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Executives

Allen Dodge - Chief Financial Officer

Kerry Hicks - Chairman & Chief Executive Officer

Analysts

Mitra Ramgopal - Sidoti & Co.

Debra Fiakas - Crystal Equity Research

Health Grades Inc. (HGRD) Q4 2009 Earnings Call February 17, 2010 11:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the fourth quarter 2009 Health Grades’ Inc., earnings conference call. My name is Latrice, and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to your host for today’s call Mr. Allen Dodge, Health Grades’ Chief Financial Officer; please proceed, sir.

Allen Dodge

Good morning. Thank you for participating in today’s call with us. Before we begin prepared remarks, I would like to remind 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 based on these factors.

Furthermore, this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, February 17, 2010. This call is being recorded on behalf of Health Grades and is copyrighted material. It cannot be recorded or rebroadcast without the company’s expressed permission. Your participation in this call implies consent to our taping.

On today’s call, Health Grades’ Chairman and CEO, 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’d also like to extend my welcome to everyone on the call today. I’m pleased to have the opportunity to discuss the strong quarter for Health Grades, and also would like to talk about why and how we see continued growth and success going forward. Allen will be providing details on the fourth quarter financial results.

I’d like to begin by highlighting some key metric to the fourth quarter and fiscal year. Allen and I will give more color on each of these points during our prepared remarks as well as in the Q-and-A session.

One; top line revenue growth was 28% over the fourth quarter of 2008 and 32% for the fiscal year 2009 over 2008, 70% operating income for the quarter and 20% for the year, which translate to 57% operating income growth, 80% retention rate with respect to our provider services contract with first or second year anniversary dates for the year.

As of January 2010, we are now reaching 90 million unique visitors to our two web properties. This strong performance comes as a result of our building against three of our top areas of focus and priorities as a company and they are; building the house rates brand with consumers and the healthcare industry, developing and optimizing the advertising sponsorship revenue model and expanding our core provider services business.

For the fourth quarter and the fiscal year, we made significant progress against each of these key initiatives. We measured the strength of the Health Grades’ brand based upon our relevance to the consumer. Really what we mean by the consumer is an activated patient which we will describe in more detail later, and the industry which we defined as both, professional services that has hospitals, providers etc., and the advertising industry meaning Pharma, Medtech major consumer goods, agencies etc.

Our website traffic continues to substantively increase in January 2010, our combined web properties of www.healtgrade.com and www.WrongDiagnosis.com attracted 90 million unique users, an increase of approximately 4.5 million from 14.5 million unique users in January 2009, maintaining our position as one of the top 10 most trafficked healthcare properties as reported by ComScore.

In addition, we have maintained to build upon our dominant position in the provider selection as evidenced by our ranking as number one doctor information resource by TNS Media. The type of consumer we attract to our web properties is just as meaningful as the volume of the traffic we drive. Based upon our recent survey of patients visiting www.healthgrades.com, 82% will be visiting a doctor within 30 days and 91% will be visiting a doctor within 50 days.

The combination of the number of patients we’ve reached as well as the acuity of these patients, we believe puts us in a position to drive and influence patient choice, for hospitals, for doctors, for advertisers in a way that no other organization has in the past. By way of definition, when I refer to acuity I mean that we have a very activated patient, one that has decided by us towards the specialty care.

As many of you have heard me say before, patients do not traffic to Health Grades to manage their flue or their colds. Our patients in many cases have self-triaged and are seeking very targeted information and care selection. In January, we released the Health Grades’ eighth annual hospital quality in clinical excellence study. This study highlighted the significant gap and quality of care between top performing hospitals and all other hospitals.

Based upon our study over our 150,000 patients plus, among Medicare patients alone may have been avoided if all hospitals performed at level of our Five Star institutions. As evidenced by our traffic growth, more and more patients are choosing Health Grades as the size of choice when making critical provider selection decision.

2009 was a break through year for the second strategic imperative, which I’d like to highlight. That is developing and optimizing an advertising sponsorship revenue model. Allen will talk to the specific of our fourth quarter and annual results in a bit, but in some way the majority of the revenue growth this year has come and attributed to our internet business group.

I noted for the last few years that I expect our revenue mix between our provider professional services business and our internet business group to move closer to a 50/50 split. For 2009, this mix moved to 60% provider professional services and 40% internet business group that is inclusive of our Strategic Health Solutions business.

In the year half provider, professional services business represented the global warming maturity of our revenues. This shift is both intentional and a reflex to what we believe to be a transformative growth strategy. Our provider professional service business is helping a static growth engine that provides the foundation for our expansion in a new product that could have been developed from our internet business group.

Although this core business area grew at a rate slightly less than 10% that we anticipated, that you will hear me describing a bit more in detail in my closing remarks, we have made significant investments in personnel in this area and we believe that will continue to be a solid grow driver for us for years to come. We believe there remains significant untapped opportunity in front of us in the provider professional services business.

The most meaningful growth driver on our internet business group in 2009 was our evolution from the majority of our display advertising on HealthGrades.com and WrongDiagnosis.com coming through remnant advertising, Google AdSense for instant.

To more vertical display advertising, the healthcare networks, which commence significant higher ad rates that the remnant inventory.

This is encouraging to us as we see significant opportunity for continued growth in this area by migrating more business to the network and ultimately more directly into adding these and direct advertisers. In summary all of our product offerings in this business have performed exceptionally well this year. Expanding our core provider services business is also an important part of our future growth.

The major factor in our ability to expand this business is to maintain high rates of retention within our existing client base. For 2009, I’m pleased to note that we retained contracts or signed new contracts representing approximately 80% of the annual contract value of hospitals whose contract at first or second year anniversary date. Our strong retention rate is a good gauge of the value we bring our clients to be sure. That being said, 2009 was a challenging environment to sell new business.

In the 2009 study published by the American Hospital Association, 55% of all hospitals were seeing a moderate to severe decrease in inpatient, admissions and 59% were experiencing a moderate to severe decrease in elective procedures. That kind of challenges that hospital state in 2009, created an opportunity for us in that environment and causes us to take a much closer look at all aspects of our provider professional services business and part of our introspective look.

We made a number of fundamental changes in both our sales and delivery model that we feel positions us very well for the future. Some of these changes are (1) nearly doubling the effective size of our sales forces. (2) Moving to a market based sales approach. (3) Placing a premium with our sales team on training and market knowledge.

The impetus for these changes is principally market driven and so far as our product status is aligned with a strategic solution that our hospital clients are seeking. This product set includes our brand building suite of marketing solutions to our quality improvement services, as well as our more recent patient Direct Connect programs, which specifically drives patients to hospital call centers.

However given that historical side, we have had a very little approach to sales, where each salesperson would not have a hospital or the client, for that would have one product to sell. We were not at all times selling strategically or rather transactionally. These changes we have made or are making in this area will give us the opportunity to be much more strategic as a deed value business partner to our clients.

Once again, I am pleased with our fourth quarter results as well as our annual results across all areas of our business. With that, I’d like to turn the call over to our Chief Financial Officer, Allen Dodge, who will discuss our financial results as well as our guidance.

Allen Dodge

Thank you, Kerry. I would like to give a bit more color to each area in terms of our results in addition to reaffirming some important points from our release this morning. The principal growth driver for our strong quarterly annual growth over 2008 was our internet business group, although our provider professional services business did also contribute to that growth as well.

The fourth quarter provider professional services revenue was $8.2 million, an increase of 4% over the same period of 2008. For the years ended December 31, 2009 and 2008, we retained contracts or signed new contracts representing approximately 80% of the annual contract value of hospitals, whose contracts had first or second year anniversary date. We are very pleased with our current retention rate.

With our recent annual ratings launch, we have seen an increase in new sales. We believe and are well positioned to provide substantial and strategic value to our clients. However, given the weakness in new sales throughout 2009, and given that we straight line our revenue recognition in this business unit, it will take some time for us to accelerate our growth in this area into 2010.

In the internet business group we saw a strong growth from all of our product areas. The most significant growth drivers for fourth quarter revenue were the performances of advertising on both, www.wrongdiagnosis.com and the www.healthgrades.com websites as well as our consumer business. The WrongDiagnosis website contributed approximately $1.6 million in revenue for the quarter.

As Kerry noted previously, the most significant driver of our increased in display advertising business is our shift from selling the majority of our inventory through remnant channels to more of that vertical network approach. Our operating margin for the fourth quarter of 2009 was 17% compared with an operating margin of 14% in the fourth quarter of 2008. The operating margin improvement is principally the result of our strong revenue growth.

In addition, we are working diligently to manage expenses. We are hiring and investing in a number of areas such as technology and price developments as well as additional sales team members. Our net income for the fourth quarter was $1.9 million or $0.06 per fully diluted share and this compares with net income of $1.0 million or $0.03 per fully diluted share from the fourth quarter of 2008. Our results of operations included write-off of our investment in Healthcare Credit Solutions.

As many of you know, over the last few years we invested in a Healthcare Credit Card Solutions that was aimed to allow consumers to build points and utilize the card for the healthcare purchases. Although we believe that the concept was a good one, we ultimately decided that the timing was premature from a market prospective, in addition to the market demand more specifically and we chose to exit this business in the fourth quarter.

Although its cost was not material for our fiscal year, I did want to highlight this decision. As a growth company, we believe it is incumbent on us to challenge the status globe and be who we are, that is a disruptive change agent. Some of these investments will work very well; as an example our initial launch to provide our ratings was new to the market in 1998 and is obviously been a tremendous success in the foundations of which this company was built upon and some of those investments will not pan out.

What is important is that we make the difficult decisions when a product is not performing and move on to other more promising initiatives. At December 31, 2009 our cash and cash equivalents were $19.2 million compared with cash and cash equivalents of $11.3 million at the close of 2008. During 2009 we generated $9.2 million in cash flow from operations.

Today we are affirming our financial guidance for 2010, specifically we are forecasting revenue to increase 20% with an operating margin of between 19% and 22%, although we do not get quarterly guidance, given some of the investments Kerry and I described early on the call. We do expect that our margins maybe somewhat lower than our guidance for the first half of the year, and will increase to the high end or above our guidance range for the second half of the year.

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 year. We made substantial progress against our top strategic imperatives I discussed earlier. In addition, we are working on our foundational growth initiatives to really propel growth out in the future.

In closing, I like to highlight some of the significant initiatives underway for 2010 and some of which I touched on previously. These core initiatives are as follows: Implement a one sales organization for provider professional and services; market launch and broad adoption of our patient direct connect product; build our Life Sciences direct sales organization.

I touched on the implementation of our integrated market sales organization earlier on the call. We believe this is an important and fundamental change to our sales approach. We need to and we are elevating the value of our ratings and award products as to become a much more strategic and trusted resource of our hospital clients. The market launch of our patient direct connect product, which against typically is connecting www.healthgrades.com patient population directly to a hospital clients call center.

It’s still in its initial phases, but all are performing exceptionally well. As we noted previously, we have a number of pilots currently running and our focus in the first half of the year are current pilots in a more confidential program, as well as to initiate a number of new pilots. The patient direct connect product is a significant initiative in 2010, and we expect to see this product contribute significant revenues for us.

Finally, we have built out a direct sales force to pursue relationships with ad agencies and directly with Pharma and Med Device Companies. This Group is newly formed and it’s in the process of establishing relationships with the major ad agencies. We expect this group to drive substantial direct sales, particularly in the later half of 2010.

I look forward to reporting on our progress in each of the major initiatives throughout 2010 as well. We thank all of our shareholders for your continued support and interest. That concludes our prepared remarks. Operator, we’d like to open the call now for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mitra Ramgopal - Sidoti & Co.

Mitra Ramgopal - Sidoti & Co.

You mentioned that you’re looking to double the sales force. I was wondering, what’s the size of it as we enter 2010? Are you looking to double it from current levels?

Allen Dodge

We actually have already hired really the positions that we expected to, so we’re really gone from essentially eight fulltime, what we would consider territory reps or new languages, Regional Account Executives, and we’ve doubled that to 16 individuals.

I mean, there are also folks that are going after more the national accounts, so really is more of a shift in both narrowing or making the territory of a little bit smaller, but giving us a broader coverage and really have those sales team members focused on owning an entire hospital relationship rather than selling individual products and have the ability to own the hospital relationship. We drive what’s most relevant to those C-Suite Executives.

Mitra Ramgopal - Sidoti & Co.

Again, I think you mentioned the Health Credit Solutions is one of the things you tried. It obviously didn’t work, but it seems like you’re still going to be pretty active as it relates to new product development, growth initiatives, etc. So it appears it hasn’t sort of slowed you down in your outlook?

Allen Dodge

That was a decision we made, yes pretty much early in the fourth quarter as we looked to wind down the businesses. By virtue of that we thought there were greater market opportunities. So we will add to our portfolio of ratings products.

Again, so the areas and all that would represent high area of interests right, which is like pain management or palliative care for instance emergency department ratings, oncology to cancer ratings, outpatient services, so there’s still broad room from a market end product development prospective.

Then in addition, we fully expect to have other layer products, which are not purely ratings and award based, but are more business intelligence or patient acquisition type of products or surfaces.

Mitra Ramgopal - Sidoti & Co.

In the guidance you have given, is any event sort of built in or is that going to be more in 2011 and beyond?

Allen Dodge

The exceptional growth for the Patient Direct Connect, again we’re going to be conservative with our estimates. Again anytime that we launch a new product, if we’ve learned anything it takes us three times longer as three times more effort that is kind of embedded in that initiative, so we’re going to be conservative and none of that is built into the 2010 guidance.

Mitra Ramgopal - Sidoti & Co.

Finally, you ended the year with a nice cash balance. I think you mentioned you did not buyback any shares in the quarter. Could you remind us as to how much you have available on the share repurchase and would uses of cash include acquisitions, given the success of WrongDiagnosis?

Allen Dodge

Mitra, we have about 700,000 shares left that we could buyback if we chose to go net direction. With respect to acquisitions, we would say that we still remain in really kind of active surveillance mode.

We were very pleased with performing sales and the Adviware acquisition clearly has added quite a bit over the last year in terms of our incremental growth over and above what the run rate was when we acquired that business, but we want to be very cautious about any other investment we may make, to make sure that it has substantial upside chart as well.

So we will continue to look without that and it will be coming as a more of build versus buy if there are things that we would like to build, and really connect in particular patients and physicians, hospitals and will be to an extent, as well as potential on the content side, so along with direct and targeted content and not general content for content sake. So one way to answer that is saying we are in surveillance mode, but not something that is eminent on the horizon soft.

Mitra Ramgopal - Sidoti & Co.

Allen, the tax rate, I note that it was affected in the fourth quarter because of the write-down, but for 2010 we should expect again return to more normal levels?

Allen Dodge

Yes, our expectation is around 38% maybe a couple of points higher than that, meaning between 38% and 39%, but our target is right around 38% for 2010.

Operator

Your final question comes from Debra Fiakas - Crystal Equity Research.

Debra Fiakas - Crystal Equity Research

Just to go back to the questions about the sales force, it seems like you doubled your sales force. Did this include just simply new hires or did you sort of change out your existing sales force to hire a different kind of talent?

Allen Dodge

Yes it’s a great question Debra and the short answer is it’s really both. One thing we have learned among many things over the years is the type of sales persons we’re looking for; is one that has a great deal of experience in strategic selling and a lot of focus on the C-Suite. Certainly health care experience is also very important, but to your point, yes there were a number of individuals I would say at the end of ‘08 early in 2009 that were just not the right fit and we did swap those individuals out.

So some of that effective doubling is replacing individuals with folks that we do think now do have the right skills, that as we looked backed at what has made our best reps most successful. So again, really it’s a little bit of both, but in terms of what we believe is kind of effective sales force, it is close to a doubling and that is in place to that.

Debra Fiakas - Crystal Equity Research

Then in regard to the Patient Direct Connect pilots that you are running, you apparently have sufficient sales and promotional people for that program, but when you roll it out to everyone into the country, will you need to invest in additional infrastructure, website programming, that sort of thing, in order to make it go full scale?

Allen Dodge

There will be some; I would call modest infrastructure costs, which are more on the client’s services side, frankly not on the sales side. As we move to this integrated market sales organization, it’s a Regional Account Executive that’s going to be responsible for selling all products and services into an account or into a market. So there’s no additional ad on the sales side and there are incremental costs that I would characterize those to and it’s actually marginal to modest as it relates to the client services.

Debra Fiakas - Crystal Equity Research

Then in regards to WrongDiagnosis, now that you’ve been working with them for a period of time, do you plan any changes or investments in WrongDiagnosis or are they kind of in a steady state, borrowing your words from your initial remarks?

Kerry Hicks

We’re certainly pleased with the performance. Again we will continue to augment and I think improve the consumer experience on both properties, looking at much more integration between the two sites and then lastly is to make sure that we are truly patient facing as it relates again to patients making decisions at critical time periods.

So our contract between both sides is to do without that unique position between the patient and the provider and our ability again to match, not only if there’s Pharma, Medtech, because that’s obviously relevant, because you need typically a physician to write the order or implant any device.

Again if that unique conduit was, we sit right between the patient and the provider and how we are helping the patient essentially migrate rather than how we are helping them, assisting them in their activities as it relates to making meaningful health care decisions.

Operator

There are no further questions at this time. I would like to turn the call back over to Mr. Allen Dodge for closing remark.

Allen Dodge

Thank you everybody for the participation on the call and again we are very pleased with the quarter and the year, and we look forward to continuing to report on our results through the remainder of 2010.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and everyone have a wonderful day.

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Source: Health Grades Inc. Q4 2009 Earnings Call Transcript
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