Fourth-quarter and full-year 2009 results announced by Health Grades

Health Grades, Inc. (NASDAQ: HGRD), the leading independent healthcare ratings company, today reported financial results for the fourth quarter and year ended December 31, 2009.

Ratings and advisory revenue for the three months ended December 31, 2009 increased $3.1 million, or 28%, to $14.3 million from $11.2 million for the three months ended December 31, 2008. For the year ended December 31, 2009, ratings and advisory revenue increased $12.8 million, or 32%, to $52.5 million from $39.7 million for the year ended December 31, 2008. Revenue growth for the three months ended December 31, 2009 was principally driven by an increase of $2.8 million, or 98%, from the Company’s Internet Business Group compared to the three months ended December 31, 2008. For the year ended December 31, 2009, Internet Business Group revenue increased by $10.2 million, or 121%, and Provider Services revenue increased by $2.4 million, or 8%, compared to the year ended December 31, 2008.

Gross margins for the three months and year ended December 31, 2009 were approximately 84% and 85%, respectively, compared with 82% and 83% for the same periods of 2008. Operating margins for the three months and year ended December 31, 2009 were approximately 17% and 20%, respectively, compared to 14% and 17% for the same periods of 2008.

Operating income for the three months ended December 31, 2009 was $2.4 million, a $0.9 million increase, or 56%, over the three months ended December 31, 2008. Operating income for the year ended December 31, 2009 was $10.5 million, a $3.8 million increase, or 57%, over the year ended December 31, 2008.

Net income attributable to HealthGrades for the three months ended December 31, 2009 was $1.9 million, or $0.06 per diluted share, compared to $1.0 million, or $0.03 per diluted share, for the same period of 2008. Net income attributable to HealthGrades for the year ended December 31, 2009 was $7.1 million, or $0.23 per diluted share, compared to $4.7 million, or $0.14 per diluted share, for the year ended December 31, 2008.

Provider Services

For the three months ended December 31, 2009, Provider Services revenue, which primarily includes sales of hospital marketing products and quality-improvement products, was $8.2 million, an increase of $0.3 million, or 4%, over the same period of 2008. For the year ended December 31, 2009, Provider Services revenue was $31.7 million, an increase of $2.4 million, or 8%, over the year ended December 31, 2008. These increases reflect increased revenue from both the Company’s marketing and quality-improvement products. For the years ended December 31, 2009 and 2008, 33% and 34% of all new sales in Provider Services were to existing clients, respectively. For the years ended December 31, 2009 and 2008, the Company retained or signed new contracts representing approximately 80% of the annual contract value of hospitals whose contracts had first or second year anniversary dates.

Internet Business Group

For the three months ended December 31, 2009, Internet Business Group revenue, which includes the sale of HealthGrades’ quality reports and subscriptions to consumers, revenue from the HealthGrades Connecting Point™ product and internet advertising and sponsorship revenue, was $5.7 million, an increase of $2.8 million, or 98%, over the same period of 2008. For the year ended December 31, 2009, Internet Business Group revenue was $18.6 million, an increase of $10.2 million, or 121%, over the year ended December 31, 2008. This increase in revenue is a result of strong growth from all products within the Internet Business Group, including the contribution from the www.WrongDiagnosis.com website we acquired in October 2008. For the three months and year ended December 31, 2009, the Company’s internet advertising and sponsorship revenue included approximately $1.6 million and $4.7 million, respectively, from www.WrongDiagnosis.com. The Company’s revenue from quality reports to consumers increased to $1.1 million and $4.5 million for the three months and year ended December 31, 2009, respectively, compared to $0.6 million and $2.4 million for the three months and year ended December 31, 2008, respectively, due mainly to sales of its Watchdog subscription service.

Strategic Health Solutions

For the three months ended December 31, 2009, Strategic Health Solutions revenue, which includes sales of HealthGrades’ quality information to employers, benefit consultants, health plans and others, as well as any sales of the Company’s data was $0.5 million, unchanged from the same period in 2008. For the year ended December 31, 2009, Strategic Health Solutions revenue was $2.2 million, an increase of $0.2 million, or 12%, over the year ended December 31, 2008.

Operating Expenses

Operating expenses increased $1.9 million to $9.6 million for the three months ended December 31, 2009 from $7.6 million for the three months ended December 31, 2008. Operating expenses increased $8.0 million to $34.2 million for the year ended December 31, 2009 from $26.2 million for the year ended December 31, 2008.

Sales and marketing expenses for the three months ended December 31, 2009 were $3.5 million compared to $3.4 million for the three months ended December 31, 2008. Sales and marketing expenses for the year ended December 31, 2009 were $13.1 million compared to $10.8 million for the year ended December 31, 2008. This increase is mainly due to increased sales personnel, travel, search engine optimization and investments the Company has made in its sponsorship and advertising business. In addition, sales and marketing expenses increased due to costs related to the www.WrongDiagnosis.com and www.CureResearch.com websites, which the Company acquired in October 2008.

Product development expenses for the three months ended December 31, 2009 were $2.8 million compared to $2.0 million for the three months ended December 31, 2008. Product development expenses for the year ended December 31, 2009 were $9.4 million compared to $7.3 million for the year ended December 31, 2008. These increases are primarily due to additional personnel hired to support product development efforts, including both the improvement of existing products and the development of new product offerings. In particular, the Company added personnel to focus on advertising development initiatives, as well as several projects that are in process with its search engine partners. The Company also continues to invest in initiatives to both improve its existing data and bring new and actionable data to consumers. The Company maintains physician data relating to nearly 800,000 physicians. The Company continues to acquire new physician data and refine the Company’s data-matching process to improve both the impact and the accuracy of its information.

General and administrative expenses for the three months ended December 31, 2009 were $3.3 million compared to $2.2 million for the three months ended December 31, 2008. General and administrative expenses for the year ended December 31, 2009 were $11.7 million compared to $8.1 million for the year ended December 31, 2008. These increases are mainly due to increased personnel costs and new hires, software expenses, and the write-off of the Company’s investment in Healthcare Credit Solutions. Upon the dissolution of Healthcare Credit Solutions, the Company wrote-off $0.2 million of certain assets including fixed assets, the non-competition agreement and the Company’s investment in the subsidiary.

Income Taxes

Income tax expense for the three months and year ended December 31, 2009 was $0.8 million and $3.9 million, respectively, while income tax expense for the three months and year ended December 31, 2008 was $0.6 million and $2.7 million, respectively. For the three months and year ended December 31, 2009, the Company’s effective income tax rates were approximately 31% and 37%, respectively, compared with 40% and 38% for the three months and year ended December 31, 2008, respectively. The decreases in the effective tax rate for the three months and year ended December 31, 2009 were principally due to losses related to the write-off of the Company’s investment in Healthcare Credit Solutions.

Cash Position; Stock Repurchases

For the year ended December 31, 2009, the Company generated $9.2 million in cash flow from operations. As of December 31, 2009, the Company had $19.2 million in cash and cash equivalents, a 69% increase over the balance at December 31, 2008. As of December 31, 2009, the Company has accrued, as an increase to goodwill, $0.9 million of contingent consideration related to the acquisition of the Adviware assets. This amount is expected to be paid to the former Adviware shareholders in early 2010. For the year ended December 31, 2009, the Company did not repurchase any shares of its common stock.

2009 Results and Outlook

Kerry Hicks, Chairman and Chief Executive Officer of Health Grades, Inc. stated, “In a difficult economic environment, we are very pleased with our achievement of 32% annual revenue growth with operating margins of 20%. In particular, the performance of our Internet Business Group exceeded expectations. With annual growth of more than $10 million in this business, we are excited with the progress we have made. More importantly to us, we believe we are positioned very well for continued growth in 2010.”

Mr. Hicks continued, “As we noted previously, we are renaming our Provider Services business as Professional Services. Beginning with the first quarter of 2010 we will begin reporting revenues in two business units, Professional Services and Internet Business Group. Other than the name change for Professional Services the only other change will be that we will report revenue from what was previously known as Strategic Health Solutions within the Internet Business Group. We look forward to further solidifying our dominant search position with respect to provider selection. As we noted in our December 21, 2009 press release, we have been making a significant investment with respect to our sales team and product development in particular to ensure that we are well prepared to drive strong growth not only for 2010, but for years to come. While this may lead to somewhat lower margins for the first half of the year, we remain confident in our guidance of 19-22% operating margins for the full year 2010.”

Guidance

The Company is affirming its full year guidance for ratings and advisory revenue growth of 20% over 2009 with an operating margin of between 19% to 22%.