Inovalon Holdings, Inc.
Q4 2017 Earnings Call Transcript

Published: 21 Feb 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Inovalon Fourth Quarter 2017 Earnings Call. [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 Officer and Chief Operating Officer. I’d like to welcome you to our fourth quarter and full-year 2017 earnings call. The press release announcing our financial results for the fourth quarter and full-year 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, February 20, 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 actual results to differ materially. Additional information concerning these 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.

[Dr. Keith Dunleavy:]

Thank you, Kim. Good afternoon, everyone, and thank you for joining our call. Before we get into our fourth quarter and full-year 2017 results, I wanted to discuss the management transition we announced in our earnings release earlier today. Chris Greiner has accepted a new opportunity outside of the Company that will allow him to relocate closer to his family in New York. Chris will remain with the Company until March 16th at which time Jonathan Boldt, Inovalon’s Vice President of Finance will assume the role of interim Chief Financial Officer. Jonathan has been a key contributor to the positive of advancement of Inovalon’s financial and operational capabilities over the years, as he has taken on increasing levels are responsibility. Jonathan has been at Inovalon for six years and before that he was at Deloitte. The Board, the management team and I all have a high degree of confidence in Jonathan’s ability to execute the CFO role until a permanent replacement is named. All of us at Inovalon are sorry to see Chris go but want to extend the heartfelt appreciation for the many contributions that he has made to the Company over the five years that he has been with us. We wish him well in his new role and are happy to see that he will be able to have more time with his family. With that, Chris and I would like to share with you the results of our fourth quarter and full-year of 2017, highlight in more detail the continuing significant progress we are making in our business, our technology and our capabilities, and discuss our financial outlook for 2018. Let me begin briefly with our fourth quarter and full-year results. As Chris will discuss in more detail shortly, in the fourth quarter, we achieved double digit revenue growth and expanded our margins, both on a year-over-year basis. For the full-year 2017, we grew revenue, expanded margins and generated strong cash flow from our operations, all in line with our previously conveyed financial guidance. We are pleased with our performance and our execution in 2017 and we continue to be in a strong financial position that is very supportive of our ongoing investment in our organic business as well as our capacity to consider strategic growth opportunities. But Inovalon’s success in 2017 goes beyond just our financial performance. As important, if not more important, are the advancements we achieved in our capabilities, in our technologies and data sets and our business transition to a subscription-based cloud-based platform model. One of our most notable achievements in 2017 of course was the introduction of the Inovalon ONE platform. The Inovalon ONE platform is an integrated cloud-based platform of more than 80 individual proprietary technology tool sets or components, with each supporting critical healthcare functionality needs such as data integration, predictive analytics, EHR connectivity or data visualization. Throughout 2017, you heard us emphasize our continuing investment in modularity, cloud-native architectures, real time transactional processing, machine learning and natural language processing, and other innovative capabilities. The Inovalon ONE platform represents a significant evolutionary advancement of these investments. With the Inovalon ONE platform, we significantly enhanced existing offerings such as our data visualization and created new cloud-native platform based offerings such as our value-based provider platform. And we significantly enhanced the flexibility to speed and breadth with which we can deploy these offerings as well as the robustness, efficiency and compute performance of our cloud-native software and infrastructure. The value and delivery and market differentiation of our Inovalon ONE platform is being rapidly acknowledged by the marketplace. As we have discussed, in 2017, we won multiyear engagements with four national-scale health plans, including UnitedHealthcare, the nation’s largest health plan, and three other of the nation’s five largest health plans for a wide range of our Inovalon ONE platform offerings. We also won multiyear engagements with leading regional and state-specific players as well as migrated a number of our existing clients from legacy solutions onto the Inovalon ONE platform, while also converting contractual relationships to subscription-based structures. In addition, we won new business with a number of global leaders in the adjacent pharma life sciences market and increased the number of outcomes-based contracts in this market as well from four in 2016 to eight by the end of 2017. And I am pleased to tell you that as of today, the number of pharma and life sciences outcomes-based contracts has now been expanded to nine. These many multiyear engagements demonstrate the success that we’re having transitioning Inovalon’s revenue base from legacy enterprise solutions to subscription-based cloud-based platform offerings. To put a final point on the progress, on slide 7 of today’s supplemental presentation deck, available on our Investor website, we have broken out the contributions to the Company’s revenue, detailing services, legacy solutions and subscription-based cloud-based platform offerings. In 2017, enabled through the strong market reception to the Inovalon ONE platform, revenue from our subscription-based cloud-based platform offerings, now the largest portion of our business, grew by 30% to contribute 66% of the revenue for the Company by year’s end. And we expect to continue to see strong growth in this area of our business in 2018. Driving this expansion in subscription-based cloud-based platform offering mix is a significant increase in the number of patients on the Inovalon ONE platform, a number that reached over 94 million by the end of 2017, representing a year-over-year increase of over 450%. Importantly, these are patients not only from health plans but also from provider networks and pharmaceutical companies that have adopted and started utilizing the Inovalon ONE platform. And yet, the vast majority of clients represented by these more than 94 million patients on the platform are currently utilizing only a small fraction of the platform’s capabilities. As these clients engage with us over time for an increasing scope of capabilities enabled through the platform, something which the platform approach makes quite easy to implement, the value achieved by the client increases as does subscription-based revenue and financial performance for Inovalon. As the healthcare industry becomes increasingly value-based and data-driven, and witnesses competitive dynamics such as vertical integration and potential new entrants, tremendous opportunities are being created for Inovalon. Important to understanding Inovalon is understanding the capabilities needed to support and succeed in value-based healthcare. At the core of value-based initiatives is the need to aggregate and analyze data, garner meaningful insights from the results and use these insights to drive material change to outcomes and economics. To achieve this, four competencies are needed. Number one, large scale data connectivity, integration and validation capabilities; number two, advanced analytics and high-speed compute capabilities; number three, tool sets to translate the resulting insights into real world impact; and number four, purpose-built data visualization and reporting capabilities. And to inform these competencies is the need for massive scale datasets. These massive datasets are needed because value-based care is measured on a relative performance basis and achieved through advanced forms of analytics that require massive training datasets. In 2017, Inovalon expanded on all of these core tenets of capabilities. And we’re seeing the market respond to these market differentiators. Two that I’d like to call out. The first is healthcare ecosystem connectivity. Connectivity empowers our ability to access data and drive impact with our analytical insights. Through direct connectivity, we can achieve this in real time and autonomously, providing highly differentiated capabilities for clients as well as highly efficient operations for the Company. As of the end of the fourth quarter of 2017, Inovalon had achieved direct electronic healthcare record system connectivity with more than 126,000 physicians, representing growth of 23% year-over-year and greater than 200% compounded annual growth rates since 2014. We expect to see further expansion of our connectivity in 2018. The second area of callout is our data assets. In this setting of our growing connectivity and Inovalon ONE platform adoption, our datasets continue to see strong expansion and deepening. As of the end of the fourth quarter of 2017, Inovalon’s MORE2 Registry dataset unique patient count expanded to over 240 million and the medical event count expanded to nearly 38 billion, increases of 59% and a 183%, respectively on a year-over-year basis. This data is highly differentiated in the market. It is primary sourced, longitudinally matched, it crosses all major healthcare programs meaning commercial, Medicare, Medicaid and includes not only data elements such as patients claims but laboratory results, medication data, patient reported data and a deep clinical data of electronic medical record from diabetes and cardiology cases to rheumatology and oncology cases, all counting in the millions of patients. And these data sets are driving meaningful differentiation and growing translation into financial performance. Looking forward into 2018, we see our strong underlying business performance continuing as we further expand the adoption of our cloud-based Inovalon ONE platform. Demand for these capabilities fueled the reacceleration in our organic growth to 14%, exiting 2017. At the same time, our positive outlook is being partially offset by the short-term effects of the well-publicized ACA-related decisions by certain health plans within our client base. Last year, during a period of heightened uncertainty around ACA enrollment, decisions were made by a limited number of our clients to withdraw from certain ACA markets. These decisions, which are unrelated to Inovalon’s capabilities or value delivery, resulted in a short-term negative impact of approximately 8% on the Company’s growth rate in 2018, predominantly in the first half of the year. The strong underlying growth we are seeing in our business is expected to surpass this short-term impact, resulting in full-year projected growth, excluding any unannounced acquisitions of approximately 5% at the midpoint of guidance. Notably, adjusting for the impact of these client-specific ACA decisions, Inovalon’s growth rate in 2018 would be consistent with the Company’s organic growth rate exiting the fourth quarter of 2017. It’s also important to note that the better than expected stability of the ACA enrollment in 2018 could result in health plans reentering these markets, which could be a positive factor of Inovalon. In conclusion, 2017 was a good year for Inovalon, a year in which we executed well against our strategic plan, achieved our financial guidance, advanced our technology and capabilities to differentiate ourselves in the marketplace and continued to make progress, transitioning our business to a subscription-based cloud-based platform model. We look forward to continuing our strong business and financial progression in 2018 and beyond. With that, let me ask Chris to review our fourth quarter and full-year financial results and discuss our 2018 financial outlook in more detail. Chris?

[Chris Greiner:]

Thank you, Keith, and good afternoon, everyone. Inovalon delivered another quarter of strong financial results, wrapping up the year in which we achieved our forecasted revenue and profit guidance, and materially advanced the Company across many strategic fronts, as you heard from Keith. From a financial and business model standpoint, we focused on converting existing clients from enterprise legacy solutions and signing long-term subscription-based agreements with new clients. We succeeded on these fronts with annualized contract value signings up 45% year-to-year in aggregate and on a per opportunity basis, up 54% year-to-year. Like other companies who embark on similar transitions, there is often an expected adverse shorter term impact on growth as clients migrate to new revenue models. But, the longer term benefits result in increased predictability of revenues, more flexible go-to-market offerings and increased operating leverage potential, which we are seeing. Towards that end, 2017 was a year in which we executed very well on these fronts and delivered a financial sequence to the year, consistent with the forecast models we supply to the investor community. As important, the underlying business drivers that manifested themselves in the second half and fourth quarter results of 2017 are seen as building in momentum, as you will hear from me shortly. Coming off year-to-year revenue growth of 10% in the third quarter of 2017, in the fourth quarter, we saw an acceleration to 19% year-to-year and 14% year-to-year on an organic basis. As displayed on slide seven of our supplemental earnings presentation, growth is being propelled by the migration of revenues to subscription-based platform offerings, which grew by 30% year-to-year to 66% of revenues in 2017 from 54% in 2016. The strong growth we delivered in fourth quarter also generated powerful operating leverage with gross margins expanding 780 basis points year-to-year and adjusted EBITDA margins increasing 740 basis points year-to-year. The results demonstrate how we successfully expanded gross margins every quarter, both on a sequential basis and year-over-year, driven by a combination of an improving mix and pricing environment, and strong returns from technology-enabled efficiency initiatives. Our strong operating leverage continues to support our investment in sales and marketing and innovation. Sales and marketing expense in the fourth quarter of 2017 was $9.7 million or 8.5% of revenue compared with $7.4 million or 7.7% of revenue in 4Q 2016. Our level of investment in innovation also continues to grow and remain at a healthy level as a percentage of revenue. Investment in innovation which includes R&D expense and capitalized R&D-related investment was $26.4 million in the fourth quarter of 2017, an increase of 24.8% year-over-year and representing 23% of revenue, up from 22% of revenue in fourth quarter 2016. We continued to invest in new cloud-based offerings for the Inovalon ONE platform, including in high-demand areas of visualization, data integration, analytical capabilities and compute power to further enhance our competitive differentiation. The returns on these investments can also be seen in the expansion of our MORE2 Data Registry, EHR connectivity with providers and trailing 12-months patient analytics months were PAM. Finally, fourth quarter non-GAAP diluted net income per share was $0.06, up a $0.01 or 20% year-over-year. Note that in addition to our customary add backs, fourth quarter non-GAAP diluted net income per share excludes the onetime benefit of $0.23 per share from the Tax Cuts and Jobs Act of 2017, enacted on December 22, 2017. Our results for the full-year across the elements of the P&L were in line with the range that we provided in our Q3 2017 earnings report. Full-year revenue was $449.4 million, up 5% from 2016. Adjusted EBITDA was $109 million, up 9% from 2016. Adjusted EBITDA margin was 24.3%, up 90 basis points versus 2016 and non-GAAP net income per diluted share was $0.29. Turning to the balance sheet. Inovalon ended 2017 with $476 million in cash, cash equivalents and short-term investments, which includes the impact of $28.6 million for share repurchases in the fourth quarter as well as higher levels of investment versus Q3. For the full-year 2017, we repurchased 7.1 million shares for total of $93.6 million. Our share repurchase program was fully utilized and expired on December 31 2017. In addition, Inovalon delivered very-strong cash flow from operations of $97.7 million, up $4.9 million from 2016, driven in part by our continued focus on accounts receivable day sales outstanding, which improved to 71 days at the end of Q4 of 2017 versus 80 days at the end of 2016. Now, let me shift gears and turn to the outlook. The same forces that are driving the Company’s improved and revenue profit profile in the second half of 2017 are expected to persist in 2018. For the full-year 2018, we are forecasting revenue growth of 5% year-to-year at the midpoint of guidance with 7% at the higher end of the range. We will continue to transition the business to an increasingly subscription-based platform offering model. As represented on slide 7 of our supplemental earnings presentation, the mix of these contract structures is forecasted to account for almost 70% of revenue and with it, providing a lift in margins associated with the presence of higher value client offerings and continuation of technology-enabled efficiency initiatives. Combined, we forecast adjusted EBITDA margins to be 24.8%, up 50 basis points year-to-year at the midpoint of guidance. Slide eight in our supplemental earnings presentation illustrates the key revenue growth drivers of the Company in 2018, in a format consistent with what we provided in 2017. You will note that in parallel to the positive transformation the Company is driving toward a subscription-based platform model, there will be a temporary short-term adverse impact by client-specific ACA decision. We expect this to be most pronounced during the first half of the year. In 2017, a number of the nation’s largest health plans, many of which are clients of Inovalon, made strategic financial decisions to withdraw from many ACA markets. While ACA enrollment ultimately was down only slightly from 2017 levels, much better outcome than originally predicted, the decision by these clients resulted in related lower contract activity. This is seen as adversely impacting Inovalon’s 2018 revenue growth rate by approximately 8 points. Net client revenue churn is expected to be approximately 5 points and viewed to be in line with what we expect from client count retention rate of approximately 88% in 2017. New client sales contribution to year-over-year growth of 16 points is demonstrative of the building momentum the Company is seeing in its platform and services sales. Absent the reduced ACA contract activity, full-year 2018 revenue growth at the midpoint of guidance would be largely consistent with the Company’s 4Q 2017 organic exit growth rate of 14% year-to-year and bodes well for us going forward. In terms of profit, Inovalon is forecasting adjusted EBITDA margins to expand by 50 basis points with a good balance of positive leverage from platform efficiencies, mix and prices changes as well as savings and overhead, more than offsetting continued investment in sales and marketing and innovation, and from volume related impacts from the ACA-related reductions that I spoke of. At a more detail level, this translates to the following full-year 2018 financial guidance. Revenue is expected to be between $462 million and 482 million, up 5% year-to-year at the midpoint over 2017. Net income is expected to be between $12 million and $16 million. Adjusted EBITDA is expected to be between $113 million and $121 million, with adjusted EBITDA margin representing 50 basis points of improvement at the midpoint of guidance. Non-GAAP net income is expected to be between $44 million and $49 million. Diluted net income per share is expected to be between $0.09 and $0.11. And non-GAAP diluted net income per share is expected to be between $0.31 and $0.35. Before I turn the call back to the operator, let me quickly summarize key highlights of our 2017 results and 2018 guidance. First, the transformation the Company undertook in late 2016 is executing according to plan and forecast. We are successfully transitioning to an increasingly subscription-based platform offering model. Second, this migration is not just resulting in an improving revenue trajectory but it is also driving expanded datasets, connectivity and compute activity. Third, the 2018 outlook and transformation dynamics that underpin it are persisting nicely. Inovalon’s full-year growth rates from 2017 of 5% are projected to continue in 2018, and normalized for client-specific ACA participation decisions would reflect growth rates consistent with how the Company exited its fourth quarter 2017 of 14% on an organic basis year-to-year. Now, before I close and we move to Q&A, I’d like to thank Keith, the Board, my fellow colleagues, our clients and shareholders, for the opportunity I have had to serve Inovalon on its great mission to empower data-driven healthcare. I’ll be cheering and a strong supporter of Inovalon as it continues its exciting journey of transforming healthcare. With that let me turn the call back over to the operator to conduct our Q&A session.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Ricky Goldwasser of Morgan Stanley. Your line is open.

[Mark Rosenblum:]

Hey, guys. It’s Mark Rosenblum on for Ricky. I just had a question on the cadence of top-line and EBITDA for 2018. You mentioned that the 8% headwind would be more pronounced in the first half. Can you just give us some guidance on how we should model that out?

[Chris Greiner:]

Hey, Mark, Chris here. First, I think, we’ve seen, the puts and takes of various different forecast approaches over the years have been public and really made a point to run towards an annualized number this year. For the sake of modeling purposes and being careful not to provide a quarterly guidance, because we purposely are focused on the year and getting to our goals, we’ll look a lot like the first half of 2016 in terms of the skews of revenues. And from a growth rate perspective, it’ll look similar to the first half of 2017 with the acceleration in the second half of the year, consistent with what we saw last year.

[Mark Rosenblum:]

Okay, got you. And then, on the ACA headwind, can you just give a little bit more detail on exactly what the headwind was in terms of like what is the contract activity and why is it mostly more pronounced in the first half?

[Dr. Keith Dunleavy:]

Hey, Mark, this is Keith. I’ll take that one. Thanks for being on the call. So, a number of the ACA providers in the U.S. last year did some strategic maneuvering in advance of what was the regulatory deadline for filing for insurance approval in various states. So, not knowing how the political environment and the regulatory environment were going to end the year, a number of them took defensive positions. And just to give you an illustrative example, in a state that has a lot of different counties or regions or areas, they might have pulled out of all but a couple, which makes it easier for them to reenter the market again, much easier than if they literally pulled out of the state altogether. So, we saw that in a number of plans. These are well-publicized announcements in the marketplace that then trickles down into them having lower contract activity with us. Because of the flexibility we now have with the modularity and the subscription nature of our platform, we have a capability to move that volume more to the front-end of the year and get that done and behind us, get the client taken care of, achieve the various different volume capabilities. And we saw us do that in ‘017, we gave projections as to the first half of the year, second half of the year projections in ‘017, and we delivered on precisely what we said we would do. So, again, here we have increased flexibility; we have some clients to pull out. At the end of the day as we all know, the ACA membership ended up only slightly below ‘017 numbers, which bodes well for us going down the road with these clients and other new clients that we’ve added, but we’ll see this as a front-end headwind as we get these clients taken care of.

[Chris Greiner:]

To add to Keith, it’s also important to point out that save [ph] one client, all those clients are still under contract with us.

[Dr. Keith Dunleavy:]

Exactly right.

[Mark Rosenblum:]

Okay. Got you. And then, just one quick follow-up. So, is the HEDIS product that is causing the headwind is that the right way to think of it?

[Dr. Keith Dunleavy:]

No, Mark. HEDIS is not affected. And in fact, I shouldn’t say, it’s not affected, but that is a very, very minority factor here. What this is more is a risk and quality improvement to both measurement and improvement capabilities for the ACA space, specifically. So, in many of our contracts, we -- if a regulatory change is made then we have to reflect that and that's exactly what happened to you so it's not a reflection of capability of the platform but how many counties, how many memberships they had in those platforms.

[Operator:]

Our next question comes from the line of Matthew Gilmore of Robert Baird.

[Matthew Gilmore:]

Maybe asking about the Inovalon ONE migration and I know the scene there has been a more modular and have flexible offering and I guess that two parts to these but first when clients switch over to the new platform does that result in a larger relationship with Inovalon or do they have plans and in source certain functions and then the second part to that would be what components of the platforms seem more or less attraction when that migration occurs?

[Dr. Keith Dunleavy:]

So, the platform definitely expands our opportunity with the client, so in the legacy approach to our business large more and monolithic decisions needs to be made by client to move to our services whether they are going to lift away from a competitor or an internal sourcing to in block move to our store or some of the else to that matter. What we have done through the modularly platform as we've made that a much easier transition if somebody wants to start using our platform and then once they are on a platform it's a much easier process to scale them up in volume and in functionality. So quite across the board the expansions on to the platform are providing us materially more opportunity going forward. As we mentioned in our prepared remarks we have about 94 at the end of the year we had about 94 million patients on the platform and look at the growth we're getting in the subscription based business is 30% growth in that segment of the business within that 94 million patient representation the vast-vast majority we are using only a small portion of the capabilities of the platform so as they say let me turn on that let me turn on that let me turn on the third thing that is very rapid acceleration of revenue opportunity as you can see by a 30% expansion in a one year period.

[Matthew Gilmore:]

Okay and then maybe one on revenue visibility with the guidance and I guess some of the headwinds from clients churn and ACA decisions are known items and then for the 16% underlying growth from new clients that same guidance can you give us the sense for how much of that is sold and I would guess the vast majority of it but any indications there in terms of what you need to sell and convert to revenue relative to the 16 points of growth?

[Chris Greiner:]

I'll take that one and I'll just refer to Page 8 in the supplemental and just kind of walk it from left to right. So, the net client churn of about 5 points of headwind is consistent with what we would expect from client count retention rates of 88% we've just historically said that range is between 87% and 93%, so back to normal if you will, we talked about the ACA short-term headwind of 8 points. In terms of new client sales that you pointed out in couple of data points first from the annualized contract size that both Keith and I commented on earlier those are growing quite nicely and that is an annualized view, so partial component of that revenue was realized in 2017 and there is still more to flow in 2018 and that metric was up 45% year-over-year on the per opportunities basis. But yields are just getting better up 54% on a year-over-year basis. So, I think its reflective of what we signed last year they are larger in nature and then if you look forward to what the pipeline would indicate there are more of those large platform opportunities at present in the platform. And then you look at the pipeline and you drop from it, are you winning at a higher percentage are you accelerating your time to close and the answer is yes to both those questions. So, in combination of all those forces that we see it contributing about 16 points and last step just for completeness on CCS that’s just simply the flow-through over the last six months that will be inorganic equates to about 8.5 million to 9 million.

[Operator:]

Our next question comes from the line of Ryan Daniels with William Blair. Your question please.

[Ryan Daniels:]

Without beating a dead horse, I want to go back to the ACA related issues as I think that will be a key focus and I'm just trying to appreciate further how some of those lives given that lives were relatively stable did not spill over any other customers and therefore generate revenue for you. Is it just a fact that that will take some time for those wise its building to existing customers to ramp up and grant growth or were you disproportionately skewed to some of the providers that exceeded the exchanges versus those that stayed in?

[Dr. Keith Dunleavy:]

Ryan, its Keith, thanks for being on the call. It's the ladder Ryan and I think that if you take a look at some of the more publicly visible ACA players in the marketplace and we have a policy that we don’t talk about individual client as far as and if you were to look in the well-publicized both the Wall Street releases as well as just their public releases you will see that a number of them cut materially back in the geographical regions within each state that they were allowed to or they sought a regulatory permission to sell ACA business in a '18. So, let's just create an illustrative around this just try and help on the point. So take a large ACA plan that might be or ACA health plan that might be in many different states, let's make one up like 10 states, so if you are in a bunch of different states and there are some of those states that you feel that you have a lot of exposure in the uncertainties that last year presented you then reduce from perhaps being selling in the 100% of the regions of that state to maybe they only submit to the state insurance commissioner permission to sell in 10% of that state. You will notice in the regulatory filings many health plans they did not go entirely out of state they very frequently dropped down to a foothold in the states to see how the ACA transition would go from last year to this year. So, they are still in those states but because volume follows the geographies that volume went somewhere else. And you're right in at the end of the day ACA membership was down somewhere the neighborhood of 3% year-over-year far better than people expected, nevertheless if you would not applied for regulatory permission to sell ACA in a geography regardless you can't. So, yes some of that membership went to some of other clients and yes, the clients that -- remained in the marketplace are now a -- we can see as a upside opportunity for us, but nevertheless in the interim the smart thing for us to do is pull them out of the model as we have done.

[Ryan Daniels:]

And then final question just maybe more of a housekeeping question, a question on capital deployment, with strengthened balance sheet and the tax law changes driving strong cash flows in the out years, number one, can you talk a little bit about your investment priorities I assume that it remains tuck in M&A activity, that you've discussed in the past and also any potential likelihood for share repurchase given that that's now expired and you've successfully executed one last year?

[Dr. Keith Dunleavy:]

So, we are very fortunate to have a strong balance sheet, strong cash flow generation capability, very small amount of leverage, so obviously as we've always stated, we look at all opportunities, all options on how to apply that to best benefit of shareholders over time. So, the whole range is always something that we want to be keeping an eye on.

[Operator:]

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

[Jamie Stockton:]

Just one question for me, Keith could you touch on how you feel the pricing environment looks right now maybe relative to the last couple of years, I mean as everybody has been asking about obviously there's the ACA noise and you guys have the CARA transition noise, if you can kind of step that aside and think about like-for-like product portfolios, how do you feel about pricing now?

[Dr. Keith Dunleavy:]

Jamie, so, a couple of years back so as you look at '16 most predominantly we were definitely seeing pricing pressure in the marketplace, that's on what we would describe as that the legacy solutions that was a challenge for us as you remember, as we went into '17 or to the tail end of '16 and into '17 our release of new capabilities in marketplace have really turned that around. So, throughout 2017 we have been seeing that in the setting of delivering stronger and stronger value for our clients, which we have the ability to show the clients, outline them or outline for them that value that has been clearly demonstrated it has continued to translate into strong pricing power for us. So, our focus is always on delivering great value to our clients. By doing that not only a financial basis, but also on a capabilities basis and a differentiation basis to help our clients be differentiated in their respective marketplace and their respective agendas if you will, a lot of that has to do with speed, of our compute capabilities, a lot of it has to do with our ability to calculate relative performance which is unique in the marketplace, because of the size of our dataset, and then increasingly the cloud based nature of our platforms allow for them to configure the individual components of the platform precisely as they wanted. We see that as delivering a lot more stickiness for us but it also translates into the client getting more what they want and not feeling like they're paying for parts and pieces that they don't want and that combination of differentiation, value delivery and unique of what they want is allowing us to see better pricing in the marketplace and you're seeing that translate into our margins during the year, so strong year in margins throughout the year as we grew the platform component throughout the year. Chris.

[Chris Greiner:]

Yeah, I think you know Jamie if you look at the gross margin expansion on full year basis it’s right on 360 basis points and just in the fourth quarter alone those gross margins were up 780 basis points. I think proportionally it’s indicative for what we would expect to see next year in terms of the mix of contributions between pricing and mix of offerings and efficiency initiatives, so in the fourth quarter out of the almost 800 basis points of margin expansion that we drove about 400 was driven by a mix in price and another 370 odd was driven by efficiency initiatives and I think it's that type of good balance that we're also projecting across the full year 2018.

[Dr. Keith Dunleavy:]

And just to tag team here Jamie on one other point, you didn't ask about but I think it's related, what are we seeing in pricing in the marketplace if we would argue that that reflects differentiation and value delivery to our client base, so we're also seeing that show up in other ways with our clients and one of the ways is the length of some of these contracts we're starting to see. We announced during the year you know the United contract that was a five-year contract. We announced that several others during the year and we clarified on today's prepared remarks that in the top five health plans in the United States by size, size measured by total patient count under those health plans so I think that's a pretty readily known list, four of them are now on the Inovalon One platform and in those for obviously we press released some of that activity during the year you also remember that those contracts are also five year contracts in nature. We've also recently gone through some important renewals and those renewals renewed out to approximately four years in duration so up from the previous length of our times when companies are feeling bit on their heels renewals are shorter in duration we're actually seeing renewal strength that is taking up the longer numbers so something else to share.

[Operator:]

Thank you, our next question comes from the line of Donald Hooker of KeyBanc, your line is open.

[Donald Hooker:]

Great, good afternoon, so excluding this client loss related to the ACA and that sort of unique headwind obviously the business model out of Inovalon has changed a lot towards subscription, so I was wondering if you could help. What is this what is the sort of remaining seasonality to the business going forward, so when you think about modeling and you think from outside modeling the revenues for the company if you took a dollar how would that dollar spread out across the four quarters of a typical year given your new mix?

[Dr. Keith Dunleavy:]

Thanks for being on the call Don and thanks for the question so you know we would like to avoid kind of sort of giving quarterly guidance, that's not our intention here, we're really, we're pleased that what we said we are going to do in 2017 we did and executed on that quarterly basis, we want to turn attention to the longer term view and bigger picture and we're confident of our execution on that just like we did in 2017 but to put it little bit of answer to your question also you asked some other pieces in there that I'll touch on. Number one you said the ACA client loss we have a number of ACA clients and very often as we ensure and appreciate our health plan might have Medicare or Medicaid commercial lines of business and obviously we have a growing number of pharmaceutical companies as clients we announced the outcomes they've contracting counts just went up 9 we obviously have device manufacturers with these clients, we have providers and to integrate in healthcare delivery systems as clients. But speaking just for a moment on the payer side first to touch on your ACA, we only lost one of them, there were some rumors in the market as to that, we did lose one client that had some ACA business and ended up that they did not remain in any particular place and we ended up losing that client but the other business that rather consistently stayed with us and we're doing nice business with them and depending on your views to the marketplace we see that as a nice upside opportunity but nevertheless we moved it out of our model. And then the only other piece that which spending a lot of time and talking about ACA it might be smart off to talk about Medicare for instance. So while ACA at this point is only at in the neighborhood of 10% so how much more downside to that is there if it's a 10% and we've carved it out of our projection meaning the organization is coming back into the ACA market Medicare on the other side is 48% directionally 48% in our 2018 outlook and strong and obviously we deliver enormous amount of value for them again remember we have a growing amount of pharma, life sciences, device manufacturing provider and other types of business but as we spend a lot of time talking about ACA I wanted to give you some directional exposure left there we've converted a lot into subscription based contracts and it's now only in the neighborhood of 10% in 2018, whereas Medicare is 5 times that number.

[Donald Hooker:]

And maybe just or maybe separate always interested in your experience to the life sciences area. I was just curious or at maybe a high level what's driving some of those contracts is that the health plan comp to you and sort of being judicious and how they want to look at how effective medications are or is it more drug companies on the offense trying to differentiate their product by willing to go at risk. Just curious as out sort of the if there are one or two key drivers in your mind to that business going forward that we should pay attention to?

[Dr. Keith Dunleavy:]

First of all we would argue that the one is the data point, two is a line, three is a trend and we are now at nine so we're making good progress in this area, we are looking forward to making a lot more going forward but we're seeing a degree of network effect a degree of because of the number of connections and because of the number of patients in our system we are increasingly being seeing as this agnostic platform that serves multiple difference and of the marketplace as we move more and more towards a type of vertical integration of the data driven enablement of value based care. So, what we're getting is interest in drive from both sides of the market meaning on this particular issue the two sides being the payer side and the pharma manufacturer side. So for the payer what our solution delivers is in the discovery phase of the engagement we are able to leverage the 240 plus million patients in our data sets to work through the predicted modeling of what will be financial benefit B to the health plan the clinical quality outcomes benefit B to the patient and the provider and be able to arm the pharmaceutical company to go to the payer and say if you put this on formulary if you apply this in this way you will see significant benefit in your cost and quality of outcomes and back that up with significant amounts of substantiated real world data. That's a convincing argument on the payer side and because it is a net positive for the health plan it is not a cost element for the health plan for the pharmaceutical manufacturer they are getting an expanded market opportunity they are getting a stickier client relationship and they are getting a tighter involvement with how their drug is brought to market through that health plan. So, both parties are interested and obviously the patient is the one that ultimately benefits the most but we're seeing interest from both sides, we have great relationships with hundreds of both, hundreds health plans and hundreds of pharmaceutical companies we would like to see ourselves as we move forward being seeing as the agnostic platform that provides that vertical integration between those important players in that market. But it's exciting and we see it only accelerating.

[Operator:]

And our final question for the session comes from Frank Sparacino of First Analysis.

[Frank Sparacino:]

In terms of the product mix legacy and subscription we don’t have to go through it and detailed to that but it would be helpful to get a break down in terms of was falls into that bucket particularly legacy bucket from a solution perspective. My question is that historically you guys have provided a breakdown of business by market segment and the K I don’t know if you anticipate doing that again here for '17? But I was trying to look at the business from a segment perspective and it sounds like the pharma side is growing as you talked about with the OBCs. If we look at the other parts of the business particularly in the payer side, I guess the question would be relative to the 5% overall growth that business at the midpoint of '17 is the payer side growing less than that and if we look at payer -- what is from a solution perspective, what's growing what's not growing?

[Chris Greiner:]

Frank, I'll hit the let me hit the next by vertical first and then I'll hand over the Keith to talk about what's driving the growth in '18. The progression that the company saw from '16 to '17 is as follows

[Dr. Keith Dunleavy:]

So in terms of as we look forward Frank, we see a number of different growth areas, as Chris alluded to we're seeing continued growth in the pharma space, the pharma life sciences space, we're also seeing growth in the device and device manufacturer space, we're seeing a number of new capabilities going -- being well received in the -- our provider space at this point, and -- as, I'm going to try and put them in order for you here in a second, but the payer space has a lot of the platform capabilities speak to that area extensively, we're actually seeing really nice growth there. Okay, so how do they line up if we've to put them in order? First of all, we need to adjust a little bit for the wall of different size numbers, right, so it's easy for our device space to grow significantly on a percentage basis because it's starting from a smaller base, but if we talk about just percentages of growth, the opportunity is right now strongest in device and pharma followed by payer, followed by provider.

[Frank Sparacino:]

And just one quick follow-up, on earlier question regarding the 16% growth, that was new client sales in 2018, I apologize if I just missed this, but Chris I don't think you've quantified right of that 60%, the question was what was contracted, what has yet to be sold, is it half and half or what is it specifically?

[Dr. Keith Dunleavy:]

You're right Frank we did not break that out, we would point you to the exiting organic growth rate that we saw in the second half of last year, which was at about 14% we've done a lot to expand our offering scope of both the products that we can sell and the size and specification capability of our sales team to sell them, so we see a nice strength and opportunity in that base, we haven’t broken it out, we don't typically do that, but to go from our second half growth rates of last year persisting into this year we feel very good about that.

[Dr. Keith Dunleavy:]

So, in closing first of all thank you, thanks for spending your time with us this evening. As always, we appreciate it, and we appreciate your interest in Inovalon. I'd like to hit three points, number one, we really are pleased with the execution of the financial performance in 2017, we delivered what we said we're going to deliver, we grew revenue, we expanded our margins and we delivered really strong cash flows. Number two, beyond the financials, something that's really important to us also is we brought to the marketplace a really impressive platform, we brought to the marketplace the cloud based Inovalon ONE platform that's giving us the modularity and differentiation and flexibility in the marketplace that is been extremely well received, seeing a 30% growth year-over-year in the subscription nature of our business which is also helping in many other places for the company, both profitability wise and value and differentiation wise. Number 3, adjusting for the near-term issue of the ACA, it had nothing to do with our capabilities or performance in the market and was very visible and in the media for sure. We are growing the company at double digit organic growth rates. You saw them as we exited last year, as we back out the ACA impact, we’re still seeing those double digit organic underlying business strength today and we see that continuing through 2018. So we really look forward to sharing our progress with you throughout 2018. We thank you again for your time. Good night.

[Operator:]

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day.