Inovalon Holdings, Inc.
Q2 2015 Earnings Call Transcript

Published: 10 Aug 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Inovalon Q2 2015 earnings call. At this time all participants are in a listen only mode. [Operator Instructions]. As a reminder, this call is being recorded. I would now like to turn the conference over to Miss Kim Collins, Senior Vice President of Corporate Communications. Miss Collins, please proceed.

[Kim Collins:]

Good afternoon. This is Kim Collins, Senior Vice President of Corporate Communications at Inovalon. I'm here today with Dr. Keith Dunleavy, Inovalon's Chief Executive Officer and Chairman of the Board; and Tom Kloster, our Chief Financial Officer. I'd like to welcome you to our second-quarter 2015 earnings presentation. The press release announcing our financial results for the first quarter was distributed this afternoon. And, a replay of today's call will be available in a few hours and posted on Inovalon's investor relations page on our website. For those of you who listen to the rebroadcast of this presentation, we remind you that the remarks made are herein are as of today August 5, 2015, and will not be updated subsequent to this initial earnings call. I'll remind you that certain statements made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995, including statements related to our 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, our presentation also contains certain non-GAAP financial measures. You will find definitions of these non-GAAP measures and reconciliation charts at the end of the Company's earnings release and on the Company's website. Now, it's my pleasure to turn the call over to Dr. Keith Dunleavy.

[Keith Dunleavy:]

Thank you, Kim. We are very pleased with the results of our second quarter. The overall strong trajectory of the Company and the degree to which we are having a positive impact on healthcare. During the period we made significant expansions in multiple areas of our capacity. We witnessed strong delivery of value to our clients. Resulting in a significant acceleration of average cross-sell timelines and meaningfully advanced our innovation and development of large-scale, real-time data integration and analytics capabilities. We are seeing a significant recognition of Inovalon's unique capabilities at both the larger, more traditional enterprise end and the smaller new entered end of the healthcare landscape. As we continue to bring industry-leading capabilities to the marketplace, we are very excited about, not only our client level value delivery and corporate financial performance, but also the behind-the-scenes advancements and preparations for further expansion in our leadership position. And with that, I'd like to hand the call over to Tom Kloster, our Chief Financial Officer.

[Tom Kloster:]

Keith, thank you and good afternoon and thank you all for joining our Q2 earnings call. I am really pleased to be reporting what are simply outstanding financial results for the second quarter. Our financial results are at record levels. We are reporting record revenue of $117.6 million, a 17% increase as compared to the year ago period. Which, also was a record for us at that time. Record adjusted EBITDA of $52.7 million, also a 17% increase over the prior year second quarter. And record non-GAAP net income of $27.4 million. With those figures in mind, let me provide you with some underlying details and factors supporting these record financial results. Our year-over-year revenue growth, which was $16.6 million, continues to be roughly evenly comprised of growth from new client relationships of $9.4 million or 57% of the total growth. An expansion of revenue from existing clients of $7.2 million, or 43% of the total growth. This is consistent with the makeup of our revenue growth in the first quarter, when the percentages were 58% and 42%, respectively. I think this is an important point, as it demonstrates, not only our ability to consistently add substantial revenue from new clients, but also our ability to expand the scope of services from existing clients once they experience the benefits from our capabilities. Further, as mentioned in our release, we are seeing the average timeframe in which new clients initiate a request for additional services becoming shorter and shorter. Going from 16 months in the prior years to 7.4 months in the first half of 2015. I think this is a strong indicator of our successful efforts and our resource deployment toward efficient and effective data integration and the implementation of a targeted client service support infrastructure. Resulting in meaningful ROI to our clients. During the quarter, among the many contracts that we executed and operationalized, we experienced a timing delay with the execution of one large contract that was expected to be signed and operationalized in Q2. It has now been signed in Q3 and will be operational later this quarter. The delay of this contract signing caused our Q2 revenue to be slightly below our previous expectations and will also impact our Q3 revenue versus expectations. If the contract had closed on our previously expected timeline, we would have recognized, in Q2, even higher revenue than the record results being reported today. And, well within or above, our previous guidance. Nevertheless, I think it is important to point out, that the nature of this contract is such that we fully expect the full value from this contract to be realized in 2015. The second quarter adjusted EBITDA was $52.7 million, which is squarely within our previous guidance of $51 million to $54 million. As a percentage of revenue, adjusted EBITDA was 44.8%, as compared to 44.6% in the prior year. This is outstanding performance. Especially, when considered that we have, one, added incremental costs in 2015 as a result of being a public company.; two, we have devoted an additional resource to sales and marketing, as evidenced by a $700,000 incremental increase this quarter versus the prior year; and three, a material investment that we made during the Q2 period, to increase our capacity and to expand our technology development scale. The expanded connectivity and processing automation that we continue to integrate into our operations has resulted in increased efficiency, which is evident, as we have grown EBITDA margins despite these incremental costs. Let me now drop down below EBITDA where there are two items to note. First, over the course of the second quarter, and into the early part of the third quarter, we deployed a portion of our cash resources into very secure, highly liquid, and highly rated short-term investments. Primarily treasuries, CDs, and corporate bonds. Accordingly, we generated approximately $600,000 of interest income during Q2 and expect that figure to be approximately $1 million per quarter going forward. Second, we continue to see various states and municipalities implement revised methodologies for corporations to apportion their income to their respective states and municipalities. These new legislative acts have resulted in a significant increase in our effective tax rates versus original expectations entering the year. In Q2, New York City enacted new legislation which was retroactive back to January 1, 2015. This legislation alone, increased our effective tax rate during the second quarter by 1.7% and lowered our earnings per share by $0.01 in the second quarter. The tax legislation changes over the course of the year have altered our effective tax rate to be 43% for the full year, versus our original expectations of 40% and have reduced our earnings per share estimates by $0.03 for the full year. We are actively considering methods to reduce our effective tax rate, but any action we may take is not expected to have an effect on 2015. Lastly, allow me to comment briefly on our extremely strong balance sheet. We ended the quarter with $797 million of combined cash, cash equivalents, and short-term investments. And, we have an undrawn revolver of $100 million, thereby a very strong liquidity position. You may note that our June 30 accounts receivable balance of $87 million was a bit higher than in the past quarters. This increase is part expected due to higher revenue this quarter, and in part, due to the timing of customer payments. On July 1, we collected in excess of $12 million and for the full month of July, in excess of $52 million. We have consistently enjoyed an extremely strong AR days sales outstanding with virtually zero bad debt. And, that continues to be the case as our AR levels were reduced dramatically in July. With that, I'll turn it back to Keith.

[Keith Dunleavy:]

Thank you, Tom. I will now touch on a number of key highlights. During the second quarter of 2015, Inovalon experienced strong customer contract growth, both in addition of new client partners to Inovalon's client portfolio, such as Piedmont Community Health Plan and Family Care Health; and also notably in the number of clients expanding the number of solutions contracted with the Company. Very relevant in the setting of the significant expansion of contracted patient populations in 2014, the successful demonstration of value for the expanded client base during the first and second quarters of 2015 is witnessing in a significant acceleration in cross-sell rate and the timeline associated with additional engagements. For example, clients such as Independent Health and Gateway Health Plan, both organizations which have become clients of Inovalon within recent quarters, have already expanded with multiple additional engagements. When compared to the historical average time to capture a follow-on SOW for clients, a metric that has been approximately 16.0 months on average since 2007, the follow-on time decreased by 8.6 months, or 54%. Down to 7.4 months for clients adding SOWs during the first half of 2015. Further, the arrival of the Affordable Care Act related health plan population appears to not only be providing incremental opportunities for growth, but are also providing an additional entry point for Inovalon's development of new client relationships, and therefore, providing a multiplier opportunity in the setting of strong value demonstration early on in these new engagements. Expanding upon Inovalon's mission to achieve significant advancements in efficiency and functionality, better enabled with direct, real-time data system interconnectivity and platform automation, Inovalon made significant progress during the second-quarter period. Multiple electronic health care records systems integrations occurred during the quarter. Adding, for example, significant provider networks utilizing Epic's HER platform to Inovalon's interconnectivity reach. Further research and development associated with interconnecting with large complex healthcare ecosystems, such as provider-based, integrated healthcare delivery systems, which typically utilize highly diverse internal networks, progressed well during the second-quarter period. As a result of such direct connect capabilities Inovalon's analytics continued to expand their reach, regarding the identification of necessary data, the accessing such information in real-time, the undertaking of advanced analytical processes, and the supporting of the translation of such data into insight, and in turn, the insight into action in rapid succession. With the ongoing strong success in interconnectivity and related automation, the Company continues to expect revenue from fully automated, cloud-based, data-driven intervention platform services to expand in 2015 upwards of 100% from the levels reported in 2014. Second quarter of 2015 witnessed a 26% quarter-over-quarter increase in revenue in comparison to the first quarter of 2015. In addition to the investments in operational capacity to support this growth, the Company also increased its technology development capacity during the quarter. In anticipation of certain initiatives which began in the second quarter and which are planned for acceleration in the second half of 2015. These expansions have been undertaken with a view towards, not only the short-term growth, but in anticipation of new significant technology capability launches and continued long-term growth. The incremental investment is believed to be prudent in the setting of several future planned expansions in Inovalon's capabilities and product suite. Allow me to speak to the market dynamics of the second quarter of 2015. During the period, the healthcare marketplace was active with several M&A deals announced amongst leading managed-care organizations. None of Inovalon's contracts are directly impacted in any negative way by any of the announced managed care M&A deals. In fact, several of Inovalon's contracts may stand to benefit from the announced deals. And, additional opportunities have come to light in the setting of Inovalon's cloud-based and big data technologies being uniquely capable of handling the integration and analysis of data for larger patient populations. Inovalon is in various stages of discussion with regard to these opportunities. In addition, divestitures of portions of patient populations that may be required for any regulatory approval of announced deals are expected to result in the expansion of certain managed care organizations, which are believed to be opportunities for Inovalon. With that, I will turn to other financial data and key metrics of the Company. Growth of our data sets was significant during the period. At June 30, 2015, the MORE Squared Registry dataset contained more than 123 million unique patient counts and 9.8 billion medical event counts, increases of 10% and 12% respectively, compared with the June 30, 2014 numbers. Investment in innovation progressed strongly. For the three months ended June 30, Inovalon's ongoing investment supporting innovations in advanced cloud-based data analytics and cloud-based, data-driven intervention platforms was $11.2 million, or 10% of revenue compared with $11.1 million or 11% of revenue for the three months ended June 30, 2014. Reflecting the marketplace's continued expansion of demand for Inovalon's computational analytical capabilities, Inovalon's trailing twelve-month patient analytical month, or, PAM count, which the Company believes is indicative of our overall level of analytical activity, grew to a record of $18.8 billion at June 30, 2015. An increase of 32 billion at June 30, 2015. An increase of 30% compared with June 30, 2014. While, not directly correlated to revenue, we see the Company's growth in PAM as a strong indicator of the market's expanding demand for Inovalon's analytics. Moving onto financial guidance for the 2015 period. Inovalon is affirming its full-year 2015 guidance that previously we released on May 6, 2015. With the exception of the updating of the non-GAAP net income and non-GAAP diluted net income per share, to reflect the effect of the intra-quarter changes in New York City tax and other statutory tax regulation changes that Tom spoke of. As a result, our full-year 2015 guidance is summarized as follows. Revenue is expected to be between $425 million and $445 million for the period. Adjusted EBITDA is expected be between $156 million and $162 million. Non-GAAP net income of between $75 million and $80 million. And, non-GAAP diluted net income per share of between of $0.51 and $0.54. In addition to this affirmation, Inovalon is also affirming the general guidance with respect to the full-year 2015 data analytics and data-driven intervention revenue mix previously provided on May 6. Further, Inovalon is providing the following general guidance for its third quarter of 2015. Reflecting the contract signing timing dynamics discussed previously on this call. Revenue is expected to be between $97 million and $105 million for the period. Adjusted EBITDA is expected to be between $26 million and $32 million. Non-GAAP net income of between $12 million and $15 million. And therefore, non-GAAP diluted net income per share of between $0.08 and $0.10. In closing, we had a very strong quarter. And, adjusting for the timing impact of one contract on revenue, we were well within and even would've been ahead of, our projected financial guidance. We are delivering very strong and differentiated value to clients. Resulting in strong continued client expansion and a significant acceleration of time to cross-sell and close additional engagements. We continued our strong expansion of connectivity within the healthcare system and increased our automation efficiencies. And, we have made significant investments in operational capacity and technology development capacity. All, while achieving extremely strong financial performance margins. Altogether, we expanded our technology, our capacity, our client base, and our financial performance to significant records. We are very excited about what lies before us and the leadership role we see ourselves playing in this very large and very important market. Thank you for your time and thank you for your interest in Inovalon. With that, I will hand the call over to the operator to take your questions.

[Operator:]

Thank you. [Operator Instructions]. And our first question comes from the line of Jamie Stockton from Wells Fargo. Your line is open.

[Jamie Stockton:]

I guess, maybe, the first one is the contract that you guys referenced that slipped out of the second quarter. Can you give us some feel for the type of business that was? Analytics or interventions? Like, my guess is it is analytics. And, I know that you said that you don't expect it to impact the value that you're going to get from that contract this year. So, can you talk about the revenue recognition? Is it just that the amount of work that you're going to do is going to be more concentrated in the second half of the year, and therefore, it's not going to really impact the total revenue this year?

[Keith Dunleavy:]

Yes, so, the contract that ended up signing in Q3, operationalizing in the latter part of Q3, is a very complex and sophisticated client situation and a platform situation. It's a excellent demonstration of our capabilities. And, because of the sophistication and complexity of it, not just what we're offering, but the nature of the client. Made it is such that, the execution -- getting to execution of it, just took that much longer on their end, more, really, than our end. But, the nature of the contract, as we conveyed, as Tom said, is an amount that has fully contained the full value of the contract inside of 2015 and actually has quite a bit of positive opportunity in it for us. It is heavily analytics. It does have a intervention platform. It is a fully automated intervention platform, its nature. So, it has very nice performance metrics for us, as well as very strong value delivery to the client. So, we expect that to be operationalizing here and affecting us, as we've mentioned. But, a really unique contract that we feel extremely comfortable and confident on the full recognition inside of this second half of the year.

[Jamie Stockton:]

Okay. That's great. And, maybe, just one other question. Obviously, you're seeing a lot of growth in the fully automated interventions part of the business. I'm wondering if you could give us some sense for the percentage of sources that you would need to pull records from an intervention standpoint, that you have been able to automate today? So, if you go to a health plan who already has a lot of members in an area of the country where you've got other customers. And therefore, you've built some of these data connections already to help out some of your existing clients. And, you're trying to pitch this health plan, incrementally, that they should sign up with Inovalon. Do you go to them and say hey, we have the ability to automatically pull 30% of these types of records that you would need? Or, how high is that percentage today with your typical region?

[Keith Dunleavy:]

Great question, Jamie. So, it varies dramatically from opportunity to opportunity. We have a rapidly expanding region as your question implies. There is this multiplier effect, of once you get access to a particular provider network or geography. Which, I'll give a couple examples of in a moment. The typical provider in the United States today, works with approximately 10.8 different payer systems. So therefore, once integrated in with that provider group, whether it was one or more payers that led to you approaching that provider environment, you get this expansion capability of, in effect, being able to go to the other nine in this example, payer organizations with tremendous efficiency and speed. That is increasingly, a very significant aspect of our pitch with our client base and it is a strong selling point. There is not a hard and fast percentage that we would encourage you to use. Although, we are seeing in some of our regions creep dramatically upward. If you keep in mind that the entire United States, depending on how you look at the statistics about electronic health care records, the integration of EHRs into provider groups, is again, depending on how you read the metrics, somewhere between about 42% and as high as 75%. Again, it depends on what the agenda, or the methodology of calculating that is, is putting forward. So, you're dealing with a percentage of that penetration as far as the answer to the question you're asking. In certain places like New York, we have a dramatically strong penetration and in some opportunities we will see 60% or 70% penetration of EHR integration with a unique client. And then, obviously, you can have the other extreme with some health plans that are much more diffusely distributed around the country. So, if -- one of the things that was accomplished during this quarter, which we were not allowed to announce in great detail, but we're giving you insight here, is we achieved very important Epic integration capabilities during the quarter. And, rapidly started turning on large provider systems to great advantage to our clients and also our financial performance. What you're not seeing in some of our margins, which Tom spoke to a bit, is that we are able to continue to increase our investment in the rate at which we're achieving these in our technology expansion capacity and our operational capacity. While still rising -- or, raising our overall margin performance. So, we're, in effect, financing these accelerations of technology and operation capacity with the expansion in margin that we're achieving through these integrations.

[Operator:]

Thank you. Our next question comes from Andre Benjamin from Goldman Sachs. Your line is open.

[Andre Benjamin:]

Thank you. My first question is based on your current guidance for full-year revenue growth. I know there's been a lot of focus on how PAM growth correlates with the results in revenue. How should we expect to see PAM grow in the third quarter? And then, next for the fourth quarter, and in light of the con -- large contract that you said would not come on until late third quarter?

[Keith Dunleavy:]

Well, thank you, Andre. Thanks for the question. First of all, wanting to keep things properly in perspective. PAM is reflecting a full year of analytical and trailing 12-month of analytical volume. Indeed, the contract that we're speaking of, that moved into the third quarter is large and would have made our second-quarter revenue well within a range, if not above. And obviously, that would of had a very nice impact in our EBITDA and earnings per share and all other performance metrics. You could easily conclude. But, nevertheless, even with that size, adding that onto what is a trailing 12-month PAM, you want to keep in perspective what that size would be. So, we continue to see the acceleration of PAM. We are -- and do not see anything changing off of that. We're seeing a very, very -- emphasize, very robust demand for analytical capabilities and computations. They're becoming increasingly sophisticated. Which, makes us increasingly value adding to our client and also sticky with our client. But, I wouldn't expect any change in the trend on a broad level besides this march Northwards that we're seeing strongly demonstrated.

[Andre Benjamin:]

Okay. Thanks. And then, you also said that M&A has not had a negative impact for your contracts and your source of referrals. Two things on that. One, I was wondering, is the lack of negative impact due to the fact that the people doing the deals are not amongst your biggest clients of Inovalon? And therefore -- and their -- and, because you've talked to them and they've said that they don't expect to make a big change? Or, I'm sorry, and the second piece would be, if you could provide a little more detail around where you're actually seen the opportunities? And, is it because you have this in relationships or not?

[Keith Dunleavy:]

Sure. So, in the setting of all of the deals occurring, Inovalon will be doing business with all of those entities. So, we do business with them today. Humana is not a client of ours. All of the other organizations that have been in the press are. And, we do, obviously it's disclosed in our S-1, Anthem is a very large client of ours. The details of other relationships are not disclosed. However, we are finding that, not only because of the value and capabilities that we can add, bring to bear, but also, 'cause of the uniqueness in our ability to handle very large systems, very large datasets, very complex data integrations and very high speed calculations, which are very difficult for standard platforms to do at the size and scale that these organizations are achieving. What we're seeing is a significant opportunity for Inovalon to play a part in the marketplace in the setting of these large players. Being, all potentially present in the marketplace. So, as we conveyed in our announcement, we are in various degrees of talks in all cases. And, certainly we will continue to work those opportunities. So, yes, we have had multiple different conversations. Yes, we do feel optimistic about what our opportunities are. No, we do not have any legal or even non-legal related concerns of implications of these M&A deals in our current relationships. Overall, we see them as providing us multiple new opportunities. Both, within them, and as a result of the potential divestitures. Which, they potentially may be required to implement for the regulators.

[Operator:]

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

[Ricky Goldwasser:]

So, can you talk a little bit about the progress you're seeing in expanded your customer base beyond the health plans, right? When I think about contract future opportunities, obviously, the provider market is one we're very focused on. So, maybe, if you can give us, kind of, like, an idea of the revenue split between, kind of, like, the managed care and the providers versus providers in the quarter? And then, as you think about it, connectivity with Epic, do you, maybe, remind us. What percent, or, how many other EHR vendors you're already connected with? And, is this, kind of, like a required step as you grow into the provider market?

[Keith Dunleavy:]

Sure, Ricky. So, let me try and hit all of those things. First of all, we do not break out today, revenue differentiation between the payer and provider markets. And, that is more to due to the fact that the definitions between the two are definitely grayed. And, we -- I can speak about that in a moment. But also, the fact that they're becoming increasingly bored. So, a number of our large clients are provider networks. Obviously, organizations like Geisinger Health Plan is a client ours. Health First is a provider-owned network of 11 hospitals. Geisinger obviously, being focused around a one dominant hospital. And, many other ones. Some of which, we've been allowed to announce. Many of which, we haven't. So, the provider-based organizations with whom we work are a material part of our revenue. And, have become, increasingly, a material aspect of our reference, if you will, to the expansion in that space. To -- it is a significant help to our expansion in that area, the capabilities we have in the EHR space. So, yes, that is a material benefit. And, but, let me give you a list of the ones that have been publicly announced in addition to the Epic integrations; are Allscripts, Greenway, NextGen, NeoDeck. I believe those are the ones that have been publicly announced. There are a several other -- several others that we are not able yet to publicly announce. But, these capabilities are significant. They are significant, not only in their size. But also, they're significant in how much they improve our efficiency and the outcome of the value generation for our clients. But also, they're significant in differentiation in the market. I spent this past Friday with a very large healthcare system in the Northeast. And, they were extremely interested in switching over to Inovalon. They're not a client today. They were extremely interested in switching over to Inovalon. And, part of the fact mentioned was, their current solution had referenced the ability to do certain EHR integration capabilities and it simply turned out to be, functionally, not true. And, this particular opportunity for us is one in a region where we have a very, very strong network of interconnectivity. So, yes, it's a factor for of these provider organizations and the increasingly integrated healthcare delivery systems that are made up of both provider payer organizations. ACOs being very much a factor. We look forward to giving you a lot more insight into the ACO expansion coming up in the time ahead of us. We see this as a significant area of capability. The ACO market sees us as having a significant -- about, of capability. So, yes, it's a factor. Yes, we're very good at it. And yes, it's helping us sell. I -- we believe it's table stakes going forward. And, even with that said, however, our experience is, is that few other organizations have the integration capabilities and speed that Inovalon does.

[Ricky Goldwasser:]

Okay just, kind of, like, related follow up. I mean, obviously, your EBITDA margins were very impressive. You came in, ahead of, kind of like, our estimates. And, to your point, that's kind of, like, really, kind of, like, tied to, kind of like, the increased connectivity. Should we think about this as, kind of like, a new base we should be modeling off?

[Keith Dunleavy:]

So, great question, Ricky. So, a couple of notes. First of all, the gross margin. Although, we refer to as revenue less cost of revenue. And, EBITDA margins are actually behind-the-scenes. What we would think of as EBIT, materially higher than what you're seeing them as. I can speak to that a little bit. We are making, approximately, about a 1.6%, the short-term or medium-term investment in capacity expansion. That is not a recurrent expense. So, we are hitting these margin levels despite the investment in our being public expenses. Which, we've conveyed this first year is about $3 million. Despite the investment in sales and marketing expansion. And, you're seeing that come through. You're going to see that come through even more here in third and fourth quarter. And, despite the investment in our innovations, we also have been significantly expanding these capacity and technology development capabilities. So, all of those things had been previously conveyed to you. I mean, the first three had been previously conveyed to you and others as being inside our projection of margins for the full year. Which, was approximately 35% to 37%. Was our guidance on EBITDA margins for the year. What we are finding is, as you point out, our efficiencies are significantly expanding and we are investing those dollars in accelerating that even faster. So, we are taking the amount that we're going above our projections and EBITDA. And, reinvesting them into expansion of capacity of our people and expansion of our capacity to develop some technologies which we look forward to roll out to you here in the future. Which, we think are dramatically exciting and will be in many cases game changing. That we're going to do inside of, even, achieving these margins.

[Operator:]

Our next question comes from Ryan Daniels from William Blair. Your line is open.

[Ryan Daniels:]

Yes, thanks for taking the questions. I want to ask a follow- up on the integration you're achieving with EHRs. And, I'm curious, as you do that to drive more automated interventions, are you able to also open up the Company to provide incremental solutions to the provider market? And, I guess, what I'm thinking about here are things like automated degre -- data aggregation reporting for these like meaningful use or bridges to excellence in the private market. Solutions like that.

[Keith Dunleavy:]

Ryan, you're hired. We're going to put you into our product development team. (laughter) Yes, the kinds of conversations we're having are really exciting conversations. The needs and the imagination of the marketplace regarding its needs and what they want to do with those needs and how they want to compete and get ahead of others. And, as we attempted to convey with the Hewlett-Packard deal, which is a really interesting opportunity. And, we're seeing a lot of other government opportunities come our way. As the government is finding that they are financing an enormous amount of healthcare and don't have as many of the tools they need to select the right solution, monitor the right payer or provider, and make decisions on how to adjust how they regulate and pay. So, we're finding ourselves with a whole new type of client out there. In effect, being able to provide technologies to the people offering the marketplace. The government payer, in this example. And, the people operating within the marketplace. The payer or the provider. So, they have distinctly different, but, highly related interests and needs. They are to the point that you just -- to the idea you just asked about and many, many others. So, we're having a lot of opportunities thrown our way. And, they are getting -- they're becoming larger opportunities because of the nature of how healthcare is becoming larger patient population sets. Both, on the payer side, and on, if you will, the ultimate payer, the government side. So, yes, we have those abilities. We have increased flexibility as our building blocks of our platform become more interconnected. And, yes we're putting those to use and yes we believe you'll see those coming very interestingly to the market here going forward.

[Ryan Daniels:]

Okay. Perfect. Thank you for that. And, then just a quick follow up on the cross-selling time. It seems like a pretty important data point. I'm curious if clients that you engage now, that are moving into some of these new plans or exchanges are buying less up front. Such, that they're more amenable to add on more quickly, once they have an experience with you. Or, are these contracts relative to the patient population, relatively consistent? Such that, the accelerated cross sales are really driving stronger organic same client growth than you've seen in the past as well.

[Keith Dunleavy:]

Ryan, great question. Let me give you a little bit of detail on that. So, cross-sell and upsells. Wanting to separate them. So, historically, we would very typically, sell what would be medium-intensity programs. So, that our client could ask for additional intensity in our analytics and use an additional capacity on our intervention platform. We would call that an upsell. When they said, gosh, that was great. I also want to do it in my Medicaid population, or, I want to expand into your quality improvement program as well. We would categorize that as a cross-sell. Because, it requires an additional signature, an additional contracted statement of work. So, what we're seeing is really strength in both. The metric we gave you was for the cross-sell. And, we, anecdotally, have noticed this accelerating. I will tell you we ran the calculations recently and were excited with just how much of our experience is bearing out in that accelerated pace. But, I will tell you there's a similar phenomena happening in the upsell capability. And, that is really a testament to how strong our client services team has become and how rapidly our time to value has been accelerated in the marketplace. So, to a part of your question. Indeed, we are finding that, for certain organizations, a smarter way for us to get more rapid penetration into a market is to actually start at a lower intensity level with that client. So, if our historical approach was a medium-intensity initial approach, we are definitely finding ourselves getting into a much larger number of clients. You saw our SOW count go up by 62% last year. That is, with an increased flexibility. Because of the cloud-based environment, because of the rapid integration, and cost-effective integration capability, we can price point, go in at that smaller intensity level, establish a foothold with them, demonstrate the value with them, in, on average, as we've conveyed, eight point something months at this point. And, wa wa, upsell that client into a larger intensity and then start cross-selling them. So, we see this as fantastic beachfront. Fantastic footprint expansion. And, I'll tell you, it is extremely rare for an organization to have us come in as, alongside somebody else. When we get even a small penetration into an organization, usually we are the only one there. And, we -- it is ours to lose to expand over a period of time. It doesn't happen overnight. It's months. Not days. Not weeks. But, it has sure come down very rapidly. We suspect we're going to see that come down even more. Because of a very important event here with the closing out of the first cycle of the ACA. With the closing out of the first cycle of the Affordable Care Act, the health plan space is seeing, in fact, the completion of the 3Rs cycle and the fruition, if you will, of the integrity of all the calculations. And, that is, we're seeing, leading to them, being more willing and substantiated by objective data. Willing to increase their investment in what Inovalon does for them. We're excited about that. And, we're seeing it bear out in the numbers. Not just today, tomorrow, and this quarter, but in the years to come.

[Operator:]

Thank you. Our next question is from Sean Wieland from Piper Jaffray. Your line is open.

[Sean Wieland:]

So, what's the size of this single contract that slipped? And, can you talk about other -- the revenue recognition milestones that it will allow you to recognize at all in Q4?

[Keith Dunleavy:]

Sure, Sean. So, I don't know if I would describe it as slipped. We are -- we want to stay focused on our client's value. And, certainly, some organizations may have pushed to get it signed in Q2. Maybe compromised pricing. Maybe compromised terms. Maybe compromised various different things to focus on a projection as opposed to the longer-term picture. We thought that the right thing to do, in the size of this complexity and the nature of this particular client; we thought the smart thing was to have it close when the right time for it to close was. So, I don't know if I would describe it as slipped. But nevertheless, you're right. It ended up in Q3 and we typically don't talk about any particular sizes of a client. We are certainly giving you inference to its size because we've conveyed that it would have put us well into, if not above, our projections for the quarter. If it had closed when we initially thought it would. And obviously, you've seen what the adjustments we've made for the third quarter. So, that gives you the ability to size it. But, we certainly have larger ones than this one. We have other clients that have larger contracts than this one. But, this is a very, very nice, sizable and sophisticated contract. Speaking to revenue recognition. Yes, indeed, we can wri -- recognize all of this revenue once operations actually begin. Which, we expect here in the latter portions of Q3. And, we can recognize them all within Q3 and Q4. So, there's no revenue recognition issues that would push revenue outside of Q4. All of the milestones which we do have, are very short-term milestones. Because of the speed by which the analytical processes churns through the different steps and then achievements of value for the client. So yes, very often they might have, just, for me to give you generality. They might have a 30-day window of revenue recognition. And, hypothetically, if that could lead for revenue to be in one month versus another month. But, it's not an issue when we're talking about the full year.

[Sean Wieland:]

Okay. Another topic on HEDIS reporting during the quarter. How did your HEDIS business do, relative to your expectations for the quarter? And, can you tell us where the HEDIS revenue drops into your various categories of revenue.

[Keith Dunleavy:]

First of all, Sean, our HEDIS business this year was unbelievably outstanding. Phenomenal. We probably did -- well, we're approx -- well over, I think, 50% of the entire US market in that particular area; with, clients that do it in-house representing approximately 25% of the market, and then, our competition, about 25% of the market. So, call us 50/25/25. We've been doing this for over a decade. And, this was, by far, the most impressive year's performance. And, I will tell you, that the interest in our QSI-XL platform, that's our quality analytics platform. That is on our big data platform. So, we have two platform formations -- or, formulations. One, is our traditional QSI-XL, our QSI. And, the other one is QSI-XL, which runs on a big data platform. When you hit about 1.3 million members within a population, your -- the performance metrics of big data versus traditional architectures starts to become dramatic. When you start getting up into your much larger populations, it's extremely dramatic. So, we are today, at a stage where the vast majority of large healthcare systems in the United States are using our platform, are -- or, are in talks to use our platform. That has tremendous speed benefits for them. And, for where and what they need to do with their quality data. And, obviously, has tremendous benefits to Inovalon and its shareholders. So, tremendous year. But, it also really clarified to the marketplace the capabilities of our big data platform. And, we are seeing a very, very significant wave of interest of the larger players in the US now turning to that platform. We are doing demos of this where we have 100, 150 organizations on the demo. To put it in perspective to how much interest we're getting in that platform. So, very positive.

[Sean Wieland:]

I was just hoping we could put some quantifier, put some parameters around it. In terms of, maybe, the year-over-year growth in your HEDIS business. Or, could you size what the impact in the quarter. Because, I think Q2 is where the bulk of your HEDIS revenue is recognized.

[Keith Dunleavy:]

Well, so, A, we don't break it out. But, let me help you dispel a -- some thinking around that. So, certainly in years past, when HEDIS was the -- and for everybody that's on this call, HEDIS is one of the quality reporting datasets that's regulatory needed. HEDIS is a standard created by NCQA. And, submitted -- required by the federal government in Medicare, often, required by states and other programs, it's one of many other, certainly, one of the dominant types of quality measurement in reporting. We're the largest provider in that space. Historically, you're absolutely right, Sean. That season, is to call it a season, would begin in Q1 and finalize in May and June of each year. But, that has changed dramatically over recent years. When organizations have gone, they've transitioned from it being a regulatory check box. To being, this runs my quality insight and quality incentivization financial performance reporting of preparations. And so, what we've seen is a lot of organizations, certainly starting with the more sophisticated ones, start to increase the frequency by which they did that calculation. So, yes, four years ago, organizations would do it once a year. Are there some that still do it that way? Yes. But, increasingly, organizations went to a few times a year, quarterly, monthly. We are now doing contracts where we are running those calcs, increasingly, to literally, a real-time calculation. So that, organizations are able to, not only understand their quality and see where it's going to impact their financial performance. But also, change and impact how they run their business based upon that quality data. So, for us, it's increasingly a year-round process. Many of our clients, and certainly, the larger dollar amount clients, are now doing this on a year-round basis. So, the number of contracts we're looking at today, meaning, literally, in August for second half of the year is material. When, normally, those would be contracts that would be signing in fourth quarter to start revenue in first quarter. That world has changed materially and we're seeing that pace of change accelerate.

[Operator:]

Our final question comes from the line of Matt Gilmore from Robert W Baird. Your line is open.

[Matt Gilmore:]

I wanted to ask about the commercial ACA sales activity and the CMS risk-adjusted report. Keith, you touched on this briefly. But, I was curious to get your main takeaways from the CMS report. And also, how your customers did relative to expectations

[Keith Dunleavy:]

Sure. Thanks, Matt. So, first of all, we thought it was impressive that CMS executed on its timelines that it said it was going to execute on. And, the reason that that's important is because a lot of healthcare systems who have invested tens to hundreds of millions of dollars into entering into that market, and, in some cases, billions, into entering into that market. Really wanted to see the full complete execution of the 3Rs cycle and, we were heavily involved in that process, as you know. Inovalon supported the Edge server. Which is the data calculation and submission platform for a more systems -- more, what are called QHPs, qualified health plans under the ACA, than any other organization in the country. We were by far the largest provider of that technology. And so, therefore, we were on a daily basis, in touch with CMS and the people working to get the 3Rs completed. The completion of that process and the release of that data which happened recently, was very much in line with how we expected it to come in line. Certainly, I think people would say there were a few surprises in it. And, people are working to ferret out those few surprises and try to understand where -- what was the source of the surprise. And, I mean, in general in the marketplace. Certainly, in the areas that we worked, as not every organization in the country is a client of ours, of course. But, we had very good insight into the pieces that we worked on. And, those all came very much in line with what was expected. We're pleased to say. So, keep in mind, when that data came out, that is the data that reflects a summation of many different contributing components. It's very difficult for someone leading that report, not aware of the underlying components that went into the individual health plan's determination of what their anticipated risk or anticipated patient disease level, and, how they were going to set up their premium bids for that membership. Let alone, what they did on their financial planning internally. Which, for public plans, you could see it, obviously, in their accruals if they were expecting to receive payments and reserves if they were expecting to be a payer. There's a lot of other variables behind the scenes. So, what was really important, was the insights that we were able to, very fortunately have, is know what health plans were truly expecting and how that lined up with how what they were expecting. So, very broadly, it was consistent with what was expected. Certainly, I think there are, again, a few areas in the market that people are looking to true up and make sure they understand why the math came out the way it did. But, most importantly for us, most importantly, the health plans space, the payers space, saw the system work. And, saw that the work we did and the system, in general, return a very strong ROI. And therefore, what we're seeing now is, people willing to open up their checkbooks to invest more into these type of technologies that allowed them to have better insight into, and better performance in, the ACA space. So, now with one cycle done, we're seeing a very positive trend of preparing for next year on a larger scale.

[Matt Gilmore:]

Okay. Great. That's really helpful. And, Tom, you -- I think you mentioned Inovalon's exploring some methodologies to produce a tax rate. Can you give us a sense for what strategies you may be considering? And, if you execute those strategies, how big of an impact that would have on your tax rate?

[Tom Kloster:]

Yes, Matt. I certainly can. Our effective tax rate, which now is 43% for the full year. Is really driven by the state considerations. And, that's what happened in Q2. As various states and municipalities are changing the methodology of how we apportion income into their respective states. So, we are exploring. I think it's premature to comment that there's anything that we're going to do that would lower that effective tax rate. Some of it will just happen naturally. Based on a dispersion of our clients and where those clients are. So, most of our significant states, or, at high rate states, have already changed their methodologies. So, we shouldn't see too much more effect of any further changes. But, we are actively looking at various alternatives.

[Operator:]

At this time I'd like to turn the call back to management for any closing remarks.

[Keith Dunleavy:]

Thanks very much operator. We really appreciate everybody's time this evening. We certainly know that you have a lot of earnings to listen to. We have a lot of information in our release and hopefully covered a lot of it here in questions. We are extremely excited about how the next few months and quarters are going to play out. We look forward to updating you as that roles forward. We think it's going to be a very exciting time. Thank you very much. Take care. Good evening.

[Operator:]

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