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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-K
 (MARK ONE)
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
FISCAL YEAR ENDED DECEMBER 31, 2006 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 
of incorporation or organization)
    
    62-1623449
(I.R.S. Employer Identification No.)
 500 Golden Ridge Road, Suite 100
GOLDEN, CO
(Address of principal executive offices)
    
    80401
(Zip Code)
   Title of each class
    
    Name of each exchange on which registeredCommon stock, $0.001 par value per share
    
    NASDAQ Capital Market
   o þ
 o þ
 þ o
 o
 o þ o
 o þ




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##### 



PART IItem 1.
    
    Business
    
    
    2Item 1A.
    
    Risk Factors
    
    
    15Item 1B.
    
    Unresolved Staff Comments
    
    
    20Item 2.
    
    Properties
    
    
    20Item 3.
    
    Legal Proceedings
    
    
    20Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    23PART IIItem 5.
    
    Market for the
Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    23Item 6.
    
    Selected Financial Data
    
    
    24Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    25Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    32Item 8.
    
    Financial Statements and Supplementary Data
    
    
    32Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    55Item 9A.
    
    Controls and Procedures
    
    
    55Item 9B.
    
    Other Information
    
    
    57PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    57Item 11.
    
    Executive Compensation
    
    
    57Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    57Item 13.
    
    Certain Relationships and Related Transactions
    
    
    58Item 14.
    
    Principal Accountant Fees and Services
    
    
    58PART IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    58Exhibit 10.1Exhibit 10.1.2Exhibit 10.5.1Exhibit 10.6Exhibit 23.1Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  Special Note Regarding Forward-Looking Statements
  
  
  BUSINESS
 Overview
   2




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
    
    Over 5,000 hospitals;
    
    Over 700,000 physicians in more than 120 specialties; and
    
    Over 16,000 nursing homes.
     Healthcare Provider Quality Information
    3




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Hospital Specialty and Programmatic Ratings
      Institutional and Service Line Hospital Awards  DHA-CE
   4




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Physician Quality Reports
  Internet Patient Acquisition 
 Nursing Home Ratings
  5




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Information and Related Services for Hospitals, Employers, Consumers, Benefits Consulting Firms,
Payers and Professionals
  Services for Hospitals
 
    
    Cardiac;
    
    Orthopedics;
    
    Vascular;
    
    Pulmonary;
    
    Neurosciences;
    
    Gastrointestinal;
    
    Critical care;
    
    General surgery;
    
    Bariatric surgery;
    
    Maternity care; and
    
    Womens health.
 Strategic Quality Initiative (SQI).
  
    
    HealthGrades 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;
    
    Premium placement of Enhanced Hospital Profile on the HealthGrades website in the
physician search section for the Internet Patient Acquisition (IPAC) Service Line(s)
licensed;
    
    Client password-protected access to a template in which Client can input and update its
hospital profile information at Clients convenience;
    
    Quality Ratings Analysis (QRA) to help hospitals to understand the data methodology
underlying their ratings and what they can do to continue to improve their quality;
    
    Ratings comparisons developed and approved by HealthGrades;
    
    Detailed analysis of client outcomes to understand individual star ratings; and
    
    Competitive comparisons to use in service line market positioning.
   6




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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 Distinguished Hospital
Award for Clinical Excellence trophy;
    
    Customized video featuring a HealthGrades executive congratulating the client on the
Americas 50 Best Hospitals Award;
    
    One additional on-site visit by a HealthGrades senior consultant or vice president for CEO media training; and
    
    Services for the clients CEO to help the client learn how to best discuss quality with the media;
  Distinguished Hospital Program for Patient Safety (DHP-PS).
 
    
    HealthGrades name and logo;
    
    Distinguished Hospital Award for Patient Safety (DHA-PS) designation and trophy for that year; and
    
    Marketing messages developed by HealthGrades.
  Quality Assessment and Implementation (QAI).
 Quality Assessment (QA).
 Quality Report for Hospital Professionals  Clinical Service Line.
 Quality Report for Hospital Professionals  Patient Safety.
 Additional Services for Employers, Benefits Consulting Firms, Payers and Others
  7




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Find a High-Quality Provider:
 
    
    Hospital Quality Guide
    
    Physician Quality Guide
    
    Nursing Home Quality Guide
    
    Home Health Quality Guide
  Hospital Quality Guide
 
    
    Easy-to-understand star ratings on over 100 medical issues (28 medical issues utilizing
our methodology and over 73 medical issues utilizing 3Ms APR-DRG methodology) and by
service line based on risk-adjusted outcome measures;
    
    Cost, length of stay, procedure volume and distance to facility;
    
    Hospital profile information;
    
    The Leapfrog Group (a data collection, analysis, and support services group) safety measures;
    
    AHRQ patient safety indicators;
    
    CMS quality measures;
    
    Overall hospital rating; and
    
    Consumer-friendly navigation and terminology.
 Physician Quality Guide
 
    
    Addresses and phone numbers;
    
    State and federal sanction information (if any) within the last 5 years;
    
    Board certification;
    
    Medical school attended;
    
    Years since medical school;
    
    Gender;
    
    Foreign languages; and
    
    Ratings of affiliated hospitals (hospitals for which the physician has privileges).
 Nursing Home Quality Guide
 
    
    Overall star rating based on comparison to other facilities within the state;
    
    Details of the last four licensing surveys;
    
    Complaint investigations;
    
    Repeat violations; and
    
    State averages for violations and inspections.
 Home Health Quality Guide
 
    
    Overall star rating based on comparison to other home health agencies within an individual state;
    
    Licensing survey deficiencies;
    
    Complaint investigations; and
    
    Repeat violations.
  8




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Healthcare Budget:
 Medical Cost Calculator
 
    
    Access real-world prices that help consumers to budget and plan healthcare expenditures;
 
    
    Cost information on 55 episodes of care and more than 200 tests by geography, gender and age;
    
    Research the price of diagnostic tests and calculate out-of-pocket costs based on
coverage and category, such as stress tests, MRIs and blood pressure checks; and
    
    Estimate the cost of a visit, including the price for specialty procedures and
standard examinations.
 Provider Select
 
    
    Verify which health plans individual providers are affiliated with or select physicians
and hospitals based on health plan coverage; and
    
    Determine which physicians are accepted by your specific health plan to help prepare for
a medical procedure or to choose providers during open enrollment of employee benefits.
 Optimize Your Health:
 Preventative Care
 
    
    Interactive tools which help consumers assess health status or issues based on personal
data (e.g., risk of heart disease, diabetes, asthma, depression, etc.); and
    
    Personal calculators to track and manage: calories, stress, activities and smoking.
 Managing Your Condition
 
    
    Information and tools to assist consumers in managing a chronic disease or condition;
and
    
    Action sets provide consumers with in-depth information and practical tools to help them
take action in managing chronic illnesses.
 Decision Support
 
    
    Decision Points provide the framework to help consumers make personal health decisions
about tests and treatment option; and
    
    Interactive tools and quizzes guide consumers to more personalize healthcare.
 Drug Checks
 
    
    Tools that empower consumers to improve communication with their doctor and pharmacist
by providing in-depth content on a variety of medications and conditions; and
    
    A comprehensive reference list of prescription and non-prescription drugs and
medications.
 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;
  9




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
    
    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
 Hospital Quality Report
 
    
    Ratings for all procedures and diagnoses rated by HealthGrades for the hospital;
    
    Survey data prepared in connection with the Leapfrog Group;
    
    HealthGrades 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;
    
    Board certification information;
    
    Education information, including medical school and residency;
    
    Malpractice data;
    
    Memberships;
    
    Fellowships;
    
    State and federal sanction information (if any) within the last 5 years;
    
    Name and address of area hospitals;
    
    Gender and age;
    
    National comparative statistics in board certification and sanction activity regarding
physicians in the same specialty field; and
    
    Information on how to choose a physician with a checklist and guide.
 Competition
    10




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Company History
   Government Regulation
        11




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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
    12




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only
  Government Regulation of the Internet
     Intellectual Property
    13




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
    
    Hospital Ratings;
    
    Hospital Awards; and
    
    Hospital Patient Safety
  
    
    Hospital Quality Report;
    
    Physician Quality Report;
    
    Physician Quality Comparison Report;
    
    Nursing Home Quality Report; and
    
    Nursing Home Quality Comparison Report
   Employees
  Available Information
     14




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
    
    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.
        
    
    data providers that provide detailed utilization and outcomes information to hospitals;
  17




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
    
    healthcare consulting companies;
    
    companies or organizations providing or maintaining online healthcare information;
    
    vendors of healthcare information, products and services distributed through other means, including direct sales, mail and
fax messaging;
    
    companies and organizations providing or maintaining general purpose consumer online services that provide access to
healthcare content and services;
    
    companies and organizations providing or maintaining public sector and non-profit websites that provide healthcare
information and services without advertising or commercial sponsorships;
    
    companies and organizations providing or maintaining 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
     
    
    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
     18




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
    
    state privacy and confidentiality laws;
    
    state laws regulating healthcare professionals, such as physicians, pharmacists and nurse practitioners;
    
    Medicaid 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
     19




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NAME
    
    AGE
    
    POSITIONKerry R. Hicks
    
    
    47
    
    
    Chairman, President and Chief Executive OfficerDavid G. Hicks
    
    
    48
    
    
    Executive Vice PresidentSarah Loughran
    
    
    42
    
    
    Executive Vice PresidentAllen Dodge
    
    
    39
    
    
    Executive Vice President, Chief Financial Officer,
Secretary and TreasurerSteve Wood
    
    
    63
    
    
    Executive Vice President
       
  
  Market Information
  HIGH
    
    
    LOWYear Ended December 31, 2005First Quarter
    
    $
    5.10
    
    
    $
    2.77Second Quarter
    
    
    5.95
    
    
    
    3.72Third Quarter
    
    
    5.50
    
    
    
    3.25Fourth Quarter
    
    
    6.48
    
    
    
    3.20Year Ended December 31, 2006First Quarter
    
    $
    6.89
    
    
    $
    5.28Second Quarter
    
    
    5.30
    
    
    
    3.04Third Quarter
    
    
    4.67
    
    
    
    4.08Fourth Quarter
    
    
    4.99
    
    
    
    4.18
  23




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Purchases of Equity Securities by the Issuer
   TotalNumber of
    
    
    MaximumShares
    
    
    Number ofPurchased
    
    
    Shares Thatas Part of
    
    
    May Yet BeTotal
    
    
    Average
    
    
    Publicly
    
    
    PurchasedNumber
    
    
    Price Paid
    
    
    Announced
    
    
    Under theof Shares
    
    
    per Share
    
    
    Plans or
    
    
    Plans orPeriod
    
    Purchased
    
    
    (1)
    
    
    Programs
    
    
    ProgramsOctober 1, 2006 through October 31, 2006
    
    
    
    
    
    $
    
    
    
    
    
    
    
    
    2,475,840November 1, 2006 through November 30,
2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,475,840December 1, 2006 through December 31,
2006
    
    
    234,360
    
    
    
    4.32
    
    
    
    234,360
    
    
    
    2,241,480Total
    
    
    234,360
    
    
    $
    4.32
    
    
    
    234,360
    
    
    
    2,241,480
 (1)
 Performance Chart
 12/29/2006
    
    
    12/30/2005
    
    
    12/31/2004
    
    
    12/31/2003
    
    
    12/31/2002Health Grades, Inc.
    
    $
    6,414.29
    
    
    $
    9,028.57
    
    
    $
    4,142.86
    
    
    $
    857.14
    
    
    $
    42.86NASDAQ Stock Market (US)
    
    $
    126.22
    
    
    $
    114.88
    
    
    $
    112.49
    
    
    $
    103.37
    
    
    $
    69.13NASDAQ Computer & Data
Processing Index
    
    $
    116.09
    
    
    $
    103.44
    
    
    $
    100.04
    
    
    $
    90.85
    
    
    $
    68.96
 
   Year Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002Ratings and advisory revenue
    
    $
    27,764,021
    
    
    $
    20,794,173
    
    
    $
    14,536,304
    
    
    $
    8,803,929
    
    
    $
    5,091,891Physician practice service fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    195,492Income (loss) from operations
    
    
    4,817,122
    
    
    
    3,942,424
    
    
    
    1,760,600
    
    
    
    (1,275,775
    )
    
    
    (1,770,555
    )Income (loss) before cumulative effect of a
change in accounting principle
    
    
    3,181,510
    
    
    
    4,139,853
    
    
    
    1,782,143
    
    
    
    (1,283,687
    )
    
    
    (562,482
    )Net income (loss)
    
    $
    3,181,510
    
    
    $
    4,139,853
    (2)
    
    $
    1,782,143
    
    
    $
    (1,283,687
    )
    
    $
    (1,650,793
    )(1)Net income (loss) per common share (basic)
    
    $
    0.11
    
    
    $
    0.15
    
    
    $
    0.07
    
    
    $
    (0.05
    )
    
    $
    (0.05
    )(1)Weighted average number of common shares
used in computation (basic)
    
    
    28,432,185
    
    
    
    27,039,057
    
    
    
    25,058,173
    
    
    
    26,679,467
    
    
    
    36,189,748Net income (loss) per common share (diluted)
    
    $
    0.09
    
    
    $
    0.12
    
    
    $
    0.05
    
    
    $
    (0.05
    )
    
    $
    (0.05
    )(1)Weighted average number of common
shares and common share equivalents
used in computation (diluted)
    
    
    33,628,330
    
    
    
    34,833,521
    
    
    
    33,031,087
    
    
    
    26,679,467
    
    
    
    36,189,748
  24




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(1) Goodwill and Other
Intangible Assets
 (2)
  DECEMBER 31,
    
    
    DECEMBER 31,
    
    
    DECEMBER 31,
    
    
    DECEMBER 31,
    
    
    DECEMBER 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002Working capital (deficit)
    
    
    7,027,821
    
    
    
    5,024,057
    
    
    
    96,190
    
    
    
    (1,820,137
    )
    
    
    44,207Total assets
    
    
    31,019,585
    
    
    
    23,844,473
    
    
    
    12,931,127
    
    
    
    8,821,239
    
    
    
    7,117,551Total long-term debt
    
    
    3,863
    
    
    
    5,254
    
    
    
    
    
    
    
    
    
    
    
    
 
    Revenue Growth and Client Retention
    25




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Share-Based Payment
   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.
  26




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Year ended
    
    
    Year ended
    
    
    Year endedProduct Area
    
    December 31, 2006
    
    
    December 31, 2005
    
    
    December 31, 2004Provider Services
    
    $
    20,068,557
    
    
    $
    15,038,998
    
    
    $
    11,019,852Internet Business Group
    
    
    5,099,838
    
    
    
    3,004,152
    
    
    
    1,918,400Strategic Health Solutions
    
    
    2,595,626
    
    
    
    2,751,023
    
    
    
    1,598,052Total
    
    $
    27,764,021
    
    
    $
    20,794,173
    
    
    $
    14,536,304
   Provider Services.
 Internet Business Group
 Strategic Health Solutions.
   27




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28




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Provider Services.
 Internet Business Group
 Strategic Health Solutions.
     29




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Share-Based Payment
     30




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Payments Due by PeriodLess than 1
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    year
    
    
    2-3 years
    
    
    4-5 years
    
    
    5 yearsContractual ObligationsCapital Lease Obligations
    
    $
    5,838
    
    
    $
    1,668
    
    
    $
    3,336
    
    
    $
    834
    
    
    $
    Operating Lease Obligations
    
    
    2,548,504
    
    
    
    581,352
    
    
    
    1,179,173
    
    
    
    787,979
    
    
    
    Employee Contracts
    
    
    546,711
    
    
    
    546,711
    
    
    
    
    
    
    
    
    
    
    
    Purchase Obligations
    
    
    717,806
    
    
    
    468,651
    
    
    
    249,155
    
    
    
    
    
    
    
    Total
    
    $
    3,818,859
    
    
    $
    1,598,382
    
    
    $
    1,431,664
    
    
    $
    788,813
    
    
    $
    
   Share Based Payments
 Amendment of FASB Staff
Position FAS 123(R)-1. , Classification and Measurement of Freestanding Financial Instruments Originally issued
in Exchange for Employee Services under FASB Statement No. 123(R)
 Technical Correction of FASB Statement No. 123(R) SFAS 123(R)
 Defined Benefit Pension and Other Postretirement Plans
 Employers Accounting for
Defined Benefit Pension and Other Postretirement Plans  An Amendment of FASB Statements No. 87, 88,
106 and 132R.
  31




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Fair Value Measurement
 Fair Value Measurement.
 Accounting for Uncertainty in Income Taxes
 Accounting for Uncertainty in
Income Taxes  An Interpretation of FASB Statement No. 109 Accounting for Income Taxes
 
 Effects of Prior Year Misstatements
 Financial Statements  Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements
   
   HEALTH GRADES, INC.:Reports of Independent Registered Public Accounting Firm
    
    
    33Balance Sheets
    
    
    34Statements of Income
    
    
    35Statements of Stockholders Equity
    
    
    36Statements of Cash Flows
    
    
    37Notes to Financial Statements
    
    
    38
  32




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Share-Based Payment
  Internal ControlIntegrated
Framework
 /s/ GRANT THORNTON LLP
 
  
 Internal ControlIntegrated Framework
    Internal ControlIntegrated Framework Internal
ControlIntegrated Framework
  /s/ GRANT THORNTON LLP
 
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DECEMBER 31,2006
    
    
    2005ASSETSCash and cash equivalents
    
    $
    16,024,373
    
    
    $
    9,682,106Short-term investments
    
    
    
    
    
    
    1,988,154Accounts receivable, net
    
    
    8,895,709
    
    
    
    5,613,725Prepaid expenses and other current assets
    
    
    712,021
    
    
    
    569,551Deferred income taxes
    
    
    
    
    
    
    1,080,562Total current assets
    
    
    25,632,103
    
    
    
    18,934,098Property and equipment, net
    
    
    1,765,961
    
    
    
    1,595,065Intangible assets, net
    
    
    115,001
    
    
    
    177,729Goodwill
    
    
    3,106,181
    
    
    
    3,106,181Deferred income taxes
    
    
    400,339
    
    
    
    31,400Total assets
    
    $
    31,019,585
    
    
    $
    23,844,473LIABILITIES AND STOCKHOLDERS EQUITYAccounts payable
    
    $
    340,742
    
    
    $
    265,689Accrued payroll, incentive compensation and related expenses
    
    
    1,838,282
    
    
    
    1,525,844Accrued expenses
    
    
    311,941
    
    
    
    289,088Current portion of capital lease obligations
    
    
    1,391
    
    
    
    1,310Current portion of deferred rent
    
    
    75,074
    
    
    
    70,263Deferred revenue
    
    
    15,897,374
    
    
    
    11,742,827Deferred income taxes
    
    
    63,190
    
    
    
    Income taxes payable
    
    
    76,288
    
    
    
    15,020Total current liabilities
    
    
    18,604,282
    
    
    
    13,910,041Long-term portion of capital lease obligations
    
    
    3,863
    
    
    
    5,254Long-term portion of deferred rent
    
    
    268,392
    
    
    
    311,599Total liabilities
    
    
    18,876,537
    
    
    
    14,226,894Commitments and contingenciesStockholders 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 48,775,357 and 47,674,779 shares issued as of December
31, 2006 and 2005, respectively
    
    
    48,775
    
    
    
    47,674Additional paid-in capital
    
    
    94,604,033
    
    
    
    91,984,099Accumulated deficit
    
    
    (65,465,104
    )
    
    
    (68,646,614
    )Treasury stock, 20,321,910 and 19,563,390 shares as of December
31, 2006 and 2005, respectively
    
    
    (17,044,656
    )
    
    
    (13,767,580
    )Total stockholders equity
    
    
    12,143,048
    
    
    
    9,617,579Total liabilities and stockholders equity
    
    $
    31,019,585
    
    
    $
    23,844,473
   34




---



##### Table of Contents



2006
    
    
    2005
    
    
    2004Revenue:Ratings and advisory revenue
    
    $
    27,764,021
    
    
    $
    20,794,173
    
    
    $
    14,536,304Other
    
    
    6,231
    
    
    
    13,333
    
    
    
    1,44727,770,252
    
    
    
    20,807,506
    
    
    
    14,537,751Cost of revenue:Cost of ratings and advisory revenue
    
    
    4,593,310
    
    
    
    3,168,668
    
    
    
    2,488,202Gross margin
    
    
    23,176,942
    
    
    
    17,638,838
    
    
    
    12,049,549Operating expenses:Sales and marketing
    
    
    8,423,777
    
    
    
    5,801,590
    
    
    
    4,932,210Product development
    
    
    3,547,335
    
    
    
    3,035,728
    
    
    
    2,017,441General and administrative
    
    
    6,388,708
    
    
    
    4,859,096
    
    
    
    3,339,298Income from operations
    
    
    4,817,122
    
    
    
    3,942,424
    
    
    
    1,760,600Other:Other
    
    
    (43
    )
    
    
    1,405
    
    
    
    Interest income
    
    
    689,230
    
    
    
    205,124
    
    
    
    21,543Interest expense
    
    
    (387
    )
    
    
    (763
    )
    
    
    Income before income taxes
    
    
    5,505,922
    
    
    
    4,148,190
    
    
    
    1,782,143Income tax expense
    
    
    2,324,412
    
    
    
    8,337
    
    
    
    Net income
    
    $
    3,181,510
    
    
    $
    4,139,853
    
    
    $
    1,782,143Net income per common share (basic)
    
    $
    0.11
    
    
    $
    0.15
    
    
    $
    0.07Weighted average number of common shares
used in computation (basic)
    
    
    28,432,185
    
    
    
    27,039,057
    
    
    
    25,058,173Net income per common share (diluted)
    
    $
    0.09
    
    
    $
    0.12
    
    
    $
    0.05Weighted average number of common shares
used in computation (diluted)
    
    
    33,628,330
    
    
    
    34,833,521
    
    
    
    33,031,087
   35




---



##### Table of Contents



COMMON STOCK
    
    
    ADDITIONAL$0.001 PAR VALUE
    
    
    PAID-IN
    
    
    ACCUMULATED
    
    
    TREASURYSHARES
    
    
    AMOUNT
    
    
    CAPITAL
    
    
    DEFICIT
    
    
    STOCK
    
    
    TOTALBalance at January 1, 2004
    
    
    44,052,153
    
    
    $
    44,052
    
    
    $
    89,814,939
    
    
    $
    (74,568,610
    )
    
    $
    (13,767,580
    )
    
    $
    1,522,801Stock based compensation expense 
non-employee
    
    
    
    
    
    
    
    
    
    
    157,500
    
    
    
    
    
    
    
    
    
    
    
    157,500Employee stock option exercise
    
    
    828,023
    
    
    
    828
    
    
    
    121,969
    
    
    
    
    
    
    
    
    
    
    
    122,797Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,782,143
    
    
    
    
    
    
    
    1,782,143Balance at December 31, 2004
    
    
    44,880,176
    
    
    
    44,880
    
    
    
    90,094,408
    
    
    
    (72,786,467
    )
    
    
    (13,767,580
    )
    
    
    3,585,241Stock based compensation expense 
non-employee
    
    
    
    
    
    
    
    
    
    
    24,311
    
    
    
    
    
    
    
    
    
    
    
    24,311Employee stock option exercise
    
    
    2,078,020
    
    
    
    2,078
    
    
    
    624,215
    
    
    
    
    
    
    
    
    
    
    
    626,293Stock warrant exercise
    
    
    716,583
    
    
    
    716
    
    
    
    85,978
    
    
    
    
    
    
    
    
    
    
    
    86,694Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    1,155,187
    
    
    
    
    
    
    
    
    
    
    
    1,155,187Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,139,853
    
    
    
    
    
    
    
    4,139,853Balance at December 31, 2005
    
    
    47,674,779
    
    
    
    47,674
    
    
    
    91,984,099
    
    
    
    (68,646,614
    )
    
    
    (13,767,580
    )
    
    
    9,617,579Stock based compensation expense 
employees
    
    
    
    
    
    
    
    
    
    
    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
    )
    
    $
    12,143,048
   36




---



##### Table of Contents



2006
    
    
    2005
    
    
    2004OPERATING ACTIVITIESNet income
    
    $
    3,181,510
    
    
    $
    4,139,853
    
    
    $
    1,782,143Adjustments to reconcile net income to net
cash provided by operating activities:Depreciation and amortization
    
    
    698,317
    
    
    
    393,835
    
    
    
    146,051Bad debt expense
    
    
    15,000
    
    
    
    20,000
    
    
    
    3,569Loss (gain) on disposal of assets
    
    
    43
    
    
    
    (1,405
    )
    
    
    7,146Stock based compensation expense   non-employees
    
    
    14,396
    
    
    
    24,311
    
    
    
    157,500Stock based compensation expense  employees
    
    
    726,421
    
    
    
    
    
    
    
    Accretion of discount on held-to-maturity securities
    
    
    (204,323
    )
    
    
    
    
    
    
    Tax benefit from stock option exercises
    
    
    (1,420,574
    )
    
    
    1,155,187
    
    
    
    Deferred income taxes
    
    
    774,813
    
    
    
    (1,111,962
    )
    
    
    Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (3,296,984
    )
    
    
    (2,599,350
    )
    
    
    (1,349,609
    )Prepaid expenses and other current assets
    
    
    (142,470
    )
    
    
    (315,712
    )
    
    
    (22,999
    )Accounts payable
    
    
    75,053
    
    
    
    221,654
    
    
    
    (72,082
    )Accrued payroll, incentive compensation
and related expenses
    
    
    312,438
    
    
    
    347,263
    
    
    
    30,420Accrued expenses
    
    
    22,853
    
    
    
    (33,689
    )
    
    
    147,397Income taxes payable
    
    
    1,507,835
    
    
    
    (56,278
    )
    
    
    (2,045
    )Deferred revenue
    
    
    4,154,547
    
    
    
    4,013,632
    
    
    
    1,943,758Deferred rent
    
    
    (38,396
    )
    
    
    381,862
    
    
    
    Net cash provided by operating activities
    
    
    6,380,479
    
    
    
    6,579,201
    
    
    
    2,771,249INVESTING ACTIVITIESPurchases of property and equipment
    
    
    (806,978
    )
    
    
    (1,548,541
    )
    
    
    (300,156
    )Acquisitions of intangible assets
    
    
    
    
    
    
    (235,230
    )
    
    
    Purchases of held-to-maturity investments
    
    
    (9,512,523
    )
    
    
    (2,588,154
    )
    
    
    Sale of property, plant and equipment
    
    
    450
    
    
    
    8,950
    
    
    
    847Proceeds from sale or maturity of held-to-maturity
investments
    
    
    11,705,000
    
    
    
    600,000
    
    
    
    Net cash provided by (used in) investing activities
    
    
    1,385,949
    
    
    
    (3,762,975
    )
    
    
    (299,309
    )FINANCING ACTIVITIESPayments under capital lease obligation
    
    
    (1,310
    )
    
    
    (969
    )
    
    
    Excess tax benefits from stock-based payment arrangements
    
    
    1,420,574
    
    
    
    
    
    
    
    Purchases of treasury stock
    
    
    (3,277,076
    )
    
    
    
    
    
    
    Exercise of common stock options and warrants
    
    
    433,651
    
    
    
    712,987
    
    
    
    122,797Net cash (used in) provided by financing activities
    
    
    (1,424,161
    )
    
    
    712,018
    
    
    
    122,797Net increase in cash and cash equivalents
    
    
    6,342,267
    
    
    
    3,528,244
    
    
    
    2,594,737Cash and cash equivalents at beginning of period
    
    
    9,682,106
    
    
    
    6,153,862
    
    
    
    3,559,125Cash and cash equivalents at end of period
    
    $
    16,024,373
    
    
    $
    9,682,106
    
    
    $
    6,153,862SUPPLEMENTAL CASH FLOW INFORMATIONInterest paid
    
    $
    387
    
    
    $
    763
    
    
    $
    Income tax paid
    
    $
    33,277
    
    
    $
    21,390
    
    
    $
    2,045NON CASH FINANCING AND INVESTING ACTIVITYProperty, plant and equipment acquired with capital lease
    
    $
    
    
    
    $
    7,533
    
    
    $
    Property, plant and equipment acquired in accounts payable
    
    $
    
    
    
    $
    65,054
    
    
    $
    14,710
   37




---



##### Table of Contents



Strategic Quality Initiative, Strategic Quality Partnerships and Quality Assessment and
Implementation Programs:
   38




---



##### Table of Contents



Health Management Suite:
   Healthcare Quality Reports:
  Internet Patient Acquisition:
   39




---



##### Table of Contents



Accounting for Revenue Arrangements with Multiple Deliverables.
      Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use
        40




---



##### Table of Contents



Computer equipment and software
    
    3-5 yearsInternally developed software
    
    3 yearsFurniture and fixtures
    
    5-7 yearsLeasehold improvements
    
    6 years
  Accounting
for the Impairment or Disposal of Long-Lived Assets
             41




---



##### Table of Contents



Earnings Per share
  2006
    
    
    2005
    
    
    2004Numerator for both basic and diluted earnings
per share:Net income
    
    $
    3,181,510
    
    
    $
    4,139,853
    
    
    $
    1,782,143Denominator:Denominator for basic net income per
common shareweighted average shares
    
    
    28,432,185
    
    
    
    27,039,057
    
    
    
    25,058,173Effect of dilutive securities:Outstanding employee stock options, warrants
And restricted stock awards
    
    
    5,196,145
    
    
    
    7,794,464
    
    
    
    7,972,914Denominator for diluted net income per
common shareadjusted weighted average
shares and assumed conversion
    
    
    33,628,330
    
    
    
    34,833,521
    
    
    
    33,031,087
  Accounting
for Stock Issued to Employees
 Share-Based Payment Accounting for Stock-Based Compensation
  Amendment of FASB Staff
Position FAS 123(R)-1. , Classification and Measurement of Freestanding Instruments Originally issued
in Exchange for Employee Services under FASB Statement No. 123(R)
  42




---



##### Table of Contents



Technical Correction of FASB Statement No. 123(R) SFAS 123(R)
 Financial Statements  Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements
 Employers Accounting for
Defined Benefit Pension and Other Postretirement PlansAn Amendment of FASB Statements No. 87, 88,
106 and 132R.
 Fair Value Measurement.
 Accounting for Uncertainty in
Income Taxes  An Interpretation of FASB Statement No. 109 Accounting for Income Taxes
  43




---



##### Table of Contents



DECEMBER 312006
    
    
    2005Trade accounts receivable
    
    $
    8,914,916
    
    
    $
    5,617,932Less allowance for doubtful accounts
    
    
    19,207
    
    
    
    4,207$
    8,895,709
    
    
    $
    5,613,725
    DECEMBER 312006
    
    
    2005Furniture and fixtures
    
    $
    329,312
    
    
    $
    330,792Computer equipment and software
    
    
    3,248,301
    
    
    
    3,163,104Leasehold improvements and other
    
    
    397,896
    
    
    
    397,8963,975,509
    
    
    
    3,891,792Accumulated depreciation and amortization
    
    
    (2,209,548
    )
    
    
    (2,296,727
    )Net property and equipment
    
    $
    1,765,961
    
    
    $
    1,595,065
   Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use
     44




---



##### Table of Contents



2007
    
    $
    62,7282008
    
    
    26,7902009
    
    
    23,5232010
    
    
    1,9602011
    
    
    
       45




---



##### Table of Contents



.
   Share-Based Payment
 Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards
   46




---



##### Table of Contents



Equity Plan
 Valuation Assumptions for Stock Options
  2006
    
    2005
    
    2004Dividend yield
    
    0%
    
    0%
    
    0%Expected volatility
    
    111%
    
    111-158%
    
    151-178%Risk-free interest rate
    
    4.84%
    
    3.67-3.96%
    
    2.44-3.16%Expected life
    
    3-5 years
    
    3 years
    
    3 years
   WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicOptions
    
    
    Price
    
    
    Term (in years)
    
    
    ValueOutstanding at December 31, 2005
    
    
    7,975,186
    
    
    $
    0.61Granted
    
    
    23,000
    
    
    
    6.40Exercised
    
    
    (1,100,578
    )
    
    
    0.39Forfeited
    
    
    (234,999
    )
    
    
    3.15Expired
    
    
    (13,066
    )
    
    
    5.81Outstanding at December 31, 2006
    
    
    6,649,543
    
    
    $
    0.56
    
    
    
    4.94
    
    
    $
    26,119,290Vested or expected to vest at December 31, 2006
    
    
    6,639,586
    
    
    $
    0.56
    
    
    
    4.93
    
    
    $
    26,391,859Exercisable at December 31, 2006
    
    
    6,317,633
    
    
    $
    0.45
    
    
    
    4.78
    
    
    $
    25,525,853
     47




---



##### Table of Contents



2006
    
    
    2005
    
    
    2004WEIGHTED-
    
    
    
    
    
    
    WEIGHTED-
    
    
    
    
    
    
    WEIGHTED-AVERAGE
    
    
    
    
    
    
    AVERAGE
    
    
    
    
    
    
    AVERAGEEXERCISE
    
    
    
    
    
    
    EXERCISE
    
    
    
    
    
    
    EXERCISEOPTIONS
    
    
     PRICE
    
    
     OPTIONS
    
    
     PRICE
    
    
     OPTIONS
    
    
     PRICEOutstanding
at beginning of year
    
    
    7,975,186
    
    
    $
    0.61
    
    
    
    9,778,384
    
    
    $
    0.41
    
    
    
    9,831,408
    
    
    $
    0.31Granted
    
    
    23,000
    
    
    $
    6.40
    
    
    
    490,500
    
    
    $
    3.65
    
    
    
    919,004
    
    
    $
    1.32Exercised
    
    
    (1,100,578
    )
    
    $
    0.39
    
    
    
    (2,078,020
    )
    
    $
    0.30
    
    
    
    (828,023
    )
    
    $
    0.15Forfeited
    
    
    (234,999
    )
    
    $
    3.15
    
    
    
    (215,678
    )
    
    $
    1.69
    
    
    
    (144,005
    )
    
    $
    0.99Expired
    
    
    (13,066
    )
    
    $
    5.81
    
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    Outstanding at end of year
    
    
    6,649,543
    
    
    $
    0.56
    
    
    
    7,975,186
    
    
    $
    0.61
    
    
    
    9,778,384
    
    
    $
    0.41Exercisable at end of year
    
    
    6,317,633
    
    
    $
    0.45
    
    
    
    6,755,757
    
    
    $
    0.38
    
    
    
    8,062,638
    
    
    $
    0.36
 2006
    
    
    2005
    
    
    2004Weighted-average fair value of options
granted during the year:
    
    $
    4.84
    
    
    $
    2.89
    
    
    $
    1.14Intrinsic value of options exercised during
the year:
    
    $
    4,693,045
    
    
    $
    7,662,096
    
    
    $
    833,798Fair value of shares vested during the year:
    
    $
    635,779
    
    
    $
    326,927
    
    
    $
    379,374
  OPTIONS OUTSTANDINGWEIGHTED
    
    
    
    
    
    
    OPTIONS EXERCISABLEAVERAGE
    
    
    WEIGHTED-
    
    
    
    
    
    
    WEIGHTEDREMAINING
    
    
    AVERAGE
    
    
    
    
    
    
    AVERAGERANGE OF
    
    NUMBER
    
    
    CONTRACTUAL
    
    
    EXERCISE
    
    
    NUMBER
    
    
    EXERCISEEXERCISE PRICES
    
    OUTSTANDING
    
    
    LIFE (YEARS)
    
    
    PRICE
    
    
    EXERCISABLE
    
    
    PRICE$0.06-$0.17
    
    
    4,000,168
    
    
    
    5.10
    
    
    $
    0.10
    
    
    
    4,000,168
    
    
    $
    0.10$0.30-$0.50
    
    
    438,877
    
    
    
    6.10
    
    
    
    0.32
    
    
    
    438,877
    
    
    
    0.32$0.53-$0.63
    
    
    1,100,175
    
    
    
    2.83
    
    
    
    0.58
    
    
    
    1,100,175
    
    
    
    0.58$0.75-$0.88
    
    
    213,028
    
    
    
    4.00
    
    
    
    0.81
    
    
    
    208,028
    
    
    
    0.81$1.01-$1.95
    
    
    528,157
    
    
    
    7.18
    
    
    
    1.35
    
    
    
    362,759
    
    
    
    1.39$2.10-$2.94
    
    
    113,000
    
    
    
    6.49
    
    
    
    2.84
    
    
    
    95,999
    
    
    
    2.88$3.00-$3.98
    
    
    91,667
    
    
    
    7.92
    
    
    
    3.50
    
    
    
    32,996
    
    
    
    3.50$4.10-$4.70
    
    
    89,000
    
    
    
    8.64
    
    
    
    4.48
    
    
    
    27,160
    
    
    
    4.41$5.36-$5.94
    
    
    8,000
    
    
    
    9.01
    
    
    
    5.80
    
    
    
    500
    
    
    
    5.36$6.10-$6.75
    
    
    41,000
    
    
    
    4.49
    
    
    
    6.69
    
    
    
    24,500
    
    
    
    6.75$9.75-$11.75
    
    
    26,471
    
    
    
    0.57
    
    
    
    11.48
    
    
    
    26,471
    
    
    
    11.48$0.06-$11.75
    
    
    6,649,543
    
    
    
    4.94
    
    
    $
    0.56
    
    
    
    6,317,633
    
    
    $
    0.45
 2006 Plan
  Weighted AverageNumber of
    
    
    Grant-Date FairRSAs
    
    
    Value Per ShareNonvested at December 31, 2005
    
    
    
    
    
    $
    Granted
    
    
    1,086,832
    
    
    
    4.40Vested
    
    
    
    
    
    
    Cancelled
    
    
    (11,500
    )
    
    
    4.43Nonvested at December 31, 2006
    
    
    1,075,332
    
    
    
    4.40Vested or expected to vest at December 31, 2006
    
    
    234,593
    
    
    $
    4.40
  48




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Pro Forma Information for Period Prior to SFAS 123(R) Adoption
  Year Ended
    
    
    Year EndedDecember 31, 2005
    
    
    December 31, 2004Net income, as reported
    
    $
    4,139,853
    
    
    $
    1,782,143Add: Stock-based employee
compensation expense included
in reported net income under
APB No. 25
    
    
    
    
    
    
    Deduct: Stock-based
compensation expense
determined using a fair value
based method for all awards,
net of related tax effects
    
    
    (545,054
    )
    
    
    (223,150
    )Pro forma net income
    
    $
    3,594,799
    
    
    $
    1,558,993Basic net income per share:As reported
    
    $
    0.15
    
    
    $
    0.07Pro forma
    
    $
    0.13
    
    
    $
    0.06Diluted net income per share:As reported
    
    $
    0.12
    
    
    $
    0.05Pro forma
    
    $
    0.10
    
    
    $
    0.05
    2007
    
    $
    581,3522008
    
    
    594,8222009
    
    
    584,3512010
    
    
    548,4322011
    
    
    239,547Thereafter
    
    
    Total
    
    $
    2,548,504
   Accounting for Income Taxes
  49




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2006
    
    
    2005Deferred tax assets:Deferred rent
    
    $
    121,910
    
    
    $
    145,108Accrued liabilities
    
    
    67,629
    
    
    
    48,152Stock-based compensation expense
    
    
    57,160
    
    
    
    Intangible assets, net
    
    
    34,265
    
    
    
    16,388Allowance for doubtful accounts
    
    
    7,299
    
    
    
    1,599Other
    
    
    6,579
    
    
    
    Alternative minimum tax credit
    
    
    
    
    
    
    15,445Net operating loss carryforwards
    
    
    299,510
    
    
    
    1,222,379594,352
    
    
    
    1,449,071Valuation allowance for deferred
tax assets
    
    
    
    
    
    
    Gross deferred tax asset
    
    
    594,352
    
    
    
    1,449,071Deferred tax liabilities:Prepaid expenses
    
    
    158,087
    
    
    
    207,013Property and equipment, net
    
    
    99,116
    
    
    
    130,096Gross deferred tax liability
    
    
    257,203
    
    
    
    337,109Net deferred tax asset
    
    $
    337,149
    
    
    $
    1,111,962
   2006
    
    
    2005
    
    
    2004Current:Federal
    
    $
    1,346,815
    
    
    $
    1,029,882
    
    
    $
    State
    
    
    202,784
    
    
    
    90,417
    
    
    
    1,549,599
    
    
    
    1,120,299
    
    
    
    Deferred:Federal
    
    
    682,289
    
    
    
    (978,360
    )
    
    
    State
    
    
    92,524
    
    
    
    (133,602
    )
    
    
    774,813
    
    
    
    (1,111,962
    )
    
    
    Total
    
    $
    2,324,412
    
    
    $
    8,337
    
    
    $
    
    2006
    
    
    2005
    
    
    2004Federal statutory income tax rate
    
    
    34.0
    %
    
    
    34.0
    %
    
    
    34.0
    %State income taxes, net of federal benefit
    
    
    3.5
    
    
    
    4.3
    
    
    
    6.4Non-deductible expenses
    
    
    3.8
    (1)
    
    
    0.4
    
    
    
    0.8Miscellaneous
    
    
    0.9
    
    
    
    (2.3
    )
    
    
    (3.4
    )Deferred tax asset valuation allowance
    
    
    
    
    
    
    (36.2
    )
    
    
    (37.8
    )Effective income tax rate
    
    
    42.2
    %
    
    
    0.2
    %
    
    
    0.0
    %
 (1)
  50




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2006
    
    March 31
    
    
    June 30
    
    
    September 30
    
    
    December 31Revenue:Ratings and advisory
    
    $
    6,102,257
    
    
    $
    6,662,090
    
    
    $
    7,247,615
    
    
    $
    7,752,059Other
    
    
    120
    
    
    
    5,000
    
    
    
    
    
    
    
    1,111Total revenue
    
    
    6,102,377
    
    
    
    6,667,090
    
    
    
    7,247,615
    
    
    
    7,753,170Expenses:Cost of ratings and advisory revenue
    
    
    1,150,146
    
    
    
    1,078,381
    
    
    
    1,114,898
    
    
    
    1,249,885Gross margin
    
    
    4,952,231
    
    
    
    5,588,709
    
    
    
    6,132,717
    
    
    
    6,503,285Operating expenses:Sales and marketing
    
    
    1,794,506
    
    
    
    1,788,568
    
    
    
    2,266,895
    
    
    
    2,573,808Product development
    
    
    829,886
    
    
    
    834,518
    
    
    
    877,015
    
    
    
    1,005,916General and administrative
    
    
    1,718,573
    
    
    
    1,449,246
    
    
    
    1,536,769
    
    
    
    1,684,120Income from operations
    
    
    609,266
    
    
    
    1,516,377
    
    
    
    1,452,038
    
    
    
    1,239,441Other:Other
    
    
    450
    
    
    
    
    
    
    
    (493
    )
    
    
    Interest income
    
    
    137,427
    
    
    
    167,735
    
    
    
    181,872
    
    
    
    202,196Interest expense
    
    
    (113
    )
    
    
    (92
    )
    
    
    (87
    )
    
    
    (95
    )Income before income taxes
    
    
    747,030
    
    
    
    1,684,020
    
    
    
    1,633,330
    
    
    
    1,441,542Income tax expense
    
    
    348,906
    
    
    
    704,734
    
    
    
    691,061
    
    
    
    579,711Net income
    
    
    398,124
    
    
    
    979,286
    
    
    
    942,269
    
    
    
    861,831Net income per share (basic)
    
    $
    0.01
    
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    0.03Weighted average shares outstanding
(basic)
    
    
    28,233,054
    
    
    
    28,408,361
    
    
    
    28,449,118
    
    
    
    28,636,680Net income per share (diluted)
    
    $
    0.01
    
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    0.03Weighted average shares outstanding
(diluted)
    
    
    34,267,275
    
    
    
    33,987,459
    
    
    
    33,778,190
    
    
    
    33,498,144
 2005
    
    March 31
    
    
    June 30
    
    
    September 30
    
    
    December 31Revenue:Ratings and advisory
    
    $
    4,699,927
    
    
    $
    4,868,748
    
    
    $
    5,334,279
    
    
    $
    5,891,219Other
    
    
    6,552
    
    
    
    387
    
    
    
    6,375
    
    
    
    19Total revenue
    
    
    4,706,479
    
    
    
    4,869,135
    
    
    
    5,340,654
    
    
    
    5,891,238Expenses:Cost of ratings and advisory revenue
    
    
    726,760
    
    
    
    795,997
    
    
    
    780,949
    
    
    
    864,962Gross margin
    
    
    3,979,719
    
    
    
    4,073,138
    
    
    
    4,559,705
    
    
    
    5,026,276Operating expenses:Sales and marketing
    
    
    1,344,943
    
    
    
    1,270,813
    
    
    
    1,331,590
    
    
    
    1,854,244Product development
    
    
    783,294
    
    
    
    734,664
    
    
    
    766,611
    
    
    
    751,159General and administrative
    
    
    1,317,005
    
    
    
    1,246,867
    
    
    
    1,115,081
    
    
    
    1,180,143Income from operations
    
    
    534,477
    
    
    
    820,794
    
    
    
    1,346,423
    
    
    
    1,240,730Other:Other
    
    
    
    
    
    
    1,405
    
    
    
    
    
    
    
    Interest income
    
    
    20,432
    
    
    
    34,316
    
    
    
    58,394
    
    
    
    91,982Interest expense
    
    
    
    
    
    
    (73
    )
    
    
    (588
    )
    
    
    (102
    )Income before income taxes
    
    
    554,909
    
    
    
    856,442
    
    
    
    1,404,229
    
    
    
    1,332,610Income tax (benefit) expense
    
    
    
    
    
    
    (1,051,017
    )
    
    
    537,447
    
    
    
    521,907Net income
    
    
    554,909
    
    
    
    1,907,459
    
    
    
    866,782
    
    
    
    810,703Net income per share (basic)
    
    $
    0.02
    
    
    $
    0.07
    
    
    $
    0.03
    
    
    $
    0.03Weighted average shares outstanding
(basic)
    
    
    25,980,483
    
    
    
    26,889,435
    
    
    
    27,504,864
    
    
    
    27,756,808Net income per share (diluted)
    
    $
    0.02
    
    
    $
    0.05
    
    
    $
    0.02
    
    
    $
    0.02Weighted average shares outstanding
(diluted)
    
    
    34,447,212
    
    
    
    34,955,601
    
    
    
    35,032,559
    
    
    
    34,874,073
  54




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Internal ControlIntegrated
Framework
  55




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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, rights and RSAs
    
    
    warrants and rights
    
    
    (a))Plan category
    
    (a)
    
    
    (b)
    
    
    (c)Equity compensation
plans approved
by security holders
    
    
    7,724,875
    
    
    $
    0.48
    
    
    
    4,472,336Equity compensation
plans not approved
by security holders
    
    
    N/A
    
    
    
    
    
    
    
    N/ATotal
    
    
    7,724,875
    
    
    
    
    
    
    
    4,472,336
  56




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57




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##### Table of Contents



EXHIBITNUMBER
    
    DESCRIPTION3.1
    
    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 Plan10.1.2
    
    Form of RSA Agreements10.3*
    
    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))10.4.1*
    
    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 of 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 10.5 to our Form 10-K for the year ended
December 31, 2005)10.5.1
    
    Building Lease Amendment10.6
    
    Directors Compensation10.7
    
    Executive Officer Offer of Employment Letter (incorporated
by reference to Form 8-K exhibit 99.1, filed on July 10,
2006)23.1
    
    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.
   58




---



##### Table of Contents



HEALTH GRADES, INC.Date: March 16, 2007
    /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, 2007/s/ Allen Dodge

Allen Dodge
    
    Executive Vice President, Chief Financial Officer,
Secretary and Treasurer
(Principal Financial and Accounting Officer)
    
    March 16, 2007/s/ Mary Boland
    
    Director
    
    March 16, 2007Mary Boland/s/ Leslie S. Matthews, M.D.
    
    Director
    
    March 16, 2007Leslie S. Matthews, M.D./s/ J.D. Kleinke
    
    Director
    
    March 16, 2007J.D. Kleinke/s/ John Quattrone
    
    Director
    
    March 16, 2007John Quattrone
  59




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BALANCE AT
    
    
    CHARGED TO
    
    
    CHARGED TO
    
    
    
    
    
    
    BALANCE ATBEGINNING
    
    
    COSTS AND
    
    
    OTHER
    
    
    
    
    
    
    END OFDESCRIPTION
    
    OF PERIOD
    
    
    EXPENSES
    
    
    ACCOUNTS
    
    
    DEDUCTIONS
    
    
    PERIODYear ended December 31, 2006Allowance for doubtful
accounts on trade
receivables
    
    $
    4,207
    
    
    $
    15,000
    
    
    $
    
    
    
    $
    
    
    
    $
    19,207Year ended December 31, 2005Allowance for doubtful
accounts on trade
receivables
    
    $
    15,236
    
    
    $
    20,000
    
    
    $
    
    
    
    $
    (31,029
    ) (1)
    
    $
    4,207Year ended December 31, 2004Allowance for doubtful
accounts on trade
receivables
    
    $
    11,667
    
    
    $
    3,569
    
    
    $
    
    
    
    $
    
    
    
    $
    15,236
 (1)
    
    Represents actual amounts charged against the allowance for the periods presented.
  60




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EXHIBITNUMBER
    
    DESCRIPTION10.1*
    
    2006 Equity Compensation Plan10.1.2
    
    Form of RSA Agreements10.5.1
    
    Building Lease Amendment10.6
    
    Directors Compensation23.1
    
    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.
   61