<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

                                   (MARK ONE)

         [X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                 OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
                     FISCAL YEAR ENDED DECEMBER 31, 2001 OR

         [ ]    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.
             (Exact name of registrant as specified in its charter)

                     DELAWARE                               62-1623449
          (State or other jurisdiction                  (I.R.S. Employer
          of incorporation or organization)             Identification No.)

           44 UNION BOULEVARD, SUITE 600
             LAKEWOOD, COLORADO                               80228
      (Address of principal executive offices)              (Zip Code)

       Registrant's telephone number, including area code: (303) 716-0041

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

                                      None

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                     COMMON STOCK, PAR VALUE $.001 PER SHARE
                                (Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy statement incorporated
by reference in Part III of this annual report on Form 10-K or any amendment to
this annual report on Form 10-K. [ ]

As of March 29, 2002, the aggregate market value of the Common Stock held by
non-affiliates of the registrant was $3,293,348. Such aggregate market value was
computed by reference to the closing sale price of the Common Stock as reported
on the OTC Bulletin Board on such date. For purposes of making this calculation
only, the registrant has defined "affiliates" as including all directors and
beneficial owners of more than five percent of the Common Stock of the Company.

As of March 29, 2002 there were 36,406,649 shares of the registrant's Common
Stock outstanding.



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                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Definitive Proxy Statement for the Registrant's 2002 Annual
Meeting of Stockholders to be filed within 120 days after the end of the fiscal
year covered by this Annual Report on Form 10-K -- Part III.

                                TABLE OF CONTENTS

<Table>
<S>          <C>                                                                <C>
                                     PART I
Item 1.      Business.........................................................   2
Item 2.      Properties.......................................................  20
Item 3.      Legal Proceedings................................................. 20
Item 4.      Submission of Matters to a Vote of Security Holders............... 20

                                     PART II

Item 5.      Market for the Registrant's Common Equity and Related
                Stockholder Matters............................................ 21
Item 6.      Selected Financial Data........................................... 22
Item 7.      Management's Discussion and Analysis of Financial Condition And
                Results of Operations.......................................... 22
Item 7A.     Quantitative and Qualitative Disclosures About Market Risk........ 28
Item 8.      Financial Statements and Supplementary Data....................... 28
Item 9.      Changes in and  Disagreements  with Accountants on Accounting and
                Financial Disclosure........................................... 28

                                    PART III

Item 10.     Directors and Executive Officers of the Registrant................ 29
Item 11.     Executive Compensation............................................ 29
Item 12.     Security Ownership of Certain Beneficial Owners and Management.... 29
Item 13.     Certain Relationships and Related Transactions.................... 29

                                     PART IV

Item 14.     Exhibits, Financial Statement Schedules, and Reports on Form 8-K.. 30
</Table>

This Report contains forward-looking statements that address, among other
things, the generation of increased revenues, potential income tax refund,
potential equity and/or debt financing. These statements may be found under
"Item 1-Business," "Item 1-Risk Factors," and "Item 7-Management's Discussion
and Analysis of Financial Condition and Results of Operations" as well as in the
Report generally. We generally identify forward-looking statements in this
report using words like "believe," "intend," "expect," "may," "will," "should,"
"plan," "project," "contemplate," "anticipate" or similar statements. Actual
events or results may differ materially from those discussed in forward-looking
statements as a result of various factors, including: the failure of the Company
to generate increased revenues, the failure of the Company to receive the income
tax refund or the inability of the Company to raise additional financing. In
addition other factors that could cause actual events or results to differ
materially from those discussed in the forward looking statements are addressed
in "Item 1-Risk Factors" and matters set forth in the Report generally. We
undertake no obligation to update publicly any forward-looking statements for
any reason, even if new information becomes available or other events occur in
the future.

                                     PART I

Item 1. Business.

                                    BUSINESS

OVERVIEW

     We are a healthcare ratings and consulting company. We grade, or provide
consumers with the means to assess and compare the quality or qualifications of,
the following types of healthcare providers:

     o    hospitals

     o    nursing homes



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     o    home health agencies

     o    hospice programs

     o    fertility clinics

     We offer services to hospitals who are either attempting to build a
reputation based upon quality of care or are working to identify areas to
improve quality. For hospitals that have received high ratings, we offer the
opportunity to license our ratings and trademarks and provide assistance in
their marketing programs. For providers that have not received high ratings, we
offer quality improvement services.

     We provide basic and expanded profile information for a variety of
providers and facilities. We make this information available to consumers,
employers and health plans to assist them in selecting healthcare providers. The
basic profile information is available free of charge on our website,
www.healthgrades.com. For certain providers, we offer healthcare quality reports
for a fee. These reports provide more detailed information than what is
available free of charge on our website. Report pricing and content varies based
upon the type of provider and whether the user is a consumer or a healthcare
professional.

     We provide online integrated healthcare quality solutions for employers,
health plans and other organizations that are looking to license access to our
database of healthcare providers.

     We collaborated with The Leapfrog Group to analyze and report the findings
of Leapfrog's hospital patient safety survey. The Leapfrog Group, a consortium
of more than 90 Fortune 500 companies and other large private and public
healthcare purchasers, began a national effort in November 2000 to reward
hospitals for advances in patient safety and to educate employees, retirees, and
families about the importance of hospitals' efforts in this area. The Leapfrog
Group's survey assesses the extent to which urban, acute care hospitals in
select regions of the U.S. currently meet or are striving to implement three
patient safety practices. For Leapfrog enrollees, we have developed a Leapfrog
Enrollee Assistance Program (LEAP). HealthGrades' LEAP provides employers,
health plans, and other members of The Leapfrog Group with an online and text
solution, including access to essential hospital-quality information.

     We also provide limited physician practice management services to a
musculoskeletal practice under a management services agreements that expires in
September 2002.

COMPANY HISTORY

     We were incorporated in Delaware in December 1995 under the name Specialty
Care Network, Inc. Upon commencement of operations in 1996, we were principally
engaged in the management of physician practices engaged in musculoskeletal
care, which is the treatment of conditions relating to bones, joints, muscles
and connective tissues. Through March 31, 1998, we entered into comprehensive
affiliation arrangements with 21 practices including 164 physicians. Due to
difficulties in the physician practice management industry in general, and with
respect to our affiliated physician practices in particular, we terminated or
restructured our arrangements with various physician practices, beginning in
late 1998 and continuing thereafter. As a result, the scope of our physician
practice management business has become far more limited, particularly after a
restructuring of our arrangements with nine practices in June 1999. During 1998,
we began to focus on the provision of healthcare information through the
establishment of our health care provider ratings and profile information, which
we first introduced on our website. Since that time, we have expanded the scope
of our healthcare information services to encompass the direct provision of
information to employers, health plans and others; engaged in assisting
hospitals in promoting their services; and provided other services, as described
below.

     In January 2000, we changed our name to Healthgrades.com, Inc. In November
2000, we changed our name to Health Grades, Inc.

HEALTH CARE INFORMATION; HEALTHGRADES.COM

     We compile comprehensive information regarding various healthcare providers
and distill the information to meet the requirements of consumers, employers,
health plans and other customers. We provide certain information for no charge
on our healthgrades.com internet site. Our revenues are generated, in part,
through the provision of health care information derived from our database in a
manner that can be useful to employers, health plans and others.



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     Healthgrades.com is a comprehensive health care information website that
provides rating and other profile information regarding a variety of providers
and facilities. We make this information available through several health care
"report card" sections and provider profile modules. Our goal is to provide
comprehensive, objective health care ratings and profiles to assist consumers in
making the most informed decisions regarding their health and that of their
families.

     We distinguish the healthgrades.com website from most other health care
information websites based on the nature of the information we provide. Most
other health care information websites provide general information regarding
specific diseases, conditions or procedures. Healthgrades.com, in contrast,
provides information to assist the user in finding quality care or a quality
provider, using our rating and profile information. However, we do not endorse
any particular provider or facility. We strive to provide unbiased ratings
regarding the quality of providers and facilities by developing proprietary
algorithms or other methodologies and applying them to a number of databases
used on our ratings websites.

     We provide information on our healthgrades.com website through the
following sections:

     Hospital Report Cards(TM) - This page provides a list of hospitals and
ratings for the hospitals with respect to different medical procedures or
diagnoses chosen by the user. Information with regard to procedures and
diagnoses is provided in the following areas:

     o    cardiac;

     o    orthopaedics;

     o    neurosciences;

     o    pulmonary/respiratory;

     o    obstetrics; and

     o    vascular surgery.

     For each particular diagnosis or procedure chosen by the user, other than
those relating to obstetrics, we provide a rating system of five stars, three
stars or one star (five stars is the highest rating; one star is the lowest)
with regard to the performance of all hospitals in the United States. We base
all of our ratings, except ratings on obstetrics, on three years of MEDPAR
(Medicare Provider Analysis and Review) data that we purchase from the Centers
for Medicare and Medicaid Services (formerly Health Care Financing
Administration), known as CMS. The MEDPAR database contains the inpatient
records of all Medicare patients. We apply proprietary algorithms to the MEDPAR
data to account for variations in risk in order to make the data comparable from
hospital to hospital. Generally, approximately 70% of hospitals studied are
classified as three stars. The three star rating is applied when there is very
little difference, statistically speaking, between a hospital's predicted and
actual performance. Approximately 15% of hospitals are rated five stars, which
means that their performance is better than expected on a statistically
significant basis. Approximately 15% of hospitals are rated one star, meaning
that their performance was worse than expected on a statistically significant
basis. We have applied for a patent with respect to our hospital rating system
and methodology.

     For our obstetrics ratings, which also are subject to the five star rating
system, we use state all-payor files from 17 individual states derived from the
inpatient records of persons who utilize hospitals in those states. We believe
that the 17 states are the only states with sufficient data for use on our
website. This data represents all discharges for the 17 states. We analyzed the
following factors for each hospital within the 17 all-payor states:

     o    Actual complication rates from vaginal and cesarean section single
          birth deliveries

     o    Volume of vaginal and cesarean single birth deliveries

     o    Presence of newborn intensive care unit (NICU)

     Each of the factors was assigned a score. Volume for vaginal and cesarean
single birth deliveries was ordered into tenth percentile groups by state with
the highest volume percentile group in each state receiving a value of 10 and
the lowest volume percentile group in each state receiving a value of 1.
Complication rates were placed into tenth percentile groups by state. The
highest complication rate percentile group in each state received a value of 1
while the lowest complication rate percentile group in each state received a
value of 10. The presence of a NICU was assigned a value of 10 while no NICU was
assigned a value of 1. We then developed a system that assigned a weight to each
factor based on its importance to the quality of obstetric care in the hospital.
These weightings were



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developed by interviewing a group of obstetricians who had an average of 17
years of practice experience. Each factor's score was multiplied by its
percentage weight and then summed to create an overall score. The top 30% of
hospitals (in the 17 states) receive five stars, the middle 40% receive three
stars and the bottom 30% receive one star.

     Nursing Home Report Cards(TM) - This page provides rankings of the
performance of nursing homes across the United States that were Medicare or
Medicaid certified and active in these programs. In preparing the ratings, we
analyzed licensing survey data from CMS's Online Survey Certification and
Reporting (OSCAR) database and complaint data from CMS's Skilled Nursing
Facility (SNF) Complaint database. Licensing surveys are inspections that assess
compliance with standards of patient care such as staffing, quality of care and
cleanliness. Complaint surveys are investigations of complaints and serious
problems. We performed an analysis of the standards that were not met
(deficiencies) from the four most recent licensing surveys and the last four
years of complaint surveys. Complaint surveys older than December 1997 were not
included in the analysis. Stand-alone Medicare and/or Medicaid nursing homes
were analyzed apart from Medicare, hospital-based nursing homes. We did not rate
Medicare, hospital-based nursing homes because these facilities are designed for
short-term patient care. In addition, nursing homes with only one licensing
survey were not included in our analysis. The ratings were assigned on a state
by state basis, rather than nationally, because the surveys from which
information is derived are conducted by state agencies, and there may be
variations in the states' survey process and results.

     In conjunction with a group of nursing home professionals (which included
nursing home administrators, a physician, long-term care ombudsman, a nurse
consultant and others), we developed a proprietary scoring system that
translated the scope and severity of each deficiency into a numerical value. A
low numerical value indicated a deficiency that was not severe (no actual harm
to the resident) and isolated (involved very few residents) in scope. A high
numerical value indicated a deficiency that was very severe (actual harm to the
resident) and was widespread throughout the nursing home. Each nursing home
received several scores from the analysis of licensing surveys and complaint
surveys. We then performed a statistical analysis of these scores that produced
a weight for each area. The weighted scores were summed to produce an overall
score for each nursing home. Based upon the overall score, the best 30% of
nursing homes received five stars, and the middle 40% of nursing homes received
three stars.

     Home Health Report Cards(TM) - This page provides rankings of the
performance of Medicare certified home health agencies across the United States.
Home health agencies provide health and social services to persons at their
homes. These persons are recovering from an illness or injury or require
assistance with daily needs such as eating, dressing and bathing. We rate home
health agencies based upon data provided by CMS. Information is derived from
complaint surveys and licensing surveys. Complaint surveys are conducted by a
state survey team in response to one or more complaints about a home health
agency. Licensing surveys are surveys completed for Medicare certification. The
licensing survey information is derived from individual state agencies, which
enter the information into the OSCAR database. These surveys generally occur
every 36 months, but may occur more frequently based on the results of the
previous survey. In preparing the ratings, we reviewed survey information from
the most recent licensing surveys and a maximum of four complaint surveys of
home health agencies. Only home health agencies that were active in the Medicare
program during this time period were included in the analysis. Specifically, we
utilized the following elements to capture the quality of care and operational
stability of each home health agency:

     o    Complaint surveys (two elements):

          o    Number of complaint surveys within the last four years

          o    Number of complaint surveys dated within six months of each other

     o    Condition level deficiencies (very serious deficiencies that may give
          cause for penalties or de-certification by Medicare) (four elements) -
          Number of condition level deficiencies on each of the past four
          surveys

     o    Standard level deficiencies (non-serious deficiencies that require a
          plan for correction) (four elements) - Number of standard level
          deficiencies on each of the last four surveys

     o    Condition level deficiencies reported on both the most recent and
          prior survey

     o    Standard level deficiencies reported on both the most recent and prior
          survey

     o    Surveyor's summary score on the quality of care during the most recent
          survey

     o    Years in operation



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     o    Ownership changes as compared to years in operation

     Working with a group of health care professionals whose area of expertise
is home health care, we developed a proprietary weighting system that translates
the 15 elements detailed above into numeric scores. Home health agencies were
sorted by state based upon the overall score. The top 30% of home health
agencies in each state received five stars, the middle 60% received three stars
and the bottom 10% received one star. As is the case with nursing homes, the
ratings were assigned on a state-by-state basis, rather than nationally, because
the surveys from which information is derived on the OSCAR database are
conducted by state agencies, and there may be variations in the states' survey
process and results. In addition, our site provides specific information with
regard to particular deficiencies found in the surveys.

     Hospice Report Cards(TM) - This page differs from some of our other report
card pages in that it does not provide ratings. Instead, it provides users with
the means to assess hospice programs across the United States that participate
in Medicare. The data on our Hospice Report Card site is purchased from CMS, and
is derived from their Provider of Service ("POS") file. The POS file contains
data on every hospice program that participates in Medicare. Hospice services
are categorized as "core services" or "non-core services." Core services, as
defined in the POS file, are important, basic elements of hospice care that are
crucial to virtually every hospice patient and their family. These services
include the following:

     o    nursing care provided by or under the supervision of a registered
          nurse;

     o    medical social services provided under the direction of a physician;

     o    physician services; and

     o    counseling.

     Non-core services are also important to high-quality hospice care, but each
non-core service may be inappropriate or unnecessary for every hospice patient.
Non-core hospice services, as defined in the POS file, include:

     o    physical therapy;

     o    occupational therapy;

     o    speech pathology;

     o    home health aide;

     o    homemaker services;

     o    medical supplies; and

     o    short-term inpatient care.

     Hospice report cards provide users with a list of hospices from which they
can refine their search based upon the following criteria:

     o    whether the program provides nursing care directly by hospice
          employees;

     o    whether the program provides medical social services directly by
          hospice employees;

     o    whether the program provides physician services directly by hospice
          employees;

     o    whether the program provides counseling directly by hospice employees;
          and



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     o    whether the program provides all non-core hospice services.

     Fertility Clinic Report Cards(TM) - Like our Hospice Report Card pages,
this page differs from our other report card pages in that it does not provide
ratings. Instead, it provides users with the means to assess fertility clinics
across the United States. Information on healthgrades.com represents one year
(1997) of assisted reproductive technology ("ART") data. ART is defined as any
clinical treatment or procedure that involves the handling of human eggs and
sperm to help a woman become pregnant. Types of ART include IVF (in vitro
fertilization), GIFT (gamete intrafallopian transfer), ZIFT (zygote
intrafallopian transfer), egg or embryo donation and surrogate birth.

     The ART data on the healthgrades.com website is acquired from an annual
report published by the National Center for Chronic Disease Prevention and
Health Promotion of the Centers for Disease Control and Prevention ("CDC"), the
American Society of Reproductive Medicine, the Society for Assisted Reproductive
Technology ("SART") and RESOLVE, a national consumer group. Fertility clinics in
the United States are required to provide ART data to SART and information for
335 fertility clinics are represented in the 1997 CDC/SART report.

     Each fertility clinic profile consists of the following five elements:

          o    General information (contact information for each facility)

          o    Program characteristics. Program characteristics include whether
               the clinic accepts single women and gestational carriers (women
               who carry children for other women), whether the clinic utilizes
               a donor egg program and whether the clinic is a member of SART.
               Users are informed of the percentage of facilities nationwide
               which have the designated program characteristics.

          o    Type of ART (each fertility clinic's ART procedures (e.g., % of
               procedures using IVF) is compared to the national average)

          o    Patient diagnosis (individual clinic patient diagnoses are
               compared to the national average)

          o    Pregnancy success rates (individual clinic pregnancy success
               rates are compared in four age categories to the national
               average). For each age category, success rates are provided for
               three types of ART cycles: cycles that utilize fresh embryos from
               nondonor eggs, cycles that utilize frozen embryos from non-donor
               eggs, and cycles that utilize donor eggs.

     Other Provider Profiles - In addition to the report card sections, we
provide profiles containing information with regard to the following providers
or facilities. The approximate number of providers or facilities addressed in
each profile is indicated in parenthesis:

          o    Physicians (620,000);

          o    Hospitals (5,000);

          o    Children's Hospitals (70);

          o    Chiropractors (60,000);

          o    Assisted living residences (21,000);

          o    Mammography facilities (10,000);

          o    Acupuncturists (1,000);

          o    Naturopathic physicians (760);

          o    Birth centers (75);



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          o    Emergency Centers (10,000);

          o    Cancer Centers (50).

INFORMATION AND RELATED SERVICES FOR HOSPITALS, EMPLOYERS, HEALTH PLANS,
PROFESSIONALS AND CONSUMERS

     The information provided on our healthgrades.com website, and the database
from which this information is derived, forms the basis of our marketing
efforts. While certain information is provided free of charge on our website, we
seek to generate revenues from hospitals and other providers, as well as
employers, health plans and others as described below:

     SERVICES FOR HOSPITALS - We offer a Strategic Quality Initiative (SQI)
program and a Quality Assessment and Improvement (QAI) program for hospitals.
The SQI program provides business development tools to hospitals that are highly
rated on our website. Under our SQI program, we license the Health Grades name
and our "report card" ratings to hospitals. The license may be in a single area
(for example, Cardiac) or multiple areas (for example, Cardiac, Neuroscience and
Orthopaedics.) We also assist hospitals in promoting their ratings and measuring
the success of their efforts utilizing our team of in-house healthcare
consultants. Another key feature of this program is a detailed comparison of the
data underlying a hospital's rating to local and national benchmarks. This
comparison is utilized by the hospital to support its quality improvement
efforts. We offer the SQI program to highly rated providers only after our
ratings are completed and do not adjust our ratings based on whether a provider
is willing to license with us.

     Our QAI program is principally designed to help hospitals measure and
improve the quality of their care in particular areas where they have lower
ratings. Using our database and focusing on a particular hospital's information
and ratings we can help identify areas to improve quality and benchmark how well
the hospital performs relative to national and regional best practices. Detailed
quality comparisons are also available from the hospital to the individual
physician level. Our consultants work on-site with the hospital staff and
physicians to present the data and assist in the quality analysis.

     As our programs are targeted toward specific areas (for example, Cardiac,
Neurosciences, etc.) some of our hospital clients choose to work with us
utilizing our SQI programs for their higher rated areas and utilizing our QAI
programs for their lower rated areas.

     As of March 31, 2002, over 100 hospitals have joined either our SQI program
or our QAI program.

     SOLUTIONS FOR EMPLOYERS, HEALTH PLANS AND OTHERS - We license access to,
and customize our database for employers, health plans and others. Depending on
the client's needs, we can customize our content for the intended users (for
example, health plan members who are affiliated with the health plan). Some of
the healthcare quality information available to our clients and their Web users
includes:

     o    Physicians

          o    Every practicing physician in the nation

          o    Sanction database for every state except HI, SD, DC.

          o    Board certification status by specialty

          o    Hospital affiliations

          o    Health Plan affiliations

          o    Accepting new patients status

     o    Hospitals

          o    Every hospital in the nation

          o    Ratings based on outcomes for the most current three-year data
               set

          o    Ratings by procedure or diagnosis in the six areas addressed by
               our Hospital Report Cards

     o    Nursing Homes

          o    Every Medicare/Medicaid - licensed nursing home in the nation

          o    Ratings based on health and complaint surveys over the last four
               years



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          o    Benchmark data to help evaluate risk

          o    Detailed deficiency information

     HEALTHCARE QUALITY REPORTS FOR PROFESSIONALS - We offer comprehensive
quality information to organizations in need of current and historical quality
information on nursing homes and hospitals. In addition, we offer reports on
physicians that contain detailed information with respect to education history,
professional licensing history and other items.

     Our primary clients for our Nursing Home Quality Reports are medical
professional liability underwriters and other organizations that are interested
in access to a reliable source of quality data on nursing homes. We currently
offer three categories of reports on nursing homes. Our Nursing Home Quality
Report for Professionals contains detailed information on ownership,
certification history, staffing and patient demographics as well as performance
and ranking data from health, complaint and life safety surveys. Our Executive
Summary is a three-page report which summarizes this information. Our Risk
Assessment is a two to three page textual analysis of the Nursing Home Quality
Report that highlights potential problem areas within a facility that require
risk management.

     Our Hospital Reports contain detailed information on ownership, services
provided and clinical performance outcomes. Some of the features of our reports
include:

          o    Risk and severity-adjusted performance measures for cardiac,
               neuroscience, vascular, orthopaedics, pulmonary and obstetrics
               procedures and diagnoses

          o    Comparative statistics and state/national benchmarks

          o    Infections, complication and mortality rates

          o    "Cases At Risk" analysis, which projects how many cases are
               likely to have adverse outcomes based upon our proprietary
               mortality or complication rate analysis

In addition to the information contained in our Hospital Reports, we offer
access to a selection of public record reports to further assess risk, such as:

          o    Business information to include bankruptcies, liens, judgments,
               credit reports, corporate records and federal employer
               identification numbers

          o    Background checks on administrators and officers and directors

          o    Media searches

    Our Physician Reports contain detailed information on a physician's
demographics, which include:

          o    Education history

          o    Professional licensing history

          o    Board certifications

          o    State medical board and Medicare sanction history

          o    Hospital and health plan affiliations

          o    Our quality ratings for each hospital affiliation

          o    Bankruptcies, liens and judgments

    We also offer credit reports and civil and criminal records checks in
separate reports.

    HEALTHCARE QUALITY REPORTS FOR CONSUMERS - We currently offer Nursing Home
Quality Reports for Consumers. These reports include:

          o    Our rating for the particular nursing home

          o    Health survey history with descriptions and severity of the
               deficiencies for last four surveys

          o    Repeating deficiencies

          o    Outcomes from complaints in the last four years

          o    How the nursing home compares to others in the state

          o    Our methodology and helpful hints for choosing a nursing home



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ARRANGEMENTS WITH CONTENT PROVIDERS

     We market our website through relationships with other companies that
operate internet websites and an aggressive public relations campaign. Several
of the companies pay a fee to us to license access to our information, and some
others provide on-line content to us. These arrangements provide additional
exposure to our website. As a result, we believe our marketing to health care
providers, employers, payors and others is enhanced because of the increased
user population that we can make available to those entities who wish to license
our data in connection with their own marketing programs.

COMPETITION

     With respect to our quality services for hospitals, we face competition
from data providers, such as Solucient and healthcare consulting companies such
as GE Medical Systems and Premier that offer certain consulting services to
hospitals. We believe that the ability to demonstrate the value of marketing and
consulting programs, name brand recognition and cost are the principal factors
that affect competition.

     We face competition with respect to our solutions for employers, health
plans and others from companies that provide online information and decision
support tools regarding healthcare providers and physicians. There are several
companies that currently offer online healthcare information and support tools
such as Subimo and Doctor Quality. We believe that the ability to provide
accurate and comprehensive healthcare information in a manner that is
cost-effective to the client is the principal factor that affects competition in
this area.

     We face competition on our nursing home quality reports with companies such
as CareScout, which provide ratings of nursing homes and charge professionals
and consumers for this information.


PHYSICIAN PRACTICE MANAGEMENT OPERATIONS

     We provide the following services under a management services agreement to
one musculoskeletal physician practices:

     o    assessment of the financial performance, organizational structure,
          wages and strategic plan of the practice;

     o    advice with respect to current and future marketing and contracting
          plans with third-party payors and managed care plans;

     o    negotiation of malpractice insurance coverage;

     o    provision of access to our patient information databases;

     o    analysis of annual performance on a comparative basis with other
          practices that have contracted with us; and

     o    analysis of coding and billing practices.

     The remaining management services agreement expires in September 2002. The
scope of our physician practice management business has contracted significantly
and we do not intend to continue providing these services after September 2002.

GOVERNMENT REGULATION

     The delivery of health care services has become one of the most highly
regulated of professional and business endeavors in the United States. Both the
federal government and the individual state governments are responsible for
overseeing the activities of individuals and businesses engaged in the delivery
of health care services. Federal law and regulations are based primarily upon
the Medicare and Medicaid programs. Each of these programs is financed, at least
in part, with Federal funds. State jurisdiction is based upon the state's
interest in regulating the quality of health care in the state, regardless of
the source of payment.

     We believe our Internet service activities and physician practice
management operations materially comply with applicable laws. However, we have
not received or sought a legal opinion from counsel or from any Federal or state
judicial or regulatory authority



                                       10
<PAGE>

with respect to our Internet service activities or our practice management
operations. Additionally, many aspects of our business have not been the subject
of state or Federal regulatory interpretation. The laws applicable to us and the
practices that contract with us are subject to evolving interpretations. If we,
or these practices, are reviewed by a government authority, we may receive a
determination that could be adverse to us or the practices. Furthermore, the
laws applicable to either us or the practices may be amended in a manner that
could adversely affect us.

     Federal Anti-kickback Law. A federal law commonly known as the
"Anti-kickback Law" prohibits the knowing or willful solicitation, receipt,
offer or payment of any remuneration that is made in return for:

     o    the referral of patients covered under Medicare, Medicaid and other
          federally-funded health care programs; or

     o    the purchasing, leasing or ordering of any good, facility, item or
          service reimbursable under those programs.

     The law also prohibits remuneration that is made for the recommendation of,
or the arranging for, the purchasing, leasing, or ordering of any good,
facility, item or service reimbursable under those programs. The law has been
broadly interpreted by a number of courts to prohibit remuneration that is
solicited, received, offered or paid for otherwise legitimate purposes if one
purpose of the arrangement is to induce referrals or the other prescribed
activities. The penalties for violations of this law include:

     o    civil monetary penalties;

     o    criminal sanctions;

     o    exclusion from further participation in federally funded health care
          programs (mandatory exclusion in certain cases);

     o    the ability of the Secretary of Health and Human Services to refuse to
          enter into or terminate a provider agreement; and

     o    debarment from participation in other federal programs.

     In 1991, the federal government published regulations that provide
exceptions or "safe harbors" to the Anti-kickback Law. Subsequently, in November
1999, final regulations were issued establishing additional safe harbor
provisions under the Anti-kickback Law, as well as clarifying the original 1991
safe harbor regulation. The failure of an activity to qualify under a safe
harbor provision, while potentially leading to greater regulatory scrutiny, does
not render the activity illegal.

     There are several aspects of our activities to which the Anti-kickback Law
may be relevant. For example, the Anti-kickback Law has been construed to apply
to referral services, where a consumer group, professional society or some other
organization charges a health care provider a fee or other payment in exchange
for referring such health care provider to a prospective patient. The
Anti-kickback Law, and the safe harbor regulations promulgated thereunder, are
unclear as to whether activities such as our activities with respect to our
HealthGrades.com website would be construed as "referral services." Since, under
certain circumstances, hospitals, nursing homes and other health care providers
achieving a five-star rating may pay us a fee in exchange for banner
advertisements on our website and the use of our name and logo in marketing the
health care provider's services, it is possible that we could be deemed to be
engaged in referral services in such a manner so as to implicate the
Anti-kickback Law. Although a referral services safe harbor was adopted in 1991,
we do not believe that our current activities with respect to our
HealthGrades.com website would qualify under the referral services safe harbor.

     Additionally, the Office of Inspector General has stated on a number of
occasions that any compensation arrangement between a health care provider and
another party for the purpose of marketing health care items or services that
are directly or indirectly reimbursable by a federal health care program
potentially implicates the Anti-kickback Law, irrespective of the methodology
used to compensate the party providing the marketing services. Generally, the
Office of Inspector General takes the position that marketing services fall
under the category of a "recommendation" of a good, facility, item or service
reimbursable under the federal health care program. To the extent that certain
health care providers pay a flat fee payment to us in exchange for placing a
banner ad on our websites or in exchange for other activities by us which could
be construed as marketing services, the Anti-kickback Law may be implicated. In
addressing this issue, the Office of Inspector General has identified several
characteristics of arrangements among health care providers and sales agents
that appear to be associated with an increased potential for program abuse.
These suspect characteristics include:

     o    compensation to the sales agent based on a percentage of sales;



                                       11
<PAGE>

     o    direct billing of a health care program by the health care provider
          for the item or services sold by the sales agent;

     o    direct contact between a sales agent and physicians in a position to
          order items or services;

     o    direct contact between the sales agent and federal health care program
          beneficiaries;

     o    the use of sales agents who are health care professionals or persons
          in a similar position to exert undue influence over purchases or
          patients; or

     o    the marketing of items or services that are separately reimbursable by
          a Federal health care program (whether on the basis of charges or
          costs).

     We do not believe that our activities with respect to certain health care
providers who achieve a five-star rating on the healthgrades.com website involve
any of these suspect characteristics, or other characteristics which the Office
of Inspector General would consider abusive or likely to lead to federal health
care program abuse. Fees paid to us by health care providers are not in any
manner determined based on the amount of revenue or other financial benefit
generated by our activities, we are not marketing specific services or items
with respect to hospitals or other health care providers, and our
healthgrades.com website is not directed to physicians, other health care
professionals or federal health care program beneficiaries.

     Finally, we provide, on a limited basis, certain management services to a
physician practice.

     In at least one advisory opinion, the Inspector General of the Department
of Health and Human Services has stated that under certain circumstances,
payments by a physician practice to a medical practice management company in
exchange for certain marketing services, billing and collection services, and
managed care contract negotiation services could constitute illegal remuneration
as defined in the Anti-kickback Law, especially where the fee paid by the
medical practice to the management company is based on a percentage of medical
practice revenue. We do not believe that the limited management services we
provide to a physician practice is the types of services to which this advisory
opinion is directed, and our fees under our management services arrangements are
no longer based on a percentage of medical practice revenue.

     We do not provide billing and collection services, marketing services or
managed care-contracting services under any of our current physician practice
management operations. Although our healthgrades.com activities (to the extent
they may be deemed "referral services") and general marketing activities do not
qualify for protection under the safe harbor regulations, we believe that our
activities are not the type of activities and arrangements the Anti-kickback Law
prohibits. We are not aware of any legal challenge or proceeding pending against
similar activities under the Anti-kickback Law. A determination that we violated
the Anti-kickback Law would be detrimental to us.

     State Anti-kickback Laws. Many states have laws that prohibit payment of
kickbacks in return for the referral of patients. Some of these laws apply only
to services reimbursable under state Medicaid programs. A number of these laws
apply to all health care services in the state, regardless of the source of
payment for the service. Based on court and administrative interpretation of the
federal Anti-kickback Law, we believe that most of these laws prohibit payments
to referral sources where a purpose for the payment is for a referral. Most
state anti-kickback laws have received limited judicial and regulatory
interpretation. Therefore, it is possible that our activities may be found not
to comply with these laws. Noncompliance with such laws could subject us to
penalties and sanctions.

     Fee-Splitting Laws. Most states prohibit a physician from splitting fees
with a referral source. Some states have a broader prohibition against any
splitting of a physician's fees, regardless of whether the other party is a
referral source. In most states, we believe that a management fee payment made
by a physician to a management company would not be considered fee-spitting if
the payment constitutes reasonable payment for services rendered to the
physician or physician's medical practice.

     We are paid by physicians (and their medical practices) for whom we provide
management services. Although we believe that our management service agreements
comply with applicable state laws relating to fee-splitting, a state authority
may nevertheless determine that we and the practices that contract with us are
violating the state's fee-splitting laws. Such a determination could render any
of our service agreements in such state unenforceable or subject to modification
in a manner that is adverse to us.

     Health Care Reform. In recent years, a variety of legislative proposals
designed to change access to and payment for health care services in the United
States have been introduced. Although no major health reform proposals have been
passed by Congress to date, such legislation has been and may be considered by
Congress and state legislatures. We can make no prediction as to whether health



                                       12
<PAGE>

care reform legislation or similar legislation will be enacted or, if enacted
its effect on us.

POTENTIAL GOVERNMENT REGULATION OF THE INTERNET

     Any new law or regulation pertaining to the Internet, or the application or
interpretation of existing laws, could decrease demand for our services,
increase our cost of doing business or otherwise cause our business to suffer.

     Laws and regulations may be adopted in the future that address
Internet-related issues, including online content, user privacy, pricing and
quality of products and services. This legislation could increase our cost of
doing business and negatively affect our business. Moreover, it may take years
to determine the extent to which existing laws governing issues like property
ownership, libel, negligence and personal privacy are applicable to the
Internet. Currently, U.S. privacy law consists of disparate state and federal
statutes regulating specific industries that collect personal data. Most of them
predate and therefore do not specifically address online activities. In
addition, a number of comprehensive legislative and regulatory privacy proposals
are now under consideration by federal, state and local governments in the
United States.

INTELLECTUAL PROPERTY

     We regard the protection of our intellectual property rights to be
important. We rely on a combination of trademark and trade secret restrictions
and contractual provisions to protect our intellectual property rights. We
require selected employees to enter into confidentiality and invention
assignment agreements as well as non-competition agreements. The contractual
provisions and other steps we have taken to protect our intellectual property
may not prevent misappropriation of our technology or deter third parties from
developing similar or competing technologies. We have obtained federally
registered trademarks for HealthGrades and The Healthcare Ratings Experts.

     We are seeking federal registration of our trademark for The Healthcare
Quality Experts. We also have a patent pending on our health care rating system
and methods. We cannot assure that this patent will be issued, or that, even it
issued, this patent will adequately protect our technology or processes or
otherwise result in commercial advantage to us.

     There is also significant uncertainty regarding the applicability to the
Internet of existing laws regarding matters such as property ownership and other
intellectual property rights. The vast majority of these laws were adopted prior
to the advent of the Internet and, as a result, do not contemplate or address
the unique issues of the Internet and related technologies.

     For further information, see "Risk Factors - Our propriety rights may not
be fully protected, and we may be subject to intellectual property infringement
claims by others."

EMPLOYEES

     As of March 31, 2002, we had 41 employees, most of whom were located at our
corporate offices.



                                       13
<PAGE>

                                  RISK FACTORS

                          Risks Related to Our Business

OUR HEALTH CARE INFORMATION BUSINESS HAS NOT BEEN PROFITABLE AND MAY NEVER
BECOME PROFITABLE.

     We began developing our health care information business in 1998. For the
year ended December 31, 2001, net losses before income taxes for our health care
information business were $2,948,051. During 2001, we completed certain expense
reduction measures that included a reduction in our employee base. Despite our
efforts to reduce expenditures, we may continue to incur operating losses as we
fund operating and capital expenditures to expand our health care information
database and website, market our health care information, upgrade our technology
and continue to build our brand. Our business model assumes that consumers will
be attracted to and use the health care ratings and profile information and
related content available on our website, which will, in turn, enable us to
license access to the information on our website to hospitals, other providers
and other Internet sites. In addition, our business model assumes that
employers, health plans and other potential customers will seek our health care
information to help increase the quality and reduce the cost of health care. Our
business model is not yet proven, and we cannot assure you that we will ever
achieve or sustain profitability or that our operating losses will not increase
in the future.

SINCE WE HAVE CHANGED OUR PRINCIPAL BUSINESS FOCUS, WE ARE ESSENTIALLY A NEW
COMPANY AND ACCORDINGLY ARE SUBJECT TO THOSE RISKS ASSOCIATED WITH A NEW
COMPANY.

     We were founded in 1995, but have only been engaged in the health care
information business since 1998 and have continued to modify the scope and focus
of our business. As a result, our company is essentially a new venture.
Therefore, we do not have a significant operating history upon which you can
evaluate us or our prospects, and you should not rely upon our past performance
to predict our future performance. In making the transition from a physician
practice management company to a health care ratings services company, we
substantially changed our business operations and management focus. We are also
facing new challenges, including a lack of meaningful historical financial data
upon which to plan future budgets, a radically different competitive environment
and other risks described below. We cannot assure you that our new model will be
successful.

WE MAY NEED ADDITIONAL CAPITAL TO CONTINUE OUR BUSINESS IF WE DO NOT GENERATE
SUFFICIENT REVENUES OVER THE NEXT TWELVE MONTHS.

     We believe that we have sufficient resources to meet our requirements for
at least the next 12 months. However, if our revenues fall short of our
expectations or our expenses exceed our expectations, we may need to raise
additional capital through public or private debt or equity financing. We may
not be able to secure sufficient funds on terms acceptable to us. If equity
securities are issued to raise funds, our stockholders' equity may be diluted.
If additional funds are raised through debt financing, we may be subject to
significant restrictions.

OUR BUSINESS WILL SUFFER IF WE ARE NOT ABLE TO OBTAIN RELIABLE DATA AS A BASIS
FOR OUR HEALTH CARE INFORMATION.

     To provide our health care information, we must be able to receive
comprehensive, reliable data. We currently obtain this data from a number of
public and private sources. Our business could suffer if some of these sources
were to cease to make such information available and suitable alternative
sources are not identified on a timely basis. Moreover, our ability to attract
and retain customer interest is dependent on the reliability of the information
that we purchase. If our information is inaccurate or otherwise erroneous, our
reputation and consumer following could be damaged. In the past, we have had
disputes with two providers of information who sought to terminate our
arrangements based on allegations, which we deny, that our use of the
information violated the terms of our agreements with the providers. We have
located alternate sources of information or modified the scope of information
provided in response to these disputes. Nevertheless, our failure to obtain
suitable information, if needed to use in place of information provided by a
source that determines to stop providing information, could hurt our business.

OUR PLAN FOR REVENUE GENERATION MAY NOT BE VIABLE.

     Our business plan contemplates that we will generate revenues from our
health care information business principally by:

     o    licensing our data, healthgrades.com name and trademarks to
          highly-rated hospitals and other health care providers for use in
          connection with their marketing programs;



                                       14
<PAGE>

     o    advising lower rated hospitals on improving their quality of care;

     o    providing employers, health plans and others with information for use
          by employees or members in selecting providers and facilities
          available to employees or members;

     o    licensing access to our ratings content through linking agreements to
          other companies that operate Internet "yellow pages" or health care
          sites; and

     o    providing professionals and consumers with provider quality reports;

     However, we do not yet know whether we will be able to generate significant
revenues from these activities. Specifically, we have not yet generated
substantial revenues from employers or health plans, or our quality reports. In
addition, we do not know whether employers or health plans will view our rating
and profile information as useful in connection with their operations or whether
our quality reports will be accepted by their target markets (for example,
professionals and/or consumers). Moreover, while we have licensed access to our
healthgrades.com content to several health care information websites, these
contracts generally have a relatively short term or can be terminated on short
notice and have generated only limited revenues. Many of the Internet health
care companies that license our data are recently formed entities that do not
have a history of financial viability and may not have the resources to continue
licensing arrangements with us, even if they view such arrangements to be
helpful. In addition, while we have entered into licensing agreements with a
number of hospitals, the use of Internet information in conjunction with
hospital and other provider marketing campaigns is a new, unproven concept. We
may not be able to expand or retain acceptance by hospitals and other providers.

WE MAY BE SUED FOR INFORMATION RETRIEVED FROM OUR WEBSITES OR OTHERWISE PROVIDED
TO EMPLOYERS AND OTHERS.

     We may be subjected to claims for defamation, negligence, copyright or
trademark infringement, personal injury or other legal theories relating to the
information we publish on our websites or otherwise provide to customers. These
types of claims have been brought, sometimes successfully, against online
services as well as print publications in the past. We have received threats
from some providers that they will assert defamation and other claims in
connection with the information posted on our healthgrades.com website. One
provider has brought a claim in Washington state, and also alleges that our use
of our rating system constitutes a business practice that violates state law and
may also be a basis for product disparagement, negligent misrepresentation and
other claims. That case has been dismissed for lack of personal jurisdiction,
however, that ruling is on appeal. We previously filed a complaint against the
provider seeking a judgment that, among other things, the provider's claims were
barred by the user agreement, that we did not violate state or federal law as a
result of our rating of the provider and our ratings are protected by the free
speech protections of the United States Constitution and relevant state
constitutions. The case was dismissed as the court declined to enforce our user
agreement which allows us to bring suit in Colorado. That ruling is also under
appeal.

     Patients who file lawsuits against providers often name as defendants all
persons or companies with any nexus to the providers. As a result, patients may
file lawsuits against us based on treatment provided by hospitals or other
facilities that are highly rated by us, or doctors who are identified on our
website or through other information that we provide. In addition, a court or
government agency may take the position that our delivery of health information
directly, or information delivered by a third-party website that a consumer
accesses through our website, exposes us to malpractice or other personal injury
liability for wrongful delivery of health care services or erroneous health
information. The amount of insurance we maintain with insurance carriers may not
be sufficient to cover all of the losses we might incur from these claims and
legal actions. In addition, insurance for some risks is difficult, impossible or
too costly to obtain, and as a result, we may not be able to purchase insurance
for some types of risks.

IF WE DO NOT ESTABLISH, MAINTAIN AND STRENGTHEN OUR BRAND, OUR ABILITY TO EXPAND
OUR BUSINESS WILL BE IMPAIRED.

     To expand our audience of users and increase our online traffic, and
increase interest in our other health care ratings services, we must establish,
maintain and strengthen our brand. For us to be successful in establishing our
brand, consumers must perceive us as a trusted source of health care
information; hospitals, other providers and other health care information
websites must perceive us as an effective marketing and sales channel for their
services and products; and employees and health plans must perceive us as a
source of valuable information that can be used to enhance the quality and
cost-effectiveness of health care. We may be required to increase substantially
our marketing budget in our efforts to establish brand recognition and brand
loyalty. Our business will suffer if our marketing efforts are not productive or
if we cannot strengthen our brands.



                                       15
<PAGE>

OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO ATTRACT, RETAIN AND MOTIVATE HIGHLY
SKILLED EMPLOYEES.

     We have recently reduced the size of our employee base in order to lower
expenses. Nevertheless, our ability to execute our business plan and be
successful depends upon our ability to attract, retain and motivate highly
skilled employees when needed. We rely on the continued services of our senior
management and other personnel. If we are able to expand our business, we will
need to hire additional personnel to support our operations. We may be unable to
retain our key employees or attract or retain other highly qualified employees
in the future. If we do not succeed in attracting new personnel as needed and
retaining and motivating our current personnel, our business will suffer.

WE MAY EXPERIENCE SYSTEM FAILURES THAT COULD INTERRUPT OUR SERVICES.

     The success of our healthgrades.com website and activities related to the
website will depend on the capacity, reliability and security of our network
infrastructure. We rely on telephone communication providers to provide the
external telecommunications infrastructure necessary for Internet
communications. We will also increasingly depend on providers of online content
and services for some of the content and applications that we make available
through healthgrades.com. Any significant interruptions in our services or an
increase in response time could result in the loss of potential or existing
users or licensees. Although we maintain insurance for our business, we cannot
guarantee that our insurance will be adequate to compensate us for losses that
may occur or to provide for costs associated with business interruptions.

     We must be able to operate our website 24 hours a day, 7 days a week,
without material interruption. To operate without interruption, we and our
content providers must guard against:

     o    damage from fire, power loss and other natural disasters;

     o    communications failures;

     o    software and hardware errors, failures or crashes;

     o    security breaches, computer viruses and similar disruptive problems;
          and

     o    other potential interruptions.

     Our website may be required to accommodate a high volume of traffic and
deliver frequently updated information. Our users may experience slower response
times or system failures due to increased traffic on our website or for a
variety of other reasons. We could experience disruptions or interruptions in
service due to the failure or delay in the transmission or receipt of this
information. Any significant interruption of our operations could damage our
business.

OUR PROPRIETARY RIGHTS MAY NOT BE FULLY PROTECTED, AND WE MAY BE SUBJECT TO
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS BY OTHERS.

     Our failure to adequately protect our intellectual property rights could
harm our business by making it easier for our competitors to duplicate our
services. We have two trademarks that have been registered with the U.S. Patent
and Trademark office and others for which we are seeking registration. We cannot
assure that registrations will be forthcoming for our pending applications. We
also have a patent pending on our hospital rating system and methodology, but we
can give no assurance that the patent will be issued. In addition, we require
some of our employees to enter into confidentiality and invention assignment
agreements and, in more limited cases, non-competition agreements. Nevertheless,
our efforts to establish and protect our proprietary rights may be inadequate to
prevent imitation of our services by others or may be subject to challenge by
others. Furthermore, our ability to protect some of our proprietary rights is
uncertain since legal standards relating to the validity, enforceability and
scope of intellectual property rights in Internet related industries are
uncertain and are still evolving.

     In addition to the risk of failing to adequately protect our proprietary
rights, there is a risk that we may become subject to a claim that we infringe
upon the proprietary rights of others. Although we do not believe that we are
infringing upon the rights of others, third parties may claim that we are doing
so. The possibility of inadvertently infringing upon the proprietary rights of
another is increased



                                       16
<PAGE>


for businesses such as ours because there is significant uncertainty regarding
the applicability to the Internet of existing laws regarding matters such as,
copyrights and other intellectual property rights. A claim of intellectual
property infringement may cause us to incur significant expenses in defending
against the claim. If we are not successful in defending against an infringement
claim, we could be liable for substantial damages or may be prevented from
offering some aspects of our services. We may be required to make royalty
payments, which could be substantial, to a party claiming that we have infringed
their rights. These events could damage our business.

WE MAY LOSE BUSINESS IF WE ARE UNABLE TO KEEP UP WITH RAPID TECHNOLOGICAL OR
OTHER CHANGES.

     If we are unable to keep up with changing technology and other factors
related to our market, we may be unable to attract and retain users, customers
and licensees, which would reduce or limit our revenues. The markets in which we
compete are characterized by rapidly changing technology, evolving technological
standards in the industry, frequent new service and product announcements and
changing consumer demand. Our future success will depend on our ability to adapt
to these changes, and to continuously improve the content, features and
reliability of our services in response to competitive service and product
offerings and the evolving demands of the marketplace. In addition, the
widespread adoption of new Internet networking or telecommunications
technologies or other technological changes could require us to incur
substantial expenditures to modify or adapt our website or infrastructure, which
might negatively affect our ability to become or remain profitable.

OUR BUSINESS WILL SUFFER IF WE ARE NOT ABLE TO COMPETE SUCCESSFULLY.

     The market for health care information is new, rapidly evolving and
competitive. We expect competition to increase significantly, and our business
will be adversely affected if we are unable to compete successfully. We
currently compete, or potentially compete, with many providers of health care
information services and products, both online and through traditional means. We
compete, directly and indirectly, for users, consumers and licensees principally
with:

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

     o    healthcare consulting companies;

     o    companies or organizations providing or maintaining online health care
          information;

     o    vendors of health care information, products and services distributed
          through other means, including direct sales, mail and fax messaging.

     o    companies and organizations providing or maintaining general purpose
          consumer online services that provide access to health care content
          and services;

     o    companies and organizations providing or maintaining public sector and
          non-profit websites that provide health care information and services
          without advertising or commercial sponsorships;

     o    companies and organizations providing or maintaining web search and
          retrieval services and other high-traffic websites; and

     o    publishers and distributors of traditional media, some of which have
          established or may establish websites.

Some of these competitors are larger, have greater resources and have more
experience in providing health care information than us.

RISKS RELATED TO HEALTH CARE INFORMATION AND THE INTERNET

HEALTH CARE REFORMS AND THE COST OF REGULATORY COMPLIANCE COULD NEGATIVELY
AFFECT OUR BUSINESS.

     The health care industry is heavily regulated. Various laws, regulations
and guidelines promulgated by government, industry and professional bodies
affect, among other matters, the provision, licensing, labeling, marketing,
promotion and reimbursement of health care services and products. Our failure or
the failure of our subscribers, licensees or customers to comply with any
applicable regulatory requirements or industry guidelines could:



                                       17
<PAGE>

     o    result in limitation or prohibition of business activities;

     o    subject us or licensees or customers to adverse publicity; or

     o    increase the costs of regulatory compliance or subject us or our
          licensees or customers to monetary fines or other penalties.

     A federal law commonly known as the Medicare/Medicaid Anti-kickback Law,
and several similar state laws, prohibit payments that are intended to induce
physicians or others either to refer patients or to acquire or arrange for or
recommend the acquisition of health care products or services. Another federal
law, commonly known as the "Stark" law, prohibits physicians from referring
Medicare and Medicaid patients for designated health services to entities with
which they have a financial relationship, unless that relationship qualifies for
an explicit exception to the referral ban. Some of these laws have been applied
to payments by physicians for marketing and referral services and could
constrain our relationships, including financial and marketing relationships
with licensees such as hospitals. It is possible that additional or changed
laws, regulations or guidelines could be adopted in the future.

THE INTERNET IS SUBJECT TO MANY LEGAL UNCERTAINTIES AND POTENTIAL GOVERNMENT
REGULATIONS THAT MAY DECREASE USAGE OF OUR WEBSITE, INCREASE OUR COST OF DOING
BUSINESS OR OTHERWISE HAVE A DAMAGING EFFECT ON OUR BUSINESS.

     Any new law or regulation pertaining to the Internet, or the application or
interpretation of existing laws, could decrease usage for our website, increase
our cost of doing business or otherwise cause our business to suffer.

     Laws and regulations may be adopted in the future that address
Internet-related issues, including online content, user privacy, pricing and
quality of products and services. This legislation could increase our cost of
doing business and negatively affect our business. Moreover, it may take years
to determine the extent to which existing laws governing issues like property
ownership, libel, negligence and personal privacy are applicable to the
Internet. Currently, U.S. privacy law consists of disparate state and federal
statutes regulating specific industries that collect personal data. Most of them
predate and therefore do not specifically address online activities. In
addition, a number of comprehensive legislative and regulatory privacy proposals
are now under consideration by federal, state and local governments in the
United States.

OUR BUSINESS COULD BE IMPAIRED BY STATE AND FEDERAL LAWS DESIGNED TO PROTECT
INDIVIDUAL HEALTH INFORMATION.

     If we fail to comply with current or future laws or regulations governing
the collection, dissemination, use and confidentiality of patient health
information, our business could suffer.

     Consumers sometimes enter private information about themselves or their
family members when using our services. Also, our systems record use patterns
when consumers access our databases that may reveal health-related information
or other private information about the user. In addition, information regarding
employee usage of health care providers and facilities can also be compiled by
our systems in connection with services we offer to employers and other health
plans. Numerous federal and state laws and regulations govern collection,
dissemination, use and confidentiality of patient-identifiable health
information, including:

     o    state privacy and confidentiality laws;

     o    state laws regulating health care professionals, such as physicians,
          pharmacists and nurse practitioners;

     o    Medicaid laws;

     o    the Health Insurance Portability and Accountability Act of 1996 and
          related rules proposed by the Health Care Financing Administration;
          and

     o    Health Care Financing Administration standards for Internet
          transmission of health data.

     Congress has been considering proposed legislation that would establish a
new federal standard for protection and use of health information. While we are
not gathering patient health information at this time, other third-party
websites that consumers access



                                       18
<PAGE>

through our website and employees, health plans and other customers may not
maintain systems to safeguard any health information they may be collecting. In
some cases, we may place our content on computers that are under the physical
control of others, which may increase the risk of an inappropriate disclosure of
information. For example, we contract out the hosting of our website to a third
party. In addition, future laws or changes in current laws may necessitate
costly adaptations to our systems.

ONLINE SECURITY BREACHES COULD HARM OUR BUSINESS.

     Our security measures may not prevent security breaches. Substantial or
ongoing security breaches on our system or other Internet-based systems could
reduce user confidence in our website, causing reduced usage that adversely
affects our business. The secure transmission of confidential information over
the Internet is essential to maintain confidence in our websites. We believe
that consumers generally are concerned with security and privacy on the
Internet, and any publicized security problems could inhibit the growth of the
Internet and, therefore, our provision of health care information on the
Internet.

     We will need to incur significant expense to protect and remedy against
security breaches when we identify a significant business risk. Currently, we do
not store sensitive information, like patient information or credit card
information, on our websites. If we launch services that require us to gather
sensitive information, our security expenditures will increase significantly.

     A party that is able to circumvent our security systems could steal
proprietary information or cause interruptions in our operations. Security
breaches could also damage our reputation and expose us to a risk of loss or
litigation and possible liability. Our insurance policies may not be adequate to
reimburse us for losses caused by security breaches. We also face risks
associated with security breaches affecting third parties conducting business
over the Internet or customers and others who license our contract.

OTHER RISKS

OUR OFFICERS AND DIRECTORS MAINTAIN SIGNIFICANT CONTROL OF HEALTH GRADES, INC.

     Our current officers and directors and entities with which they are
affiliated beneficially own approximately 37.6% of our outstanding common stock.
In addition, Chancellor V, L.P. holds 34.7% of our outstanding common stock. If
our officers, directors and Chancellor V, L.P. act together, they will be able
to control the management and affairs of Health Grades, Inc. and will have the
ability to control all matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions. This
concentration of ownership may have the effect of delaying, deferring or
preventing an acquisition of us and may adversely affect the market price for
our common stock.

OUR CERTIFICATE OF INCORPORATION AND BYLAWS INCLUDE ANTI-TAKEOVER PROVISIONS
THAT MAY DETER OR PREVENT A TAKEOVER ATTEMPT.

     Some provisions of our certificate of incorporation and bylaws and
provisions of Delaware law may deter or prevent a takeover attempt, including an
attempt that might result in a premium over the market price for our common
stock. Our certificate of incorporation requires the vote of 66 2/3% of the
outstanding voting securities in order to effect certain actions, including a
sale of substantially all of our assets, certain mergers and consolidations and
our dissolution or liquidation, unless these actions have been approved by a
majority of the directors. Our certificate of incorporation also authorizes our
Board of Directors to issue up to 2,000,000 shares of preferred stock having
such rights as may be designated by our Board of Directors, without stockholder
approval. Our bylaws provide that stockholders must follow an advance
notification procedure for certain nominations of candidates for the Board of
Directors and for certain other stockholder business to be conducted at a
stockholders meeting. The General Corporation Law of Delaware restricts certain
business combinations with interested stockholders upon their acquisition of 15%
or more of our common stock.

     All of these provisions could make it more difficult for a third party to
acquire, or could discourage a third party from attempting to acquire, control
of us.



                                       19
<PAGE>

WE HAVE NO INTENTION TO PAY DIVIDENDS ON OUR COMMON STOCK.

     We have never declared or paid any cash dividends on our common stock. We
currently intend to retain all future earnings to finance the expansion of our
business.

Item 2. Properties

     We have a seven-year lease for our approximately 12,200 sq. foot
headquarters facility in Lakewood, Colorado, which expires on February 15, 2003.
Our annual lease payments for this facility is approximately $233,000.

Item 3. Legal Proceedings

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Executive Officers of the Registrant

The following table sets forth certain information concerning the executive
officers of the Company:

<Table>
<Caption>
                    NAME                         AGE                    POSITION
<S>                                              <C>  <C>
Kerry R. Hicks..........................         42   President, Chief Executive Officer
David G. Hicks..........................         43   Executive Vice President-Information Technology
G. Allen Dodge..........................         34   Senior Vice President-Finance, CFO & Treasurer
Peter A. Fatianow.......................         38   Senior Vice President-Corporate Services
Sarah Loughran..........................         37   Senior Vice President-Provider Services
Michael D. Phillips.....................         44   Senior Vice President-Provider Sales
</Table>

KERRY R. HICKS, one of our founders, has served as our Chief Executive Officer
since our inception in 1995. He also served as our President from our inception
until November 1999 and since March 2002. From 1985 to 1995, he served as Senior
Vice President of LBA Healthcare Management.

DAVID G. HICKS has served as our Executive Vice President - Information
Technology since November 1999. He was Senior Vice President of Information
Technology from May 1999 to November 1999 and Vice President of Management
Information Systems from March 1996 until May 1999. From 1994 to March 1996, Mr.
Hicks worked as Manager of Information Technology for the Association of
Operating Room Nurses. From 1992 to 1994, Mr. Hicks worked as Manager of
Financial Systems for Coors Brewing Company.

G. ALLEN DODGE, has served as Senior Vice President - Finance and Chief
Financial Officer since May 2001. He was Vice President - Finance/Controller
from March 2000 to May 2001 and Corporate Controller from September 1997 to
March 2000. From 1994 to September 1997 Mr. Dodge held various positions with
Ernst & Young LLP in Denver, Colorado. Mr. Dodge is a Certified Public
Accountant.

PETER A. FATIANOW has served as our Senior Vice President - Business Development
since March 2000. He has served in several capacities for our subsidiary, HG.com
and its successor Healthcare Ratings, Inc. since July 1998, most recently as
Senior Vice President - Operations. He was previously our Vice President of
Business Development from our inception until July 1998. From July 1998 until
February 1999, he was a partner of Consolidation Capital Partners LLC, which
provided consulting services to us in connection with our restructuring
transaction with our former affiliated practices. From July 1994 to February
1996, Mr. Fatianow worked as an Associate Vice President in Healthcare Corporate
Finance with Morgan Keegan & Company, Inc.

SARAH LOUGHRAN has served as our Senior Vice President - Provider Services since
December 2001 and as Senior Vice President - Content of our subsidiary, HG.com
and its successor, Healthcare Ratings, Inc. since 1998. She was our Senior Vice
President - Content from March 2000 to December 2001. From 1996 to 1997, Ms.
Loughran worked as Assistant Vice President for Product Development for HCIA,
where she developed a number of information application products. From 1994 to
1996, Ms. Loughran served as a Senior Consultant at LBA Healthcare Management.



                                       20
<PAGE>

MICHAEL D. PHILLIPS has served as Senior Vice President - Provider Sales since
December 2001. He was previously Vice President of Provider Sales since April
2000. Prior to joining Health Grades, Mr. Phillips was Vice President of Sales
at HCIA-Sachs and LBA Healthcare Management as well as National Sales Manager
for HPI Health Care Services.

Kerry R. Hicks and David G. Hicks are brothers.

                                     PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters


The following table sets forth the high and low sales prices for our Common
Stock for the quarters indicated as reported on the Nasdaq Small Cap Market
through the first quarter of 2001. Subsequent to the first quarter of 2001, the
high and low sales prices for our Common Stock for the quarters indicated are as
reported by the OTC Bulletin Board (OTCBB).

<Table>
<Caption>
                                                              HIGH         LOW
                                                            --------     --------
<S>                                                         <C>          <C>
Year Ended December 31, 2000
    First Quarter                                           $3  1/2      $2
    Second Quarter                                           2  9/16        15/16
    Third Quarter                                            1 29/32         3/4
    Fourth Quarter                                           1  1/4          7/32

Year Ended December 31, 2001
    First Quarter                                           $  13/16     $   7/32
    Second Quarter                                              5/16         1/10
    Third Quarter                                               7/32         5/64
    Fourth Quarter                                              1/10         1/24
</Table>

We have never paid or declared any cash dividends and do not anticipate paying
any cash dividends in the foreseeable future. We currently intend to retain any
future earnings for use in our business.

     Effective April 16, 2001, we reached an agreement with Chancellor V., L.P.
("Chancellor V") and Essex Woodlands Health Ventures Fund IV, L.P. ("Essex"),
regarding a commitment (the "Commitment") to provide us with up to $2.0 million
of equity financing. Chancellor V and Essex were the two principal investors in
the Equity Financing described above. In consideration for the commitment, we
issued to Chancellor and Essex warrants (the "Commitment Warrants") to purchase
an aggregate of 500,000 shares of our common stock at an exercise price per
share of $0.26, which was the closing market price per share of our common stock
as reported by Nasdaq on April 16, 2001. The Commitment Warrants will expire on
April 16, 2007. In addition, we repriced warrants to purchase 100,000 shares of
our common stock that were issued to Chancellor V and Essex in March 2000 to the
same $0.26 per share exercise price.

     Under the terms of the agreement with Chancellor V and Essex, we were
granted the option until December 31, 2001, to sell our common stock to
Chancellor V and Essex at an aggregate purchase price of up to $2.0 million.
Effective October 9, 2001, we exercised our option to receive the entire $2.0
million. Under the terms of the Commitment, in exchange for the $2.0 million, we
issued an aggregate of 13,333,333 shares of our common stock to Chancellor and
Essex. In addition, we issued six-year warrants to purchase 350,000 shares of
our common stock at an exercise price per share of $0.15. The warrants have a
six-year term.

     Under the terms of the Commitment, the price per share for the purchase of
our common stock was equal to the lesser of $0.26 and the closing market price
per share of our common stock on the date that we provided notice to Chancellor
V and Essex that we intended to exercise the option, but in no event less than
$0.15 per share. As the closing market price per share of our common stock was
less than $0.15 per share on the date we provided notice to Chancellor V and
Essex, the common stock was issued to Chancellor V and Essex at $0.15 per share.

     We effected the transaction in reliance on the exemption contained in
Section 4(2) of the Securities Act.

                                       21
<PAGE>

Item 6. Selected Financial Data

Statement of Operations Data

<Table>
<Caption>
                                                         YEAR ENDED     YEAR ENDED     YEAR ENDED     YEAR ENDED     YEAR ENDED
                                                        DECEMBER 31,   DECEMBER 31,   DECEMBER 31,   DECEMBER 31,   DECEMBER 31,
                                                        ------------   ------------   ------------   ------------   ------------
                                                            2001           2000           1999           1998           1997
                                                        ------------   ------------   ------------   ------------   ------------
<S>                                                     <C>            <C>            <C>            <C>            <C>
Revenue:
      Ratings and advisory revenue                      $  3,025,302   $  1,578,979   $    407,577   $         --   $         --
      Physician practice service fees                        551,925      4,249,658     28,948,397     76,649,778     45,966,531
      Other                                                    4,490          9,051      2,229,774      2,531,524      3,689,390
                                                        ------------   ------------   ------------   ------------   ------------
                                                           3,581,717      5,837,688     31,585,748     79,181,302     49,655,921
                                                        ------------   ------------   ------------   ------------   ------------
Costs and expenses:
   Ratings and advisory costs and expenses:
      Production, content and product development          1,064,308      2,085,402      1,217,917             --             --
      Sales and marketing                                  1,331,146      1,572,505      1,853,191             --             --
   Physician practice services costs and expenses:
      Clinic expenses                                             --             --     15,234,416     55,188,411     31,644,618
      Impairment loss on service agreements                       --             --             --     94,582,227             --
      Litigation and other costs                             606,562        812,084      5,309,168      3,564,392             --
      Impairment loss on intangible assets and
         other long-lived assets                                  --             --             --      3,316,651             --
   General and administrative                              8,200,474      8,723,434     10,570,223     14,468,537      7,861,015
                                                        ------------   ------------   ------------   ------------   ------------
      Total costs and expenses                            11,202,490     13,193,425     34,184,915    171,120,218     39,505,633
                                                        ------------   ------------   ------------   ------------   ------------
(Loss) income from operations                             (7,620,773)    (7,355,737)    (2,599,167)   (91,938,916)    10,150,288
Other:
      Gain (loss) on settlement agreements, sale of
         assets, practice disputes and amendment
         and restatement of service agreements               191,915       (699,010)     2,766,284             --             --
      Gain on sale of equity investment                           --             --        127,974      1,240,078             --
      Gain on sale of subsidiary                                  --             --        221,258             --             --
      Interest income                                         90,409        511,657        312,447        187,450        536,180
      Interest expense                                       (28,794)      (471,553)    (2,489,427)    (3,741,089)      (942,144)
                                                        ------------   ------------   ------------   ------------   ------------
(Loss) income before income taxes                         (7,367,243)    (8,014,643)    (1,660,631)   (94,252,477)     9,744,324
Income tax benefit (expense)                                      --        469,897      2,625,561     32,466,391     (3,873,926)
                                                        ------------   ------------   ------------   ------------   ------------

Net (loss) income                                       $ (7,367,243)  $ (7,544,746)  $    964,930   $(61,786,086)  $  5,870,398
                                                        ============   ============   ============   ============   ============
Net (loss) income per common share (basic)              $      (0.30)  $      (0.39)  $       0.07   $      (3.39)  $       0.38
                                                        ============   ============   ============   ============   ============
Weighted average number of common shares
      used in computation (basic)                         24,399,699     19,535,841     14,202,748     18,237,827     15,559,368
                                                        ============   ============   ============   ============   ============


Net (loss) income per common share (diluted)            $      (0.30)  $      (0.39)  $       0.07   $      (3.39)  $       0.37
                                                        ============   ============   ============   ============   ============

Weighted average number of common
      shares and common share equivalents
      used in computation (diluted)                       24,399,699     19,535,841     14,817,732     18,237,827     16,071,153
                                                        ============   ============   ============   ============   ============
</Table>

BALANCE SHEET DATA

<Table>
<Caption>
                            DECEMBER 31, 2001   DECEMBER 31, 2000   DECEMBER 31, 1999   DECEMBER 31, 1998    DECEMBER 31, 1997
                            -----------------   -----------------   -----------------   -----------------    -----------------
<S>                         <C>                 <C>                 <C>                 <C>                  <C>
Working capital (deficit)   $         161,324   $       4,292,698   $       1,383,945   $     (21,457,105)   $      21,924,386
Total assets                        7,747,904          14,371,174          20,392,868          70,179,278          140,301,650
Total long-term debt                       --                  --           8,803,283             680,152           33,885,141
Total short-term debt                      --           1,559,213           7,702,005          53,514,615                   --
</Table>

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations

GENERAL

     We are a healthcare ratings and consulting company. We grade, or provide
consumers with the means to assess and compare the quality or qualifications of,
various types of healthcare providers.

     We offer services to hospitals that are either attempting to build a brand
name reputation based upon quality of care or are working to identify areas to
improve quality. For hospitals that have received high ratings, we offer the
opportunity to license our ratings and trademarks and provide assistance in
their marketing programs. For providers who have not received high ratings, we
offer quality improvement services.



                                       22
<PAGE>

     We provide basic and expanded profile information for a variety of
providers and facilities. This information is made available to consumers,
employers and health plans to assist them in selecting healthcare providers. The
basic profile information is available free of charge on our website,
www.healthgrades.com. For certain providers, we offer healthcare quality
reports. These reports provide more detailed information than what is available
free of charge on the healthgrades.com website. Report pricing and content
varies based upon the type of provider and whether the user is a consumer or a
healthcare professional.

     We provide online integrated healthcare quality solutions for employers,
health plans and other organizations that are looking to license access to our
database of healthcare providers. In addition, we collaborated with The Leapfrog
Group, a consortium of more than 90 Fortune 500 companies and other large
private and public healthcare purchasers, to analyze and report the findings of
Leapfrog's hospital patient safety survey. The Leapfrog Group began a national
effort in November 2000 to reward hospitals for advances in patient safety and
to educate employees, retirees, and families about the importance of hospitals'
efforts in this area. The Leapfrog Group's survey assesses the extent to which
urban, acute care hospitals in select regions of the U.S. currently meet or are
striving to implement three proven patient safety practices. For Leapfrog
enrollees, we developed a Leapfrog Enrollee Assistance Program (LEAP).
HealthGrades' LEAP provides employers, health plans, and other members of The
Leapfrog Group with an online and text solution, including access to essential
hospital-quality information.

     In addition to the services noted above, which constitute our ratings and
advisory business, we also provide limited physician practice management
services to a musculoskeletal practice under a management services agreement
that expires in September 2002.

     Prior to the restructuring transaction described below under "MODIFICATION
OF ARRANGEMENTS AND RESTRUCTURING TRANSACTION", we entered into long-term
service agreements with 21 practices that affiliated with us. When we entered
into the transactions, we also acquired all of the non-medical assets of the
affiliated practices. In exchange, we paid consideration consisting of cash, our
securities or both. Under our service agreements, we received a service fee and
we provided among other things, facilities and management, administrative and
development services to the affiliated practices, and employed most
non-physician personnel of the affiliated practices, in return for specified
service fees. The operating expenses incurred by us included the salaries, wages
and benefits of personnel (other than physician owners and certain technical
medical personnel), supplies, expenses involved in administering the clinical
aspects of the affiliated practices and depreciation and amortization of assets.
In addition to the operating expenses discussed above, we incurred personnel and
administrative expenses in connection with our corporate offices, which provided
management, administrative and development services to the affiliated practices.

MODIFICATION OF ARRANGEMENTS AND RESTRUCTURING TRANSACTION

     During 1998 and 1999, we closed restructuring transactions and/or entered
into settlement agreement with many of our affiliated practices. Under the
restructure agreements, we transferred, with respect to each practice, all of
the accounts receivable relating to the practice; tangible and intangible assets
purchased or acquired by us in respect of the practice, other than those
disposed of in the ordinary course of business, since the date we affiliated
with the practice; all prepaid expenses relating to the practice; all inventory
relating to the practice; and all other assets relating to the practice. The
amount we received, in cash and our common stock, from each practice and its
physician owners for the assets sold to the practice generally equaled the sum
of (1) the book value of the accounts receivable relating to the practice on the
effective date of closing; (2) the book value of all fixed assets and other
capital assets relating to the practice on the effective date of closing; (3)
the book value of all prepaid expenses relating to the practice on the effective
date of closing; (4) the book value of all notes and other receivables the
physician owners of the practice owed to us on the effective date of closing;
and (5) the cash balance of the practice's deposit account on the effective date
of closing, reduced by the book value of the liabilities and obligations
relating to the practice on the effective date of closing.

     In addition, we entered into a management services agreement with each of
the practices and their physician owners to replace the existing service
agreement. As consideration for our agreement to enter into the management
services agreement, the practices and their physician owners paid us an
additional amount of cash, or paid cash and returned shares of our common stock
to us.

     During 1999 and continuing through 2001, we also entered into settlement
agreements with several affiliated practices which terminated the service
agreements with the respective affiliated practices. As of March 31, 2002, we
have one management services arrangement remaining, which expires in September
2002.



                                       23
<PAGE>

ACQUISITION OF MINORITY INTERESTS AND OFFICER NOTES; EQUITY FINANCING

     In June 1999, we entered into an agreement with the former stockholders of
Provider Partnerships, Inc. ("PPI") to resolve certain issues raised by the
former stockholders of PPI relating to the transaction in which we acquired PPI.
At that time, we formed HG.com, Inc. (formerly known as Healthgrades.com, Inc.)
("HG.com") and transferred to HG.com certain assets that were developed by us
into one of our websites (formerly HealthCareReportCards.com, currently
Healthgrades.com) and other related internet products. The remaining
non-internet related assets of PPI were transferred to us, and PPI was
subsequently liquidated. Additionally, one of our employees and Venture5 LLC,
whose members consist of the former PPI stockholders, owned minority interests
in HG.com. We owned the majority interest. In September 1999, we entered into an
agreement with Venture5 under which we agreed to purchase a number of shares of
our majority-owned subsidiary, HG.com, Inc. which would increase our ownership
in HG.com, Inc. to 90%. On December 31, 1999, we paid $4,000,000 to Venture5
(the "Minority Interest Purchase") in full satisfaction of this obligation. We
financed the Minority Interest Purchase by borrowing $3,550,000 from some of our
officers (the "Officers") and issued notes to the officers totaling $3,550,000
(hereafter, the "Officer Notes").

     On March 17, 2000, we closed on an equity financing transaction (the
"Equity Financing") which raised $18 million. Pursuant to the terms of the
Equity Financing, certain investors paid $14.8 million to us in return for
7,400,000 shares of our common stock and five-year warrants to purchase
2,590,000 shares of our common stock at an exercise price of $4.00 per share.
Net proceeds of the Equity Financing, after payment of certain legal and other
financing fees, were approximately $14.4 million. In connection with the Equity
Financing, we also issued an aggregate of 165,000 shares to our bank syndicate
as a financing fee. We also issued a warrant to purchase 150,000 shares of our
common stock to a company that served as a financial advisor to us in connection
with the Equity Financing, at an exercise price of $3.45 per share. In
connection with the Equity Financing, certain of our officers exchanged $3.2
million in notes payable for an aggregate of 1.6 million shares of our common
stock and five-year warrants to purchase 560,000 shares of our common stock at
$4.00 per share. In accordance with the provisions of EITF 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, upon the exchange of the notes payable, we
recorded an expense of $347,200 based upon the estimated fair market value of
the warrants issued to the officers. This expense is included in general and
administrative expenses in our 2000 Consolidated Statement of Operations.

     Effective February 3, 2000, we merged our majority-owned subsidiary,
HG.com, Inc., into a wholly-owned subsidiary, HealthcareRatings, Inc.
(hereafter, the "Merger Transaction"). In order to effect the Merger
Transaction, we gave the minority shareholders of HG.com 800,000 shares of
Company common stock. In connection with the Merger Transaction, we recorded
goodwill in the amount of $1,850,000 based on the fair value of the stock issued
as of the transaction date.

ADDITIONAL FINANCING

     Effective April 16, 2001, we reached an agreement with Chancellor V., L.P.
("Chancellor V") and Essex Woodlands Health Ventures Fund IV, L.P. ("Essex"),
regarding a commitment (the "Commitment") to provide us with up to $2.0 million
of equity financing. Chancellor V and Essex were the two principal investors in
the Equity Financing described above. In consideration for the commitment, we
issued to Chancellor and Essex warrants (the "Commitment Warrants") to purchase
an aggregate of 500,000 shares of our common stock at an exercise price per
share of $0.26, which was the closing market price per share of our common stock
as reported by Nasdaq on April 16, 2001. The Commitment Warrants will expire on
April 16, 2007. In addition, we repriced warrants to purchase 100,000 shares of
our common stock that were issued to Chancellor V and Essex in March 2000 to the
same $0.26 per share exercise price.

     Under the terms of the agreement with Chancellor V and Essex, we were
granted the option until December 31, 2001, to sell our common stock to
Chancellor V and Essex at an aggregate purchase price of up to $2.0 million.
Effective October 9, 2001, we exercised our option to receive the entire $2.0
million. Under the terms of the Commitment, in exchange for the $2.0 million, we
issued an aggregate of 13,333,333 shares of our common stock to Chancellor and
Essex. In addition, we issued six-year warrants to purchase 350,000 shares of
our common stock at an exercise price per share of $0.15. The warrants have a
six-year term.

     Under the terms of the Commitment, the price per share for the purchase of
our common stock was equal to the lesser of $0.26 and the closing market price
per share of our common stock on the date that we provided notice to Chancellor
V and Essex that we intended to exercise the option, but in no event less than
$0.15 per share. As the closing market price per share of our common stock was
less than $0.15 per share on the date we provided notice to Chancellor V and
Essex, the common stock was issued to Chancellor V and Essex at $0.15 per share.



                                       24
<PAGE>

CRITICAL ACCOUNTING POLICIES

     In accordance with the Securities and Exchange Commission financial
reporting release FR-60, Cautionary Advice Regarding Disclosure About Critical
Accounting Policies, we performed an analysis of our financial statements to
identify our Critical Accounting Policies. FR-60 defines Critical Accounting
Policies as those most important to the financial statement presentation and
that require the most difficult, subjective, complex judgments. As facts,
circumstances and financial position are subject to change at each reporting
period, we will review our Critical Accounting Policies on a quarterly basis to
determine which policies should be included. For the 2001 year, we have
identified revenue recognition (with respect to our ratings and advisory
revenue) and goodwill as our two Critical Accounting Policies.

Revenue Recognition - Ratings and Advisory Revenue

     We currently derive our ratings and advisory revenue principally from
annual fees from hospitals that participate in our Strategic Quality Initiative
(SQI) program. The SQI program provides business development tools to hospitals
that are highly rated on our website. Under our SQI program, we license the
Health Grades name and our "report card" ratings to hospitals. The license may
be in a single area (for example, Cardiac) or multiple areas (for example,
Cardiac, Neurosciences and Orthopaedics.) We also assist hospitals in promoting
their ratings and measuring the success of their efforts utilizing our team of
in-house healthcare consultants. Another key feature of this program is a
detailed comparison of the data underlying a hospital's rating to local and
national benchmarks.

     We recognize revenue related to these arrangements in a straight-line
manner over the term of the agreement (typically one year). We follow this
method because the primary deliverable under the agreement is the license to
utilize our rating over the contract term. In addition, consulting services are
performed as requested by the client as needed over the term of the agreement.
As we typically receive a non-refundable payment for the contract term upon
execution of the agreement, we record the cash payment as deferred revenue that
is then amortized to revenue over the contract term.

     Currently, the EITF is working to reach a final consensus regarding EITF
00-21, Accounting for Revenue Arrangements with Multiple Deliverables, which
addresses how to account for multiple-deliverable revenue arrangements and
focuses on when a revenue arrangement should be separated into different
revenue-generating deliverables or "units of accounting" and if so, how the
arrangement considerations should be allocated to the different deliverables or
units of accounting. We continue to follow the status of the EITF and, based on
the tentative conclusions reached by the EITF, do not believe the final
consensus will have an impact on how we currently account for our SQI
agreements.

Goodwill

     We evaluate our goodwill for impairment whenever indicators of impairment
exist. Because we experienced substantial operating losses in 2001, we performed
an analysis of future undiscounted cash flows to determine if an impairment of
goodwill existed. As total estimated future undiscounted cash flows were in
excess of the net $4.2 million in recorded goodwill we determined that no
impairment was present. We estimated total future undiscounted cash flows based
upon current estimates of future operating results over the remaining useful
life assigned to goodwill. Total future operating cash flows were examined as
the goodwill relates to the formation of our current ratings business, which is
where we anticipate substantially all of our future operating cash flow.

     In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, goodwill will no longer be amortized but
will be subject to annual impairment tests in accordance with the Statements.

     We will apply the new rules on accounting for goodwill beginning in the
first quarter of 2002. Application of the nonamortization provisions of the
Statement is expected to result in an increase in net income of approximately
$839,000 ($0.03 per share) per year. We are in the process of performing the
first of the required impairment tests of goodwill and will determine what the
effect of these tests will be on our earnings and financial position prior to
the end of the second quarter of 2002.



                                       25
<PAGE>

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000

REVENUE:

Ratings and advisory revenue

Ratings and advisory revenue was approximately $3.0 million for the year ended
December 31, 2001, an increase of approximately $1.4 million or 92% from the
year ended December 31, 2000. During 2001, approximately 74% of our ratings and
advisory revenue was derived from our strategic quality initiative services,
reflecting an increase in the number of clients for our strategic quality
initiative programs. Approximately 17% of our ratings and advisory revenue was
derived from licensing access to our database of healthcare information. As of
December 31, 2001 we had over 100 facilities under agreement for our hospital
services compared to 49 as of December 31, 2000.

Physician practice service fees

Physician practice service fees include services fees and other revenue derived
from our physician practice management business. For the year ended December 31,
2001, physician practice service fees decreased to approximately $550,000 from
$4.2 million for the year ended December 31, 2000. This decrease reflects the
substantial reduction in our physician practice management operations. As of
March 31, 2002, we have one physician practice under contract for limited
management services. This contract will expire in September 2002, at which time
we intend to terminate our physician practice management business.

COSTS AND EXPENSES:

Production, content and product development

Production, content and product development costs were approximately $1.1
million for the year ended December 31, 2001, compared to $2.1 million for the
year ended December 31, 2000. Production, content and product development costs
were higher in 2000 because we significantly expanded our healthgrades.com
website during 2000. Since January 1, 2001, we have enhanced our website by
including report card pages for home health agencies and hospices and adding
directories for naturopathic physicians and birthing centers.

Litigation and other costs

During 2001 we continued to be involved in litigation with certain of our former
affiliated practices. For the year ended December 31, 2001, litigation and other
costs decreased approximately $205,000 to $607,000 from $812,000 for the year
ended December 31, 2000. As of December 31, 2001, we have settled all
outstanding litigation from our physician practice management business.

General and administrative

General and administrative expenses decreased to approximately $8.2 million for
the year ended December 31, 2001, compared to $8.7 million for the year ended
December 31, 2000. This decrease of approximately $500,000 is primarily due to
the fact that in 2001 we focused on reducing certain controllable costs and
personnel in areas that were not directly contributing to our healthcare ratings
business. For example, our employee base was reduced in 2001 from 51 employees
as of December 31, 2000 to 41 employees as of December 31, 2001. For 2000 and
2001, general and administrative expenses included goodwill amortization expense
of $817,000 and $839,000, respectively. FASB Statement No. 142, Goodwill and
Other Intangible Assets ("FAS 142"), is effective beginning January 2002. One of
the effects of the Statement is that we will no longer amortize goodwill
beginning January 2002. See Note 3 to our Consolidated Financial Statements for
further discussion of FAS 142.

Gain (loss) on settlement agreements, sale of assets, practice disputes and
amendment and restatement of service agreements

During the year ended December 31, 2001, we incurred a gain on sale of assets,
practice disputes and amendment and restatement of service agreements, of
approximately $192,000. This gain was the result of the settlement of a lawsuit
related to a note payable by us to a former vendor. Under the terms of the
settlement, the note payable was canceled. The cancellation of the note as well
as the reversal of accrued interest on the note was recorded as a gain.



                                       26
<PAGE>

Interest expense

We incurred interest expense of approximately $90,000 for the year ended
December 31, 2001, compared to interest expense of approximately $512,000 for
the year ended December 31, 2000. This decrease reflects the fact that we repaid
the entire balance of our debt payable to a bank syndicate in March 2001. We
currently have no outstanding debt.

YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999

REVENUE:

Ratings and advisory revenue

Ratings and advisory revenue was $1.6 million for the year ended December 31,
2000, an increase of $1.2 million from the year ended December 31, 1999. This
increase is primarily due to our entry into additional strategic quality
initiative agreements with hospitals and other healthcare providers during 2000.
Ratings and advisory revenue was approximately $408,000 for the year ended
December 31, 1999. During 2000, approximately 60% of our ratings and advisory
revenue was derived from our strategic quality initiative services.
Approximately 31% of our ratings and advisory revenue was derived from licensing
access to our database of healthcare information.

Physician practice services fees

Physician practice service fees include services fees and other revenue derived
from our physician practice management business. For the year ended December 31,
2000, physician practice service fees decreased to approximately $4.2 million
from $28.9 million for the year ended December 31, 1999. This decrease reflects
the substantial reduction in our physician practice management operations. For
the year ended December 31, 2000, physician practice service fees includes a
non-recurring payment of approximately $2.5 million related to the termination
of management services agreements with three of our affiliated practices.

COSTS AND EXPENSES:

General and administrative expenses

General and administrative expenses decreased to approximately $8.7 million for
the year ended December 31, 2000, compared to $10.6 million for the year ended
December 31, 1999. This decrease of approximately $1.9 million is primarily due
to the reduction in employees during the latter part of 1999 as a result of the
substantial reduction in our physician practice management operations.

Production, content and product development costs

Production, content and product development costs were approximately $2.1
million for the year ended December 31, 2000, compared to $1.2 million for the
year ended December 31, 1999. The increase from 1999 is primarily due to the
expansion of the healthgrades.com website during the first part of 2000. Since
January 1, 2000, we have enhanced our website by including report card pages for
home health agencies and hospices and adding directories for naturopathic
physicians and birthing centers. Additionally, through an agreement with
GeoAccess, we have enhanced our physician data.

Clinic expenses

Previously, under our long-term service agreements with physician practices, we
provided, among other things, facilities and management, administrative and
development services to the affiliated practices, and employed most
non-physician personnel of the affiliated practices, in return for specified
service fees. The operating expenses incurred by us included the salaries, wages
and benefits of personnel (other than physician owners and certain technical
medical personnel), supplies, expenses involved in administering the clinical
aspects of the affiliated practices and depreciation and amortization of assets.
We did not incur any clinic expenses for the year ended December 31, 2000 as we
are no longer obligated to pay clinic expenses under our management services
arrangements with physician practices.

Litigation and other costs

During 2000 we continued to be involved in litigation with certain of our former
affiliated practices. For the year ended December 31,



                                       27
<PAGE>

2000, litigation and other costs decreased $4.5 million to $.8 million from $5.3
million for the year ended December 31, 1999. This decrease is due to the fact
that during the latter part of 1999 and in the first half of 2000, we reached
settlement agreements with several former affiliated practices.

(Loss) gain on sale of assets, practice disputes and amendment and restatement
of service agreements

During the year ended December 31, 2000, we incurred a loss on sale of assets
and other, of approximately $699,000. This amount consisted primarily of a loss
of $352,000 on the settlement of a dispute with one of our former affiliated
practices, a loss of $275,000 on the sale of two MRI units, a gain of
approximately $142,000 primarily related to a litigation settlement with one of
our former affiliated practices, and a loss of approximately $214,000 related to
the writedown of certain assets.

LIQUIDITY AND CAPITAL RESOURCES

For the year ended December 31, 2001, we incurred a loss from operations of
approximately $7.4 million and sustained negative cash flows from operations of
approximately $3.6 million due primarily to the development and expansion of our
healthcare ratings business. During the latter part of 1999 and continuing
through 2000 and 2001, we transitioned our core business from physician practice
management to healthcare ratings services. In connection with this transition,
revenues from our physician practice management services were substantially
reduced, and during 2001, we eliminated certain controllable costs and reduced
personnel in areas that were not directly contributing to the healthcare ratings
business. We continue to incur significant costs to develop and expand our
healthcare ratings services by, among other things, adding staff to sell the
Company's healthcare ratings services. Management intends to address these
issues through the continued generation of increased revenues as we continue to
expand our healthcare ratings services business. Management believes that its
current operational plans will be sufficient to allow us to sustain our
operations at least through December 31, 2002.

Although we anticipate that we have sufficient funds available to support
ongoing operations for at least the next twelve months, if our revenues fall
short of our expectations or our expenses exceed our expectations, we may need
to raise additional capital through public or private debt or equity financing.
We may not be able to secure sufficient funds on terms acceptable to us. If
equity securities are issued to raise funds, our stockholders' equity may be
diluted. If additional funds are raised through debt financing, we may be
subject to significant restrictions. Furthermore, we typically receive a
non-refundable payment for the contract term upon execution of our strategic
quality initiative agreements. As a result, our operating cash flow is
substantially dependent upon our ability to continue to sign new agreements. Our
current operating plan includes growth in new sales from our strategic quality
initiative and quality assessment and improvement agreements. For the reasons
described above, failure to achieve our new sales plan would have a material
negative impact on our financial position and cash flow.

On March 9, 2002, President Bush signed into law the Job Creation and Worker
Assistance Act of 2002 ("JCWA Act"). One of the provisions of the JCWA Act
extends the net operating loss carryback provisions of the Internal Revenue Code
from two years to five years for losses incurred in 2001 and 2002. Prior to the
passage of the JCWA Act we did not have the ability to utilize our 2001 tax loss
to offset prior year income because we had no taxable income in 1999 or 1998.
However, with the passage of the JCWA Act, we believe we have the ability to
carryback our 2001 tax loss to 1997, a year in which we generated taxable
income. Based upon our preliminary analysis, we believe we will receive a tax
refund of approximately $1.0 million as a result of the JWCA Act. We anticipate
we will receive the refund in the second or third quarter of 2002. As we
finalize our analysis of the JCWA Act and applicable Internal Revenue Code
sections, we will update this estimate if necessary.

During the first quarter of 2001, we repaid the remaining balance on our bank
indebtedness of approximately $1.4 million.

Item 7a. Quantitative and Qualitative Disclosure about Market Risk

Not applicable

Item 8. Financial Statements and Supplementary Data

See pages 34-55 of this document.

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

Not applicable.



                                       28
<PAGE>

                                    PART III

Item 10. Directors and Executive Officers of the Registrant

This information (other than the information relating to executive officers
included in Part I) will be included in an amendment to this Form 10-K, which
will be filed within 120 days after the close of the Company's fiscal year
covered by this report, and is hereby incorporated by reference to such
amendment.

Item 11. Executive Compensation

This information will be included in an amendment to this Form 10-K, which will
be filed within 120 days after the close of the Company's fiscal year covered by
this report, and is hereby incorporated by reference to such amendment.

Item 12. Security Ownership of Certain Beneficial Owners and Management

This information will be included in an amendment to this Form 10-K, which will
be filed within 120 days after the close of the Company's fiscal year covered by
this report, and is hereby incorporated by reference to such amendment.

Item 13. Certain Relationships and Related Transactions

This information will be included in an amendment to this Form 10-K, which will
be filed within 120 days after the close of the Company's fiscal year covered by
this report, and is hereby incorporated by reference to such amendment.



                                       29
<PAGE>

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

     (a) 1. Financial Statements.

     The financial statements listed in the accompanying Index to Financial
     Statements and Financial Statement Schedule at page S-1 are filed as part
     of this Form 10-K.

     (a) 2. Financial Statement Schedules.

The following financial statement schedule is filed as part of this Form 10-K:

Schedule II - Valuation and Qualifying Accounts.

All other schedules have been omitted because they are not applicable, or not
required, or the information is shown in the Financial Statements or notes
thereto.

     (a) 3. Exhibits.



                                       30
<PAGE>

The following is a list of exhibits filed as part of this annual report on Form
10-K. Where so indicated by footnote, exhibits which were previously filed are
incorporated by reference.

       EXHIBIT
       NUMBER                               DESCRIPTION

         3.1               Certificate of Amendment of Amended and Restated
                           Certificate of Incorporation and Amended and Restated
                           Certificate of Incorporation

         3.2               Amended and Restated Bylaws

         10.1              1996 Equity Compensation Plan, as amended
                           (incorporated by reference to Exhibit 10.1 to the
                           Company's Quarterly Report on Form 10-Q for the
                           quarter ended March 31, 2001.)

         10.5              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
                           the Company's Registration Statement on Form S-1
                           (File No. 333-17627))




                                       31
<PAGE>


         10.9              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
                           the Company's Annual Report on Form 10-K for the
                           fiscal year ended December 31, 1997)

         21                Subsidiaries of the registrant.

         23                Consent of Ernst & Young LLP.

(b) Reports on Form 8-K

The Company did not file any reports on Form 8-K for the quarter ended December
31, 2001.



                                       32
<PAGE>

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                       HEALTH GRADES, INC.

Date: April 1, 2002                             /s/ Kerry R. Hicks
                                                 -------------------------------
                                                 Kerry R. Hicks
                                                 Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<Table>
<Caption>
                   NAME                                    TITLE                    DATE
                   ----                                    -----                    ----
<S>                                             <C>                             <C>
        /s/ Kerry R. Hicks                      Chief Executive Officer             April 1, 2002
        ----------------------------            (Principal Executive Officer)
        Kerry R. Hicks


        /s/ G. Allen Dodge                      Senior Vice President -             April 1, 2002
        ----------------------------            Finance, Chief Financial
        G. Allen Dodge                          Officer and Treasurer
                                                (Principal Financial and
                                                Accounting Officer)


        /s/ Peter H. Cheesbrough                Director                            March 28, 2002
        ----------------------------
        Peter H. Cheesbrough


        /s/ Leslie S. Matthews, M.D.            Director                            March 28, 2002
        ----------------------------
        Leslie S. Matthews, M.D.


        /s/ Mats Wahlstrom                      Director                            March 30, 2002
        ----------------------------
        Mats Wahlstrom


        /s/ John Quattrone                      Director                            March 22, 2002
        ----------------------------
        John Quattrone
</Table>



                                       33
<PAGE>

                          INDEX TO FINANCIAL STATEMENTS

<Table>
<S>                                                                        <C>
           HEALTH GRADES, INC. AND SUBSIDIARIES:
               Report of Independent Auditors.......................       35
               Consolidated Balance Sheets..........................       36
               Consolidated Statements of Operations................       37
               Consolidated Statements of Stockholders' Equity .....       38
               Consolidated Statements of Cash Flows................       39
               Notes to Consolidated Financial Statements...........       41
</Table>



                                       34
<PAGE>

                         Report of Independent Auditors

Board of Directors and Stockholders of Health Grades, Inc.

We have audited the accompanying consolidated balance sheets of Health Grades,
Inc. and subsidiaries (collectively the "Company") as of December 31, 2001 and
2000, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 2001. Our audits also included the financial statement schedule listed in
the Index at Item 14(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Health Grades,
Inc. and subsidiaries at December 31, 2001 and 2000, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.

                                       /s/ ERNST & YOUNG LLP
                                       -----------------------------------------
                                       Ernst & Young LLP

Denver, Colorado
February 8, 2002



                                       35
<PAGE>

                      Health Grades, Inc. and Subsidiaries

                           Consolidated Balance Sheets

<Table>
<Caption>
                                                                           DECEMBER 31
                                                                      2001            2000
                                                                  ------------    ------------
<S>                                                               <C>             <C>
ASSETS
Cash and cash equivalents                                         $  2,295,557    $  4,797,868
Accounts receivable, net                                               778,370         827,694
Due from affiliated practices in litigation, net                            --       1,944,919
Prepaid expenses, inventories and other                                132,581         206,417
Current portion notes receivable                                        12,726         635,186
                                                                  ------------    ------------

Total current assets                                                 3,219,234       8,412,084

Property and equipment, net                                            334,178         860,953
Goodwill, net of accumulated amortization of
     $1,655,508 and $816,609 in 2001 and 2000, respectively          4,194,492       5,033,391
Other assets                                                                --          64,746
                                                                  ------------    ------------
Total assets                                                      $  7,747,904    $ 14,371,174
                                                                  ============    ============
</Table>

<Table>
<Caption>
                                                                          DECEMBER 31
                                                                      2001            2000
                                                                  ------------    ------------
<S>                                                               <C>             <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable                                                  $    149,772    $     69,591
Accrued payroll, incentive compensation and related
   expenses                                                            472,067         599,463
Accrued expenses                                                       222,966         646,110
Notes payable                                                               --       1,559,213
Deferred income                                                      2,136,175       1,170,009
Income taxes payable                                                    76,930          75,000
                                                                  ------------    ------------

Total current liabilities                                            3,057,910       4,119,386
Deferred income                                                             --         188,021
                                                                  ------------    ------------

Total liabilities                                                    3,057,910       4,307,407

Commitments and contingencies

Stockholders' equity:
   Preferred stock, $0.001 par value, 2,000,000
     shares authorized, no shares issued or outstanding                     --              --
   Common stock, $0.001 par value, 50,000,000 shares
     authorized, and 42,165,733 and 28,817,400 shares
     issued in 2001 and 2000, respectively                              42,166          28,817
   Additional paid-in capital                                       89,549,538      87,381,917
   Accumulated deficit                                             (71,634,130)    (64,266,887)
   Treasury stock (7,559,057 shares in 2001 and 7,309,057
     shares in 2000)                                               (13,267,580)    (13,080,080)
                                                                  ------------    ------------

Total stockholders' equity                                           4,689,994      10,063,767
                                                                  ------------    ------------

Total liabilities and stockholders' equity (deficit)              $  7,747,904    $ 14,371,174
                                                                  ============    ============
</Table>



See accompanying notes to consolidated financial statements.



                                       36
<PAGE>

                      Health Grades, Inc. and Subsidiaries

                      Consolidated Statements of Operations

                            Years ended December 31,

<Table>
<Caption>
                                                      2001            2000            1999
                                                  ------------    ------------    ------------
<S>                                               <C>             <C>             <C>
Revenue:
  Ratings and advisory revenue                    $  3,025,302    $  1,578,979    $    407,577
  Physician practice service fees                      551,925       4,249,658      28,948,397
  Other                                                  4,490           9,051       2,229,774
                                                  ------------    ------------    ------------
                                                     3,581,717       5,837,688      31,585,748
                                                  ------------    ------------    ------------

Costs and expenses:
  Ratings and advisory costs and expenses:
    Production, content and
     product development                             1,064,308       2,085,402       1,217,917
    Sales and marketing                              1,331,146       1,572,505       1,853,191

Physician practice services costs and expenses:
  Clinic expenses                                           --              --      15,234,416
  Litigation and other costs                           606,562         812,084       5,309,168
General and administrative                           8,200,474       8,723,434      10,570,223
                                                  ------------    ------------    ------------

                                                    11,202,490      13,193,425      34,184,915
                                                  ------------    ------------    ------------
Loss from operations                                (7,620,773)     (7,355,737)     (2,599,167)
Other:
   Gain (loss) on settlement agreements, sale of
     assets, practice disputes, and amendment
     and restatement of service agreements             191,915        (699,010)      2,766,284
   Gain on sale of equity investment                        --              --         127,974
   Gain on sale of subsidiary                               --              --         221,258
   Interest income                                      90,409         511,657         312,447
   Interest expense                                    (28,794)       (471,553)     (2,489,427)
                                                  ------------    ------------    ------------

Loss before income taxes                            (7,367,243)     (8,014,643)     (1,660,631)
Income tax benefit                                          --         469,897       2,625,561
                                                  ------------    ------------    ------------

Net (loss) income                                 $ (7,367,243)   $ (7,544,746)   $    964,930
                                                  ============    ============    ============

Net (loss) income per common share (basic)        $      (0.30)   $      (0.39)   $       0.07
                                                  ============    ============    ============

Weighted average number of common shares
   used in computation (basic)                      24,399,699      19,535,841      14,202,748
                                                  ============    ============    ============

Net (loss) income per common
   share (diluted)                                $      (0.30)   $      (0.39)   $       0.07
                                                  ============    ============    ============

Weighted average number of common
   shares and common share equivalents
   used in computation (diluted)                    24,399,699      19,535,841      14,817,732
                                                  ============    ============    ============
</Table>



See accompanying notes to consolidated financial statements.



                                       37
<PAGE>

                      Health Grades, Inc. and Subsidiaries

                    Consolidated Statements of Stockholders'
                               Equity Years ended
                        December 31, 2001, 2000 and 1999


<Table>
<Caption>
                                                  COMMON STOCK
                                                $0.001 PAR VALUE        ADDITIONAL
                                           --------------------------    PAID-IN     ACCUMULATED     TREASURY
                                              SHARES         AMOUNT      CAPITAL       DEFICIT         STOCK          TOTAL
                                           ------------  ------------  ------------  ------------   ------------   ------------
<S>                                        <C>           <C>           <C>           <C>            <C>            <C>
Balances at January 1, 1999                  18,618,873  $     18,619  $ 66,993,627  $(57,687,071)  $ (3,963,673)  $  5,361,502
Non-cash compensation expense
 related to employee stock options                   --            --       448,374            --             --        448,374
Exercise of employee stock options              119,813           120        67,275            --             --         67,395
4,182,634 shares acquired as
 treasury stock                                      --            --            --            --     (7,076,811)    (7,076,811)
Net income                                           --            --            --       964,930             --        964,930
                                           ------------  ------------  ------------  ------------   ------------   ------------
Balance at December 31, 1999                 18,738,686        18,739    67,509,276   (56,722,141)   (11,040,484)      (234,610)
                                           ------------  ------------  ------------  ------------   ------------   ------------
Non-cash compensation expense
 related to employee stock options                   --            --        55,718            --             --         55,718
Exercise of employee stock options              113,714           113        62,688            --             --         62,801
888,779 shares acquired as
 treasure stock                                      --            --            --            --     (2,039,596)    (2,039,596)
Equity financing, net                         7,565,000         7,565    14,348,635            --             --     14,356,200
Cancellation of officer notes                 1,600,000         1,600     3,198,400            --             --      3,200,000
Non-cash compensation expense
 related to officer note cancellation                --            --       347,200            --             --        347,200
Acquisition of minority interest                800,000           800     1,849,200            --             --      1,850,000
Retainer warrants - SmallCaps Online                 --            --        10,800            --             --         10,800
Net loss                                             --            --            --    (7,544,746)            --     (7,544,746)
                                           ------------  ------------  ------------  ------------   ------------   ------------
Balance at December 31, 2000                 28,817,400        28,817    87,381,917   (64,266,887)   (13,080,080)    10,063,767
                                           ------------  ------------  ------------  ------------   ------------   ------------

Exercise of employee stock options               15,000            16         8,423            --             --          8,439
250,000 shares acquired as treasury stock            --            --            --            --       (187,500)      (187,500)
Retainer warrants - SmallCaps Online                 --            --        10,800            --             --         10,800
Non-cash financing fee                               --            --       161,731            --             --        161,731
Common stock issued                          13,333,333        13,333     1,986,667            --             --      2,000,000
Net loss                                             --            --            --    (7,367,243)            --     (7,367,243)
                                           ------------  ------------  ------------  ------------   ------------   ------------
Balance at December 31, 2001                 42,165,733  $     42,166  $ 89,549,538  $(71,634,130)  $(13,267,580)  $  4,689,994
                                           ============  ============  ============  ============   ============   ============
</Table>



See accompanying notes to consolidated financial statements.



                                       38
<PAGE>

                      Health Grades, Inc. and Subsidiaries

                      Consolidated Statements of Cash Flows

                            Years ended December 31,

<Table>
<Caption>
                                                              2001            2000            1999
                                                          ------------    ------------    ------------
<S>                                                       <C>             <C>             <C>
OPERATING ACTIVITIES
Net (loss) income                                         $ (7,367,243)   $ (7,544,746)   $    964,930
Adjustments to reconcile net income (loss) to net
   cash provided by (used in) operating activities:
     Non-cash compensation expense related to
       employee stock options                                       --          55,718         448,374
     Retainer warrants                                          10,800          10,800              --
     Depreciation expense                                      526,111         707,408       1,757,700
     Amortization expense                                      838,899         816,609       1,567,352
    Bad debt expense                                            59,014         324,607          33,570
    Gain on sale of equity investment                               --              --        (127,973)
    Gain on sale of subsidiary                                      --              --        (221,258)
    Non-cash compensation expense related to officer
      note cancellation                                             --         347,200              --
    Non-cash financing fee                                     161,731              --              --
    (Gain) loss on settlement agreements and disposal
      of assets                                               (191,915)        699,748         181,251
    Gain on sale of assets, practice disputes,
      and amendment and restatement of
      service agreements                                            --              --      (2,766,284)
    Impact of termination agreement                                 --              --      (1,073,777)
    Equity in loss of investee                                      --              --          23,852
     Deferred income tax benefit                                    --              --      (1,083,178)
     Changes in operating assets and liabilities, net
       of the effects of the non-cash acquisitions of
       net assets of affiliated physician practices and
       Provider Partnerships, Inc., sale of assets
       and execution of new service agreements
       and practice disputes:
         Accounts receivable, net                               (9,690)      1,785,701        (259,264)
         Due from affiliated practices in litigation         1,944,919        (243,261)     (1,360,023)
         Prepaid expenses and other assets                      73,836         (16,019)        600,456
         Prepaid and recoverable income taxes                    1,930       1,913,589       2,419,513
         Accounts payable and accrued expenses                (325,084)     (1,105,507)        962,440
         Accrued payroll, incentive compensation
           and related expenses                               (127,396)        320,989      (1,270,994)
         Deferred income                                       778,145        (433,369)      1,791,399
         Due to affiliated physician practices, net                 --              --      (3,326,014)
                                                          ------------    ------------    ------------
Net cash used in operating activities                       (3,625,943)     (2,360,533)       (737,928)

INVESTING ACTIVITIES
Purchases of property and equipment                            (14,746)       (418,642)     (1,140,438)
Proceeds from sale of medical equipment                             --         125,000       1,001,856
Increase in other assets                                        64,746           4,352              --
Proceeds from sale of majority interest in a subsidiary
  and equity investments, net of cash                               --              --       3,208,397
Increases in  goodwill and intangible assets                        --              --      (4,000,000)
Repayments from affiliates                                          --              --         131,233
Advances to investee                                                --              --        (991,386)
                                                          ------------    ------------    ------------
Net cash provided by (used in) investing activities             50,001        (289,290)     (1,790,338)
</Table>



                                       39
<PAGE>

<Table>
<Caption>
                                                              2001           2000           1999
                                                          ------------   ------------   ------------
<S>                                                       <C>            <C>            <C>
FINANCING ACTIVITIES
Proceeds from sale of assets, practice disputes
   and amendment and restatement of service agreements    $         --   $         --   $ 39,416,313
Cash restricted for repayment of note payable                       --             --     (1,178,848)
Proceeds from officer notes                                         --             --      3,550,000
Net proceeds from equity financing                           2,000,000     14,356,200             --
Issuance of notes receivable                                        --        (35,000)            --
Principal repayments on note payable                        (1,369,767)   (10,406,673)   (41,030,000)
Principal repayments on officer notes                               --       (350,000)            --
Principal repayments on capital lease obligations                   --             --        (48,805)
Purchases of treasury stock                                   (187,500)            --             --
Exercise of employee stock options                               8,439         62,801         67,395
Principal payments from loans to physician
   stockholders                                                     --             --        124,756
Repayments of notes receivable                                 622,459      3,503,596        556,569
Loans to physician stockholders                                     --             --        (30,548)
                                                          ------------   ------------   ------------

Net cash provided by financing activities                    1,073,631      7,130,924      1,426,832
                                                          ------------   ------------   ------------

Net increase (decrease) in cash and
   cash equivalents                                         (2,502,311)     4,481,101     (1,101,434)
Cash and cash equivalents at beginning of period             4,797,868        316,767      1,418,201
                                                          ------------   ------------   ------------

Cash and cash equivalents at end of period                $  2,295,557   $  4,797,868   $    316,767
                                                          ============   ============   ============

SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid                                             $     38,467   $    559,700   $  2,393,289
                                                          ============   ============   ============

Income taxes received                                     $     (1,930)  $ (2,383,485)  $ (3,961,898)
                                                          ============   ============   ============

Gain on sale of assets, practice disputes and amendment
  and restatement of service agreements:
  Assets disposed of                                                                    $ 43,069,171
  Liabilities transferred                                                                 (3,859,015)
  Treasury stock acquired                                                                 (7,076,811)
  Less: Notes receivable                                                                  (3,436,384)
        Cash received                                                                    (31,463,245)
                                                                                        ------------
Gain on sale of assets, practice disputes and amendment
  and restatement of service agreements                                                 $ (2,766,284)
                                                                                        ============

Sale of subsidiary:
  Assets disposed of                                                                    $      9,619
  Liabilities assumed                                                                        343,832
  Note receivable                                                                           (172,200)
                                                                                        ------------

  Loss on sale of assets                                                                $    181,251
                                                                                        ============
</Table>



See accompanying notes to consolidated financial statements.



                                       40
<PAGE>

                      Health Grades, Inc. and Subsidiaries

                   Notes to Consolidated Financial Statements

                                December 31, 2001

1. DESCRIPTION OF BUSINESS

Health Grades, Inc. ("the Company") is a healthcare ratings and consulting
company. The Company grades, or provides consumers with the means to assess and
compare the quality or qualifications of, various types of healthcare providers.

The Company offers services to hospitals that are either attempting to build a
brand name reputation based upon quality of care or are working to identify
areas to improve quality. For hospitals that have received high ratings, the
Company offers the opportunity to license its ratings and trademarks and provide
assistance in their marketing programs. For providers who have not received high
ratings, the Company offers quality improvement services.

The Company provides basic and expanded profile information for a variety of
providers and facilities. This information is made available to consumers,
employers and health plans to assist them in selecting healthcare providers. The
basic profile information is available free of charge on the Company's website,
www.healthgrades.com. For certain providers, the Company offers healthcare
quality reports. These reports provide more detailed information than what is
available free of charge on the healthgrades.com website. Report pricing and
content varies based upon the type of provider and whether the user is a
consumer or a healthcare professional.

The Company provides online integrated healthcare quality solutions for
employers, health plans and other organizations that are looking to license
access to the Company's database of healthcare providers. In addition, the
Company collaborated with The Leapfrog Group, a consortium of more than 90
Fortune 500 companies and other large private and public healthcare purchasers,
to analyze and report the findings of Leapfrog's hospital patient safety survey.
The Leapfrog Group began a national effort in November 2000 to reward hospitals
for advances in patient safety and to educate employees, retirees, and families
about the importance of hospitals' efforts in this area. The Leapfrog Group's
survey assesses the extent to which urban, acute care hospitals in select
regions of the U.S. currently meet or are striving to implement three proven
patient safety practices. For Leapfrog enrollees, the Company developed a
Leapfrog Enrollee Assistance Program (LEAP). HealthGrades' LEAP provides
employers, health plans, and other members of The Leapfrog Group with an online
and text solution, including access to essential hospital-quality information.

In addition to the services noted above, which constitute the Company's ratings
and advisory business, the Company also provides limited physician practice
management services to musculoskeletal practices under management services
agreements that have terms expiring through September 2002.

During 1996, 1997 and 1998, the Company acquired substantially all of the assets
and certain liabilities of physician practices ("the Affiliated Practices")
through a combination of asset purchases and mergers. Concurrent with its
acquisitions, the Company simultaneously entered into long-term service
agreements with the Affiliated Practices. Under the terms of the service
agreements, the Company, among other things, provided facilities and management,
administrative and development services, including assistance in the negotiation
of contracts between the Affiliated Practices and third party payors, in return
for service fees. Such fees were payable monthly and consisted of the following:
(i) service fees based on a percentage ranging from 20%-50% of the adjusted
pre-tax income of the Affiliated Practices (generally defined as revenue of the
Affiliated Practices related to professional services less amounts equal to
certain clinic expenses, but not including physician owner compensation or most
benefits to physician owners) plus (ii) reimbursement of certain clinic
expenses.

In 1998 and 1999, the Company restructured its arrangements with most of the
Affiliated Practices. Under the restructured arrangements, the Company
transferred, with respect to each practice, all of the accounts receivable
relating to the practice; tangible and intangible assets purchased or acquired
by the Company in respect of the practice, other than those disposed of in the
ordinary course of business since the date the Company affiliated with the
practice; all prepaid expenses relating to the practice; all inventory relating
to the practice; and all other assets relating to the practice. The amount
received, in cash and Company common stock, by the Company from each practice
and its physician owners for the assets sold to the practice generally equaled
the sum of (1) the book value of the accounts receivable relating to the
practice on the effective date of closing; (2) the book value of all fixed
assets and other capital assets relating to the practice on the effective date
of closing; (3) the book value of all prepaid expenses relating to the practice
on the effective date of closing; (4) the book value of all notes and other
receivables the physician owners of the practice owed to the



                                       41
<PAGE>

Company on the effective date of closing; and (5) the cash balance of the
practice's deposit account on the effective date of closing, reduced by the book
value of the liabilities and obligations relating to the practice on the
effective date of closing.

In addition, the Company and each of the practices and their physician owners
entered into a management services agreement to replace their existing service
agreement. As consideration for the Company's agreement to enter into the
management services agreement, the practices and their physician owners paid to
the Company an additional amount of cash, or paid cash and returned to the
Company shares of its common stock.

Under the new management service agreements, the Company reduced the level of
services previously provided to the practices participating in the
restructuring. As a result, services provided to each practice under the new
agreements were as follows:

     o    Assessing the financial performance, organizational structure, wages
          and strategic plan of the practice;

     o    Advising with respect to current and future marketing and contracting
          plans with third party payors and managed care plans;

     o    Negotiating malpractice insurance coverage;

     o    Providing access to patient information databases;

     o    Analyzing annual performance on a comparative basis with other
          practices that have contracted with the Company; and

     o    Analyzing billing practices.

In addition, the terms of the management services arrangements were reduced,
generally from forty-year terms to five-year terms beginning from the initial
affiliation date of the affected practice.

During 2000 and 2001, the Company also entered into settlement agreements with
several Affiliated Practices, which terminated the service agreements with the
respective Affiliated Practices. As of December 31, 2001, the Company has three
management services arrangements remaining which expires in September 2002.

2. BASIS OF PRESENTATION

The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. For the year ended December 31, 2001, the
Company incurred a loss from operations of approximately $7.4 million and
sustained negative cash flows from operations of approximately $3.6 million due
primarily to the development and expansion of its healthcare ratings business
and litigation costs associated with the Company's physician practice management
operations. As described more fully in Note 1, during the latter part of 1999
and continuing through 2000 and 2001, the Company transitioned its core business
from physician practice management to healthcare ratings services. In connection
with this transition, revenues from the Company's physician practice management
services were substantially reduced and during 2001 the Company eliminated
certain controllable costs and reduced personnel in areas that were not directly
contributing to the healthcare ratings business. The Company continues to incur
significant costs to develop and expand its healthcare ratings services by,
among other things, adding staff to sell the Company's healthcare ratings
services. Management intends to address these issues through the continued
generation of increased revenues as the Company continues to expand its
healthcare ratings services business. Management believes that its current
operational plans will be sufficient to allow the Company to sustain its
operations at least through December 31, 2002.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the Company and its subsidiaries.
All significant intercompany balances and transactions have been eliminated in
consolidation.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires



                                       42
<PAGE>

management to make estimates and assumptions that affect the amounts reported in
the financial statements and footnotes. These estimates are based on
management's current knowledge of events and actions they may undertake in the
future, and actual results could differ from those estimates.

REVENUE RECOGNITION AND ACCOUNTS RECEIVABLE

Ratings and advisory revenue

The Company currently derives ratings and advisory revenue principally from
annual fees paid by hospitals that participate in its Strategic Quality
Initiative (SQI) program. The SQI program provides business development tools to
hospitals that are highly rated on the Company's website. Under the SQI program,
the Company licenses the Health Grades name and its "report card" ratings to
hospitals. The license may be in a single area (for example, Cardiac) or
multiple areas (for example, Cardiac, Neuroscience and Orthopaedics.) The
Company also assists hospitals in promoting their ratings and measuring the
success of their efforts utilizing the Company's team of in-house healthcare
consultants. Another key feature of this program is a detailed comparison of the
data underlying a hospital's rating to local and national benchmarks.

The Company recognizes revenue related to these arrangements in a straight-line
manner over the term of the agreement (typically one year). The Company follows
this method, because the primary deliverable under the agreement is the license
to utilize its rating over the contract term. In addition, consulting services
are performed as requested by the client as needed over the term of the
agreement. As the Company typically receives payment for the entire contract
term upon execution of the agreement, the Company records the cash payment as
deferred revenue, which is then amortized to revenue over the contract term.

Currently, the Emerging Issues Task Force (EITF) is working to reach a final
consensus regarding EITF 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables, which addresses how to account for multiple-deliverable
revenue arrangements and focuses on when a revenue arrangement should be
separated into different revenue-generating deliverables or "units of
accounting" and if so, how the arrangement considerations should be allocated to
the different deliverables or units of accounting. The Company continues to
monitor the status of the EITF and, based on the tentative conclusions reached
by the EITF, does not believe the final consensus will have an impact on how the
Company currently accounts for its SQI agreements.

Physician practice service fees

Physician practice service fees include services fees and other revenue derived
from the Company's physician practice management business.

PRODUCTION, CONTENT AND PRODUCT DEVELOPMENT COSTS

Beginning in 1999, the Company began incurring production, content and product
development costs related to the development and support of its websites. These
costs (which consist primarily of salaries and benefits, consulting fees and
other costs related to software development, application development and
operations expense) are expensed as incurred.

Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," requires
the capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based upon the Company's product
development process, technological feasibility is established upon the
completion of a working model. Costs incurred by the Company between completion
of a working model and the launch of its websites were not significant.

ADVERTISING COSTS

Advertising costs are expensed as incurred.

FINANCIAL INSTRUMENTS

The carrying amounts of financial instruments as reported in the accompanying
balance sheets approximate their fair value primarily due to the short-term
and/or variable-rate nature of such financial instruments.



                                       43
<PAGE>

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Costs of repairs and maintenance are
expensed as incurred. Depreciation is computed using the straight-line method
over the estimated useful lives of the underlying assets. Amortization of
leasehold improvements are computed using the straight-line method over the
shorter of the lease term or the estimated useful lives of the underlying
assets. The estimated useful lives used are as follows:

<Table>
<S>                                                 <C>
                  Computer equipment and software   3-5 years
                  Furniture and fixtures            5-7 years
                  Leasehold improvements            5 years
</Table>

GOODWILL

Goodwill, which is stated at cost, was acquired in connection with two
transactions. During 1999, the Company purchased a number of shares of its
majority-owned subsidiary, HG.com, Inc., which increased the Company's ownership
in HG.com, Inc. to 90%, resulted in $4 million in goodwill being recorded. In
connection with a merger transaction that took place during February 2000, the
Company recorded goodwill in the amount of $1,850,000 based on the fair value of
its common stock issued as of the transaction date. Goodwill is being amortized
over an estimated useful life of seven years. (See Note 7 for further discussion
of these transactions.)

Pursuant to the provisions of Statement of Financial Accounting Standards No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of, the Company evaluates goodwill for impairment whenever
indicators of impairment exist. Due to the substantial operating losses in 2001,
the Company performed an analysis of future undiscounted cash flows to determine
if an impairment of goodwill existed as of December 31, 2001. As total estimated
future undiscounted cash flows were in excess of the net $4.2 million in
recorded goodwill the Company determined that no impairment was present. The
Company estimated total future undiscounted cash flows based upon current
estimates of future operating results over the remaining useful life assigned to
goodwill. Total future operating cash flows were examined as the goodwill
relates to the formation of the Company's current ratings business, which is
where management anticipates substantially all of the future operating cash flow
for the Company.

In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new standards, goodwill will no longer be amortized
but will be subject to annual impairment tests in accordance with the
Statements.

The Company will apply the new rules on accounting for goodwill beginning in the
first quarter of 2002. Application of the nonamortization provisions of the
Statement is expected to result in an increase in net income of approximately
$839,000 ($0.03 per share) per year. The Company is currently in the process of
performing the first of the required impairment tests of goodwill and will
determine what the effect of these tests will be on the earnings and financial
position of the Company prior to the end of the second quarter of 2002.

STOCK-BASED COMPENSATION

The Company accounts for its stock-based compensation arrangements under the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees ("APB No. 25"). In 1995, Financial Accounting Standards
Board Statement No. 123, Accounting for Stock-Based Compensation ("SFAS No.
123"), was issued, whereby companies may elect to account for stock-based
compensation using a fair value based method or continue measuring compensation
expense using the intrinsic value method prescribed in APB No. 25. SFAS No. 123
requires that companies electing to continue to use the intrinsic value method
make pro forma disclosure of net income and net income per share as if the fair
value based method of accounting had been applied. See Note 11 for the pro forma
disclosures required by SFAS No. 123.

4. ACCOUNTS RECEIVABLE AND MANAGEMENT FEE REVENUE

Accounts receivable consisted of the following:

<Table>
<Caption>
                                                     DECEMBER 31
                                                   2001       2000
                                                 --------   --------
<S>                                              <C>        <C>
Trade accounts receivable                        $835,789   $634,197
Less allowance for doubtful accounts               57,419     80,183
                                                 --------   --------
                                                  778,370    554,014

Management fees, including reimbursement of
  clinic expenses (net of an allowance of $--
  and $231,895 in 2001 and 2000, respectively)         --    273,680
                                                 --------   --------
                                                 $778,370   $827,694
                                                 ========   ========
</Table>

     For the years ending December 31, 2001 and 2000, the Company derived a
substantial amount of its revenue from its ratings and advisory services.
Furthermore, the Company's strategic quality initiative services accounted for
74% and 60% of total ratings and advisory revenue for the years ending December
31, 2001 and 2000, respectively. Approximately 17% and 31% of the Company's
ratings and advisory revenue was derived from licensing access to its database
of healthcare information for the years ending December 31, 2001 and 2000,
respectively.


                                       44
<PAGE>

Management fee revenue, exclusive of reimbursed clinic expenses, was
approximately $.6 million, $4.2 million and $11.6 million for the years ended
December 31, 2001, 2000 and 1999, respectively.

Due from Affiliated Practices in litigation represented amounts due from
Affiliated Practices with which the Company was involved in disputes. All legal
proceedings involving the Company's Affiliated Practices have been settled.
Gross accounts receivable for these practices were $1,944,919 as of December 31,
2000. Gross accounts receivable include patient accounts receivable purchased
from the related Affiliated Practice, management fees and reimbursement of
clinic expenses.

5. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

<Table>
<Caption>
                                                    DECEMBER 31
                                                2001            2000
                                            ------------    ------------
<S>                                         <C>             <C>
Furniture and fixtures                      $    907,340    $    963,325
Computer equipment and software                1,737,939       1,745,836
Leasehold improvements and other                  10,784          10,784
                                            ------------    ------------
                                               2,656,063       2,719,945
Accumulated depreciation and amortization     (2,321,885)     (1,858,992)
                                            ------------    ------------

Net property and equipment                  $    334,178    $    860,953
                                            ============    ============
</Table>

6. NOTES PAYABLE

Effective September 1999, the Company entered into an amendment to its credit
facility, which converted the credit facility to a term loan. The term loan
provided for monthly principal and interest payments through November 2000, with
interest payable at a floating rate based on the bank syndicate's prime lending
rate plus .75%. The term loan did not contain any financial covenants other than
timely principal and interest payments. The term loan was secured by
substantially all of the assets of the Company.

Effective March 2000, the Company entered into an amendment to its term loan.
The amendment extended the final payment on the loan to November 2001. The
revised term loan provided for monthly principal and interest payments through
November 2001, with interest payable at a floating rate based on the bank
syndicate's prime lending rate plus .75%. The monthly principal payments under
the term loan were $50,000 per month beginning April 2000, with the final
payment for any remaining balance on the loan due November 2001. The Company
issued 165,000 shares of Company common stock to the bank syndicate in
connection with the amendment as a financing fee.

During the first quarter of 2001, the Company repaid the remaining note payable
balance of approximately $1.4 million.

7. ACQUISITION OF MINORITY INTERESTS AND OFFICER NOTES

In June 1999, the Company entered into an agreement with the former PPI
stockholders to resolve certain issues raised by the former stockholders of PPI
relating to the transaction in which the Company acquired PPI. At that time, the
Company formed HG.com, Inc. (formerly known as Healthgrades.com, Inc.,
hereafter, "HG.com") and transferred to HG.com one of the Company's websites
(formerly HealthCareReportCards.com, currently healthgrades.com) and other
related internet products. The remaining non-internet related assets of PPI were
transferred into the Company and PPI was subsequently liquidated. Additionally,
Venture5 LLC ("Venture 5"), whose members consist of the former PPI
stockholders, and an employee of the Company owned a minority interest in
HG.com. The Company owned the majority interest. In September 1999, the Company
entered into an agreement with Venture5 under which the Company agreed to
purchase a number of shares of HG.com, Inc. that would increase the Company's
ownership in HG.com, Inc. to 90%. On December 31, 1999, the Company paid
$4,000,000 to Venture5 (the "Minority Interest Purchase") in full satisfaction
of this obligation. The Company financed the Minority Interest Purchase through
the issuance of notes payable to certain officers (the "Officers") of the
Company totaling $3,550,000.



                                       45
<PAGE>

Effective February 3, 2000, the Company merged its majority-owned subsidiary,
HG.com, Inc. into a wholly-owned subsidiary, HealthCare Ratings, Inc. (the
"Merger Transaction"). In order to effectuate the Merger Transaction, the
Company gave the remaining minority shareholders of HG.com 800,000 shares of the
Company's common stock. In connection with the Merger Transaction, the Company
recorded goodwill in the amount of $1,850,000 based on the fair value of the
Company's common stock issued as of the transaction date.

8. EQUITY FINANCING

On March 17, 2000, the Company closed on an equity financing transaction (the
"Equity Financing") which raised $18 million. Pursuant to the terms of the
Equity Financing, certain investors paid $14.8 million to the Company in return
for 7,400,000 shares of Company common stock and five-year warrants to purchase
2,590,000 shares of Company common stock at an exercise price of $4.00 per
share. Net proceeds of the Equity Financing, after payment of certain legal and
other financing fees, were approximately $14.4 million. In connection with the
Equity Financing, the Company also issued an aggregate of 165,000 shares to its
bank syndicate as a financing fee. The Company also issued a five year warrant
to purchase 150,000 shares of Company common stock to a company that served as a
financial advisor to the Company in connection with the Equity Financing, at an
exercise price of $3.45 per share. In connection with the Equity Financing, the
Officers exchanged $3.2 million in notes payable for an aggregate of 1.6 million
shares of Company common stock and five-year warrants to purchase 560,000 shares
of Company common stock at $4.00 per share. In accordance with the provisions of
EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios, upon the exchange of the
notes payable, the Company recorded an expense of $347,200 based upon the
estimated fair market value of the warrants issued to the Officers. This expense
is included in general and administrative expenses in the Company's Consolidated
Statement of Operations for the year ended December 31, 2000.

Effective April 16, 2001, the Company reached an agreement with Chancellor V.,
L.P. ("Chancellor V") and Essex Woodlands Health Ventures Fund IV, L.P.
("Essex"), regarding a commitment (the "Commitment") to provide the Company with
up to $2.0 million of equity financing. Chancellor V and Essex were the two
principal investors in the Equity Financing described above. In consideration
for the commitment, the Company issued Chancellor and Essex warrants (the
"Commitment Warrants") to purchase an aggregate of 500,000 shares of our common
stock at an exercise price per share of $0.26, which was the closing market
price per share of the Company's common stock as reported by Nasdaq on April 16,
2001. The Commitment Warrants expire on April 16, 2007. In addition, the Company
repriced warrants to purchase 100,000 shares of the Company's common stock that
were issued to Chancellor V and Essex in March 2000 to the same $0.26 per share
exercise price.

Under the terms of the agreement with Chancellor V and Essex, the Company was
granted the option until December 31, 2001, to sell its common stock to
Chancellor V and Essex at an aggregate purchase price of up to $2.0 million.
Effective October 9, 2001, the Company exercised its option to receive the
entire $2.0 million. Under the terms of the Commitment, in exchange for the $2.0
million, the Company issued an aggregate of 13,333,333 shares of Company common
stock to Chancellor and Essex. In addition, the Company issued six-year warrants
to purchase 350,000 shares of Company common stock at an exercise price per
share of $0.15.

Under the terms of the Commitment, the price per share for the purchase of
Company common stock was equal to the lesser of $0.26 and the closing market
price per share of its common stock on the date that the Company provided notice
to Chancellor V and Essex that the Company intended to exercise the option, but
in no event less than $0.15 per share. As the closing market price per share of
the Company's common stock was less than $0.15 per share on the date the Company
provided notice to Chancellor V and Essex, the common stock was issued to
Chancellor V and Essex at $0.15 per share.

9. SEGMENT DISCLOSURES

Management regularly evaluates the operating performance of the Company by
reviewing results on a product or service provided basis. The Company's
reportable segments are Physician Practice Services ("PPS") and Ratings and
Advisory Revenue. PPS derives its revenue primarily from management services
provided to physician practices. Ratings and Advisory Revenue ("RAR") is derived
primarily from marketing arrangements with hospitals and fees related to the
licensing of its content (including set-up fees). The Company's other segment
represents ambulatory surgery center services and health care consulting for the
year ended December 31, 1999. Both of the Company subsidiaries that generated
revenue for the "other" segment were liquidated during 1999.

The Company uses net (loss) income before income taxes for purposes of
performance measurement. The measurement basis for segment assets includes
intangible assets.

Segment information for PPS represents the operating results for Health Grades,
Inc. The RAR segment includes the operating results for Healthcare Ratings, Inc.
(HRI), the Company's only subsidiary with significant operations. HRI contains
the revenue from the Company's ratings and advisory business. Expenses of HRI
include direct salaries and wages of HRI expenses, disbursements made directly
from HRI and depreciation recorded on HRI assets. In addition, the Company's
goodwill amortization is included in the RAR segment information. All corporate
employees and operating expenses are included in the PPS segment. The Company
has not performed any expense allocation other than certain telephone and
utilities expense.

Due to the changes in the Company's business direction over the last few years,
the Company is currently evaluating the need for segment disclosures. During
2002, the Company anticipates that substantially all of its revenue and
operating expenses will be derived from its ratings and advisory business.


                                       46
<PAGE>

<Table>
<Caption>
                                                AS OF AND FOR THE YEAR ENDED
                                                        DECEMBER 31,
                                            2001            2000            1999
                                        ------------    ------------    ------------
<S>                                     <C>             <C>             <C>
PPS
Revenue from external customers         $    551,925    $  4,249,658    $ 28,948,397
Interest income                               33,588         148,464         220,621
Interest expense                              28,794         471,553       2,489,427
Depreciation and amortization expense        292,566         493,811       3,142,428
Segment net (loss) income
before income taxes                       (4,419,192)     (3,710,587)      5,029,937
Segment assets                            20,680,689      25,831,100      26,796,899
Segment asset expenditures                    11,042         210,680         794,258

RAR
Revenue from external customers         $  3,025,302    $  1,578,979    $    407,577
Interest income                               56,821         363,193              --
Depreciation and amortization expense      1,072,443       1,030,206         182,624

Segment net loss before income taxes      (2,948,051)     (4,304,056)     (5,558,935)
Segment assets                             5,283,971       6,068,902       4,634,979
Segment asset expenditures                     3,704         207,962         346,180

OTHER
Revenue from external customers                   --              --    $    132,831
Interest income                                   --              --          91,826
Equity in net loss of investee                    --              --         (23,852)
Segment net loss before income taxes              --              --      (1,023,633)
Segment assets                                    --              --              --
Segment asset expenditures                        --              --              --
</Table>

<Table>
<Caption>
                                                  AS OF AND FOR THE YEAR ENDED
                                                          DECEMBER 31,
                                              2001            2000            1999
                                          ------------    ------------    ------------
<S>                                       <C>             <C>             <C>
REVENUE
Total for reportable segments                3,577,277       5,828,637      29,488,805
Other revenue                                    4,490           9,051       2,096,943
                                          ------------    ------------    ------------
Total consolidated revenue                $  3,581,717    $  5,837,688    $ 31,585,748
                                          ============    ============    ============

LOSS BEFORE INCOME TAXES
Total net loss before tax for
  reportable segments                     $ (7,367,243)   $ (8,014,643)   $ (1,552,631)
Adjustment                                          --              --        (108,000)
                                          ------------    ------------    ------------
Loss before income taxes                  $ (7,367,243)   $ (8,014,643)   $ (1,660,631)
                                          ============    ============    ============

ASSETS
Total assets for reportable segments      $ 25,964,660    $ 31,900,002    $ 31,431,878
Elimination of advances to subsidiaries    (10,421,736)     (9,733,808)     (5,095,805)
Elimination of investment in
  subsidiaries                              (7,795,020)     (7,795,020)     (5,943,205)
                                          ------------    ------------    ------------
Consolidated total assets                 $  7,747,904    $ 14,371,174    $ 20,392,868
                                          ============    ============    ============
</Table>

     For each of the years presented, the Company's primary operations and
assets were within the United States.

10. COMMON STOCK AND WARRANTS

The Company records treasury stock at cost, with regard to monetary
transactions. With regard to non-monetary transactions, the common stock
transferred to the Company is recorded at estimated fair value.

As of December 31, 2001, the Company had the following common shares reserved
for future issuance:

<Table>
<S>                                                              <C>
Awards under the 1996 Equity Compensation Plan                   4,810,778
Awards under the 1996 Incentive and Non-Qualified Stock
  Option Plan                                                        3,500
                                                                 ---------
Total shares reserved for future issuance                        4,814,278
                                                                 =========
</Table>



                                       47
<PAGE>

In June 2000, the Company issued to SmallCaps Online Group, LLC five-year
warrants to purchase 20,000 shares of Health Grades common stock at $2.00 per
share, in consideration for certain financial advisory services to be rendered
to the Company.

In connection with a severance agreement with a former Company executive,
effective March 29, 2001, the former executive surrendered 250,000 shares of
Company common stock. The cost of these shares is included as treasury shares
purchased in the Company's Consolidated Statements of Stockholders' Equity for
the year ended December 31, 2001.

11. STOCK OPTION PLANS

On March 22, 1996, the Company adopted the 1996 Incentive and Non-Qualified
Stock Option Plan (the "Plan") under which nontransferable options to purchase
up to 5,000,000 shares of common stock of the Company were available for award
to eligible directors, officers, advisors, consultants and key employees. On
January 10, 1997, the Board of Directors voted to terminate the Plan.

The exercise price for incentive stock options awarded during the year ended
December 31, 1996 was not less than the fair market value of each share at the
date of the grant, and the options granted thereunder had a term of ten years.
Options, which were generally contingent on continued employment with the
Company, could be exercised only in accordance with a vesting schedule
established by the Company's Board of Directors. Of the 553,500 shares
underlying options granted during the year ended December 31, 1996 at an
exercise price of $1.00 per share, 3,500 shares underlying the options remain
outstanding and exercisable at December 31, 2001. The other 550,000 shares
underlying options were forfeited or exercised during 1997.

On October 15, 1996, the Company's Board of Directors approved the 1996 Equity
Compensation Plan (the "Equity Plan"), which initially provided for the grant of
options to purchase up to 2,000,000 shares of the Company's common stock. The
total number of shares authorized for issuance under the Equity Plan increased
to 6,000,000 in 1998, 7,000,000 in 2000 and 8,000,000 in 2001. Both incentive
stock options and non-qualified stock options may be issued under the provisions
of the Equity Plan. Employees of the Company and any subsidiaries, members of
the Board of Directors and certain advisors are eligible to participate in this
plan, which will terminate no later than October 14, 2006. The granting and
vesting of options under the Equity Plan are authorized by the Company's Board
of Directors or a committee of the Board of Directors.

Pro forma information regarding net income and earnings per share is required by
SFAS No. 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that accounting
pronouncement. The fair value for options awarded during the years ended
December 31, 2001, 2000 and 1999 were estimated at the date of grant using an
option pricing model with the following weighted-average assumptions: risk-free
interest rate over the life of the option of 3.6% to 6.0%; no dividend yield;
and expected two to eight year lives of the options. The estimated fair value
for these options was calculated using the minimum value method in 1996 and may
not be indicative of the future impact since this model does not take into
consideration volatility and the commencement of public trading in the Company's
common stock on February 7, 1997. The Black-Scholes model was utilized to
calculate the value of the options issued during 2001, 2000, and 1999. The
volatility factors utilized in 2001, 2000, and 1999 were 1.60, 1.46 and 1.55,
respectively.

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

For purposes of pro forma disclosure, the estimated fair value of the options is
amortized to expense over the options' vesting period. Because compensation
expense associated with an award is recognized over the vesting period, the
impact on pro forma net (loss) income as disclosed below may not be
representative of compensation expense in future years.

The Company's pro forma information for the years ended December 31 is as
follows:

<Table>
<Caption>
                                    2001             2000             1999
                                -------------    -------------    -------------
<S>                             <C>              <C>              <C>
Pro forma net loss              $  (8,074,334)   $  (8,384,271)   $    (404,224)
Pro forma net loss per common
   share (basic)                        (0.33)           (0.43)           (0.03)
Pro forma net loss per common
   share (diluted)                      (0.33)           (0.43)           (0.03)
</Table>



                                       48
<PAGE>

A summary of the Company's stock option activity and related information for the
years ended December 31 is as follows:

<Table>
<Caption>
                                              2001                      2000                       1999
                                    ------------------------   ------------------------   ------------------------
                                                   WEIGHTED-                  WEIGHTED-                  WEIGHTED-
                                                   AVERAGE                    AVERAGE                    AVERAGE
                                                   EXERCISE                   EXERCISE                   EXERCISE
                                     OPTIONS        PRICE       OPTIONS        PRICE       OPTIONS        PRICE
                                    ----------    ----------   ----------    ----------   ----------    ----------
<S>                                 <C>           <C>          <C>           <C>          <C>           <C>
Outstanding at Beginning of Year     6,537,083    $     4.31    5,536,312    $     6.10    5,277,665    $     8.41
   Granted
     Exercise price equal to
       fair value of common stock      775,333          0.39    2,682,489          1.35    2,345,692          0.91
   Exercised                           (15,000)         0.70     (113,714)         0.55     (119,813)         0.56
   Forfeited                        (2,483,138)         4.32   (1,568,004)         5.86   (1,967,232)         6.43
                                    ----------    ----------   ----------    ----------   ----------    ----------

Outstanding at end of year           4,814,278          3.68    6,537,083          4.31    5,536,312          6.10
                                    ==========                 ==========                 ==========

Exercisable at end of year           3,365,928          4.50    3,382,639          5.13    3,130,383          4.52
                                    ==========                 ==========                 ==========
</Table>


<Table>
<Caption>
                                               2001       2000       1999
                                             --------   --------   --------
<S>                                          <C>        <C>        <C>
Weighted-Average Fair Value of Options:
     Exercise price equal to fair value of
       common stock                          $   0.33   $   1.09   $    .72
</Table>

Exercise prices for options outstanding and the weighted-average remaining
contractual lives of those options at December 31, 2001 are as follows:

<Table>
<Caption>
                 OPTIONS OUTSTANDING                       OPTIONS EXERCISABLE
-------------------------------------------------------   ----------------------
                                 WEIGHTED
                                  AVERAGE     WEIGHTED-                 WEIGHTED
                                 REMAINING     AVERAGE                   AVERAGE
   RANGE OF         NUMBER      CONTRACTUAL   EXERCISE      NUMBER      EXERCISE
EXERCISE PRICES   OUTSTANDING      LIFE         PRICE     EXERCISABLE    PRICE
---------------   -----------   -----------   ---------   -----------   --------
<S>               <C>           <C>           <C>         <C>           <C>
    $0.17-$0.49       381,500          9.51   $    0.20            --       $N/A
      0.50-0.99     2,295,858          7.82        0.61     1,724,797       0.58
      1.00-1.99       415,577          8.47        1.52       236,427       1.52
      2.00-4.99       174,168          8.05        3.18        90,838       3.50
      6.00-6.99       319,109          6.37        6.71        91,400       6.62
           8.00       195,000          4.92        8.00       195,000       8.00
      9.00-9.99       541,144          6.31        9.85       535,544       9.85
    10.00-12.99       466,922          5.85       12.23       466,922      12.23
    13.00-13.25        25,000          5.87       13.25        25,000      13.25
---------------   -----------   -----------   ---------   -----------   --------
    $0.17-13.25     4,814,278          7.44   $    3.68     3,365,928   $   4.50
                  ===========                             ===========
</Table>

12. LEASES

The Company is obligated under operating leases for its offices. Future minimum
payments under the operating leases with terms in excess of one year are
summarized as follows for the years ending December 31:

<Table>
<S>                           <C>
                2002          $ 233,000
                2003             29,125
                2004                 --
                2005                 --
                2006                 --
                              ---------
              Totals          $ 262,125
                              =========
</Table>

Rent expense for the years ended December 31, 2001, 2000 and 1999 under all
operating leases was approximately $272,000, $240,000 and $2,100,000,
respectively. Approximately $1,900,000 of such amounts was charged directly to
the Affiliated Practices as clinic expenses for the year ended December 31,
1999.

13. INCOME TAXES

The Company is a corporation subject to federal and certain state and local
income taxes. The provision for income taxes is made pursuant to the liability
method as prescribed in Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes. The liability method requires recognition of
deferred income taxes based on temporary differences between the financial
reporting and income tax bases of assets and liabilities, using currently
enacted income tax rates and regulations.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for



                                       49
<PAGE>

financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities at
December 31, 2001 and 2000 are as follows:

<Table>
<Caption>
                                          2001            2000
                                      ------------    ------------
<S>                                   <C>             <C>
Deferred tax assets:
  Property and equipment, net         $    191,295    $    154,714
  Web development costs                     87,868         121,157
  Accrued liabilities                       29,679          90,890
  Deferred start-up expenditures            26,236         194,362
  Allowance for doubtful accounts           23,541         247,934
  Net operating loss carryforwards       7,888,410       4,941,059
                                      ------------    ------------
                                         8,247,029       5,750,116
Valuation allowance for deferred
  tax assets                            (8,195,339)     (5,645,584)
                                      ------------    ------------

Gross deferred tax asset                    51,690         104,532
                                      ------------    ------------

Deferred tax liabilities:
  Prepaid expenses                          51,690          71,363
  Deferred gain on installment sale             --          33,169
                                      ------------    ------------

Gross deferred tax liability                51,690         104,532
                                      ------------    ------------

Net deferred tax liability            $         --    $         --
                                      ============    ============
</Table>

The Company has established a $8,195,339 valuation allowance as of December 31,
2001. The valuation allowance results from uncertainty regarding the Company's
ability to produce sufficient taxable income in future periods necessary to
realize the benefits of the related deferred tax assets. During 2001, the
valuation allowance was increased by $2,549,755 principally due to the Company's
2001 operating loss.

The income tax (benefit) expense for the years ended December 31, 2001, 2000,
and 1999 is summarized as follows:

<Table>
<Caption>
                2001           2000            1999
            ------------   ------------    ------------
<S>         <C>            <C>             <C>
Current:
  Federal   $         --   $   (472,897)   $ (1,662,165)
  State               --          3,000         119,782
            ------------   ------------    ------------
                      --       (469,897)     (1,542,383)
            ------------   ------------    ------------
Deferred:
  Federal             --             --        (839,331)
  State               --             --        (243,847)
            ------------   ------------    ------------
                      --             --      (1,083,178)
            ------------   ------------    ------------
Total       $         --   $   (469,897)   $ (2,625,561)
            ============   ============    ============
</Table>

The income tax (benefit) expense differs from amounts currently payable because
certain revenues and expenses are reported in the statement of operations in
periods that differ from those in which they are subject to taxation. The
principal differences relate to different methods of calculating depreciation
for financial statement and income tax purposes, business acquisition and
start-up expenditures that are capitalized for income tax purposes and expensed
for financial statement purposes and currently non-deductible book accruals and
reserves.

A reconciliation between the statutory federal income tax rate of 34% and the
Company's 0.0%, (5.9%) and (158.1%) effective tax rates for the years ended
December 31, 2001, 2000, and 1999, respectively, is as follows:

<Table>
<Caption>
                                              2001       2000       1999
                                             ------     ------     ------
<S>                                          <C>        <C>        <C>
Federal statutory income tax rate             (34.0)%    (34.0)%    (34.0)%
State income taxes, net of federal benefit     (5.1)      (5.6)      (4.9)
Non-deductible goodwill amortization,
 business acquisition and other costs           5.3        3.7        5.3
Miscellaneous                                  (0.8)      (2.9)       3.4
Deferred tax asset valuation allowance         34.6       32.9     (127.9)
                                             ------     ------     ------

Effective income tax rate                       0.0%      (5.9)%   (158.1)%
                                             ======     ======     ======
</Table>

The Company has approximately $19,000,000 in net operating loss carryforwards,
which expire during 2019 through 2021. Certain changes in stock ownership can
result in a substantial limitation on the amount of the net operating loss
carryforwards that can be utilized following an ownership change. The Company
has determined it has undergone such an ownership change during 2001.
Consequently, future utilization of the net operating loss carryforwards will be
subject to these limitations. Additionally,



                                       50
<PAGE>

approximately $4,500,000 of the net operating loss carryforwards relate to the
Company's wholly-owned subsidiary, Healthcare Ratings, Inc., and are subject to
Separate Return Limitation Year ("SRLY") limitations. The SRLY limitations
permit an offset to consolidated taxable income only to the extent of taxable
income attributable to the member with the SRLY loss.

14. LEGAL PROCEEDINGS

The Company is subject to legal proceedings and claims that arise in the
ordinary course of its business. In the opinion of management, the amount of
ultimate liability with respect to these actions will not materially affect the
financial position of the Company.

15. COMMITMENTS AND CONTINGENCIES

The Company has entered into employment agreements that provide key executives
and employees with minimum base pay, annual incentive awards and other fringe
benefits. The Company expenses all costs related to the agreements in the period
that the services are rendered by the employee. In the event of death,
disability, termination with or without cause, voluntary employee termination,
and change in ownership of the Company, etc., the Company may be partially or
wholly relieved of its financial obligations to such individuals. However, under
certain circumstances, a change in control of the Company may provide
significant and immediate enhanced compensation to the employees possessing
employment contracts. At December 31, 2001, the Company was contractually
obligated to pay base pay compensation to certain officers of $419,506 through
December 31, 2002.

16. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per
share for the years ended December 31, 2001, 2000 and 1999.

<Table>
<Caption>
                                                      2001             2000             1999
                                                  -------------    -------------    -------------
<S>                                               <C>              <C>              <C>
Numerator for both basic and diluted earnings
  per share:
  Net income (loss)                               $  (7,367,243)   $  (7,544,746)   $     964,930
                                                  =============    =============    =============
Denominator:
  Denominator for basic net income (loss) per
     common share--weighted average shares           24,399,699       19,535,841       14,202,748
  Effect of dilutive securities:
     Employee stock options                                  --               --          614,984
                                                  -------------    -------------    -------------
  Denominator for diluted net income (loss) per
     common share--adjusted weighted average
     shares and assumed conversion                   24,399,699       19,535,841       14,817,732
                                                  =============    =============    =============

Net (loss) income per common share (basic)        $       (0.30)   $       (0.39)   $        0.07
                                                  =============    =============    =============
Net (loss) income per common share (diluted)      $       (0.30)   $       (0.39)   $        0.07
                                                  =============    =============    =============
</Table>

For additional disclosures regarding employee stock options, and warrants, see
Notes 7 and 11.

Options to purchase 4,814,278 and 6,537,083 shares of common stock were
outstanding during 2001 and 2000, but were not included in the computation of
diluted earnings per common share for the respective years because the effect
would be antidilutive based on the Company's net loss for the year.

Options to purchase 3,608,804 shares of common stock were outstanding during
1999, but were not included in the computation of diluted earnings per share for
the years then ended because the options' exercise price was greater than the
average market price of the common shares and, therefore, the effect would be
antidilutive.

17. EMPLOYEE BENEFIT PLAN

Effective May 1, 1997, the Company adopted a defined contribution employee
benefit plan covering substantially all employees of the Company, most
affiliated physicians and other employees of the affiliated practices.
Participants must have attained age 21 and completed one year of service with
either the Company or one of the Affiliated Practices in order to participate in
the plan. The plan was designed to qualify under Section 401(k) of the Internal
Revenue Code of 1986, as amended. The plan included a matching contribution
equal to up to 4% of eligible employee salaries and a discretionary defined
contribution. There was no discretionary contribution made for the year ended
December 31, 1999.



                                       51
<PAGE>

Effective January 1, 1999, the matching contribution component of the employee
benefit plan was eliminated and replaced with a Qualified Non-Elective
Contribution equal to 3% of annual compensation. The employer contribution was
applicable to all eligible participants, regardless of whether or not the
participant contributed to the employee benefit plan. Additionally, effective
April 1, 1999, the age and service requirements of the employee benefit plan
were eliminated. On September 13, 2000, the Board of Directors of the Company
approved the termination of the Company's employee benefit plan.

Effective January 2001, the Company established a new retirement savings plan.
The new plan is a defined contribution plan covering substantially all employees
of the Company. The new plan includes a Qualified Non-Elective Contribution
equal to 3% of annual compensation, applicable to all eligible participants,
regardless of whether or not the participant contributes to the plan.

Expense under the Company's benefit plans, including the discretionary matching
contributions, aggregated approximately $122,000, $108,000 and $612,000 for
2001, 2000 and 1999, respectively, of which approximately $0, $0 and $540,000
were charged directly to the Affiliated Practices as clinic expenses.

18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the quarterly results of operations for the years
ended December 31, 2001 and 2000.



<Table>
<Caption>
2001                                  MARCH 31        JUNE 30         SEPT. 30        DEC. 31
                                    ------------    ------------    ------------    ------------
<S>                                 <C>             <C>             <C>             <C>
Revenue:
   Ratings and advisory
     revenue                        $    558,862    $    661,310    $    874,617    $    930,513
   Physician practice
     service fees                        136,016         136,015         136,016         143,878
   Other                                   2,709             877            (300)          1,204
                                    ------------    ------------    ------------    ------------
                                         697,587         798,202       1,010,333       1,075,595
Costs and expenses:
   Ratings and advisory
     costs and expenses:
     Production, content and
       product development               291,435         255,090         259,635         258,148
     Sales and marketing                 371,652         281,876         316,182         361,436
     Physician practice
       services costs and
       expenses:
     Litigation and other costs           45,087         324,137         237,338              --
     General and administrative        2,296,250       2,497,436       2,010,924       1,395,864
                                    ------------    ------------    ------------    ------------

         Total costs and expenses      3,004,424       3,358,539       2,824,079       2,015,448
 (Loss) income from operations        (2,306,837)     (2,560,337)     (1,813,746)       (939,853)
 Other:
    (Loss) gain on settlement
      agreements, sale of assets,
      practice disputes and
      amendment and restatement
      of service agreements                  325              --             (29)        191,619
    Interest income                       54,566          23,642           6,756           5,445
    Interest expense                     (28,563)           (231)             --              --
                                    ------------    ------------    ------------    ------------

(Loss) income before income
      taxes                           (2,280,509)     (2,536,926)     (1,807,019)       (742,789)
Income tax benefit (expense)                  --              --              --              --
                                    ------------    ------------    ------------    ------------

Net (loss) income                     (2,280,509)     (2,536,926)     (1,807,019)       (742,789)
                                    ============    ============    ============    ============

Net (loss) income per common
  share (basic)                     $      (0.11)   $      (0.12)   $      (0.08)   $      (0.02)
                                    ============    ============    ============    ============
Weighted average number of
  common shares used in
  computation (basic)                 21,507,758      21,273,425      21,273,425      33,447,338
                                    ============    ============    ============    ============

Net (loss) income per common
  share (diluted)                   $      (0.11)   $      (0.12)   $      (0.08)   $      (0.02)
                                    ============    ============    ============    ============

Weighted average number of
  common shares and
  common share equivalents
  used in computation
  (diluted)                           21,507,758      21,273,425      21,273,425      33,447,338
                                    ============    ============    ============    ============
</Table>



                                       52
<PAGE>

<Table>
<Caption>
2000                                  MARCH 31        JUNE 30         SEPT. 30        DEC. 31
                                    ------------    ------------    ------------    ------------
<S>                                 <C>             <C>             <C>             <C>
Revenue:
   Ratings and advisory
     revenue                        $    310,533    $    376,534    $    428,156    $    463,756
   Physician practice
     service fees                      1,579,430       1,988,381         375,923         305,924
   Other                                   2,719              --           1,128           5,204
                                    ------------    ------------    ------------    ------------
                                       1,892,682       2,364,915         805,207         774,884
Costs and expenses:
   Ratings and advisory
     costs and expenses:
     Production, content and
       product development               618,827         586,765         466,593         413,217
     Sales and marketing                 269,309         401,844         491,871         409,481
     Physician practice
       services costs and
       expenses:
     Litigation and other costs          369,223         202,612          85,271         154,978
     General and administrative        2,174,166       1,888,247       2,260,894       2,400,127
                                    ------------    ------------    ------------    ------------

         Total costs and expenses      3,431,525       3,079,468       3,304,629       3,377,803
 (Loss) income from operations        (1,538,843)       (714,553)     (2,499,422)     (2,602,919)
 Other:
    (Loss) gain on sale of
      assets, practice
      disputes and amendment
      and restatement of
      service agreements                (336,653)        141,874         (61,473)       (442,758)
    Interest income                       51,154         208,202         141,024         111,277
    Interest expense                    (316,075)        (59,718)        (52,648)        (43,112)
                                    ------------    ------------    ------------    ------------

(Loss) income before income
      taxes                           (2,140,417)       (424,195)     (2,472,519)     (2,977,512)
Income tax benefit (expense)                  --              --              --         469,897
                                    ------------    ------------    ------------    ------------

Net (loss) income                     (2,140,417)       (424,195)     (2,472,519)     (2,507,615)
                                    ============    ============    ============    ============

Net (loss) income per common
  share (basic)                     $      (0.16)   $      (0.02)   $      (0.11)   $      (0.12)
                                    ============    ============    ============    ============
Weighted average number of
  common shares used in
  computation (basic)                 13,504,008      21,522,105      21,536,065      21,538,769
                                    ============    ============    ============    ============

Net (loss) income per common
  share (diluted)                   $      (0.16)   $      (0.02)   $      (0.11)   $      (0.12)
                                    ============    ============    ============    ============

Weighted average number of
  common shares and
  common share equivalents
  used in computation
  (diluted)                           13,504,008      21,522,105      21,536,065      21,538,769
                                    ============    ============    ============    ============
</Table>

19. SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental noncash investing and financing activities are as follows:

The Company used approximately $1.2 million classified as restricted cash in its
1999 consolidated balance sheet to pay down the Company's term loan in 2000.

In 2000, the Company received 888,779 shares of its common stock under the terms
of a settlement agreement with one of its former affiliated practices.

In February 2000, the Company merged its majority-owned subsidiary, HG.com, Inc.
into a recently formed, wholly-owned subsidiary, HealthCare Ratings, Inc. (the
"Merger Transaction"). In connection with the Merger Transaction, the minority
shareholders of HG.com were given 800,000 shares of Company common stock.



                                       53
<PAGE>

In March 2000, certain of the Company's officers exchanged $3.2 million in notes
payable for an aggregate of 1.6 million shares of Company common stock and
five-year warrants to purchase 560,000 shares of Company common stock at $4.00
per share.

20. SUBSEQUENT EVENTS

On February 7, 2002, the Company's stockholders approved the Health Grades, Inc.
Stock Purchase Plan (the "Stock Purchase Plan"), an amendment to increase the
total number of shares authorized for issuance under the Equity Plan to
13,000,000 shares and increased the number of shares of Company common stock
authorized for issuance to 100,000,000 shares.



                                       54
<PAGE>

                      Health Grades, Inc. and Subsidiaries

                Schedule II -- Valuation and Qualifying Accounts

<Table>
<Caption>
                                     BALANCE AT     CHARGED TO         CHARGED TO                           BALANCE AT
                                     BEGINNING      COSTS AND            OTHER                                END OF
          DESCRIPTION                OF PERIOD       EXPENSES           ACCOUNTS         DEDUCTIONS           PERIOD
          -----------               ------------   ------------       ------------      ------------       ------------
<S>                                 <C>            <C>                <C>               <C>                <C>
Year ended December 31, 2001
     Allowance for doubtful
       accounts on management fee
       receivables                  $    231,895   $         --       $         --      $   (231,895)(2)   $         --

     Allowance for doubtful
       accounts on trade
       receivables                  $     80,183   $     85,319       $         --      $   (108,083)(2)   $     57,419


Year ended December 31, 2000
     Allowance for contractual
       adjustments and doubtful
       accounts on receivables
       due from affiliated
       Physician practices in
       litigation                   $    839,032   $         --       $         --      $   (839,032)(4)   $         --

     Allowance for doubtful
       accounts on management fee
       receivables                  $  1,434,073   $     35,090       $         --      $   (357,876)(2)   $    231,895
                                                                                        $   (879,392)(4)

     Allowance for doubtful
       accounts on trade
       receivables                  $         --   $     80,183       $         --      $         --       $     80,183
Year ended December 31, 1999
Reserves and allowances deducted
  from asset accounts:
     Allowance for contractual
       adjustments and doubtful
       accounts on patient
       accounts receivable          $ 22,161,082   $         --       $ 29,670,283(1)    (21,862,431)(4)   $         --
                                                                                         (29,968,934)(2)
     Allowance for contractual
       adjustments and doubtful
       accounts on receivables
       due from affiliated
       Physician practices in
       litigation                   $  7,397,144   $  2,407,848       $         --      $ (6,706,068)(4)   $    839,032
                                                     (1,719,532)(3)             --          (540,360)(5)

     Allowance for doubtful
       accounts on management
       fee receivables              $         --   $  1,040,428       $    540,360(5)   $   (146,715)(6)   $  1,434,073
</Table>

(1)  Contractual adjustments recognized in the purchase of monthly net accounts
     receivable balances for the periods presented.

(2)  Represents actual amounts charged against the allowance for the periods
     presented.

(3)  Recoveries of amounts previously reserved, included in other revenue in the
     consolidated financial statements.

(4)  Sold in conjunction with disposition of restructured affiliated practices.

(5)  Transferred from allowance for contractual adjustments and doubtful
     accounts due from affiliated practices in litigation to allowance for
     doubtful accounts on management service fee receivables.



                                       55
<PAGE>

                    SUPPLEMENTAL INFORMATION TO BE FURNISHED
                         WITH REPORTS FILED PURSUANT TO
                           SECTION 15(d) OF THE ACT BY
                      REGISTRANTS WHICH HAVE NOT REGISTERED
                  SECURITIES PURSUANT TO SECTION 12 OF THE ACT.


         No annual report covering the Registrant's last fiscal year and no
proxy statement, form of proxy or other soliciting material relating to the
Registrant's 2002 annual meeting of stockholders has been sent to the
Registrant's stockholders. The Registrant intends to send a report to
stockholders for the period covered by this report and a proxy statement and
proxy with respect to the Registrant's next annual meeting of stockholders. The
Registrant will furnish copies of such material when such material is sent to
its stockholders. Such material shall not be deemed to be "filed" with the
Commission or otherwise subject to the liabilities of Section 18 of the
Securities Exchange Act of 1934.



                                       56
<PAGE>

                                INDEX TO EXHIBIT

<Table>
<Caption>
       EXHIBIT
       NUMBER                                DESCRIPTION
       -------                               -----------
<S>                        <C>
         3.1               Certificate of Amendment of Amended and Restated
                           Certificate of Incorporation and Amended and Restated
                           Certificate of Incorporation

         3.2               Amended and Restated Bylaws

         10.1              1996 Equity Compensation Plan, as amended
                           (incorporated by reference to Exhibit 10.1 to the
                           Company's Quarterly Report on Form 10-Q for the
                           quarter ended March 31, 2001.)

         10.5              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
                           the Company's Registration Statement on Form S-1
                           (File No. 333-17627))

         10.9              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
                           the Company's Annual Report on Form 10-K for the
                           fiscal year ended December 31, 1997)

         21                Subsidiaries of the registrant.

         23                Consent of Ernst & Young LLP.
</Table>



                                       57