##### 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, 2007
 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
    
    The Nasdaq Stock Market LLC(Nasdaq Global Select Market)
   o  þ
 o  þ
 þ o
 o
  Large Accelerated Filer o
    
    Accelerated Filer þNon-Accelerated Filer o (Do not check if a smaller reporting company)
    
    Smaller Reporting Company o
 o  þ




---



##### 



PART IItem 1. Business
    
    
    3Item 1A. Risk Factors
    
    
    15Item 1B. Unresolved Staff Comments
    
    
    21Item 2. Properties
    
    
    22Item 3. Legal Proceedings
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    25PART IIItem 5. Market for the Registrants Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
    
    
    26Item 6. Selected Financial Data
    
    
    28Item 7. Managements Discussion and Analysis of Financial Condition and Results
of Operations
    
    
    29Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    36Item 8. Financial Statements and Supplementary Data
    
    
    37Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
    
    
    65Item 9A. Controls and Procedures
    
    
    65Item 9B. Other Information
    
    
    65PART IIIItem 10. Directors, Executive Officers and Corporate Governance
    
    
    66Item 11. Executive Compensation
    
    
    66Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
    
    
    66Item 13. Certain Relationships, Related Transactions and Director Independence
    
    
    66Item 14. Principal Accounting Fees and Services
    
    
    66PART IVItem 15. Exhibits and Financial Statement Schedules
    
    
    67Exhibit 10.6Exhibit 21.1Exhibit 23.1Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  Special Note Regarding Forward-Looking Statements
   2




---



##### Table of Contents



BUSINESS
 Overview
    
    
    Over 5,800 hospitals;
    
    Over 750,000 physicians in more than 125 specialties; and
    
    Over 19,000 nursing homes.
      3




---



##### Table of Contents



Healthcare Provider Quality Information
   Hospital Specialty and Programmatic Ratings -
      4




---



##### 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 was less than 3.36.7.
    
    Designated the hospitals that remained on the list as 2008 DHA-CE recipients.
    Physician Quality Reports
  5




---



##### Table of Contents



Internet Patient Acquisition -
 Nursing Home Ratings
 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.
  6




---



##### Table of Contents



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 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 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 Distinguished Hospital
Award for Clinical Excellence 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
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 designation and trophy for that year;
and
    
    Marketing messages developed by HealthGrades.
   7




---



##### Table of Contents



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
 Home Health
 Provider Select
 Estimate Healthcare Costs:
 Treatment Cost Calculator
 Medication Cost Calculator
  8




---



##### Table of Contents



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
 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.
  9




---



##### Table of Contents



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;
    
    Malpractice data;
    
    Fellowships and internships;
    
    State and federal sanction information (if any) within the last 5 years;
    
    Name and address of area hospitals and affiliated hospitals;
    
    Gender;
    
    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.
 Internet Advertising
 
    
    Physician profile (free)  includes physicians name, address, specialties and medical
school 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.
  Healthcare Credit Solutions 
 Competition
   10




---



##### Table of Contents



Company History
   Government Regulation
     11




---



##### Table of Contents



Healthcare Legislation
  12




---



##### Table of Contents



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




---



##### Table of Contents



Intellectual Property
     Employees
  Available Information
   14




---



##### Table of Contents



Risks Related to Our Business
        15




---



##### Table of Contents



16




---



##### Table of Contents




    
    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




---



##### Table of Contents




    
    Our public website will face competition from numerous other companies, both in attracting
users and in generating revenue from advertisers and sponsors. We will compete for users with
online services and web sites that provide health-related information, including both
commercial sites and not-for-profit sites. We will also compete for advertisers and sponsors
with both healthcare-related and non-healthcare related content and services.
    
    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.
    
    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 website, our
advertising revenues may be adversely affected.
   18




---



##### Table of Contents




    
    data providers that provide detailed utilization and outcomes information to hospitals;
    
    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
   19




---



##### Table of Contents




    
    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
   20




---



##### Table of Contents



21




---



##### Table of Contents



Indemnification of our Chief Executive Officer and Derivative Complaint
     th
   22




---



##### Table of Contents



th
  23




---



##### Table of Contents



th
  Gotham/Primarius Complaint
         24




---



##### Table of Contents



NAME
    
    AGE
    
    POSITIONKerry R. Hicks
    
    
    48
    
    
    Chairman, President and Chief Executive OfficerDavid G. Hicks
    
    
    49
    
    
    Executive Vice PresidentSarah Loughran
    
    
    43
    
    
    Executive Vice PresidentAllen Dodge
    
    
    40
    
    
    Executive Vice President, Chief Financial Officer,
Secretary and TreasurerSteve Wood
    
    
    64
    
    
    Executive Vice President
        25




---



##### Table of Contents



Market Information
  HIGH
    
    
    LOWYear Ended December 31, 2006First Quarter
    
    $
    6.89
    
    
    $
    5.28Second Quarter
    
    
    5.30
    
    
    
    3.04Third Quarter
    
    
    4.67
    
    
    
    4.08Fourth Quarter
    
    
    4.99
    
    
    
    4.18Year Ended December 31, 2007First Quarter
    
    $
    6.30
    
    
    $
    4.44Second Quarter
    
    
    6.96
    
    
    
    5.36Third Quarter
    
    
    6.69
    
    
    
    4.62Fourth Quarter
    
    
    6.84
    
    
    
    4.81
 Holders of Record
  Dividend Policy
   26




---



##### Table of Contents



Performance Graph
   
 The stock price performance included in this graph is not necessarily indicative of future stock price performance.
 12/31/02
    
    
    12/31/03
    
    
    12/31/04
    
    
    12/30/05
    
    
    12/29/06
    
    
    12/31/07Health Grades, Inc.
    
    $
    100.00
    
    
    $
    2,000.00
    
    
    $
    9,666.67
    
    
    $
    21,066.67
    
    
    $
    14,966.67
    
    
    $
    19,833.33$
    (.03
    *)
    
    $
    (.60
    *)
    
    $
    (2.90
    *)
    
    $
    (6.32
    *)
    
    $
    (4.49
    *)
    
    $
    (5.95
    *)Nasdaq Stock Market (US)
    
    $
    100.00
    
    
    $
    149.52
    
    
    $
    162.72
    
    
    $
    166.18
    
    
    $
    182.57
    
    
    $
    197.98Nasdaq Computer & Data Processing
Index
    
    $
    100.00
    
    
    $
    131.80
    
    
    $
    145.30
    
    
    $
    150.23
    
    
    $
    168.68
    
    
    $
    206.11
  *
    
    Health Grades, Inc. closing share price as of respective year-end date  27




---



##### 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(3)
    
    
    ProgramsOctober 1, 2007 through October 31, 2007
    
    
    2,677
    
    
    $
    5.90
    
    
    
    
    
    
    
    1,739,046November 1, 2007 through November 30,
2007
    
    
    287,907
    
    
    
    5.48
    
    
    
    287,700
    
    
    
    1,451,346December 1, 2007 through December 31,
2007
    
    
    267,862
    
    
    
    5.25
    
    
    
    267,345
    
    
    
    1,184,001Total
    
    
    558,446
    
    
    $
    5.37
    
    
    
    555,045
    
    
    
    1,184,001
  (1)
    
    Includes 3,401 shares purchased to cover employment taxes on restricted stock vesting.(2)
    
    Average price paid per share excludes commissions and service charges.(3)
    
    On June 22, 2006, our Board of Directors announced and authorized the
repurchase of up to 3,000,000 shares of our common stock under a stock repurchase program
that does not have an expiration date and may be limited or terminated at any time without
prior notice. Under the program, purchases may be made from time to time at prevailing
prices, subject to certain restrictions on volume, pricing and timing. 
   Year Ended December 31,2007
    
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003Ratings and advisory revenue
    
    $
    32,741,610
    
    
    $
    27,764,021
    
    
    $
    20,794,173
    
    
    $
    14,536,304
    
    
    $
    8,803,929Income (loss) from operations
    
    
    9,198,853
    (1)
    
    
    4,817,122
    
    
    
    3,942,424
    
    
    
    1,760,600
    
    
    
    (1,275,775
    )Net income (loss)
    
    $
    6,748,171
    (2)
    
    $
    3,181,510
    
    
    $
    4,139,853
    (4)
    
    $
    1,782,143
    
    
    $
    (1,283,687
    )Net income (loss) per common share (basic)
    
    $
    0.24
    (3)
    
    $
    0.11
    
    
    $
    0.15
    
    
    $
    0.07
    
    
    $
    (0.05
    )Weighted average number of common shares
used in computation (basic)
    
    
    28,621,171
    
    
    
    28,432,185
    
    
    
    27,039,057
    
    
    
    25,058,173
    
    
    
    26,679,467Net income (loss) per common share (diluted)
    
    $
    0.20
    (3)
    
    $
    0.09
    
    
    $
    0.12
    
    
    $
    0.05
    
    
    $
    (0.05
    )Weighted average number of common
shares and common share equivalents
used in computation (diluted)
    
    
    33,703,558
    
    
    
    33,628,330
    
    
    
    34,833,521
    
    
    
    33,031,087
    
    
    
    26,679,467
  (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 $0.8 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, 2007
    
    
    DECEMBER 31, 2006
    
    
    DECEMBER 31, 2005
    
    
    DECEMBER 31, 2004
    
    
    DECEMBER 31, 2003Working capital (deficit)
    
    $
    10,222,065
    
    
    $
    7,027,821
    
    
    $
    5,024,057
    
    
    $
    96,190
    
    
    $
    (1,820,137
    )Total assets
    
    
    36,935,329
    
    
    
    31,019,585
    
    
    
    23,844,473
    
    
    
    12,931,127
    
    
    
    8,821,239Total long-term debt
    
    
    2,387
    
    
    
    3,863
    
    
    
    5,254
    
    
    
    
    
    
    
    
  28




---



##### Table of Contents



Revenue Growth and Client Retention
       Share-Based Payment
  29




---



##### Table of Contents



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, 2007
    
    
    December 31, 2006
    
    
    December 31, 2005Provider Services
    
    $
    25,130,997
    
    
    $
    20,068,557
    
    
    $
    15,038,998Internet Business Group
    
    
    6,132,250
    
    
    
    5,099,838
    
    
    
    3,004,152Strategic Health Solutions
    
    
    1,478,363
    
    
    
    2,595,626
    
    
    
    2,751,023Total
    
    $
    32,741,610
    
    
    $
    27,764,021
    
    
    $
    20,794,173
  30




---



##### Table of Contents



Ratings and advisory revenue
 Provider Services.
 Internet Business Group
  Strategic Health Solutions.
 Cost of ratings and advisory revenue
 Other Revenue
  31




---



##### Table of Contents



Sales and marketing costs.
 Product development costs
 General and administrative expenses
 Interest expense
 Interest income.
  Ratings and advisory revenue
 Provider Services.
  32




---



##### Table of Contents



Internet Business Group
 Strategic Health Solutions.
 Cost of ratings and advisory revenue
 Sales and marketing costs
 Product development costs
 General and administrative expenses
  33




---



##### Table of Contents



Interest expense
 Interest income
         34




---



##### Table of Contents



Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 year
    
    
    2-3 years
    
    
    4-5 years
    
    
    5 yearsContractual ObligationsCapital Lease Obligations
    
    $
    4,170
    
    
    $
    1,668
    
    
    $
    2,502
    
    
    $
    
    
    
    $
    Operating Lease Obligations
    
    
    2,114,577
    
    
    
    659,229
    
    
    
    1,220,507
    
    
    
    234,841
    
    
    
    Employee Contracts
    
    
    570,220
    
    
    
    570,220
    
    
    
    
    
    
    
    
    
    
    
    Purchase Obligations
    
    
    552,821
    
    
    
    350,206
    
    
    
    202,615
    
    
    
    
    
    
    
    Total
    
    $
    3,241,788
    
    
    $
    1,581,323
    
    
    $
    1,425,624
    
    
    $
    234,841
    
    
    $
    
     Fair Value Measurement.
  35




---



##### Table of Contents



The Fair
Value Option for Financial Assets and Financial Liabilities  Including an Amendment of FASB
Statement 115
 Definition of Settlement in FASB
Interpretation No. 48 Accounting for
Uncertainty in Income Taxes
 Business Combinations
 Noncontrolling Interests in Consolidated Financial Statements  an amendment of Accounting
Research Bulletin No. 51
  
      36




---



##### Table of Contents



HEALTH GRADES, INC.:Reports of Independent Registered Public Accounting Firm
    
    
    38Consolidated Balance Sheets
    
    
    40Consolidated Statements of Income
    
    
    41Consolidated Statements of Stockholders Equity
    
    
    42Consolidated Statements of Cash Flows
    
    
    43Notes to Consolidated Financial Statements
    
    
    44
  37




---



##### Table of Contents



Internal ControlIntegrated Framework
  
  38




---



##### Table of Contents



Internal ControlIntegrated Fram
    Internal
ControlIntegrated Framework
   
  39




---



##### Table of Contents



DECEMBER 31,2007
    
    
    2006ASSETSCash and cash equivalents
    
    $
    23,369,368
    
    
    $
    16,024,373Accounts receivable, net
    
    
    6,935,341
    
    
    
    8,895,709Prepaid expenses and other current assets
    
    
    836,222
    
    
    
    712,021Total current assets
    
    
    31,140,931
    
    
    
    25,632,103Property and equipment, net
    
    
    1,641,456
    
    
    
    1,765,961Intangible assets, net
    
    
    357,128
    
    
    
    115,001Goodwill
    
    
    3,106,181
    
    
    
    3,106,181Deferred income taxes
    
    
    689,633
    
    
    
    400,339Total assets
    
    $
    36,935,329
    
    
    $
    31,019,585LIABILITIES AND STOCKHOLDERS EQUITYAccounts payable
    
    $
    326,039
    
    
    $
    340,742Accrued payroll, incentive compensation and related expenses
    
    
    2,222,970
    
    
    
    1,838,282Accrued expenses
    
    
    432,928
    
    
    
    311,941Current portion of capital lease obligations
    
    
    1,476
    
    
    
    1,391Current portion of deferred rent
    
    
    68,544
    
    
    
    75,074Deferred revenue
    
    
    17,739,152
    
    
    
    15,897,374Deferred income taxes
    
    
    113,914
    
    
    
    63,190Income taxes payable
    
    
    13,843
    
    
    
    76,288Total current liabilities
    
    
    20,918,866
    
    
    
    18,604,282Long-term portion of capital lease obligations
    
    
    2,387
    
    
    
    3,863Long-term portion of deferred rent
    
    
    229,321
    
    
    
    268,392Total liabilities
    
    
    21,150,574
    
    
    
    18,876,537Commitments and contingenciesMinority interest
    
    
    248,011
    
    
    
    Stockholders 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 50,895,623 and 48,775,357 shares issued as of December
31, 2007 and 2006, respectively
    
    
    50,895
    
    
    
    48,775Additional paid-in capital
    
    
    96,860,004
    
    
    
    94,604,033Accumulated deficit
    
    
    (58,716,933
    )
    
    
    (65,465,104
    )Treasury stock, 21,424,236 and 20,321,910 shares as of December
31, 2007 and 2006, respectively
    
    
    (22,657,222
    )
    
    
    (17,044,656
    )Total stockholders equity
    
    
    15,536,744
    
    
    
    12,143,048Total liabilities and stockholders equity
    
    $
    36,935,329
    
    
    $
    31,019,585
   40




---



##### Table of Contents



2007
    
    
    2006
    
    
    2005Revenue:Ratings and advisory revenue
    
    $
    32,741,610
    
    
    $
    27,764,021
    
    
    $
    20,794,173Other
    
    
    3,425,465
    
    
    
    6,231
    
    
    
    13,33336,167,075
    
    
    
    27,770,252
    
    
    
    20,807,506Cost of revenue:Cost of ratings and advisory revenue
    
    
    5,323,672
    
    
    
    4,593,310
    
    
    
    3,168,668Gross margin
    
    
    30,843,403
    
    
    
    23,176,942
    
    
    
    17,638,838Operating expenses:Sales and marketing
    
    
    9,147,911
    
    
    
    8,423,777
    
    
    
    5,801,590Product development
    
    
    5,491,725
    
    
    
    3,547,335
    
    
    
    3,035,728General and administrative
    
    
    7,004,914
    
    
    
    6,388,708
    
    
    
    4,859,096Income from operations
    
    
    9,198,853
    
    
    
    4,817,122
    
    
    
    3,942,424Other:Other
    
    
    
    
    
    
    (43
    )
    
    
    1,405Interest income
    
    
    1,330,903
    
    
    
    689,230
    
    
    
    205,124Interest expense
    
    
    (1,771
    )
    
    
    (387
    )
    
    
    (763
    )Minority interest
    
    
    327,835
    
    
    
    
    
    
    
    Income before income taxes
    
    
    10,855,820
    
    
    
    5,505,922
    
    
    
    4,148,190Income tax expense
    
    
    4,107,649
    
    
    
    2,324,412
    
    
    
    8,337Net income
    
    $
    6,748,171
    
    
    $
    3,181,510
    
    
    $
    4,139,853Net income per common share (basic)
    
    $
    0.24
    
    
    $
    0.11
    
    
    $
    0.15Weighted average number of common shares
used in computation (basic)
    
    
    28,621,171
    
    
    
    28,432,185
    
    
    
    27,039,057Net income per common share (diluted)
    
    $
    0.20
    
    
    $
    0.09
    
    
    $
    0.12Weighted average number of common shares
used in computation (diluted)
    
    
    33,703,558
    
    
    
    33,628,330
    
    
    
    34,833,521
   41




---



##### Table of Contents



COMMON STOCK
    
    
    ADDITIONAL$0.001 PAR VALUE
    
    
    PAID-IN
    
    
    ACCUMULATED
    
    
    TREASURYSHARES
    
    
    AMOUNT
    
    
    CAPITAL
    
    
    DEFICIT
    
    
    STOCK
    
    
    TOTALBalance at January 1, 2005
    
    
    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
-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
    )
    
    $
    15,536,744
   42




---



##### Table of Contents



2007
    
    
    2006
    
    
    2005OPERATING ACTIVITIESNet income
    
    $
    6,748,171
    
    
    $
    3,181,510
    
    
    $
    4,139,853Adjustments to reconcile net income to net
cash provided by operating activities:Depreciation and amortization
    
    
    1,046,254
    
    
    
    698,317
    
    
    
    393,835Bad debt expense
    
    
    
    
    
    
    15,000
    
    
    
    20,000Loss (gain) on disposal of assets
    
    
    25,996
    
    
    
    43
    
    
    
    (1,405
    )Stock based compensation expense -  non-employees
    
    
    
    
    
    
    14,396
    
    
    
    24,311Stock based compensation expense - employees
    
    
    961,715
    
    
    
    726,421
    
    
    
    Accretion of discount on held-to-maturity securities
    
    
    
    
    
    
    (204,323
    )
    
    
    Tax benefit from stock option exercises
    
    
    (871,469
    )
    
    
    (1,420,574
    )
    
    
    1,155,187Deferred income taxes
    
    
    (238,570
    )
    
    
    774,813
    
    
    
    (1,111,962
    )Minority interest
    
    
    (327,835
    )
    
    
    
    
    
    
    Changes in operating assets and liabilities:Accounts receivable, net
    
    
    1,960,368
    
    
    
    (3,296,984
    )
    
    
    (2,599,350
    )Prepaid expenses and other current assets
    
    
    (124,201
    )
    
    
    (142,470
    )
    
    
    (315,712
    )Accounts payable
    
    
    (14,703
    )
    
    
    75,053
    
    
    
    221,654Accrued payroll, incentive compensation
and related expenses
    
    
    384,688
    
    
    
    312,438
    
    
    
    347,263Accrued expenses
    
    
    113,461
    
    
    
    22,853
    
    
    
    (33,689
    )Income taxes payable
    
    
    836,152
    
    
    
    1,507,835
    
    
    
    (56,278
    )Deferred revenue
    
    
    1,841,778
    
    
    
    4,154,547
    
    
    
    4,013,632Deferred rent
    
    
    (45,601
    )
    
    
    (38,396
    )
    
    
    381,862Net cash provided by operating activities
    
    
    12,296,204
    
    
    
    6,380,479
    
    
    
    6,579,201INVESTING ACTIVITIESPurchases of property and equipment
    
    
    (788,346
    )
    
    
    (806,978
    )
    
    
    (1,548,541
    )Acquisitions of intangible assets
    
    
    
    
    
    
    
    
    
    
    (235,230
    )Purchases of held-to-maturity investments
    
    
    
    
    
    
    (9,512,523
    )
    
    
    (2,588,154
    )Sale of property, plant and equipment
    
    
    10,000
    
    
    
    450
    
    
    
    8,950Proceeds from sale or maturity of held-to-maturity investments
    
    
    
    
    
    
    11,705,000
    
    
    
    600,000Net cash provided by (used in) investing activities
    
    
    (778,346
    )
    
    
    1,385,949
    
    
    
    (3,762,975
    )FINANCING ACTIVITIESPayments under capital lease obligation
    
    
    (1,391
    )
    
    
    (1,310
    )
    
    
    (969
    )Excess tax benefits from stock-based payment arrangements
    
    
    871,469
    
    
    
    1,420,574
    
    
    
    Purchases of treasury stock
    
    
    (5,612,566
    )
    
    
    (3,277,076
    )
    
    
    Exercise of common stock options and warrants
    
    
    569,625
    
    
    
    433,651
    
    
    
    712,987Net cash (used in) provided by financing activities
    
    
    (4,172,863
    )
    
    
    (1,424,161
    )
    
    
    712,018Net increase in cash and cash equivalents
    
    
    7,344,995
    
    
    
    6,342,267
    
    
    
    3,528,244Cash and cash equivalents at beginning of period
    
    
    16,024,373
    
    
    
    9,682,106
    
    
    
    6,153,862Cash and cash equivalents at end of period
    
    $
    23,369,368
    
    
    $
    16,024,373
    
    
    $
    9,682,106SUPPLEMENTAL CASH FLOW INFORMATIONInterest paid
    
    $
    1,771
    
    
    $
    387
    
    
    $
    763Income tax paid
    
    $
    3,523,998
    
    
    $
    33,277
    
    
    $
    21,390NON CASH FINANCING AND INVESTING ACTIVITYProperty and equipment acquired with capital lease
    
    $
    
    
    
    $
    
    
    
    $
    7,533Property and
equipment acquired in accounts payable or accrued expenses
    
    $
    7,526
    
    
    $
    
    
    
    $
    65,054SAB 51 capital reallocation adjustment for investment in
majority-owned subsidiary
    
    $
    171,846
    
    
    $
    
    
    
    $
    Non-competition agreements contributed to HCS by HealthCo
    
    $
    404,000
    
    
    $
    
    
    
    $
    
   43




---



##### Table of Contents



Strategic Quality Initiative, Strategic Quality Partnerships and Quality Assessment and
Implementation Programs:
   44




---



##### Table of Contents



Health Management Suite:
   Healthcare Quality Reports:
  Internet Patient Acquisition Program:
   45




---



##### Table of Contents



Internet Advertising:
    Multiple element arrangements
 Accounting for Revenue Arrangements with Multiple Deliverables.
      Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use
  46




---



##### 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 Goodwill and Other Intangible Assets
    47




---



##### Table of Contents



Earnings Per Share
  2007
    
    
    2006
    
    
    2005Numerator for both basic and diluted earnings
per share:Net income
    
    $
    6,748,171
    
    
    $
    3,181,510
    
    
    $
    4,139,853Denominator:Denominator for basic net income per
common shareweighted average shares
    
    
    28,621,171
    
    
    
    28,432,185
    
    
    
    27,039,057Effect of dilutive securities:Outstanding employee stock options, warrants
and restricted stock awards
    
    
    5,082,387
    
    
    
    5,196,145
    
    
    
    7,794,464Denominator for diluted net income per
common shareadjusted weighted average
shares and assumed conversion
    
    
    33,703,558
    
    
    
    33,628,330
    
    
    
    34,833,521
  48




---



##### Table of Contents



Accounting
for Stock Issued to Employees
 Share-Based Payment Accounting for Stock-Based Compensation
    Accounting for Sales of Stock by a Subsidiary
  Fair Value Measurement.
  49




---



##### Table of Contents



The Fair
Value Option for Financial Assets and Financial Liabilities  Including an Amendment of FASB
Statement 115
 Definition of Settlement in FASB
Interpretation No. Accounting for
Uncertainty in Income Taxes
 Business Combinations
 Noncontrolling Interests in Consolidated Financial Statements  an amendment of Accounting
Research Bulletin No. 51
    2007
    
    
    2006Trade accounts receivable
    
    $
    6,954,548
    
    
    $
    8,914,916Less: allowance for doubtful accounts
    
    
    19,207
    
    
    
    19,207$
    6,935,341
    
    
    $
    8,895,709
   50




---



##### Table of Contents



DECEMBER 312007
    
    
    2006Furniture and fixtures
    
    $
    407,222
    
    
    $
    329,312Computer equipment and software
    
    
    3,763,997
    
    
    
    3,248,301Leasehold improvements and other
    
    
    436,723
    
    
    
    397,8964,607,942
    
    
    
    3,975,509Accumulated depreciation and amortization
    
    
    (2,966,486
    )
    
    
    (2,209,548
    )Net property and equipment
    
    $
    1,641,456
    
    
    $
    1,765,961
           51




---



##### Table of Contents



2007
    
    
    2006Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Value
    
    
    Amount
    
    
    Amortization
    
    
    ValueIntangible assets with finite lives:Survey builder and tools
    
    $
    212,230
    
    
    $
    182,212
    
    
    $
    30,018
    
    
    $
    235,230
    
    
    $
    120,229
    
    
    $
    115,001Non-competition agreements
    
    
    404,000
    
    
    
    76,890
    
    
    
    327,110
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    616,230
    
    
    $
    259,102
    
    
    $
    357,128
    
    
    $
    235,230
    
    
    $
    120,229
    
    
    $
    115,001
  2008
    
    $
    110,8182009
    
    
    80,8002010
    
    
    80,8002011
    
    
    80,8002012
    
    
    3,910
     Effective Date
    
    New Aggregate AmountFebruary 15, 2008
    
    $
    170,000February 15, 2009
    
    $
    45,000
   Stock Repurchase Program
   52




---



##### Table of Contents



Equity Compensation Plan
    .
   Share-Based Payment
 Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards
  53




---



##### Table of Contents



Stock-Based Compensation Expense
  2007
    
    
    2006
    
    
    2005(1)Cost of ratings and advisory revenue
    
    $
    101,426
    
    
    $
    98,568
    
    
    $
    Sales and marketing
    
    
    417,802
    
    
    
    311,563
    
    
    
    24,311Product development
    
    
    158,391
    
    
    
    159,398
    
    
    
    General and administrative
    
    
    284,096
    
    
    
    171,288
    
    
    
    Total stock-based compensation expense
    
    $
    961,715
    
    
    $
    740,817
    
    
    $
    24,311Related tax benefit
    
    $
    237,184
    
    
    $
    49,626
    
    
    $
    9,241
  (1)
    
    Amount of stock-based compensation recognized in 2005 was recorded pursuant to SFAS
123 as compensation to a consultant. Equity Plan
 Valuation Assumptions for Stock Options
  2007
    
    
    2006
    
    
    2005Dividend yield
    
    
    N/A
    
    
    
    0%
    
    
    
    0%Expected volatility
    
    
    N/A
    
    
    
    111%
    
    
    
    111-158%Risk-free interest rate
    
    
    N/A
    
    
    
    4.84%
    
    
    
    3.67-3.96%Expected life
    
    
    N/A
    
    
    3-5 years
    
    3 years
   WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicOptions
    
    
    Price
    
    
    Term (in years)
    
    
    ValueOutstanding at December 31, 2006
    
    
    6,649,543
    
    
    $
    0.56Granted
    
    
    
    
    
    
    Exercised
    
    
    (704,184
    )
    
    
    0.81Forfeited
    
    
    (36,616
    )
    
    
    4.41Expired
    
    
    (35,471
    )
    
    
    9.91Outstanding at December 31, 2007
    
    
    5,873,272
    
    
    $
    0.45
    
    
    
    3.83
    
    
    $
    32,308,958Vested or expected to vest at December 31, 2007
    
    
    5,871,489
    
    
    $
    0.45
    
    
    
    3.83
    
    
    $
    32,306,049Exercisable at December 31, 2007
    
    
    5,813,842
    
    
    $
    0.41
    
    
    
    3.79
    
    
    $
    32,212,003
  54




---



##### Table of Contents



2007
    
    
    2006
    
    
    2005WEIGHTED-
    
    
    
    
    
    
    WEIGHTED-
    
    
    
    
    
    
    WEIGHTED-AVERAGE
    
    
    
    
    
    
    AVERAGE
    
    
    
    
    
    
    AVERAGEEXERCISE
    
    
    
    
    
    
    EXERCISE
    
    
    
    
    
    
    EXERCISEOPTIONS
    
    
    PRICE
    
    
    OPTIONS
    
    
    PRICE
    
    
    OPTIONS
    
    
    PRICEOutstanding at beginning of year
    
    
    6,649,543
    
    
    $
    0.56
    
    
    
    7,975,186
    
    
    $
    0.61
    
    
    
    9,778,384
    
    
    $
    0.41Granted
    
    
    
    
    
    $
    
    
    
    
    23,000
    
    
    $
    6.40
    
    
    
    490,500
    
    
    $
    3.65Exercised
    
    
    (704,184
    )
    
    $
    0.81
    
    
    
    (1,100,578
    )
    
    $
    0.39
    
    
    
    (2,078,020
    )
    
    $
    0.30Forfeited
    
    
    (36,616
    )
    
    $
    4.41
    
    
    
    (234,999
    )
    
    $
    3.15
    
    
    
    (215,678
    )
    
    $
    1.69Expired
    
    
    (35,471
    )
    
    $
    9.91
    
    
    
    (13,066
    )
    
    $
    5.81
    
    
    
    
    
    
    $
    Outstanding at end of year
    
    
    5,873,272
    
    
    $
    0.45
    
    
    
    6,649,543
    
    
    $
    0.56
    
    
    
    7,975,186
    
    
    $
    0.61Exercisable at end of year
    
    
    5,813,842
    
    
    $
    0.41
    
    
    
    6,317,633
    
    
    $
    0.45
    
    
    
    6,755,757
    
    
    $
    0.38
 2007
    
    
    2006
    
    
    2005Weighted-average fair value of options
granted during the year:
    
    
    N/A
    
    
    $
    4.84
    
    
    $
    2.89Intrinsic value of options exercised during
the year:
    
    $
    3,376,505
    
    
    $
    4,693,045
    
    
    $
    7,662,096Fair value of options vested during the year:
    
    $
    408,213
    
    
    $
    635,779
    
    
    $
    326,927
  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
    
    
    3,784,835
    
    
    
    4.10
    
    
    $
    0.10
    
    
    
    3,784,835
    
    
    $
    0.10$0.30-$0.48
    
    
    242,083
    
    
    
    4.98
    
    
    
    0.32
    
    
    
    242,083
    
    
    
    0.32$0.56-$0.63
    
    
    1,090,067
    
    
    
    1.83
    
    
    
    0.58
    
    
    
    1,090,067
    
    
    
    0.58$0.75-$0.88
    
    
    213,028
    
    
    
    3.00
    
    
    
    0.81
    
    
    
    213,028
    
    
    
    0.81$1.01-$1.82
    
    
    280,592
    
    
    
    6.06
    
    
    
    1.31
    
    
    
    280,592
    
    
    
    1.31$2.25-$2.94
    
    
    100,667
    
    
    
    5.43
    
    
    
    2.86
    
    
    
    94,667
    
    
    
    2.86$3.00-$3.98
    
    
    56,333
    
    
    
    6.73
    
    
    
    3.49
    
    
    
    45,163
    
    
    
    3.52$4.10-$4.70
    
    
    71,334
    
    
    
    7.69
    
    
    
    4.50
    
    
    
    36,575
    
    
    
    4.47$5.36-$5.94
    
    
    8,000
    
    
    
    8.01
    
    
    
    5.80
    
    
    
    3,166
    
    
    
    5.73$6.10-$6.75
    
    
    26,333
    
    
    
    1.83
    
    
    
    6.65
    
    
    
    23,666
    
    
    
    6.71$0.06-$6.75
    
    
    5,873,272
    
    
    
    3.83
    
    
    $
    0.45
    
    
    
    5,813,842
    
    
    $
    0.41
  55




---



##### Table of Contents



2006 Plan
  WeightedAverageGrant-Date
    
    
    AggregateFair Value
    
    
    IntrinsicNumber of RSAs
    
    
    Per Share
    
    
    ValueNonvested at December 31, 2006
    
    
    1,075,332
    
    
    $
    4.40Granted
    
    
    329,250
    
    
    
    6.33Vested
    
    
    (43,340
    )
    
    
    4.42Forfeited
    
    
    (29,276
    )
    
    
    5.39Nonvested at December 31, 2007
    
    
    1,331,966
    
    
    $
    4.85
    
    
    $
    7,925,198Expected to Vest at December 31, 2007
    
    
    442,967
    
    
    $
    5.62
    
    
    $
    2,635,654
 2007
    
    
    2006
    
    
    2005Intrinsic value of RSAs vested during the year:
    
    $
    257,873
    
    
    
    N/A
    
    
    
    N/AFair value of shares vested during the year:
    
    $
    191,736
    
    
    
    N/A
    
    
    
    N/A
   Pro Forma Information for Period Prior to SFAS 123(R) Adoption
  Year EndedDecember 31, 2005Net income, as reported
    
    $
    4,139,853Add: 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
    )Pro forma net income
    
    $
    3,594,799Basic net income per share:As reported
    
    $
    0.15Pro forma
    
    $
    0.13Diluted net income per share:As reported
    
    $
    0.12Pro forma
    
    $
    0.10
  56




---



##### Table of Contents



2008
    
    $
    659,2292009
    
    
    650,8562010
    
    
    569,6512011
    
    
    234,841Thereafter
    
    
    Total
    
    $
    2,114,577
   Accounting for Income Taxes
  2007
    
    
    2006Deferred tax assets:Deferred rent
    
    $
    113,189
    
    
    $
    121,910Accrued liabilities
    
    
    102,987
    
    
    
    67,629Stock-based compensation expense
    
    
    221,423
    
    
    
    57,160Intangible assets, net
    
    
    60,600
    
    
    
    34,265Allowance for doubtful accounts
    
    
    7,299
    
    
    
    7,299Capitalized start-up costs
    
    
    90,123
    
    
    
    Other
    
    
    12,812
    
    
    
    6,579Net operating loss carryforwards
    
    
    279,543
    
    
    
    299,510887,976
    
    
    
    594,352Valuation allowance for deferred
tax assets
    
    
    
    
    
    
    Gross deferred tax asset
    
    
    887,976
    
    
    
    594,352Deferred tax liabilities:Prepaid expenses
    
    
    244,167
    
    
    
    158,087Property and equipment, net
    
    
    68,090
    
    
    
    99,116Gross deferred tax liability
    
    
    312,257
    
    
    
    257,203Net deferred tax asset
    
    $
    575,719
    
    
    $
    337,149
   57




---



##### Table of Contents



2007
    
    
    2006
    
    
    2005Current:Federal
    
    $
    3,846,923
    
    
    $
    1,346,815
    
    
    $
    1,029,882State
    
    
    499,296
    
    
    
    202,784
    
    
    
    90,4174,346,219
    
    
    
    1,549,599
    
    
    
    1,120,299Deferred:Federal
    
    
    (209,424
    )
    
    
    682,289
    
    
    
    (978,360
    )State
    
    
    (29,146
    )
    
    
    92,524
    
    
    
    (133,602
    )(238,570
    )
    
    
    774,813
    
    
    
    (1,111,962
    )Total income tax expense
    
    $
    4,107,649
    
    
    $
    2,324,412
    
    
    $
    8,337
    2007
    
    
    2006
    
    
    2005Federal statutory income tax rate
    
    
    34.0
    %
    
    
    34.0
    %
    
    
    34.0
    %State income taxes, net of federal benefit
    
    
    2.8
    
    
    
    3.5
    
    
    
    4.3Non-deductible expenses
    
    
    0.8
    (1)
    
    
    3.8
    (1)
    
    
    0.4Miscellaneous
    
    
    0.2
    
    
    
    0.9
    
    
    
    (2.3
    )Deferred tax asset valuation allowance
    
    
    
    
    
    
    
    
    
    
    (36.2
    )Effective income tax rate
    
    
    37.8
    %
    
    
    42.2
    %
    
    
    0.2
    %
  (1)
    
    Includes compensation cost related to incentive stock options.     58




---



##### Table of Contents



Agreement with Hewitt Associates LLC
         59




---



##### Table of Contents



Indemnification of our Chief Executive Officer and Derivative Complaint
     th
   60




---



##### Table of Contents



th
  th
   61




---



##### Table of Contents



Gotham/Primarius Complaint
            62




---



##### Table of Contents



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.  63




---



##### Table of Contents



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
  Indemnification and Derivative Complaint
   Gotham/Primarius Complaint
  Treasury Stock
   64




---



##### Table of Contents



2006 Plan and Certain Employment Agreements
  Related Party Transaction
  
   
        Internal Control-Integrated Framework
 
    65




---



##### Table of Contents



Number of securitiesremaining availableNumber of securities
    
    
    
    
    
    
    for future issuanceto be issued upon
    
    
    Weighted-average
    
    
    under equityexercise of
    
    
    exercise price of
    
    
    compensation plansoutstanding options,
    
    
    outstanding options,
    
    
    (excluding securitieswarrants and rights
    
    
    warrants, rights and RSAs
    
    
    reflected in column (a))Plan category
    
    (a)
    
    
    (b)
    
    
    (c)Equity compensation
plans approved
by security holders
    
    
    7,205,238
    (1)
    
    $
    0.37
    
    
    
    4,434,554Equity compensation plans not approved
by security holders
    
    
    N/A
    
    
    
    
    
    
    
    N/ATotal
    
    
    7,205,238
    
    
    
    
    
    
    
    4,434,554
  (1)
    
    1,331,966 of securities to be issued upon exercise relate to restricted stock
awards not yet vested.  
   
    66




---



##### Table of Contents



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, 2007
    
    $
    19,207
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    19,207Year ended December 31, 2006
    
    $
    4,207
    
    
    $
    15,000
    
    
    $
    
    
    
    $
    
    
    
    $
    19,207Year ended December 31, 2005
    
    $
    15,236
    
    
    $
    20,000
    
    
    $
    
    
    
    $
    (31,029
    )(1)
    
    $
    4,207
  (1)
    
    Represents actual amounts charged against the allowance for the periods presented.  67




---



##### 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 Plan (incorporated by reference to
our Proxy Statement, filed on June 26, 2006)10.1.2*
    
    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))10.4.1*
    
    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 10.5 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.  68




---



##### Table of Contents



HEALTH GRADES, INC.Date: March 17, 2008
    /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 17, 2008/s/ Allen Dodge
Allen Dodge
    
    Executive Vice President, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer
    
    March 17, 2008/s/ Mary Boland
Mary Boland
    
    Director
    
    March 17, 2008/s/ Leslie S. Matthews, M.D.
Leslie S. Matthews, M.D.
    
    Director
    
    March 17, 2008/s/ John Quattrone
John Quattrone
    
    Director
    
    March 17, 2008/s/ Michael Beaudoin
Michael Beaudoin
    
    Director
    
    March 17, 2008
  69




---



##### 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 Plan (incorporated by reference to our Proxy
Statement, filed on June 26, 2006)10.1.2*
    
    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))10.4.1*
    
    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 10.5 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.  70