Inovalon's (INOV) CEO Keith Dunleavy on Q2 2016 Results - Earnings Call Transcript

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Inovalon Holdings, Inc (NASDAQ:INOV) Q2 2016 Earnings Conference Call August 3, 2016 5:00 PM ET

Executives

Kim Collins - SVP Corporate Communications

Keith Dunleavy - CEO

Tom Kloster - CFO

Analysts

Jamie Stockton - Wells Fargo

Donald Hooker - KeyBanc

Andre Benjamin - Goldman Sachs

Jeff Garro - William Blair

Sean Wieland - Piper Jaffray

Operator

Good day, ladies and gentlemen, and welcome to the Inovalon's Second Quarter 2016 Earnings Call. At time all participants are in a listen only mode. Later we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded.

And now I will turn the conference over to your host, Kim Collins. Please 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 second quarter 2016 earnings call.

The press release announcing our financial results for the second quarter was distributed this afternoon, and a replay of today's call will be available in a few hours and posted on the Investor Relations page on Inovalon's website.

For those of you who listen to the rebroadcast of this call, we remind you that remarks made herein are as of today August 3, 2016 and will not be updated subsequent to this initial earnings call.

I'll remind you that certain statements made during this call may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995, including statements related to future results of operations and financial position, our business strategy and plans, market growth, and our objectives for future operations. Those statements involve a number of factors that could cause actual results to differ materially. Additional information concerning these factors is contained in the Company's earnings release and filings with the SEC.

In an effort to provide additional information to investors this conference call on webcast is accompanied by a presentation which is available on the homepage of the IR section of our website. You are encouraged to download a copy of this presentation to follow along with our prepared remarks. Our presentation also includes certain non-GAAP financial measures. You'll find definitions of these non-GAAP measures and reconciliation charts at the end of the Company's earnings release and on our Company website.

Now it is my pleasure to turn the call over to Dr. Keith Dunleavy.

Keith Dunleavy

Thank you, Kim. Good afternoon everyone and thank you very much for joining our call. Tom and I would like to share with you the results of our second quarter, update you on our continuing evolution of our business and the broader healthcare landscape and disuses our updated view.

Before I proceed please let me reiterate that we have posted slide deck supplemental information in the Investor Relations section of our website which we think you might find helpful

Turning to our second quarter we made strong progress against our strategic plan. As Tom will discuss in detail shortly revenue year-to-date is consistent with our expectations and non-GAAP diluted net income per share was in line with consensuses. And we again generated healthy cash flow to add to our strong balance sheet.

In addition our investments in sales and marketing have expanded our pipeline to record levels. We signed new business in virtually every business line and product line, including new large scale implementation of QSI Excel and multiple data diagnostics contracts. We push further into adjacent markets with several deals including with Bristol-Myers Squibb in the pharma/life sciences space where we will be hoping BMSs real world outcomes and value base contracting initiatives. And we saw strong increases in our interconnectivity or dataset size and compute volumes.

These are all very positive indications for the future in Inovalon and clearly demonstrate that we are a leader bringing innovative relevant products and technologies to an increasingly data driven healthcare market place. As we have discussed the healthcare market is a dynamic in growing market undergoing fundamental changes as it navigates from batch processed, volume based business models to transactionally processed value based clinical outcomes based business models. We are seeing significant opportunities within the SeaChange and these opportunities are reveling themselves at a seemingly accelerating pace. In order to capture these opportunities we are rapidly expanding our platform capabilities as well as the infrastructure in capacity that support these capabilities.

Inevitably however while there are leading edge technologies, there are by definition also older technologies. We are excited about both our newest advancements, both those formally rolled out and those yet to be rolled out and our ability to advance our older technologies.

Let me take a few moments to talk about what we are seeing in our business and in the healthcare market, describe how Inovalon is responding and discuss the financial implications of our strategic decisions. First many technology companies experience a natural evolutionary cycle as older more mature products a transitioned overtime and replaced with newer more innovative products. Earlier this year market dynamics begin putting increasing pressure and one of our older more mature platforms CARA, our retrospective risk score accuracy improvement offering, rather and then responding to these market dynamics in this advantages ways for example by simply engaging in price discounting against competitors with limited focus on profitability. We chose to play it to our strings and do what Inovalon has done for years, innovate. We are in the process of transitions platform to the next level of innovation, a level where we provide increasing performance and value to our clients that our competitors can't touch, and yet a higher level of profitability for Inovalon overtime.

I want to emphasize this dynamic is not a new one to Inovalon, even if it is somewhat accelerated in the specific products case. We have experienced similar dynamics in our business over the years. And we have responded by developing increasingly innovative and relevant platforms in technologies. A good example is our successful transition to our new cloud based big data quality analytics platform QSI Excel which we are seeing strong demand for and signed large scale national network implementations during the quarter. We know how to successfully execute this product advancement strategy and are already seeing positive market response supporting the renew and signing of new business for Inovalon.

At this early stage however this transition also entails additional investment. As a result we will see a dampening impact on revenue and margins in the short-term. But a stronger client value realization and greater efficiency realization in the medium and longer term. Second, two additional important trends to know on Inovalon’s introduction are the number of new offerings over the last year and the strong expansion of our sales pipeline.

Today our pipeline is more than twice as large as we entered the year. And this is even after considering the many deals that we have won and closed over the past few quarters. We credit this performance to our investment in sales in marketing, our leverage of the Avalere acquisition and the relevance and value our technologies and offering have in the market place, including our new offerings like QSI Excel, data diagnostics and our pharma/life sciences and post-acute care platforms.

As we have discussed before we see tremendous opportunities before us. Both in our core pair market as well as the large and attractive adjacent markets of pharma/life sciences and providers, the latter including the post-acute care market.

We've started to capitalize on these attractive opportunities with the wins that we have announced with Bristol-Myers Squibb, Kindred Healthcare and others and we continue to develop and introduce new innovative and increasingly fully cloud based offerings and not just one or two but a number of new offerings over the past year alone. These offerings are highly integrated, leveraging common core capabilities within our platform stack. As an organization begins working with Inovalon it is becoming easier and easier for them to rapidly turn on additional functionality or enhance the scope of their existing engagement with us.

As a result, we're not only expanding the audience to whom our capabilities may be valuable but also deepening the degree to which these capabilities can be valued in an existing client. The fully cloud based offerings we are introducing and the strong market interest we are seeing however requires incremental investment in our technology platform and infrastructure. While these incremental investments will have an impact on our profitability over the next few quarters we believe that they're critical to drive our vision of large scale on demand transactional data driven healthcare.

The benefit that we will reap is significant. For instance the development of our active-active-active hybrid cloud architecture and associated migration to pure cloud offerings will allow us to decrease our capital infrastructure by more than 25% and accelerate the speed by which we can turn on very large scale engagements speeding both time to revenue by several months and decreasing implementation costs significantly, not to mention delivering market differentiating processing speeds and a host of capabilities that are unparalleled in the market. The other point to spend some time on is our sales pipeline and the dynamics we are seeing there. As you know we've been investing significantly in our sales and marketing capabilities.

Frankly, it has proceeded very well. Final capture is coming in from a significantly expanded set of prospects in market and the overall pipeline has more than doubled this year. And we are seeing nice follow through to contract closure. This all said however it did take somewhat longer than we expected, the onboarding of new people, establishment of new processes and methodologies and the introduction of many new offerings takes time. As a result while closing deals nicely the time left in the year for these to undergo implementation and realize meaningful revenue in a year is diminished. Obviously these achieve full realization of revenue next year in 2017.

Before I turn the call over to Tom let me conclude by saying that I appreciate the fact that the change in our near term guidance will disappoint some, however I want to be clear that our products, technologies and data sets are advancing at tremendous speeds. We have conviction that we're making the right investments for the longer term, and while it is early for too many details we are seeing a very strong 2017 coming into view. With that let me ask Tom to review the second quarter financial results and discuss our 2016 financial outlook in more detail.

Tom?

Tom Kloster

Thank you Keith and good afternoon everyone. My remarks will touch upon the highlights of our financial results for the quarter, cover a few key items that stand out in our results, discuss our balance sheet position and then wrap up with a discussion of our financial guidance for 2016.

As Keith mentioned, the financial results for the second quarter and first half were generally consistent with our revenue expectations. While product mix legacy product evolution and accelerated investment in innovation tampered down our profitability performance. Second quarter revenue of 123.8 million increased 5% over the prior year of second quarter, bringing our year-to-date revenue slightly above the previously presented expectations.

During the second quarter we continue to advance our sales infrastructure both in terms of scale and sophistication of support tools. We stretch deeper into the adjacent markets of pharma/life sciences and post-acute care, and we experienced continued strong client demand for data driven innovation services. And as Keith mentioned, we also experienced a more rapid evolution that previously envision of one of our older product lines.

Adjusted EBITDA for the second quarter was 40.8 million or 32.9% of revenue as compared to 44.8% in the prior year quarter. For the reasons outlined in our release and as Keith just discussed we have chosen to make substantial investments in many areas of our business, including new product roll outs, innovation, connectivity solutions, infrastructure and network capabilities expansion, the growth and sophistication of our sales and marketing organization and the extension of our corporate development capabilities. All in an effort to accelerate the pace at which we can capitalize on the significant market opportunities we see before us.

As intended similar to the first quarter sales and marketing investments expanded significantly, more than doubling as a percentage of revenue from 2% in the second quarter of 2015, to 4.9% this quarter, but helping to drive our record pipeline which is increased by more than 100% since the start of the year.

Additionally R&D investments were further expanded to 7.7 million this quarter as compared to 5.5 million in the prior year quarter. All of these factors in combination with the product mix and addition of Avalere blended down adjusted EBITDA margin as compared to the prior year. Our net income and EPS on a non-GAAP basis came in at 20.6 million and $0.14 respectively in the second quarter, in line with consensus.

So now let me comment on our balance sheet and cash flow this quarter. Inovalon remains in a very strong financial position with over 743 million of cash, cash equivalents and short-term investments as of June 30. In addition for the six months of 2016 we generated 32.4 million in cash from operations up 64% from 19.7 million in the prior year period. Our strong balance sheet cash flow generation and debt capacity positions us well to consider various strategic investments in acquisition opportunities while at the same time beginning to execute against the share repurchase plan, our Board of Directors authorized last quarter. As we mentioned in the release the repurchase has not yet started.

Now let me address our outlook for the remainder of 2016. As Keith discussed and as presented in the earnings release and supplemental slide deck we are adjusting our 2016 financial guidance to reflect certain timing developments and strategic decisions to accelerate investments. Specifically as it relates to revenue we're very pleased with the development of our sales and marketing organization. The success to-date is evidenced in our dramatically larger sales pipeline expanding by more than a 100% from the start of the year and the material client and product wins we're experiencing in literally every product category.

Having said that the process of building out this capacity took longer than we planned resulting in the conversion of sales pipeline to revenue expectations for 2016 being pushed to the right. I want to emphasize a point made earlier which is that this does not represent a revisiting to the significant opportunities we see for revenue growth. Rather it is an issue of timing. A second factor influencing our change in 2016 revenue projections is the previously mentioned change in how clients wanted to purchase one of our more mature products and our response to migrate clients to the more advanced cloud based platform technology.

From an adjusted EBITDA standpoint beyond the impacts just mentioned affecting revenue our revised 2016 guidance reflects the strategic decisions made to accelerate our investments in numerous product and technology innovations. Including transition to the advanced native cloud based platforms. Technology infrastructure enhancements to support our expanding QSI-XL and data diagnostics demand and numerous efficiency initiatives such as EHR connectivity, OCR and natural language processing enhancements. In our process flow management platform known as SAPPHIRE.

Additionally, in a way of corporate infrastructure we are continuing to expand our corporate development resources and provide more automated system capabilities to support the effectiveness of our business development organization. We are taking these actions in order to capitalize on the many attractive opportunities that we see before us. As well as to respond to certain market trends by further differentiating Inovalon's technologies and platforms. While these actions will have a downward impact on revenue and adjusted EBITDA in the near term we strongly believe that we'll translate into even greater financial and competitive success for the company in the medium and longer term.

With these elements in mind our updated 2016 financial guidance is as follows. Revenue is expected to be between 470 million and 490 million. Net income on a GAAP basis is expected to be between 43 million and 53 million. Adjusted EBITDA is expected to be between 130 million and 148 million and adjusted EBITDA margin is expected to be between 28% and 30%. Non-GAAP net income is expected to be between 60 million and 70 million, diluted net income per share is expected to be between $0.28 and $0.35 and finally non-GAAP diluted net income per share is expected to be in between $0.39 and $0.46.

In conclusion I'd like to reiterate Keith’s comments that while we see a short-term impact due to the factors previously discussed the fact is much of the ground for a strong 2017 is already laid. A transition to a native cloud based technology platform, strategic investment, introducing new products into the market, a strong existing client base, new business signed this year but just now ramping and a significantly expanded sales pipeline. Combined these give us confidence in a strong growth and margin expansion in 2017.

With that let me now turn the call back to the operator to conduct our Q&A session.

Question-and-Answer Session

Operator

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

Jamie Stockton

I guess maybe the first one on CARA, Keith, if we think about the retrospective risk adjustment market, would you say that it is accurate that you guys are experiencing some share losses when it comes to the Medicare advantage part of the market, that’s really what is driving the issue and that maybe your share when it comes to medicate or for commercial is either stable or going up at this point?

Keith Dunleavy

You are insight is spot on. So the way you just described it is very concise with the caveat [ph] I'd add that two things. The Medicare market which is the most seasoned segment of the market, is certainly driving an evolution in how we approach it and we’ve taken those same evolutions and have applied those technology advantages and benefits to our clients, in the Medicare and commercial making those even stronger in our value offering to our clients as well as the differentiation to us and our shareholders.

Further just got point on it, to be clear during the quarter having already started the application of these new approaches in the CARA space we are already signing and expanding business in that area displacing competitors already with this approach in different stages, some in discussion, some in contracting, some already now signed and being implemented. So you are right in your premise just wanted to add a little bit more color to it.

Jamie Stockton

Is the -- is there a trade-off going on between retrospective risk adjustment and prospective that is allowing you to -- are you replacing some of the lost retrospective that’s essentially what you’re talking about?

Keith Dunleavy

So you are correct again. So the concept of prospective requires a more sophisticated concept of the analytics. So in prospective work one not only needs to handle over normal logistical and data interaction elements that we would in any product line, but in the prospective line of business you are doing predictive analytics to not only understand where the gaps in care or quality or utilization might be, but also you are doing analytics to predict provider activity patient activity and facility activity and how those all relate to each other. So it's a much more complicated product and delivers a greater and greater value to the client.

So as that product line is successful it by itself can erode the retrospective need, so our focus over the years has increasingly been in the more sophisticated more prospective and predictive analytical arenas, so that naturally does cause a degradation in the retrospective piece. Nevertheless we think that retrospective piece is a very important part of the total equation and therefore applying these new types of analytics which we developed and hones in the prospective arena now through the retrospective arena is going to give us a great one-two punch for our client base.

Jamie Stockton

And maybe just now I ask question. You have a lot of business around Medicare advantage. The loss of some of these relationships with CARA is that impacting the rest of your portfolio of what you have sold around those lives?

Keith Dunleavy

So there are three different questions in there Jaime. So, first of all we really have a nicely diversified book of business across Medicare, medicate, commercial and even in commercial large group and small individual, which would be the ACA space. So while we definitely started 10 years ago in the Medicare space we have dramatically expanded away from that and I'll give you a number, we've really worked through the majority -- the vast majority of the migration of this issue, that we see affecting us here today.

We have literally all but one remaining to work our way through so we're now in the single digits of remaining Medicare business to work through single digits and percentage basis, to work through in the remaining Medicaid space and even in that arena in that single digit space we've already have the discussions with them, they've already responded in a very positive way and we feel good about how that will progress and I'll point out we have virtually know open and remaining contract subject to this in 2017.

So, we worked through it nicely we really made a decision in Q2, as you can tell to address this quickly top respond with those in technology and making sure we took care of our clients getting it done, getting it behind us and move on with a more powerful version of the products.

Jamie Stockton

Okay, but as far as the rest of what you are doing around those lives has there been any disruption outside of just risk adjustment I guess this is what I'm asking.

Keith Dunleavy

No Jamie, we really haven't seen any consistent relationship or relationship that’s between the two factors. Certainly as you might expect if a client does a lot of care with you and a smattering of other things that could affect the contract negotiations for those other things, but we deliver a lot of value in those other lines of work, quality work, utilization work, compliance work, and data submission work and disease identification work and the other lines of products that we have, so it's a very good question and certainly we have some clients that as they take a different direction they could take a different direction in the whole portfolio, but we have not seen that to be materially any case, and again like I said we’ve already work through the portfolio to the very large degree. So we do not think what you're describing is a factor that we have to face and in fact I’ve already secured the vast majority of putting this behind us.

Jamie Stockton

Okay, thank you.

Operator

Thank you, and our next question comes from the line of Donald Hooker from KeyBanc.

Keith Dunleavy

Donald, good evening.

Donald Hooker

Good evening, can you hear me?

Keith Dunleavy

Little faint Don, if you could speak up a little bit please.

Donald Hooker

Great, if you can hear me now, my -- thinking about your guidance and you talk about the sales pipeline and the technology change with CARA. Can you maybe quantify some of this a bit? So it looks like you lowered your midpoint of your -- just doing some quick math here, maybe $35 million at the midpoint for your 2016 guidance. How much is CARA in that lower guidance? Can you quantify the issue?

Keith Dunleavy

Happy to Don. So think of it is roughly a 50-50 issue in that 35 million. So roughly half of that 35, we have responded to the CARA issue and it has resulted in that impact that we're looking to do a you know a fast progression through, get it all into place, get it all done, get it behind us approach. And the other half of that 35 is really a right-shifted sales pipeline issue as Tom spoke to.

The sales pipeline is very strong, very positive and not just in one area but literally payer provider pharma and various different product lines at various different stages and we’ve made a number of changes to how we track that pipeline making it a very strong process of accuracy of tracking that pipeline. So that is a very solid and positive thing that we're seeing, but as we pointed out, it took longer than we wanted and while we're signing a lot of great business when you something take longer than you wanted it to in a fiscal year period. We've now signed that business, we're now implementing that business meaning chunks of that business and that's requiring us to take the expense of turning on that business and the ramp -- the area under the ramp of that revenue coming in doesn't start to really hit until Q4 of this year.

An easy example of that would be we signed a very nice national QSI-XL contract during the quarter. That's expensive infrastructure that’s very advanced cloud based infrastructure, we run those in private cloud environments, we're building out a number of private clouds that we own and operate. That expense has been hitting in the second quarter, continues to hit in the third quarter. But that revenue starts to come in from that particular one in the fourth quarter and we have many more like that in advanced stages in our pipeline.

So, half-and-half one being a fast, get it behind us, the other being a right shifted, we're doing the right things, but it did take a little bit longer, but it's a timing issue.

Donald Hooker

Sorry, I guess the first part I see for the long term, take pain now and get the gain later. I guess from the sales force side, I guess maybe in retrospect, if I'm interpreting your -- you feel like you were too frugal with the sales force and if I'm understanding you in retrospect and there's a big opportunity and so I guess going forward you probably don't want to make that mistake again. So, should we rethink about good-good top line growth opportunities or maybe rethink about those margins longer term?

Keith Dunleavy

The mistake done which you're correct was my mistake a long time ago. We came into the IPO saying hey we're underinvested in sales and marketing, if you've heard us say it once, we probably said it a 100 times, we became public at about 2.1% which absolutely was under-investing and we've been pouring on that investments, since then, but one of the things you've also heard from me is you don't grow money at an immature set of infrastructure, we have great people in that group, they needed time to multiply themselves, expand themselves now and add in the additional toolsets and sophistication that we now see them having.

They've hit a really nice critical math, we've growth yet to do, so you're going to see that continue to expand but it definitely wasn't a matter of being frugal. I wouldn't describe it as frugal, we've had it as a focus, we've made it a focus. It's wanting to make sure you hire the right people. It's wanting to make sure you do it the right way. It's wanting to make sure you don't just quickly bring in somebody or some process that three months later you're hitting yourself over the head and replacing them and losing six months, eight months or worse.

The sales marketplace is one where everybody talks to everybody. We want to make sure that Inovalon is a place that the right sales people want to come to sell the leading edge product and that's what we're achieving. So, frugal is not the way I'd describe it, behind schedule is the way I would describe it. And although we don't put out metrics on all of this, we're seeing really nice execution and translation from a very large pipeline down into sales.

Operator

Thank you. And our next question comes from the line of Andre Benjamin from Goldman Sachs.

Andre Benjamin

I just want to make some properly understanding what is happening with the CARA issue, [indiscernible] this year and next. The half of the 35 million capital you talked is it a function of people cancelling or is it just the fact that you're platform needs to be updated into the an ability from new business, so, I'm just trying to figure out people that are concerned what are they doing in the meantime as you get the platform up and running?

Keith Dunleavy

So, first of all people can't cancel our contracts, we've really solid contracts, but we're we also were always mindful of doing the right thing for our client and so we have many clients that have multiple different products in place. And as the market started to provide a -- as we -- as Tom described it organization who are less focused on their profitability offering in types or version of CARA capabilities our clients started to say how do we compare that approach to Inovalon approach and we quickly sat down with our clients, talked about the functionality what is the functionality they needed and the way they would like see their offering done. That really plays to our strength and quickly started the process of a redesign or a phase way that basically changes some of the timing on how and when CARA is done during the year and changes the flexibility that the client has to be able to do so.

And yes along the way for some clients we didn’t react fast enough and some of them we don’t have in the second half of the year. And so that’s just a pure, because we didn’t put that in place say a year ago we’re going to have to go win back couple of clients and we are confident that we will. But for the most part it is quickly learning from that experience, quickly responding to that experience and putting in a technology capability that we don’t see anyone else in market place being able to do and not only sophisticated wise for the benefit of our clients, but also efficiency wise for the benefit of our margins and our shareholders.

Andre Benjamin

Got it. And then a somewhat more philosophical question. As you have had a number of somewhat short-term issues that you have been forced to make, strategic decisions between short-term pain and longer-term gain, how should we think about as we see things arising in the marketplace, and know that you're going to be under some competitive pressures in other parts of the business going forward?

Should we think that you're usually going to make a decision between taking the short-term pain and really focusing on that three to five years out or should we assume that it will be case-by-case? We will get a number of questions around the guidance revisions, the willingness to stick to hitting [ph] the near-term targets, if it could partially impact your ability to be more competitive longer-term. Just trying to think about the tradeoff between the two on timing.

Keith Dunleavy

It’s a great question, Andre. We are absolutely very sensitive to the short-term and very focused on the long term. We’ve got a balance sheet of 750 million and we want to make sure we are putting that work to be unequivocally the leader in the space. We believe that this space has multiple billions of dollars of expansion for us and we absolutely are going to capture it. So that is our unequivocal focus, but obviously one into be sensitive to the near term.

I am a very interested shareholder myself and in addition to being the CEO and this was the right decision for us to make to take this and quickly turn it into a listening to our clients, delivering what they wanted and making it so that going forward we are turning the tables on those that we were able to come into the market with a less sophisticated approach.

We don’t see any other product falling into this phenomena or scenario Andre. We obviously have spent a lot of time analyzing this, spending a lot of time with clients, working through a very large RFP pipeline, a very large sales pipeline and getting the opportunity to talk to many different audiences, we don’t see any other products falling into this particular phenomena and we did see this evolving it accelerated in Q2 and we did not want it to be a slippery slope creep issue, we don’t want to have a loss of other clients, we quickly got it done.

So, philosophically were focused on the long-term, sensitive to the short-term, want to put our $750 million to work. But we believe that with varying definitions of what is short and medium term, we see some very-very positive things coming and some very strong build in the interest that we have. And a lot of this is signing now and it's a matter of getting it all on to revenue recognition. So this is not a long way Andre this is not a, we hope to turn profitable some number of years out and grow from there, we were really driving very strongly now and see it accelerating.

Andre Benjamin

Thank you.

Operator

Thank you. And our next question comes from the line of Jeff Garro from William Blair.

Jeff Garro

The diving into the number a bit, looking at the revised guidance and revised seasonality expectations, still see a roughly $50 million sequential ramp from Q3 to Q4. So curious how we can getting some comfort with the significant ramp like that with some of the pressures in the business evolving pretty rapidly in the current quarter?

Keith Dunleavy

Appreciate the question. So, you are obviously mathematically correct. Let’s think about what are the pressures that are causing us to make the second half adjustment. This is a timing issue, so this is a pushing things a bit further out, a lot of things have already been signed, a lot of those things are going through implementation were going through the spends now, they start generating revenue a little bit further out in the year. So than it's a lot of what we're seeing and we're seeing a lot of continued build.

So we feel very comfortable with what we're putting out as far as numbers but the math of your point is very correct, just think about whether the forces that caused this issue. Remember we only have one more client left in this evolution, all of this were doing as a rapid evolution. It's August now and we've got the vast majority of this behind us so we know what these pipelines will look like.

Jeff Garro

And is there any amount of business that is currently unsigned that needs to be signed and then implemented and generating revenues by yearend to meet the targets?

Keith Dunleavy

Absolutely, Jeff. For sure we have things in different stages of contract and pipeline. We fully expect the characteristics of how our pipeline is closing to continue and typically right now as the slowest time of the year the July, August and in the healthcare space is not typically when you are signing clients, but I will tell you we’re signing clients in July and August.

So we do have certain expectations in some of our pipeline will close and we do have those go into some of our number, not a lot of it as you would expect because if you sign something later and later in the year you don’t get a whole lot of that revenue, call it recognition, but I don't mean GAAP revenue recognition, I just mean area under the curb. It's not a big number but we do expect some of our current in pipelines to convert into revenue in this year.

Jeff Garro

Understood. Maybe one more about the pipeline that you've discussed, the tremendous growth there, was hoping maybe you could quantify new contracts signs in the first half and in some way or maybe just for instance your expectations versus prior period results.

Keith Dunleavy

We appreciate that, we are not breaking out the number of contracts, it is significant during the first half and even accelerating in the second half. As you I'm sure have noticed we have dramatically diminished that which we try to press release in the market, as we’re trying to be sensitive to our new clients that can sometimes receive a whole lot of phone calls from interested people wanting to do homework.

So we have dramatically decreased the announcement of it, but we’ve had a very wide and expanding range of types of clients, we've had large academic institutions, we've had -- we’ve started signing employee unions in the quarter. So going direct into, if you will, consumer market sales, national top healthcare network, national contracts. We've signed multiple regional health plans, couple of them displacing four or five competitors in one contract. We had one signed during the quarter where they purchased I believe eight products of our and displaced I believe five competitors of ours in one swoop of the pen.

So we’re starting to see -- we've been through several cycles, I've been doing this for 15 years and the market goes through cycles, and there was a cycle last year where there was a lot of talk about insourcing and best in class. We're starting to see people increasingly appreciate the benefit of integrated platforms that are modular and can work with the client with flexibility and we're seeing the displacement of some of older technologies working to our favor. So we sign business in every line of business and every product line, pharma, provider, payer and we see a lot more of that in the pipeline.

Jeff Garro

That's great and one more from me. You've disclosed some very impressive patient analytic month or PAM metric growth in the quarter and in recent quarters, revenue growth doesn't seem to be quite matching. So curiously just looking bigger picture, the business model, if you could help explain why that you know really strong PAM isn't quite translating into better revenue growth for the year and why that might change as we hit 2017 and beyond.

Keith Dunleavy

Great question so, so our medical events account grew at approximately 20% year over year, our PAM count accelerated up to 29% year over year, both of those if you look at those graphs and to everybody we purposely included a supplemental slide deck which we all hope you take a look at. We spent a fair amount of time wanting to give you additional information and clarity in that deck.

If you look at those, the data in our data set and the PAM compute you are going to see those accelerating as you look at them and this is behind the scenes metrics that are going on here. Since your question Jeff, why is that not translating into revenue, first of all specifically on PAM we're producing increasingly sophisticated product offerings that are increasingly differentiated by the compute capabilities. QSI-XL is an excellent example. That grants our clients the ability to do processing 10, 15, 20-times faster than even our own previous platforms and our own previous platforms were on par if not better than others in the marketplace.

That allows our client base to run a much higher compute process during the time period, the month or quarter as the case maybe and that is causing that to rise, we've been signing more of that business and that -- there's a transition period that we -- when we install a new version of a technology for our client, sometimes we allow them to continue to run the older, previous platform while they start running on the new platform.

So, for a number of reasons we're seeing PAM increased, you're not seeing that translate into revenue yet, think of it as translating into a lot of market differentiation with revenue reflection to come.

Operator

Thank you. And our next question comes from the line of Sean Wieland from Piper Jaffray.

Sean Wieland

I was hoping you could give us a midyear update on your breakdown of revenues by analytic subscription fully automated processes, and partially automated processes. I know you'd like to give this one for year but given the circumstances that would help.

Keith Dunleavy

You're right we do give those annually. We don't break those out quarterly. We'll definitely give them at the end of the year again as we did last year in December. We took feedback from our audiences, yourself and your colleagues and others on the buy side as to what metrics were most helpful and how we could best present them, we'll do that definitely again this year. But we're not breaking those out midyear.

Sean Wieland

Well, the thought behind my question is you called out the partial growth in the partially automated processes, can you give us an idea of the kind of growth that you're seeing there or any color there?

Keith Dunleavy

Yes, let me make sure we're properly understanding you're questions Sean. So, during the quarter we also saw a little bit of this in Q1, some of the additional volume that some of clients wanted us to implement. Obviously our clients are less concerned with whether or not a process is efficient or inefficient to Inovalon. That the interventions that they requested because they have some play on that, they have some ability to adjust, there is different thresholds in the analytical platforms. Some of that they requested was are they lower automated rates over that shorter period of time which did have some product mix impact on the margins.

I think the total number if you look in the -- we do some waterfalls in these supporting supplement is in the neighborhood on the EBITDA basis -- we break it out on a gross margin basis and on an EBITDA basis. Obviously the factor impacts both the same amount it’s about two to three points in total expected for the full year.

So, we're not talking a lot, at least for us, we see this as a phenomena of happen stance during those two quarters, but not a fundamental change in how our clients are looking at things. And then also one of the things that’s in the release, but we didn’t really talk about it on the call is how much acceleration we are seeing in connectivity.

We announced last week the relationships with Athena Health, integrating with their platform they have phenomenon coverage in provider groups, great organization. We’ve also been collaborating with Epic dramatically extending the technology reach of our integration through that collaboration adding about more of 100 Epic systems and remember an Epic system is whole hospital system.

We also added Medent and other EHR connections on individual group level, that’s all expanding our profitability, that’s all expanding in converting things that partially automated into literally fully automated and I know this is something that you track a lot of. You are going to see actual those the headcounts related to our partial automation, increasingly dropping. We are seeing phenomenon efficiency gains there and we see that accelerating here going forward. It’s being massed by these other investments but these are several 100 basis points improvement in efficiency that we are getting.

Sean Wieland

Okay and then a couple of specific things on CARA, can you give us a number of either what percentage of revenue it represents or a dollar amount of revenue the margin profile of the business and I want to understand why would this be happening midyear. I would think that this would go into -- these kinds of things would go into effect on a contract renewal that would start for the planned year?

Keith Dunleavy

Sure, so let me take this, there are two separate parts of your questions Sean. And so the first part is can you help us breakout different metrics and numbers around that product line. We don’t breakout individual, product lines, we don’t track individual product line down to the EBITDA level and we don’t break that out to investor community. What we do, what we are happy to talk about is the fact that the Medicare portion of our CARA product is really only a smaller portion of overall total book of business. And we only have single digits left to actually work though that transition. So this is not a large effect left and we believe having already had discussion with that remaining client audience we feel very good about how that transition will work. And as we mentioned we have none of this still impacting us in '17.

Which leads into your second point. Why is it happening, I think you said in the second quarter? It's really not happening in the second quarter, it’s a matter of going back to Andre’s question about where are we philosophically about how to approach things like this. You are correct that you would see something like this progress over a period of time. And it was affecting us over a period of time, but a period of time that we factored into our calculations and projections, but when we started to see it accelerate in the second quarter we made a decision to take it head on and to literally clean out the rest of this issue in a way that is responsive to our client base and be able to be more secure in how those renewals we are going to go.

So I'd rather go to client proactively and say let me give you this additional functionality and capability, something that you probably will like quite a bit and let’s extend out the contracts several years. Just as an example, and do that proactively and get it all wrapped up and done. So we actually caused the acceleration so it was in a bleed but rather a strategic decision in movement.

Sean Wieland

So how does the new CARA product compare with the old in terms of pricing? What kind of a -- what about from a pricing perspective and a margin perspective, new versus old?

Keith Dunleavy

So, we're not going to go into product pricing discussions on this calls for reasons I hope you appreciate, but the new design is a higher and more differentiated value for the clients and a higher and more differentiated value for an Inovalon and therefore our shareholder. So it leverages our more advanced cloud capabilities, it's a phased process, it introduces a much more modular design a lot of additional capabilities that we don’t think it appropriately to go into in the public form of this call.

But it is a functionality set that our clients are responding very positively to and it is very good for them in what is achieves from and also very efficient for Inovalon to deliver. Obviously wide investments to get there, which we've disclosed about $20 million of additional investments we have baked into these number which we have broken out for you in the waterfalls in the supplemental materials, but well worth it because this really does transition the game to a one remaining product where we think this is an issue?

Sean Wieland

Okay, thanks a lot.

Keith Dunleavy

So, I believe with that it's being 5:59 here in the East coast, we are out of time on the questions and I want to take the opportunity to thank all of you for participating on the call. Before we conclude allow me to leave you with a few, in fact four important points for your consideration.

That number one: We've developed a truly tremendous technology platform and dataset both of which we believe are very unique in the marketplace. The technology has been organically developed, works extremely well in integrated fashion and enables a very differentiated meaningful and measurable value impact for our client. That is a significant differentiator across in the marketplace. We’re able to are on the rapidly leverage of the platform and we have to build it out into expanding products capabilities.

As you will see in the months and quarters to come the rate at which we are now able to role new products out into adjacent space is nothing showed a phenomenal. We try to bring some of these to light in the supplemental materials. We are rapidly moving into pharma/life sciences, extremely successfully provider in post-acute care market and you'll hear more about that going forward.

Number two: We have developed a tremendous client base. When we went public we had roughly a 100 clients, when we ended last year we had near 400 clients and we continue to add significantly during the first and second quarters of this year, very frequently and on an increasing basis displacing competitors.

Number three: We have a strength in our people. Our teams here in Inovalon I tell you are truly amazing. Our data experts, our innovation experts, our interoperability team, our technology team, our client services, our accounts team, our products team, operations, sales and marketing, even our financial, legal and human resources are truly impressive here at Inovalon and they bring their A-game.

Number four: The market is enormous. This is not a market where A care client or A star client A predictive modeling client is a delta in our longer term view. We have tens of billions of dollars of opportunity that we are going after and capturing. So while the size of the opportunity can be measured in many ways, it is enormous by anybody's account.

So we have leading technology, data, people and a huge market need. Four ingredients which we see as very considerable, very sustainable, very differentiated and giving us altogether a highly competitive advantage.

So it's not lost on us specially me as both the CEO and a major shareholder that the quarter-to-quarter road has pluses and minuses on the surface. I get that, we get that. But the rate of our progress forward, the advancement of our technology or datasets or people, the market expansion that we're seeing in front of us gives us unbelievable incredibly strong confidence and excitement about what we see in front of us.

We've laid the foundation as Tom said, we're aggressively executing against it, we have multiple strategic initiatives and we truly see a very strong and positive path forward in 2017. We appreciate your time, we thank you for your interest and we look forward to keeping you all up to date. Thank you and good night to all of you.

End of Q&A

Operator

Ladies and gentlemen thank you for your participation in today's conference, this does conclude the program and you may now disconnect, everyone have a good day.

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