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Health Grades, Inc. (HGRD)

Q1 2010 Earnings Call Transcript

April 21, 2010 11:00 am ET

Executives

Allen Dodge – EVP and CFO

Kerry Hicks – Chairman and CEO

Analysts

Mitra Ramgopal – Sidoti

Debra Fiakas – Crystal Equity Research

Operator

Good day, ladies and gentlemen and welcome to the first quarter 2010 Health Grades, Inc. conference call. My name is Tamina, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

(Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, 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 facts, 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, April 21, 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 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 also like to extend my welcome to everyone on the call today. I am pleased to have the opportunity to discuss a strong quarter for Health Grades and also talk about why and how we see continued growth and success going forward. Allen will be providing details on the first quarter results. I would like to begin by highlighting some of key metrics for the quarter. Allen and I will give more color on each of these points during our prepared remarks.

One, our topline revenue growth was 20% over the first quarter of 2009. Two, we achieved a 20% operating margin for the quarter. Three, we had an 80% rate with respect to our Professional Services contract with first or second year anniversary date that lasted during the quarter. Four, the unique visitors to our web properties increased 15.9 million to 57.4 million for the first quarter, which represents a 38% growth over the first quarter of 2009.

I will focus my comments on progress we made during the first quarter on two strategic initiatives. Although we have a number of strategic initiatives that we continue to make meaningful progress against many of them, I wanted to give you more color on two I consider to be the most significant. Those initiatives are developing and optimizing the advertising and sponsorship revenue model, and evolution in our provider services sales and delivery model for being product focused to market focused.

There are a number of factors to the development and optimization of our advertising and sponsorship model. The most tangible measure of success against this initiative is revenue growth in our Internet Business Group. With 40% revenue growth in this business in the first quarter of 2010 over the same period of 2009, clearly we are executing well against the strategic initiative. In terms of our development and optimization efforts, our focus is on increasing free or organic traffic, and improving our revenue mix for both Health Grades and the Wrong Diagnosis web properties.

As I mentioned earlier, the unique visitors to our web properties increased roughly 16 million or 38% in the first quarter compared to the same period of 2009. As many of you know, we are committed to grow our traffic not by paying for key words on Google and other search engines, but rather through organic search. Today, approximately 98% of our web traffic from our combined properties comes through organic search that means to put fundamentally that we do not pay a fee for 98% of our traffic.

The intrinsic value of the user who comes to us through organic search is factor [ph] times more valuable than a user that is generated through paid search as you can well imagine. We think this is a significant differentiator to Health Grades against many other competitors and others looking to build an online presence in healthcare. Many companies have attempted to build healthcare web properties and drive traffic through paid search. That certainly works to drive traffic however, it is not the right traffic and the model in our opinion is just simply not sustainable.

The easiest way to explain this is give an industry example. For companies that are in the auto industry, for example, it makes sense for them to pay for direct consumers who may be looking at other consumer goods through a car buying website. Arguably consumers who are looking for consumer goods may have an interest in purchasing a car. However, in healthcare, the opposite is true. Consumers actively avoid healthcare ad until such time that they have a direct and immediate need. And while it may be important for many of our clients from a branding perspective in the hospital industry to be known as a quality provider in general image ads, there need to be a tangible benefit in securing consumers that have an immediate need to a healthcare website such as Health Grades.

As such our approach has been and continues to be to differentiate our web properties by continuing to add impactful and targeted healthcare content and search engines optimize this content. On HealthGrades.com this comes through the addition of meaningful physician (inaudible) element such as health plans accepted, which we launched in the first quarter, and additional hospital ratings and awards such as transplant awards, which we launched at the end of 2009 among other items.

For Wrong Diagnosis, we continued to expand on the breadth and depth of the disease and condition content. Since we acquired this web property in October 2008, we have expanded the number of diseases and symptoms from 12,000 and 4,500 respectively to 20,000 and 10,000 respectively.

With respect to improving our revenue mix, we have made significant progress on HealthGrades.com. We now derive a meaningful revenue stream from our sponsorship program sold to hospitals and single specialty providers, which we now call Patient Direct Connect, which for many of you on this call you have known as Connecting Point. Patient Direct Connect is a highly patient targeted hospital marketing program that is deployed online. Based on our first quarter results, we are on a run rate of roughly $8.4 million for 2010. This includes revenues related to our tenant and Fresenius contracts, our legacy Connecting Point contracts, as well as recent conversions of some of our patient direct pilot into more substantial longer-term opportunities.

With respect to our Wrong Diagnosis web property, we are still in the very early stages of our direct sales effort. We do now have several dedicated sales representatives who are building relationships and working to close sponsorship deals with advertising agencies, pharmaceutical, and medical device companies.

Lastly, I want to give you an update on the significant progress we made against our evolution in our provider Professional Services sales and delivery model from being, what I would characterize as, product focused to a much more market focused approach. As we noted on our fourth quarter earnings call, we recently nearly doubled the effective size of our sales force with the expansion in the size of our sales team we contracted the sales territory, but also gave our sales reps the ability to sell all of our provider Professional Services products directly.

Previously, we had a dedicated sales team that was responsible for the sales of one of our three core products. Now, each of our professional reps is responsible for selling all three of our core products that is our traditional marketing programs, our quality improvement services, and our physician sponsorship programs into their territory. As of March, we have fully integrated the new sales orientation. All of our sales team members have been trained on each of the product offerings and have completed a certification program with respect to an integrated sales approach. We believe this approach positions Health Grades – more directly aligns our sales team with our clients delivery personnel, and we expect not only increase sales from this approach but also more satisfied clients that will not only remain with Health Grades but also see the value of increasing their investment or their spend with Health Grades.

Once again, I am very pleased with our first quarter results across all of our areas of our business, and with that I would 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 press release.

In the first quarter our Professional Services revenue was $8.4 million, an increase of 5% over the same period of 2009. For the quarter ended March 31, 2010, we retained contracts or signed new contracts representing approximately 80% of the annual contract value of hospitals who contracts had first or second year anniversary dates. We are very pleased with our current retention rates.

We are also beginning to see meaningful improvement in hospitals management willingness to sign new agreements. As evidence to this point, the annual contract value of new sales in the first quarter of 2010 is at 50% over the first quarter of 2009. Keep in mind however, that given the weakness in new sales throughout 2009 due to the economic environment, and given that we straight lined our revenue recognition in this business, it will take some time for us to accelerate our growth in this area in 2010.

In the Internet Business Group, we saw strong growth from all of our product areas. The most significant growth drivers in the first quarter revenue are good performance of advertising on both WrongDiagnosis.com and HealthGrades.com websites, as well as our sponsorship business. Revenue from our display advertising on our web properties was up $1.5 million from the same period of 2009, principally due to the significant traffic increase from the prior year. In addition, we saw an increase of approximately $600,000 from our hospital sponsorship programs, which we now call Patient Direct Connect. As Kerry mentioned, we are beginning to see conversion of some of our pilot programs into meaningful annual contracts.

Our operating margin for the first quarter of 2010 was 20%, which is consistent with the first quarter of 2009. Our net income for the first quarter was $1.9 million or $0.06 per fully diluted share, and this compares with net income of $1.6 million or $0.05 per fully diluted share in the first quarter of 2009. As of March 31, 2010, our cash and cash equivalents were $23.1 million compared with cash and cash equivalents of $19.2 million at the close of 2009. During the first quarter of 2010, we generated $5.7 million in cash flow from operations.

Today, we are affirming our financial guidance for 2010. Specifically, we are forecasting revenue to increase 20% over 2009 with an operating margin between 19% and 22%.

With that, I would 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 quarter. We made substantial progress against our top strategic imperatives, as I discussed earlier. In addition, we continued to work on our foundation for continuous future growth. In closing, I want to highlight some of the significant initiatives underway for 2010, and which you can expect me to update you on throughout the remainder of 2010.

The four-quarter [ph] initiatives are as follows. One, implementation of a one field organization for provider professional services and doubling the effective size of our sales team; two, market launch and its option of our Patient Direct Connect product; three, build out of our Life Sciences direct sales organization; four, continued substantial organic traffic growth.

I touched on the implementation of our one sales organization earlier on this call. We believe this is an important and fundamental change to our sales approach and we are beginning to see positive results from this change. The market launch of our Patient Direct Connect product connecting HealthGrades.com patient population directly to our hospital call center is still in its initial phases but is performing exceptionally well.

As we noted earlier on the call, we are beginning to covert some of our pilots into significant annual contracts. Our focus continues to be to convert our current pilots in a more comprehensive program, as well as to initiate a significant number of new pilots, and indeed new longer-term contracts. The Patient Direct Connect product is a significant initiative in 2010 for us.

Finally, we now have a direct sales force in place to pursue relationships with ad agencies and directly with pharmaceutical and medical device companies. This group is newly formed and it is in the process of establishing relationships, leveraging those relationships, and selling it to the major ad agencies as well as directly to pharma and med tech.

I look forward to reporting on our progress in each of these major initiatives throughout 2010. As always, we want to thank all of our shareholders for your continued support. That concludes our prepared remarks. Operator, we are now ready to open the call to questions please.

Question-and-Answer Session

Operator

Certainly. (Operator instructions) Our first question comes from the line of Mitra Ramgopal with Sidoti. Please proceed.

Mitra Ramgopal – Sidoti

Yes, good morning. Just a few questions, first, Kerry, if you can just help me again with the investments you have made in the sales force, the plan I think was to double it, if you can say how many sales people you have right now and what is kind of the plan by the end of 2010?

Kerry Hicks

Sure. So going forward our effective sales people are roughly eight, those who contributed any sales to the organization and we have doubled that to 16. So that plan has been in place. It has been effectuated and the date for that was March 1 of this year.

Mitra Ramgopal – Sidoti

Okay. So pretty much the bulk of the investment is – you might add incremental but not to the same extent as we saw.

Kerry Hicks

That is correct, Mitra.

Mitra Ramgopal – Sidoti

We saw really nice growth if we look at the Internet ad sponsorship revenue, I do not know if you can add some more color in terms of what the kind of sources you are seeing, anything incremental?

Kerry Hicks

It is really across the enterprise and let me caveat that, with the exception of our “consumer sales.” So our consumer sales will either be direct consumer report or our subscription service called Watchdog. The other two parts of the business which is obviously selling direct to the ad agencies, and then through the vertical network as well as sponsorship all of those – the latter two in terms of the three legs of the stool, those last two really drove the growth in that our business unit.

Mitra Ramgopal – Sidoti

Okay. And I know you mentioned one of the big focuses here is on Patient Direct Connect. Clearly you have had a lot of success with the Fresenius relationship. Going forward, is it likely you are going to be announcing more such relationships or you are just going to incorporate everything and not break it out?

Allen Dodge

Yes, (inaudible) Mitra, it is a very good question. One, there is a competitive dimension you know again to that product offering, and there is tremendous amount of IP that we have put against it. So we want to be protective of that position as well as our IP. Second is there is a competitive issue too. So many of our clients actually signed, the contracts that they signed, part of the agreement is a confidentiality provision that we cannot disclose to any third-party which unfortunately also means our investors. So, even if we were allowed to we would be somewhat hesitant but you ought to expect as we expect, again, in the Internet Business Group and for that to build, and we report on our overall run rate quarter over quarter in 2010 in that line item.

Mitra Ramgopal – Sidoti

Okay and a noted goal was – you were on track as you said to exceed over $8 million in revenue for 2010, what was it in 2009?

Allen Dodge

Yes in 2009, our Connecting Point, kind of our sponsorship program, was closer to about $5.5 million.

Mitra Ramgopal – Sidoti

Okay thanks, Allen I do not know if you can help us with Wrong Diagnosis in terms of how much revenue was contributed in the quarter?

Allen Dodge

Yes, we have not broken up the quarter anymore given that we have a full year baked in, but it was close to $1.7 million in the first quarter, so going forward our expectation is that we really look at the two web properties combined now, we look at that really as our display advertising business. So, going forward, you could expect us really to talk more of that as one unit versus breaking it up.

Mitra Ramgopal – Sidoti

Okay thanks, and on the gross margin if I recall back in 2009, the numbers were probably a little different by a couple of hundred thousand, was anything sort of reclassified?

Allen Dodge

Yes, it is a good point Mitra, there was just a couple of hundred thousand dollars. We just did a little bit more looking into some of the cost of sales associated with the Internet Business Group in particular, so to your point, it is not significant, it was about $250,000 maybe $285,000, but the comparability is still the same. You can still see that our gross margin has remained roughly equivalent around 82%, 83%.

Mitra Ramgopal – Sidoti

Right and final question, I saw a nice build in cash, again any – as you look for users outside of the existing investments you are making, any thoughts in terms of potential acquisitions or anything like that?

Kerry Hicks

We are probably screened and we have an individual (inaudible) is dedicated to that effort. And we probably screened somewhere close to 50 different companies or even web properties. We are down to in essential six, we are betting those, it is always (inaudible) and I think our venture should expect to offer us to take a very conservative approach. I think you will see the result from that conservative kind of discipline in our performance of the Wrong Diagnosis website. But, we are active in the space, but we are highly sensitive to dilution obviously, and we are highly sensitive strategically again to make absolutely certain that any acquisition does indeed meet a strategic imperative of ours, which is unique content, unique patient level, traffic, any asset that helps us connect to our position, so it would be those three big categories, there are probably others, but those are the ones that come to my mind now.

Mitra Ramgopal – Sidoti

Great, thanks again guys.

Operator

Our following question comes from the line of Debra Fiakas with Crystal Equity Research. Please proceed.

Debra Fiakas – Crystal Equity Research

Thank you. I wanted to ask about a follow-up on your comments during your opening remarks Kerry, about the implementation of the unified sales organization, you mentioned positive results, and I wondered if you can tell us what kind of results are you seeing? Is that simply that your pipeline has got more opportunities in it or you are seeing better conversion of leads to sale, what is happening now?

Allen Dodge

Yes, Debra this is Allen, actually a number of those things are happening. We are building a bigger pipeline and now that we have really condensed the territories and better aligned that sales team with our client delivery professional personnel who actually had historically and will continue to have significant relationships with those clients as well, but we are seeing more sales, as I mentioned earlier on the call, our sales in general our closed annual contract value is up 50% in the first quarter of 2010 versus the first quarter of 2009.

So, I think it is going to continue to take more time to keep building that but, yes our pipeline is increasing, selling more than we ever have in the previous year, again I think that better alignment we expect will continue to show us better results as we get into the latter part of this year.

Debra Fiakas – Crystal Equity Research

Okay, I think it was Kerry who mentioned or perhaps it was you, Allen, who mentioned that you are converting the hospital pilots at a greater rate, do you attribute that to simply the economic recovery or is this also an element of this new approach to your sales strategy?

Allen Dodge

Yes, it is a good question. As a point of clarification, when we talked about converting the pilot, the only pilots that we put in place are pilots related to the Patient Direct Connect program. So, our traditional marketing programs, what you historically know as our strategic quality initiatives, strategic quality partnership, our traditional ratings business that we continue to sell as annual agreement. The Patient Direct Connect, given that is a newer product offering and sold in a different way, it is more based on the number of times the Patient Direct Connect module is displaced on a page.

So, in essence, it is variable but dependent on the search traffic that comes to our site. That we are selling more initially as a paid pilot and so what we have suggested is, some of those pilots were in place in 2009, and some of those now are beginning to convert to annual contract agreement. Hopefully that makes sense.

Debra Fiakas – Crystal Equity Research

Okay, so it is really just a matter of having established the relationships in the first place.

Allen Dodge

That is right. It is a matter of establishing those two or three-month pilot programs, hospitals seeing success, seeing the value that those programs deliver and then signing a more longer term annual agreement.

Debra Fiakas – Crystal Equity Research

Okay, excellent, thank you.

Operator

We have no further questions at this time.

Allen Dodge

We appreciate your time for updating on our Q2 call. Again thanks to everyone for your continued support.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect and have a wonderful day.

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