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Athenahealth Inc. (NASDAQ:ATHN)

Q3 2008 Earnings Call

November 7, 2008 8:30 am ET

Executives

Carl Byers - Senior Vice President, Chief Financial Officer and Treasurer

Jonathan Bush - Chairman, President and Chief Executive Officer

Jennifer Heizer - Senior Manager of Investor Relations

Analysts

Randall Stanicky - Goldman Sachs

Newton Juhng - BB&T Capital Markets

Donald Hooker - UBS

Richard Close - Jefferies

Sean Wieland - Piper Jaffray

Doug Simpson - Merrill Lynch

Corey Tobin - William Blair

Frank Sparacino - First Analysis

David Blair - Cantor Fitzgerald

Leo Carpio - Caris & Company

Linda McDowell - Manchester Management

Operator

Welcome to the Athenahealth third quarter 2008 earnings results conference call. Today’s call is being recorded. With us today is Chief Financial Officer, Mr. Carl Byers and Chief Executive Officer, Mr. Jonathan Bush. At this time, I’d like to turn the call over to Ms. Jennifer Heizer, Senior Manager of Investor Relations. Please go ahead, ma’am.

Jennifer Heizer

Good morning and thank you for joining us. With me on the call today is Jonathan Bush our Chairman and CEO; and Carl Byers, our Chief Financial Officer.

Certain statements contained in this conference call may be considered forward-looking as defined by the Private Securities Litigation Reform Act of 1995. In particular, any statements we make about our expectations for future financial and operational performance or the benefits of our service offerings.

Forward-looking statements may often be identified with words such as we expect, we anticipate, upcoming or similar indications of future expectations. These statements involve various risks and uncertainties that could cause our actual results to differ materially from those expressed in such forward-looking statements and these include the risks and uncertainties under the heading Risk Factors in our most recent annual report on Form 10-K and other periodic reports filed with the SEC, which are available on our web site at www.investor.athenahealth.com and on the SEC’s web site at www.sec.gov.

Investors are cautioned not to place undue reliance on such forward-looking statements, as there is no assurance that the matter contained in such statements will occur. The forward-looking statements we make on today’s call are based on our beliefs and expectations as of today, November 7, 2008 only. We do not undertake any obligation to revise or update such forward-looking statements.

Finally, please note that on today’s call we will refer to certain non-GAAP financial measures in which are certain non-cash or non-recurring items from our GAAP financial results. We believe that in order to properly understand our short-term and long-term financial trends, investors may wish to consider the impact of these items as a supplement to the financial performance measures, determined in accordance with GAAP.

Please refer to yesterday’s press release announcing our third quarter 2008 results available on our web site at investor.athenahealth.com for a reconciliation of these non-GAAP performance measures to our GAAP financial results.

With that, I’ll now turn the call over to Jonathan Bush, who will discuss the highlights of the quarter; after that Carl Byers will discuss the financial results and we’ll welcome your questions; Jonathan.

Jonathan Bush

Thank you, Jennifer and welcome to the team. Good morning everyone and thank you for joining us. I’m pleased to report that the third quarter for Athenahealth was the strongest ever. We generated record revenue of $35.4 million representing growth of 35% over Q3 2007, adjusted gross margin in the third quarter is 59% driven by enhanced operating leverage.

In terms of bottom line we achieved $0.14 per diluted share in adjusted net income and I’m happy to report that we added a record number of net new physicians and providers to this network. Total physicians grew by 1,611 bringing total physicians to 11,967, an increase of 33% compared to 3Q of 2007. If you count both providers and also non-physician providers we added 3,743 bringing the total medical provider count on Athenahealth to 17,297, an increase of 50% over Q3 2007.

Our operating teams are focused on driving continued growth with the same high standard of service that our clients have come to expect from us and each business model lends itself well to scaling since our entire client base shares the same web made software application, the same dynamic rules engine and the same backend service platform. That said, scaling it gives magnitude, and always required significant effort and focus. Let me share a few details in that regard.

First our implementation and provider enrollment teams have added unprecedented levels of new providers to the network, those functions are still quite manual though we need to continue to make investments to help them scale. Second, our client service organization has achieved an uptick in client satisfaction. It is another area in which we can expand the rate of growth. It does require us to adapt and automate some of the work we currently do manually though.

Third, as volumes continue to grow on our network and as we begin serving more enterprise clients, we are reviewing our data center architecture and technology strategy, the team has been devoid to explore opportunities for improving performance and scale on this front and we’ll share updates on that as it become available.

Last and certainly not the least, these operating teams of Athenahealth are doing a fantastic job. They’ve built processes that can handle significantly more volume than we service today and our work to build a second operating location in Maine is going extremely well with over 100 employees there at the end of Q3, since it’s only opening at the end of May.

The ability of our teams to execute effectively in the phase of higher growth and industry change is one of the key strengths of our company. We believe we have built a strong foundation for growth and that we are well positioned to continue to execute successfully. However, when you’re experiencing top line growth like this, it’s important to focus on measures that are leading indicators of what performance is likely to be and where the strain will be. For those metrics, I focused on employee engagement which in the third quarter was 3.8 out of 5 using the same framework as described on prior earnings call.

Going into next year, we’re implementing new performance management system, enhanced training and a revised compensation system, which will hopefully better our teams with the value we expect and those will have a positive impact on the employee engagement score.

Day-to-day the lives of our client, which is measuring the financial impact we are having in their behalf, was 46.8 days at the end of Q3. This is up sequentially 1.6 days over the previous quarter and one day over Q3 of the previous year. We believe that these increases are due done primarily to a shift in the mix of payments, from payers over to their clients to the patient’s themselves. The work we’re doing to better estimate and collect on those payments at that point of care, in the moment of care should have a positive impact on DAR in the future, but that’s an area of serious focus.

Finally, client satisfaction increased to 87% in the quarter, this is measured the same way we described in prior earnings call and it’s up three points sequentially and it gets us back to flat year-over-year. Our participation rate though is very high, much higher in this quarter; so I’m especially confident that this is a good reflection of where we actually stand with our clients. Looking ahead, we believe that change is underway to our client service organization; we have a further positive impact on satisfaction as well as scalability.

Before, I turn the call over to Carl, I want to hit briefly on a few recent developments and some key initiatives. First and foremost, I’m please to report that our former Chief Operating Officer, Jim MacDonald, is doing very well and also that our efforts to recruit a new Senior Executive are getting underway.

As I said at the time we announced Jim’s departure, the infrastructure and team that Jim built are his greatest among many here and that team’s depth and capability give us the strength and luxury of time to make sure we get the next person who joins our organization just right.

Second I’m very pleased to report that our work with the PSS World Medical Team is starting to yield some promising results. The 14 channel support professionals PSS helped us deploy in the second quarter are beginning to have an impact. We’ve been training top PSS reps and leaders in a series of three days boot camps to deepen this relationship and the combination is resulting in increased demand for our services from PSS clients. We believe this is just the beginning of what we’re going to do together.

Third, we are pleased to announce the renewal of our partnership with Acusis. We expect this partnership to continue to support growth in the enterprise segment which is an area where we’re seeing great success.

Last, I’d like to comment on our progress with Neuro Services. We continue to see strong interest in AthenaClinical; this is our unique service based approach to medical records. It is important to note how volume intensive this area of physician life can be. Unlike standalone software EMRs AthenaClinicals takes over much of the workflow associated with that backroom work keeping medical charge up-to-date. In fact, if you look at the 549 providers now using AthenaClinicals to support them in the last quarter we are now handling 1.2 million documents per quarter on their behalf.

Finally, we are getting good traction with Reminder Call, a patient communication capability acquired from Crestline which was doing business as MedicalMessaging.net early in September. With this service fully integrated into athenaNet we can implement practices on the service in a matter of hours allowing them to reduce patient no shows and increase revenue with minimal effort. Our effort cross sell this service at our annual user conference was extraordinarily successful and our work to build a broader patient set of services is coming along nicely.

In summary Q3 was our strongest quarter, yet we look forward to sharing our fourth quarter and full year results with you early in 2009. In addition I want you to note that we will be hosting our first ever Investor Summit at our headquarters here in Watertown Massachusetts on December 4. So please mark your calendars and contact Jennifer Heizer in Investor Relations for more detail.

Carl will now walk you through the financial results, after which we’re looking forward to your questions.

Carl Byers

Thank you, Jonathon. Our financial results in Q3, 2008 were very strong. We are pleased to see revenue growth to $35.4 million in the quarter up 35% over the same period last year. This was our 35 consecutive quarter of revenue growth. As Jonathon mentioned our third quarter growth was driven by a record increase in the number of physicians actively using our services to 11,967 in Q3 2008, up from 8,978 in Q3 of 2007.

Because, we work with clients who emphasis non-physician providers such as MinuteClinic, we also provide a total medical provider account, which includes physician and non-physician providers of care. In Q3 of 2008 we submitted claims on behalf of 17,297 medical providers, compared to 13,554 in Q2. This sequential increase was influence significantly, by the go live of MinuteClinic in the quarter, even though we don’t expect to see the full impact from that account on claim collections and revenues until the fourth quarter.

We always note that most of our revenue is tied directly to the collections of our clients. So we typically experience fluctuations in those numbers that mere the activity for the medical practices we reserve. For this reason we believe year-over-year comparisons are more useful than sequential comparison.

Total client collections posted to Athenahealth in the third quarter were $932 million, up 32% from the same period last year, which was $704 million. This typical first to experience increase in the collections per MD and in our related revenue per MD on a year-over-year basis primarily driven by increased reimbursement rates and productivity gains among other factors.

In the third quarter of 2008, these metrics were largely flat compared to the same period last year. We attribute this difference, the fact that there was an unprecedented volume of provider implementations in the period and the full effect of those implementation on our collections and related revenue we will not be seen until the fourth quarter when we expect the new providers to ramp up.

Turning to the macro environment, there has been significant focus in the industry and some confuting messages regarding whether the economics slowdown will affect healthcare adversely in a way not seen in previous recession.

We have very good data about physician volumes, appointment and claims data as well as other drivers of physician revenue, because we are well diversified across more than 60 medical specialties, 40 states and practices of a wide range of sizes. As of Q3, based on a same store analysis of appointments per provider, we do not see a reduction in the volume of physician out office activity overall.

Turning to certain pockets of the physician landscape, they are affected disproportionably by discretionary patient payment, but given our diverse claim portfolio with every areas of weakness there maybe have not had a noticeable impact on our aggregate data. We’ll continue to monitor this closely as the economic picture becomes clear. Overall, we believe that the macro themes of cost containment and tight credit play to the strength of our business model compared to alternatives that require significant expenditure of fund.

Turning to profitability, in Q3 our adjusted gross margin increased 58.6% due to further automation progress. The rate of automation of the processing of information about payments, which is measured by the Electronic Remittance Advice rate or ERA rate continue to improve. A few years ago our ERA rate was practically zero. In the month of June, our operation and technology teams achieved a 50% ERA rate for the first time.

In the third quarter, our ERA rate was 52.3% overall compared to 35.7% in Q3 2007. There is still substantial room from improvement in the ERA rate and in addition, we have the opportunity to automation a serious of other transactions; we currently handle manually today across our operations.

Our adjusted EBITDA margin in a period was 17.3%, an increase of 110 basis points compared to the same period last year. Our adjusted net income per diluted share which excludes the impact of stock-based compensation was $0.14. These expanded margins reflect only part of the operating leverage potential of our business. They also are net of significantly increased spending to acquire new clients, as shown in our sales of marketing line. Specifically variable commission expense contributed significantly to that increase, which is triggered by both implementation and new contract signings.

While we are pleased that our business model tend to deliver expanding margins as we grow, our primary focus is on the financial opportunity associated with becoming much larger than we are today. We have an enormous addressable market, in leading position with a unique business model.

If you consider the magnitude, the economics and the strategic position of this business, now with 12,000 physicians, over 100,000 physicians, which will still be just 1 out of 7 practicing doctors, our buyers toward growth and innovation becomes very clear.

Before turning the call over to question, I want to summarize a few key balance sheet items from the quarter. First we acquire the MedicalMessaging.net assets in September for $7.7 million. Second in September we also closed a $6 million term loan with Banc of America, related to the operating center in Maine that we purchased at the beginning of this year.

Third, we put in place the working capital lending facility with BOA for $15 million expandable to $30 million. We don’t plan to keep a balance on this line, given our cash position and our profitability, but it provides collateral to back daily financial operations and to create reserved source of financing.

Finally I’m happy to note that in this tribunal financial environment, the company’s cash and investments remain liquid and secured. We ended the quarter with cash, cash equivalents and short-term investments of $78.5 million. In summary this was a strong quarter financially, I’m look forward to a very strong fourth quarter as well.

With that we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Randall Stanicky - Goldman Sachs.

Randall Stanicky – Goldman Sachs

Carl, I appreciate your comments on the macro backdrop. Can you just maybe help us understand how the economy perhaps is impacting the physicians specifically and perhaps their decision to go with the Athena solution and then maybe if there is any impact on their interest in your clinical offering? Thanks.

Carl Bayers

Sure Randall, I think they are both rational and psychological questions people have about the market behavior. On the rational side, on the front-end when it comes to choosing a solution of your practice we are now advantaged compared to the standalone software solutions that require CapEx.

The bottom line is for a doctor practice, if they’re going to make an investment that money is coming out of their bonus pool or it’s going to be financed, and neither of those are attractive options in this climate; whereas, Athena which one of our analyst calls, a no money down solution is different. In that our job is to free cash out of your balance sheet, improve your cash flow on a sustained basis and required a very little upfront in terms of investments.

So, on the front-end, because we don’t have a negative that others do have, we were good comparatively, that’s the rational front-end piece. I think the psychological question people have, is do people just go into a bunker mentality, when they see their 401K go down and I think that really cuts both ways.

One the one hand some people might say, “hey, I’ll just wimp along on whatever solution I have,” but because that’s not a rational solution, we think what’s more important is some people look at this as an opportunity to make a significant change in the interest of their financial position and so on balance we think that not only are we rationally more a better choice in the front-end in this climate, or any climate for that matter, but psychologically, we think that’s a net positive because people have a reason to focus on this.

So, on the front-end I think that’s the rational and the psychological. On the back-end its really about physician offers and volumes and as we noticed through Q3 looking at the data we have, we do not see a meaningful change and so in that sense patients logically will continue to seek healthcare and we don’t anticipate that changing, but we’ll be watching it very closely.

Jonathan Bush

This is Jonathan. You got to remember that how little our market share is, so major macro shifts, we think those macro shift as Carl mentioned are going to actually help us, but other macro shifts that you continue to follow at Athena, in the overall demand, it probably don’t get in the way of a relatively nominal number of doctors that we need to hit our bookings goal. So don’t forget what we are accompanying with 2% market share and so we don’t need all that docs to grow 30%, 40%.

Randall Stanicky – Goldman Sachs

It’s a good point. I mean, you are not seeing any slowdown, as you talking to physicians as they think about moving into your offering; I guess given some things that are going on their end, is that fair to say?

Carl Byers

That’s correct.

Randall Stanicky – Goldman Sachs

Okay and Carl just one question, we talked last quarter about some of the back half costs and your margins obviously continue to improve. Can you maybe help us think about some of the spending initiatives in this quarter versus how we should think about them in the fourth quarter?

Carl Byers

Sure, I think on the direct operating expense line driving the gross margin, you have investments that have taken place in the second and third quarters and are likely to continue at a certain pace, to build the infrastructure to be a much larger company and to properly service the business that we anticipate. So the sequential direct operating expense has been higher in the last two periods then what has happened previously, so we have done that.

What has counter availed that is both strong revenue performance, service to our clients and automation improvements like the IRR rate that I mentioned which have yielded more in gross margin points than we had originally counted on and so the net effect has been increasing margins, that’s with the direct operating expense line.

On the indirect areas, just a few comments there. Sales and marketing is a function of growth. In general historically, if you look at the lagged relationship between sales and marketing expense and incremental revenue, it was about a 2:1 relationship meaning if we spend $0.50 in sales and marketing it tends to yield a dollar of incremental recurring revenue.

The IRR on that is tremendously large and therefore we should be taking that deal all they want and that’s our buyers. So we see the sequential increase in the third quarter in the sales and marketing expense as a very positive sign about what’s happening in our business. As for sales and marketing that’s the key analysis to do.

For R&D its really about supporting the business ensuring that we’re expanding the value preposition incrementally each year and investing in new services and its really the work of a lot of the people on this R&D team that has contributed to the gross margin expansion and so if we compare that to what we originally said our five-year target was during our IPO deliver year ago, we said in 2011 we’ll have gross margins between 57 and 60. Well here we are at 59 and that’s because of the work of the R&D teams and the process improvement teams to automate and improve those areas of the business. So, we will continue, to see as a good use of funds to invest in R&D, so that we can drive the margins higher.

Lastly G&A, where the two big step functions historically were; (a) the IPO, which was not fully reflected in Q3 ‘07 because the IPO was at the end of the quarter. Seems like DNO insurance, but also the infrastructure to the staff the people that go into being a public company and then secondly, the purchase of the facility in Maine which was not originally anticipated, but it was smart move to explore our growth and that drove some G&A expense step up early this year.

So, those of the two elements driving G&A growth; I did mention that we’re in this for the big opportunity that’s out there and so we will make investments on an ongoing basis to build toward that business opportunity, but long in the sort of it is, this business model has enough operating leverage inherent in it, that even as we increased our spending the margins have been expanding.

Randall Stanicky – Goldman Sachs

No, big spending pick up next quarter then?

Carl Byers

Like we said before, we are preparing for revenue growth in Q4 higher than what we’ve seen. We think we made the investments that are needed, but there is further investment that we will make on an ongoing basis. So, I’m not telegraphing a significant shift in spending pattern in Q4, but we will absolutely spend on sales and marketing, if it means recurring revenue follows and we think investors should look at it in that way essentially, because we’re buying annuities in the customer relationships that we expense upfront in the former sales and marketing. That’s a very wise investment to make in and one that we will continue to make.

Jonathan Bush

Is it fair to say, Carl; when we do better on growth you shouldn’t expect us to put at all on the bottom line. If we have our own pleasant surprises around here on our growth as we have been having obviously. We don’t expect to drop at all to the bottom line we will think that to be an imprudent investment.

Carl Byers

Well, coming back to our original five-year plan, as we make improvements on the gross margin line, not all those will follow to the EBITDA line, because that’s a very large market opportunity and our opportunity is to pursue it.

Operator

Your next question comes from Newton Juhng - BB&T Capital Markets.

Newton Juhng – BB&T Capital Markets

Jonathan, during your comments you mentioned that with AR being up 1.6 days sequentially due to a shift in the mix from repairs to the clients and so, can you just give us a little more details there as to are we seeing the situation where people have to pay more for their own services and so, is that what you would call function of the economic times?

Jonathan Bush

Yes and yes and I direct you to athenapayerview.com, which is the wonderful kind of opened source public information website that we put together and update each year. That shows those mixes and other patterns on the aggregate payer market, as we see them across all our providers, but yes, your absolutely seeing more-and-more; I think it’s over 20% more or over two years now of doing payer view.

A 20% more of that dollar, there is a covered insurance dollar actually coming from the patient directly, so a person with a card, he says, “I’m insured,” 20% more of what comes to doctor from that insured person visit, is going to come directly from the patient’s pocket and obvious this has implications for us.

Our product development efforts are focused very much on capturing charges at the time of service and the moment of service and integrating some sensational credit card capability into Athenanet on the front end and on the backend remitted by side, we really need stuff that we will be able to talk about over course of next year to follow that trend and get on top of it.

Newton Juhng – BB&T Capital

Just in terms of where you are right now are you able to detail what the difference is here in terms of the person versus the payer and how much of a delta there is and the collections there?

Jonathan Bush

I don’t have it with me here Newton, but if you want to follow-up we can actually provide little more detail on that.

Newton Juhng – BB&T Capital

Okay. Sure. In the near terms, I was just wondering if that was the status of RediClinic; whether or not you’ve been able to go live on all those sites and also the status of Clinicals within the one that you’re planning on doing that?

Jonathan Bush

You probably have good closure details in which how many sites on RediClinic.

Carl Byers

RediClinic is one of the many folks innovating in a retail clinic market where you have nurse, practitioners delivering care and they are a client that has a lot opportunity to grow; they have a relationship with Wal-Mart where the two of them have announced significant expansion plan and have a similar relationship with AGB.

So our opportunity is to grow with them as they grow and so we certainly are serving them fully everywhere we can, in the Wal-Mart stores the EMR side, it was a different provider, but we’re handling the revenue cycle outside the Wal-Marts. They prefer our EMR solution and so we’ll continue to grow with them and support the growth.

Jonathan Bush

Yes. We live in all 33 other sites.

Newton Juhng – BB&T Capital

One more last quick one; has your sale forces made any changes to it’s approach to adopt to the current economic environment, just wondering if with a situation I mean with what it is, they are looking to kind of move with times?

Jonathan Bush

We have made a lot of changes to our sale force not as a response to changes on Wall Street okay and that’s good.

Newton Juhng – BB&T Capital

I can hear you Jonathan.

Jonathan Bush

Okay. Somebody is backed up his opportunity because this, we don’t know what that noise is? Changes in sales force are significant; we’ll be announcing a bunch of them. Obviously we added that large sale force in permission with PSS on the ground focused sort of out in front of our sales force generating leads.

We have already as you know had a separate small group sales force. This time next year you will see that we’ll have a separate enterprise. A lot sooner than this time next year, we’ll see a separate enterprise group and of course we are always investing in the automation rates on how we do contract and the simplification of the contracting experience we think like that directly related to macro changes in the economy.

Operator

Your next question comes from Donald Hooker - UBS.

Donald Hooker – UBS

Hey just now that you have some of these mini clinics online. Can you just review some of the economics that you lay out in the prior quarter, because this is obviously a big change to your P&L kind of revenue per provider, kind of what do you expect going to next quarter?

Carl Byers

Don this is Carl, I’ll take that. Obviously, it’s one of the largest accounts. We signed this deal in Q2 and went live in Q3 and so we’re very happy with the performance of the team implementing them to able to bring them on that quickly. As you know, they have no physicians, we all nurse practitioners and we don’t want to get into providing clients specific detail unless we have their consent do so, but if you look at the difference between our physician growth, which is about 33% and our total provider growth which is about 50% year-over-year, do you feel it’s safe assumption that the delta was driven by that client, most in largest degree.

So in terms of the economics, I think we’ve said previously that they certainly negotiated on the percentage, but the starting point of negation is our retail environment where average ticket is smaller and so our average percentage is higher. Further more we have a per claim minimum in this deal, so there is a surge of low dollar claims and our effective percentage is strong. So it’s for that reasonably we feel like this deal will have absolutely fine margins.

Donald Hooker – UBS

Okay that’s fine, and also did you mention in the beginning and I apologize if I miss it, how many PSS providers you picked up?

Carl Byers

We don’t breakout the growth by channel partners PSS is one of our most important relationships, but we don’t get into partner-by-partner detail in that way we have a wide network in partners.

Donald Hooker – UBS

Just one more; I think in the prior quarters you talked about it. I assumed this hasn’t changed, but just the renewal rates are still up in high 90’s; any change there?

Jonathan Bush

Renewal rates remain in the high 90’s. We did have a attrition blip in the third quarter, which we believe is in fact of blip and so we didn’t make a big deal about it. We expect it still to be 97% recurring revenue. I’ll let you know if that changes.

Operator

Your next question comes from Sean Wieland - Piper Jaffray.

Sean Wieland – Piper Jaffray

So, I just want to focus for second on the big jump in doc count and can you kind of tell us how much of that increase was related to the market shifting to this model and how much of that is due to actions that you specifically took?

Carl Byers

In terms of our growth?

Sean Wieland – Piper Jaffray

Yes.

Carl Byers

I guess, I think it’s all the actions we particularly took. Sean but I imagine that the fact that we remain the only software enabled business service in this space helps us. We haven’t yet study awareness levels again. We did in 2005 in awareness levels of our model and our company was very low.

We intend to study them again in Q4 this quarter to see whether we are just getting better or whether people are getting to know us better, but also don’t forget we did have a couple of very big deals which we announced to you earlier in the year, and the execution on implementation on those particularly MinuteClinic win better than should have reasonably expected. Everybody did everything right on the first version of the project plan, so that spike you’re seeing here is larger related to the surprisingly big performance finding and then on boarding the MinuteClinic relationship.

Sean Wieland – Piper Jaffray

And then just to be clear; the doc count doesn’t include anything from MinuteClinic; that just our non-doc providers, is that correct?

Jonathan Bush

That’s correct.

Carl Byers

So as Jonathan pointed, the doc growth is absolutely testament to the appeal of our value proposition. There were some large deals we announced early in the year that did go live the quarter as expected which helped with that performance.

Sean Wieland – Piper Jaffray

Okay and just a couple of questions on ‘09; Carl do you have any thoughts on a tax rate for 2009?

Carl Byers

We do not have any new guidance for you on that. I think in terms our clinical we think we’ve engineered the solution in a way that adds value to physician practices and we think that standalone model is right for some people, but probably not right for lot of others. So we do to expect the attach rate to be something that improves overtime. Did you say attach rate or tax rate?

Sean Wieland - Piper Jaffray

I said taxes?

Carl Byers

Oh, we don’t tax clinical. So this has been a great learning opportunities, this Q-and-A here today, with the phones. With regards to tax rates, it’s always difficult for people to map out the cash versus the accrual dynamics. We will not be a full tax payer until late ‘09 depending on how your model shows which ramping profitability.

In terms of the GAAP side of the house, we have a large deferred tax asset that we a have full reserve against today and in the fourth quarter we will be viewing that and the possible action which we have not determined yet would be to reverse the reserve, because of the certainty of seeing the actual net income against which we applied, the NOL. So I think we’ll update you at the investor summit on December 4 about that and try to give you a very clear expectation.

Sean Wieland - Piper Jaffray

Okay and then one other thing on ‘09 is I think the 14 PSSI reps that you’re going to start picking up the tab for in Q2. Is that still the plan and what kind of sequential jump do you think you’ll see there?

Jonathan Bush

That is the plan. I think what PSS did on day one of our relationship was identify the tactics that drive success and the first year we didn’t have these folks in the field and they put points in the board, but they were right, these folks haven’t in the field is very beneficial. So they actually contributed significantly to the cost to those 14 people, 13 employees to PSS subsidizes that because they wanted us to understand to take that step and understand the power of it.

Their hope is that we will; now I pick up the tab but expanded and I think as Jonathan commented its going very well; we officially think they’re right, the are using the right tactics and so that’s a fair expectation. That will fit inside the same numbers Carl gave you. We do still think we can keep going the way we are spending $0.50 on the dollar of new current revenue, Inclusive of PSS sales specialist and other folks.

Operator

Your next question comes from Richard Close - Jefferies.

Richard Close – Jefferies

Yes. Quickly I guess, stay on the PSS, I think they said, in there are most recent call, that a year-to-date added about 200 docs with you guys and that targets of 1,000 sort of pipeline there support of 1000 docs by year end?

Carl Bush

We probably comment on bookings forecast; even to verify their bookings forecast which I’m sure they should give with us. We are doing very well, but the way we would ever to be able to talk about those things is if we have enough air in our data set to do someone else’s. This is a very new program. We are feeling very good about the progress plan we gave you and I have to say PSS is playing a prominent role, in a lot of the higher than expected growth we are doing, but I can’t give you numbers on what we think, we booked.

Richard Close – Jefferies

Okay. Great and then Carl with respect to the same-store appointments to give us I guess some comfort there; do you have the specific numbers, I guess year-over-year respect to that? You said, there has really been no change, but any numbers specifically.

Carl Bush

Well I don’t have that in front of me Richard and I don’t know if we want to get into a regular reporting on appointments per provider given the big status that we already provide, but like I said there was definitely some differences specialty-by-specialty less of our geographically, but the overall answer was not a significant change and so we’ll look into whether or not we want to shares some more detail on that front. The December Investor Summon, in fact that will be a good time to update you on if things will change from Q3 but also may be to give you a hard metric.

Richard Close – Jefferies

Okay, if we look at the physician growth obviously, it exceeded us by a mile; how much of that should we attribute to community and community health and if you can give us an update on that implementation how that has gone through the third quarter?

Carl Bush

Community health is a long-term projects rather than a kind of a massive initiative; a one-time initiative as the MinuteClinic implementation was. So we expect a steady portion of our new enterprise category of booking and implementations to be with CHS. It’s going very well and I have a lot of respect with the folks that are assigned to lead this on their side.

The issue raises that all of the issue that come up and all of the practices, all of the time have to do with our governor on what new practices we get. Similarly their MNA activity governs where our attention goes. So whereas we can set out a discrete project to say, “we’re just going to run through this x thousand doctors,” we probably have a lot more doctors, but their program are in support of them and if they have a short-term acquisition need or short-term blips need we jump on that and leave the established doctors sitting on whatever legacy system their on until the wires out.

So that’s the way we should operate with them and it makes us hard to sort of give you guidance on when all 3000 doctors can be seen on it.

Richard Close – Jefferies

Okay. So, if we look at the third quarter growth rate I guess in terms of docs live and 33% versus I think it was 27% or so in the second quarter, that increase or accelerated growth rate; you wouldn’t attribute most of that to community?

Jonathan Bush

We wouldn’t attribute most of that. When we first announced the CHS deal early this year, we put in the press release that there is a initial trench of 300 doctors gathered around the country who are served there at Nashville and they had their own in-house service and our goal at that time was to bring those 300 onto us in Q3 and they did contribute meaningfully to the incremental docs in Q3, but compared to the overall growth that’s just a piece of it.

Richard Close – Jefferies

Okay, and then I guess just a final question here. Carl on the electronic remittance that’s been trending higher over the less several quarters and I was wondering if you can give us some sort of details with respect in your long-term or your five year target on the gross margin; what did you assume in terms of the level of electronic remittance?

Carl Byers

I think we assumed we will get that number fairly high, but we also didn’t expect that would happen as quickly as it has happened, but I would have also [inaudible] to add is the gross margin target in the initial five year plan of 57 to 60 was conservative and so if you look at it across multiple transaction sets with relatively high levels of automation, the gross margins will look a lot less like that initial projection and a lot more like our favorite company to compare ourselves to which is pay checks, which currently has gross margins around 70%. Now do I think we’ll get there in that regional timeframe, no I don’t think that is likely, but the point is the long-term opportunity here looks a lot more like by paychecks.

Richard Close – Jefferies

Okay, and then as a follow up, where do you see electronic remittance sort to plateauing?

Carl Byers

I think for all the automation rates, they’re basically looking at each incremental payer or lab or pharmacy connection and looking at the ROI on a per set up basis and so there is a bit of an 80/20 roll and they can take at some point where the manual cost of small volume of claims to one particular intermediary just isn’t worth automation. We do think automation is important to scaling, so we’re biased towards it on margins but the long way of saying that, I think overall automation rates, we have to see them get over 70% across a wide range of transaction sets over the long run and that would certainly drive very high gross margins.

Jonathan Bush

The first payer, united or something like that will be getting ERA rates 4% of all volume is one interface. Today none of the interfaces we’re building will even give us one quarter of 1%. So we’re down in the very small increments with each move, but of course if the network gets bigger, a quarter of 1% is kind of a big number.

Operator

Your next question comes from Doug Simpson - Merrill Lynch.

Doug Simpson – Merrill Lynch

One of my questions have been answered and I just wanted to touch base on two things. One, can you talk about how you’re thinking about better combined looking into next year and then just as you’re thinking about your forecast and outlook how is that going to play into things in terms of collections and then secondly I’m sure if you addressed it earlier, apologize if I missed it, but the relationship of the eclipses given the many notes deal there, how do you think about the future that relationship over kind of the next three years?

Carl Byers

We’ll I’ll taking eclipses question and then we’ll beg ignorance on what a benefit by down is and get clarification on that.

Doug Simpson – Merrill Lynch

Just leaner benefits.

Carl Byers

Sure Okay. We’ll then I’ll take that one. The only thing we see with regard benefit buy down is this shift of the core allowable; the amount that your covered for by an insurance company and if the shift is within the allowable from allowable and payable by the insurance company to allowable and payable by the patient after the insurance company pays the smaller amount.

That shift is ongoing and there is a lot of detail about who’s shifting how much and when on the Athena payer view website and what that means of course is that as I mentioned earlier we need to be of lot better at guessing, calculating analyzing electronically retaining what those amounts are at the moment of service, not waiting for the claim to go out and then capturing to credit cards capability instantly, that patient collection.

Regarding eclipses we did just sign the remaining agreement with them and we had several very exciting deals we continue to work on with them. Obviously I’m not forecasting a huge amount of AthenaClinicals sales given the recent acquisition of many notes, which is a great company and makes a lot of sense for them to offer their hospital clients one throat to choke as they say on the clinical side, but they remain convinced that the unique sort of software enabled service model that we got on the claims side, makes their big deals go down quicker when we are in there covering the physician billing peak and so we remain an enthusiastic pair of partners.

Operator

Your next question comes from Corey Tobin - William Blair.

Corey Tobin – William Blair

Should we expect this to improve sequentially each quarter. In other words, what’s the potential at this point for an occasional sequential billing decline in that gross margin?

Carl Byers

Well, we always mention our view, which is that you have to look at this business on a year-over-year basis. There are seasonal patterns on both the revenue side and the cost side and so if you look at the trend historically, you will see while we’ve had a nice run of margin expansion here, you will see some patterns there and so that means that it does not go in a straight line at all times. We are very happy with what our gross margins are, we are happy with the work that could drive them further up.

But, we’re also focused on the long-run opportunity, which periodically requires investment and so we would not sign up for perpetually increasing gross margins on a sequential basis but you should expect to see them go up year over year.

Corey Tobin – William Blair

Okay. Great and then shifting gears for a second. It is nice to see again the up tick there, can you comment on where the penetration levels were there and the current client base are versus the general expectations? Thanks.

Carl Byers

Yes, well obviously the numbers are so small that it would be a little bit early to try to demonstrate and pull patterns out of it in terms of the interest. Interest is very wide across our customer base at any in fact we are engaged in a little bit of push-back trying to choose the segment of customers that we think we can most scaleable ramp up. We are working a lot.

For example on increasing the automation associated with the implementation process and kind of doing what we called shrink wrapping the implementations and say look try it this way for 90 days before you start thinking about exactly how you think you should do it. That means we are going to be doing a lot more of the mainstream small and medium size groups as a share of our next years with implementations and then a few with big enterprise that really a have a time constrain and need do it at now so, will accommodate our customer support.

Corey Tobin – William Blair

In the interest of getting through all the questions that are out there by the market open we are going to start a little lightening around mode here.

Operator

Your next question comes from Frank Sparacino - First Analysis.

Frank Sparacino – First Analysis

Hi, guys. Really a quick Call, can you just give us the headcount by functional at the end of the quarter?

Carl Byers

Sure. Q3 we had direct headcount of 477, as Jonathan mentioned in the script we are over a 100 in Maine, which is a great milestone given we just opened for business in the second quarter. Total staff in sales and marketing 92; 35 current quarter, 15 of which are in the small practice segment, so we’ve seen some sequential growth there. R&D is a 109 G&A 86 so, total of 764.

Operator

Your next question comes from [David Blair] - Cantor Fitzgerald.

David Blair - Cantor Fitzgerald

Thank you for taking the call. We clearly had a very big sequential increase in the positions on the system we talked a little bit in the call about, some of the sources of that, but it would appear that’s going to also maintain that increase which may continue and I wanted to know the factors which considered that cause us to ramp it down, and I guess it appears that you could have a very meaningful improvement in margins in the next few quarters and I know you should be careful and to understand that even if we put in similar margins to the third quarter and increase in sales and marketing it’s difficult to fully count down [inaudible] to understand what analysts might be missing?

Carl Byers

Yes, I think in terms of the growth question. We really have base strong implementations in the second and third quarter, some of the Q2 implementations will have on last date to quarter and so no clients have been submitted so a few of those doctors reflected in Q3 account talks within that this street number of individuals for only some of the recent on claim that so we didn’t submit a claim for some amount on the Q2 that shop in Q3.

So basically, that number if you work historically does downs around, it doesn’t only go up period growth rate now, but just like the margin sequentially we wouldn’t sign up for those always gone up, we wouldn’t sign up for there is a number of doctors that added in the quarter and ratcheting up that way either, it will bounce around, but the trend is up into the right in general.

In terms of margins, I commented earlier we are not interested in the margins of a 12,000 docs business we are interested in the margins of a 100,000 docs business and so that involved investment and so I think across the board that all kinds of way we can spend money that is well spent for the long run we do have an toward the margins of quarters, but our buyers is towards growth innovation and that is as reflected next month.

David Blair - Cantor Fitzgerald

You haven’t missed anything. I mean we are feeling pretty good about everything. Would you like to add to that if you don’t mind Carl?

Carl Byers

When I looked at the five-year plan, when we hit our road show and I said can we keep doing the bookings that we need to do out all these years. I felt pretty confident that we could do it and incrementally as we’ve beaten those bookings and wrote numbers I felt that we could still grow 30% on top of what we’ve done.

Now we’ve just done a 50% increase in the number of providers’ year-over-year, I don’t think I could do 50% growth next several years. It can happen I would love for it happen and we are making plans for it to happen, but I don’t think it will not be able to keep of with this is it we keep beating by this much each time so, that’s the only sort of, but the yes, things we’re looking good and we still only have the couple of percent market share.

Operator

Your next question comes from Leo Carpio - Caris & Company.

Leo Carpio – Caris & Company

Regarding the competitive environment; any impact you’ve seen for the whole all scripts merger with Misis or are thing just the same pretty much?

Jonathan Bush

No change in competitive environment, obviously we heard that some of our legacy software type business model competitors buying billing services, which we are flattered by and we’d like to thank them publicly for honoring of our business model with those acquisitions, but so far we haven’t seen them in the market, I assume we will at some point. Hopefully also the venture capitals that ought to have been awake over the last five years watching Athena, they’ve got some folks in garages working hard on other web native kind of software but so far no changes to announce.

Leo Carpio – Caris & Company

Okay, I don’t know if you provided us. Did you provide any info on the first pass claims verification rate this quarter?

Jonathan Bush

I’m happy to share that its 91%, which was down 1% sequentially. We’ve mentioned that NPI was handled extremely well by the company one way has been handle is by turning around any NPI related issues very quickly so, that the cash flow is not interrupted, but I can effect the first half resolution rate and so, little bit of NPI noted that I think or its way in the third quarter into that with so, anticipate?

Operator

Your final question comes from Linda McDowell - Manchester Management.

Linda McDowell - Manchester Management

I’m trying to get a sense of how this way there is sort of it different forces on a revenue for provider that’s with the fourth quarter, the MinuteClinic versus some of the docs coming on at the end of the quarter I’m any guidance on a look at that?

Carl Byers

This is Carl, I think that we’ve said now for a few earnings call in a row that we think revenue growth in Q4 will be very strong and that is still the case, but in the little one keep up to just should have take the high point of revenue provider and jack up the revenue to levels that are unrealistic, so I think the point is we’ve had a surgery provider, that is added to the denominator in this equations, which is wide with the flat year-over-year, and it may take little low to for the working twice through the systems especially for continue to add providers at the strong rate. So I would just be cautious at some extent with the over all revenue growth in the context of it being very strong compared to prior quarters.

Linda McDowell - Manchester Management

Okay and are all the MinuteClinic’s up and running

Carl Byers

Yes this shows a big buying implementation. There is some seasonality there in Q4 for them, was one of the reasons they showed that and wanted to go wide as quickly as we did as they want to make sure they had a operational solutions in place for the growth they expect

Linda McDowell - Manchester Management

Great, thanks for the help.

Carl Byers

Thank you all for your attention. We look forward to the next call.

Operator

This concludes today’s conference. We thank you for your participation. You may now disconnect.

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Source: Athenahealth Inc. Q3 2008 Earnings Call Transcript
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