UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)		Form 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                           to                                         

Commission File Number 001-33689

 

athenahealth, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware		04-3387530
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

311 Arsenal Street, Watertown, Massachusetts		02472
(Address of principal executive offices)		(Zip Code)

617-402-1000

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ   No o

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes þ   No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ		Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o   No þ

As of July 22, 2010, there were 34,143,627 shares of the registrant’s $0.01 par value common stock outstanding.

athenahealth, Inc.
FORM 10-Q
INDEX

				PAGE
Item 1.		Condensed Consolidated Financial Statements (unaudited).			1
		Condensed Consolidated Balance Sheets at June 30, 2010, and December 31, 2009			1
		Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009			2
		Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009			3
		Notes to Condensed Consolidated Financial Statements			4
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations.			17
Item 3.		Quantitative and Qualitative Disclosures About Market Risk.			26
Item 4.		Controls and Procedures.			26
PART II—OTHER INFORMATION
Item 1.		Legal Proceedings.			27
Item 1A.		Risk Factors.			27
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds.			28
Item 3.		Defaults Upon Senior Securities.			28
Item 4.		(Removed and Reserved).			28
Item 5.		Other Information.			28
Item 6.		Exhibits.			28
SIGNATURES					29

PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (unaudited).

athenahealth, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per-share amounts)

		June				December
		30, 2010				31, 2009
Assets
Current assets:
Cash and cash equivalents		$	27,945			$	30,526
Short-term investments			61,457				52,323
Accounts receivable - net			35,247				33,323
Deferred tax assets			3,932				5,544
Prepaid expenses and other current assets			6,529				4,663
Total current assets			135,110				126,379
Property and equipment - net			31,053				24,871
Restricted cash			8,885				9,216
Software development costs - net			2,768				2,324
Purchased intangibles - net			13,570				14,490
Goodwill			22,120				22,120
Deferred tax assets			12,295				10,284
Other assets			1,116				1,393
Total assets		$	226,917			$	211,077
Liabilities & Stockholders’ Equity
Current liabilities:
Current portion of long-term debt and capital lease obligations		$	3,322			$	3,437
Accounts payable			2,246				1,880
Accrued compensation			14,647				15,774
Accrued expenses			11,316				10,781
Current portion deferred revenue			5,419				4,038
Interest rate derivative liability			655				291
Current portion of deferred rent			1,372				1,288
Total current liabilities			38,977				37,489
Deferred revenue, net of current portion			32,169				28,684
Other long-term liabilities			1,191				1,191
Deferred rent, net of current portion			6,746				7,444
Debt and capital lease obligations, net of current portion			7,643				8,951
Total liabilities			86,726				83,759
Commitments and contingencies (note 12)
Stockholders’ equity:
Preferred stock, $0.01 par value: 5,000 shares authorized; no shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively			-				-
Common stock, $0.01 par value: 125,000 shares authorized; 35,417 shares issued, and 34,139 shares outstanding at June 30, 2010; 35,166 shares issued and 33,888 shares outstanding at December 31, 2009.			354				352
Additional paid-in capital			181,113				169,715
Treasury stock, at cost, 1,278 shares			(1,200	)			(1,200	)
Accumulated other comprehensive loss			(175	)			(73	)
Accumulated deficit			(39,901	)			(41,476	)
Total stockholders’ equity			140,191				127,318
Total liabilities and stockholders’ equity		$	226,917			$	211,077

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

athenahealth, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per-share amounts)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
						(as restated)(1)								(as restated)(1)
Revenue:
Business services		$	56,399			$	44,429			$	108,964			$	84,324
Implementation and other			2,153				1,219				4,065				2,352
Total revenue			58,552				45,648				113,029				86,676
Expense:
Direct operating			24,101				19,397				47,620				37,958
Selling and marketing			12,693				8,888				24,753				15,887
Research and development			4,824				3,439				8,898				6,620
General and administrative			11,403				8,394				23,080				16,595
Depreciation and amortization			2,657				1,798				5,077				3,437
Total expense			55,678				41,916				109,428				80,497
Operating income			2,874				3,732				3,601				6,179
Other income (expense):
Interest income			66				320				144				722
Interest expense			(118	)			(283	)			(335	)			(457	)
(Loss) gain on interest rate derivative contract			(304	)			308				(364	)			500
Other income			33				79				63				115
Total other (expense) income			(323	)			424				(492	)			880
Income before income taxes			2,551				4,156				3,109				7,059
Income tax provision			(1,253	)			(1,912	)			(1,534	)			(3,277	)
Net income		$	1,298			$	2,244			$	1,575			$	3,782
Net income per share - Basic		$	0.04			$	0.07			$	0.05			$	0.11
Net income per share - Diluted		$	0.04			$	0.06			$	0.04			$	0.11
Weighted average shares used in computing net income per share:
Basic			34,106				33,527				34,061				33,472
Diluted			35,178				34,822				35,190				34,818

(1)

See Note 2 “Restatement and Reclassification of Previously Issued Consolidated Financial Statements” of Accompanying Notes to Condensed Consolidated Financial Statements.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

athenahealth, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

		Six Months Ended
		June 30,
		2010				2009
CASH FLOWS FROM OPERATING ACTIVITIES:						(as restated)(1)
Net income		$	1,575			$	3,782
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			5,997				3,596
Amortization of premium (discounts) on investments			733				(442	)
Provision for uncollectible accounts			423				168
Deferred income taxes			(399	)			2,880
Tax benefit from stock-based awards			(1,281	)			(1,231	)
Increase in fair value of contingent consideration			304				-
Loss (gain) on interest rate derivative contract			364				(500	)
Stock compensation expense			6,694				3,992
Changes in operating assets and liabilities:
Accounts receivable			(2,347	)			(612	)
Prepaid expenses and other current assets			(584	)			(1,289	)
Other long-term assets			277				32
Accounts payable			128				800
Accrued expenses			(896	)			(1,431	)
Deferred revenue			4,866				2,801
Deferred rent			(614	)			(543	)
Net cash provided by operating activities			15,240				12,003
CASH FLOWS FROM INVESTING ACTIVITIES:
Capitalized software development costs			(1,579	)			(1,060	)
Purchases of property and equipment			(9,870	)			(5,061	)
Proceeds from sales and maturities of investments			50,450				37,000
Proceeds from sale or disposal of equipment			363				3,366
Purchases of short-term investments			(60,372	)			(51,770	)
Decrease in restricted cash			331				332
Net cash used in investing activities			(20,677	)			(17,193	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock under stock plans			3,425				697
Payments on long-term debt and capital lease obligations			(1,786	)			(2,319	)
Tax benefit from stock-based awards			1,281				1,231
Net cash provided by (used in) financing activities			2,920				(391	)
Effects of exchange rate changes on cash and cash equivalents			(64	)			(32	)
Net decrease in cash and cash equivalents			(2,581	)			(5,613	)
Cash and cash equivalents at beginning of period			30,526				28,933
Cash and cash equivalents at end of period		$	27,945			$	23,320
Supplemental disclosures of non-cash items - Property and equipment recorded in accounts payable and accrued expenses		$	273			$	37
Supplemental disclosures of cash flow information - Cash paid for interest		$	284			$	317
Cash paid for taxes		$	1,389			$	514
Change in fair value of contingent consideration		$	304			$	-
Property and equipment acquired under capital leases		$	363			$	3,366

(1)

See Note 2 “Restatement and Reclassification of Previously Issued Condensed Consolidated Financial Statements” of Accompanying Notes to Condensed Consolidated Financial Statements.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

athenahealth, Inc.

1. BASIS OF PRESENTATION

     The accompanying unaudited condensed consolidated financial statements have been prepared by athenahealth, Inc. (the “Company” or “we”) in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and as required by Regulation S-X, Rule 10-01. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of items of a normal and recurring nature) necessary to present fairly the financial position as of June 30, 2010, and the results of operations for the three and six month periods ended June 30, 2010 and 2009 and cash flows for the six month period ended June 30, 2010 and 2009. The results of operations for the three and six month periods ended June 30, 2010 are not necessarily indicative of the results to be expected for the full year. When preparing financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures at the date of the financial statements. Actual results could differ from those estimates.

     The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated through the date of issuance of these financial statements. The accompanying unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2009, included in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission (“SEC”) on March 15, 2010.

2. RESTATEMENT AND RECLASSIFICATION OF PREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS

     On March 9, 2010, we concluded that we needed to restate our previously issued consolidated financial statements for the years ended December 31, 2008 and 2007. We also concluded that we needed to restate our previously issued condensed consolidated financial statements for the first, second, and third quarters of 2009. The restatement resulted primarily from a correction in the timing of revenue recognition of deferred implementation fees.

     As part of the process to finalize our financial results for the year ended December 31, 2009, we undertook a comprehensive review of our significant accounting policies. As a result of our review, we concluded that, in prior and future periods, we will amortize deferred implementation revenue over a longer expected performance period of twelve years in order to reflect the estimated expected customer life. Previously, the expected performance period was estimated based upon the initial customer contract term, which, for the vast majority of contracts, was one year in duration. As a result of these adjustments, we also revised our previously calculated income tax expense for each quarter in 2009. All information presented in the condensed consolidated financial statements and the related notes include all such restatement adjustments.

     In addition, in connection with the restatement, we have corrected previously issued financial statements for the three and six months ended June 30, 2009, for the following reclassification items none of which had any effect on net income or stockholders’ equity for any period: a) reimbursements of out of pocket (“pass through”) expenses which were previously netted against operating expense have been grossed up and included in Implementation and other revenue in the consolidated statements of operations and b) draw downs of the capital lease lines which were previously presented as sources of cash within the “financing activities” section of the condensed consolidated statements of cash flows have been reclassified as “investing activities.”

     The following tables summarize the effects of the restatement and presentation reclassifications on our previously issued condensed consolidated financial statements:

athenahealth, Inc.

     Summary of increases (decreases) in Net Income

		Three months ended				Six months ended
		June 30,				June 30,
		2009				2009
(in thousands, except per share amounts)
Net income, as previously reported		$	3,029			$	5,367
Net adjustments
Implementation revenue			(1,308)				(2,642)
Income tax provision			523				1,057
Net income, restated		$	2,244			$	3,782
Basic earning per common share:
Net income, as previously reported		$	0.09			$	0.16
Net adjustments
Implementation revenue			(0.04)				(0.08)
Income tax provision			0.02				0.03
Net income, restated		$	0.07			$	0.11
Diluted earning per common share:
Net income, as previously reported		$	0.09			$	0.15
Net adjustments
Implementation revenue			(0.04)				(0.07)
Income tax provision			0.01				0.03
Net income, restated		$	0.06			$	0.11
Weighted average shares used in computing net income per share:
Basic			33,527				33,472
Diluted			34,822				34,818

athenahealth, Inc.

     Condensed Consolidated Statement of Operations impact for the three months ended June 30, 2009

		For the Three Months Ended June 30, 2009
		As Previously												As
		Reported				Adjustments				Reclassifications				Restated
Revenue:
Business services		$	44,429			$	-			$	-			$	44,429
Implementation and other			2,290				(1,308	)			237				1,219
Total revenue			46,719				(1,308	)			237				45,648
Expenses:
Direct operating			19,160				-				237				19,397
Selling and marketing			8,888				-				-				8,888
Research and development			3,439				-				-				3,439
General and administrative			8,394				-				-				8,394
Depreciation and amortization			1,798				-				-				1,798
Total expenses			41,679				-				237				41,916
Operating income (loss)			5,040				(1,308	)			-				3,732
Other income (expense):
Interest income			320				-				-				320
Interest expense			(283	)			-				-				(283	)
Gain on interest rate derivative contract			308				-				-				308
Other income			79				-				-				79
Total other income			424				-				-				424
Income (loss) before income tax benefit			5,464				(1,308	)			-				4,156
Income tax benefit			(2,435	)			523				-				(1,912	)
Net income			3,029				(785	)			-				2,244
Net income per share - Basic		$	0.09			$	(0.02	)		$	-			$	0.07
Net income per share - Diluted		$	0.09			$	(0.03	)		$	-			$	0.06
Weighted average shares used in computing net income per share:
Basic			33,527				33,527				33,527				33,527
Diluted			34,822				34,822				34,822				34,822

athenahealth, Inc.

     Condensed Consolidated Statement of Operations impact for the six months ended June 30, 2009

		For the Six Months Ended June 30, 2009
		As Previously												As
		Reported				Adjustments				Reclassifications				Restated
Revenue:
Business services		$	84,324			$	-			$	-			$	84,324
Implementation and other			4,494				(2,642	)			500				2,352
Total revenue			88,818				(2,642	)			500				86,676
Expenses:
Direct operating			37,458				-				500				37,958
Selling and marketing			15,887				-				-				15,887
Research and development			6,620				-				-				6,620
General and administrative			16,595				-				-				16,595
Depreciation and amortization			3,437				-				-				3,437
Total expenses			79,997				-				500				80,497
Operating income (loss)			8,821				(2,642	)			-				6,179
Other income (expense):
Interest income			722				-				-				722
Interest expense			(457	)			-				-				(457	)
Gain on interest rate derivative contract			500				-				-				500
Other income			115				-				-				115
Total other income			880				-				-				880
Income (loss) before income tax benefit			9,701				(2,642	)			-				7,059
Income tax benefit			(4,334	)			1,057				-				(3,277	)
Net income			5,367				(1,585	)			-				3,782
Net income per share -   Basic		$	0.16			$	(0.05	)		$	-			$	0.11
Net income per share -   Diluted		$	0.15			$	(0.04	)		$	-			$	0.11
Weighted average shares used in computing net income per share:
Basic			33,472				33,472				33,472				33,472
Diluted			34,818				34,818				34,818				34,818

athenahealth, Inc.

     The following table includes selected information from our condensed consolidated statements of cash flows presenting previously reported and restated cash flows, for the six months ended June 30, 2009:

		For the six months ended
		June 30, 2009
		As Previously				As
		Reported				Restated
Net income		$	5,367			$	3,782
Deferred income taxes (1)			3,937				2,880
Deferred revenue (1)			159				2,801
Proceeds from the sales and disposals of property and equipment (2)			-				3,366
Net cash used in investing activities			(20,559)				(17,193)
Proceeds from long-term debt and capital lease obligations (2)			3,366				-
Net cash provided by (used in) financing activities			2,975				(391)

	(1)		Revenue and related tax effect due to the correction of the accounting for implementation fees.
	(2)		To correct the presentation of draw downs of capital lease obligations.

3. RECENT ACCOUNTING PRONOUNCEMENTS

          Effective January 1, 2010, we adopted the new accounting standards for revenue recognition for multiple deliverable revenue arrangements. This new authoritative guidance amends previously issued guidance to eliminate the residual method of allocation for multiple-deliverable revenue arrangements, and requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. The new authoritative guidance also establishes a selling price hierarchy for determining the selling price of a deliverable, which includes (1) vendor-specific objective evidence (“VSOE”), if available, (2) third-party evidence (“TPE”), if vendor-specific objective evidence is not available, and (3) estimated selling price (“ESP”), if neither vendor-specific nor third-party evidence is available. Additionally, it expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. During the second quarter of 2010 we elected to adopt early, as permitted by the guidance. As such, we have prospectively (retroactive to January 1, 2010) applied the provisions of the new authoritative guidance to all revenue arrangements entered into or materially modified after January 1, 2010. Adopting the new standard will allow the company to allocate the arrangement consideration if multiple service offerings are sold at the same time. A sale of multiple services offerings could include any combination of the following services: athenaCollector, athenaClinicals, athenaCommunicator or Business Analytics.

          In accordance with the new authoritative guidance, we allocate arrangement consideration to each deliverable in an arrangement based on its relative selling price. We determine selling price using VSOE, if it exists; otherwise, we use TPE. If neither VSOE nor TPE of selling price exists for a unit of accounting, we use ESP.

          VSOE is generally limited to the price charged when the same or similar product is sold separately. If a product or service is seldom sold separately, it is unlikely that we can determine VSOE for the product or service. We define VSOE as a median price of recent standalone transactions that are priced within a narrow range, as defined by us. TPE is determined based on the prices charged by our competitors for a similar deliverable when sold separately. It may be difficult for us to obtain sufficient information on competitor pricing to substantiate TPE and therefore we may not always be able to use TPE.

          If we are unable to establish selling price using VSOE or TPE, and the order was received or materially modified after the implementation date of January 1, 2010 for the new authoritative guidance, we will use ESP in our allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact if the product or service were sold by us on a standalone basis. Our determination of ESP involves a weighting of several factors based on the specific facts and circumstances of the arrangement. We consider the selling price for similar services, our ongoing pricing strategy and policies, the value of any enhancements that have been built into the deliverable and the characteristics of the varying markets in which the deliverable is sold.

athenahealth, Inc.

          We plan to analyze the selling prices used in our allocation of arrangement consideration at a minimum on an annual basis. Selling prices will be analyzed on a more frequent basis if a significant change in our business necessitates a more timely analysis or if we experience significant variances in our selling prices. For athenaCommunicator, the company will use an estimated selling price when allocating the arrangement consideration if it is sold with another deliverable.

          Each deliverable within a multiple-deliverable revenue arrangement is accounted for as a separate unit of accounting under the guidance of the new authoritative guidance if both of the following criteria are met: (1) the delivered item or items have value to the customer on a standalone basis and (2) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. We consider a deliverable to have standalone value if we sell this item separately or if the item is sold by another vendor or could be resold by the customer. Further, our revenue arrangements generally do not include a general right of return relative to delivered products. Deliverables not meeting the criteria for being a separate unit of accounting are combined with a deliverable that does meet that criterion. The appropriate allocation of arrangement consideration and recognition of revenue is then determined for the combined unit of accounting.

          During the six months ended June 30, 2010, the adoption of this guidance had no material impact. The new accounting standards for revenue recognition, if applied in the same manner to the year ended December 31, 2009, would not have had a material impact on total net revenue for that fiscal year. In terms of the timing and pattern of revenue recognition, the new accounting guidance is not expected to have a significant effect on total net revenue in periods immediately after the initial adoption.

          From time to time, new accounting pronouncements are issued by FASB and are adopted by us as of the specified effective date. Unless otherwise discussed, we believe that the impact of other recently issued accounting pronouncements will not have a material impact on consolidated financial position, results of operations, and cash flows, or do not apply to our operations.

4. NET INCOME PER SHARE

     Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of common shares outstanding and potentially dilutive securities outstanding during the period under the treasury stock method. Potentially dilutive securities include stock options, restricted stock units, shares to be purchased under the employee stock purchase plan, and warrants. Under the treasury stock method, dilutive securities are assumed to be exercised at the beginning of the periods and as if funds obtained thereby were used to purchase common stock at the average market price during the period. Securities are excluded from the computations of diluted net income per share if their effect would be antidilutive to earnings per share.

     The following table reconciles the weighted average shares outstanding for basic and diluted net income per share for the periods indicated.

		Three Months				Three Months				Six Months				Six Months
		Ended June 30,				Ended June 30,				Ended June 30,				Ended June 30,
		2010				2009				2010				2009
Net income		$	1,298			$	2,244			$	1,575			$	3,782
Weighted average shares used in computing basic net income per share			34,106				33,527				34,061				33,472
Net income per share - Basic		$	0.04			$	0.07			$	0.05			$	0.11
Net income		$	1,298			$	2,244			$	1,575			$	3,782
Weighted average shares used in computing basic net income per share			34,106				33,527				34,061				33,472
Effect of dilutive securities			1,072				1,295				1,129				1,346
Weighted average shares used in computing diluted net income per share			35,178				34,822				35,190				34,818
Net income per share - Diluted		$	0.04			$	0.06			$	0.04			$	0.11

athenahealth, Inc.

     The computation of diluted net income per share does not include 2,927 options and restricted stock units for the three and six months ended June 30, 2010, because their inclusion would have an antidilutive effect on net income per share. The computation of diluted net income per share does not include 2,120 options for the three and six months ended June 30, 2009, because their inclusion would have an antidilutive effect on net income per share.

5. COMPREHENSIVE INCOME

     Comprehensive income was as follows for the periods indicated:

		Three Months				Three Months				Six Months				Six Months
		Ended June 30,				Ended June 30,				Ended June 30,				Ended June 30,
		2010				2009				2010				2009
Net income		$	1,298			$	2,244			$	1,575			$	3,782
Unrealized holding gain (loss) on available-for-sale investments, net of tax			2				(114	)			(54	)			(175	)
Foreign currency translation adjustment, net of tax			(65	)			(34	)			(48	)			(30	)
Total comprehensive income		$	1,235			$	2,096			$	1,473			$	3,577

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

     As of June 30, 2010 and December 31, 2009, the carrying amounts of cash and cash equivalents, restricted cash, receivables, accounts payable, and accrued expenses approximated their estimated fair values because of their short-term nature of these financial instruments. All highly liquid debt instruments purchased with a maturity of three months or less at the date of acquisition are included in cash and cash equivalents. Included in cash and cash equivalents as of June 30, 2010 and December 31, 2009, are money market fund investments of $16,784 and $10,081, respectively, which are reported at fair value.

     The carrying amounts of the Company’s debt obligations approximate fair value based upon our best estimate of interest rates that would be available to the Company for similar debt obligations. The estimated fair value of our long-term debt was determined using quoted market prices and other inputs that were derived from available market information and may not be representative of actual values that could have been or will be realized in the future.

     The following table presents information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009, and indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities and fair values determined by Level 2 inputs utilize quoted prices (unadjusted) in inactive markets for identical assets or liabilities obtained from readily available pricing sources for similar instruments. The fair values determined by Level 3 inputs are unobservable values which are supported by little or no market activity.

athenahealth, Inc.

(Unaudited amounts in thousands, except per-share amounts)
 

		Fair Value Measurements At June 30, 2010, Using
		Level 1				Level 2				Level 3				Total
Cash and cash equivalents:
Money market		$	16,784			$	-			$	-			$	16,784
Available-for-sale investments:
Commerical paper			-				22,240				-				22,240
Corporate bonds			-				21,751				-				21,751
U.S. government backed securities			-				17,466				-				17,466
Accrued contingent consideration			-				-				(5,404	)			(5,404	)
Interest rate swap derivative contract			-				(655	)			-				(655	)
Total short-term investments		$	16,784			$	60,802			$	(5,404	)		$	72,182

		Fair Value Measurements as of December 31, 2009, Using
		Level 1				Level 2				Level 3				Total
Cash and cash equivalents:
Money market		$	10,081			$	-			$	-			$	10,081
Available-for-sale investments:
U.S. government backed securities			-				52,323				-				52,323
Accrued contingent consideration			-				-				(5,100	)			(5,100	)
Interest rate swap derivative contract			-				(291	)			-				(291	)
Total short-term investments		$	10,081			$	52,032			$	(5,100	)		$	57,013

     U.S. government backed securities, corporate bonds and commercial paper are valued using a market approach based upon the quoted market prices of identical instruments when available or other observable inputs such as trading prices of identical instruments in inactive markets or similar securities. The interest rate swap derivative is valued using observable inputs at the reporting date.

     It is the Company’s policy to recognize transfers between levels of the fair value hierarchy, if any, at the end of the reporting period however there have been no such transfers during the six months ended June 30, 2010.

     The fair value of the accrued contingent consideration was determined using a probability-weighted income approach at the acquisition date and reporting date. That approach is based on significant inputs that are not observable in the market, which are referred to as Level 3 inputs. Key assumptions include a discount rate of 21% and a probability adjusted level of 60%. As of June 30, 2010, the Company has accrued a liability of $5,404 for the estimated fair value of contingent considerations expected to be payable upon the acquired company reaching specific performance metrics over the next three years of operation. As of June 30, 2010, the ranges of outcomes and key assumptions have not changed materially.

Accrued contingent consideration balance as of January 1, 2010		$	5,100
Increase in fair value of contingent consideration			304
Accrued contingent consideration balance as of June 30, 2010		$	5,404

7. INVESTMENTS

     The summary of available-for-sale securities at June 30, 2010, is as follows:

						Gross Unrealized
		Amortized Cost				Gain (Loss)				Fair Value
Commercial paper		$	22,224			$	16			$	22,240
Corporate bonds			21,783				(32	)			21,751
U.S. government backed securities			17,461				5				17,466
Total		$	61,468			$	(11	)		$	61,457

     The summary of available-for-sale securities at December 31, 2009, is as follows:

athenahealth, Inc.

						Gross Unrealized
		Amortized Cost				Gains				Fair Value
U.S. government backed securities		$	52,280			$	43			$	52,323

8. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

     The summary of outstanding debt and capital lease obligations is as follows:

		As of June 30,				As of December 31,
		2010				2009
Term loan		$	5,475			$	5,625
Capital lease obligation			5,490				6,763
			10,965				12,388
Less current portion of long-term debt and capital lease obligations			(3,322	)			(3,437	)
Long-term debt and capital lease obligations, net of current portion		$	7,643			$	8,951

     2008 Term and Revolving Loans – On September 30, 2008, the Company entered into a Credit Agreement (the “Credit Agreement”) with a financial institution. The Credit Agreement consists of a revolving credit facility in the amount of $15,000 and a term loan facility in the amount of $6,000 (collectively, the “Credit Facility”). The revolving credit facility may be extended by an additional $15,000 on the satisfaction of certain conditions and includes a $10,000 sublimit for the issuance of standby letters of credit. The revolving credit facility matures on September 30, 2011, and the term facility matures on September 30, 2013, although either facility may be voluntarily prepaid in whole or in part at any time without premium or penalty. As of June 30, 2010, there were no amounts outstanding under the revolving credit facility. On September 30, 2008, the Company borrowed a total of $6,000 under the term loan facility for general working capital purposes. The term loan has a 5 year term which is payable quarterly starting December 31, 2008, for $75 each quarter. The Company has the option to extend the loan, subject to agreement of the lender, at the end of the 5 year term.

     The revolving credit loan and term loan bear interest, at the Company’s option, at either (i) the financial institution’s London Interbank Offered Rate (“LIBOR”), or (ii) the higher of (a) the Federal Funds Rate plus 0.50% or (b) the financial institution’s prime rate (the higher of the two being the “Base Rate”). For term loans, these rates are adjusted down 100 basis points for Base Rate loans and up 100 basis points for LIBOR loans. For revolving credit loans, a margin is added to the chosen interest rate that is based on the Company’s consolidated leverage ratio, as defined in the Credit Agreement, which margin can range from 100 to 275 basis points for LIBOR loans and from 0 to 50 basis points for Base Rate loans. A default rate shall apply on all obligations in the event of a default under the Credit Agreement at a rate per annum equal to 2% above the applicable interest rate. The Company was also required to pay commitment fees and upfront fees for this Credit Facility. The interest rate as of June 30, 2010, and December 31, 2009, for the term loan was 4.5%.

     The obligations of the Company and its subsidiaries under the Credit Agreement are collateralized by substantially all assets.

     The Credit Agreement also contains certain financial and nonfinancial covenants, including limitations on our consolidated leverage ratio and capital expenditures, defaults relating to non-payment, breach of covenants, inaccuracy of representations and warranties, default under other indebtedness (including a cross-default with our interest rate swap), bankruptcy and insolvency, inability to pay debtors, attachment of assets, adverse judgments, ERISA violations, invalidity of loan and collateral documents, payments of dividends, and change of control. Upon an event of default, the lenders may terminate the commitment to make loans and the obligation to extend letters of credit, declare the unpaid principal amount of all outstanding loans and interest accrued under the Credit Agreement to be immediately due and payable, require us to provide cash and deposit account collateral for our letter of credit obligations, and exercise their security interests and other rights under the credit agreement.

     Capital Lease Obligations – In June 2007, the Company entered into a master lease and security agreement (the “Equipment Line”) with a financing company. The Equipment Line allows for the Company to lease from the financing company eligible equipment purchases, submitted within 90 days of the applicable equipment’s invoice date. Each lease has a 36 month term which is payable in equal monthly installments, commencing on the first day of the fourth month after the date of the disbursements of such loan and continuing on the first day of each month thereafter until paid in full. The Company has accounted for these as capital leases. At June 30, 2010 and December 31, 2009, the Company had $5,490 and $6,763, respectively, of outstanding capital leases. The weighted average interest rate implicit in the leases was 4.3%.

athenahealth, Inc.

9. INTEREST RATE DERIVATIVE

     In October 2008, the Company entered into a derivative instrument which has a decreasing notional value over the term to offset the cash flow exposure associated with its interest payments on certain outstanding debt. Our interest rate swap is not designated as a hedging instrument. The derivative is accounted for at fair value with gains or losses reported in earnings.

     The swap had a notional amount of $5,850 to hedge changes in cash flows attributable to changes in the LIBOR rate associated with the September 30, 2008, issuance of the Term Loan. We pay a fixed rate of 4.55% and receive a variable rate based on one month LIBOR plus 1%. The fair value of derivatives as of June 30, 2010, is summarized in the following table.

		Liability Derivatives
		Balance Sheet Location				Fair Value
Interest rate derivative contract		Interest rate derivative liability				$	655
Total derivative						$	655

     The effect of derivative instruments on the consolidated statement of operations for the three months ending June 30, 2010 and 2009, respectively, is summarized in the following table.

(Loss) Recognized in

Gain Recognized in Earnings

Location of (Loss) Gain

Earnings for Three Months

for Three Months Ended

Recognized in Earnings

Ended June 30, 2010

June 30, 2009

Interest rate contracts

(Loss) gain on interest rate derivative contract

$

(304

)

$

308

     The effect of derivative instruments on the consolidated statement of operations for the six months ending June 30, 2010 and 2009, respectively, is summarized in the following table.

Location of (Loss) Gain

(Loss) Recognized in Earnings for

Gain Recognized in Earnings for

Recognized in Earnings

Six Months Ended June 30, 2010

Six Months Ended June 30, 2009

Interest rate contracts

(Loss) gain on interest rate derivative contract

$

(364

)

$

500

     Derivatives are carried at fair value, as determined using standard valuation models, and adjusted, when necessary, for credit risk and are separately presented on the balance sheet. The following is a description/summary of the derivative financial instrument we have entered into to manage the interest rate exposure:

Remaining

Maturity

Notional

Fiscal Year

(Fiscal

Fair Value at

Description

Underlying

Amount

Receive

Pay

Entered Into

Year)

June 30, 2010

Interest rate swap

Interest on

$

5,475

LIBOR

4.55% fixed

2008

2028

$

(655

)

- variable to fixed

Term Loan

plus 1%

10. STOCK-BASED COMPENSATION

     Employee Stock Purchase Plan

athenahealth, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited amounts in thousands, except per-share amounts)

     In 2007, our 2007 Employee Stock Purchase Plan (“2007 ESPP”) was adopted by the Board of Directors and approved by the Company’s shareholders. A total of 500 shares of common stock have been reserved for future issuance to participating employees under the 2007 ESPP. The initial offering period under the 2007 ESPP began March 1, 2008, and each offering period is six months. The expense to the Company for the three months ended June 30, 2010, and 2009, was $92 and $106, respectively. The expense to the Company for the six months ended June 30, 2010, and 2009, was $158 and $203, respectively. Cash received from the 2007 ESPP issuances during the six months ended June 30, 2010 and 2009, was $470 and $304, respectively.

     Stock Option Plan

     The Company’s stock award plans provide the opportunity for employees, consultants, and directors to be granted options to purchase, receive awards, or make direct purchases of shares of the Company’s common stock. In 2007, the Board of Directors and the Company’s shareholders approved the 2007 Stock Option and Incentive Plan (the “2007 Stock Option Plan”), effective as of the close of our initial public offering, which occurred on September 25, 2007. The Board of Directors authorized 1,000 shares in addition to any shares forfeited under our 2000 Stock Option Plan. Options granted under the plan may be incentive stock options or nonqualified stock options under the applicable provisions of the Internal Revenue Code. The 2007 Stock Option Plan also allows for granting of restricted stock unit awards under the terms of the plan. The 2007 Stock Option Plan includes an “evergreen provision” that allows for an annual increase in the number of shares of common stock available for issuance under the 2007 Stock Option Plan. On January 1, 2010, under the “evergreen provision” of the 2007 Stock Option Plan, an additional 995 shares were made available for future grant under the 2007 Stock Option Plan.

     At June 30, 2010, and 2009, there were approximately 1,331 and 847 shares, respectively, available for grant under all the Company’s stock award plans.

     The following table presents the stock option activity for the six months ended June 30, 2010:

						Weighted-			Weighted-Average		Aggregate
						Average			Remaining Contractual		Instrinsic
		Shares				Exercise Price			Term (in years)		Value
Stock options outstanding - January 1, 2010			3,432			$21.62
Stock options granted			671			$38.33
Stock options exercised			(237	)		$12.51
Stock options forfeited			(111	)		$32.48
Stock options outstanding - at June 30, 2010			3,755			$24.85			7.7		$	22,317
Stock options exercisable - at June 30, 2010			1,761			$16.31			6.4		$	21,098
Stock options vested and expected to vest at June 30, 2010			3,511			$24.28			7.6		$	22,188
Weighted-average fair value of stock options granted for the six months ended June 30, 2010						$19.88

     The aggregate intrinsic value in the table above represents the value (the difference between the closing price for the Company’s common stock on June 30, 2010, and the exercise price of the options, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2010. The Company recorded total stock-based compensation expense for stock options of $3,123 and $1,970 for the three months ended June 30, 2010 and 2009, respectively. The Company recorded total stock-based compensation expense for stock options of $5,756 and $3,789 for the six months ended June 30, 2010 and 2009, respectively.

     The Company uses the Black-Scholes option pricing model to value share-based awards and determine the related compensation expense. The assumptions used in calculating the fair value of share-based awards represent management’s best estimates. The following table illustrates the weighted average assumptions used to compute stock-based compensation expense for awards granted:

		Three Months ended June 30,								Six Months ended June 30,
		2010				2009				2010				2009
Risk-free interest rate			2.4%-3.0	%			1.9%-2.9	%			2.4%-3.0	%			1.9% - 2.9	%
Expected dividend yield			0.0	%			0.0	%			0.0	%			0.0	%
Expected option term (years)			6.25				6.25				6.25				6.25
Expected stock volatility		49% to 50%					48.0	%		49% to 52%				48% to 49%

athenahealth, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited amounts in thousands, except per-share amounts)

     The risk-free interest rate estimate was based on the U.S. Treasury rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued.

     The expected dividend yield was based on our expectation of not paying dividends in the foreseeable future. The weighted average expected option term reflects the application of the simplified method. The simplified method defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches. In December 2007, the SEC issued additional guidance, which permits entities, under certain circumstances, to continue to use the simplified method beyond December 31, 2007. We have continued to utilize this methodology for the six months ended June 30, 2010, due to the short length of time our common stock has been publicly traded. The resulting fair value is recorded as compensation cost on a straight-line basis over the requisite service period, which generally equals the option vesting period. Since the Company completed its initial public offering in September 2007, it did not have sufficient history as a publicly traded company to evaluate its volatility factor and expected term. As such, we analyzed the volatilities of a group of peer companies to support the assumptions used in its calculations. We averaged the volatilities of the peer companies with in-the-money options, sufficient trading history and similar vesting terms to generate the assumptions.

     At June 30, 2010 and 2009, there was $32,196 and $26,131, respectively, of unrecognized stock-based compensation expense related to unvested share-based compensation stock option arrangements granted under the Company’s stock award plans. This expense is expected to be recognized over a weighted-average period of approximately 2.8 years.

     Cash received from stock option exercises during the three months ended June 30, 2010 and 2009, was $156 and $160, respectively. The intrinsic value of the shares issued from option exercises in the three months ended June 30, 2010 and 2009, was $2,346 and $2,188, respectively, and represents the difference between the exercise price of the option and the market price of the Company’s common stock on the dates exercised. The weighted-average grant date fair value of options granted during the three months ended June 30, 2010, and 2009 was $18.60 and $13.28, respectively. The Company generally issues previously unissued shares for the exercise of stock options, however the Company may reissue previously acquired treasury shares to satisfy these issuances in the future.

     Cash received from stock option exercises during the six months ended June 30, 2010 and 2009, was $2,955 and $386, respectively. The intrinsic value of the shares issued from option exercises in the six months ended June 30, 2010 and 2009, was $6,803 and $5,639, respectively, and represents the difference between the exercise price of the option and the market price of the Company’s common stock on the dates exercised. The weighted-average grant date fair value of options granted during the six months ended June 30, 2010 and 2009, was $19.88 and $13.02, respectively. The Company generally issues previously unissued shares for the exercise of stock options, however the Company may reissue previously acquired treasury shares to satisfy these issuances in the future.

Restricted Stock Units

     The 2007 Stock Option Plan also allows for granting of restricted stock unit awards under the terms of the plan. Such restricted units vest in four equal, annual installments on the anniversaries of the vesting start date. The Company estimated the fair value of the restricted stock units using the market price of its common stock on the date of the grant. The fair value of restricted stock units is amortized on a straight-line basis over the vesting period.

							Weighted-			Aggregate
							Average Grant			Instrinsic
			Shares				Date Fair			Value
	Outstanding - January 1, 2010			-			$0.00
	Restricted stock units granted			228			$37.36
	Restricted stock units vested			-			$0.00
	Restricted stock units cancelled			(12	)		$36.78
	Outstanding - at June 30, 2010			216			$37.39			$	5,640

     As of June 30, 2010, $7,698 of total unrecognized compensation costs related to restricted stock units is expected to be recognized over a weighted average period of 3.6 years. This amount does not include the cost of new restricted stock units that may be granted in future periods or any changes in the Company’s forfeiture percentage. As of June 30, 2010, $695 and $780 of compensation expense was recorded for restricted stock units during the three and six months ended June 30, 2010, respectively. During the three and six months ended June 30, 2010, no restricted stock units became vested. There were no restricted stock units outstanding during the three and six months ended June 30, 2009.

athenahealth, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited amounts in thousands, except per-share amounts)

Summary of Stock-Based Compensation Expense

     Total stock-based compensation expense for the three and six months ended June 30, 2010 and 2009, are as follows (no amounts were capitalized):

		Three months ended June 30,								Six months ended June 30,
		2010				2009				2010				2009
Stock-based compensation expense charged to:
Direct operating		$	652			$	400			$	1,120			$	775
Selling and marketing			888				529				1,578				1,043
Research and development			679				251				1,003				494
General and administrative			1,691				896				2,993				1,680
Total		$	3,910			$	2,076			$	6,694			$	3,992

11. INCOME TAXES

     The provision for income taxes represents the Company’s federal and state income tax obligations as well as foreign tax provisions. The Company’s provision for income taxes was $1,534 and $3,277 for the six months ended June 30, 2010 and 2009, respectively. The Company’s provision for income taxes was $1,253 and $1,912 for the three months ended June 30, 2010 and 2009, respectively. The Company used an estimated annual tax rate of 49% and 46% to calculate the quarterly tax provision for the six months ended June 30, 2010 and 2009, respectively. Management is required to estimate the annual effective tax rate based upon its forecast of annual pre-tax income. To the extent that actual pre-tax results for the year differ from the forecast estimates applied at the end of the most recent interim period, the actual tax rate recognized in fiscal year 2010 could be materially different from the forecasted rate.

     The Company’s policy is to record interest and penalties related to unrecognized tax benefits in income tax expense. As of June 30, 2010, interest or penalties related to uncertain tax positions accrued by the Company was not material. The Company files U.S., state and foreign income returns in jurisdictions with varying statutes of limitation. The Company’s primary state jurisdiction is the Commonwealth of Massachusetts. The Company is under corporate excise tax audit in Massachusetts for fiscal years 2006 through 2008. At the time of this filing, the Company has not received any indication on audit related adjustments. The Internal Revenue Service (“IRS”) has audited the Company’s federal income tax filings through fiscal year 2008.

     The Company has accounted for the acquisition of Anodyne Health Partners, Inc., as a business combination using the acquisition method. Allocation of the purchase price for the acquisition was based on preliminary estimates of the fair value of the net assets acquired, including deferred tax assets and liabilities, and is subject to adjustment upon finalization of the Company’s preliminary purchase price allocation. The preliminary allocation may be revised as a result of additional information regarding taxes.

12. COMMITMENTS AND CONTINGENCIES

     On March 2, 2010, a complaint was filed by Prompt Medical Systems, L.P. naming the Company and several other defendants in a patent infringement case (Prompt Medical Systems, L.P. v. AllscriptsMisys Healthcare Solutions, Inc. et al, Civil Action No. 6:2010cv00071, United States District Court for the Eastern District of Texas). The complaint alleges that we have infringed on a patent with a listed issue date in 1996 entitled “Method for Computing Current Procedural Terminology Codes from Physician Generated Documentation” and seeks an injunction enjoining infringement, damages, and pre- and post-judgment costs and interest. The Company and two other defendants filed a motion to dismiss the complaint; however, the court has not ruled on this motion. We believe that we have meritorious defenses to the complaint and continue to contest it vigorously.

     On March 19, 2010, a putative shareholder class action complaint was filed in the United States District Court for the District of Massachusetts against the Company and certain of its current and former officers entitled Casula v. athenahealth, Inc. et al, Civil Action No. 1:10-cv-10477. The complaint alleges that the defendants violated the federal securities laws by disseminating false and misleading statements through a press release, statements by senior management, and SEC filings. The alleged false and misleading statements concern, among other things, the amortization period for deferred implementation revenues. The complaint seeks unspecified damages, costs, and expenses. We believe that we have meritorious defenses to the complaint, and we will contest the claims vigorously.

     In addition, from time to time we may be subject to other legal proceedings, claims, and litigation arising in the ordinary course of business. We do not, however, currently expect that the ultimate costs to resolve any pending matter will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

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

     This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical fact contained in this Quarterly Report on Form 10-Q are forward-looking statements, including those regarding expanded sales and marketing efforts; changes in expenses related to operations, selling, marketing, research and development, general and administrative matters, and depreciation and amortization; liquidity issues; additional fundraising; and the expected performance period and estimated term of our client relationships, as well as more general statements regarding our expectations for future financial and operational performance, product and service offerings, regulatory environment, and market trends. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue”; the negative of these terms; or other comparable terminology. Forward-looking statements in this Item 2 include, without limitation, statements reflecting management’s expectations for future financial performance and operating expenditures, expected growth, profitability and business outlook, increased sales and marketing expenses, increased cross-selling efforts among the Company’s service offerings, expected client implementations, expected certification and regulatory approvals, the benefits of the Company’s current service offerings and research and development for new service offerings, and the benefits of current and expected strategic sales and marketing relationships.

     Forward-looking statements are only current predictions and are subject to known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from those anticipated by such statements. These factors include, among other things, those set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, under the heading Part I, Item 1A “Risk Factors” and any set forth below under Part II, Item 1A, “Risk Factors.”

     Although we believe that the expectations reflected in the forward-looking statements contained in this Quarterly Report on Form 10-Q are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except as required by law, we are under no duty to update or revise any of such forward-looking statements, whether as a result of new information, future events, or otherwise, after the date of this Quarterly Report on Form 10-Q.

Restatement

     With this Quarterly Report on Form 10-Q, we have restated the following previously filed consolidated financial statements, data, and related disclosures:

	(1)		Our consolidated statements of operations for the three and six months ended June 30, 2009, and the related cash flows for the six months ended June 30, 2009 located in Part I, Item 1 of this Quarterly Report on Form 10-Q; and
	(2)		Our management’s discussion and analysis of financial condition and results of operations as of and for the three and six months ended June 30, 2009, contained herein.

     The restatement results from our review of revenue recognition practices. See Note 2, “Restatement and Reclassification of Previously Issued Consolidated Financial Statements” of the Notes to Consolidated Financial Statements in Part I, Item 1 for a detailed discussion of the review and effect of the restatement.

     The following discussion and analysis of our financial condition and results of operations incorporates the restated amounts. For this reason the data set forth in this section may not be comparable to discussions and data in our previously filed Quarterly Reports of Form 10-Q.

Overview

     athenahealth is a leading provider of Internet-based business services for physician practices. Our service offerings are based on four integrated components: our proprietary Internet-based software, our continually updated database of payer reimbursement process rules, our back-office service operations that perform administrative aspects of billing and clinical data management for physician practices, and our automated and live patient communication services. Our principal offering, athenaCollector, automates and manages billing-related functions for physician practices and includes a medical practice management platform. We have also developed a service offering, athenaClinicals, which automates and manages medical-record-related functions for physician practices and includes an electronic health record, or EHR, platform. ReminderCall, which we added to our service suite in September 2008, is our automated appointment reminder system that allows patients to either confirm the appointment or request rescheduling. We have now combined ReminderCall with other automated patient messaging services, live operator services, and a patient web portal in the first edition of our athenaCommunicator services suite that we beta launched in 2009 and made commercially available on March 17, 2010. We refer to athenaCollector as our revenue cycle management service, athenaClinicals as our clinical cycle management service, and athenaCommunicator as our patient cycle management service. As a complement to these services, Anodyne Analytics, is a web-based, Software-as-a-Service business intelligence platform that organizes and displays detailed and insightful practice performance data for decision makers at our client practices. Our services are designed to help our clients achieve faster reimbursement from payers, reduce error rates, increase collections, lower operating costs, improve operational workflow controls, improve patient satisfaction and compliance, and more efficiently manage clinical and billing information.

     For the six months ended June 30, 2010, we generated revenue of $113.0 million from the sale of our services compared to $86.7 million for the six months ended June 30, 2009. For the three months ended June 30, 2010, we generated revenue of $58.6 million from the sale of our services compared to $45.6 million for the three months ended June 30, 2009. In 2009, we generated revenue of $188.5 million from the sale of our services compared to $136.3 million in 2008. Given the scope of our market opportunity, we have increased our spending each year on growth, innovation, and infrastructure. Despite increased spending in these areas, higher revenue and lower operating expenses as a percentage of revenue typically lead to greater operating income. However, the reversal of a valuation allowance against deferred tax assets that occurred in the fourth quarter of 2008 has had and will have an impact on net profits as our pre-tax income now results in the recognition of proportionate income tax expense in the income statement.

     Our revenue is predominately derived from business services that we provide on an ongoing basis. This revenue is generally determined as a percentage of payments collected by us on behalf of our clients, so the key drivers of our revenue include growth in the number of physicians working within our client accounts, the collections of these physicians, and the number of services purchased. To provide these services, we incur expenses in several categories, including direct operating, selling and marketing, research and development, general and administrative, and depreciation and amortization expense. In general, our direct operating expense increases as our volume of work increases, whereas our selling and marketing expense increases in proportion to our rate of adding new accounts to our network of physician clients. Our other expense categories are less directly related to growth of revenues and relate more to our planning for the future, our overall business management activities, and our infrastructure. We manage our cash and our use of credit facilities to ensure adequate liquidity, in adherence to related financial covenants.

Critical Accounting Policies

     The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and assumptions are used for, but are not limited to: (1) revenue recognition; including our estimated expected customer life; (2) allowance for doubtful accounts; (3) asset impairments (4) depreciable lives of assets; (5) economic lives and fair value of leased assets; (6) income tax reserves and valuation allowances; (7) fair value of stock options; (8) allocation of direct and indirect cost of sales; and (9) litigation reserves. Future events and their effects cannot be predicted with certainty, and accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our consolidated financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. We evaluate and update our assumptions and estimates on an ongoing basis and may employ outside experts to assist in our evaluations. Actual results could differ from the estimates we have used.

     Critical accounting policies are those policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. We believe our critical accounting policies include our policies regarding revenue recognition and accounts receivable, software development costs, stock-based compensation, income taxes, goodwill and purchased intangible assets. For a more detailed discussion of our critical accounting policies, please refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, as filed with the Securities and Exchange Commission on March 15, 2010. For recent accounting pronouncements, please refer to Note 3.

Financial Operations Overview

     Revenue. We derive our revenue from two sources: from business services associated with our revenue cycle, clinical cycle, patient cycle and Anodyne Analytics offerings and from implementation and other services. Implementation and other revenue consist primarily of professional services fees related to assisting clients with the initial implementation of our services and for ongoing training and related support services. Business services accounted for approximately 96% and 97% of our total revenues for the six months ended June 30, 2010 and 2009, respectively. Business services revenue are typically 2% to 8% of a practice’s total collections depending upon the services purchased, the size, complexity, and other characteristics of the practice, plus a per-statement charge for billing statements that are generated for patients. Accordingly, business services revenue is largely driven by: the number of physician practices and other service providers we serve, the number of physicians and other medical providers working in those physician practices, the volume of activity and related collections of those physicians, the mix of our services used by those physician practices and other medical providers, and our contracted rates. We expect to increase the number of physician practices we serve through increased sales and marketing expense, and we expect our existing clients to use more of our services through cross-selling efforts and growth in the number of combined services sales. There is moderate seasonality in the activity level of physician practices. Typically, discretionary use of physician services declines in the late summer and during the holiday season, which leads to a decline in collections by our physician clients about 30 to 50 days later. Additionally, the volume of activity and related collections vary from year to year based in large part on the severity, length and timing of the onset of the flu season. While we believe that the severity, length and timing of the onset of the cold and flu season will continue to impact collections by our physician clients, there can be no assurance that our future sales of these products will necessarily follow historical patterns. Implementation revenue and other revenue are largely driven by the increase in the volume of our new business. As a result, we expect implementation and other revenue to

increase in absolute terms for the foreseeable future but to remain relatively consistent as a percentage of total revenue. None of our clients accounted for more than 10% of our total revenues for the three and six months ended June 30, 2010, and 2009.

     Direct Operating Expense. Direct operating expense consists primarily of salaries, benefits, claim processing costs, other direct expenses, and stock-based compensation related to personnel who provide services to clients, including staff who implements new clients. We expense implementation costs as incurred. We include in direct operating expense all service costs associated with athenaCollector, athenaClinicals, athenaCommunicator, ReminderCall, and Anodyne Analytics. Although we expect that direct operating expense will increase in absolute terms for the foreseeable future, the direct operating expense is expected to decline as a percentage of revenue over time as we increase automation. We expect to increase our overall level of automation as we become a larger operation, with higher volumes of work in particular functions, geographies, and medical specialties. We include in direct operating expense the service costs associated with our athenaClinicals offering, which includes transaction handling related to lab requisitions, lab results entry, fax classification, and other services. We also expect these expenses to increase in absolute terms for the foreseeable future but to decline as a percentage of revenue. This decrease will also be driven by increased levels of automation and economies of scale. Direct operating expense does not include allocated amounts for rent, occupancy and other indirect costs (including building maintenance and utilities), depreciation, and amortization, except for amortization related to purchased intangible assets.

     Selling and Marketing Expense. Selling and marketing expense consists primarily of marketing programs (including trade shows, brand messaging, and on-line initiatives) and personnel-related expense for sales and marketing employees (including salaries, benefits, commissions, stock-based compensation, non-billable travel, lodging, and other out-of-pocket employee-related expenses). Although we recognize substantially all of our revenue when services have been delivered, we recognize a large portion of our sales commission expense at the time of contract signature and at the time our services commence. Accordingly, we incur a portion of our sales and marketing expense prior to the recognition of the corresponding revenue. We have increased our sales and marketing expenses from year to year and we expect to continue to increase our investment in sales and marketing by hiring additional direct sales personnel and support personnel to add new clients and increase sales to our existing clients and expanding awareness through paid search and other similar initiatives. We also plan to expand our marketing activities, such as attending trade shows, expanding user groups, and creating new printed materials. As a result, we expect that sales and marketing expense will increase in absolute terms and will likely remain at current levels as a percentage of total revenue in the near-term.

     Research and Development Expense. Research and development expense consists primarily of personnel-related expenses for research and development employees (including salaries, benefits, stock-based compensation, non-billable travel, lodging, and other out-of-pocket employee-related expenses) and consulting fees for third-party developers. We expect that in the future, research and development expense will increase in absolute terms but not as a percentage of total revenue as new services and more mature products require incrementally less new research and development investment.

     General and Administrative Expense. General and administrative expense consists primarily of personnel-related expense for administrative employees (including salaries, benefits, stock-based compensation, non-billable travel, lodging, and other out-of-pocket employee-related expense), occupancy and other indirect costs (including building maintenance and utilities), and insurance premiums; software license fees; outside professional fees for accountants, lawyers, and consultants; and compensation for temporary employees. We expect that general and administrative expense will increase in absolute terms as we invest in infrastructure to support our growth and incur additional expense related to being a publicly traded company and our restatement. Though expenses are expected to continue to rise in absolute terms, we expect general and administrative expense to decline as a percentage of total revenue over time.

     Depreciation and Amortization Expense. Depreciation and amortization expense consists primarily of depreciation of fixed assets and amortization of capitalized software development costs, which we amortize over a two-year period from the time of release of related software code. As we grow, we will continue to make capital investments in the infrastructure of the business and we will continue to develop software that we capitalize. At the same time, because we are spreading fixed costs over a larger client base, we expect related depreciation and amortization expense to decline as a percentage of total revenue over time.

     Other Income (Expense). Interest expense consists primarily of interest costs related to our equipment-related term leases and our term loan and revolving loans under our credit facility, offset by interest income on investments. Interest income represents earnings from our cash, cash equivalents, and short-term investments. The gain (loss) on the interest rate derivative contract represents the change in the fair market value of a derivative instrument that is not designated as a hedge. Although this derivative has not been designated for hedge accounting, we believe that such instrument is correlated with the underlying cash flow exposure related to variability in interest rate movements on our term loan.

Results of Operations

     Comparison of the Six Months Ended June 30, 2010 and 2009

		Six Months Ended June 30,								Change
		2010				2009				Amount				Percent
		(in thousands)
Business services		$	108,964			$	84,324			$	24,640				29	%
Implementation and other			4,065				2,352				1,713				73	%
Total		$	113,029			$	86,676			$	26,353				30	%

     Revenue. Total revenue for the six months ended June 30, 2010, was $113.0 million, an increase of $26.4 million, or 30%, over revenue of $86.7 million for the six months ended June 30, 2009. This increase was due almost entirely to an increase in business services revenue.

     Business Services Revenue. Revenue from business services for the six months ended June 30, 2010, was $109.0 million, an increase of 29%, over revenue of $84.3 million for the six months ended June 30, 2009. This increase was primarily due to the growth in the number of physicians and medical providers using our services. The number of physicians using our services at June 30, 2010, was 17,136, a net increase of 3,545, or 26%, from 13,591 physicians at June 30, 2009. The number of active medical providers using our services at June 30, 2010, was 24,782, a net increase of 4,459, or 22%, from 20,323 active medical providers at June 30, 2009. Also contributing to this increase was the growth in related collections on behalf of these physicians and medical providers. The amount of collections processed for the six months ended June 30, 2010, was $2.7 billion, an increase of $0.4 billion, over posted collections of $2.3 billion for the six months ended June 30, 2009.

     Implementation and Other Revenue. Revenue from implementations and other sources was $4.1 million for the six months ended June 30, 2010, an increase of $1.7 million, or 73%, over revenue of $2.4 million for the six months ended June 30, 2009. This increase was driven by new client implementations and increased professional services for our larger client base. The numbers of accounts live on our revenue cycle management service, athenaCollector, at June 30, 2010, was 1,753, a net increase of 347 accounts from 1,406 accounts at June 30, 2009. The number of accounts live on our clinical cycle management service, athenaClinicals, at June 30, 2010, was 352, a net increase of 172 accounts from 180 accounts at June 30, 2009. The increase in implementation and other revenue is the result of the increase in the volume of our business.

		Six Months Ended June 30,								Change
		2010				2009				Amount				Percent
		(in thousands)
Direct operating costs		$	47,620			$	37,958			$	9,662				25	%

     Direct Operating Costs. Direct operating expense for the six months ended June 30, 2010, was $47.6 million, an increase of 25%, over costs of $38.0 million for the six months ended June 30, 2009. This increase was primarily due to an increase in the number of claims that we processed on behalf of our clients and the related expense of providing services, including transactions expense and employee-related costs. The amount of customer collections processed for the six months ended June 30, 2010, was $2.7 billion, an increase of $0.4 billion, over posted customer collections of $2.3 billion for the six months ended June 30, 2009. Direct operating employee-related costs increased $3.4 million from the six months ended June 30, 2009, to the six months ended June 30, 2010. This increase is primarily due to the 20% increase in headcount since June 30, 2009. We increased the professional services headcount as part of our redesign of our client services organization and to meet the current and anticipated demand for our services as our customer base has expanded and includes larger medical groups. For the six months ended June 30, 2010, direct operating expense includes $0.9 million of amortization of purchased intangibles expense related to the purchase of certain assets through acquisitions completed in 2009 and 2008, compared to less than $0.2 million in the six months ended June 30, 2009. Stock-based compensation expense also increased $0.3 million from the six months ended June 30, 2009 to the six months ended June 30, 2010.

		Six Months Ended June 30,								Change
		2010				2009				Amount				Percent
		(in thousands)
Selling and marketing		$	24,753			$	15,887			$	8,866				56	%
Research and development			8,898				6,620				2,278				34	%
General and administrative			23,080				16,595				6,485				39	%
Depreciation and amortization			5,077				3,437				1,640				48	%
Total		$	61,808			$	42,539			$	19,269				45	%

     Selling and Marketing Expense. Selling and marketing expense for the six months ended June 30, 2010, was $24.8 million, an increase of $8.9 million, or 56%, over costs of $15.9 million for the six months ended June 30, 2009. This increase was primarily due to increases in stock-based compensation expense of $0.5 million, an increase in employee-related costs and sales commission of $4.3 million due to an increase in headcount, a $1.1 million increase in travel related expenses, a $0.8 million increase other marketing related events, a $1.8 million increase in online and offline marketing, and a $0.4 million increase in external partner commission payments. Our marketing and sales headcount increased by 67% since June 30, 2009, as we hired additional sales personnel to focus on adding new customers and increasing penetration within our existing markets.

     Research and Development Expense. Research and development expense for the six months ended June 30, 2010, was $8.9 million, an increase of $2.3 million, or 34%, over research and development expense of $6.6 million for the six months ended June 30, 2009. This increase was primarily due to a $1.7 million increase in employee-related costs due to an increase in headcount, an increase in stock-based compensation expense of $0.5 million and a $0.1 million increase in consulting related expenses. Our research and development headcount increased 24% since June 30, 2009, as we hired additional research and development personnel in order to upgrade and extend our service offerings and develop new technologies.

     General and Administrative Expense. General and administrative expense for the six months ended June 30, 2010, was $23.1 million, an increase of $6.5 million, or 39%, over general and administrative expenses of $16.6 million for the six months ended June 30, 2009. This increase was partially due to a $1.2 million increase in employee-related costs due to an increase in headcount, an increase in stock-based compensation expense of $1.4 million, a $0.5 million increase in travel related expenses, $0.5 million increase in facilities related expenses, and a $0.5 million increase in bad debt expense. Our general and administrative headcount increased by 8% since June 30, 2009, as we added personnel to support our growth. Legal, audit, insurance and consulting expenses increased $2.1 million primarily due to $1.6 million relating to our restatement and other additional costs of being a public company. Additionally, under new authoritative guidance on business combinations adopted January 1, 2009, any changes in the fair value of contingent consideration after the acquisition date affect earnings. The potential contingent consideration of $7.7 million was recorded in the initial purchase price allocation at its estimated fair value of $5.1 million. A portion of the contingent consideration relating to the Anodyne acquisition is expected to be paid in 2011 and 2012 totaling $0.8 million and is presented in other long-term liabilities. The contingent consideration will be adjusted to fair value to the amount payable when, and if, earned. The difference between the estimated and earn-out amount will be charged or credited to expense. For the six months ended June 30, 2010, approximately $0.3 million was expensed relating to this contingent consideration.

     Depreciation and Amortization. Depreciation and amortization expense for the six months ended June 30, 2010, was $5.1 million, an increase of 48% over depreciation and amortization expense of $3.4 million for the six months ended June 30, 2009. This was primarily due to higher depreciation from fixed asset expenditures in 2010 and 2009.

     Other Income (Expense). Interest income for the six months ended June 30, 2010, was $0.1 million, a decrease of $0.6 million from interest income of $0.7 million for the six months ended June 30, 2009. The decrease was directly related to the lower interest rates during 2010 and due to a lower cash balance due to the cash paid for an acquisition of $30 million in the fourth quarter of 2009. Interest expense for the six months ended June 30, 2010, and 2009 was $0.3 million and $0.5 million, respectively, which is driven by the balance of outstanding debt. The loss on interest rate derivative for the six months ended June 30, 2010, was less than $0.4 million, compared to a gain on interest rate derivative for the six months ended June 30, 2009, of $0.5 million. The gain or loss on the interest rate derivative was the result of the change in the fair market value of a derivative instrument that was not designated a hedge. Although this derivative does not qualify for hedge accounting, we believe that the instrument is closely correlated with the underlying exposure, thus managing the associated risk. The gains or losses from changes in the fair value of derivative instruments that are not accounted for as hedges are recognized in earnings.

     Income Tax Provision. We recorded a provision for income taxes for the six months ended June 30, 2010, of approximately $1.5 million compared to $3.3 million for the six months ended June 30, 2009. We have provided income tax expense for the six months ended June 30, 2010 and 2009, using the expected effective tax rate for the entire year of 49% and 46%, respectively.

     Comparison of the Three Months Ended June 30, 2010 and 2009

		Three Months Ended June 30,								Change
		2010				2009				Amount				Percent
		(in thousands)
Business services		$	56,399			$	44,429			$	11,970				27	%
Implementation and other			2,153				1,219				934				77	%
Total		$	58,552			$	45,648			$	12,904				28	%

     Revenue. Total revenue for the three months ended June 30, 2010, was $58.6 million, an increase of $12.9 million, or 28%, over revenue of $45.6 million for the three months ended June 30, 2009. This increase was due almost entirely to an increase in business services revenue.

     Business Services Revenue. Revenue from business services for the three months ended June 30, 2010, was $56.4 million, an increase of $12.0 million, or 27%, over revenue of $44.4 million for the three months ended June 30, 2009. This increase was primarily due to the growth in the number of physicians and medical providers using our services. The number of physicians using our services at June 30, 2010, was 17,136, a net increase of 3,545, or 26%, from 13,591 physicians at June 30, 2009. The number of active medical providers using our services at June 30, 2010, was 24,782, a net increase of 4,459, or 22%, from 20,323 active medical providers at June 30, 2009. Also contributing to this increase was the growth in related collections on behalf of these physicians and medical providers. The amount of collections processed for the three months ended June 30, 2010, was $1.4 billion, an increase of $0.2 billion, over posted collections of $1.2 billion for the three months ended June 30, 2009.

     Implementation and Other Revenue. Revenue from implementations and other sources was $2.2 million for the three months ended June 30, 2010, an increase of $0.9 million, or 77%, over revenue of $1.2 million for the three months ended June 30, 2009. This increase was driven by new client implementations and increased professional services for our larger client base. The numbers of accounts live on our revenue cycle management service, athenaCollector, at June 30, 2010, was 1,753, a net increase of 347 accounts from 1,406 accounts at June 30, 2009. The number of accounts live on our clinical cycle management service, athenaClinicals, at June 30, 2010, was 352, a net increase of 172 accounts from 180 accounts at June 30, 2009. The increase in implementation and other revenue is the result of the increase in the volume of our business.

		Three Months Ended June 30,								Change
		2010				2009				Amount				Percent
		(in thousands)
Direct operating costs		$	24,101			$	19,397			$	4,704				24	%

     Direct Operating Costs. Direct operating expense for the three months ended June 30, 2010, was $24.1 million, an increase of $4.7 million, or 24%, over costs of $19.4 million for the three months ended June 30, 2009. This increase was primarily due to an increase in the number of claims that we processed on behalf of our clients and the related expense of providing services, including transactions expense and employee-related costs. The amount of customer collections processed for the three months ended June 30, 2010, was $1.4 billion an increase of $0.2 billion, over posted customer collections of $1.2 billion for the three months ended June 30, 2009. Direct operating employee-related costs increased $1.7 million from the three months ended June 30, 2009, to the three months ended June 30, 2010. This increase is primarily due to the 20% increase in headcount since June 30, 2009. We increased the professional services headcount as part of a redesign of our client services organization and in order to meet the current and anticipated demand for our services as our customer base has expanded and includes larger medical groups. For the three months ended June 30, 2010, direct operating expense includes $0.5 million of amortization of purchased intangibles expense related to the purchase of certain assets through acquisitions completed in 2009 and 2008 compared to less than $0.1 million in the three months ended June 30, 2009. Stock-based compensation expense also increased $0.3 million from the three months ended June 30, 2009, to the three months ended June 30, 2010.

		Three Months Ended June 30,								Change
		2010				2009				Amount				Percent
		(in thousands)
Selling and marketing		$	12,693			$	8,888			$	3,805				43	%
Research and development			4,824				3,439				1,385				40	%
General and administrative			11,403				8,394				3,009				36	%
Depreciation and amortization			2,657				1,798				859				48	%
Total		$	31,577			$	22,519			$	9,058				40	%