| HEALTH GRADES INC Item 1A Risk Factors |
| Risks Related to Our Business OUR BUSINESS WILL SUFFER IF WE ARE NOT ABLE TO OBTAIN RELIABLE DATA AS A BASIS FOR OUR HEALTHCARE INFORMATION To provide our healthcare information, we must be able to receive comprehensive, reliable data |
| We currently obtain this data from a number of public and private sources |
| Currently, the information we utilize to compile our hospital ratings is acquired from the Centers for Medicare and Medicaid Services (“CMS”) |
| For the year ended December 31, 2005, revenues derived from SQP, SQI, and QAI products accounted for approximately 72prca of our total ratings and advisory revenue |
| These products are based exclusively on our hospital ratings |
| Moreover, some of our QRS modules are based on information acquired from CMS Our business could suffer if some of our data sources, particularly, CMS, were to begin charging for use or access to this data, or cease to make such information available, and suitable alternative sources were not identified on a timely basis |
| Moreover, our ability to attract and retain customers is dependent on the reliability of the information that we use and purchase |
| If our information is inaccurate or otherwise erroneous, our reputation and customer 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 denied, that our use of the information violated the terms of our agreements with the providers |
| 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, or which charges substantially more for such data, could hurt our business |
| FAILURE TO EFFECTIVELY MANAGE THE GROWTH OF OUR OPERATIONS AND INFRASTRUCTURE COULD DISRUPT OUR OPERATIONS AND PREVENT US FROM MAINTAINING OR INCREASING PROFITABLITY We have expanded meaningfully in the past few years and are seeking to increase our sales efforts, attract new clients, maintain existing clients and develop new products |
| To manage our growth, we must successfully attract qualified personnel and successfully integrate new personnel into our operations |
| Our failure to manage personnel and otherwise appropriately manage expansion of our business could adversely affect our business and future growth |
| WE MAY BE SUED FOR INFORMATION WE OBTAIN OR INFORMATION RETRIEVED FROM OUR WEBSITES OR OTHERWISE PROVIDED TO EMPLOYERS AND OTHERS We may be subjected to claims for defamation, negligence, copyright or trademark or patent 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 |
| We have had disputes with certain physicians with respect to the accuracy of their data that is included in reports we sell to consumers and professionals, and have settled litigation with some of these physicians |
| Continuing to improve the accuracy of our data by both internal process measures and by obtaining data from various sources for comparative purposes will continue to be important for us |
| 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, among other things, treatment provided by hospitals or other facilities that are highly rated by us, or by doctors who are identified on our website |
| 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 healthcare services or erroneous health information |
| Such exposure may adversely affect our business |
| Moreover, the amount of insurance we maintain 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 STRENGTHEN RECOGNITION OF OUR BRAND NAME, OUR ABILITY TO EXPAND OUR BUSINESS WILL BE IMPAIRED 15 _________________________________________________________________ [65]Table of Contents To expand our audience of online users, increase our online traffic and increase interest in our other healthcare information services, we must strengthen recognition of our brand name |
| To be successful in this effort, consumers must perceive us as a trusted source of healthcare information; hospitals and other providers must perceive us as an effective marketing and sales channel for their services and products; and employees, payers, insurers, consumers and others must perceive us as a source of valuable information that can be used to enhance the quality and cost-effectiveness of healthcare |
| We may be required to increase substantially our marketing budget in our efforts to strengthen brand name recognition |
| OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO ATTRACT, RETAIN AND MOTIVATE HIGHLY SKILLED EMPLOYEES Our ability to execute our business plan and be successful depends upon our ability to attract, retain and motivate highly skilled employees when needed |
| As we expand our business, we 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 depend on providers of online content and services for some of the content and applications that we make available through healthgrades |
| Any significant interruptions in our services or increase in response time could result in the loss of potential or existing users or customers |
| 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: • damage from fire, power loss and other natural disasters; • communications failures; • software and hardware errors, failures or crashes; • security breaches, computer viruses and similar disruptive problems; and • other potential interruptions |
| Our website may be required to accommodate a high volume of traffic and deliver frequently updated information |
| Our website 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 If we fail to adequately protect our intellectual property rights, our business could be harmed by making it easier for our competitors to duplicate our services |
| We have certain trademarks and copyrights that have been registered with the US Patent and Trademark Office and the US Copyright Office, respectively |
| 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 or branding 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 |
| 16 _________________________________________________________________ [66]Table of Contents 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 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 HOSPITALS AND OTHERS UTILIZE OUR NAME AND RATINGS WITHOUT OUR PERMISSION In order for a hospital to use our name and ratings information, we require them to enter into a marketing agreement with us |
| However, hospitals, the media and others may take the position that certain use of our ratings is “fair use” and not proprietary |
| We will need to continue to enforce the protection of our proprietary information and aggressively pursue selected hospitals and others that utilize our name and ratings information without our permission |
| If our enforcement efforts are unsuccessful, our business may be adversely affected |
| 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 or customers, 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 remain profitable |
| WE RELY LARGELY ON ADVERTISING AND SEARCH ENGINE PLACEMENT TO GENERATE TRAFFIC TO OUR WEBSITE We rely on online media to attract a significant percentage of the visitors to our web site |
| Prices for online advertising could increase as a result of increased demand for advertising inventory, which would cause our expenses to increase and could result in lower margins |
| Our advertising contracts with online search engines are typically short-term |
| If one or more search engines on which we rely for advertising modifies or terminates its relationship with us, our expenses could increase, the number of visitors we generate could decrease and our revenues or margins could decline |
| Additionally, changes to our position within search engine search results could cause visits to our website and the number of reports ordered from our website to decline |
| OUR BUSINESS WILL SUFFER IF WE ARE NOT ABLE TO COMPETE SUCCESSFULLY The market for healthcare 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 healthcare information services and products, both online and through traditional means |
| We compete, directly and indirectly, for users and customers principally with: • data providers that provide detailed utilization and outcomes information to hospitals; • healthcare consulting companies; • companies or organizations providing or maintaining online healthcare information; • vendors of healthcare information, products and services distributed through other means, including direct sales, mail and fax messaging; • companies and organizations providing or maintaining general purpose consumer online services that provide access to healthcare 17 _________________________________________________________________ [67]Table of Contents content and services; • companies and organizations providing or maintaining public sector and non-profit websites that provide healthcare information and services without advertising or commercial sponsorships; • companies and organizations providing or maintaining web search and retrieval services and other high-traffic websites; and • publishers and distributors of traditional media, some of which have established or may establish websites Some of these competitors are larger, have greater resources and have more experience in providing healthcare information than us |
| RISKS RELATED TO HEALTHCARE INFORMATION AND THE INTERNET HEALTHCARE REFORMS AND THE COST OF REGULATORY COMPLIANCE COULD NEGATIVELY AFFECT OUR BUSINESS The healthcare industry is heavily regulated |
| In the ordinary course of business, healthcare entities and companies that do business with them are subject to state and federal regulatory scrutiny, supervision, oversight and control |
| These various laws, regulations and guidelines affect, among other matters, the provision, licensing, labeling, marketing, promotion and reimbursement of healthcare services and products |
| Our failure or the failure of our customers to comply with any applicable legal or regulatory requirements, or any investigation or audit of our or our customers’ practices could: • result in limitation or prohibition of business activities; • subject us or our customers to legal fees and expenses and adverse publicity; or • increase the costs of regulatory compliance and, if found by a court of competent jurisdiction to have engaged in improper practices, subject us or our customers to criminal or civil monetary fines or other penalties A federal law commonly known as the Medicare/Medicaid Anti-Kickback Law prohibits kickbacks, rebates and bribes in return for referrals |
| This law provides an extremely broad base for finding violations |
| Indeed, any remuneration, direct or indirect, offered, paid, solicited or received in return for referrals of patients or business for which payment may be made in whole or in part under Medicare or Medicaid could be considered a violation of law |
| The statute also prohibits payments made to anyone to induce them to “recommend purchasing, leasing or ordering any good, facility, service or item for which payment may be made in whole or in part” by Medicare |
| We believe that our operations comply with applicable legal regulatory requirements of the anti-kickback laws |
| Nevertheless, 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 customers such as hospitals |
| It is possible that additional or more restrictive laws, regulations or guidelines could be adopted in the future |
| Criminal provisions prohibit knowingly filing false claims or making false statements or causing false statements to be made by others, and civil provisions prohibit the filing of claims or causing the filing of claims that one knows were false |
| Criminal penalties include fines and imprisonment |
| Civil penalties under the federal False Claims Act (“FCA”) include fines of up to dlra10cmam000 per claim plus treble damages, for each filed claim |
| Although we are not filing claims ourselves, liability under the FCA can extend to those who cause claims to be filed |
| In addition, under the Deficit Reduction Act of 2005, states are encouraged to enact their own false claims laws, which could increase the number of false claims suits at the state level |
| To the extent that consulting advice provided to our customers could be construed as aiding or abetting the presentation of false claims by the customers, we could be subject to false claims liability |
| THE INTERNET IS SUBJECT TO MANY LEGAL UNCERTAINTIES AND POTENTIAL GOVERNMENT LAWS AND REGULATIONS THAT MAY DECREASE USAGE OF OUR WEBSITE, INCREASE OUR COST OF DOING BUSINESS OR OTHERWISE HAVE A DAMAGING EFFECT ON OUR BUSINESS Laws and regulations have been adopted and will likely continue to be adopted in the future that address Internet-related issues, 18 _________________________________________________________________ [68]Table of Contents 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 many more years to determine the extent to which laws and regulations passed prior to the popular use of the Internet govern issues like property ownership, libel, negligence and personal privacy are applicable to the Internet |
| Currently, US 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 |
| Laws and regulations in countries outside the United States restrict the availability of new markets in other countries where those markets would otherwise be available for expansion, and reduce any potential savings in relocating any operations of the Company to those countries |
| Moreover, restrictive privacy and other laws outside the United States serve as a model for new and more restrictive laws inside the United States at both the Federal and the State levels |
| 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 |
| 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 healthcare providers and facilities can also be compiled by our systems in connection with services we offer to employers and other payers |
| Numerous federal and state laws and regulations govern collection, dissemination, use and confidentiality of patient-identifiable health information, including: • state privacy and confidentiality laws; • state laws regulating healthcare professionals, such as physicians, pharmacists and nurse practitioners; • Medicaid laws; • the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and related rules proposed by the Health Care Financing Administration; and • CMS standards for electronic transmission of health data Congress may consider future legislation that would establish more strict standards for protection and use of health information |
| While we are not gathering patient health information at this time and we are not a covered entity under HIPAA, other third-party websites that consumers access through our website and employees, payers 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 our provision of healthcare 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, such as 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 |
| 19 _________________________________________________________________ [69]Table of Contents 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 |
| OTHER RISKS OUR CERTIFICATE OF INCORPORATION AND BYLAWS INCLUDE ANTI-TAKEOVER PROVISIONS THAT MAY DETER OR PREVENT A CHANGE OF CONTROL 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 2/3prca 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 2cmam000cmam000 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 15prca 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, and thereby could prevent our stockholders from receiving a premium for their shares |
| In addition, the foregoing provisions could impair the ability of existing stockholders to remove and replace our management and/or our Board of Directors |
| 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 |