial
written submissions have been provided to the arbitrator. Additional submissions
and information may be requested by the arbitrator or the arbitrator may decide
the dispute based upon the current state of the record.
Reconstructive Orthopaedic Associates
By letter dated April 28, 2000, our counsel raised certain concerns with
Reconstructive Orthopaedic Associates ("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) 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 June 27, 2000, we filed a motion to dismiss Count II (fraud and negligent
misrepresentation) and an answer and counterclaim. The counterclaim asserted
claims for breach of fiduciary duty against Drs. Rothman and Albert and
restitution of unjust enrichment and constructive trust and accounting claims
against all counterclaim defendants.
On or about July 11, 2000, ROA filed an amended complaint attempting to plead
the fraud and negligent misrepresentation claims with greater specificity. On
July 19, 2000, the court entered an order dismissing Count II of the Complaint.
On or about July 28, 2000, Plaintiffs filed a Motion for Reconsideration of the
July 19, 2000, Order dismissing Count II. By Order dated October 2, 2000 the
court denied the Plaintiffs Motion for Reconsideration. Thus, Count II has been
dismissed.
On July 17, 2000, Plaintiffs filed a motion to dismiss our counterclaims. On
July 31, 2000, we submitted a response in opposition to the motion to dismiss
counterclaims. By order dated October 12, 2000, the court denied Plaintiffs
motion to dismiss our counterclaim.
For further history regarding the above proceedings, please see the Company's
Annual Report on Form 10-K for the year ending December 31, 1999, Part I, Item
3. Legal Proceedings.
ITEM 2. CHANGES IN SECURITIES
During the nine months ended September 30, 2000, we issued to SmallCaps Online
Group, LLC five-year warrants to purchase 20,000 shares of our common stock at
$2.00 per share, in consideration for certain financial advisory services to be
rendered to us.
On August 23, 2000, we issued to GeoAccess, Inc. ("GeoAccess") rights to acquire
a total of 125,000 shares of our common stock in lieu of up to two cash payments
totaling $250,000 for certain services provided by GeoAccess to us. GeoAccess
must make the election to take shares in lieu of scheduled cash payments by
February 23, 2001.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -- The following is a list of exhibits filed as part of this
quarterly report on Form 10-Q.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
3.1 Certificate of Amendment of Amended and Restated
Certificate of Incorporation
3.2 Amended and Restated Bylaws
11 Statement re: computation of per share earnings
27 Summary financial data schedule
</TABLE>
(b) Reports on Form 8-K. During the nine months ended September 30, 2000,
there were no reports on Form 8-K filed by the Company.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HEALTH GRADES, INC.
Date: November 14, 2000 By: /s/ D. Paul Davis
------------------ --------------------------------
D. Paul Davis
Executive Vice President, Finance
(Chief Financial Officer)
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Health Grades, Inc. and Subsidiaries
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
3.1 Certificate of Amendment of Amended and Restated
Certificate of Incorporation
3.2 Amended and Restated Bylaws
11 Statement re: computation of per share earnings
27 Summary Financial Data Schedule
</TABLE>
