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ATHN > SEC Filings for ATHN > Form 10-Q on 18-Oct-2013All Recent SEC Filings

Show all filings for ATHENAHEALTH INC

Form 10-Q for ATHENAHEALTH INC


18-Oct-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical fact contained in this Quarterly Report on Form 10-Q are forward-looking statements, including those regarding the combination or integration of newly acquired services; the integration of Epocrates; the purchase of the Arsenal on the Charles campus; expected tax credits from states; expanded sales and marketing efforts; changes in expenses related to operations, selling, marketing, research and development, general and administrative matters, and depreciation and amortization; liquidity issues; additional fundraising; and the expected performance period and estimated term of our client relationships, as well as more general statements regarding our expectations for future financial and operational performance, product and service offerings, regulatory environment, and market trends. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," or "continue"; the negative of these terms; or other comparable terminology. Forward-looking statements in this Item 2 include, without limitation, statements reflecting management's expectations for future financial performance and operating expenditures, expected growth, profitability and business outlook, increased sales and marketing expenses, increased cross-selling efforts among our service offerings, expected client implementations, expected certification and regulatory approvals and the benefits of our current service offerings and research and development for new service offerings and the benefits of current and expected strategic and sales and marketing relationships.
Forward-looking statements are only current predictions and are subject to known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from those anticipated by such statements. These factors include, among other things, those set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, under the heading Part I, Item 1A "Risk Factors" and any set forth below under Part II, Item 1A, "Risk Factors." Although we believe that the expectations reflected in the forward-looking statements contained in this Quarterly Report on Form 10-Q are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except as required by law, we are under no duty to update or revise any of such forward-looking statements, whether as a result of new information, future events, or otherwise, after the date of this Quarterly Report on Form 10-Q.
Overview
athenahealth provides business services that help medical caregivers achieve and sustain financial health by collecting more money and exercising more control over their administrative and clinical tasks. These services are designed to reduce the administrative burden of complex billing rules, quality measurement and reporting, clinical documentation and data exchange, patient communication and referrals, and many of the related tasks that distract medical caregivers and staff from delivering care. Our services are delivered and consumed through a single instance of our cloud-based platform, athenaNet. We differentiate our services by regularly deploying updates and improvements through athenaNet to clients without any action on the part of the client. athenaNet enables us to quickly implement our solution at a low up-front cost and to seamlessly work in tandem with our clients in real time.
The services provided through our single-instance cloud are currently packaged as five integrated components: athenaCollector for revenue cycle management, athenaClinicals for electronic health record management, athenaCommunicator for patient communication management, and athenaCoordinator for referral cycle management. The use of our single-instance platform allows all clients to benefit from the collective knowledge of all of our other clients through our patented billing Rules Engine and our clinical Quality Management Engine. Our clients use these rules engines to monitor and benchmark their performance with peer practices across the network. Complementing athenaCollector is our cloud-based analytics service, athenaClarity, which delivers actionable insight in both fee-for-service and risk-based payment environments.
Each service we provide is supported by a model comprised of three distinct components: Software, Knowledge, and Work. The cloud-based software is provided at no extra charge to users but is the primary conduit through which we exchange information between clients, payers, and our staff of experts. Knowledge is infused into each of our services via our Rules Engine as we work with clients, payers, and other partners to codify rules associated with reimbursement, clinical quality measures, and other factors related to our clients' performance. The third component to each of our services is the Work that we perform on behalf of our clients. Wherever possible, we replace manual processes with automation, but where automation is not possible, we provide that manual labor rather than returning it to clients to be completed. This unique service model of Software, Knowledge, and Work has allowed us to align our success with our clients' performance, creating a continual cycle of improvement and efficiency. We charge clients a percentage of collections in most cases, so our financial results are a direct reflection of our ability to drive revenue to medical practices.


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For the nine months ended September 30, 2013, we generated revenue of $423.4 million from the sale of our services compared to $306.0 million for the nine months ended September 30, 2012. Given the scope of our market opportunity, we have increased our spending each year on growth, innovation, and infrastructure. Our revenue is predominately derived from business services that we provide on an ongoing basis. This revenue is generally determined as a percentage of payments collected by us on behalf of our clients, so the key drivers of our revenue include growth in the number of physicians and other medical providers working within our client accounts, the collections of these physicians, and the number of services purchased. To provide these services, we incur expenses in several categories, including direct operating, selling and marketing, research and development, general and administrative, and depreciation and amortization. In general, our direct operating expense increases as our volume of work increases, whereas our selling and marketing expense increases in proportion to our intended growth rate of adding new accounts to our network of physician clients. Our other expense categories are less directly related to growth of revenues and relate more to our planning for the future, our overall business management activities, and our infrastructure. We manage our cash and our use of credit facilities to ensure adequate liquidity, in adherence to related financial covenants.
Recent Developments
Watertown, MA Corporate Headquarters - the Arsenal on the Charles On May 10, 2013, we acquired the real estate commonly known as the Arsenal on the Charles, located in Watertown, Massachusetts. The Arsenal on the Charles is an expansive 29-acre, multi-building, commercial property where we were leasing our headquarters prior to the transaction. The purpose of this acquisition is to allow for future expansion of the corporate headquarters to accommodate anticipated headcount growth. The purchase price was $168.5 million, subject to working capital adjustments. The fair value of the consideration paid was $167.3 million, all of which was paid in cash. The acquisition of our Watertown, Massachusetts, corporate headquarters increased our total assets on the condensed consolidated balance sheet by approximately $170 million, primarily due to increases in property and equipment of $144.1 million and intangible assets of $25.5 million. Total liabilities increased by approximately $160 million due to increases in borrowings. See Note 2. Acquisitions in the notes to the condensed consolidated financial statements for detailed information related to the business combination accounting. Massachusetts Incentive Tax Credits
During the three months ended June 30, 2013, the Commonwealth of Massachusetts awarded us approximately $9.5 million of Massachusetts investment tax credits over 10 years, subject to fulfillment of capital investment and jobs commitments by us. The agreement was signed during the three months ended September 30, 2013.
Epocrates, Inc.
On March 12, 2013, we acquired Epocrates, a leading provider of essential clinical content, practice tools, and health industry engagement via mobile devices at the point of care. The Epocrates member network consists of more than one million health care professionals, including approximately 50% of U.S. physicians, who routinely use its solutions and services. Epocrates' portfolio includes top-ranked medical applications, such as the industry's #1 medical application among U.S. physicians, which provides convenient, point-of-care access to information such as dosing, drug interactions, pricing, and insurance coverage for thousands of brand, generic, and over-the-counter drugs. The features available through its unique physician platform are often referenced multiple times per day and help health care professionals make more informed prescribing decisions, improve workflow, and enhance patient safety. Epocrates offers its products on major U.S. mobile platforms, including Apple, Android, and BlackBerry. Epocrates generates revenue by providing clients in the health care industry (e.g., pharmaceutical companies, managed care companies, and market research firms) with interactive services to engage with its network of members and through the sale of subscriptions to its premium drug and clinical reference tools to health care professionals. Its client base is located almost entirely within the U.S. We acquired Epocrates for the assembled workforce, expected synergies, and accelerated awareness of athenahealth's services across the physician market and to deliver high-value information to the clinical community.
The acquisition of Epocrates increased our total assets on the condensed consolidated balance sheet by approximately $180 million, primarily due to increases in goodwill of $148 million, purchased intangible assets of $140 million and accounts receivable of $23 million, which were offset by a decrease in cash of $145 million. Total liabilities and stockholders' equity increased $180 million, primarily due to increases in borrowings of $105 million, net long-term deferred tax liabilities of $40 million, deferred revenue of $30 million, and a $13 million increase in additional paid-in capital related to the equity portion of the fair value of consideration paid. See Note 2. Acquisitions in the notes to the condensed consolidated financial statements for detailed information related to the business combination accounting.


Critical Accounting Policies
Our discussion and analysis of our results of operations and liquidity and capital resources are based on our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"). In connection with the preparation of our condensed consolidated financial statements in conformity with GAAP, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors we believe to be relevant at the time we prepare our condensed consolidated financial statements. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our condensed consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
Our condensed consolidated financial statements use estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and assumptions are used for, but are not limited to:
(1) revenue recognition; including our estimated expected customer life;
(2) asset impairments; (3) estimated useful lives of assets; (4) fair value of stock options; (5) allocation of direct and indirect expenses; (6) fair value of contingent consideration and acquired intangible assets in a business combination; and (7) litigation reserves. Future events and their effects cannot be predicted with certainty, and accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our condensed consolidated financial statements will change as new events occur, as more experience is acquired, as additional information is obtained, and as our operating environment changes. We evaluate and update our assumptions and estimates on an ongoing basis and may employ outside experts to assist in our evaluations. Actual results could differ from the estimates we have used. Critical accounting policies are those policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. We believe our critical accounting policies include our policies regarding revenue recognition and business combinations related to purchased intangible assets and contingent consideration. For a more detailed discussion of our critical accounting policies, please refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, as filed with the Securities and Exchange Commission on February 11, 2013. Financial Operations Overview
Revenue. We derive our revenue from two sources: from business services associated with our revenue cycle management, electronic health record management, patient communication management, referral cycle management, analytics offerings, and from Epocrates; and from implementation and other services. Implementation and other revenue consists primarily of professional services fees related to assisting clients with the initial implementation of our services, for ongoing training and related support services, and for third-party tenant revenue. Business services accounted for 93% of our total revenues for the three months ended September 30, 2013 and 97% for the three months ended September 30, 2012. Business services accounted for 95% of our total revenues for the nine months ended September 30, 2013 and 97% for the nine months ended September 30, 2012. Business services revenue are typically 2% to 8% of a practice's total collections depending upon the services purchased, the size, complexity, and other characteristics of the practice, plus a per-statement charge for billing statements that are generated for patients. Accordingly, business services revenue is largely driven by the number of physician practices and other service providers we serve, the number of physicians and other medical providers working in those physician practices, the volume of activity and related collections of those physicians, the mix of our services used by those physician practices and other medical providers, and our contracted rates. There is moderate seasonality in the activity level of physician practices. Typically, discretionary use of physician services declines in the late summer and during the holiday season, which leads to a decline in collections by our physician clients about 30 to 50 days later. Additionally, the volume of activity and related collections vary from year to year based in large part on the severity, length and timing of the onset of the flu season. While we believe that the severity, length and timing of the onset of the cold and flu season will continue to impact collections by our physician clients, there can be no assurance that our future sales of these services will necessarily follow historical patterns. Implementation and other revenue are largely driven by the increase in the volume of our new business. As a result, we expect implementation and other revenue to increase in absolute terms for the foreseeable future but to remain relatively consistent as a percentage of total revenue. None of our clients accounted for more than 10% of our total revenues for the three and nine months ended September 30, 2013 and 2012. Direct Operating Expense. Direct operating expense consists primarily of salaries, benefits, claim processing costs, other direct expenses, and stock-based compensation related to personnel who provide services to clients, including staff who implement new clients. We expense implementation costs as incurred. We include in direct operating expense all service costs


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associated with athenaCollector, athenaClinicals, athenaCommunicator, athenaCoordinator, athenaClarity, and Epocrates. We expect to increase our overall level of automation as we become a larger operation, with higher volumes of work in particular functions, geographies, and medical specialties. Although we expect that direct operating expense will increase in absolute terms for the foreseeable future, the direct operating expense is expected to decline as a percentage of revenue as we increase automation. Direct operating expense does not include allocated amounts for rent, occupancy and other indirect costs (including building maintenance and utilities), depreciation, and amortization, except for a portion of amortization related to purchased intangible assets. Direct operating expense includes costs associated with third party tenant revenue for the Arsenal on the Charles.
Selling and Marketing Expense. Selling and marketing expense consists primarily of marketing programs (including trade shows, brand messaging, and on-line initiatives) and personnel-related expense for sales and marketing employees (including salaries, benefits, commissions, stock-based compensation, non-billable travel, lodging, and other out-of-pocket employee-related expenses). Although we recognize substantially all of our revenue when services have been delivered, we recognize a large portion of our sales commission expense at the time of contract signature and at the time our services commence. Accordingly, we incur a portion of our sales and marketing expense prior to the recognition of the corresponding revenue. We have increased our sales and marketing expenses from year to year and we expect to continue to increase our investment in sales and marketing by hiring additional direct sales personnel and support personnel to add new clients and increase sales to our existing clients and to expand awareness through paid search and other similar initiatives. We also plan to expand our marketing activities, such as attending trade shows, expanding user groups, and creating new printed materials. As a result, we expect that, in the near-term, sales and marketing expense will increase in line with revenue growth. Sales and marketing expense does not include allocated amounts for rent, occupancy and other indirect costs (including building maintenance and utilities), depreciation, and amortization, except for a portion of amortization related to purchased intangible assets. Research and Development Expense. Research and development expense consists primarily of personnel-related expenses for research and development employees (including salaries, benefits, stock-based compensation, non-billable travel, lodging, and other out-of-pocket employee-related expenses) and consulting fees for third-party developers. We expect that, in the near-term, research and development expenditures will increase in absolute terms and will likely remain consistent as a percent of revenue as we develop and enhance new and existing services; however, the amount of expenditures that should be capitalized as software development costs versus expensed as research and development could vary based on the specific projects we undertake.
General and Administrative Expense. General and administrative expense consists primarily of personnel-related expense for administrative employees (including salaries, benefits, stock-based compensation, non-billable travel, lodging, and other out-of-pocket employee-related expense), occupancy and other indirect costs (including building maintenance and utilities), and insurance premiums; and, outside professional fees for accountants, lawyers, external costs associated with acquisitions, change in the fair value of contingent consideration, and consultants. We expect that general and administrative expense will increase in absolute terms as we invest in infrastructure to support our growth. Though expenses are expected to continue to rise in absolute terms, we expect general and administrative expense to decline as a percentage of total revenue over time.
Depreciation and Amortization Expense. Depreciation and amortization expense consists primarily of depreciation of fixed assets and amortization of capitalized software development and acquisition costs, which we amortize over a two to three-year period from the time of the release of the related software code. As we grow, we will continue to make capital investments in the infrastructure of the business and we will continue to develop software that we capitalize. In the near term, we expect depreciation and amortization expense to increase as a percentage of total revenue.
Interest Expense. Interest expense consists primarily of interest costs related to our term and revolving loans under our credit facility and the amortization of deferred financing fees.
Income Tax (Provision) Benefit. Income tax (provision) benefit consists of federal and state income taxes in the United States and India. The difference between our effective tax rate and our statutory rate is mainly related to transaction costs associated with stock acquisitions, any changes in the fair value of contingent consideration related to non-tax deductible goodwill, the treatment of Incentive Stock Options ("ISOs"), and the impact of certain tax deduction limits related to certain of our highly compensated officers. Transaction costs related to stock acquisitions are primarily non-tax deductible. The changes in the fair value of contingent consideration related to non-tax deductible goodwill and the treatment of disqualifying dispositions related to ISOs are also treated as discrete items which means they are recorded in the quarter in which they occur and could cause significant differences between the quarterly and annual effective tax rate. Also, we substantially ceased issuing ISOs in 2009, but we expect continued volatility related to these options since we cannot anticipate when disqualifying dispositions related to these options will occur. We expect that our income tax provision for the 2013 fiscal year will be substantially lower than in prior years based on expected lower pretax income (loss).


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Results of Operations
Revenue. Total revenue for the three and nine months ended September 30, 2013 is
primarily due to an increase in business services revenue.
Comparison of the Three and Nine Months Ended September 30, 2013 and 2012
                       Three Months Ended                                   Nine Months Ended
                         September 30,                 Change                 September 30,                  Change
                       2013          2012         Amount     Percent        2013          2012         Amount      Percent
                         (in thousands)
Business
services           $  141,326     $ 102,256     $ 39,070         38 %   $  400,708     $ 295,915     $ 104,793         35 %
Implementation
and other              10,201         3,630        6,571        181 %       22,716        10,052        12,664        126 %
Total              $  151,527     $ 105,886     $ 45,641         43 %   $  423,424     $ 305,967     $ 117,457         38 %

Business Services Revenue. The increase in business services revenue is primarily driven by the growth in the number of physicians and providers using our services, and includes revenue from Epocrates. The three and nine months ended September 30, 2013 includes $13.4 million and $33.5 million of total revenue, respectively, attributable to Epocrates business services revenue. The increases in the number of physicians and providers using our revenue cycle management service, athenaCollector; electronic health record management service, athenaClinicals; and patient communication management service, athenaCommunicator; are as follows:

                                    As of September 30,
                                     2013          2012           Change
                                    Number        Number    Number     Percent
 athenaCollector   Physicians      33,764         27,013     6,751       25 %
                   Providers       47,195         38,145     9,050       24 %
 athenaClinicals   Physicians      11,401          7,340     4,061       55 %
                   Providers       15,483         10,062     5,421       54 %
athenaCommunicator Physicians      17,330          8,739     8,591       98 %
                   Providers       23,024         12,149    10,875       90 %

Also contributing to the increase in business services revenue was the growth in related collections on behalf of these physicians and providers. The amount of collections processed are as follows:

Three Months Ended Nine Months Ended
September 30, Change September 30, Change
2013 2012 Amount Percent 2013 2012 Amount Percent
(in millions)

Collections processed $ 2,975 $ 2,303 $ 672 29 % $ 8,378 $ 6,643 $ 1,735 26 %

Implementation and Other Revenue. The increase in revenue from implementation and other revenue was driven by new client implementations, increased professional services for our larger client base, an increased volume of our new business, and third-party tenant revenue of $6.1 million associated with the Arsenal on the Charles property from the date of acquisition in May through September 30, 2013.

                     Three Months Ended                              Nine Months Ended
                        September 30,              Change              September 30,               Change
                      2013        2012       Amount      Percent      2013        2012       Amount      Percent
                       (in thousands)
Direct operating     $63,245     $41,866   $ 21,379        51 %     $175,820    $121,678   $ 54,142         44 %


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Direct Operating Expense. The increase in direct operating expense is primarily due to an increase in the number of claims that we process on behalf of our clients and the related expense of providing services, including transactions expense and employee-related costs. The total claims submitted on behalf of clients are as follows: . . .

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