Inovalon Holdings, Inc.
Q2 2017 Earnings Call Transcript

Published: 3 Aug 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Inovalon Second Quarter 2017 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 Chris Greiner, our Chief Financial and Chief Operating Officer. I’d like to welcome you all to our second quarter 2017 earnings call. The press release announcing our financial results for the second 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, August 2, 2017, 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 actual results to differ materially. Additional information concerning those factors is contained in 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 those 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. Chris, and I would like to share with you the results of our second quarter 2017, highlight in more detail, the continuing significant progress we are making in our business, and discuss our updated financial outlook for 2017. Let me begin briefly with our second quarter results. As Chris will discuss in more detail shortly, our revenue and profitability in the second quarter again came in ahead of our expectations. We are pleased with our execution. We continue to see the benefits of our investments, driving both top-line and bottom-line performance and our strong financial position continues to support our ongoing investments in our organic business as well as our capacity to consider strategic acquisitions and opportunistic repurchase of shares. The theme of Inovalon has been one of data. And the role it can play in advancing healthcare. It has been the theme of persistently inventing in innovation and advancing our capabilities in market differentiation. You’ve been hearing about these investments and the resulting capabilities over many quarters. More recently, you’ve specifically been hearing about our increasing sophistication in our cloud software architecture, breaking previously monolithic compute processes into containerized microservices, dramatically improving performance and reducing costs. You’ve been hearing about enhancing the sophistication of our data visualization graphical user interfaces, significantly increasing the ability of our clients to interact with our platforms, and corporate data and analytical results. And enhancing the modularity of our platforms, which increases our flexibility and speed to market, for new technology capabilities and for increasing the sophistication of our data model architecture, to allow for larger and more complex data sets. The benefits of these investments are being realized in the many new capabilities that we are introducing to the marketplace. One significant area of advancement has been the introduction of our integrated platform now referred to as the Inovalon ONE platform. For more than a decade, Inovalon has been building a portfolio of capabilities to empower the healthcare ecosystem’s transformation from volume-based to value-based models. Through the Inovalon ONE platform, we are bringing to the marketplace a national-scale capability to interconnect, with the healthcare ecosystems on massive scale, aggregate and analyze data inpetabyte volumes, arrive at sophisticated insights in real-time, and drive meaningful impact wherever it is analytically identified best to intervene. The Inovalon ONE Platform is an integrated, cloud-based platform of more than 80 individual proprietary technology toolsets, each referred to as a “Component”, with each supporting critical healthcare functionality needs, such as data integration, predictive analytics, EHR connectivity, or data visualization. Components are grouped together in the modules, each of which share cohesive interoperability and common data management characteristics. The Inovalon ONE Platform represents a significant evolutionary advancement of our investments in modularity, cloud native architecture, real-time transactional processing and data visualization. Applications of the Inovalon ONE platform are wide ranging and highly customizable. The configuration of certain components within the platform, for example, can provide a client with tools that enable dramatic reductions in post-acute care costs and readmission rates. The activation of additional components can then provide the same client the ability to achieve clinical quality outcomes improvement or improved risk or accuracy. The activation of still additional components can empower the direct integration of a client with their key partner EHRs and facilitate medication adherence improvements. With the Inovalon ONE platform components can be rapidly configured to empower the operationalization of a wide range of large-scale value-based healthcare initiatives, resulting in dramatic increases in flexibility, performance and value for our clients, as well as a differentiation of operational cost efficiencies for Inovalon. Importantly, the powerful combination of capabilities, flexibility and performance offered by the Inovalon ONE platform, is witnessing significant interest in the marketplace. As we announced a few weeks ago, Inovalon recently entered into new multi-year engagements with two separate national health plans to implementing Inovalon ONE platform to empower several value-based initiatives involving approximately 15 million health plan members, spanning Medicare Advantage, managed Medicaid and commercial programs. This is in addition to our engagement by a top five national health plan of our Value-Base Provider Platform involving nearly 20 million patients, which we announced earlier this year and was the first engagement utilizing the Inovalon ONE platform, although was prior at the time to our branding of the platform as the Inovalon ONE platform. While we cannot disclose the names of our clients or provide specific terms of these engagements, they are multi-year deals each ranging up to five years in duration of multimillion-dollar annual commitments with large, sophisticated, forward-thinking healthcare companies with whom we are proud to be associated. As we scale these new engagements, we look forward to supporting our clients’ value-based initiatives and to partnering with other major players in the healthcare ecosystem, to enable and advance the transition from volume-based to value-based and outcomes-based models. As an example, the highly extensible nature of the Inovalon ONE platform subsequent to our announcement of the recent two national health plans engaging on the platform, announced on July 17, one of the two health plans has already executed another agreement to activate additional components for a five-year period to add clinical quality improvement and associated data visualization capabilities for their entire footprint. One of the highly differentiated aspects of the Inovalon ONE platform is that it benefits from insights garnered from the Company’s large proprietary datasets. As you’ll recall we utilize our datasets to implement a number of highly differentiated capabilities, comparative analytics, machine learning model training, data ingestion integrity in analytics, discovery phase cohort development and many other examples. Rather excitingly, these datasets best represented in the company’s MORE2 Registry, are expanding significantly. In addition to our client-based expansion and our connectivity expansion, both of which increased the flow of data into the MORE2 Registry. Earlier this year Inovalon was certified as a qualified entity, or a QE by CMS. And during the second quarter, we started to receive from CMS the identified Medicare Parts A, B and D, medical and pharmacy claims data for use in promoting value, health outcomes, and performance improvement in the healthcare system. Inovalon is one of only four profit companies that has been certified to receive data for all 50 states in the District of Columbia. The addition of this data will further differentiate Inovalon’s advanced analytic capabilities, enhance our ability to support value-based initiatives through the Inovalon ONE platform and expand what is already one of the health care industry’s largest and deepest proprietary datasets. The QE Medicare data will be longitudinally matched and incorporated into Inovalon’s de-identified MORE2 Registry. The scale and nature of all the data currently landing at Inovalon is such that we do not have a precise date account for you as we typically do at quarter end. This will take us some additional time. Our preliminary estimates is that the combination of the new client data, interconnectivity data and QE data being received will translate into a surge in the company’s MORE2 Registry to more than 230 million unique patients and nearly 30 billion medical events, an increase of approximately 67% and 155% respectively, as compared to the end of the second quarter in 2016. And we expect to see this trend of significant proprietary dataset expansion continuing through the rest of 2017. Finally, we continue to expand our connectivity across the healthcare ecosystem. And now have a direct EHR connection with over 108,000 providers across the country, representing an increase of over 280% on a year-over-year basis. As with our datasets, we expect our connectivity and volumes to continue to expand in the second half of 2017. We continue to see significant interest from our clients in the prospects of this capability as our connectivity continues to be a significant, competitive differentiator for the company. In conclusion, we are very pleased with the results we’re seeing from our persistent investments and innovation. We’re seeing very strong expansion in a capability and we’re being received well by the marketplace. We have introduced the Inovalon ONE platform, progressed our cloud native initiatives, continued our connectivity expansion and dramatically expanded our proprietary data sets. And we’re seeing large clients sign up for these capabilities. The engagements, the ongoing interest that we’re seeing in the marketplace, provide us with a positive view for our acceleration of growth. With that let me ask Chris to review the second quarter financial results and discuss our updated 2017 financial outlook in more detail Chris.

[Chris Greiner:]

Thank you Keith. And good afternoon everyone. In a moment I will discuss our financial results for the second quarter 2017, remark on highlights within the quarter, discuss our balance sheet and capital allocation and then provide an update on our financial guidance for the year. But before doing so, let me first comment more broadly on the Company’s results, especially in the context of how we continue to see the year unfolding. You’ll recall during our February 22 conference call we highlighted a number of themes inherent in our 2017 financial guidance that continue to ring true [ph] to the first six months of the year. First, we highlighted that because of known headwinds, which were running their course through the first half of 2017, the year-over-year improvement in our financial results will become more visible in the second half of 2017. This has played out as expected. Even in this setting, however, the second quarter demonstrate another solid quarter of sequential improvement across all key financial metrics. Second, we emphasized how the company would continue to invest aggressively in expanding its go-to-market capabilities along with maintaining a steadfast commitment to investment and innovation and platform enhancement. Our second quarter results demonstrate success on each of these fronts, while also being able to deliver on operating leverage initiatives necessary to show overall sequential margin expansion. And lastly, we commented on continuing to leverage the strength of our balance sheet, to continue to deploy capital in areas that tactically make us better and strategically position the company for long-term shareholder value creation. During the second quarter we achieved both. Let me discuss how. As Keith conveyed our solid execution continued in the second quarter. We believe our performance is indicative of the momentum we are building in our business and clearly demonstrates the benefits of our ongoing investments in innovation, sales capacity and capability expansion and operational efficiency. In terms of revenue, second quarter was $110.6 million, above our expectations of $106 million to $110 million. Revenue in the second quarter continue the trend of quarter-over-quarter expansion, representing growth of 2.1% sequentially. We believe this continued sequential expansion over the course of the year is a more accurate reflection of the progress the company is making towards its improving financial performance. As expected, second quarter revenue was down a year-to-year 11 points, which includes a negative 17 point impact from the CARA transition headwind we have been discussing for the past 12 months. A dynamic that was most pronounced in the second quarter of 2017 and is now substantially behind us. Excluding the impact from CARA, we saw a very strong account growth ramping new sales contribution and improving win rates all of which reflect the demand our platform is garnering across new and existing payer, provider, pharma and device clients. With those positives persisting and the negatives behind us, the second half shapes up very nicely for us. Accompanying the sequential revenue growth was another solid quarter of gross margin performance. Gross margin of 66.4% in the second quarter was up 170 basis points over the first quarter and up 130 basis points, compared to 2Q last year. We saw continued operating leverage in our cost of delivery, driven again by a combination of technology-enabled efficiencies, including expanding connectivity and increasing leverage of our technology platforms and capabilities, as well as favorable platform offering mix and pricing. More specifically, the 170 basis points of sequential gross margin expansion was entirely driven by improvement in platform mix and pricing. Whereas the 130 basis points of year-over-year gross margin improvement which driven by a combination of technology-enabled efficiency initiatives and pricing. We saw the same quarter-over-quarter operating leverage flow through to adjusted EBITDA, generating $27.7 million, an increase of $2.8 million or 11% sequentially. Adjusted EBITDA margins were 25.1% up 210 basis points over the first quarter 2017. Consistent with our prior comments we continue to make investments in sales and marketing and innovation that position Inovalon for increasing growth, profitability and industry leadership. And we’re seeing returns from those investments. Sales and marketing expense represented 8% of revenue in the second quarter of 2017, up 310 basis points from a year ago and up 100 basis points sequentially. We continue to invest in sales resources. For example, expanding our team of solution engineers, subject matter experts going to market alongside our business development teams to architect our platform solutions, as well as investments in our systems to better identify new white space opportunities, which as I highlighted earlier was a strong contributor of revenue in the quarter. As Keith mentioned, we also continue to invest in our platform capabilities, technology infrastructure and platform offerings, which allowed us to take a major step forward with the introduction of the Inovalon ONE platform. Total second quarter investment and innovation, which includes both R&D expense and capitalized R&D related investment was $21.9 million or 20% of revenue, up 32% and 640 basis points respectively on a year-over-year basis. And as we conveyed, the returns we’re seeing from these investments can be seen not only in the advancement of our capabilities and also our new business wins, but also in the continued operating leverage from our technology-enabled efficiencies and improved offering mix. From a G&A perspective, while G&A expense increased on a year-over-year basis, the increase is largely attributable to our acquisition of Creehan, which was not present a year ago. G&A expense was flat sequentially on a deferred basis and down 70 basis points as a percentage of revenues. Finally, non-GAAP earnings per diluted share were $0.08, up a $0.01 or 14% sequentially, driven by the expanded profitability that I just discussed, as well as our share repurchase activity. Turning to the balance sheet, Inovalon remains in a very strong financial position. We ended the second quarter of 2017 with $532 million in cash, cash equivalents and short-term investments, which includes the impact of $19.8 million for share repurchases in the second quarter. As of June 30, 2017 we had approximately $48.6 million available under our remaining share repurchase authorization through the end of 2017. Inovalon and also delivered very strong cash flow from operations of $35.4 million in the second quarter, driven in part by the expected improvement in collections we discussed with you last quarter. Along those lines, day sales outstanding of 78 improved by about seven days sequentially, with further opportunity to improve over time. And for the first six months of 2017, our cash flow from operations is up 27% from a year ago period. The strength of our balance sheet, the strong cash flow characteristics of our financial business model and our existing debt capacity, continue to position us well to invest in our capabilities. And consider additional strategic opportunities and opportunistically repurchase shares. Before I transition to our outlook for 2017, allow me to share some details about a small acquisition we completed just after the end of the second quarter. As mentioned in our earnings release, on July 6, 2017 Inovalon closed the acquisition of ComplexCare Solutions CCS, a technology enabled provider of intervention services to help plans across a range of programs, including Medicare Advantage, Commercial ACA and Managed Medicaid. Importantly, CCS has been Inovalon’s largest vendor for providing technology-enabled clinical encounters informed by our analytics and clinical decision support platform ePASS. On behalf of clients for which the volumes exceed their internal capacity. The CCS acquisition presents unique opportunity to acquire known, high-quality operational capacity and scale for a growing component of our analytics portfolio, while increasing the cost efficiency of delivering Inovalon’s offerings. As I mentioned, the acquisition was small at a purchase price of approximately $3 million in cash and in assumption of a similar amount of debt. While small, we see it as a good deal for our clients and shareholders. Because Inovalon was CCS’s largest client, there will be an elimination of revenue in the consolidated results. And we are also expecting the discontinuation of certain non-Inovalon business conducted by CCS. We are expecting revenue contribution of approximately $6 million for the remainder of the year, at an operating loss and adjusted EBTIDA of approximately $2.5 million. However, we see that turning positive in 2018. Now let me turn to guidance. With the strong year-to-date performance, increased visibility into the year and the addition of CCS, we are updating our guidance as follows

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Steven Valiquette with Bank of America Merrill Lynch. Your line is now open.

[Steven Valiquette:]

Okay thanks good afternoon Keith and Chris. Thanks for taking the question. A couple of things, Slide 7 is kind of interesting as far as the increase in the platform. Just trying to get a little more on that will correlate to your revenue ramp over time if it’s possible to even think of it that way? And I feel sorry for whoever had to create the platform storyboard on Slide 6 that will say that.

[Chris Greiner:]

You’re talking to him.

[Keith Dunleavy:]

Very good evening. Thanks for the question. So your first question is – let’s talk about the dataset expansion. So the dataset has been accelerating significantly over the several quarters we saw start to emerge at the end of 2016 and really accelerate fourth quarter of 2016, first quarter of 2017 and now very dramatic here in the mid part of the year in second quarter and now continuing here in the third quarter. The data as we mentioned, coming in extensively from significant expansion of client base, significant expansion of connectivity into the healthcare ecosystem and the QE data, which is obviously very large in size. We’re – how does this translate into revenue? First, it translates into revenue in a few different ways. Number one, it turns into revenue because of the differentiation in the marketplace. Increasingly, as you’ve been hearing from us in the past value-based care is the relative performance marketplace. How this hospital is doing compared to that hospital, how this health plan is doing compared to that health plan is all a matter of relevance of overall performance within whatever the comparative cohort is. So if you are a drug company, if you’re hospital, if you’re health plan, if you’re a government entity, your desire to understand performance compared to the rest of the world if you will is growing very rapidly. Our dataset therefore gives us an enormous differentiation capability to provide for the ability to make change during a service period, during a data service period instead of finding out after the fact and having the adjustment to whatever value-based payment impact it might have for your organization, clients of Inovalon are able to find out during the data service period and do something about it. So that’s a big differentiator, it’s relevant across all of our spaces managed care providers, pharmaceuticals and device manufacturers and it’s ringing really, really well. Also we’re increasingly using that data to train our machine language, machine learning training protocols and that is making a big difference in our efficiency and the effectiveness of our systems. From data integration the ability to clean and import data in automated fashions in massive scale is enabled by the huge comparative data sets that can now train those import engines. The ability to identify disease comorbidity, quality issues, risk or accuracy issues, medication, applications within specific patients are all trained by the billions of medical events that are in that dataset. And what’s also interesting is the breadth of data we have. This isn’t just commercial data, it’s not just Medicaid data, it’s not just Medicare Advantage data, it’s not just fee-for-service data, but it’s across all of the spectrum, because remember patients are moving in and out of these different elements of the population. They get a job, they go into commercial, they lose their job, they might go into Medicaid, they grow older, they go into Medicare, and so forth. So we’re able to track patients over enormously long periods of time. And then lastly, for me to hit on, relevant to the differentiation is our data is primary source. So this is really different than for those that go out and buy their data. Inovalon obtained their data in identified format that allows for the accurate longitudinal matching and the accurate use of the analytical outputs of those to drive care paradigms and interventions. The reason that’s so important is because if you buy secondary data and its de-identified data, it’s dangerous to presume you have proper patient identification and apply it towards clinical applications because you might have the patients wrong. In our world we have that primary source of identification and therefore being able to match it up to apply to a much broader set of care applications drives revenue. So differentiation in the market, differentiation in our product capabilities, differentiation to the breadth that we can apply to you’re going to see that data expansion translate into acceleration in our revenue.

[Steven Valiquette:]

Okay.

[Keith Dunleavy:]

The second thing, I think, you touched about is just the Inovalon ONE platform greater than any different components. Lot of these components you’ve been hearing about over the years we’ve been transitioning these components into more integrated capability stets, we’ve been transitioning them into cloud-native applications that allows them to operate at a much greater efficiency that allows them the scale much more efficiently. And what it has really allowed us to do is broaden outside of our legacy client base. So as you know we started primarily in the payor space which is a fantastic place for us to have kind of count our teeth. But the toolset that we designed for them has applications across pharma, across medical devices and we’re increasingly seeing that it has applications really outside of what I think many audiences would consider traditional applications. And the rearranging ability of those components into more configured toolset solutions is a flexibility that’s awesome driving product and therefore revenue expansion.

[Steven Valiquette:]

Okay that’s great. Thanks.

[Keith Dunleavy:]

Thanks Steve.

[Operator:]

Thank you. Our next question comes from the line of Nina Deka with Piper Jaffray. Your line is open.

[Nina Deka:]

Hi guys. Thanks for taking the question.

[Keith Dunleavy:]

Hi Nina.

[Nina Deka:]

Could you provide some example of how Inovalon ONE is different now than the platform was previously? And how does new rollout of the platform is able to get you foot in the door in ways now that you’ve didn’t have before?

[Keith Dunleavy:]

Great, so in our prior world what we had was more monolithic offerings. So a client would come to us and say my challenge or my need is X, quality measurement, quality improvement, outcome space contracting, whatever the issue was risk or accuracy improvement and we would serve up to them the solutions that was designed for just that. What we’ve done now is we’ve broken those all apart into module more modular approaches and those individual pieces, which we call components, allow us to interconnect the Lego set, if you will of the platform to more customized client needs, which allows for clients that previously may not have wanted to make a monolithic all or nothing decision Inovalon versus, non-Inovalon or in-house versus outsourced. Now that is a less complicated decision for them. And that’s driving revenue and its driving stickiness. So today a client can come to us and say this piece, I think, I have taken care of, I need help in these other areas, can you solution this? And the answer is increasingly yes, because they might need seven, or eight, or ten different components to wrap around their in-house elements and bring to life a best of all worlds solution for them. So now let’s take that how is that different. Well first of all, like I said, it’s different because it allows people to make non-monolithic decisions. And once they’ve made that decision we’re a lot more sticky right because our parts and pieces are interconnected inside their business. But then also it allows for greater extensibility, meaning a client is signed up with us to do a certain set of applications and they come to us and say how hard would it be to also do this or that. And we can turn on just one, or two, or three, or five additional components of the platform that are already able to access the same data sets, the same data flows, the outputs of the other parts of the platform and very quickly, literally in days turn on a new set of capability for which we obviously get to expand our revenue with the client, but they get disproportional value out of it. And you’ve seen that already happen past the announcement we made two or three weeks ago. This is a very large, sophisticated healthcare system that’s national in scale and they turned on an additional set of components, they were able to go active nearly right away and deliver additional value for them across their entire footprint.

[Chris Greiner:]

And I think Keith, and Nina its Chris. I think I’d also add one benefit certainly the clients realize but you’ll see it show up also in the P&L is because we’re able to leverage the operation component of the platform, we’re much more seamless in front of the client. I think you’d see that in the expansion of our connectivity, you saw in the press release over 180,000 providers growth of 280 some odd percent year-over-year, we’re more automated as a result of that. You see obviously show up in the margins that are improving both sequentially and year-to-year at the growth level .

[Nina Deka:]

Okay, thank you that’s very helpful. And then just one more on the CCS acquisition. You mentioned that expect that it could be accretive in 2018. What is that that you expect to have happened to go from the negative EBITDA this year into the profitability next year?

[Chris Greiner:]

Yes, it’s quite simple Nina, it’s really the integration-related activities associated with the infrastructure that is currently supporting a company and what we will ultimately take it to in the next six months.

[Nina Deka:]

Great, thank you.

[Operator:]

Thank you. Our next question comes from the line of Shawn McBride with Robert W. Baird. Your line is open.

[Shawn McBride:]

Hi thanks for taking the questions. And congrats on a good quarter. So with respect the Inovalon ONE deals, can you talk just a little bit about the sales process that went along with these larger agreements with the health plan, as well as the implementation time frame that is expected there?

[Keith Dunleavy:]

Sure Shawn, thanks for the question. So one of things you’ll notice is that with Inovalon ONE platform we’ll talk less and less about individual products and more and more about the capabilities and the needs that a client has. And so there’s actually a bit of funny story with the first Inovalon ONE win, which this was pre-branding of Inovalon ONE, this was one we announced back in February that was nearly 20 million patients or members. We were last to the RFP. When the RFP was done for that solution. Our President happened to ride in the elevator with a senior management person from that health care organization, and they explained that in effect, they weren’t really happy with any of the responses they were back on the RFP. Our President said, "Come with me." He walked her actually downstairs, they were at a conference, found one of our colleagues in the company and they pulled up on the iPod, literally the software that she could have and talked about how rapidly she can have it implemented. And in a matter of days, that went from that discussion, which we hadn’t even originally been invited to, to full very large scale on-site solutioning of which components would fit together, the speeds that they needed, the responses that they needed, the functionality that they needed and with from that to full up implementation across more than 110,000 providers and close to 20 million patients in a very short period of time. So the beauty of that was it wasn’t a matter of what our product names might be, but what needs this health care organization had. And that very quickly, took them – this is their implementation – fully cloud base implementation. This was a beautiful native cloud architecture environment that they are in. And the scalability of that allows them tremendous flexibility to add on additional capabilities.

[Shawn McBride:]

Great thanks. And then respect to capital deployment in terms of M&A, is there any type of acquisition that is especially appealing? And then how do you think about capital deployment for the second half of the year?

[Chris Greiner:]

Yes Shawn, we’re fortunate to, as you’ve heard, have a great strength in our balance sheet, not only what’s on there now, but our cash flow capability, our access to other capital and it gives us a lot of flexibility. Nothing is changed with the strategy that we’ve conveyed before. We’re enjoying being able to look at a wide array of opportunities out in the marketplace. We want to be very prudent and thoughtful spenders of our shareholders’ money. We think that there are a number of interesting strategic opportunities for us, that we look at very carefully. But to walk through the list, as you’ve heard it before, we think of them in four different categories, if you will. The first one is expansion of our client base that we could launch additional – our technologies. And two, see more rapidly scale revenue. The second category is the purchase of additional technologies that we could more rapidly deploy into our large client base, which is now very close to 500 different health care organizations. Number three, is a scale acquisition. Certainly, CCS, although extremely small in size, I guess technically falls into that third category. And then number four, we are expecting, at some point, to expand our geography, and to apply the strength of our balance sheet to do that. So the potentiality of acquisitions – foot hold acquisitions outside of the United States. But there are a number of very interesting assets that are out there. One of the things we see ourselves as being is fundamentalists. We really look at the underlying technology, really look at how the technology is working with the client base. We are very fortunate to have tremendous subject matter expertise, a bunch of our core Inovalon people are really leaders in things like the cloud and security and processing and obviously, managed care, and also our colleagues at and bring to us subject matter expertise in a very wide array. That allows us to look at acquisitions and know about acquisitions very nicely. So nothing has changed in that strategy, except for us being pleased with how we’re proceeding through it. And you can expect us to continue to deploy that capital in a way that we believe is best for our shareholders.

[Operator:]

Thank you and our next question comes from the line of Garen Sarafian with Citigroup. Your line is open.

[Garen Sarafian:]

Good afternoon Keith and Chris. Following-up on the prior question, obtaining QE status, how much of a head start do you think you have on other vendors that may obtain cuties that this in the future. And not sure exactly when you received this designation, but have you had enough time to sort of show this off to clients yet? Or it’s directly led to any new wins or expansion of new components as a result?

[Keith Dunleavy:]

Yes great question Garen. So the QE initiative by CMS is a complex one. And it’s helpful for our audiences to be sensitive to one has to pass a rather rigorous set of considerations to be granted QE certification. And I caution those trying to figure this market out that there are many steps along the way, so organizations can make statements about their QE status that can be a little deceiving. And the certification can mean just one phase of the certification process and there are many phases along the way so that the key things to be knowledgeable about are first and foremost one needs to be able to convey to CMS, prove to CMS, that the extent of your existing data set is so large such that it fulfills certain criteria to allow you to additionally get the QE data in that region. So region by region, you have to prove to CMS, I have enough data in that region to fulfill this ratio, set of rules that CMS has set. So you see hospitals saying they’ve been QE certified literally for a county, an individual county, or you might see an organization say that you might see it might be for one state or something like that. In addition to that, you have to have certain data security aspects, you have to have certain data governance practices in place, things that are not trivial and a lot of the organizations fall down on that step. They pass the first certification they announce that they’re certified. They ultimately can’t pass the subsequent certification. We have passed all these certifications and we’ve passed them in the entire, all 50 states and the District of Columbia, which not many only four profitable organizations have done. And most importantly, we have also passed all the subsequent certifications and we’ve already been receiving the data, which those steps take a long time to work through. The actual receipt of the data is so large that that takes a long time to work through. So QE is not QE is not QE, which is a really important point. Now to your second point, now because QE data, one can obtain it in an identified fashion. Remember, the rest of our data is also identified, so we’re in a very unique situation where we can do one to two no-matching across our entire data sets. Remember patients pop in and out of Medicare. They can pop in to a commercial plan, into Medicare Advantage, back out into Medicare they can go over into multiple different types of plans. So if you bought the rest of your data, even if you got QE, or if you didn’t have patient identifiers your you can’t do that you can’t apply it to clinical analytics, you can’t apply it to the intelligence and platforms it’s just a lot of the bad that you can do relative amongst that data set but not across that in addition to other data sets. So our situation is different than nearly any other organization in the country. We’re proud of that. I’m extremely pleased with my colleagues that have put all this into place and done a great job with it. And so now where we with revenue generation on that? We’ve been preparing for this for some time. We have been starting to share these steps with a number of audiences both being largely and important clients of ours, as well as potential strategic partners of ours. We don’t want to set expectations to extensively around this, so we’re working through this. We’re excited about it. We have a number of players that are already aware of and we’re already working with. But first steps first, we’re pleased with the data arriving in our overall certifications.

[Garen Sarafian:]

Got it. That is very useful. So second question is a little bit more broader. Just given all the uncertainty in Inova [indiscernible], just curious, how does that change the conversation? So one is on overall appetite, which sounds like it hasn’t abated, but maybe any changes in what they’re weighing more or less? Or any other changes that you’re observing?

[Keith Dunleavy:]

So Gary great question. I’m going to also use your answer – your question to speak to something that we think is really important for our audiences to understand. But I’m going to take your question as what does the ACA environment and the regulatory environment, what’s that translating to? So we’re very fortunate to have a number of internal extremely qualified subject matter experts that are in fact literally the people being called upon by the health care system to figure the stuff out. While it was a confidential engagement, it ultimately was a leaded to the press [ph] that we through our – I believe our [ph] colleagues we are the ones hired by the special session of National Governor’s Association to examine how changes in the ACA would affect the Medicaid situations for instance. This was a cornerstone piece of work done on a very significant scale, ultimately ended up getting leaked out and was in The Wall Street Journal, and Bloomberg and a number of other sources. But those same colleagues of ours, we’ve obviously set to the task of saying what does all of the ACA change mean for Inovalon. What we’ve done in excruciating detail is examine the various different parts of the country, they’re called raining regions across all 50 states and actually beyond just the 50 states, in districts, county and such and examined which payor organizations are supporting each one of those regions. Remember its different medal levels you’ve got group coverage, individual coverage, on exchange, off exchange. This is a complex analysis. You’re looking at pricing levels you’re looking at shifts of patients. And I think a very important thing for the analyst community and our shareholder community to be appreciative of, is the patient doesn’t this disappear. So the patient that is dropped by organization X, ends up somewhere also in the health care system. We have nearly 500 different clients. There’s a very high statistical likelihood that we’re going to continue to generate revenue deliver value for that patient in another place. But let’s talk specifically. So we took an examination of every single that pass and so far by every single organization, not just our client base, because remember if a non-client of ours pulls out of a rating region, in which we have a client, that increases the math effect of patients that then been would have a statistical likelihood of becoming a member in a plan that’s a client of ours. So it’s not just a matter of losses but in some regions we’re getting gains. And further still, we have a number of very large national clients that are announcing expansions of their ACA coverage, regions in the U.S. But even where we have situations like a known client, and since it was publicly made known that Anthem has done some withdrawals, we’ve very carefully examined exactly where Anthem has been making their decisions, obviously, they’re a great and very much beloved client of ours, with whom we enjoy working. But they are making their various different strategic decisions in the marketplace. If we take an examination for instance of the State of California, in virtually every one of the rating regions that they are pulling out in California, we serve multiple additional clients, in virtually every single one of those regions. And in fact, we have at least three major clients in those regions. So in our analysis, we’ve done a same-store sales analysis, if you will, meaning taking every single change that’s been announced, including those announced yesterday and today, and mapped those out to precisely all of our coverage areas, all of our client base, and so forth. When we map out every single change to date on a same-store sales basis, this comes to, for a 2018 impact, to the neighborhood of around negative 1% impact on our business. It’s very closely orbiting right around a negative 1% because these models have a little bit of variability in them.

[Garen Sarafian:]

Is that associated [ph] with revenue?

[Keith Dunleavy:]

In revenue. Revenue to Inovalon. In our 2018 implication from all announced changes. But that’s the same-store sales basis and we’ve been growing our client base extensively this year. Much more significantly than that negative 1% implication. So if our same-store sales impact from all changes in the ACA that have been announced, even those over the last two days, this is current as of literary a few hours ago, and our new incremental in 2017 business is significant, very significant number of member wise expanding. We are seeing a very positive, actually growth expansion in our revenue going into 2018 even within the ACA. Now let me pivot for a second to another related aspect that is very interesting to us. We have examined how do our clients do, compared to the rest of the marketplace. Are all things created equal? If the organic growth rate in Medicare Advantage is approximately certain percentage and the growth rates of all areas are announced by CMS or federal governments or state governments, how does our client base within that behave? Do we grow slower than the rest of the market? Do we grow faster than the rest of the market? I’m not making claims here on causality, and certainly we could talk about our views whether or not our financial benefit that we deliver to our client helps them grow faster, or is it that the more progressive, more forward-thinking clients select Inovalon, we’re not here to debate the causality potentialities there. But the facts of the matter are is that as we look at our product lines, Medicare Advantage, ACA, and so fourth, we are growing materially faster in our client base than the rest of the marketplace. Clients that use Inovalon’s products to better are growing organically faster than their peers. And for that reason, we’re seeing nice uplift literally just on a PMPM and base level of our business. And as we moved increasingly towards a subscription engagement contract base, which you see now and Chris talking about sequential quarter thinking as opposed to year-over-year quarter thinking, that expansion of subscription based on an expanding organic client base is boding quite well for us. So I’ve said an awful lot. I used your question as the opportunity to raise those very detailed analyses. But I’ll give you one nugget of detail that we found amazing. In Medicare Advantage, which is a dominant area of work that we do, certainly, our largest area of business in any one product line, our membership growth rate is 9.02%. That is compared to the growth rate of the non-Inovalon Medicare Advantage marketplace of 2.56%. So we are growing, our client base is growing their patient base at a 6.46% difference than the rest of the marketplace. So these are positive factors. We’re also seeing it in the ACA, so even when factoring in the same-store change, we’re seeing a positive 2018 on those numbers. Sorry for the long answer.

[Garen Sarafian:]

No, I appreciate your response. Thank you very much.

[Operator:]

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

[Mark Rosenblum:]

Hey guys, this is Mark Rosenblum for Ricky. I just wanted to get some color on the cadence of revenue. So it looks like there’s significant uptick in organic growth in the fourth quarter. Can you guys give us color on what level of visibility you have there? And what variables would pull that revenue forward? Or push it out into 2018?

[Chris Greiner:]

Hey Mark, Chris here. I’ll piggyback off of how Keith just kind of transitioned at the end of his last response. I think perhaps a different way to look at it, while I absolutely acknowledge the change in growth rates year-over-year from first half to second half, I think, first half is down on an as-reported around 3% and the second half will be up 17%. I’d encourage you to look at it a bit differently as we worked hard to transition the portfolio more and more to a subscription model, it lends itself better to building the business sequentially quarter-over-quarter, which is obviously what we’ve been trying to do and have successfully done to the first six months for the year. If you look at that growth, rather then looking it on a pure year-to-year basis and think about it on a quarter-to-quarter basis, first, the second quarter as we provided in the supplemental deck, grew at about 2%. The growth from 2Q to 3Q is about 4% so again pretty modest, and then the growth from 3Q to 4Q is back at 3%. So it’s not as Herculean when you look at it from that lens, and that’s how we’ve been approaching the business and the backlog.

[Mark Rosenblum:]

Okay. So then just following-up on that, on the transition, can you just give us some color like how much of the revenue model changed to a subscription? And should we think of it like as a per member per month is that the right way to think of the change?

[Chris Greiner:]

You’re correct in the current member per month. Hard to quantify with precision, but certainly the announced deals that we’ve signed have all been part of those models and are large, exciting opportunities for us.

[Keith Dunleavy:]

Mark, the only thing that I’ll add to that would be as you’ve heard us talk to through those transition in modularity over the last 12 months, that was not just a transition of the technology and the products, that was also on those renewals and those transitions, we transitioned many of them to these subscription-based contracts.

[Mark Rosenblum:]

Got you. Okay, thanks for the color.

[Chris Greiner:]

Yes, thanks, Mark.

[Operator:]

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

[Unidentified Analyst:]

Hi, thanks for the question, this is actually Nathan in for Jamie. I guess your sales marketing spend seemed to step up, are you doing anything different there?

[Keith Dunleavy:]

We’re scaling it. So as we talk about, we’ve been adding sophistication into that process, we’ve been adding a number of new product lines into that. So we’ve talked about it a little bit before we break up the country into a number of different regions, each region is supported by East and West and then Senior and then break it down tiers. I don’t think there’s anything magical about that compared to other companies. We’ve been layering in increasing subject matter experts as Chris alluded to in his discussion we’ve been increasing the sophistication of our tracking systems and reporting systems. I think we’ve spoken to this before. It’s really working, and we’re just increasingly scaling that and now layering in more and more into the pharmacy, specialty pharmacy and payer – I’m sorry, provider space. So we’re always more easily able to penetrate the payer space. We’ve been really coming in heavy on a number of additional people in the other areas.

[Chris Greiner:]

Yes, Nathan, it’s Chris. I think I’ll just add that for the year, we continue to see it right around 7% of revenue. But as Keith mentioned, whether it was last quarter in the growth of new client wins or this quarter as I mentioned in the prepared remarks, the win rates that we’re seeing so it’s now maturing and the evolution of the sales force, the learning of the platform, the capabilities of the company is translating to win rates, when you look at it both in terms of early-stage pipeline, so when it first enters the funnel or when it’s late in the funnel it’s been progressed, it’s up nicely.

[Keith Dunleavy:]

Maybe the last thing to pile on, on this one, what’s changed, we’ve really also seen a great improvement in our client services and our clients win rate. Melissa Evans our SVP in client services here she’s doing just a fantastic job. The more and more client services are aligned right next to the product and client that’s just as more cross-sell, upsell as we can deliver more value to the client.

[Unidentified Analyst:]

Okay, great. Thanks.

[Operator:]

Thank you. And our last question comes from the line of Ryan Daniels with William Blair. Your line is open.

[Unidentified Analyst:]

Hey guys, it’s actually Rob on for Ryan. More broadly, can you talk about what you’re seeing in the device and pharma space, especially around outcomes-based contracting or value-based contracting and your role there? Is that a significant part of your pipeline today?

[Keith Dunleavy:]

Hey, Rob thanks for the question. So real important difference between Inovalon and the vast majority of the rest of the world is in [ph] contracting. Some organizations, we were talking to one the other day, they said they have many different outcomes-based contracts in place. What they are talking about is what we would call aggregate report and administrative contracts. Meaning, it’s March, April May of 2018, I’m going to tally up your data from 2017, and I’m going to determine who owes who in some kind of contractual relationship. Very different than the Inovalon model. The Inovalon model is we’re going to tell you, in real-time or near real-time, how the patients are doing with respect to the actual performance that you’re targeting and actually do something about it to improve compliance persistence, outcomes, cost-benefit and actually change the impact such that the realization that the FDA study says about the drug comes true. Cost savings gets incurred, the patient benefit and the actual true-up actually happens in near real-time. So Inovalon’s platform, and this is all leveraging the Inovalon ONE capability set, is aggregate the data real-time, analyze it in real-time, intervene in current data service period and adjust payments and incentivizations as you go along. So this is a big area for us. We’re excited. We’re seeing a lot of positive reception of this in the pharma space and it’s increasing in the device manufacturing space, as well. So we have contracts in both of those areas and we’re looking forward to going into more of that in the future.

[Unidentified Analyst:]

Alright.

[Keith Dunleavy:]

So with that, thank you very much, all of you. Thanks, Chelsea, for handling the call. Thank you, all you for carving out part of your evening. I would like to leave you with three themes, if I could. Number one, our investments and innovation are yielding the significant advancements and capabilities that we have been looking for, efficiencies, market differentiation, and the marketplace is receiving these capabilities quite well. You’re seeing these in large, meaningful engagements with sophisticated national health care organizations. Number two, we’re executing well. We’re expanding the subscription-based portions of our business we’re showing sequential improvements in many of our key metrics, both financial and nonfinancial alike. And number three, look this is an enormous market. This is a giant market in payor, provider pharma device space and you’ll increasingly hear us say not just in the United States. And you heard Chris say in his closing remarks we’re pleased and excited to now be in a period of double-digit growth. Thank you very much for your time tonight. We look forward to updating you on the third quarter when that comes. In the meantime, we’ll be out at a number of financial conferences. As we come here out of the summer, looking forward to meeting and speaking with you at those. Good night to all of you. Thank you again.

[Chris Greiner:]

Thanks everybody.

[Operator:]

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