##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-K
  þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2008 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE TRANSITION PERIOD FROM
 _______ 
TO
 _______
 Commission file number 0-22019
 HEALTH GRADES, INC.
  DELAWARE(State or other jurisdiction
    
    62-1623449of incorporation or organization)
    
    (I.R.S. Employer Identification No.)500 Golden Ridge Road, Suite 100GOLDEN, CO
    
    80401(Address of Principal Executive Offices)
    
    (Zip Code)
   Title of each class
    
    Name of each exchange on which registeredCommon Stock, $0.001 par value per share
    
    The Nasdaq Stock Market LLC(Nasdaq Global Select Market)
   Yes o No þ
 Yes o No þ
 þ o
 o
  Large Accelerated Filer o
    
    Accelerated Filer þ
    
    Non-Accelerated Filer o
    
    Smaller Reporting Company o(Do not check if a smaller reporting company)
 o þ




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##### 



PART IItem 1. Business
    
    
    3Item 1A. Risk Factors
    
    
    15Item 1B. Unresolved Staff Comments
    
    
    22Item 2. Properties
    
    
    23Item 3. Legal Proceedings
    
    
    23Item 4. Submission of Matters to a Vote of Security Holders
    
    
    26PART IIItem 5. Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    27Item 6. Selected Financial Data
    
    
    30Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    31Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    38Item 8. Financial Statements and Supplementary Data
    
    
    39Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    65Item 9A. Controls and Procedures
    
    
    65Item 9B. Other Information
    
    
    67PART IIIItem 10. Directors, Executive Officers and Corporate Governance
    
    
    67Item 11. Executive Compensation
    
    
    67Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    67Item 13. Certain Relationships and Related Transactions, and Director Independence
    
    
    67Item 14. Principal Accountant Fees and Services
    
    
    67PART IVItem 15. Exhibits and Financial Statement Schedules
    
    
    68Exhibit 10.1Exhibit 10.6Exhibit 21.1Exhibit 23.1Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  Special Note Regarding Forward-Looking Statements
   2




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##### Table of Contents



BUSINESS
 Overview
   www.healthgrades.com
 
    
    Over 5,900 hospitals;
 
    
    Over 750,000 physicians in more than 125 specialties; and
 
    
    Over 15,000 nursing homes.
  www.healthgrades.com
 www.healthgrades.com
   3




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www.healthgrades.com
 www.WrongDiagnosis.com www.CureResearch.com
 Healthcare Provider Quality Information
  www.healthgrades.com
 Hospital Specialty and Programmatic Ratings 
    4




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##### Table of Contents



Institutional and Service Line Hospital Awards 
  1.
    
    Calculated the average overall star rating for each hospital by averaging all their
MedPAR-based ratings.2.
    
    Calculated the average z-score (standard score) for each hospital by averaging all their
MedPAR-based z-scores.3.
    
    Ranked hospitals in descending order by their average star rating within the two groups:
teaching and non-teaching.4.
    
    Broke ranking ties by average z-score.5.
    
    Selected the top 20 percent of hospitals from each group.6.
    
    Excluded hospitals whose average star rating was less than 3.42.7.
    
    Designated the hospitals that remained on the list as 2009 DHA-CE recipients.
    
    
    More than 100 survey responses;
 
    
    At least 50 acute care beds; and
 
    
    A minimum HealthGrades average star rating of 2.5.
  5




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Physician Quality Reports
 WatchDog Subscription
 Connecting Point 
 Nursing Home Ratings
  6




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##### Table of Contents



Information and Related Services for Hospitals, Employers, Consumers, Benefits Consulting Firms,
Payers, Professionals, and Pharmaceutical and Medical Device Solutions
 www.healthgrades.com
 Services for Hospitals
 
    
    Cardiac;
 
    
    Orthopedics;
 
    
    Vascular;
 
    
    Pulmonary;
 
    
    Neurosciences;
 
    
    Gastrointestinal;
 
    
    Critical care;
 
    
    General surgery;
 
    
    Bariatric surgery;
 
    
    Prostate surgery;
 
    
    Maternity care; and
 
    
    Womens health.
 Strategic Quality Initiative (SQI)
  
    
    Our name, logo, stars and current ratings data including performance score;
 
    
    National designation (e.g., Top 5% in the Nation, Top 10% in the Nation) as applicable;
 
    
    Specialty Excellence Award for a licensed service line as applicable;
 
    
    State rank (e.g., Best in State, Best in Region) as applicable (not available for
maternity care or womens health);
 
    
    Marketing messages developed and approved by HealthGrades;
 
    
    Quality Ratings Analysis (QRA) to help hospitals understand the data methodology
underlying their ratings and what they can do to continue to improve their quality;
 
    
    Ratings comparisons developed and approved by us;
 
    
    Detailed analysis of client outcomes to understand individual star ratings; and
 
    
    Competitive comparisons to use in service line market positioning.
  Strategic Quality Partnership (SQP)
 Americas 50 Best Hospitals
 
    
    All of the SQP features described above;
 
    
    Either the Americas 50
Best Hospitals trophy or the standard DHA-CE trophy;
 
    
    Customized video featuring a HealthGrades executive congratulating the hospital on the
Americas 50 Best Hospitals Award;
 
    
    One additional on-site visit by a HealthGrades senior consultant or vice president for
Chief Executive Officer media training; and
 
    
    Services for the clients Chief Executive Officer to help the client learn how to best
discuss quality with the media.
  7




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Distinguished Hospital Program for Patient Safety (DHP-PS)
 
    
    HealthGrades name and logo;
 
    
    Distinguished Hospital Award for Patient Safety designation and trophy for that year;
and
 
    
    Marketing messages developed by HealthGrades.
  Outstanding
Patient Experience Award (OPEA)
 Quality Assessment and Implementation (QAI)
 Quality Assessment (QA)
 Quality Report for Hospital Professionals  Clinical Service Line
 Quality Report for Hospital Professionals  Patient Safety
 Health Management Suite
 Find a High-Quality Provider:
 Hospitals
 Physicians
 Nursing Homes
  8




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Home Health
 Provider Select
 Estimate Healthcare Costs:
 Treatment Cost Calculator
 Medication Cost Calculator
 Optimize Your Health:
 Health Risk Assessment
 Personal Health Record
 Medical Library
 Healthcare Quality Reports for Professionals
 Nursing Home Quality Report for Professionals
 Hospital Quality Report for Professionals
 
    
    Risk and severity-adjusted performance measures for cardiac, neurosciences, stroke,
vascular, orthopedics and pulmonary service lines, as well as the underlying medical issue
for each service line;
 
    
    Programmatic ratings for womens health and obstetrics;
 
    
    Comparative statistics and state/national benchmarks;
 
    
    Infections, complication and mortality rates; and
 
    
    Cases At Risk analysis, which projects how many cases are likely to have adverse
outcomes based upon our proprietary mortality or complication rate analysis.
 Healthcare Quality Reports for Consumers
  9




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Hospital Quality Report
 
    
    Ratings for all procedures and diagnoses rated by HealthGrades for the hospital;
 
    
    Survey data prepared in connection with the Leapfrog Group;
 
    
    Our methodology and helpful hints for choosing a hospital; and
 
    
    Cost data.
 Nursing Home Quality Report
 
    
    Our rating for the particular nursing home;
 
    
    Health survey history with descriptions and severity of the deficiencies for the last
four licensing surveys;
 
    
    Instances of repeated deficiencies;
 
    
    How the nursing home compares to others in the state; and
 
    
    Our methodology and helpful hints for choosing a nursing home.
 Physician Quality Report
 
    
    Addresses and phone numbers;
 
    
    Specialties;
 
    
    Board certification information;
 
    
    Education information, including medical school, year graduated and residency,
fellowships and internships;
 
    
    Physician memberships and associations;
 
    
    Malpractice data;
 
    
    State and federal sanction information (if any) within the last 5 years;
 
    
    Name and address of area hospitals and affiliated hospitals;
 
    
    Group practice;
 
    
    Gender;
 
    
    Languages spoken;
 
    
    National comparative statistics in board certification, years in practice and sanction
activity regarding physicians in the same specialty field; and
 
    
    Information on how to choose a physician with a checklist and guide.
  
    
    Physician profile (free)  includes physicians name, address, specialties and health
plans accepted among other items;
 
    
    Patient ratings (free)  experience surveys completed by our users;
 
    
    Hospital affiliations (free)  hospital name and our ratings by clinical services area
for hospitals at which physician is affiliated;
 
    
    Health tools (free)  checklist to assist consumers in selecting a physician;
 
    
    Background check (fee-based)  a premium physician quality report which includes
information on board certification, malpractice history, federal and state sanctions from
all 50 states, among other items; and,
 
    
    Procedure costs (fee-based)  detailed cost information for a variety of medical
procedures.
 Content
Licensing
 Pharmaceutical and Medical Device Solutions 
 Focal Point
  10




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Internet Advertising 
  www.WrongDiagnosis.com www.CureResearch.com
 Healthcare Credit Solutions 
 Competition
  www.CureResearch.com
  Company History
    11




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Government Regulation
         12




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Healthcare Legislation
 Privacy of Information and HIPAA
  
    
    state privacy and confidentiality laws;
 
    
    state laws regulating healthcare professionals, such as physicians, pharmacists and
nurse practitioners;
 
    
    Medicaid laws;
 
    
    the U.S. Health Insurance Portability and Accountability Act of 1996, or HIPAA, as
described in detail below, and related rules proposed by the Health Care Financing
Administration; and
 
    
    CMS standards for electronic transmission of health data
     Government Regulation of the Internet, Data and Privacy
   13




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Intellectual Property
     Employees
  Available Information
 www.healthgrades.com
  14




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RISKS
RELATED TO OUR BUSINESS
 Our business will suffer if we are not able to obtain reliable data as a basis for our healthcare
information.
  Failure to effectively manage the growth of our operations and infrastructure could disrupt our
operations and prevent us from maintaining or increasing profitability.
  Our proprietary rights may not be fully protected.
   15




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The nature of our business and our reliance on intellectual property subjects us to the risk of
litigation.
   We may lose business if hospitals and others utilize our name and ratings without our permission.
  We may be sued for information we obtain or information retrieved from our websites or otherwise
provided to employers and others.
 www.healthgrades.com
    16




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If we do not strengthen recognition of our brand name, our ability to expand our business will be
impaired.
  If we were to lose the services of Kerry Hicks or other members of our executive management team,
we may not be able to execute our business strategy.
  Our business will suffer if we are unable to attract, retain and motivate highly skilled employees.
  We may experience system failures that could interrupt our services.
 www.healthgrades.com www.healthgrades.com
  
    
    damage from fire, power loss and other natural disasters;
 
    
    communications failures;
 
    
    software and hardware errors, failures or crashes;
 
    
    security breaches, computer viruses and similar disruptive problems; and
 
    
    other potential interruptions.
   17




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Failure by third party vendors of technology.
  We may lose business if we are unable to keep up with rapid technological or other changes.
  We rely largely on advertising and search engine placement to generate traffic to our website.
  We may be unsuccessful in our efforts to increase advertising and sponsorship revenue.
 www.healthgrades.com
 
    
    Our advertising initiative is in its early stages. Many of our competitors have greater
financial, technical, product development and other resources than we do. These organizations
may be better known than we are and have more customers or users than we do. We cannot
provide assurance that we will be able to compete successfully against these organizations or
any alliances they have formed or may form. As there are no substantial barriers to entry
into the online advertising market, we expect that competitors will continue to enter this
market.
 
    
    Our websites face competition from numerous other companies, both in attracting users and
in generating revenue from advertisers and sponsors. We compete for users with online
services and websites that provide health-related information, including both commercial
sites and not-for-profit sites. We also compete for advertisers and sponsors with both
healthcare-related and non-healthcare related content and services.
 
    
    There are numerous items outside of our control that may limit our ability to accurately
forecast or generate revenues from this area including, but not limited to: advertisers
budgets and buying patterns, the time between the initial contact with an advertising network,
agency or potential advertiser/sponsor and the execution of a contract, which may be lengthy,
and seasonal factors relating to the prevalence of specific health conditions that may affect
the timing of promotional campaigns for specific products, among other items.
 
    
    Failure to effectively compete for online advertising may have a material adverse effect on
our revenues and results of operations.
 
    
    If unable to provide quality
graphics to attract users and advertisers to our websites, our
advertising revenues may be adversely affected.
 
    
    Technologies have been developed that can block the display of our ads.
 
    
    We are exposed to the risk of fraudulent clicks and other invalid clicks on our ads from a
variety of potential sources. Invalid clicks are clicks that we have determined are not
intended by the user to link to the underlying content. Click fraud occurs when a user
intentionally clicks on an ad displayed on a website for a reason other than to view the
underlying content. If we are unable to stop these invalid clicks, we will be required to
provide refunds to our advertisers, which would negatively affect our profitability and our
reputation.
   18




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Our online business has a limited operating history.
  Our business will suffer if we are not able to compete successfully.
  
    
    data providers that provide detailed utilization and outcomes information to hospitals;
 
    
    healthcare consulting companies;
 
    
    companies or organizations that provide or maintain online healthcare information;
 
    
    vendors of healthcare information, products and services distributed through other means,
including direct sales, mail and fax messaging;
 
    
    companies and organizations that provide or maintain general purpose consumer online
services that provide access to healthcare content and services;
 
    
    companies and organizations that provide or maintain public sector and non-profit websites
that provide healthcare information and services without advertising or commercial
sponsorships;
 
    
    companies and organizations that provide or maintain web search and retrieval services and
other high-traffic websites; and
 
    
    publishers and distributors of traditional media, some of which have established or may
establish websites.
  The recent global economic downturn may impact our business, operating results or financial
condition.
  New acquisitions such as Adviware could be costly and may place significant strain on our
management systems and resources which could negatively impact our operations.
  
    
    potential inability to successfully integrate acquired operations and products or to
realize cost savings or other anticipated benefits from integration;
 
    
    loss of key employees of acquired operations;
  19




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
    
    the difficulty of assimilating geographically dispersed operations and personnel of the
acquired companies;
 
    
    the potential disruption of our ongoing business;
 
    
    unanticipated expense related to acquisitions; including significant transaction costs
which under accounting rules, are required to be expensed rather than capitalized;
 
    
    the impairment of relationships with employees and customers of either an acquired company
or our own business;
 
    
    the potential for
acquisitions to result in dilutive issuances of our equity
securities; and
 
    
    the potential unknown liabilities associated with acquired business.
  RISKS RELATED TO HEALTHCARE INFORMATION AND THE INTERNET
 Healthcare reforms and the cost of regulatory compliance could negatively affect our business.
  
    
    result in limitation or prohibition of business activities;
 
    
    subject us or our customers to legal fees and expenses and adverse publicity; or
 
    
    increase the costs of regulatory compliance and, if found by a court of competent
jurisdiction to have engaged in improper practices, subject us or our customers to criminal or
civil monetary fines or other penalties
       20




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The internet is subject to many legal uncertainties and potential government laws and regulations
that may decrease usage of our websites, increase our cost of doing business or otherwise have a
damaging effect on our business.
   We may be subject to claims brought against us as a result of content we provide.
  If we fail to comply with current or future laws or regulations governing the collection,
dissemination, use and confidentiality of patient health information, our business could suffer.
  
    
    state privacy and confidentiality laws;
 
    
    state laws regulating healthcare professionals, such as physicians, pharmacists and nurse
practitioners;
 
    
    Medicaid and Medicare laws;
 
    
    the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and related rules
proposed by the Health Care Financing Administration; and
 
    
    CMS standards for electronic transmission of health data.
   21




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Online security breaches could harm our business.
    OTHER RISKS
 Our certificate of incorporation and bylaws include anti-takeover provisions that may deter or
prevent a change of control.
   We have no intention to pay dividends on our common stock.
  
    22




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Indemnification of our Chief Executive Officer and Derivative Complaint
     th
  23




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24




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th th
 Gotham/Primarius Complaint
        25




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##### Table of Contents



NAME
    
    AGE
    
    
    POSITIONKerry R. Hicks
    
    
    49
    
    
    Chairman, President and Chief Executive OfficerDavid G. Hicks
    
    
    50
    
    
    Executive Vice PresidentSarah Loughran
    
    
    44
    
    
    Executive Vice PresidentAllen Dodge
    
    
    41
    
    
    Executive Vice President, Chief FinancialOfficer, Secretary and TreasurerSteve Wood
    
    
    65
    
    
    Executive Vice President
        26




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Item 5.  Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 Market Information
  HIGH
    
    
    LOWYear Ended December 31, 2007First Quarter
    
    $
    6.42
    
    
    $
    4.40Second Quarter
    
    
    6.97
    
    
    
    5.30Third Quarter
    
    
    6.72
    
    
    
    4.45Fourth Quarter
    
    
    6.84
    
    
    
    4.35Year Ended December 31, 2008First Quarter
    
    $
    6.13
    
    
    $
    5.00Second Quarter
    
    
    5.80
    
    
    
    4.29Third Quarter
    
    
    4.54
    
    
    
    2.81Fourth Quarter
    
    
    3.10
    
    
    
    1.16
 Holders of Record
  Dividend Policy
   27




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##### Table of Contents



Performance Graph
   
 The stock price performance included in this graph is not necessarily indicative of future stock price performance.
 12/31/03
    
    
    12/31/04
    
    
    12/30/05
    
    
    12/29/06
    
    
    12/31/07
    
    
    12/31/08Health Grades, Inc.
    
    $
    100.00
    
    
    $
    483.33
    
    
    $
    1,053.33
    
    
    $
    748.33
    
    
    $
    991.67
    
    
    $
    343.33$
    (0.60
    )*
    
    $
    (2.90
    )*
    
    $
    (6.32
    )*
    
    $
    (4.49
    )*
    
    $
    (5.95
    )*
    
    $
    (2.06
    )*Nasdaq Stock Market
(US)
    
    $
    100.00
    
    
    $
    108.84
    
    
    $
    111.16
    
    
    $
    122.11
    
    
    $
    132.42
    
    
    $
    63.80Nasdaq Computer &
Data Processing
Index
    
    $
    100.00
    
    
    $
    110.23
    
    
    $
    113.97
    
    
    $
    127.96
    
    
    $
    156.36
    
    
    $
    90.00
 *
    
    Health Grades, Inc. closing share price as of respective year-end date  28




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##### Table of Contents



Purchases of Equity Securities by the Issuer
   TotalNumber of
    
    
    MaximumShares
    
    
    Number ofPurchased
    
    
    Shares Thatas Part of
    
    
    May Yet BeTotal
    
    
    
    
    
    
    Publicly
    
    
    PurchasedNumber of
    
    
    Average
    
    
    Announced
    
    
    Under theShares
    
    
    Price Paid
    
    
    Plans or
    
    
    Plans orPeriod
    
    Purchased(1)
    
    
    per Share(2)
    
    
    Programs
    
    
    ProgramsOctober 1, 2008 through October 31, 2008
    
    
    257,499
    
    
    $
    2.40
    
    
    
    254,169
    
    
    
    917,459November 1, 2008 through November 30,
2008
    
    
    104,010
    
    
    
    1.90
    
    
    
    103,940
    
    
    
    813,519December 1, 2008 through December 31,
2008
    
    
    56,182
    
    
    
    1.47
    
    
    
    55,721
    
    
    
    757,798Total
    
    
    417,691
    
    
    $
    2.15
    
    
    
    413,830
    
    
    
    757,798
 (1)
    
    Includes shares purchased from employees to cover payroll taxes associated with
vesting of restricted stock awards.(2)
    
    Average price paid per share excludes commissions and service charges.  29




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##### Table of Contents



Year Ended December 31,2008
    
    
    2007
    
    
    2006
    
    
    2005
    
    
    2004Ratings and advisory revenue
    
    $
    39,663,384
    
    
    $
    32,741,610
    
    
    $
    27,764,021
    
    
    $
    20,794,173
    
    
    $
    14,536,304Income from operations
    
    
    6,685,521
    
    
    
    9,198,853
    (1)
    
    
    4,817,122
    
    
    
    3,942,424
    
    
    
    1,760,600Net income
    
    $
    4,690,769
    
    
    $
    6,748,171
    (2)
    
    $
    3,181,510
    
    
    $
    4,139,853
    (4)
    
    $
    1,782,143Net income per common share (basic)
    
    $
    0.17
    
    
    $
    0.24
    (3)
    
    $
    0.11
    
    
    $
    0.15
    
    
    $
    0.07Weighted average number of common shares
used in computation (basic)
    
    
    26,963,824
    
    
    
    28,621,171
    
    
    
    28,432,185
    
    
    
    27,039,057
    
    
    
    25,058,173Net income per common share (diluted)
    
    $
    0.15
    
    
    $
    0.20
    (3)
    
    $
    0.09
    
    
    $
    0.12
    
    
    $
    0.05Weighted average number of common
shares and common share equivalents
used in computation (diluted)
    
    
    31,431,811
    
    
    
    33,703,558
    
    
    
    33,628,330
    
    
    
    34,833,521
    
    
    
    33,031,087
 (1)
    
    Income from operations for the year ended December 31, 2007 includes approximately
$4.3 million of the arbitration award from Hewitt.(2)
    
    Net income for the year ended December 31, 2007 includes the arbitration award from
Hewitt in the amount of approximately $2.8 million, net of tax.(3)
    
    Net income per common share basic and diluted for the year ended December 31, 2007
includes approximately $0.10 and $0.08 attributed to the Hewitt award, respectively.(4)
    
    Net income for the year ended December 31, 2005 includes a $1.5 million reversal of
the valuation allowance for deferred tax assets previously reflected in our financial statements.
The valuation allowance resulted from uncertainty regarding our ability to realize the benefits of
the related deferred tax assets.  DECEMBER 31, 2008
    
    
    DECEMBER 31, 2007
    
    
    DECEMBER 31, 2006
    
    
    DECEMBER 31, 2005
    
    
    DECEMBER 31, 2004Working capital (deficit)
    
    $
    (2,059,954
    )(1)
    
    $
    10,222,065
    
    
    $
    7,027,821
    
    
    $
    5,024,057
    
    
    $
    96,190Total assets
    
    
    35,085,170
    
    
    
    36,935,329
    
    
    
    31,019,585
    
    
    
    23,844,473
    
    
    
    12,931,127Total long-term debt
    
    
    984
    
    
    
    2,387
    
    
    
    3,863
    
    
    
    5,254
    
    
    
    
 (1)
    
    Deficit results from use of cash in stock repurchase activity.  30




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Revenue Growth and Client Retention
 www.WrongDiagnosis.com www.CureResearch.com
     Share-Based Payment
   31




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Ratings and advisory revenue.
 Cost of ratings and advisory revenue.
 Sales and marketing costs
 Product development costs. Accounting for the Costs of Computer Software Developed or Obtained for Internal Use
 General and administrative expenses.
   Year ended
    
    
    Year ended
    
    
    Year endedProduct Area
    
    December 31, 2008
    
    
    December 31, 2007
    
    
    December 31, 2006Provider Services
    
    $
    29,261,442
    
    
    $
    25,130,997
    
    
    $
    20,068,557Internet Business Group
    
    
    8,392,948
    
    
    
    6,132,250
    
    
    
    5,099,838Strategic Health Solutions
    
    
    2,008,994
    
    
    
    1,478,363
    
    
    
    2,595,626Total
    
    $
    39,663,384
    
    
    $
    32,741,610
    
    
    $
    27,764,021
  32




---



##### Table of Contents



Ratings and advisory revenue
 Provider Services.
 Internet Business Group www.healthgrades.com
 Strategic Health Solutions.
 Cost of ratings and advisory revenue
 Other Revenue
 Sales and marketing costs.
  33




---



##### Table of Contents



Product development costs
 General and administrative expenses
 Interest expense
 Interest income.
  Ratings and advisory revenue
 Provider Services.
 Internet Business Group
   34




---



##### Table of Contents



Strategic Health Solutions.
 Cost of ratings and advisory revenue
 Other Revenue
 Sales and marketing costs.
 Product development costs
 General and administrative expenses
 Interest expense
 Interest income.
     35




---



##### Table of Contents



Payments Due by PeriodLess than 1
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    year
    
    
    1-3 years
    
    
    3-5 years
    
    
    5 yearsContractual ObligationsCapital Lease Obligations
    
    $
    3,400
    
    
    $
    2,400
    
    
    $
    1,000
    
    
    $
    
    
    
    $
    Operating Lease Obligations
    
    
    2,537,767
    
    
    
    992,351
    
    
    
    1,545,416
    
    
    
    
    
    
    
    Employee Contracts
    
    
    1,180,756
    
    
    
    593,791
    
    
    
    586,965
    
    
    
    
    
    
    
    Purchase Obligations
    
    
    477,960
    
    
    
    435,460
    
    
    
    42,500
    
    
    
    
    
    
    
    Total
    
    $
    4,199,883
    
    
    $
    2,024,002
    
    
    $
    2,175,881
    
    
    $
    
    
    
    $
    
   36




---



##### Table of Contents



Recently Adopted Accounting Pronouncements
 The Fair
Value Option for Financial Assets and Financial Liabilities  Including an Amendment of FASB
Statement 115
 Fair Value
Measurement . Effective Date FASB Statement No. 157
 Recently Issued Accounting Pronouncements Not Yet Adopted
 Determining Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities
 The Hierarchy of
Generally Accepted Accounting Principles The Meaning of
Presented Fairly in Conformity With Generally Accepted Accounting Principles
  37




---



##### Table of Contents



Determination of the Useful Life of Intangible
Assets Goodwill and Other Intangible
Assets
 Business Combinations
 Noncontrolling Interests in Consolidated Financial Statements  an amendment of Accounting Research
Bulletin No. 51
  
      38




---



##### Table of Contents



HEALTH GRADES, INC.:Report of Independent Registered Public Accounting Firm
    
    
    40Consolidated Balance Sheets
    
    
    41Consolidated Statements of Income
    
    
    42Consolidated Statements of Stockholders Equity
    
    
    43Consolidated Statements of Cash Flows
    
    
    44Notes to Consolidated Financial Statements
    
    
    45
  39




---



##### Table of Contents



Internal Control  Integrated Framework )
  
  40




---



##### Table of Contents



DECEMBER 31,2008
    
    
    2007ASSETSCash and cash equivalents
    
    $
    11,327,741
    
    
    $
    23,369,368Accounts receivable, net
    
    
    9,563,163
    
    
    
    6,935,341Prepaid income taxes
    
    
    12,603
    
    
    
    Prepaid expenses and other current assets
    
    
    1,087,914
    
    
    
    836,222Total current assets
    
    
    21,991,421
    
    
    
    31,140,931Property and equipment, net
    
    
    2,451,210
    
    
    
    1,641,456Intangible assets, net
    
    
    854,613
    
    
    
    357,128Goodwill
    
    
    9,104,060
    
    
    
    3,106,181Deferred income taxes
    
    
    683,866
    
    
    
    689,633Total assets
    
    $
    35,085,170
    
    
    $
    36,935,329LIABILITIES AND STOCKHOLDERS EQUITYAccounts payable
    
    $
    224,252
    
    
    $
    326,039Accrued payroll, incentive compensation and related expenses
    
    
    3,352,294
    
    
    
    2,222,970Accrued expenses
    
    
    629,359
    
    
    
    432,928Current portion of capital lease obligations
    
    
    1,898
    
    
    
    1,476Current portion of deferred rent
    
    
    
    
    
    
    68,544Deferred revenue
    
    
    19,713,079
    
    
    
    17,739,152Deferred income taxes
    
    
    130,493
    
    
    
    113,914Income taxes payable
    
    
    
    
    
    
    13,843Total current liabilities
    
    
    24,051,375
    
    
    
    20,918,866Long-term portion of capital lease obligations
    
    
    984
    
    
    
    2,387Long-term portion of deferred rent
    
    
    309,131
    
    
    
    229,321Total liabilities
    
    
    24,361,490
    
    
    
    21,150,574Commitments and contingenciesMinority interest
    
    
    
    
    
    
    248,011Stockholders equity:Preferred stock, $0.001 par value, 2,000,000 shares authorized,
no shares issued or outstanding
    
    
    
    
    
    
    Common stock, $0.001 par value, 100,000,000 shares authorized,
and 52,744,438 and 50,895,623 shares issued as of December
31, 2008 and 2007, respectively
    
    
    52,743
    
    
    
    50,895Additional paid-in capital
    
    
    98,242,403
    
    
    
    96,860,004Accumulated deficit
    
    
    (54,026,164
    )
    
    
    (58,716,933
    )Treasury stock, 23,982,694 and 21,424,236 shares as of December
31, 2008 and 2007, respectively
    
    
    (33,545,302
    )
    
    
    (22,657,222
    )Total stockholders equity
    
    
    10,723,680
    
    
    
    15,536,744Total liabilities and stockholders equity
    
    $
    35,085,170
    
    
    $
    36,935,329
   41




---



##### Table of Contents



2008
    
    
    2007
    
    
    2006Revenue:Ratings and advisory revenue
    
    $
    39,663,384
    
    
    $
    32,741,610
    
    
    $
    27,764,021Other
    
    
    24,952
    
    
    
    3,425,465
    
    
    
    6,23139,688,336
    
    
    
    36,167,075
    
    
    
    27,770,252Cost of revenue:Cost of ratings and advisory revenue
    
    
    6,759,233
    
    
    
    5,323,672
    
    
    
    4,593,310Gross margin
    
    
    32,929,103
    
    
    
    30,843,403
    
    
    
    23,176,942Operating expenses:Sales and marketing
    
    
    10,845,768
    
    
    
    9,147,911
    
    
    
    8,423,777Product development
    
    
    7,279,283
    
    
    
    5,491,725
    
    
    
    3,547,335General and administrative
    
    
    8,118,531
    
    
    
    7,004,914
    
    
    
    6,388,708Income from operations
    
    
    6,685,521
    
    
    
    9,198,853
    
    
    
    4,817,122Other:Other
    
    
    
    
    
    
    
    
    
    
    (43
    )Interest income
    
    
    429,757
    
    
    
    1,330,903
    
    
    
    689,230Interest expense
    
    
    (2,912
    )
    
    
    (1,771
    )
    
    
    (387
    )Minority interest
    
    
    304,004
    
    
    
    327,835
    
    
    
    Income before income taxes
    
    
    7,416,370
    
    
    
    10,855,820
    
    
    
    5,505,922Income tax expense
    
    
    2,725,601
    
    
    
    4,107,649
    
    
    
    2,324,412Net income
    
    $
    4,690,769
    
    
    $
    6,748,171
    
    
    $
    3,181,510Net income per common share (basic)
    
    $
    0.17
    
    
    $
    0.24
    
    
    $
    0.11Weighted-average number of common shares
used in computation (basic)
    
    
    26,963,824
    
    
    
    28,621,171
    
    
    
    28,432,185Net income per common share (diluted)
    
    $
    0.15
    
    
    $
    0.20
    
    
    $
    0.09Weighted-average number of common shares
used in computation (diluted)
    
    
    31,431,811
    
    
    
    33,703,558
    
    
    
    33,628,330
   42




---



##### Table of Contents



COMMON STOCK
    
    
    ADDITIONAL$0.001 PAR VALUE
    
    
    PAID-IN
    
    
    ACCUMULATED
    
    
    TREASURYSHARES
    
    
    AMOUNT
    
    
    CAPITAL
    
    
    DEFICIT
    
    
    STOCK
    
    
    TOTALBalance at January 1, 2006
    
    
    47,674,779
    
    
    $
    47,674
    
    
    $
    91,984,099
    
    
    $
    (68,646,614
    )
    
    $
    (13,767,580
    )
    
    $
    9,617,579Stock based
compensation expense  employee
    
    
    
    
    
    
    
    
    
    
    726,421
    
    
    
    
    
    
    
    
    
    
    
    726,421Stock based compensation expense 
non-employee
    
    
    
    
    
    
    
    
    
    
    14,396
    
    
    
    
    
    
    
    
    
    
    
    14,396Employee stock option exercise
    
    
    1,100,578
    
    
    
    1,101
    
    
    
    432,550
    
    
    
    
    
    
    
    
    
    
    
    433,651Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    1,446,567
    
    
    

    
    
    
    
    
    
    
    
    1,446,567758,520 shares repurchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,277,076
    )
    
    
    (3,277,076
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,181,510
    
    
    
    
    
    
    
    3,181,510Balance at December 31, 2006
    
    
    48,775,357
    
    
    
    48,775
    
    
    
    94,604,033
    
    
    
    (65,465,104
    )
    
    
    (17,044,656
    )
    
    
    12,143,048Stock based compensation expense 
employee
    
    
    
    
    
    
    
    
    
    
    961,715
    
    
    
    
    
    
    
    
    
    
    
    961,715Employee stock option exercise
    
    
    704,184
    
    
    
    704
    
    
    
    568,921
    
    
    
    
    
    
    
    
    
    
    
    569,625Restricted stock awards
    
    
    1,416,082
    
    
    
    1,416
    
    
    
    (1,416
    )
    
    
    
    
    
    
    
    
    
    
    Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    898,597
    
    
    
    
    
    
    
    
    
    
    
    898,5971,102,326 shares repurchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,612,566
    )
    
    
    (5,612,566
    )SAB 51 capital reallocation adjustment
for investment in majority-owned
subsidiary
    
    
    
    
    
    
    
    
    
    
    (171,846
    )
    
    
    
    
    
    
    
    
    
    
    (171,846
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,748,171
    
    
    
    
    
    
    
    6,748,171Balance at December 31, 2007
    
    
    50,895,623
    
    
    
    50,895
    
    
    
    96,860,004
    
    
    
    (58,716,933
    )
    
    
    (22,657,222
    )
    
    
    15,536,744Stock based compensation expense 
employee
    
    
    
    
    
    
    
    
    
    
    450,627
    
    
    
    
    
    
    
    
    
    
    
    450,627Employee stock option exercise
    
    
    1,272,034
    
    
    
    1,272
    
    
    
    595,565
    
    
    
    
    
    
    
    
    
    
    
    596,837Restricted stock awards
    
    
    576,781
    
    
    
    576
    
    
    
    (576
    )
    
    
    
    
    
    
    
    
    
    
    Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    336,783
    
    
    
    
    
    
    
    
    
    
    
    336,7832,558,458 shares repurchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,888,080
    )
    
    
    (10,888,080
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,690,769
    
    
    
    
    
    
    
    4,690,769Balance at December 31, 2008
    
    
    52,744,438
    
    
    $
    52,743
    
    
    $
    98,242,403
    
    
    $
    (54,026,164
    )
    
    $
    (33,545,302
    )
    
    $
    10,723,680
   43




---



##### Table of Contents



2008
    
    
    2007
    
    
    2006OPERATING ACTIVITIESNet income
    
    $
    4,690,769
    
    
    $
    6,748,171
    
    
    $
    3,181,510Adjustments to reconcile net income to net
cash provided by operating activities:Depreciation and amortization
    
    
    1,226,164
    
    
    
    1,046,254
    
    
    
    698,317Bad debt expense
    
    
    20,000
    
    
    
    
    
    
    
    15,000Loss on disposal of assets
    
    
    1,061
    
    
    
    25,996
    
    
    
    43Stock based compensation expense   non-employees
    
    
    
    
    
    
    
    
    
    
    14,396Stock based compensation expense  employees
    
    
    450,627
    
    
    
    961,715
    
    
    
    726,421Accretion of discount on held-to-maturity securities
    
    
    
    
    
    
    
    
    
    
    (204,323
    )Tax benefit from stock option exercises
    
    
    (308,329
    )
    
    
    (871,469
    )
    
    
    (1,420,574
    )Deferred income taxes
    
    
    22,346
    
    
    
    (238,570
    )
    
    
    774,813Minority interest
    
    
    (304,011
    )
    
    
    (327,835
    )
    
    
    Changes in operating assets and liabilities, net of acquisition:Accounts receivable
    
    
    (2,647,822
    )
    
    
    1,960,368
    
    
    
    (3,296,984
    )Prepaid expenses and other current assets
    
    
    (210,265
    )
    
    
    (124,201
    )
    
    
    (142,470
    )Accounts payable
    
    
    (101,787
    )
    
    
    (14,703
    )
    
    
    75,053Accrued payroll, incentive compensation
and related expenses
    
    
    1,129,324
    
    
    
    384,688
    
    
    
    312,438Accrued expenses
    
    
    159,661
    
    
    
    113,461
    
    
    
    22,853Income taxes payable
    
    
    310,337
    
    
    
    836,152
    
    
    
    1,507,835Deferred revenue
    
    
    1,973,927
    
    
    
    1,841,778
    
    
    
    4,154,547Deferred rent
    
    
    6,943
    
    
    
    (45,601
    )
    
    
    (38,396
    )Net cash provided by operating activities
    
    
    6,418,945
    
    
    
    12,296,204
    
    
    
    6,380,479INVESTING ACTIVITIESPurchases of property and equipment
    
    
    (1,860,066
    )
    
    
    (788,346
    )
    
    
    (806,978
    )Business acquisition
    
    
    (6,670,983
    )
    
    
    
    
    
    
    Purchases of held-to-maturity investments
    
    
    
    
    
    
    
    
    
    
    (9,512,523
    )Sale of property, plant and equipment
    
    
    
    
    
    
    10,000
    
    
    
    450Proceeds from sale or maturity of held-to-maturity investments
    
    
    
    
    
    
    
    
    
    
    11,705,000Net cash (used in) provided by investing activities
    
    
    (8,531,049
    )
    
    
    (778,346
    )
    
    
    1,385,949FINANCING ACTIVITIESPayments under capital lease obligation
    
    
    (2,609
    )
    
    
    (1,391
    )
    
    
    (1,310
    )Excess tax benefits from stock-based payment arrangements
    
    
    308,329
    
    
    
    871,469
    
    
    
    1,420,574Purchases of treasury stock
    
    
    (10,888,080
    )
    
    
    (5,612,566
    )
    
    
    (3,277,076
    )Exercise of common stock options and warrants
    
    
    596,837
    
    
    
    569,625
    
    
    
    433,651Minority interest capital contribution
    
    
    56,000
    
    
    
    
    
    
    
    Net cash used in financing activities
    
    
    (9,929,523
    )
    
    
    (4,172,863
    )
    
    
    (1,424,161
    )Net (decrease) increase in cash and cash equivalents
    
    
    (12,041,627
    )
    
    
    7,344,995
    
    
    
    6,342,267Cash and cash equivalents at beginning of period
    
    
    23,369,368
    
    
    
    16,024,373
    
    
    
    9,682,106Cash and cash equivalents at end of period
    
    $
    11,327,741
    
    
    $
    23,369,368
    
    
    $
    16,024,373SUPPLEMENTAL CASH FLOW INFORMATIONInterest paid
    
    $
    2,912
    
    
    $
    1,771
    
    
    $
    387Income tax paid
    
    $
    2,397,979
    
    
    $
    3,523,998
    
    
    $
    33,277NON CASH FINANCING AND INVESTING ACTIVITYProperty and equipment acquired with capital lease
    
    $
    1,628
    
    
    $
    
    
    
    $
    Property and equipment acquired in accounts payable or accrued
expenses
    
    $
    36,770
    
    
    $
    7,526
    
    
    $
    SAB 51 capital reallocation adjustment for investment in
majority-owned subsidiary
    
    $
    
    
    
    $
    171,846
    
    
    $
    Non-competition agreements contributed to HCS by HealthCo
    
    $
    
    
    
    $
    404,000
    
    
    $
    
   44




---



##### Table of Contents



www.healthgrades.com
 www.WrongDiagnosis.com www.CureResearch.com
          45




---



##### Table of Contents



Strategic Quality Initiative, Strategic Quality Partnerships and Quality Assessment and
Implementation Programs:
      Health Management Suite:
   Content Licensing:
   46




---



##### Table of Contents



Healthcare Quality Reports:
  Connecting Point (formerly known as Internet Patient Acquisition):
   Focal Point:
   Internet Advertising:
     Multiple element arrangements
 Accounting for Revenue Arrangements with Multiple Deliverables.
  47




---



##### Table of Contents



Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use
         Computer equipment and software
    
    35 yearsInternally developed software
    
    3 yearsFurniture and fixtures
    
    57 yearsLeasehold improvements
    
    6 years
  48




---



##### Table of Contents



Accounting for the Impairment or Disposal of
Long-Lived Assets Goodwill and Other Intangible Assets
             49




---



##### Table of Contents



Earnings Per Share
  2008
    
    
    2007
    
    
    2006Numerator for both basic and diluted earnings
per share:Net income
    
    $
    4,690,769
    
    
    $
    6,748,171
    
    
    $
    3,181,510Denominator:Denominator for basic net income per
common shareweighted-average shares
    
    
    26,963,824
    
    
    
    28,621,171
    
    
    
    28,432,185Effect of dilutive securities:Outstanding employee stock options, warrants
and restricted stock awards
    
    
    4,467,987
    
    
    
    5,082,387
    
    
    
    5,196,145Denominator for diluted net income per
common shareadjusted weighted-average
shares and assumed conversion
    
    
    31,431,811
    
    
    
    33,703,558
    
    
    
    33,628,330
  Share-Based Payment Accounting for Stock-Based Compensation
  Recently Adopted Accounting Pronouncements
 The Fair
Value Option for Financial Assets and Financial Liabilities  Including an amendment of FASB
Statement No. 115
  50




---



##### Table of Contents



Fair Value
Measurement . Effective Date FASB Statement No. 157
 Recently Issued Accounting Pronouncements Not Yet Adopted
 Determining Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities
 The Hierarchy of
Generally Accepted Accounting Principles The Meaning of
Presented Fairly in Conformity With Generally Accepted Accounting Principles
 Determination of the Useful Life of Intangible
Assets Goodwill and Other Intangible Assets
 Business Combinations
 Noncontrolling Interests in Consolidated Financial Statements  an amendment of Accounting Research
Bulletin No. 51
   51




---



##### Table of Contents



2008
    
    
    2007Trade accounts receivable
    
    $
    9,583,220
    
    
    $
    6,954,548Less: allowance for doubtful accounts
    
    
    20,057
    
    
    
    19,207$
    9,563,163
    
    
    $
    6,935,341
    2008
    
    
    2007Furniture and fixtures
    
    $
    455,344
    
    
    $
    407,222Computer equipment and software
    
    
    5,512,932
    
    
    
    3,763,997Leasehold improvements and other
    
    
    479,686
    
    
    
    436,7236,447,962
    
    
    
    4,607,942Accumulated depreciation and amortization
    
    
    (3,996,752
    )
    
    
    (2,966,486
    )Net property and equipment
    
    $
    2,451,210
    
    
    $
    1,641,456
     www.WrongDiagnosis.com www.CureResearch.com
 EstimatedAmount
    
    
    Useful LifePrepaid expenses and other current assets
    
    $
    37,104Identifiable intangible assets
    
    
    636,000
    
    
    5 yearsGoodwill
    
    
    5,997,879
    
    
    n/aTotal assets acquired
    
    
    6,670,983Liabilities assumed
    
    
    Total preliminary purchase price
    
    $
    6,670,983
   52




---



##### Table of Contents



Year Ended December 31,2008
    
    
    2007(unaudited)
    
    
    (unaudited)Revenues
    
    $
    40,900,359
    
    
    $
    37,980,539Net income
    
    $
    4,817,274
    
    
    $
    7,015,797Net income per share  diluted
    
    $
    0.15
    
    
    $
    0.21
    Balance at December 31, 2007
    
    
    3,106,181Goodwill acquired
    
    
    5,997,879Balance at December 31, 2008
    
    $
    9,104,060
  2008
    
    
    2007Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Value
    
    
    Amount
    
    
    Amortization
    
    
    ValueIntangible assets
with finite lives:Domain names
    
    $
    636,000
    
    
    $
    27,697
    
    
    $
    608,303
    
    
    $
    
    
    
    $
    
    
    
    $
    Non-competition
agreements
    
    
    404,000
    
    
    
    157,690
    
    
    
    246,310
    
    
    
    404,000
    
    
    
    76,890
    
    
    
    327,110Acquired
software and
tools
    
    
    212,300
    
    
    
    212,300
    
    
    
    
    
    
    
    212,230
    
    
    
    182,212
    
    
    
    30,018Total
    
    $
    1,252,300
    
    
    $
    397,687
    
    
    $
    854,613
    
    
    $
    616,230
    
    
    $
    259,102
    
    
    $
    357,128
  2009
    
    $
    208,0002010
    
    
    208,0002011
    
    
    208,0002012
    
    
    131,1102013
    
    
    99,503
  53




---



##### Table of Contents



Effective Date
    
    New Aggregate AmountFebruary 15, 2009
    
    $
    45,000
   Stock Repurchase Program
  Equity Compensation Plan
    54




---



##### Table of Contents



.
   Share-Based Payment
 Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards
 Stock-Based Compensation Expense
  2008
    
    
    2007
    
    
    2006Cost of ratings and advisory revenue
    
    $
    86,146
    
    
    $
    101,426
    
    
    $
    98,568Sales and marketing
    
    
    131,048
    
    
    
    417,802
    
    
    
    311,563Product development
    
    
    86,401
    
    
    
    158,391
    
    
    
    159,398General and administrative
    
    
    147,032
    
    
    
    284,096
    
    
    
    171,288Total stock-based compensation expense
    
    $
    450,627
    
    
    $
    961,715
    
    
    $
    740,817Related tax benefit
    
    $
    237,330
    
    
    $
    237,184
    
    
    $
    49,626
  55




---



##### Table of Contents



Equity Plan
 Valuation Assumptions for Stock Options
  2008
    
    
    2007
    
    
    2006Dividend yield
    
    
    N/A
    
    
    
    N/A
    
    
    
    0
    %Expected volatility
    
    
    N/A
    
    
    
    N/A
    
    
    
    111
    %Risk-free interest rate
    
    
    N/A
    
    
    
    N/A
    
    
    
    4.84
    %Expected life
    
    
    N/A
    
    
    
    N/A
    
    
    35 years
   Weighted-Weighted-
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicOptions
    
    
    Price
    
    
    Term (in years)
    
    
    ValueOutstanding at December 31, 2007
    
    
    5,873,272
    
    
    $
    0.45Granted
    
    
    
    
    
    
    Exercised
    
    
    (1,272,034
    )
    
    
    0.47Forfeited
    
    
    (834
    )
    
    
    4.62Expired
    
    
    (23,999
    )
    
    
    6.60Outstanding at December 31, 2008
    
    
    4,576,405
    
    
    $
    0.41
    
    
    
    2.85
    
    
    $
    7,813,949Vested or expected to vest at
December 31, 2008
    
    
    4,576,405
    
    
    $
    0.41
    
    
    
    2.85
    
    
    $
    7,813,949Exercisable at December 31, 2008
    
    
    4,559,153
    
    
    $
    0.40
    
    
    
    2.84
    
    
    $
    7,813,949
     2008
    
    
    2007
    
    
    2006WEIGHTED-
    
    
    
    
    
    
    WEIGHTED-
    
    
    
    
    
    
    WEIGHTED-AVERAGE
    
    
    
    
    
    
    AVERAGE
    
    
    
    
    
    
    AVERAGEEXERCISE
    
    
    
    
    
    
    EXERCISE
    
    
    
    
    
    
    EXERCISEOPTIONS
    
    
    PRICE
    
    
    OPTIONS
    
    
    PRICE
    
    
    OPTIONS
    
    
    PRICEOutstanding at beginning of year
    
    
    5,873,272
    
    
    $
    0.45
    
    
    
    6,649,543
    
    
    $
    0.56
    
    
    
    7,975,186
    
    
    $
    0.61Granted
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    
    23,000
    
    
    $
    6.40Exercised
    
    
    (1,272,034
    )
    
    $
    0.47
    
    
    
    (704,184
    )
    
    $
    0.81
    
    
    
    (1,100,578
    )
    
    $
    0.39Forfeited
    
    
    (834
    )
    
    $
    4.62
    
    
    
    (36,616
    )
    
    $
    4.41
    
    
    
    (234,999
    )
    
    $
    3.15Expired
    
    
    (23,999
    )
    
    $
    6.60
    
    
    
    (35,471
    )
    
    $
    9.91
    
    
    
    (13,066
    )
    
    $
    5.81Outstanding at end of year
    
    
    4,576,405
    
    
    $
    0.41
    
    
    
    5,873,272
    
    
    $
    0.45
    
    
    
    6,649,543
    
    
    $
    0.56Exercisable at end of year
    
    
    4,559,153
    
    
    $
    0.40
    
    
    
    5,813,842
    
    
    $
    0.41
    
    
    
    6,317,633
    
    
    $
    0.45
 2008
    
    
    2007
    
    
    2006Weighted-average fair value of options
granted during the year:
    
    
    N/A
    
    
    
    N/A
    
    
    $
    4.84Intrinsic value of options exercised during
the year:
    
    $
    2,632,566
    
    
    $
    3,376,505
    
    
    $
    4,693,045Fair value of options vested during the year:
    
    $
    129,833
    
    
    $
    408,213
    
    
    $
    635,779
  56




---



##### Table of Contents



OPTIONS OUTSTANDING
    
    
    OPTIONS EXERCISABLEWEIGHTED-AVERAGE
    
    
    WEIGHTED-
    
    
    
    
    
    
    WEIGHTED-RANGE OF
    
    
    
    
    
    REMAINING
    
    
    AVERAGE
    
    
    
    
    
    
    AVERAGEEXERCISE
    
    NUMBER
    
    
    CONTRACTUAL
    
    
    EXERCISE
    
    
    NUMBER
    
    
    EXERCISEPRICES
    
    OUTSTANDING
    
    
    LIFE (YEARS)
    
    
    PRICE
    
    
    EXERCISABLE
    
    
    PRICE$0.06$0.17
    
    
    2,988,604
    
    
    
    3.10
    
    
    $
    0.10
    
    
    
    2,988,604
    
    
    $
    0.10$0.30$0.56
    
    
    639,800
    
    
    
    1.18
    
    
    
    0.50
    
    
    
    639,800
    
    
    
    0.50$0.63$0.88
    
    
    568,028
    
    
    
    1.90
    
    
    
    0.69
    
    
    
    568,028
    
    
    
    0.69$1.01$1.81
    
    
    235,472
    
    
    
    5.12
    
    
    
    1.29
    
    
    
    235,472
    
    
    
    1.29$2.85$2.94
    
    
    34,000
    
    
    
    1.37
    
    
    
    2.93
    
    
    
    34,000
    
    
    
    2.93$3.00$3.98
    
    
    29,667
    
    
    
    5.27
    
    
    
    3.40
    
    
    
    29,667
    
    
    
    3.40$4.10$4.70
    
    
    68,834
    
    
    
    6.32
    
    
    
    4.49
    
    
    
    55,084
    
    
    
    4.46$5.36$6.75
    
    
    12,000
    
    
    
    7.01
    
    
    
    5.90
    
    
    
    8,498
    
    
    
    5.87$0.06$6.75
    
    
    4,576,405
    
    
    
    2.85
    
    
    $
    0.41
    
    
    
    4,559,153
    
    
    $
    0.40
 2006 Plan
  Weighted-AverageGrant-Date Fair
    
    
    AggregateValue Per
    
    
    IntrinsicNumber of RSAs
    
    
    Share
    
    
    ValueNonvested at December 31, 2007
    
    
    1,331,966
    
    
    $
    4.85Granted
    
    
    576,781
    
    
    
    3.00Vested
    
    
    (110,021
    )
    
    
    5.41Forfeited
    
    
    (73,366
    )
    
    
    5.99Nonvested at December 31, 2008
    
    
    1,725,360
    
    
    $
    4.15
    
    
    $
    3,554,242Expected to vest at December 31, 2008
    
    
    677,826
    
    
    $
    3.92
    
    
    $
    1,396,322
 2008
    
    
    2007
    
    
    2006Weighted-average fair value of RSAs
granted during the year:
    
    $
    3.00
    
    
    $
    6.33
    
    
    $
    4.40Intrinsic value of RSAs vested during the year:
    
    $
    431,207
    
    
    $
    257,873
    
    
    
    N/AFair value of shares vested during the year:
    
    $
    595,379
    
    
    $
    191,736
    
    
    
    N/A
    57




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##### Table of Contents



2009
    
    $
    992,3512010
    
    
    1,142,8482011
    
    
    402,5682012
    
    
    Thereafter
    
    
    Total
    
    $
    2,537,767
   Accounting for Income Taxes
  2008
    
    
    2007Deferred tax assets:Stock-based compensation expense
    
    $
    195,399
    
    
    $
    221,423Capitalized start-up costs
    
    
    160,361
    
    
    
    90,123Accrued liabilities
    
    
    150,104
    
    
    
    102,987Deferred rent
    
    
    115,827
    
    
    
    113,189Intangible assets, net
    
    
    
    
    
    
    60,600Allowance for doubtful accounts
    
    
    7,622
    
    
    
    7,299Other
    
    
    29,782
    
    
    
    12,812Net operating loss carryforwards
    
    
    259,576
    
    
    
    279,543918,671
    
    
    
    887,976Valuation allowance for deferred
tax assets
    
    
    
    
    
    
    Gross deferred tax asset
    
    
    918,671
    
    
    
    887,976Deferred tax liabilities:Prepaid expenses
    
    
    308,186
    
    
    
    244,167Intangible assets, net
    
    
    31,490
    
    
    
    Property and equipment, net
    
    
    25,622
    
    
    
    68,090Gross deferred tax liability
    
    
    365,298
    
    
    
    312,257Net deferred tax asset
    
    $
    553,373
    
    
    $
    575,719
  58




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##### Table of Contents



2008
    
    
    2007
    
    
    2006Current:Federal
    
    $
    2,387,855
    
    
    $
    3,846,923
    
    
    $
    1,346,815State
    
    
    315,400
    
    
    
    499,296
    
    
    
    202,7842,703,255
    
    
    
    4,346,219
    
    
    
    1,549,599Deferred:Federal
    
    
    19,559
    
    
    
    (209,424
    )
    
    
    682,289State
    
    
    2,787
    
    
    
    (29,146
    )
    
    
    92,52422,346
    
    
    
    (238,570
    )
    
    
    774,813Total income tax expense
    
    $
    2,725,601
    
    
    $
    4,107,649
    
    
    $
    2,324,412
    2008
    
    
    2007
    
    
    2006Federal statutory income tax rate
    
    
    34.0
    %
    
    
    34.0
    %
    
    
    34.0
    %State income taxes, net of federal benefit
    
    
    2.9
    
    
    
    2.8
    
    
    
    3.5Incentive stock option compensation
    
    
    (1.1
    )
    
    
    0.7
    
    
    
    3.4Non-deductible expenses
    
    
    0.9
    
    
    
    0.1
    
    
    
    0.4Miscellaneous
    
    
    0.1
    
    
    
    0.2
    
    
    
    0.9Effective income tax rate
    
    
    36.8
    %
    
    
    37.8
    %
    
    
    42.2
    %
     59




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##### Table of Contents



Indemnification of our Chief Executive Officer and Derivative Complaint
     th
   60




---



##### Table of Contents



61




---



##### Table of Contents



th th
  Gotham/Primarius Complaint
          62




---



##### Table of Contents



2008
    
    March 31
    
    
    June 30
    
    
    September 30
    
    
    December 31Revenue:Ratings and advisory
    
    $
    9,129,817
    
    
    $
    9,291,370
    
    
    $
    10,023,373
    
    
    $
    11,218,824Other
    
    
    5,992
    
    
    
    6,113
    
    
    
    6,684
    
    
    
    6,163Total revenue
    
    
    9,135,809
    
    
    
    9,297,483
    
    
    
    10,030,057
    
    
    
    11,224,987Expenses:Cost of ratings and advisory revenue
    
    
    1,572,732
    
    
    
    1,545,410
    
    
    
    1,604,983
    
    
    
    2,036,108Gross margin
    
    
    7,563,077
    
    
    
    7,752,073
    
    
    
    8,425,074
    
    
    
    9,188,879Operating expenses:Sales and marketing
    
    
    2,377,774
    
    
    
    2,380,652
    
    
    
    2,677,158
    
    
    
    3,410,184Product development
    
    
    1,689,829
    
    
    
    1,712,168
    
    
    
    1,889,339
    
    
    
    1,987,947General and administrative
    
    
    1,978,627
    
    
    
    2,000,486
    
    
    
    1,894,964
    
    
    
    2,244,454Income from operations
    
    
    1,516,847
    
    
    
    1,658,767
    
    
    
    1,963,613
    
    
    
    1,546,294Other:Interest income
    
    
    201,110
    
    
    
    127,291
    
    
    
    94,428
    
    
    
    6,928Interest expense
    
    
    (65
    )
    
    
    (51
    )
    
    
    (90
    )
    
    
    (2,706
    )Minority interest
    
    
    104,291
    
    
    
    79,866
    
    
    
    53,069
    
    
    
    66,778Income before income taxes
    
    
    1,822,183
    
    
    
    1,865,873
    
    
    
    2,111,020
    
    
    
    1,617,294Income tax expense
    
    
    665,688
    
    
    
    657,699
    
    
    
    789,065
    
    
    
    613,149Net income
    
    
    1,156,495
    
    
    
    1,208,174
    
    
    
    1,321,955
    
    
    
    1,004,145Net income per share (basic)
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.05
    
    
    $
    0.04Weighted average shares outstanding
(basic)
    
    
    27,741,844
    
    
    
    26,955,947
    
    
    
    26,705,410
    
    
    
    26,641,745Net income per share (diluted)
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.03Weighted average shares outstanding
(diluted)
    
    
    32,575,916
    
    
    
    31,699,824
    
    
    
    31,204,195
    
    
    
    30,452,885
  63




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2007
    
    March 31
    
    
    June 30(1)
    
    
    September 30
    
    
    December 31Revenue:Ratings and advisory
    
    $
    7,880,859
    
    
    $
    8,033,201
    
    
    $
    8,103,208
    
    
    $
    8,724,342Other
    
    
    2,450
    
    
    
    3,410,651
    
    
    
    3,564
    
    
    
    8,800Total revenue
    
    
    7,883,309
    
    
    
    11,443,852
    
    
    
    8,106,772
    
    
    
    8,733,142Expenses:Cost of ratings and advisory revenue
    
    
    1,358,069
    
    
    
    1,283,689
    
    
    
    1,212,626
    
    
    
    1,469,288Gross margin
    
    
    6,525,240
    
    
    
    10,160,163
    
    
    
    6,894,146
    
    
    
    7,263,854Operating expenses:Sales and marketing
    
    
    2,032,781
    
    
    
    2,209,384
    
    
    
    2,333,067
    
    
    
    2,572,679Product development
    
    
    1,230,906
    
    
    
    1,347,447
    
    
    
    1,346,859
    
    
    
    1,566,513General and administrative
    
    
    2,380,306
    
    
    
    942,324
    
    
    
    1,914,726
    (2)
    
    
    1,767,558Income from operations
    
    
    881,247
    
    
    
    5,661,008
    
    
    
    1,299,494
    
    
    
    1,357,104Other:Other
    
    
    
    
    
    
    
    
    
    
    
    (2)
    
    
    Interest income
    
    
    229,958
    
    
    
    479,507
    
    
    
    333,151
    
    
    
    288,287Interest expense
    
    
    (110
    )
    
    
    (1,125
    )
    
    
    (414
    )
    
    
    (122
    )Minority interest
    
    
    53,590
    
    
    
    78,413
    
    
    
    97,644
    
    
    
    98,188Income before income taxes
    
    
    1,164,685
    
    
    
    6,217,803
    
    
    
    1,729,875
    
    
    
    1,743,457Income tax expense
    
    
    503,351
    
    
    
    2,384,017
    
    
    
    675,178
    
    
    
    545,103Net income
    
    
    661,334
    
    
    
    3,833,786
    
    
    
    1,054,697
    
    
    
    1,198,354Net income per share (basic)
    
    $
    0.02
    
    
    $
    0.13
    
    
    $
    0.04
    
    
    $
    0.04Weighted average shares outstanding
(basic)
    
    
    28,566,594
    
    
    
    28,729,766
    
    
    
    28,708,557
    
    
    
    28,479,761Net income per share (diluted)
    
    $
    0.02
    
    
    $
    0.11
    
    
    $
    0.03
    
    
    $
    0.04Weighted average shares outstanding
(diluted)
    
    
    33,817,837
    
    
    
    33,926,878
    
    
    
    33,741,661
    
    
    
    33,398,968
 (1)
    
    - Net income in June 2007 includes the arbitration award from Hewitt of
approximately $2.8 million, net of tax.(2)
    
    - Other expense of $25,268 as filed in our Form
10-Q for the period ended September 30, 2007 was reclassified to
general and administrative expense.  Indemnification and Derivative Complaint
  Gotham/Primarius Complaint
  Executive Officers of the Registrant
    64




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Internal Control-Integrated Framework
  65




---



##### Table of Contents



Internal ControlIntegrated Fram
    Internal
ControlIntegrated Framework
  /s/ GRANT THORNTON LLP

Denver, ColoradoMarch 16, 2009
  66




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##### Table of Contents



Equity Compensation Plan Information
  Number of securitiesremaining availablefor future issuanceNumber of securities
    
    
    
    
    
    
    under equityto be issued upon
    
    
    Weighted-average
    
    
    compensation plansexercise of
    
    
    exercise price of
    
    
    (excluding securitiesoutstanding options,
    
    
    outstanding options,
    
    
    reflected in columnwarrants and rights
    
    
    warrants, rights and RSAs
    
    
    (a))Plan category
    
    (a)
    
    
    (b)
    
    
    (c)Equity compensation
plans approved by
security holders
    
    
    6,301,765
    (1)
    
    $
    0.30
    
    
    
    3,955,972Equity compensation
plans not approved
by security holders
    
    
    N/A
    
    
    
    
    
    
    
    N/ATotal
    
    
    6,301,765
    
    
    
    
    
    
    
    3,955,972
 (1)
    
    1,725,360 of securities to be issued upon exercise relate to restricted stock
awards not yet vested.  
   
    67




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(a)
    
    1. Financial Statements.
  2.
    
    Financial Statement Schedules.
     ALLOWANCE FOR DOUBTFUL
    
    BALANCE AT
    
    
    CHARGED TO
    
    
    CHARGED TO
    
    
    
    
    
    
    BALANCE ATACCOUNTS ON TRADE
    
    BEGINNING
    
    
    COSTS AND
    
    
    OTHER
    
    
    
    
    
    
    END OFRECEIVABLES
    
    OF PERIOD
    
    
    EXPENSES
    
    
    ACCOUNTS
    
    
    DEDUCTIONS
    
    
    PERIODYear ended December 31, 2008
    
    $
    19,207
    
    
    $
    20,000
    
    
    $
    
    
    
    $
    19,150
    (1)
    
    $
    20,057Year ended December 31, 2007
    
    $
    19,207
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    19,207Year ended December 31, 2006
    
    $
    4,207
    
    
    $
    15,000
    
    
    $
    
    
    
    $
    
    
    
    $
    19,207
 (1)
    
    Represents actual amounts charged against the allowance for the periods
presented. (b)
    
    Exhibits.
  68




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##### Table of Contents



EXHIBITNUMBER
    
    DESCRIPTION2.1
    
    
    Asset Purchase Agreement dated October 13, 2008 by and
among HealthGrades, Inc. and Adviware Pty Ltd.
(incorporated by reference to Exhibit 2.1 to our Form 8-K,
filed on October 14, 2008)3.1
    
    
    Form of Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to our Annual
Report on Form 10-K for the year ended December 31, 2001)3.2
    
    
    Amended and Restated Bylaws (incorporated by reference to
Exhibit 3.2 to our amendment to our Quarterly Report on
Form 10-Q/A for the quarter ended September 30, 2004, filed
on May 2, 2005)10.1
    *+
    

2006
Equity Compensation Plan Amended and Restated10.1.2
    *
    
    Form of Grant Notice of Restricted Stock Award
(incorporated by reference to Exhibit 10.1.2 to our Form
10-K for the year ended December 31, 2006)10.3
    *
    
    Employment Agreement dated as of April 1, 1996 by and
between Specialty Care Network, Inc. and Kerry R. Hicks
(incorporated by reference to Exhibit 10.3 to our
Registration Statement on Form S-1 (File No. 333-17627))10.3.1
    *
    
    Amended and Restated Employment Agreement dated August 6,
2008 by and between Health Grades, Inc. and Kerry R. Hicks
(incorporated by reference to Exhibit 10.3.1 to our Form
10-Q for the quarter ended June 30, 2008)10.3.2
    *
    
    Confidentiality and Non-Competition Agreement dated August
6, 2008 by and between Health Grades, Inc. and Kerry R.
Hicks (incorporated by reference to Exhibit 10.3.2 to our
Form 10-Q for the quarter ended June 30, 2008)10.4.1
    *
    
    Employment Agreement between Specialty Care Network, Inc.
and David Hicks, dated March 1, 1996 (incorporated by
reference to Exhibit 10.8 to our Registration Statement on
Form S-1 (File No. 333-17627))10.4.2
    *
    
    Amendment to Employment Agreement between Specialty Care
Network, Inc. and David Hicks, dated December 2, 1997.
(incorporated by reference to Exhibit 10.8.1 to our Annual
Report on Form 10-K for the fiscal year ended December 31,
1997)10.5
    
    
    Building Lease between GR Development One, LLC, Landlord
and Health Grades, Inc., Tenant. (incorporated by reference
to exhibit 10.6 to our Form 10-K for the year ended
December 31, 2005)10.5.1
    
    
    Building Lease Amendment (incorporated by reference to
exhibit 10.5.1 to our Form 10-K for the year ended December
31, 2006)10.6
    *+
    
    Directors Compensation10.7
    *
    
    Steven D. Wood Offer of Employment Letter (incorporated by
reference to exhibit 99.1 to our Form 8-K, filed on July
10, 2006)21.1
    +
    
    List of subsidiaries of Registrant23.1
    +
    
    Consent of Grant Thornton LLP31.1
    +
    
    Certification of the Chief Executive Officer pursuant to
Rule 15d-14(a) under the Securities Exchange Act.31.2
    +
    
    Certification of the Chief Financial Officer pursuant to
Rule 15d-14(a) under the Securities Exchange Act.32.1
    +
    
    Certification of the Chief Executive Officer pursuant to
Rule 15d-14(b) under the Securities Exchange Act.32.2
    +
    
    Certification of the Chief Financial Officer pursuant to
Rule 15d-14(b) under the Securities Exchange Act.
 *
    
    - Constitutes a management contract, compensatory plan or arrangement required to be filed as an
exhibit to this report.+
    
    - Filed herewith.  69




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##### Table of Contents



HEALTH GRADES, INC.Date: March 16, 2009
    /s/   Kerry R. HicksKerry R. HicksChairman, President and Chief Executive Officer  NAME
    
    TITLE
    
    DATE/s/ Kerry R. Hicks

Kerry R. Hicks
    
    Chairman, President and
Chief Executive Officer
(Principal
Executive Officer)
    
    March 16, 2009/s/ Allen Dodge

Allen Dodge
    
    Executive Vice
President, Chief
Financial Officer,
Secretary and Treasurer
(Principal Financial and
Accounting Officer
    
    March 16, 2009/s/ Mary Boland

Mary Boland
    
    Director
    
    March 16, 2009/s/ Leslie S. Matthews, M.D.

Leslie S. Matthews, M.D.
    
    Director
    
    March 16, 2009/s/ John Quattrone

John Quattrone
    
    Director
    
    March 16, 2009
  70




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##### Table of Contents



10.1
    *+
    
    2006 Equity Compensation Plan Amended and Restated10.6
    *+
    
    Directors Compensation21.1
    +
    
    List of subsidiaries of Registrant23.1
    +
    
    Consent of Grant Thornton LLP31.1
    +
    
    Certification of the Chief Executive Officer pursuant to Rule
15d-14(a) under the Securities Exchange Act.31.2
    +
    
    Certification of the Chief Financial Officer pursuant to Rule
15d-14(a) under the Securities Exchange Act.32.1
    +
    
    Certification of the Chief Executive Officer pursuant to Rule
15d-14(b) under the Securities Exchange Act.32.2
    +
    
    Certification of the Chief Financial Officer pursuant to Rule
15d-14(b) under the Securities Exchange Act.
 *
    
    - Constitutes a management contract, compensatory plan or arrangement required to be filed as an
exhibit to this report.+
    
    - Filed herewith.  71