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Executives

Allen Dodge - CFO

Kerry Hicks - Chairman and CEO

Analysts

Jackson Spears - The Robins Group

Mitra Ramgopal - Sidoti & Company

Health Grades Inc. (HGRD) Q2 2009 Earnings Call July 28, 2009 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2009 Health Grades Incorporated earnings conference call. My name is Demoli, and I will be your operator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference, Mr. Allen Dodge, Chief Financial Officer of Health Grades Incorporated. Please proceed.

Allen Dodge

Good morning. Thank you for participating in today's call with us. Before we begin prepared remarks, I'd like to remind all of you that this conference call will include forward-looking comments. All statements other than statements of historical fact may constitute forward-looking statements.

Although, we believe the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Important factors that could cause actual results to differ materially from our expectations are disclosed in the risk factors contained in our filings with the Securities and Exchange Commission, which are available at www.sec.gov. All forward-looking statements are qualified in their entirety by these factors.

Furthermore, this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, July 28, 2009. This call is being recorded on behalf of Health Grades and is copyrighted material. It cannot be recorded or rebroadcast without the company's permission. Your participation in this call implies consent to our taping.

On today's call, Health Grades' Chairman and Chief Executive Officer, Kerry Hicks, will provide a company update and discuss business highlights, and I will review the financial results. Following our prepared remarks, we will open the call for questions.

With that said, I'd like to turn the call over to Kerry Hicks. Kerry?

Kerry Hicks

Thank you, Allen. I would also like to extend my welcome to everyone on the call today. I am pleased to have the opportunity to discuss a very successful for Health Grades, and discuss our positioning with respect to why we see continued growth and success going forward. Allen will provide details on the second quarter results after my introductory remarks.

I'd like to begin by highlighting some key metrics for the first six months of the year. Allen will also give more color on each of these points during his remarks. One, topline revenue growth of 34% over the second quarter of 2008; two, 21% operating margin for the quarter and year-to-date; three, 76% retention rate with respect to our provider services contracts for the first six months of the year.

As I did on our last call, I'd like to begin with an overview of our key areas of focus. Building the brand, the Health Grades brand, that is, with consumers and industry is one of the most important initiatives we have. In June 2009, our combined web properties of healthgrades.com and wrongdiagnosis.com attracted more than 15.3 million unique users per month, maintaining our position as one of the top 10 most trafficked healthcare properties as reported by ComScore.

Our traffic growth has come both organically from our search engine optimization efforts and additional content among other initiatives, as well as from our acquisition of the wrongdiagnosis.com website in October 2008. Additions to our content include over one million alternative care providers, for instance, chiropractors, massage therapists, and the like.

In addition, we now have approximately 900,000 completed patient experience surveys. We also continue to build our brand through our continued leadership position with respect to provider ratings.

In June, we published both our top hospitals for women's health and maternity care study, as well as our Outstanding Patient Experience Award recipient. Publishing annual studies highlighting the substantial differences in quality between high and low performing hospitals is part of our mission and is what we do best.

Developing and optimizing an advertising sponsorship revenue model is a second strategic imperative for Health Grades. Allen will talk to the specifics of our second quarter results in a bit, but clearly a substantial portion of our revenue growth has come from our Internet Business Group. As we noted throughout 2008, we have made significant investments in terms of laying the groundwork for our advertising and sponsorship build-out.

I am very pleased to report the acquisition of wrongdiagnosis.com website continues to exceed our operational and strategic goals. When we acquired this asset, revenues from wrongdiagnosis.com website were on a run rate of approximately $500,000 per quarter.

In the second quarter of 2009, the Wrong Diagnosis website generated revenues of over $1 million, which implies, obviously, an implicit 100% growth quarter-on-quarter.

We continue to attract better advertising rates and are monetizing our traffic at an increasing rate through our growing network relationships and more direct campaign sales through both ad agencies and ad networks due to our increased relevance to these entities.

In addition, we have signed our first two contracts for Direct Pharmaceutical campaign. Furthermore, we continued to work on a number of projects to continue to improve the integration between Health Grades and the Wrong Diagnosis website, and improve the user experience of our sites.

Expanding our core provider services business also continues to be a critical area for our continued growth. A major factor in our ability to continue to expand this business is to maintain high rates of retention within our existing client base.

For the first six months of 2009, I am pleased to note that we retained contracts or signed new contracts representing approximately 76% of the annual contract value of hospitals whose contracts had first or second year anniversary dates.

Our strong retention rate continues to be a good gauge of the value we bring to our clients. That being said, both our hospital clients and prospects are facing significant challenges in the current economic environment.

In a recent study published by the American Hospital Association, by way of example, 55% of all hospitals are seeing a moderate to severe decrease in patient admissions and 59% are experiencing a moderate to severe decrease in elective procedures.

Obviously, this puts some relative stress on the environment, again, of which we sell into. We think over time that that ameliorates with the economic recovery. We think we're well situated, but it's clear we are facing some headwinds in that area today.

The challenges hospitals are facing continue to manifest itself to Health Grades through a lengthening of the sales cycle and some falloff at the end of our sales cycle in terms of clients that would once typically close and now some are falling off at the end of the cycle.

In addition, the second quarter always tends to be a bit soft for us given that we publish the majority of our annual ratings in the fall. As such, the second quarter is typically the lightest for us in terms of new sales cycle for our provider business.

Based on our history, we anticipate an acceleration in our new sales when we launch our new annual ratings, the latter part of this quarter, that being the third quarter. We also continue to add to our sales team and increase our leadership in this area.

Once again, we are very pleased with our second quarter results across all areas of our business. As always, the entire Health Grades team is focused on enhancing our ability to perform and to build shareholder value over the long term.

With that, I'd like to turn the call over to our Chief Financial Adviser, Allen Dodge, who will discuss our financial results, as well as our guidance. Allen?

Allen Dodge

Thank you, Kerry. I'd like to give a bit more color to each area in terms of our results, in addition to reaffirming some important from the release. The principal growth drivers for our 34% revenue growth in the second quarter 2009 over the same period of 2008 were our Internet Business Group and Provider Services business.

For the first time, we also generated revenue from our Healthcare Credit Solutions business after signing our first customers in this area.

Our Provider Services revenue was $7.8 million, an increase of 10% over the same period of 2008. As Kerry mentioned, for the first six months ended June 30, 2009, we retained contracts or signed new contracts representing approximately 76% of the annual contract value of hospitals whose contracts had first or second year anniversary dates. This compares to 75% for the same period of 2008. We are very pleased with our current retention rates.

We are also anxious for our upcoming fall ratings launch. We believe we continue to be well-positioned to provide substantial and strategic value to our clients. In an environment where most hospitals are struggling attracting the right patients, we provide a suite of products and solutions that provide substantial value.

In the Internet Business Group, we saw strong growth from all of our product areas. The most significant growth drivers were second quarter revenue compared to the prior year, with a sponsorship agreement with Fresenius Medical Care, which we signed in the second quarter of 2008, as well as wrongdiagnosis.com.

The Fresenius agreement represented approximately $510,000 in revenue for the second quarter of 2009. The Wrong Diagnosis website contributed approximately $1 million for the quarter.

In the second quarter of 2008, there were no associated revenues recorded in our financial statements for Wrong Diagnosis. For Fresenius, which was signed in June 2008, we recognized only approximately $163,000 in the second quarter of 2008.

In addition to these two items, we also continued to see strong growth from advertising on the healthgrades.com website, as well as continued sales from our new subscription service we launched in late 2008 around our consumer reports product.

We also recognized revenue for the first time from our Healthcare Credit Solutions business. Although the amount of revenue recognized is not material to the quarter, it does represent a significant milestone for this product. We are hopeful that we will continue to gain some traction in this business through the remainder of this year and into 2010.

Our operating margin for the second quarter of 2009 was 21%, compared with an operating margin of 18% in the second quarter of 2008. The significant operating margin improvement is principally result of continued strong revenue growth.

In addition, we continue to work diligently to manage our expenses. We are continuing to hire in a number of areas such as technology, product development and sales. However, we are working to ensure that our hiring does not outpace our revenue growth.

Our net income for the second quarter was $1.7 million, or $0.06 per fully diluted share, and this compares with net income of $1.2 million, or $0.04 per fully diluted share in the second quarter of 2008.

As of June 30, 2009, our cash and cash equivalents was $13.7 million compared with cash and cash equivalents of $11.3 million at the close of 2008. During the first six months of 2009, we generated $3 million in cash flow from operations.

In terms of our 2009 guidance, today we are raising our financial guidance. Specifically, we are forecasting revenue to increase by 25% over 2008 to approximately $50 million. We are maintaining our forecast for operating margin of between 17% and 21%.

With that, I'd like to turn the call over to Kerry for some closing remarks.

Kerry Hicks

Thanks, Allen. In summary, we are very pleased with our operating results for the first six months of the year, particularly given the economic environment in general, and specifically to many of our clients and prospects in the healthcare provider space.

In addition, we continue to work diligently to expand the depth and breadth of our position in hospital datasets, integrate the Health Grades and Wrong Diagnosis websites, as well as improving the functionality of the Health Grades website.

In the coming months, we will be expanding on the search capabilities for our physician data and continuing to launch improvement to the site that we believe will enhance our users' experience. As we previously noted, we expect the Internet Business Group to continue to be a substantial growth driver for us and to become a large portion of our revenues over time.

In 2009, this has begun to occur. In the first six months of the year, revenue from our Internet Business Group accounted for 32% of our total revenues compared to 19% for the same period of last year.

It is important to remember that substantially all of our business is built around our core dataset, in particular, the hospital and physician data. Our core offerings are built around leveraging these data assets in unique ways for our clients. We have been the leader in provider ratings for over 10 years and continue to innovate our offering.

As we move forward, we expect to more closely tie our offerings together in many of our market areas. By way of example, we have a number of products that are sold into hospitals and other healthcare providers. Our first product in this area was our marketing program that allowed hospitals to market their best-in-class messages.

Over time, we added a quality consultant component for hospitals that were interested in improving quality. Both of these products are housed within our Provider Services business.

We then launched our Connecting Point program, for instance, the one that Tenant operates under, which allows hospitals and other healthcare providers the ability to sponsor physicians on our website and attract the right patient.

As our offering evolves, we look to tie these products more closely so that we are viewed by the provider community as a total solutions oriented company. As our Connecting Point product evolves, we believe this will be an enhancement to the traditional marketing that hospitals conduct under our licensing business and will really take their offline messages and redeploy them and enhance them in an online offering.

We are excited about this evolution and look forward to sharing more of our provider strategies with you in the near future.

That concludes our prepared remarks. Operator, we are now ready to key up questions.

Allen Dodge

Demoli, if you could turn it over to questions now, please?

Question-and-Answer Session

Operator

Sure. (Operator Instructions) Your first question comes from the line of Jackson Spears with The Robins Group. Please proceed.

Jackson Spears - The Robins Group

Could you give us some color on the pressure on margins on the provider side, whether they are more looking at the quality of your traffic; and, two, should we some more large promotion sides somewhat like Fresenius and Tenant in the second half or early next year?

Kerry Hicks

Well, Jack, I'm not sure I completely understand your question.

Jackson Spears - The Robins Group

I'm saying, with healthcare reform coming and there is pressure on margins, would providers more apt to do large promotion side deals with you?

Kerry Hicks

Thanks, Jack. We weren't tracking with you, but now that makes sense. So, our belief and our read of the market is the competition for commercially insured patients is only going to accelerate. We're already seeing some of the, I think, of the beginning of that very strong, I think, structural movement. That is to a large degree over, what, 65% of our traffic is, again the non-Medicare age commercially insured market.

So, we think, if anything, like Pharma, like Med Device, I think there is going to be a broad movement to actually attract the "right patient," but certainly those with the most favorable demographics to hospitals. I think we're uniquely positioned in that provider continuum and that delivery of care to really take advantage of that trend.

Jackson Spears - The Robins Group

Could we see Congress making noise about banning direct-to-consumer advertising on television by drug companies? I should think that's attracting a lot more drug companies at the minimum to test you and begin part of the pipeline. What's going on in that front? Can you give us color on activity on that front?

Kerry Hicks

Again, I was up on Capitol Hill meeting with some of the senior leaders of Congress, as well as our Colorado delegation last week. So, it's fair to say the words that they use is the healthcare reform is both dynamic and fluid, and they use those terms interchangeably. So, it's hard to get a discrete and a very clear read of ultimately what the reform may take.

I do agree with you as it relates to directing advertising in general to patients away from general consumers and being able to traffic that patient level activity, again, which is unique to Health Grades, but again, data that individuals on this call have heard before. Roughly over 80% of our traffic are patients who will be seeing a doctor in 30 days. Over 90% will be seeing a doctor in 60 days.

So, again, we think, again, our position in terms of the provider delivery continuum and really that we become the fulcrum between the patient and the provider, we think, again, is leverageable first and foremost, and we think in all over time that there is tremendous market value in that position.

Jackson Spears - The Robins Group

You mentioned on the call you had two direct-to-consumer drug companies advertising. Could you give us some feel for the magnitude of the size of these programs?

Allen Dodge

Yes. They are contracts, typically, these can last a quarter, they can be six months, and they can be a year. In general, we've seen in the range of six months, say, in excess of around $100,000 in total.

Jackson Spears - The Robins Group

How many products are they doing this with you?

Allen Dodge

They are individual products.

Jackson Spears - The Robins Group

So this is a good first start. Allen, in your income statement you had equity in earnings of investment. What is that?

Allen Dodge

Yes, that relates to a small investment we have with an LLC. It's not material, but it is something where we participate in a healthcare-related entity. It is very small and I don't expect a lot in that area, but we have had seen some operations. This entity has had positive results, so we have recorded an investment in that business so we get some equity earnings from that company.

Jackson Spears - The Robins Group

Lastly, you indicated you're making some progress on your credit card product. Can you give us a little bit more color on what kind of progress, what kind of response, and who you're working with?

Kerry Hicks

Well, we can't disclose who we're working with. Again, for confidentiality reasons, until they actually launch a credit card out in the marketplace. We have all three of our key market segments not only targeted, but we had a customer in each one of those categories.

In the categories, by way of reminder, are very large multi-specialty practices, number one; number two is regional health plans; and number three, is very large health systems, meaning hospital systems. So, we have one in each category. We're moving, I think, deliberately and on a glide path, again, to launch those products at least the two of the three by the end of the year, certainly.

So, we expect to see results. We'll be launching also on our site before the end of the year a direct to patient credit card and we'll probably keep our comments tight around just what I said, and we will give you more color after the launch.

Operator

Your next question comes from the line of Mitra Ramgopal with Sidoti. Please proceed.

Mitra Ramgopal - Sidoti & Company

Yes, hi. Good morning, guys. Just a couple of questions. I noticed you did take up the revenue guidance but kept the operating margin guidance intact. After looking at the first half, it would seem that you are well on your way in terms of getting towards the high end. I was just wondering if you plan on maybe aggressively adding more personnel in the second half, for example.

Allen Dodge

The reason we maintain that guidance is, you're right, we are on the high end. Given that we're exceeding our growth expectations, we also want to make sure that we're investing for what we would say is a future state. Kerry talked a little bit on the call about being more solutions oriented. So to that point, yes, we're continuing to add to the sales personnel here. We want to be aggressive in that endeavor, and we want to make sure that we're building with a focus on 2010 and beyond.

So, the short answer is, yes, we do expect to maintain high margins, but at the same time we want to be very diligent about building and investing for our growth. So, hopefully, that makes sense.

Mitra Ramgopal - Sidoti & Company

Okay. Then just coming back a little on the core provider services business, are you seeing any more competition that might be impacting your ability to grow it out a little more?

Allen Dodge

Not really competition, Mitra. I mean, certainly in our marketing program there isn't a lot of real direct competition. So, I would say there, no, we're not seeing any competition. Certainly on the quality improvement side, the competition we tend to see is a little bit with the hospitals themselves.

I think we do such a great job with our consulting and all the services, and all of the products and solutions around that business, that's certainly a time to compete with the hospital believing they can do that themselves. We know by experience that they don't tend to be able to do that, and frankly some of those tend to come back to us later. So, there is a little bit of internal competition there.

From an overall standpoint, I would point much more to the environment and getting that message across to the hospitals, particularly new hospitals, that there is a strong ROI. This does produce tangible results. Clearly, our clients see that with our strong retention rate.

Mitra Ramgopal - Sidoti & Company

Again, if you look at the balance sheet, you clearly have a lot of cash and the ability to lever that. Given how the Wrong Diagnosis acquisition has turned out, exceeding your expectations, are you tempted to be a little more aggressive in terms of looking for similar opportunities?

Allen Dodge

Well, we set ourselves a high benchmark, certainly, and we're pleased with that initial acquisition. I think we would continue to state what we have stated previously, that we are certainly continuing to vet opportunities as they come up.

If there is something that will fit very well synergistically with the company, increase traffic, provide unique content, all of those things, we remain very active in vetting those companies. We do believe that, particularly in the private equity market, things are beginning to change a bit in terms of valuations.

Similar to the comments we made on the first quarter, I think there is still some pretty high valuation. As that changes, we're certainly opportunistic. That's probably the best language I could use, or best word, I should say.

Operator

(Operator Instructions). You have no further questions.

Kerry Hicks

Well, thank you, everyone, for your time and look forward to circling back to you to announce our third quarter results. Appreciate everyone's time. Thanks.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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Source: Health Grades Inc. Q2 2009 Earnings Call Transcript
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