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Athenahealth, Inc. (NASDAQ:ATHN)

Q2 2008 Earnings Call Transcript

August 5, 2008 8:30 am ET

Executives

Carl Byers – SVP, CFO and Treasurer

Jonathan Bush – Chairman, President and CEO

Analysts

Randall Stanicky – Goldman Sachs

Donald Hooker – UBS

Richard Close – Jefferies & Company

Sean Wieland – Piper Jaffray

Doug Simpson – Merrill Lynch

Jeremy [ph] – William Blair

Frank Sparacino – First Analysis

Leo Carpio – Caris & Company

Tod Weller – Stifel Nicolaus

Newton Juhng – BB&T Capital

Operator

Good day everyone. Welcome to the Athenahealth second quarter 2008 financial results. Today’s call is being recorded. At this time, I’d like to turn the call over to Carl Byers, Chief Financial Officer of Athenahealth. Please go ahead, sir.

Carl Byers

Good morning and thank you for joining us. With me on the call today is our Chairman and CEO, Jonathan Bush. 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 and available on our Investor Relations web site and on the SEC's web site.

Investors are cautioned not to place undue reliance on such forward-looking statements as there is no assurance that the matters contained in such statements will be achieved. The forward-looking statements we make on today's call are based on our beliefs and expectations as of today only.

We do not undertake any obligation to revise or update publicly any forward-looking statements expressed on today's call.

Finally, please note that we will refer to certain non-GAAP financial measures in which we exclude certain non-cash or non-recurring items from our financial results as determined in accordance with GAAP.

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 financial performance measures, determined in accordance with GAAP.

Please refer to yesterday’s press release announcing our second quarter 2008 financial and operating results available on our web site for a reconciliation of these non-GAAP performance measures to our financial results determined in accordance with GAAP.

With that, I'll now turn the call over to Jonathan Bush, who will discuss the highlights of the quarter, after which I will talk about the financial results.

Jonathan Bush

Thank you, Carl. Good morning and thank you for joining us. I’m very pleased with the financial results this quarter. We had $33 million of revenue representing growth of 35% over second quarter of 2007, well above our long-term target model growth rate of 30%.

Despite investments in Q2 to support growth, our adjusted gross margin in the second quarter increased to 57.9% primarily due to automation rate improvements. And in terms of our primary bottom line metric, we achieved $0.11 per diluted share in adjusted net income.

These results reflect outstanding performance by our operations team. We implemented a high volume of new business while also executing several complex and critically important initiatives in the quarter.

In particular, we executed very well on three specific initiatives. First, we launched our new operations center in Belfast, Maine which is now up and running as our second operating center. Next, we completed an on-time conversion of all outbound claims to the new required National Provider Identifier or NPI format. Third, we increased our automation rates for key payer transactions which helped reduced our direct operating cost. It each case, the outcome of the work with exceptionally good. Our operation center in Maine is ramping up very smoothly with 60 employees already onboard at quarter-end.

Our three years of planning – three years of planning for the NPI format transition led to a relatively smooth transition on May 23, with very minimal impact on our front-end denial rates. And finally, we achieved automation levels ahead of plan including an end of quarter electronic remittance rate of over 50% for the first time. I want to acknowledge Jim MacDonald, Athenahealth's Chief Operating Officer, and his superb teams for these absolutely terrific results.

At the same time, our growth team continues to deliver strong results. Q2 was our first quarter with over 1,000 live accounts than our first quarter with more than 10,000 live physicians on our network. Our growth team continues to be successful in attracting our existing medical providers to athenaClinicals which is now installed in 4% of our Collector client base. Our implementation activities are proceeding at unprecedented levels, reaffirming our view expressed on the last call that we expect growth in Q4 to be very strong. In this way, we maintained our expectation of some strong margin pressure in Q3 related to preparations for this new level of growth.

While our efforts of scaling operations they’re moving along very well, we are seeing some increased strain on client’s servicing activity. This is evident in a small sequential decreasing in client satisfaction, but under the leadership of Jody Blakeway, our new Senior Vice President of Client Services whom I mentioned on the last call, we are confident that our new near-term plan will relieve that strain effectively. It is because of precisely these sorts of dynamics that I focus these calls on deeper operating metrics. First, employee engagement was flat at 3.8 out of 5 using the same framework I have described on prior earnings calls. I am focused on increasing this rate in the near term through improvements to our overall performance management approach.

Next, we used days in AR to measure our financial performance for clients. It was 45.2% days at the end of Q2 which was down 1.3% days sequentially but flat year-over-year. While strong compared to the benchmark data of our clients, I believe our performance has the capacity to see more substantial year-over-year improvement.

These efforts include payer partnerships to reduce payment cycle time and efforts of improving effectiveness of our clients on the network. One key component of days in AR is the portion of patient encounters caught by Athena’s Rules engine, but not fixed by clients in a timely manner. Another is receivables owed to medical groups by patients rather than payers. Both of these are rising and both will benefit from client service infrastructure improvements that Jody is leading.

Finally, client satisfaction was 84%, again, measured the same way we described in prior earnings calls. This is down sequentially as well as year-over-year and reflects the recent strain I mentioned earlier. Our participation rate was lower in Q2 than usual. So we aren’t sure how much to lean into this trend. Nevertheless, the upgrade of our client services infrastructure currently underway with enable scaling while also helping our clients improve their side of the performance equation, changes that we think will enhance satisfaction overall over time.

Next, I want to hit briefly on a few key initiatives. We are very excited with the progress we are making with PSS World Medical on our new initiative to support lead generation with a dedicated team of professionals in the field. At the end of the quarter, we had staffed all but one of our 14 dedicated role and we had executed several booth camps with PSS top reps to support our new effort. It is early but the results already look to be promising. In our Clinicals area, we are more convinced than ever that our approach could truly outsource the chart room transaction flow rather than just provide client server software will be the model that wins in the end.

In the quarter, we increased our life provider camp to nearly 500 and grew our cross-sell ratio from 3% to 4%. As we continue to grow at high rates, we also aim to continue to increase our cross-sell ratio.

I also want to talk on some of our enterprise client implementation efforts. I am pleased to report that our implementation efforts with CHS, CVS Caremark MinuteClinic, Harbin Clinic, Wayne State, and others that we have announced to you are all proceeding according to plan. This is an unprecedented level of simultaneous enterprise class implementations for us and I want to acknowledge our professional services team for their absolutely superb execution. We believe our ability to deliver differentiated value to this enterprise segment demonstrates both our relevance as a potential national network for all providers as well as obviously our prospects for further near-term growth.

Finally, I want to comment on our acquisition of MedicalMessaging.net. Announced yesterday, this is primarily a capabilities related acquisition and we are very excited about it. We have come to know the business and its principles very well through working with them as a partner over the past two years and piloting integration of their patient appointment reminder service with our core Collector service. We respect the product design and the attention to client needs that MedicalMessaging has demonstrated and we concluded that by acquiring this technology, we will be better positioned to pursue our product strategy cost effectively than we would if we had built this capability ourselves in-house over years. By creating patient messaging that integrates automated live operator work, they have put several years into developing a service that fills a critical gap in the financial needs of practices. By enabling consistent, efficient, and results-oriented communication with patients, they help physicians streamline office workflow, improve patient compliance, and most importantly increase revenue per provider through reduction of no shows and late cancellation in addition to other automated services.

We are very pleased to have joined forces, not only with a well-developed service capability in the new area, but also with an exceptional team. While we will pursue cross-sell of their current services immediately, they are already seamlessly integrated into athenaNet. We also have longer term product vision that this acquisition supports. We look forward to sharing that with you in future calls.

In summary, Q2 was a quarter where rapid growth was matched with outstanding operational performance. As we move forward, we aim to enhance our client servicing infrastructure and functions and our financial performance for clients. Carl will now walk you through the financial results after which we would be happy to take your questions.

Carl Byers

Thank you, Jonathan. We are pleased to see strong revenue growth in Q2 2008 to $33 million, up 35% over the same period last year. This represents our 34th consecutive quarter of organic revenue growth. Our growth was driven by an increase in the number of physicians actively using our services to 10,356 in Q2, up from 8,136 in Q2 of last year. As we always note, most of our revenue is tied directly to the collections of our clients, so we typically experience fluctuations and mirror the activity of the medical practices we serve. Total client collections posted to athenaNet were $885 million in a quarter up from $666 million in Q2 of 2007. Our growth was the result of both new client adds and increased revenue per physician. Our business services revenue per physician was up 7.6% compared to Q2 of 2007.

As we mentioned on the last call, given our work with clients who emphasize non-physician providers such as MinuteClinic and our recently announced RediClinic client, we also want to share with you, on an ongoing basis, information about this number of total medical providers on our network. In Q2, we submitted claims on behalf of 13,554 medical providers compared with 10,515 in Q2 of 2007. In the area of athenaClinicals, our provider count live in Q2 was 498. This is the subset of athenaCollector providers counted on an activity basis for whom athenaClinicals services are being provided. As Jonathan mentioned, this provider count represents 4% of our live athenaCollector base, up from 3% in Q1 of 2008.

As Jonathan mentioned, our adjusted gross margin increased to 57.9% in Q2, up 50 basis points sequentially and up 410 basis points year-over-year. So we did encourage substantial new costs associated with adding staff. The core leverage of the business overcame that impact to result in a net increase in sequential gross margins. We did invest in our main operation significantly, building our ability to operate in two locations while also meeting the needs of our growing business. Some of the cost growth we had anticipated on the last call is still expected to occur in Q3, so we reiterate our view that margins will be impacted by prudent spending to prepare for higher rate of growth at the end of the year.

Turning to the bottom line, we posted adjusted earnings which exclude the impact of stock-based compensation of $0.11 per diluted share. Increased spending in the areas of growth and innovation were offset partially by sequentially lower general and administrative expense. Given the increase in gross profit, our adjusted EBITDA margin of 16.7% was up 320 basis points sequentially and up 570 basis points compared to Q2 of 2007. Given our enormous market opportunity, our bias is toward growth and innovation rather than focusing on margin expansion. That having been said, the inherent operating leverage in this business is very strong as is evident in these numbers. We believe that the key to scaling this business is to automate a lot of the work we currently do manually which will have the effect of further enhancing our operating leverage and driving higher margins.

Lastly, regarding the acquisition, Jonathan noted that this is primarily an acquisition of product capabilities subsequent to extensive work with this company on a partnership basis. We do not expect a significant ongoing impact of this acquisition on our income statement. The acquisition price as noted in our 8-K was $7.7 million of cash and we expect it to close toward the end of this quarter. MedicalMessaging.net has a small amount of run rate revenue about $2 million and has very little EBITDA. While there are cross-selling opportunities both ways that we aim to pursue quickly, we expect this deal to be very modestly dilutive in 2008 and roughly breakeven in 2009. This deal was done to advance our product strategy in a cost effective way. On that basis, we are excited about the opportunity it opens up for Athenahealth. So, overall, the financial performance of the company in the quarter was very strong as we delivered rapid growth in the face of industry-wide operational challenges and also realized sequential margin improvement due to improved levels of automation and related operating leverage.

With that, we would be happy to take any questions that you may have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We’ll go first to Randall Stanicky with Goldman Sachs.

Randall Stanicky – Goldman Sachs

Thanks very much for the questions guys. Just first on MedicalMessaging, can we talk about the strategy, is it a bundling strategy or is it a separate sell in to the docs? And then separately, when you talk about future product strategies, I guess this gives you some touch to the patients, should we view this more of a physician-focused product or something that maybe leverages the ability to go after the patient market at some point?

Jonathan Bush

Randall, thanks for asking. I think that, at this stage, we have strategies where it can be a bundle intercollector and clinical. It can also be a separate play we run into larger kind of hospital loan accounts that would like a fuller service, less co-sourcing, more outsourcing. And finally you didn’t mention, but we think it’s a very interesting potential beachhead play, in other words, there are several thousand physicians that are being served on legacy practice management systems by this web-native voice service and we look at it as the first step, first boots onto the beach of getting rid of those tacky things. So those are the three strategies that we are looking at and I would say bandwidth, assessing the work content had a lot do with when or if in the near term, those packaging options get used.

Randall Stanicky – Goldman Sachs

Is this the first of what we should be thinking about as some other plug-and- play opportunities from a small acquisition perspective going forward?

Jonathan Bush

We are extremely cautious about acquisitions and don’t have anything specific but needless to say the thing about buying other things is that the price and the timing can cause you to need to replan if you want to get good value. But right now, we don’t have any specific coming down the shoot [ph] and as you can imagine, with the core business as healthy as it is, we don’t plan on confusing or exhausting ourselves unnecessarily.

Randall Stanicky – Goldman Sachs

Got it. On the core business, you talked about little impact from this deal, obviously margins where up and not down this quarter. When you talk about 3Q being a little bit down as you reinvest ahead will give us a bump into the 4Q. How do we think about the magnitude? Are you still in the 57% to 59% sort of annual target that you talked about before?

Carl Byers

Thanks for the question, Randall. First of all, regarding Q2, I want to point out that our direct cost did grow at a very high level. We are up $1.2 million sequentially which was about 2x what the normal pattern had been. Furthermore, as Jonathan mentioned, Maine really has ramped up, 60 employees at the end of the quarter. In the G&A area, we spent about $700,000 running the place including an abnormally large tax bill because our new lower real estate tax rate didn’t kick in until July 1. So the cost we anticipated did occur but what also occurred is strong revenue performance. We mentioned the rep [ph] business services revenue per doc being up almost 8% which I think reflects both great execution in our regular business but also a great transition given the NPI format change which some people have predicted would cause a slow down on revenues and really materially did not.

So that was one element that overcame that increased spending and then the other element is automation. Jonathan mentioned that our electronic remittance rate at the end of the quarter was over 50% for the first time. That is the automation of the inbound paperwork from payers instead of getting a big stack of paper, scanning it and having our old system data enter it, we have our computers talk to the payers’ computers and it happens in an automated way. So, that operating leverage enhancement and the revenue performance overcame the cost growth. So, that is one of the covered [ph] Q2. As we look into Q3, absolutely the theme is still the same which is we see higher growth in Q4 than we had experienced in recent times. We want to be ready for that.

Jonathan mentioned the final thing here, enterprise class implementations at an unprecedented level. Those are all going well, but those also require investments. So, we would expect to increase our spending in Q3 as we did in Q2. And so, generally speaking, I would say that there is some potential for margin compression in Q3, but obviously if we execute really well like we did in Q2, that could be counteracted by other factors.

Randall Stanicky – Goldman Sachs

And you are planning to fully staff Maine by the end of the quarter?

Carl Byers

What we said for Maine was that, by the end of the year, we’d be over a hundred. We may in fact exceed that. We’re finding that the labor pool in Maine is available, very high quality folks to do outstanding work and a have perfect work ethic and so we’re very happy with the idea of leveraging this asset. So, I wouldn’t say fully staffed because we could have 700 people there in the long run, but in terms of our overall plans, we are, if anything, ahead of schedule.

Randall Stanicky – Goldman Sachs

Got it. Okay, I’ll stop here. Thanks a lot.

Operator

We will go next to Donald Hooker with UBS.

Donald Hooker – UBS

Great. Good morning. Thanks for taking my questions. It’s interesting you commented about these automation rates helping your margins and these electronic remittances. Is there a way to quantify the benefit of that to you? Is there just a sort of picture, help us picture it in our heads kind of where can that percentage go? Is there any reason that it might go back down or is it just pretty much going to go up over time?

Jonathan Bush

There’s always a chance things can go down just because the industry is changing all the time. We are growing into new markets and so forth, so that can change the overall mix. But the historical trend has been for automation rates to only go up and I should point out that there are – we mentioned electronic remittance, there is a basket of different transaction types and activities that we do here that has the potential to be automated. So, for example, our run rate of outbound phone calls, just to check on where is Claim Number 236, which we outsource those phone calls, it’s over a million calls a year right now. The majority of which could be eliminated or automated through techniques that such as what we call clustering analysis (inaudible) of the call and also through automated transactions with payers such as claim status inquiries. So, in terms of an image to have in your mind, I would say Athena's a value proposition to the physician is that we take on all the work on day one, no matter how messy or how manual, and that’s what we’ve been doing for all of our clients since day one. But it is our job then in the background to improve process, to automate, to deploy technology and analysis to make the actual work that is done more and more automated which has the effect of eliminating variable costs and going from being a high variable-cost outsourcing-type of model to a high fixed-cost network that has much higher operating leverage.

Donald Hooker – UBS

Got you. Thank you. And also with regards to just straight up cash collections by your physician customers, it seemed like that was very strong year-over-year. I didn’t know if you have made any comments on that, as it might go up 885 million in the second quarter versus 660 or so in the same quarter last year. Is there any kind of – is that coming back to the first pass resolution rates and things like that or is there something else going on there?

Carl Byers

Well, you see what’s wrong and I think it is a testament to the execution of our operating teams especially in the face of a lot of industry change, so we are very pleased with that result. There certainly was the opportunity for a lot more. Jonathan mentioned that our days in AR was essentially flat year-over-year and we'd like to get that down further. We see opportunities to improve the way we handle patient receivables. We've seen Medicaids are troubling in terms of the payment cycle times these days. So even though we are very pleased with the outcome, we see the potential for doing much better on that and that’s again I think a testament to the business model where we can actually see all the drivers from the first phone call to money in the bank and actually manipulate the work flow in the physician’s office and the execution on the back end to deliver the end result which doctors care most about, which is money in the bank.

Donald Hooker – UBS

Okay. Great. Thanks for your comments. I appreciate it.

Operator

We will go next to Richard Close with Jefferies & Company.

Richard Close – Jefferies & Company

Yes. Thanks. Congratulations on a good quarter. I wanted to hit on this client satisfaction if we can. I think you said 84%, if I am not mistaken, but how does that again compared to the first quarter and year over year and could the rollout of Clinicals be leading to the softer client satisfaction that you noted?

Carl Byers

Well Richard, thanks for asking. I do think this is an important area of focus, in fact, I would say this is where kind of all of our innovation energies, where the lion's share of them are now focused, having had a very good year of focusing them on the claim op side. To answer your first part of the question, 86% was where we were in the first quarter, so it is a pretty meaningful flip and we have been up in the 87%, 88% range; we shot for 90% for the year which would have been off the charts, good.

I would say the Clinicals is not the primary driver of the decline. There has been some decline in the number of customers participating with more like, kind of 70 some percent participating as opposed to usually in the 80s and 90s percent participating. And if you actually do the micro math, Richard, you will find that the people who – if everybody participated the same as last time and given the same scores last time, then we’d be back where we were. But the point is, we know we are experiencing normal and addressable growing pain in this area. As we grow quickly, the ratio of account managers to accounts does not change and so you end up with a lot of relatively new account managers. Account managers are not the persons you want to have who is very, very new. So, we are slowly tweaking that model, that service model, so that less calls need to come in in the first place, more of those calls are handled on the first try and the account managers have better tools and leverage to really do outbound management of accounts as opposed to reacting to issues.

By the way, I want to add to that one area where Maine has surpassed our fondest expectation, is in the area of customer service and we are actually looking at moving some account management up there as well. These are folks largely that are alumni of various kinds of credit cards, gold cards, call centers, and are absolutely excellent, excellent on the phone. We are really impressed. So, we’ve got a lot of things in addition to Jody’s arrival and focus on that that makes me confident about this being a new area of, kind of, renewed pride and strength. So I don’t think that going from 86% to 84% is cause for alarm, but it’s definitely cause for focus.

Richard Close – Jefferies & Company

Okay. And then retention rates, have they changed at all, based on maybe the lower satisfaction or any meaningful changes there?

Carl Byers

We didn’t see that type of change in Q2, Richard, so we look at it in a lot of different ways and then when we look, for example, at the dollars that left the system in Q2 as a percentage of business services revenue, that was 0.07%. So annualized 2.8%. So that’s consistent with what we’ve seen historically. Sometimes these things do ebb and flow. So we have our eye on that very closely, but to date we have not seen that. We always are looking forward and then trying to anticipate changes that could happen in the landscape that could affect us and so there are lots of things we think about and focus on, but so far we have not seen a material change in that number.

Richard Close – Jefferies & Company

Okay. And then just moving back to the margin, were there any investments that you plan to make in 2Q that shifted to the third quarter or was the second quarter investments pretty much in line with what you expected?

Carl Byers

Well, as I mentioned, we certainly did increase the spending quite a bit in some of the target areas that we had highlighted and it really was primarily the performance of the business, the rest of the business that overcame that trend to drive the margin progression. That being said, we continue to make those investments. One line item where we certainly increased as a function of our growth-related activity is the sales and marketing. We could have done more, though some of the costs we had originally slated for that period, we would expect to be in the second half of the year. So there are here and there, there are different elements of spending that we did defer which is one of the reasons we want to convey some caution about the margin compression theme to make sure that people know are still making investments in our growth. But obviously, the execution by the operation really delivered for the company in a way that made that diminished, had in fact diminished.

Jonathan Bush

Yes. I mean, remember guys, we would have to be crazy to forecast all of those major projects firing off so incredibly well, and they all did, so we do not forecast delivering that well every single quarter and we still forecast being a great company, a great stock, but this was a great, great quarter for the operating team.

Richard Close – Jefferies & Company

Okay. Just to be clear, the investments in the second quarter, you just mentioned there was a deferral, but just to be clear, there wasn’t a significant amount of stuff that you expected to spend in 2Q that is now going to 3Q, correct?

Carl Byers

As I said, there are some pockets of planned spending that did defer from Q2 to Q3, but we really did spend in Q2 at a higher rate in terms of the areas we had isolated. We increased our professional services and account management teams and we also ramped up Maine substantially. I mentioned we spent about $700,000 in Q2 on running Maine which was a sharp increase.

Richard Close – Jefferies & Company

And then, finally, with respect to I guess definitions, Jonathan, you mentioned margin, we may see margin pressure in 3Q, but I guess there is a difference between margin pressure if you are having this incredible improvement in automation versus margin compression. Should we be looking for margin compression sequentially?

Carl Byers

Richard, I guess what would say is because we’re making investments, there is the potential for margin compression. But at the same time, that’s less of a yellow flag for Q3 than it was for Q2 and we have seen the reason why our strong execution won’t continue and so we want to caution that we will be making investments to help the business support new growth, but we are perhaps putting up less of a strong point on that now than we did going into Q2.

Richard Close – Jefferies & Company

Thanks. Congratulations.

Carl Byers

Thank you very much.

Operator

We will take our next question from Sean Wieland with Piper Jaffray.

Sean Wieland – Piper Jaffray

Hi. Thanks, guys. Most of my questions have been asked, let me just follow up on a couple of things. First on the NPI issue, can you just compare and contrast your experience with this versus what your impression of what the industry saw and if the industry in general saw issues with this, are you seeing an increased interest in the Athena platform?

Jonathan Bush

Thank you for asking, Sean. This was, of course, one of the dogs that didn’t bark and therefore allowed us to do quite well on a gross margin, which is to say that we – our groups just did a world-class (inaudible) and it went incredibly well. We have heard horror stories across the industry and therefore, say about 50 to 60 days after that point in time, we’re expecting bank accounts to have not what they should have in them in lots of [ph] the doctor’s offices and we are hoping that that does translate into some sales. We did see that with HIPAA way back then. We got a lot more calls right after HIPAA sort of didn’t work with a lot of intermediaries and legacy systems. So, we do hope it translates into that. We don’t have any isolatable – we haven’t been able to isolate at that level of granularity the lead traffic yet, but we’re certainly hopeful for it and we’re certainly glad you pointed that. I know, at some point, there were some concerns amongst investors that may be Athena had to suffer on this front and obviously, we could have. This is an area where we focused and where we are dependent, but we just – really, if you look inside the numbers here, we were averaging a 1.2% front-end rejection rate and literally the month that NPI went live we ended up averaging a 1.0% front-end rejection rate, even lower that average which – when we’ve been hearing stories of 20% front-end rejection in the industry that normally rejects 5% to 10%. We just couldn’t be – we’re very sad obviously for all the pain it caused you, but couldn’t be happier relatively speaking.

Sean Wieland – Piper Jaffray

Okay. And then on the ERA, you said that your rate is north of 50% now. Can you tell us where it was a year ago and would you be able to equate a percentage in rate increase to a dollar amount, like for every percentage point if that goes up, you save x dollars?

Carl Byers

Sean, this is Carl. We certainly do a lot of that math in-house but we probably want to keep it that way. Suffice it to say that what we are doing with ERA is we are basically eliminating variable costs. Think of Athena as a big network and what we are doing is we have teams hard at work on what we call the last mile which is plugging our technology and our operations into third-party's whether they are payers, lab companies, or pharmacies to automate the interplay between our clients and those entities that they depend on whether it is for cash flow or medical results and so the last mile teams have really taken off in their work. To answer your question on ERA, the blended rate for the whole quarter was 48%. I mentioned that at the end of the quarter, we were north at 50% for the first time and if you go back to Q1 we are at 44%, if you go back to Q2 of 2007 that was at about 29%, and if you go back three years it was approximately 0%. So that gives you a sense of the chipping away that we are doing and so if you want to relate those numbers to costs you can go ahead and do that, but that is just one example of many opportunities to turn variable costs into fixed costs and obviously if you can get (inaudible) if you get all of your costs fixed, then you’ll have pure operating leverage.

Sean Wieland – Piper Jaffray

Okay, good. Thank you very much.

Operator

We’ll take our next question from Doug Simpson with Merrill Lynch.

Doug Simpson – Merrill Lynch

Good morning and most of my questions have been answered. I was just wondering on the client satisfaction issues, is there any way to break that down by client size and can you give us a sense in the past, Jonathan, I think you've said it probably doesn’t make sense to have that number too high and there is an opportunity to may be monetize that. I mean at 100%, it is probably the cost associated with keeping it at such high level would be prohibitive. How do you balance those two things and just may be give us some sense of the expense related to that.

Jonathan Bush

Well, as you can imagine, I don’t know how to read a baseball box score but I read client satisfaction by segment, by tenure, months on the network.

Doug Simpson – Merrill Lynch

Right.

Jonathan Bush

By specialty, by zodiac sign, so I have all that data and I’m always looking at it, we all are. I don’t think it is useful for us to reveal too much detail in terms of where we are weak and where we are strong on an open call.

Doug Simpson – Merrill Lynch

Okay.

Jonathan Bush

But it’s so educational for us, not because we can then go and buff up the customers that are unhappy. Obviously we have got systems and processes for people who could do that but it’s really, really educational in terms of how the product aspect of our network is being used, how that front end experience and the fundamental take away on satisfaction is that as we have responded to the opportunities and ideas representing larger and more sophisticated accounts over the years, the network itself, the user experience has gotten more and more and more complex. Now for a regular user, it’s fine. The rate at which people can learn new technology is much faster than the rate at which our technology gets harder to learn, but for the new people coming on to the network, more and more training is needed and that includes new employees of ours and so I think what we are really focusing on is simplification. I think that the main lesson that we’ve learned here is we have such a unique opportunity, in two ways. One, we can see use in real time. We can see how many times, who hits the back button when, when they hang up on a page, when they don’t get what they’re doing. We can see that like some sort of movie of a (inaudible) novel, the silhouettes of all these tens of thousands of workers, and so we can iterate and learn.

The other thing is we have the ability to find pieces of work that customers are doing badly or struggling with and literally do it for them, so if we find that – for example, one learning is that we found that customers have a very hard time spending a lot of hours reconciling their paper bank statement with their end of month printout from athenaNet. Well, we have been working and are soon to announce a real-time electronic service that will be added Collector for customers that use our lot box, almost all new customers use. They will do all of your bank reconciliation in real-time seamlessly automatically for you. So that is one of a million little islands in an atoll of simplification that need to be brought into line and we are very confident we can do it but it’s going to be a hard work.

Doug Simpson – Merrill Lynch

Okay. And then could you just give us a little bit more color on, given the economic backdrop, what are you seeing in terms of demand questions, sort of inbound calls on the financial side versus the clinical side and can you discern any difference on a relative basis given the economic backdrop?

Jonathan Bush

It remains the case today that medical groups – businesses that are owned by physician practitioners are interested in clinical primarily as a precautionary measure. They don’t want to wake up one day and find out that there is a new law and that they are left up the creek without a paddle. That being said, we are picking up our sales, our unique perspective on Clinicals has been of course to deliver cash, sole purpose of athenaClinicals is deliver more cash to physician pockets every month. Right now, we do that by eliminating about $1,500 to $1,700 worth of back office work, doing it for the practice in the background and we think that over the coming years, we’ll be able to add to that – the prospective of new revenue stream around paper performance which is emerging. But right now, because the cash is only on the cost side, it is not as big as Collector, doctors come to us to increase their cash flow and therefore most of them end up buying Collector first and most of the new Clinicals business is cross-sell, folks that have already realized the cash improvement on Collector and now looking for the next incremental cash improvement.

Doug Simpson – Merrill Lynch

And on the Collector side, any change in the level of activity or the type of activity in the economic backdrop, are they either coming to you more because – hey, we really need to do everything we can or are they coming to you less because (inaudible) change things – any sense on that front would be helpful.

Jonathan Bush

We addressed last time the real change in the activity level which was the significant increase in the number of the enterprise accounts that are ready to get on to this network that we have sort of reached the level of robustness in that already where the likes of Community Health Systems and CVS MinuteClinic, etc. So, that’s a real change in the complexion of the mix. Recently just early now, the fruits of our new level of engagement with PSF, where our 15 manufacturers reps call them are on the field. It’s very positive as well, so we are seeing at the smaller group end of the spectrum some uptick as well. Some significant uptick at the early, early end of the pipeline – so early that we don’t know what close rates will be, etc., but hopefully next time I'm talking to you, I’ll be talking about another step function change, but this time at the low end of the spectrum.

Doug Simpson – Merrill Lynch

Okay, great. Thanks.

Operator

We will take our next question from Corey Tobin with William Blair.

Jeremy – William Blair

Hi, guys. It is Jeremy [ph] for Corey. I wanted to hit on seasonality of user growth, I think if you look historically, it looks like incremental number of physicians coming online tends to be highest in Q3 and I’m wondering if you guys – if there’s a particular reason for that and whether you see that likely to occur in this upcoming Q3?

Carl Byers

Jeremy, this is Carl. I think historically, people have done a lot of tea-leaf reading on the ebbs and flaws of bookings and implementations of doctors versus dollars. We certainly have tried to make a science of that in our internal forecasting, but I would caution not to read too much into just one year of strength. That being said, what we told you is we are in a period of increasing growth. And so obviously that will manifest itself in doc counts and account counts and collections under management, pick your favorite metric. So I guess what I would to say is, there is no particular reason that I am aware of why the third quarter would be de facto higher on single year. But that’s certainly was the case last year and we are also in a period of increasing growth right now and so we will just comment on that when it happens.

Jeremy – William Blair

But there is no particular reason why you would say it wouldn’t – you couldn’t on a yearover-year basis continue to post solid growth?

Carl Byers

I’m sorry.

Jeremy – William Blair

I’m just trying to may be ask the question in a reverse fashion which is, is there are any reason why you wouldn’t see it on a year-over-year basis if the user accounts continue to grow at sort of (inaudible) rate if you will?

Carl Byers

Well, maybe I will answer it in a reverse fashion. We are seeing strong growth and that obviously would be reflected in the second half of this year.

Jeremy – William Blair

Okay. And with respect to – you mentioned the Medicaid payment cycle time slowing. I know you guys have seen on a state-by-state basis this sort of thing happen before as states kind of play with their budgets. Wondering if – maybe quantify the maximum potential impact of any one state in terms of your potential headwind in terms of that. And it seems in the past you’ve been to be able to easily power through that, just kind of give us some color as we go around specifically with your California budget concerns and that sort of thing.

Jonathan Bush

Well one thing I will say that is a strong support in our planning effort is that we are very well diversified. We are diversified across medical specialties. We are diversified across states, payer types, practice sizes and so what that tends to do is inoculate us against really seeing in the P&L a big impact of any one particular trend. Obviously, we are focused very much on the CMS goings on in Congress and how they are now reacting [ph] to that.

But at the Medicaid level, sure, in some states like – there was a cycle for awhile where Illinois Medicaid just stopped paying as soon as the budget was used up and no one gets paid for two months until the next budget cycle. Those types of things can happen especially the closer you get to the government, but we are so well diversified across states and specialties and payer types that we generally don’t see that in the P&L. I think where we can see it is in things like days in AR and where we focus our efforts and two areas we would highlight are self-pay and Medicaid plans in general. I would not be surprised if state budgets were the culprit behind the Medicaid increase in days in AR. Self-pay is probably more related to the shift toward consumer responsibility and we have a lot of very exciting product development initiatives going on related both to our retail clinic rollout and to our general products that we will be addressing – the core cause of those increases.

Jeremy – William Blair

But the punchline is you don’t see any major concern with respect to that – to any delays in cycle times as being a headwind on revenue growth; that seems to be such a small impact relative to the other things you’ve got going on.

Jonathan Bush

That is correct. My only caveat would be that we’re working through the aftermath of the CMS rate showdown in Washington, so there’s a backlog there that worsens. It could not have happened at a better time in terms of our quarters because they stop paying at the first day of our quarter, so we would expect all those backlogs to be cleared well before the end of the third quarter, but I would just put a bookmark on that one because there is a lot of work to dig out of that one.

Jeremy – William Blair

Okay. One last and if I could – I think Jonathan highlighted, talked a bit about PSS and how you’re still – the way you see [ph] in terms of when the impact and the magnitude, but wondering if could maybe give us mechanically – my understanding is that it’s lead generation relationship and so they’re going to be providing leads to you and then your sales force is going to close those leads. I’m wondering, mechanically, compensation-wise, is there any reason why – is there any difference how your folks are compensated to do organic deals versus one that are referred and how that might kind of shape out over the next year or two?

Jonathan Bush

That’s a very good question. No. In fact, it is the opposite. Our regular sales force has no incentive to prefer a PSS deal or not and in fact, at some level, they’d love to include the PSS reps, so the PSS rep gets more commission, so the PSS rep pays more attention to them. And then, in addition, we have this new 15-person sales force whose only (inaudible) is supporting PSS rep. All they do is ride with PSS reps and their entire compensation has to do with the leads and new business generated by PSS. So, we are, if anything, kind of borderline PSS bigots.

Jeremy – William Blair

Should we think about this as more of a 2009 impact in terms of actually showing up in the P&L or should we just even hold off on that conclusion?

Jonathan Bush

Well, I don’t know if you heard news, but we’re planning on growing on 30% a year every year or better, so I consider it to be part of that ambitious goal and hopefully every once in a while we’ll do a little better than that. So far, we’ve been doing a little better than that, but I wouldn’t say changing your estimates for organic growth way out beyond 30%, way out beyond a few years from now would be prudent. I think that’s a very ambitious goal we’ve already got.

Jeremy – William Blair

Okay. Thank you.

Operator

We will go next to Frank Sparacino with First Analysis.

Frank Sparacino – First Analysis

Hi guys. Carl, can I get the ending total headcount for the company?

Jonathan Bush

Sure. In the Q2, it was 689 folks and I can give you a little break down. We had 26 in our subsidiary in India and 546 in Watertown, 60 in Maine and the balance were US, other people who live around the country.

Frank Sparacino – First Analysis

From a sales standpoint, the total breakdown as well?

Jonathan Bush

Yes. We had 33 folks carrying quota. At the end of Q2, 19 in the group enterprise segment and 14 in the small practice segment and then another 15, right Carl, supporting the PSS or on their way up to 15.

Carl Byers

That’s correct. We don’t count the folks who support the PSS sales reps as quota-carrying sales people per se even though obviously their mission in life is to drive growth because whenever a PSS lead comes in, it is worked by one of the people that I just mentioned.

Frank Sparacino – First Analysis

And maybe last, Carl or Jonathan, if you look at the 33 as of [ph] this quarter-end, let’s exclude PSS for a moment, what is the philosophy around that number going forward? Should we expect that number to stay static or why wouldn’t it be growing at fairly healthy rates given the overall growth of the business?

Carl Byers

Sure, this is Carl. I will address that and Jonathan may want to expand on it.

We certainly do intend to increase the number of quota-carrying folks here at Athena. It tends to happen historically as a step function. If you change it every single quarter, you are sort of resizing territories in some cases every quarter which is disruptive, but if you look year-over-year, our quota-carrying headcount is up 27%. So our general view would be that we will increase the size of our sales force in line with our long-term growth rate, possibly minus incremental sales productivity improvement because obviously it is about as much work to sign a 40-doc [ph] practice as it is a 140-doc practice. So we do get some scale as the enterprise segment opens up to us. But we would expect to increase our sales force in a step function later in the year.

Frank Sparacino – First Analysis

Okay, thanks. Nice job guys.

Operator

We'll go next to Leo Carpio with Caris & Company.

Leo Carpio – Caris & Company

Good morning gentlemen. Yes, a couple of quick questions. Could you talk about the competitive environment briefly in terms of how your competition is facing up against you? Are they becoming more aggressive and is there any pricing pressures?

Jonathan Bush

Leo, no. We haven’t had any pricing pressure from competition yet. The only thing that happened in terms of prices with some other very large national accounts, sort of Hoover Enterprises, we have cooperated on price and they have cooperated on the servicing methodology and things like that. So at a very large end, we get a little more creative but by and large, no systemic indicators to me that the price needs to go anywhere, so I think that would be – I think that is a red herring right now. May be someday it will more relevant but certainly not today.

Leo Carpio – Caris & Company

Okay, and in terms of the hospitals side of customers, what’s their appetite for your product, is it still strong and good interest or in terms of RFPs?

Carl Byers

Yes. We have been very – well, RFP, let’s see, we don’t track RFP volume and a lot of the very big deals that we have signed of late, well, they have all included RFP. The RFP came after the indication of interest, so we don’t track RFP volume. But certainly as I mentioned on the last call, we do expect the enterprise segment of our growth to be significantly higher than when I was on the road show meeting all of you. And so, that remains sort of something that we are holding on to and that we are going to have more to say about.

Leo Carpio – Caris & Company

And then turning to a different point, in terms of looking to the feature, any particular segment of technology focus for possible new acquisitions or it sounds like you’re on the sideline for acquisitions for now?

Carl Byers

Yes. We are not – we are on the sidelines always and then if something comes in that will dramatically enhance the sales of Collector, we have got a very good thing here with Collector and Clinicals, but you can imagine acquisition opportunities that would – that will either act as a beachhead of pre-Clinicals or pre-Collector beachhead to soften our sales approach or an enhancement to those products, and we are always looking at companies that fit those definitions and there are a decent number of them, but none of them that are getting closer.

Leo Carpio – Caris & Company

Okay. Thanks and congratulations on the quarter.

Carl Byers

Thank you.

Operator

We'll go next is Tod Weller with Stifel.

Tod Weller – Stifel Nicolaus

Yes. Thanks a lot. Just a few questions guys, one, I was wondering if you could talk about the impacts of the larger deals that are coming online. Should we kind of expect the shortterm acceleration in metrics like provider accounts and what kind of period are you looking at there and how do you think it will impact percentage of collections as well?

Carl Byers

Thanks, Todd. We are going to sort of move more in the lightning round mode here because the markets are opening soon, and we need to cut us off in a little bit, but to address you question, most of the big deals we have announced in the last nine months, our billing lies in the second half of this year, so certainly – or into next year in the case of a very recently announced one. So, it certainly will show up in all of the metrics we’ve talked about. The new ones will be at the Retail Clinic. You won’t see any doctors because it’s all nurse practitioner driven, that’s why we now share both the total medical provider account and the physician account.

Tod Weller – Stifel Nicolaus

Great. Just one other question Carl, just on the G&A, what kind of drove the sequential decrease and how do we think about that going forward? That’s it, thanks.

Carl Byers

Sure. Well on the sequential decrease, there are two things. First of all, seasonally it tends to go down – Q1 tends to be higher for a lot of reasons related to benefit costs and so forth. And then secondly, we did have a write-down of our S1 that we had abandoned in Q1 for about $400,000 which also contributed to the sequential decrease.

Tod Weller – Stifel Nicolaus

Great, thank you.

Operator

We'll go next to Newton Juhng with BB&T Capital.

Newton Juhng – BB&T Capital

Good morning guys. Real quick here, on the self-pay fund that you kind of mentioned before. I was wondering is this a plan for some more real-time adjudication-type of service or are we talking about something else?

Carl Byers

Well, I think, I'll address that first and Jonathan may want to expand on it. For self pay, it is really about making sure you know [ph] how much the patient owes and that you have a mechanism to control the work flow to make sure that the friendly person in the smock at the front desk really makes sure the patient pays or provides a credit card number or something along those lines. In a Retail Clinic setting, that is even more important because if there is a family doctor who everybody in the family goes to all the time, there is generally an aspect that, hey we can get them next time and we will sort of shame them later with letters in the mail. But with the Retail Clinic setting, you may never see that person again. It raises the premium on collection at the time of care. Furthermore, the trend in the industry is towards more patient responsibility and that also increases the risk exposure the doctor has, so the tools we’re building relates to things like, how to estimate what the patient owes and how to actually process that payment in real time?

Newton Juhng – BB&T Capital

And Carl, you need some cooperation, I guess, with the pairs in order to get that kind of squared away?

Jonathan Bush

Yes. I want to point this out; this is really important aspect of the business. Real time adjudication is something for which we have a great deal of dependency on the payer, right? So, at the rate at which payers are ready to bill that kind of thing out is the rate at which we can pump in into the work flow? But, as with the payer rules that drive our rules engine and drives a lot of our performance, we don’t need the payers permission to calculate and analyze what the self-pay portion will be once the claim is adjudicated the old fashioned way. And once we’ve done that, we can take it to positive or take a payment from the patient at the front desk. So, that whole idea of extending our rules engine and our crafty kind of in the field research capability out into analyzing what self-pay might be for non-real-time payers which is all of them, but two, and then pumping credit cards tax are [ph] capability out into the check out moment so that we can get that money is a huge opportunity and getting incredibly important as consumer directed products drive more responsibility to the patient and as Retail Clinics get out there and try to be more real time and convenient with the routine portions of care. That's a big window for all our strengths, not just supply chain partnership – but non-partnership days analysis and adjustment of the work flow which we’re good at.

Newton Juhng – BB&T Capital

Yes. Thanks, Jonathan. That’s actually really helpful to tell that I completely agree with that. And I guess – and I just had one quick follow up here, as MinuteClinic and (inaudible) in some of these other Retail Clinic services go online for you guys, how should we be looking at the cash collections per the medical provider? Obviously, it’s probably going to go down, but can you give us some idea as to what kind of level we should be looking at as we trail out of our waiting into 2009?

Carl Byers

Newton, this is Carl. I think what I would like to do is to take this question after the call because our goal is to end when the markets are open and they are now open, and people are getting in line for the second lap of questions. So, people, what we will do is take that question offline and I can give you some commentary on that.

Newton Juhng – BB&T Capital

No problem. Thanks.

Carl Byers

Thank you all very much for your attention. I hate to cut this call short, but I know the markets are open. So, we’ll see you next time.

Operator

Once again, that does conclude today’s call. We do appreciate your participation.

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Source: Athenahealth, Inc. Q2 2008 Earnings Call Transcript
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