Inovalon Holdings, Inc.
Q3 2015 Earnings Call Transcript

Published: 5 Nov 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Inovalon Third Quarter 2015 earnings conference call. At this time all participants are in a listen only mode. [Operator Instructions] I would now like to turn the call over to your host, Ms. Kim Collins, Senior Vice President of Corporate Communications. Ma'am, you may begin.

[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 third quarter 2015 earnings presentation. The press release announcing our financial results for the third quarter was distributed this afternoon and a replay of today's call will be available in a few hours and posted on Inovalon's investor relations page on our Web site. For those of you who listen to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today November 4, 2015, and will not be updated subsequent to this initial earnings call. I'll remind you that certain statements made during 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 these 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 includes 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 Web site. It's my pleasure to turn the call over to Dr. Keith Dunleavy.

[Keith Dunleavy:]

Thank you, Kim. Good evening. The third quarter was certainly a very busy period for us here at Inovalon. Revenue came in at a record $105.5 million, a 23% increase over the year ago third quarter period. Quarterly adjusted EBITDA came in at $29.0 million and third quarter non-GAAP net income came in at $13.0 million, resulting in non-GAAP diluted net income of $0.09 per share. Demand was strong for our product offerings. Operations executed well on our engagements. Data assets increased, strengthening the power of our analytics. Data connectivity and automation expanded improving our operational efficiency. We closed on the exciting acquisition of Avalere, expanding our capacity to develop and support industry-leading capabilities while also spring-boarding Inovalon into the large adjacent space of pharma and life sciences. And we announced the release of Data Diagnostics, a technology which we believe has the potential to be truly transformative in the healthcare landscape. We are pleased with the third quarter's performance and we are very excited about the initial proof of concept, confirmations that we are experiencing from the Avalere combination. A very positive feedback that we are receiving regarding the introduction of Data Diagnostics. And we are seeing continued strengthening and differentiation on Inovalon's capabilities and our push to bring the benefits of data and analytics to healthcare landscape. With that, I will turn it over to Tom Kloster to walk us through some of the financials. Tom?

[Tom Kloster:]

Thank you. As you heard Keith mention, we completed an extremely busy quarter including the acquisition of Avalere and the announcement of our industry changing Data Diagnostics product in conjunction with Quest Diagnostics. Demand for our core capabilities remained strong. Interest in our new technologies such as data diagnostics and QSI-XL have been very positive. And our combination with Avalere is showing very nice early indications of positive synergies. Accordingly, we have continued our investment discussed in Q2 towards expanding our capacity, our product development, our sales and marketing and our client services, as we see continued strong demand for our technologies and products and see evolving opportunities in the market. While devoting efforts towards positioning the company for continued future success, we delivered a very solid quarter in line with our previously conveyed expectations. The two primary messages I would like to convey are around revenue and margins. Revenue for the quarter was $105.5 million, a $19.5 million or 23% increase as compared to the year ago quarter, of which $4.2 million was contributed by Avalere. Important to note is that we are already seeing synergy business with Avalere and as such a portion of the $4.2 million while flowing in as part of the Avalere combination, is business done together with a Inovalon's data and analytics capabilities. Across the board, our team executed well. With revenue being in line with expectations and above expectations when considering the contribution from Avalere. Only because it may be asked about, the project mentioned on our Q2 earnings call which was signed in Q3, and indeed operationalized in Q3, has produced the expected results and is on track to produce the expected Q4 results. From a margin standpoint, there are a number of factors to convey. Nothing that you have not heard us discuss in the past but let me detail out a few matters again. First, let me speak to gross margin. As mentioned in prior quarters, the revenue mix for data driven intervention platform services has increasingly been moving towards the latter half of the year. This has played out as expected in Q3 and thus you see this reflected in our gross margin percentage as compared to the prior year. This revenue mix shift accounts for approximately 210 basis points when examining the year-over-year comparison. As mentioned previously and in the prior quarter, we have made increasing investments in our operating capacity and technology to support current and future demand expectations. These capacity expansions account for approximately 220 basis points variance from the year-over-year period. Hence, together these factors resulted in Q3 gross margin percentages of 63.6% versus 67.9% in the prior year. Let's now turn to adjusted EBITDA and adjusted EBITDA margins. As you may recall from our Q2 earnings call. We spoke to several expansion investments which were focused on product development and technology capacity. What we were not able to speak to at the time of our Q2 release, was that these investments were part of the big data and cloud-based infrastructure and associated personal that were required in support of strong QSI-XL interest and the development of Data Diagnostics. Additionally, as you can see in our earnings release numbers, we have been further increasing our sales and marketing investments. Increasing from 2.8% of revenue in Q3 of 2014 to 3.7% in Q3 this year. These critical investments are expected to continue in Q4 and into 2016. These factors coupled with the near-term margin profile of Avalere and the gross margin factors noted previously, are reflected in our adjusted EBITDA margin percentages of 27.5% versus 33.3% a year ago. This all said, I am pleased to report that given our continuing success in applying operating enhancements throughout the year and our expectations during Q4, we are achieving all of these incremental investments from dollars achieved from our ahead of model EBITDA improvement goals. Meaning, despite these increased investments, our increased operating efficiencies are driving us to full year EBITDA margin percentage of 37%, independent of the near term Avalere margin profile impact. With the near-term Avalere margin profile factored in, this translates to full year adjusted EBITDA margin percentage of 35%. I think the overall message here is several things. One, we are seeing a strong demand. Two, we are operating nicely to that demand. Three, we are continuing to see good operating leverage and four, we are proactively re-investing a portion into the company to increase our operating capacity and technology development capacity. The final point I want to cover is an overview of our strong balance sheet. We ended the quarter with $714 million of combined cash, cash equivalents and short-term investments. And we have an undrawn revolver of $100 million. Further, we continue to generate significant operating cash flow. As evidenced by $44 million in positive operating cash flow during the nine months ended September 30, 2015. So in summary, Q3 is a quarter that financially played out as we forecasted. While concurrently closing on a great transaction with Avalere and releasing what we believe is a truly industry leading capability in data diagnostics. Both of which are receiving very positive indications from existing and potential customers. With that, I will turn it back to Keith.

[Keith Dunleavy:]

Thank you, Tom. During the quarter Inovalon announced the introduction of Data Diagnostics, the latest release in Inovalon's technology portfolio to the healthcare landscape. We believe that Data Diagnostics, a suite of hundreds of patient specific analyses, that can be ordered individually by clinicians on demand, will be truly transformative to the healthcare marketplace. The capability leverages vast amounts of data from Inovalon's data stores, the connectivity that we have established in the marketplace and computes in our large big data environment in our cloud-based platforms in real time, allowing physicians to gain the insights that they most valuably need at exactly the point in time and location that they need to have them. Data Diagnostics is focused on a number of different areas that are key to the healthcare landscape. These are quality outcomes, risk score accuracy, the history of a patient, cost avoidance and eligibility of patients within the marketplace. So if you will, the patient walking in to the doctor's office tomorrow, using Data Diagnostics will benefit from that physician being able to understand precisely what the clinical and quality outcomes history and forward looking performance improvement opportunities exist for that patient as of the data available at that exact point in time. And they will have that answer within seconds. Able to truly transform how effective and efficient that position is and truly impact how effectively that healthcare system can deliver care to the patients that make up their membership. Data Diagnostics serves the clinician in the environment in which they see the patient, the point of care. The audiences of Data Diagnostics, the customer if you will, are very broad in nature. They consist of health plans, ACOs, hospitals, integrated healthcare delivery systems, ASO employer groups, government programs and individual physicians groups. And I am very pleased to tell you that our market feedback and indication of interest from this broad arena of customers, is extremely strong. While the data immigration, data warehousing and data analytical processes are all housed within Inovalon cloud environments. The delivery platform is done in conjunction with Quest Diagnostics, our partner in Data Diagnostics. Quest has more than 200,000 installations of Care360, their clinical provider platform. And more than 400 integrated EHR platforms serving together approximately 50% of all physicians and hospitals within the United States. This provides data diagnostics an immediate delivery platform and channel of distribution that is massive in scale and further allows for the clinician to gain the insights and analytical knowledge provided by Data Diagnostics within the workflow of the clinical encounter. Removing the need to pivot or swivel to another platform in order to achieve the value. As Tom spoke to just a few moments ago, the increase in investments and infrastructure and people to do the development and the capacity support for the launch of Data Diagnostics was something that we started to speak to in the second quarter of 2015. As you heard from Tom, this continued in the third quarter and is accelerating here in the fourth quarter. This is in response to not only the growing excitement around the capabilities of the product but the strong feedback that we are receiving in the marketplace as we go forward with presentations of the capabilities of the platform. While still in the early stages of the platform's introduction, again, initial feedback from the marketplace is very positive. Also during the quarter, Inovalon announced the acquisition of Avalere Health. A leading provider of data driven advisory services and business intelligence platforms. Key to this acquisition is the fact that Avalere brings to Inovalon a significant group of incredibly impressive, like minded people that support and expand the capacity of Inovalon to build industry-leading products and support our customer base as it expands. Additionally, however, Avalere brings to us an incredible capability to leapfrog into the adjacent space of the pharma and life sciences industry. Avalere brings with it more than 200 pharma and life sciences companies. And each one of these have turned to Avalere over the years for strong information, insight and support in key and critical information areas of their business. Areas that are now better able to be supported with the data analytics and platforms that Inovalon brings to the combination. And rather excitingly during the quarter, even the short-period of time that followed the September 1 acquisition of the company, we have seen a strong indication of that enthusiasm from the pharma and life sciences industries to work together with Avalere and Inovalon to bring to the market place capabilities that are both innovative and highly valuable. Another key aspect of the third quarter was the capacity expansion. As you will recall, as early as May 6, the company conveyed that the benefits of connectivity, automation and other operational improvements had resulted in our tracking ahead of our previously conveyed full year EBITDA projections. We thus raised our full year targets from the 35% which they have been conveyed at, to 37%. In the second quarter, we again exceeded our full year goals for adjusted EBITDA and began to invest the excess amounts which we conveyed in our second quarter call as 1.6%. We invested this money in operational capacity, product development capacity and additional IT capacity in preparation for the expansion of our cloud capabilities in QSI-XL and the impending announcement of data diagnostics. In the third quarter this trend continued. Although somewhat clouded by the seasonality of the third quarter and the other effects which Tom described, the connectivity automation and operational benefits were again been seen internally as ahead of plan. Thus, we proactively expanded again our investments into the areas where we were seeing demand. Operational capacity expansion, product development capacity expansion and increasing amounts of big data and cloud infrastructure and the personnel associated with them. As we can see in the nine months year-to-date, adjusted EBITDA numbers through September 30, 2015, we see them at 35.9% despite all of the year-over-year investments necessitated by being public and necessitated by our expansion in sales and marketing attention. And now still there despite the expansion in operational capacity, product development capacity and big data capacity and cloud capacity, as well as associated personnel. So now as we head into the fourth quarter, we are seeing these strengths continue. We are again tracking ahead of the 37% full year projected EBITDA target and are therefore increasingly investing additional amounts funded by this above projection efficiency into areas of capacity demand for operational capacity, product development capacity, big data capacity and cloud capacity. Thus, putting our full year Inovalon EBITDA projections still at 37%. Please remember that the 37% does not reflect the 200 basis points decrement from the near term effect of Avalere's margin profile to our projected full year adjusted EBITDA margins. As we have provided each quarter, the following is a discussion of some of the other financial data and key metrics of the company. During the third quarter, the growth in our datasets reflected an increase in the MORE2Registry to more than 127 million unique patient counts and 10.3 billion medical events. Increasing approximately 7% and 14% respectively compared to the September 30 numbers in 2014. With regard to investment in innovations, for the three months ended September 30, Inovalon's ongoing investment in support of its cloud-based data analytics and data driven intervention platforms, was $14.0 million, or 13% of revenue. Up from $11.9 million which was 14% of revenue for the three months ended September 30 of 2014. Inovalon's trailing 12-month patient analytical month or PAM count, which the company believes indicates our overall level analytical activity, grew to a record $20.4 billion during the September 30 period end. An increase of 32% compared to September 30 in 2014. And now allow me to turn to 2015 full year financial guidance. In the setting of the investments and capabilities and capacity outlined on this call, the inclusion of Avalere and a pipeline which has a number of meaningful opportunities, we are providing the following update to our guidance. We are increasing revenue and its projection to now be between $435 million to $450 million for the full year. Adjusted EBITDA is expected to be between $150 million and $161 million. Non-GAAP net income is expected to be between $73 million and $80 million. Making non-GAAP diluted net income per share to be projected between $0.49 and $0.54 for the full year. In addition, Inovalon is reaffirming the general guidance with respect to full year 2015 data analytics and data driven intervention revenue mix as well as the full year 2015 mix of fully automated and partially automated previously released on May 6, independent of adjustments for the Avalere acquisition. Allow me to comment on shares outstanding. As of October 30, the company had 49.0 million shares of Class A common stock outstanding and 101.9 million shares of Class B common stock outstanding. These counts reflect a change since the June 30 numbers where the counts were 25.4 million and 122.3 million respectively. This is primarily from the result of conversion of Class B shares to Class A shares following the August 11 expiration of the company's share lockup in association with the company's IPO, as well as employee exercises of stock options and the issuance of approximately $200,000 Class A shares in connection with the acquisition of Avalere. All together, this increase in Class A common stock shares outstanding from 25.4 million to 49.0 million substantially increases the public float of Inovalon's stock. In closing, the third quarter of 2015 was an extremely busy time for Inovalon, resulting in another strong quarter of year-over-year growth complemented by an excited acquisition of Avalere Health and the announcement of Data Diagnostics. We are excited about the proof of concept confirmations on Avalere and the very positive feedback we are receiving regarding Data Diagnostics. We are only in the opening chapters of our growth and yet we are pleased with the progress and are excited by the expanding capabilities of our leadership. Please allow me to now hand the call back to our operator for your questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Andre Benjamin of Goldman Sachs. Your line is open, please go ahead.

[Andre Benjamin:]

So first question is, I was wondering if we could confirm the amount of revenue contribution you are assuming for Avalere I the fourth quarter versus the underlying business. And is it correct to interpret the guidance as a reduction to the guidance for the underlying business versus prior levels? If no, why is that not correct and if it is then what's changed in that view?

[Keith Dunleavy:]

Sure. Thank you, Andre. Great question. So first of all, may I encourage you to not view the Avalere revenue in the fourth quarter as absolutely an extrapolation of off either the September month's contribution or any prior year disclosed as we did when we did the acquisition. Avalere is proving to be a fantastic combination together with Inovalon, but our focus right now in the near term is on bringing the associates of Avalere up to speed on all the capabilities and technologies of Inovalon. They are spending time, energy and resources on that and we are doing the same. And those time, energy and resources would perhaps otherwise be focused on billable and chargeable elements. That’s not our near-term focus with Avalere but rather the bigger picture that we see developing very nicely together with them. So point number one is, I would encourage you not to view it as a linear extrapolation as you put together those numbers. The second thing that’s important in those numbers is that we are already seeing synergies between Avalere and Inovalon's business. Meaning, as Tom mentioned, even within the $4.2 million that we have cited for the September contribution, already there is a material component within that $4.2 million that is in fact enabled and put together by, in fact a data and analytical aspect to the pharmaceutical industry. So already by other measurement, that is our expansion of our Inovalon core revenue capabilities. But to get to your point, as we put these numbers together looking forward, we wanted to make sure that we took into consideration the points that I just made as well as some prudence around what we are seeing in the co-op marketplace as well as some of the timing of our larger opportunities in our pipeline. We have a number of significant opportunities in our pipeline even at this stage, we are very positively encouraged by how our pipeline looks now and continuing into '16 and wanted to make sure that we reflected a flexibility that the company thinks is prudent as to when we focus on signing and closing those deals. To make sure that we are signing and closing them at a time that is right for the company as far as pricing and terms and other aspect and now allow a decision of a December '15 versus January '15 to be the focus of exactly how we close our fourth quarter. And then also as I mentioned, some prudent caution around some of the co-ops that we have as clients. Put that all together, we put out the guidance that we have, looking to make sure that we properly guided you in the marketplace.

[Andre Benjamin:]

So I guess, just mechanically, if we are going to put Avalere deal into the model, how much of, in your opinion, we will be putting in the M&A bucket versus the underlying business? I guess is the core nature of my question.

[Keith Dunleavy:]

Yes. I appreciate it Andre. As you will see, Avalere is already very much integrating together with the capabilities of Inovalon. We are not breaking out that revenue separately. We are seeing them as very much a part of the expertise in our groups that are helping us develop products, helping us expand our client relationships and serving the needs of our customers. So I think it's premature. Ultimately, we will break those things out as we fulfill the whole year's time. But at this point we think that that is premature besides the guidance that I have just messaged to you here now, which is to caution you against doing a straight line number off of the September numbers. It's going to be a conservative approach of how we look at that contribution.

[Andre Benjamin:]

Okay. I guess lastly, I know you haven't given guidance for the next year, just as we think about the trajectory of margins since this is business that’s pulling down your margins but you are expected to be accretive going forward. Like how shall we think about the path forward, knowing that you haven't given formal guidance, just directionally?

[Keith Dunleavy:]

Sure. Directionally, as I mentioned, we are already seeing proof of concept confirmations in the marketplace. So let me describe what that means. First of all, we are already signing and executing on business together with Avalere where our data and analytics are a material component of the combined offering into the marketplace. And that combined offering is already showing to be EBITDA margins that are in excess of our historical EBITDA margin target. So the proof of concept of the longer term contribution of Avalere to our business is a very positive one. That said, over the near-term we see that as taking a bit of time to translate through how we work together with Avalere and how we bring those product offerings into the marketplace. So obviously it's premature for us to be giving guidance on '16. However, we do see the longer-term view of Avalere as being in line with our margins, if not even excess in our combination together.

[Operator:]

Thank you. Our next question comes from the line of Matthew Gilmore of Robert Baird. Your line is open. Please go ahead.

[Matt Gilmore:]

I wanted to ask about Data Diagnostics. Can you maybe talk about how you are going to market with the new capability? And I know you and Quest have much stronger geographic coverage in certain geographies like New York. Will this be a national rollout or will you focus on certain geographies first? And then second, is there a way to frame up the revenue opportunity from Data Diagnostics, perhaps not for '16 maybe the long-term opportunity?

[Keith Dunleavy:]

Sure, Matt. First of all, good evening. The rollout with Quest is really going quite well. Let me emphasize that they are incredibly positive partner. We have been very impressed by all aspects of how the collaboration is going. Internally, their technology group, their sales and marketing group, their management leadership on these projects has been very very positive. The reception that we are getting literally on a national level, meaning presenting to organizations that operate in all parts of the country has a [2a1] [ph], meaning in each and every case, has been very positive. So we are seeing reception geography agnostic but also across types of organizations. Health plan and [indiscernible] health care delivery systems, employer groups, ACOs. Very positive reception from a multitude of audience types. So today, what we have done is we have mapped out virtually everyone of the providers that interact with the Quest platform. We have mapped them into all the geographies of the U.S. We have mapped them across all of our client relationships, their client relationships. All of our data set coverage and all of those are serving as guide posts to indications of what are the top 50 targets in the marketplace. And that is part of the March on that. The sales force for Quest is significantly large. They have well in excess of 100 people that are focused on selling into the particular markets that we are directed to and then well over 1000 people that are part of the support of the rollout, meaning education of the provider and the initial introduction of the program to them. So the resources are plentiful. The coordination is significant. The opportunities are numerous and we are seeing a lot of positive indication. So, no, we are not constraining it to any particular region. It is going to be a nationwide rollout and nationwide across quite a few different types of constituents as well. And then the last thing you asked about, Matt, was what's the size of this market. We did some extensive work on this and while I don’t want to comment yet on what we see as our ramping into the opportunity or early area under the current projections or anything like that. What I am happy to share with you is the modeling of the applicability of the different data diagnostic categories. You may recall that there are five categories of data diagnostics. There are several hundred individual data diagnostics but they fall into five categories. Those are quality-related, historical data related, risk or accuracy related, utilization or cost avoidance related and eligibility related. And because we have such large data sets as to provider activity and member history and member quality progression and such, we are able to do a modeling of the applicability of the Data Diagnostics within the different clinical encounter environment. And to draw it to a point, the TAM that we see within the space is in the neighborhood of approximately $31 billion of applicable use of real time analytics across these categories.

[Matt Gilmore:]

Okay. Great. And then maybe just one more on that competitive landscape. I know one of your competitors is exploring a potential [sale] [ph] on it. I realize you might not be able to provide much commentary but can you maybe remind us how Inovalon is positioned relative to that organization. And then also given the ownership uncertainty, is there an opportunity to engaged with some of their clients from a sales front? Is that contributing to the pipeline commentary.

[Keith Dunleavy:]

Sure, Matt. I am happy to comment to the degree that I can. So, first of all, Inovalon has been very fortunate to be capturing opportunities across many of our competitive landscapes. We have seen that trend throughout 2015, during the third quarter that continued. We continue to capture very nice client wins from a multitude of organizations that you would list as competitors of ours. So as we look at opportunities to make acquisitions, as you would expect we apply a significant amount of thought and consideration to that. We want to make sure that we are only looking to buy those assets which are extremely strong contenders in the marketplace and very materially add to our capabilities. And as such that’s our methodology. I don’t know want to comment as you wouldn’t expect me to comment on any one particular, potential acquisition target. But we are well aware of the assets that are available at the marketplace throughout this year now and even once that are probably coming on the market. We are very disciplined about our approach. To your other point, does that provide us an opportunity? Yes. How much is cause and how much is effect? We don’t really know the answer to that, but we are seeing our products having a strong competitive advantage. Are being recognized, I should say, as having a strong competitive advantage. How much of that is coming from weakness in alternative or is causing weakness in our alternatives, we don’t know. But we have been capturing nice amounts of business in areas contributing to our pipeline.

[Operator:]

Thank you. The next question comes from the line of Jeff Garro of William Blair & Company. Your line is open. Please go ahead.

[Jeff Garro:]

I first want to ask about your Q4 guidance. So we see implied Q4 guidance from your revised 2015 expectations. It seems like there is a much wider range than prior quarters and now we are just down to one quarter left in the year. So I want to hear what the rationale is behind that wide range. Maybe there is issues such as higher incremental margin falling in or out a quarter or performance based fees, or discretionary expenditures driving that wide range.

[Keith Dunleavy:]

Jeff, thanks for the question and good to talk to you. So great question. Little bit tying to a question earlier on the call, we wanted to wide mouth the range as we are seeing a very nice pipeline right now that has a number of large opportunities. Remember opportunities that we look at are many years in duration. So when we sign and close a deal, we are going to live with those financial metrics for some time and we want to make sure that we don’t, in a urgency to close something on December '15, for example, versus January '15, we want to make sure that we don’t cause ourselves a margin decrement that we could have easily negotiated our way through, just to have that 30-days earlier. We appreciate that there is a lot of focus on 90-day increments in the marketplace, we are very committed to delivering a longer-term, very successful, strong margin and leader in the marketplace. So as we look at a number of these large contracts that we are getting closer and closer to, we want to give ourselves a little bit of flexibility and message that to you in the Street, that we have some great opportunities and we don’t want to be forced to sign something bad on December 31, or sign something not as strong as we could have signed on December 31. And then also as I mentioned, we want to have in there a little bit of flexibility in our messaging around the co-ops. There is some variability out there with how some of the co-ops are doing. Very often the co-ops view our services as an essential service that helps them comply with the regulatory requirement. That helps them achieve financial performance that’s going to be important to them or in the case that they don’t do well, that’s going to be important to the receivers very directly. So very often they are very keen on keeping us operating and content and even expanding the amount of work they do with us. But we want to be conservative an thoughtful about how we view that business here in the fourth quarter. So for all those reasons and then the last one being, you have heard a lot of talk about our investments in Data Diagnostics. We are just having very strong tailwinds in our efficiency. We are excited that we are able to spend that additional profitability on investments. And as we are seeing the demand for a number of these products grow rapidly, we want to make sure that we leave the flexibility to pull some triggers to do some aggressive additional investing in those areas as they are growing. Put all these factors together, we thought it was to widen up the range for us. But really strong demand, really positive setting in comparison to or receiving from some of our competitors. Pipeline looks great, market reception looks great. We are very pleased with it.

[Jeff Garro:]

Great. That’s all very helpful. One follow-up on the large opportunities. How should we think about either upfront data uploading fees or software licensing fees hitting on deals that might sign toward the end of the quarter versus whether you might have really larger upfront expenditures that could impact us, wider guidance range, that you would be investing in ahead of a multiyear large revenue opportunity.

[Keith Dunleavy:]

Great question, Jeff. Naturally a bunch of those things fall into the aspects of revenue recognition and the aspects of how we have to capitalize on various different infrastructure investments. We started increasing the investments materially back in Q2. So some of those expenses you all see, already seeing layered into our business incrementally, you are just not seeing them as much because our operational efficiency has been ahead of model. But, yes, those opportunities can occur. We have several different opportunities in our pipeline right now. They are not all of the exact same character. Some of them do have the nature of requiring material upfront components. Again, one of that smooths out with capitalization of hardware investments and the substitutes. So it's really a little bit of a mixed bag, Jeff. I would hate to drop them all into one bucket. We are very very thoughtful of them. That’s a little bit behind why we have ironed out the range there a bit. So for clarity, it's not obvious, we consider these really a positive bigger picture thing that these size opportunities are coming to us instead of to other people. These are very often not competitive at this point. It's just trying to fit them into the schemas of people's operation. So we are excited about it.

[Jeff Garro:]

Understood. And one last one if I could. Just maybe trying to dive a little deeper here and get an understanding about the capacity expansion and your viewpoint as an aggressive growth company? And if additional capacity expansion are response to new business that is already booked in excess of your projections or is it in anticipation of higher new business activity in the future.

[Keith Dunleavy:]

It's little bit of a combination, Jeff. So some of these investments, when you are investing in a product development capacity, then that’s a little bit more, I would call that a medium term investment. They are the people that you need to develop out these complex cloud and big data environment product lines. Are complex, these are expensive investments the company is making. Could infrastructure, the way we design it for these high speed product offerings requires significant amounts of investment not just in the hardware and software but also in the development of the infrastructure around it and the people groups that know how to run an operate those. Again, we have been wearing those in because it’s a lot smarter and more efficient of us to be not doing those in peak sprint but rather bringing on those capabilities as we find them and need them. So I wouldn’t view it as, this is a build for a massive contract tomorrow, but in the cloud environment it's important to understand how much excess capacity you need to handle the peak volumes. The way the public speaks about the public cloud is different than how proprietary closed clouds work for these environments. They are very very powerful infrastructure elements but you still need to make sure that you have peak cloud capacity build into your system. And that requires a significant investment which the company is making.

[Operator:]

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

[Ricky Goldwasser:]

I have few questions here. So first of all on the guidance, just a point of clarification. So when we think about the implied fourth quarter guidance, saying on a year-over-year basis, all-in in the midpoint, we are talking about 100 basis points of margin contraction versus I think, 500 basis points this quarter. So Keith, you spoke about the headwinds, right, kind of flex the co-ops, the investment, Avalere etcetera. But what are you seeing and what are you expecting to see in the fourth quarter that would offset that and really kind of like help slow down that margin contraction on a year-over-year basis. And is that the right way of looking at it.

[Keith Dunleavy:]

Well, it's a great question, Ricky, and good evening. Good to talk to you. So there is a number of cross winds going on here. So I appreciate the question very much. And I think it's important to go back and talk about what are some of things that are touching upon or impacting our margin. And I think a very important point that we want to make clear is that we are very much fortunate to be in the driver's seat of a proactively setting what we are investing in here. So one of the messages we want to be getting across strongly is , we have a lot of levers here. We are well ahead of our full year guidance projections and it's a conscious decision that we are making as to what we are spending those dollars on. Avalere, as we mentioned, led to a 1.4% impact in our EBITDA margin. The product mix in the third quarter was 2.1%. That 2.1% is a third quarter phenomena. So that’s not a fourth quarter phenomena. There is a number of factors which we have the ability to dial on if we wanted to, to further enhance that margin. We think it is smart to be tracking towards a 37% for the full year. I know you are going off of midpoint but we are trying to be clear that we want to direct you to a 37% margin and we recommend taking off 200 basis points off of that for the near term profile impact of what Avalere does. But if you are trying to track what the performance of Inovalon proper before the Avalere contribution, we are very much trying to strong message that we are at 37% with a lot of flexibility. We have a lot of flexibility in how we direct that margin because we are actually several points above that 37% and we are pulling that in and investing in the areas that we have spoken to. So we have a lot of flexibility there. The Avalere being a component that impacts that and you are absolutely right, one of the things we are staying mindful to are the co-ops and the potential impact on that. So we could offset the co-op amount if we felt or we found that we need it to, that’s a judgment call that we can make as that evolves further. But I think a point that’s really important is that we have that flexibility because of how much tailwinds we are getting.

[Ricky Goldwasser:]

Okay. That helps. And then in relating to something that you said in your response. Obviously, you talk about this demand for the data driven intervention. So I guess the question is, is this coming from like new book of business that you are bringing in? Is this more of just kind of an existing customer that decided to buy more from you or kind of like broaden what they are buying. And to your point, only a third quarter phenomena, so was that just kind of like a project and you are going back to normal breakdown.

[Keith Dunleavy:]

Great. Let me make sure that I understand your question, Ricky. Are you speaking to the shift in product mix and that impact in Q3? Is that what you are...?

[Ricky Goldwasser:]

Yes.

[Keith Dunleavy:]

Okay. Great. So, as you might recall from previous calls, we have noticed a trend, this will now be the third year of the trend, where the -- think of it like a teeter-totter. The volume of intervention activity that one does in the various quarters of the year is shifting towards the latter half of the year. So as it shifts towards the latter half of the year, it shifts away from the front half of the year, to state the obvious. But we absolutely had visibility into that. We knew that that was what was coming. As you know we have been messaging about that. So one view on it is that as clients are becoming increasingly comfortable in drawing their insights from our analytics, they in effect are happy to pay for a measure twice, cut once sort of intervention. If you think of the analytics as the measure and the cut as the intervention. So we are doing increasing amounts of analytics and then we are also shifting the intervention to later in the year. That’s exactly the phenomena we are seeing. We knew it was coming. That’s why you saw margins so high in Q2 as we anticipated this phenomena in Q3. This is why despite what appear in the short-term in this Q3. If you look at the nine months year-to-date, as I mentioned earlier, we are already at 35.9%, first nine months of the year, with tailwinds increasing as to our efficiency and operational leverage. So third quarter seasonality, total expected. Occurred as we expected it to occur. And full year is going as we expected inside of that shift.

[Ricky Goldwasser:]

Okay. And then another point of clarification. On the second quarter you talked about this contract that was pushed out. Has that contract materialized and if not, are you assuming that’s going to happen in the fourth quarter or is this just kind of out of the numbers for now?

[Keith Dunleavy:]

No, no. As you heard us mention in the second quarter, it had signed, by the time we did the second quarter call. And we confidently stated that we expected it to operationalize. As you heard Tom earlier in the call today, it did operationalize as expected in Q3. It performed as expected in Q3 and it's expected to perform as expected in the full year. So we are not making a larger deal of it because as we sought to convey back then, it was just a matter of timing of when it happened. It's going very well and all as we planned it would go. So all very positive and not more of a story there.

[Ricky Goldwasser:]

Okay. And then last but obviously very important. When we think of your relationship with Quest, I mean I understand if they are early on and do not necessarily are kind of like ready to give guidance around that. But very simply, kind of like what is the revenue model, what's the potential revenue model?

[Keith Dunleavy:]

Sure. Great question. Happy to look at it. And some of this is in some materials we have put out, the individual data diagnostic engagement. So with each underlying what we call a participating organization. So a participating organization could be an ACO, it could be a hospital, it can be an ASO employer group, it could be a health plan, it could be an integrated healthcare delivery system. Each participating organization joins the platform. They pay a data management and data interconnection fee. These are relatively low cost, so in the neighborhood of, call it 60 to 260,000 per year. The lower numbers being for the smaller organizations. I am giving you a bell curve range there. So there are some outside on both ends of those ranges. And then other than that, the individual data diagnostics are range in unit costs, again giving you the bell curve range. Although there are hundreds of them, most of them fall between roughly $15 and $50 per unit. And an individual unit is triggered when an individual physician or clinician orders one for the patient that’s sitting in front of them. So think of it like ordering a laboratory study instead of ordering a [chem-7] [ph] or urinalysis, you order data diagnostic and similar to there being a unit charge to the organization for a [chem-7] [ph] or urinalysis, there is a unit charge for a data diagnostic that’s build either through the claim or in monthly in arrears to the organization. So it's a very simple, the Wall Street would love it. It's a p times q model that is an on-demand order model by the physicians. Each time they order, it triggers a fee.

[Ricky Goldwasser:]

Got it. This is very helpful. Thank you very much.

[Keith Dunleavy:]

My pleasure, Ricky. And that I understand was our last question. And in closing, we are really proud of a solid quarter here in third quarter of 2015. We accomplished a great deal, expanding our reach and our capabilities and we are very excited about what lies ahead. So thank you all very much. Good evening to all of you and with that I will hand it back over to our operator, Ben.

[Operator:]

Thank you, sir. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Have a great rest of your day.