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Executives

Kerry Hicks - Chairman and CEO

Allen Dodge - CFO

Analysts

Jack Spears - Gar Wood

Health Grades Inc. (HGRD) Q2 2010 Earnings Call July 28, 2010 4:15 PM ET

Operator

Good day ladies and gentlemen, and welcome to the Health Grades Incorporated second quarter 2010 earnings conference call. My name is Alicia and I will be your coordinator for today. At this time, all participants are on a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) I will now like to turn the call over to Mr. Allen Dodge, Chief Financial Officer. Please proceed.

Allen Dodge

Good afternoon. Thank you for participating in today’s call with us. Before we begin prepared remarks, I would like to remind you that this conference 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 fillings with the Securities and Exchange Commission, which are available at www.fcc.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, 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 and to our (inaudible).

On today’s call Health Grades Chairman and CEO, Kerry Hicks will provide a company update and discuss business highlights. I will review the financial results. Following our prepared remarks we’ll 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 solid quarter for Health Grades. Allen will be providing additional detail on the second quarter results. While our call today will focus on second quarter results, I also want to acknowledge the additional release from this morning announcing that Health Grades has agreed to be acquired by an affiliate of Vestar Capital Partners.

The purchase price is $8.20 per share, which represents a premium of 32% over our 30 day average closing stock price in premium of 29% over the closing price of our common stock on July 27, 2010 the last trading day prior to today’s announcement. We expect to file certain documents with the SEC within the next couple of weeks, which will provide additional detail with respect to this transaction. Questions surrounding that transaction we’ll differ to the filing of the documents with the SEC.

With that I would like to turn to our second quarter results. I would like to begin by highlighting some key metrics for the second quarter. Allen and I will give more color on each of these points during our prepared remarks.

Our top line revenue growth was 25% over the second quarter of 2009. We achieved a 22% operating margin for the quarter with 34% operating income growth over the second quarter of 2009. We added 77% retention rate with respect to our professional services contract with the first or second year anniversary date for the first six months ended June 30, 2010.

The unique visitors to our web properties increased 50 million to 54.1 million for the second quarter, which represents 38% growth over the second quarter of 2009. For the first six months of the year we made significant progress against several of our key initiatives. The two initiatives upon which I would like to focus on our developing and optimizing the advertising and sponsorship revenue model, and the continued evolution of our provider, professional services sales and delivery model from being product focused to market focused. We continued to build out our advertising and sponsorship model with 50% revenue growth in this business in the second quarter of 2010 over the same period of 2009; we are pleased with the results.

We are continuing our evolution of providing more information free to consumers on our website properties. Specifically our focus is on increasing free or organic traffic and improving our revenue mix, for both Health Grades and the WrongDiagnosis web properties. As I mentioned earlier the unique visitors to our web properties increased 50 million or 38% in the second 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 we do not pay a fee for this traffic intrinsic value of the user who comes to us through organic search, his factor sounds more valuable than a user that is generated through paid search. We think this is a significant key differentiator for Health Grades against many other competitors, and others looking to build an online presence in Healthcare.

As far as our efforts continue to differentiate our technology assets, I’m pleased to announce our acquisition of HealthWorldWeb. Allen will provide financial details of this acquisition, but this internet based social decision platform related to the Medical and Healthcare industry we believe provides us with a number of unique opportunities. More specifically, the platform includes community tools, content syndication, semantic search and a proprietary recommendations engine. The engine applies pager profiles to make relevant recommendation using proprietary artificial intelligence. The recommendation engine can be turned by the user and also to establish authority of Health Grades recommendation based on six data points. In addition, applications and tools help patients apply collective knowledge to help make better, more informed decisions about physicians and potentially treatments, recovery et cetra. We are excited about the opportunities this asset provides us.

I also want to give you an update on significant progress we made against our evolution and provider professional services, sales and delivery model from being product-focused to market-focused. We are pleased with the early results of this shift. As we noted, when we initially released our 2010 annual guidance, our annual revenue increased for our provider professional services business targeted at 10%. Our achievement of 10% growth in the second quarter is an indication that the changes that we have made and continue to make in this business are beginning to produce the desired results.

Once again I’m pleased with our second quarter results across all areas of our business. With that I’d like to turn the call over to Allen, our Chief Financial Officer who will discuss our financial results and update 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 points from the release. For the second quarter our professional services revenue was $8.6 million and increase of 10% over the same period of 2009.

For the six months ended June 30, 2010 we retained contracts or signed new contracts representing approximately 77% of the annual contract value of hospitals whose contracts had first or second year anniversary dates, compared to 76% for the same period of 2009. We are pleased with our current retention rates. We are also beginning to see some improvement in hospital management’s willingness to sign new contracts. Keep in mind however, given the weakness in new sales throughout 2009 and given that we straight-line our revenue recognition in this business unit, it will continue to take some time for us to accelerate growth in this area to remainder of 2010.

In the Internet business group, we saw strong growth from all of our product areas. The most significant growth drivers for second quarter revenue with performances of advertising on both healthgrades.com and WrongDiagnosis.com websites, as well as certain portions of our sponsorship business. Revenues from our display advertising on our Web properties was up $1.4 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 $1.2 million from our sponsorship programs, which we call Patient Direct Connect. As Kerry mentioned, we are beginning to see some conversion of our pilot programs in the meaningful annual contracts.

Our operating margin for the second quarter of 2010 was 23%, a slight increase over the second quarter of 2009 operating margins of 21%. Our net income for the second quarter was $3.2 million or $0.10 per fully diluted share. Our adjusted net income was approximately $2.2 million and our adjusted diluted earnings per share was $0.07 for the quarter. As of June 30, 2010 our cash and cash equivalents were $24.6 million compared with cash and cash equivalents of $19.2 million at the close of the 2009. For the six months ended June 30, 2010 we generated $7.8 million in cash flow from operations.

As Kerry mentioned, effective July 12, 2010 we completed the acquisition of certain assets of HealthWorldWeb. The consideration paid for the assets consists of an upfront cash payment of $750,000 and contingent consideration with an aggregate potential payout of $1.5 million. Contingent consideration is payable up to $50,000 for 2010, $650,000 for 2011 and $800,000 for 2012 based upon certain levels of page view targets. As Kerry mentioned, we are excited about the opportunities this acquisition brings to the company.

With respect to 2010 guidance today we are affirming our financial guidance for 2010; specifically we are forecasting revenue to increase at approximately 20% over 2009 with an operating margin of 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 pleased with our operating results for the second quarter. As a reminder although I recognize there maybe a number of questions regarding today’s announcement with respect to our agreement to be acquired by an affiliate of Vestar Capital Partners. I am still reiterating some of the comments I made at the beginning of this call. We will need to refer you to the filings that will be made with the SEC over the coming weeks.

As always, we want to thank you for your participation on the call, this concludes our prepared remarks. Operator we are now ready to open the call to questions please.

Question-and-Answer Session

Operator

(Operator Instructions) And the first question comes from the line of Jack Spears with Gar Wood. Please proceed.

Jack Spears - Gar Wood

Kerry, congratulations on finally getting the regulation you should have virtually deserved, could you give us a feel for what the traffic is on WrongDiagnosis and Healthcare to as of July or whatever the most recent? And the reason I’m asking that is to get a feel for what your patient connect pipeline looks like.

Kerry Hicks

Yes, so a couple of points there. We don’t breakout our traffic between the properties. It indicates all our visitors to the web properties increased 50 million to 54.1 million for the second quarter, which represents a 38% growth over the second quarter of 2009. How that factors into the patients direct connect product or service, we are seeing a broad market interest. We are seeing a reasonable conversion to contracts, we are still in a testing mode with many clients who would, generally speaking opt for a trial or a pilot and convert after that period of time. So, the outlook for that product or service looks sustainable, but like most of the products on that we have introduced in the marketplace know that we are the innovator, market adoption is something rather difficult to predict.

Jack Spears - Gar Wood

What kind of results are your clients of Patient Connect getting? Are they willing to sign contracts, how are their reaction to it?

Kerry Hicks

It is positive. We are seeing very positive results as measured by both call volume and transfers of patients again to affiliated physician practice groups. So we’ve not released any of those metrics, we are just inclined to for competitive purposes, but our clients are tracking those and we have yet to see or experience any client who is not pleased with the results today.

Operator

And ladies and gentlemen, this concludes the question-and-answer session for today’s call. I will now like to turn the call over to Mr. Kerry Hicks for any closing remarks.

Kerry Hicks

I appreciate everyone’s interest. My closing remarks would be, stay tuned we’ll be filing documents with the SEC with respect to the announcement this morning, and we’ll keep everyone apprised of the activity. Thank you, very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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