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ATHN > SEC Filings for ATHN > Form 10-Q on 18-Apr-2014All Recent SEC Filings

Show all filings for ATHENAHEALTH INC

Form 10-Q for ATHENAHEALTH INC


18-Apr-2014

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 increased levels of automation of our services; option exercise activity; increased investments in our office space; evaluation and integration of Epocrates; 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; 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 research and development and sales and marketing expenses, increased cross-selling efforts among our service offerings, expected client implementations, and research and development for service offerings. 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, 2013, under the heading Part I, Item 1A, "Risk Factors" and any set forth below in this Quarterly Report on Form 10-Q 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 cloud-based business services that help medical caregivers achieve and sustain financial health by collecting more revenue and greatly reducing their administrative work burden. These services are designed to minimize the hassles that caregivers and their staff face from complex billing rules, quality measurement and reporting, clinical documentation and data exchange, patient communication and referrals, and many related tasks that can take attention away from delivering care. Our services are delivered and consumed through a single instance of our cloud-based platform, athenaNet, through which we continuously update and improve our services. Regular updates to athenaNet are free and automatic for everyone on the network. As a web-based platform, athenaNet can be quickly implemented by our staff, with low upfront costs to clients.
The services provided through our single-instance cloud are offered as a suite of four seamlessly integrated services: athenaCollector for revenue cycle and practice management, athenaClinicals for electronic health record management, athenaCommunicator for patient communication management, and athenaCoordinator for care coordination and financial and quality management. Each service is supported by a model comprised of three distinct but interconnected components: cloud-based software ("Software"), networked knowledge ("Knowledge"), and back-office work ("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, insurance payers, and our staff of experts. Knowledge is infused into each service via our rules engine as we work with clients, insurance payers, and other partners to codify rules associated with reimbursement, clinical quality measures, and other factors related to our clients' performance, making the network "smarter" and more powerful for all clients. The network's shared knowledge and transparency also allows clients to monitor and benchmark their performance against those of other practices across the network. The third component to each service 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 perform the work on our clients' behalf. These services range from receiving, scanning, and delivering incoming faxes to tracking claims with insurance payers. This unique service model of Software, Knowledge, and Work is the core of our aligned success model. We charge clients a percentage of collections, in most cases, connecting our financial results directly to that of our clients and our ability to drive revenue to medical practices.
We also provide clients in the health care industry (e.g., pharmaceutical companies, managed care companies, and market research firms) the opportunity to sponsor clinical information and decision support services in order to engage with Epocrates' member network, and offer the sale of subscriptions to Epocrates' premium drug and clinical reference tools to health care professionals.


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For the three months ended March 31, 2014, we generated revenue of $163.0 million from the sale of our services compared to $125.6 million for the three months ended March 31, 2013. 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 athenahealth-branded business services, which exclude revenue from Epocrates-branded services and third-party tenant revenue, that we provide on an ongoing basis. Revenue from business services associated with our four integrated services is generally determined as a percentage of payments collected by us on behalf of our clients, so the key drivers of such 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 expense. 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 and to ensure adherence to related financial covenants. Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations 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, we are required to make assumptions and estimates about future events, and apply judgments 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. 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. 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. On a regular basis, we review the accounting policies, assumptions, and evaluate and update our 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.
Critical accounting policies are those policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. 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, 2013, filed with the Securities and Exchange Commission on February 7, 2014.
Financial Operations Overview
Revenue. We derive our revenue from two sources: business services, and implementation and other services. Business services includes revenue from our revenue cycle and practice management service (athenaCollector); electronic health record management service (athenaClinicals); patient communication management service (athenaCommunicator); care coordination and financial and quality management service (athenaCoordinator); and subscriptions, sponsored clinical information, and decision support services for our point of care clinical application (Epocrates). Business services accounted for approximately 95% and 97% of our total revenues for the three months ended March 31, 2014 and 2013, respectively. Business services revenue for athenahealth-branded services is 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 services revenue consists primarily of professional services fees related to assisting clients with the initial implementation of our services, as well as third-party tenant revenue. Implementation and other services revenue is largely driven by the increase in the volume of our new business. As a result, we expect implementation and other services revenue to increase in absolute terms for the foreseeable future but to remain relatively consistent as a percentage of total


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revenue. None of our clients accounted for more than 10% of our total revenues for the three months ended March 31, 2014 and 2013.
Direct Operating Expense. Direct operating expense consists primarily of personnel-related expense (including stock-based compensation) related to personnel who provide services, including implementation to clients, and claim processing costs. We expense implementation costs as incurred. We include in direct operating expense all service costs incurred to fulfill our customer contracts. 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, direct operating expense is expected to decline as a percentage of revenue as we increase automation. Direct operating expense also includes costs associated with third-party tenant revenue. Direct operating expense does not include allocated amounts for rent expense, depreciation, and amortization, except for amortization related to certain purchased intangible assets.
Selling and Marketing Expense. Selling and marketing expense consists primarily of personnel-related expense for sales and marketing employees (including stock-based compensation) and marketing programs (including trade shows, brand messaging, and online initiatives). 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 amortization related to certain purchased intangible assets. Research and Development Expense. Research and development expense consists primarily of personnel-related expenses for research and development employees (including stock-based compensation) 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 increase 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 stock-based compensation), occupancy and other indirect costs (including building maintenance and utilities for space occupied by us), and outside professional fees for accountants, lawyers, 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, which we amortize over a two to three-year period from the time of release of 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. We expect depreciation and amortization expense to increase as we make investments to support our continued growth, new service offerings, and infrastructure expansion. Other (Expense) Income. Other (expense) income is primarily comprised of 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 relates to federal and state jurisdictions 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, the treatment of Incentive Stock Options ("ISOs") and the Employee Stock Purchase Plan, 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 treatment of disqualifying dispositions related to ISOs are also treated as discrete items, which means that they are recorded in the quarter in which they occur and could cause significant differences between the quarterly and annual effective tax rate. 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 stock options will occur.


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Recent Developments
We previously invested a total of $1.1 million in a privately-held entity named Castlight Health, Inc. ("Castlight"), a leading provider of cloud-based software that enables enterprises to control health care costs. This investment was initially recorded at cost. On March 14, 2014, an initial public offering ("IPO") of shares of Castlight's Class B common stock was made available for sale on the New York Stock Exchange under the symbol "CSLT." As a result of the IPO, we classified this investment as "available-for-sale" and marked the shares we hold to market based on quoted market prices as of March 31, 2014. Although the investment is classified as available-for-sale, we are prohibited from selling the investment for 180 days subsequent to the IPO. As of March 31, 2014, the aggregate fair value of the investment was $74.3 million and is recorded in the Marketable securities line on the Condensed Consolidated Balance Sheet. The unrealized gain on investment of $45.6 million is included in other comprehensive income, net of a $27.5 million short-term deferred tax liability. Results of Operations
Comparison of the Three Months Ended March 31, 2014 and 2013

                                 Three Months Ended March 31,                Change
                                      2014                  2013       Amount     Percent
                                        (in thousands)
Business services          $       154,502               $ 121,463    $ 33,039        27 %
Implementation and other             8,533                   4,133       4,400       106 %
Total                      $       163,035               $ 125,596    $ 37,439        30 %

Total revenue for the three months ended March 31, 2014 increased due to an increase in business services revenue.
Business Services Revenue. The $33.0 million increase in business services revenue is primarily driven by the growth in the number of physicians and providers using our services. The increases in the number of physicians and providers using our revenue cycle and practice management service, athenaCollector; electronic health record management service, athenaClinicals; and patient communication management service, athenaCommunicator; are as follows:

                                     Three Months Ended March 31,
                                            2014                 2013           Change
                                           Amount               Amount    Amount    Percent
 athenaCollector   Physicians          37,663                   28,850     8,813        31 %
                   Providers           52,886                   40,937    11,949        29 %
 athenaClinicals   Physicians          13,521                    8,776     4,745        54 %
                   Providers           18,343                   12,139     6,204        51 %
athenaCommunicator Physicians          24,030                   11,840    12,190       103 %
                   Providers           31,707                   16,296    15,411        95 %

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

Three Months Ended March 31, Change
2014 2013 Amount Percent
(in millions)

Collections processed $3,172.1 $2,567.0 $ 605.1 24 %

The increase in business services revenue is additionally due to revenue from sponsored clinical information and decision support services and subscriptions, or our Epocrates-branded services. The three months ended March 31, 2014 and 2013 includes $10.6 million and $5.5 million of total revenue attributable to these services, respectively.
Implementation and Other Revenue. The $4.4 million increase in revenue from implementation and other revenue was primarily driven by third-party tenant revenue of $4.2 million, primarily due to the Arsenal on the Charles property, for the three months ended March 31, 2014. We did not have any tenant revenue from the Arsenal on the Charles property for the three months ended March 31, 2013.


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                     Three Months Ended March 31,            Change
                        2014              2013         Amount      Percent
                            (in thousands)
Direct operating          $72,148           $53,185   $ 18,963       36 %


Direct Operating Expense. The number of claims that we processed on behalf of
our clients increased during the three months ended March 31, 2014. The increase
in direct operating expense is primarily due to the expense of providing these
services, including transactions expense and employee-related costs. The total
claims submitted on behalf of clients are as follows:
                               Three Months Ended March 31,                Change
                                       2014                  2013    Amount     Percent
                                       (in millions)
Total claims submitted            25.8                       20.7       5.1       25 %

Direct operating employee-related costs, including stock-based compensation, increased $7.2 million in the three months ended March 31, 2014 compared to the three months ended March 31, 2013, primarily due to an 11% increase in headcount and an increase in the fair value of our recently issued stock-based compensation expense. We increased headcount to meet the current and anticipated demand for our services as our customer base continues to expand and includes larger medical groups.
Direct operating expense for the three months ended March 31, 2014 also includes $2.6 million of costs associated with third-party tenant revenue. No cost associated with third-party tenant revenue was included in direct operating expense during the three months ended March 31, 2013.

                                                 Three Months Ended
                                                     March 31,                     Change
                                                 2014          2013         Amount       Percent
                                                   (in thousands)
Selling and marketing                        $   43,227     $  32,922     $ 10,305          31  %
Research and development                         15,155        11,944        3,211          27  %
General and administrative                       29,357        31,077       (1,720 )        (6 )%
Depreciation and amortization                    14,249         8,341        5,908          71  %
Total                                        $  101,988     $  84,284     $ 17,704          21  %

Selling and Marketing Expense. The increase in selling and marketing expense was in part due to compensation costs, including stock-based compensation expense, internal sales commissions and external channel partner commission, which increased approximately $4.5 million. The cost of compensation is primarily driven by headcount. Our sales and marketing headcount increased 26% since March 31, 2013, as we hired additional sales personnel to focus on adding new customers and increasing penetration within our existing markets. Additionally, amortization related to purchased intangible assets allocated to selling and marketing expense increased $3.2 million for the three months ended March 31, 2014 compared to the three months ended March 31, 2013, primarily due to our acquisition of Epocrates during the three months ended March 31, 2013. Research and Development Expense. The increase in research and development expense was primarily due to higher compensation costs, including stock-based compensation expense, which increased approximately $2.4 million, largely due to a 43% increase in headcount. The additional research and development personnel were necessary in order to upgrade and expand our service offerings and develop new technologies. The increase in research and development expense was also impacted by an increase of $0.8 million in consulting fees for third-party developers. We anticipate that research and development expense will continue to increase in the foreseeable future.
General and Administrative Expense. General and administrative expense declined in the three months ended March 31, 2014, primarily due to $8.5 million of transaction and integration costs associated with the Epocrates and Arsenal transactions and stock-based compensation related to the acceleration of vesting for certain Epocrates employees upon termination during the three months ended March 31, 2013.
The decline in general and administrative expense was partially offset by a $4.7 million increase in compensation costs (including stock-based compensation not related to the Epocrates acceleration of vesting). This increase is primarily due to a 24% increase in headcount from March 31, 2013. We increased our general and administrative personnel to support our growth. Finally, occupancy and other indirect costs (including building maintenance and utilities for space occupied by us) increased by $1.7 million for the three months ended March 31, 2014. The increase we experienced in headcount drove an increased investment in our infrastructure.


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Depreciation and Amortization Expense. Depreciation and amortization expense for the three months ended March 31, 2014 increased approximately $5.9 million, or 71%, from the three months ended March 31, 2013. This increase was partially due to $2.6 million of depreciation from higher fixed asset expenditures and . . .

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