Inovalon Holdings, Inc.
Q3 2018 Earnings Call Transcript

Published: 10 Nov 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Inovalon Third Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. And now, I'll turn the conference over to your host, Kim Collins. Please begin.

[Kim Collins:]

Good afternoon. This is Kim Collins, Senior Vice President of Communications at Inovalon. I'm here today with Dr. Keith Dunleavy, Inovalon's Chief Executive Officer and Chairman of the Board; and Jonathan Boldt, our Vice President of Finance and Interim Chief Financial Officer. I'd like to welcome you to our third quarter 2018 earnings call. The press release announcing our financial results for the third quarter was distributed this afternoon, and a replay of today's call will be available in a few hours and posted on the Investor Relations page on Inovalon's website. For those of you listening to the rebroadcast of this call, we remind you that the remarks made herein are as of today, November 7, 2018, and will not be updated subsequent to this initial earnings call. I'll remind you that certain statements made during this call may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995, including statements related to future results of operations and financial position, our business strategy and plans, market growth and our objectives for future operations. Those statements involve a number of factors that could cause additional results to differ materially. Additional information concerning these factors is contained on the Company's earnings release and filings with the SEC. In an effort to provide additional information to investors, this conference call and webcast is accompanied by a presentation, which is available on the IR section of our website. You are encouraged to download a copy of this presentation to follow along with our prepared remarks. Our presentation also includes certain non-GAAP financial measures. You'll find definitions of these non-GAAP measures and reconciliation charts at the end of the Company's earnings release and on the Company's website. Now it is my pleasure to turn the call over to Dr. Keith Dunleavy.

[Keith Dunleavy:]

Thank you, Kim. Good afternoon, everyone, and thank you for joining our call. Inovalon is seeing a strong inflection in its business, with the unique data, connectivity, analytics and compute speeds of the Inovalon ONE Platform seeing increased demand in the marketplace, providing differentiation and value for our clients and growth and profitability for Inovalon. While the transition to recognizing the growth that we have now signed for 2019 has taken a somewhat slower ramp than we wanted for 2018, our focus of putting in place the industry's leading platform is paying off. As part of today's release of information, we are pleased to be introducing a number of new metrics, annualized contract value, or ACV in sales; annual recurring revenue; and annual client retention. We hope that you find these helpful in understanding the inflection that we are achieving and the strength in our business that we are seeing. We encourage you to download the supplemental deck that we have provided to accompany today's release and prepared remarks. Revenue for the quarter was $145.8 million, an increase of 26% year-over-year. This revenue was below our previous expectations due principally due to factors

[Jonathan Boldt:]

Thank you, Keith, and good afternoon, everyone. I want to begin by highlighting a few key points building on Keith's comments. First, we continue to successfully transition our revenue base to subscription-based contracts and have substantially completed that process as we enter 2019. Second, our ongoing investments in high-value, differentiated platform-based solutions, technology-based efficiencies and other cost actions continue to yield strong profitability expansion and healthy cash flow. And third, strong performance in renewals, client retention and new contract sales are building on our recurring base of revenue and providing us with significant visibility in 2019, where we see delivering 19% to 23% revenue growth, inclusive of 12% to 14% of organic growth, with nearly 95% coverage already in place. Clearly, 2019 is shaping up to be an impressive year. Now turning to our third quarter results, third quarter 2018 revenue was $145.8 million, an increase of 26% year-over-year. Acquired revenue, which now only represents ABILITY's contribution, was $37.9 million. We continue to see growth in our subscription-based platform revenue, which grew 8.6% year-over-year and 2.6% sequentially and now represents 83% of total revenue. As Keith discussed, during the third quarter, we transitioned most of our remaining legacy contracts to subscription-based contracts, which as we have discussed, generally have the short-term impact on our revenue. To further accelerate and substantially complete this transition and maintain focus on our long-term business strategy, we also discontinued pursuing new legacy opportunities. The net effect of these factors resulted in legacy revenue being only 6% of total revenue in the third quarter and is expected to be only approximately 7% for the year. We have provided additional details on our third quarter revenue performance on Slide 9 in our Q3 2018 supplemental earnings deck. As Keith mentioned, third quarter 2018 gross margin was again strong at 75.0%, a significant year-over-year increase of 820 basis points and up 50 basis points sequentially. Excluding ABILITY, gross margin remained over 70% at an impressive 70.9% in Q3 2018. This represents a year-over-year gross margin expansion of 410 basis points and sequential expansion of 70 basis points. Gross margin expansion continued to be driven by our increasing mix of high-margin subscription-based platform offerings and realization of our technology-enabled efficiencies. Our strong gross margin illustrates the significant leverage opportunity as revenue expands. General and administrative expenses for the third quarter was $47.2 million, an increase of $10.9 million year-over-year and a decrease of $13.0 million sequentially. On a year-over-year basis, the increase in G&A was driven by $7.5 million of acquired G&A from ABILITY, which is lower than the last quarter, and $5.3 million of other non-comparable expenses, which was partially offset by a $1.9 million reduction in other expenses. Adjusting for the other non-comparable expenses, normalized third quarter G&A was $41.9 million, well below the guidance range of $49 million to $53 million of normalized quarterly G&A expense that we previously provided. Pointing out the efficiency in another way, normalized G&A increased only 15.4% as compared with the year-over-year revenue increase of 26.1%. Additional details are provided on Slide 10 of our Q3 earnings supplement deck. Driven by our expanding gross margin and lower G&A expenses, adjusted EBITDA in the third quarter came in at $52.4 million, an increase of $21.6 million or 70.2% year-over-year and sequentially decreased only $400,000 despite lower sequential revenue. Adjusted EBITDA margin for the third quarter of 2018 was 36.0% compared to 26.6% for the third quarter of 2017 and 34.6% for the second quarter of 2018. The stronger profitability drove third quarter 2018 non-GAAP net income per share of $0.11, up 22% on a year-over-year basis. Turning to the balance sheet, Inovalon ended the third quarter of 2018 in a strong financial position. As of September 30, 2018, cash, cash equivalents and short-term investments were $115 million. Total outstanding debt was $980 million. Reported balance sheet debt was $951 million, net of issuance discounts and deferred financing fees. And the company had not drawn any amount from the $100 million revolving credit facility. Of note, the Company's net debt ratio as defined within our debt agreement, remain under 4

[Operator:]

[Operator Instructions] Our first question comes from the line of Donald Hooker of KeyBanc. Your line is now open.

[Donald Hooker:]

Good afternoon. So I guess maybe my question, so you guys mentioned – I hate to waste my one question on this, but did you guys mentioned what ABILITY contributed in the quarter? I would guess that's probably near $40 million or so.

[Jonathan Boldt:]

Hi, Don. Good afternoon. It was $37.9 million.

[Donald Hooker:]

Okay, maybe that's the question.

[Keith Dunleavy:]

Don, why don't you go ahead and feel free to ask another question.

[Donald Hooker:]

Yes, and just it was kind of a quick one, right. So maybe when I think about just getting to the 2018 guidance, I mean there's still a pretty big swing. Is that just timing of contract signings to get us started going into 2019? It's like from the top to bottom end of the guidance for the fourth quarter?

[Keith Dunleavy:]

That's exactly right, Don. Thanks for joining the call by the way, and thanks for the question, but you hit it. As we've signed a lot of business in the last couple of quarters and that's now in the process of ramping, and literally, at this ramp rate a few weeks, one way or the other way on that ramp, inclination impacts what actually gets recognized in the quarter quite a bit. But as you point out, once ramped, which we expect it to be ramped up by the end of the quarter, really has no significant impact on 2019 performance.

[Donald Hooker:]

Got it, okay. Thank you.

[Keith Dunleavy:]

Thanks Don.

[Operator:]

Thank you. Our next question comes from the line of Sean Wieland of Piper Jaffray. Your line is now open.

[Sean Wieland:]

How many questions do I get?

[Keith Dunleavy:]

Sean, why don't you go ahead and shoot. We'll do the best we can.

[Sean Wieland -:]

Okay. So let's start with 2018 guidance. Timing of new engagements signed later than expected and impacted transition for the remainder of legacy business. Those are the two buckets we're talking about for 2018, right?

[Keith Dunleavy:]

That's right.

[Sean Wieland:]

I mean, is that about a 50-50 mix between the two then it looks like?

[Keith Dunleavy:]

So on the legacy conversion and the discontinuation of pursuing legacy in our pipeline that we're able to quantify at about $25 million impact through the second half of the year. The remainder and the reason why the range exists is the timing issue and the ramp associated with that. So exactly when they signed and then a number of different processes need to happen to turn the signed contracts into the actual revenue that is not able to be as precisely nailed as the $25 million, hence the range because of when they actually started how they ramp.

[Sean Wieland:]

But if you do sign that, you will recognize revenue associated with that?

[Keith Dunleavy:]

They've all been signed. So it's all signed and in the process of ramping. None of our projections there are contingent upon additional signatures, and the coverage or visibility that we've conveyed is solid and already at nearly 95% for next year. But for this year, we're not waiting on any signatures to achieve that range.

[Sean Wieland:]

Okay. So here's one thing I don't understand, so focusing on the legacy for a minute. What exactly is the transition away from legacy revenue? I see you're doing about – you did about $8.7 million in legacy revenue, big sequential step down, but a little step down from Q1. You're still going to have to do more than $10 million in legacy revenue in the fourth quarter and you're going to have to keep doing about $11 million per quarter to hit that legacy revenue guidance. So it seems like the legacy revenue isn't necessarily going away, it's just flattening and what exactly is in that and why isn't it going away?

[Keith Dunleavy:]

So a few different things in there, Sean, so first of all, you're right. It's not going away. For the full-year, we expect it to be around 7%, down to about 7%. The legacy in 2019, those are already signed and in place contracts. So that's not expectation to go sell. We're not pursuing additional legacy contracts. So the contracts you see in place for 2019 projection are ones that have already been signed and are in place. So you're correct, there will be some legacy revenue in 2019. Our estimation at the midpoint is approximately 7%. But again, those are with clients that have declared they want to keep it, they want to have it in place, and they’ve already signed. It is in place.

[Sean Wieland:]

Okay. I’ll leave it there. Thank you.

[Keith Dunleavy:]

Thanks Sean.

[Operator:]

Thank you. Our next question comes from the line of Ricky Goldwasser of Morgan Stanley. Your line is now open.

[Rivka Goldwasser:]

Yes. Good evening and congratulations guys for the guide. A couple of questions here. First of all, if you can give us some color on just kind of the customer mix, where are you seeing most accelerated adoption and new wins? And what's driving that on the client side? And then my next question is going to be on margins.

[Keith Dunleavy:]

Ricky, thanks. Thanks for the question, thanks for the congratulations. We are seeing strength in all areas of the business. Virtually, in every segment we're seeing strong ACVs, up significantly year-over-year. We've broken them out in a few different places in the prepared remarks as well as in the actual release. Sometimes, we give year-over-year, sometimes 3Q, sometimes we give them with services, without services. The intention there is that with a little pad of paper, you can see that each segment is growing quite strongly. The strongest two we're seeing a lot – well, really strongest three, I should say, is payer and provider as well as pharmacy. But some of that is announced. As you know, we don't do that many announcements. We conveyed that we've signed more than 82 new logos this year, up significantly. But yet do almost no announcements of those. So strong ACV growth, we're talking 50%, 60%, 100% in some areas across the board in our different areas.

[Rivka Goldwasser:]

Okay. And then on the margin expansion opportunity, can you talk a little bit about just when you think about the visibilities you have, what's within your control versus depends on other factors? And how should we think about the cadence of that margin expansion throughout 2019?

[Keith Dunleavy:]

So the margin is being driven by a number of different things. So first of all, it's being driven by a mix shift to a higher-value, increasingly pure SaaS-based platform offering. That higher value is being recognized by the client, meaning the client is achieving higher value, and therefore, we're able to achieve a higher margin profile with that mix shift as well. We're also successfully connecting a broader amount of the health care ecosystem, having greater efficiencies through that process, which is also helping us on the operating side. We've achieved a lot of synergies with ABILITY, which is helping margins there, as you've seen. And we're on track for [2009] continuation. In how to spread over the year, we've achieved a rather nice cadence of that. I'll turn to Jonathan to break it down a little bit more for the year.

[Jonathan Boldt:]

Yes. As we continue to look through till 2019, we continue to see that margin expansion, continue to build upon it as we progress throughout the year. Still delivering, obviously, the increased efficiencies we're seeing from our technology investments but continue to see that spreading nicely throughout 2019.

[Keith Dunleavy:]

And perhaps, Ricky, the one other thing to throw in, if you look at the margin bridges that we provide in the supplemental deck, you'll notice that we're able to achieve these expansion margins and continue to invest more into strategic areas of the company. Most notably, investing in things like connectivity and the technology, but also our sales and marketing efforts.

[Rivka Goldwasser:]

So at this point, when you think about how the business is shaping up and the leverage, do you have kind of like margin goals? When we look at the slide that you provided, right, we think if you go back to where you were, treat margins around 35%, 37%. So how should we think about just kind of that progression from 2019 level?

[Keith Dunleavy:]

Great question. As we look at 2019, one of the ways we think about it is, not only are we showing the additional expansion of another 200, 220 basis points throughout the year, but if you think about how much we have layered on in areas to invest, most specifically sales and marketing, the normalized EBITDA, if you will, is about 8% higher than that. So on a normalized basis, we're operating now at an EBITDA margin that is materially higher than we ever have before. But we continue to see expansion of that going forward. We continue to see the ability to drive even higher areas of value for our clients, they're recognizing that. Some of the offerings with – synergistic offerings with ABILITY are rather promising. And the continued application of data and analytics in a pure SaaS way is also being recognized as a really high-value area. So we're not done yet on expanding that margin, but we think for 2019, this is the right way to think about where we see the progression going through the year.

[Rivka Goldwasser:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Jamie Stockton of Wells Fargo. Your line is now open.

[James Stockton:]

Hey, good evening. Thanks for taking the question. I'll try to stick to one here. When we think about the 95% coverage, or I think maybe the $612 million number that you guys put in the presentation, from a contract renewal standpoint, what's the exposure there? I would assume that not 100% of that is already under contract. If you could just give us some color around that, that'd be great.

[Keith Dunleavy:]

Sure, Jamie. That is very close to 100% under coverage. So anything that's not already under coverage has been agreed to in principle and is awaiting a signatory process or in the final stage. To put a number on that, it's about 3% of that is agreed to in principle but still waiting signature. So that is a really solid, nearly 95%.

[James Stockton:]

Okay. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Frank Sparacino of First Analysis. Your line is now open.

[Frank Sparacino:]

Hi. Just want to go back to an earlier question in terms of the new sales activity and where you're seeing momentum. And if you could be more specific just from a product perspective, that would be helpful.

[Keith Dunleavy:]

Hey, Frank, thanks for the question. So we've broken it out in a number of different ways in the release, giving platform, platform described in the prepared remarks, both the written and what we just delivered as the total minus ABILITY, minus services. So that's going to break out for you pure platform elements that are going to be payer provider and pharmacy and pharma areas. Then, of course, ABILITY is provider leaving services. We're not breaking out that ACV in the individual product areas, as increasingly, our clients really view their engagements with us as engagement on a platform and then which componentry or modules are they engaging to achieve the goals that they are looking to achieve. You'll see going forward that the health care marketplace has a mix of what an organization does. There are some health plans that not only are servicing things like Medicare, Medicaid and commercial, but are also delivering specialty pharmacy services or also working with provider systems that they own. So it's not as much breaking it out by what you and I would call perhaps a branded product offering, but rather an assortment of modules across the Inovalon ONE Platform. But we're seeing it quite strongly across the board.

[Frank Sparacino:]

Thank you.

[Operator:]

Thank you. And our next question comes from the line of Jamie Stockton of Wells Fargo. Your line is now open.

[James Stockton:]

So the ABILITY business, I was curious what the implied growth assumption is maybe from a pro forma revenue number in 2018 for that year-over-year in 2019.

[Keith Dunleavy:]

So Jamie, thanks for the additional question. We're looking at it as roughly an eight to 10 sort of projection in our 2019 numbers.

[James Stockton:]

Okay, that's great. And then maybe I'll throw one more in here, in case I'm the last one in the queue. The 3% improvement in contract value year-over-year that I think you guys have talked about, is there a way for us to think about what the moving parts are there between what pricing looks like, which I think has obviously been the biggest issue the last two or three years. And then also kind of the upsell of additional functionality into these clients, if you could just maybe give us some flavor for how those two things are influencing the 3%, that'd be great.

[Keith Dunleavy:]

Sure. Let me take a shot at that, and then you see whether or not I've answered it adequately. That increase, first of all, it's really more than a 3% increase. We're seeing roughly an 8% increase year-over-year. You might remember both 2017 and 2018, we referred to a term of client churn of roughly about 5% to 6%. That was clients leaving the portfolio and/or not expanding their business with us and the impact that, that had creating, obviously, a 5% to 6% headwind. So the reversal of that phenomena is the result of multiple different things, each contributing separately. First and foremost, it's because the clients are seeing the products as highly valuable products to their business and they are therefore renewing. Just plain and simple, our renewal rate was very high, very strong and consistently as such. Second of all, they're buying additional products from us, so we call that obviously cross sell. And then additionally, you may have seen the press release a few weeks ago, clients that use the Inovalon ONE Platform for quality improvement, for instance, saw a dramatically higher benefit to their quality performance versus the rest of the country. I'd love to encourage people to look at that press release because it is, in our view, knowing how hard it is to move clinical quality performance, impressive. But that generates a lot of additional financial performance for our clients, allows them to offer more at a lower premium or market more and often in many states or many areas, gives them a marketing advantage over their competitors, and they grow more, and their membership is up strongly. So all these factors, strong renewal strength at the table because they're getting great value, and also they're financially doing well. Our clients are doing better than the not our clients in the marketplace, which also makes them want to do more with us and makes them grow faster than others. So all these are contributing. So really, really positive. And I'll point out, Jamie, that that's 100.3% as of November 7. So all of these coverage numbers are as of November 7. We're obviously selling more. I signed another contract today. We'll continue to sign contracts as we move along in this year. And obviously throughout all of next year, that we'll add to that coverage and add to the overall client base. So I'd like to thank everybody for spending time with us this evening. As always, we really appreciate the time and interest with Inovalon. We recognize that our revision in 2018 guidance is disappointing and our overall 2019 outlook will perhaps be met with some skepticism. But I'd really like to leave you with and emphasize three important points. Number one, we've achieved a meaningful transformation of the company to a cloud-based platform provider where we now have 83% of our revenue in a subscription-based manner. The revenue implications of transitioning from legacy contracts to subscription-based contracts are well known in the software industry and they're now behind us. The market demand – the second point, for our data-driven platform is strong and growing, as significantly indicated by our numbers today, demonstrated in annual revenue retention rates that are now up at 103%, an 8% increase year-over-year. And strength in our ACV sales, even excluding ABILITY and services, year-to-date, up more than 90% year-over-year, with third quarter ACV sales up over 100% year-over-year. And the third point, while we're ramping in the fourth quarter and we've now signed the business that we've been referencing. The contracts and client base are now in hand. They support that visibility that we're seeing going forward. Both on a reported basis, we expect 19% to 23%. On an organic basis, we're now seeing 12% to 14%, even at this early date of November 7. And that's with strong profitability, profitability that's expanding, cash flow that's expanding even beyond what we saw this year. So I just want to emphasize these numbers, our ability to put these out as early as November 7, 2018, and a significance that, that means in our business inflection. We've really crossed an important line, in our view, an important inflection line, delivering significant value for our clients and benefiting significantly from an industry-leading capability. We're excited about the year ahead and the financial performance that we look forward to demonstrating. Thank you very much again for your time tonight. Good night. End of Q&A

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone, have a great day.