10-Q 1 a2226451z10-q.htm 10-Q

Table of Contents

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark One)    

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015

or

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to              

Commission File Number 001-36841



INOVALON HOLDINGS, INC.
(Exact name of registrant as specified in its charter)



Delaware
(State or other jurisdiction of
incorporation or organization)
  47-1830316
(I.R.S. Employer
Identification No.)

4321 Collington Road,
Bowie, Maryland

(Address of principal executive offices)

 

20716
(Zip Code)

(301) 809-4000
Registrant's telephone number, including area code

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o   Accelerated filer o   Non-accelerated filer ý
(Do not check if a
smaller reporting company)
  Smaller reporting company o

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No ý

        As of November 3, 2015, the registrant had 49,351,375 shares of Class A common stock outstanding and 101,529,091 shares of Class B common stock outstanding.

   


Table of Contents


INOVALON HOLDINGS, INC.

FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2015


TABLE OF CONTENTS

 
   
  Page  

PART I—FINANCIAL INFORMATION

       

Item 1.

 

Condensed Consolidated Financial Statements (Unaudited)

    1  

 

Condensed Consolidated Balance Sheets

    1  

 

Condensed Consolidated Statements of Income

    2  

 

Condensed Consolidated Statements of Comprehensive Income

    3  

 

Condensed Consolidated Statements of Stockholders' Equity (Deficit)

    4  

 

Condensed Consolidated Statements of Cash Flows

    5  

 

Notes to Condensed Consolidated Financial Statements

    6  

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

    23  

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

    43  

Item 4.

 

Controls and Procedures

    44  

PART II—OTHER INFORMATION

   
 
 

Item 1.

 

Legal Proceedings

    45  

Item 1A.

 

Risk Factors

    45  

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

    45  

Item 3.

 

Defaults Upon Senior Securities

    46  

Item 4.

 

Mine Safety Disclosures

    46  

Item 5.

 

Other Information

    46  

Item 6.

 

Exhibits

    46  

SIGNATURES

   
47
 

Table of Contents


PART I—FINANCIAL INFORMATION

Item 1.    Condensed Consolidated Financial Statements

        


INOVALON HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and par value amounts)

 
  September 30,
2015
  December 31,
2014
 
 
  (Unaudited)
   
 

ASSETS

             

Current assets:

             

Cash and cash equivalents

  $ 166,507   $ 162,567  

Short-term investments

    547,580      

Accounts receivable (net of allowances of $741 and $1,827 at September 30, 2015 and December 31, 2014, respectively)

    93,531     43,938  

Prepaid expenses and other current assets

    16,680     6,015  

Income tax receivable

    22,849     6,797  

Deferred income taxes

    1,436     491  

Total current assets

    848,583     219,808  

Non-current assets:

             

Property, equipment and capitalized software, net

    60,757     50,962  

Goodwill

    136,507     62,269  

Intangible assets, net

    63,397     7,447  

Other assets

    4,136     2,083  

Total assets

  $ 1,113,380   $ 342,569  

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

             

Current liabilities:

             

Accounts payable

  $ 18,758   $ 10,974  

Accrued compensation

    38,750     15,305  

Other current liabilities

    9,619     1,992  

Deferred revenue

    4,566     3,904  

Deferred rent

    763     567  

Credit facilities

    15,000     18,750  

Capital lease obligation

    109     99  

Total current liabilities

    87,565     51,591  

Non-current liabilities:

             

Credit facilities, less current portion

    270,000     281,250  

Capital lease obligation, less current portion

    251     168  

Deferred rent

    2,657     2,619  

Deferred income taxes

    36,005     15,163  

Total liabilities

    396,478     350,791  

Commitments and contingencies (Note 10)

             

Stockholders' equity (deficit):

             

Common stock, $0.000005 par value, 900,000,000 shares authorized, zero shares issued and outstanding at each of September 30, 2015 and December 31, 2014, respectively

         

Class A common stock, $0.000005 par value, 750,000,000 shares authorized, 47,032,571 and 11,109,285 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively

         

Class B common stock, $0.000005 par value, 150,000,000 shares authorized, 103,615,293 and 122,257,145 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively

    1     1  

Preferred stock, $0.0001 par value, 100,000,000 shares authorized, zero shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively

         

Additional paid-in-capital

    486,541     110,317  

Retained earnings

    231,492     181,477  

Treasury stock, at cost, zero shares at September 30, 2015 and 11,109,285 at December 31, 2014

        (300,017 )

Accumulated other comprehensive loss

    (1,132 )    

Total stockholders' equity (deficit)

    716,902     (8,222 )

Total liabilities and stockholders' equity (deficit)

  $ 1,113,380   $ 342,569  

   

See notes to condensed consolidated financial statements.

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INOVALON HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited, in thousands, except per-share amounts)

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2015   2014   2015   2014  

Revenue

  $ 105,459   $ 85,991   $ 316,710   $ 271,622  

Expenses:

                         

Cost of revenue(1)

    38,394     27,579     103,847     85,065  

Sales and marketing(1)

    3,946     2,410     8,173     5,355  

Research and development(1)

    6,283     6,184     17,198     17,376  

General and administrative(1)

    32,437     21,645     82,022     62,920  

Depreciation and amortization

    5,526     5,043     15,253     15,012  

Total operating expenses

    86,586     62,861     226,493     185,728  

Income from operations

    18,873     23,130     90,217     85,894  

Other income and (expenses):

                         

Realized losses on short-term investments

    (329 )       (329 )    

Interest income

    1,184     1     1,807     4  

Interest expense

    (1,110 )   (147 )   (3,318 )   (209 )

Income before taxes

    18,618     22,984     88,377     85,689  

Provision for income taxes

    8,498     9,318     38,362     33,836  

Net income

  $ 10,120   $ 13,666   $ 50,015   $ 51,853  

Net income attributable to common stockholders, basic and diluted

  $ 10,115   $ 13,666   $ 50,003   $ 51,853  

Net income per share attributable to common stockholders, basic and diluted:

                         

Basic net income per share

  $ 0.07   $ 0.10   $ 0.35   $ 0.39  

Diluted net income per share

  $ 0.07   $ 0.10   $ 0.34   $ 0.38  

Weighted average shares of common stock outstanding:

                         

Basic

    148,871     131,779     144,000     133,640  

Diluted

    151,835     134,538     147,409     135,835  

(1)
Includes stock-based compensation expense as follows:

Cost of revenue

  $ 28   $   $ 85   $  

Sales and marketing

    66         122      

Research and development

    292         952      

General and administrative

    1,619     518     4,540     1,340  

Total stock-based compensation expense

  $ 2,005   $ 518   $ 5,699   $ 1,340  

   

See notes to condensed consolidated financial statements.

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INOVALON HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited, in thousands)

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2015   2014   2015   2014  

Net income

  $ 10,120   $ 13,666   $ 50,015   $ 51,853  

Other comprehensive income:

                         

Realized losses on short-term investments reclassified from accumulated other comprehensive income

    (329 )       (329 )    

Net change in unrealized gains and (losses) on available-for-sale investments

    849         (803 )    

Comprehensive income

  $ 10,640   $ 13,666   $ 48,883   $ 51,853  

   

See notes to condensed consolidated financial statements

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INOVALON HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

(Unaudited, in thousands, except share amounts)

 
   
   
   
   
  Issued Class A & B
Common Stock
   
   
   
   
   
   
 
 
  Preferred Stock   Common Stock   Treasury Stock    
   
  Accumulated
Other
Comprehensive
Loss
  Total
Stockholders'
Equity
(Deficit)
 
 
  Additional
Paid-in
Capital
  Retained
Earnings
 
 
  Shares   Amount   Shares   Amount   Shares   Amount   Shares   Amount  

Balance—December 31, 2014

      $       $     133,366,430   $ 1     (11,109,285 ) $ (300,017 ) $ 110,317   $ 181,477   $   $ (8,222 )

Issuance of common stock upon initial public offering, net of offering costs

                    14,255,518                 359,170             359,170  

Issuance of treasury stock upon initial public offering, net of offering costs

                            11,109,285     300,017     (20,115 )           279,902  

Stock compensation expense

                    71,946                 5,581             5,581  

Issuance of common stock related to business combination

                    235,737                 3,847             3,847  

Exercise of stock options

                    2,718,233                 11,702             11,702  

Tax benefit from exercise of non-qualified stock options

                                    16,039             16,039  

Other comprehensive loss

                                            (1,132 )   (1,132 )

Net income

                                        50,015         50,015  

Balance—September 30, 2015

      $       $     150,647,864   $ 1       $   $ 486,541   $ 231,492   $ (1,132 ) $ 716,902  

   

See notes to condensed consolidated financial statements.

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INOVALON HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 
  Nine Months Ended
September 30,
 
 
  2015   2014  

Cash flows from operating activities:

             

Net income

  $ 50,015   $ 51,853  

Adjustments to reconcile net income to net cash provided by operating activities:

             

Stock-based compensation expense, (inclusive of $118 and $0, respectively, of ESPP expense)

    5,699     1,340  

Depreciation

    13,683     11,185  

Amortization of intangibles

    1,570     3,827  

Amortization/accretion of premiums or discounts on short-term investments

    1,315      

Realized losses on short-term investments

    329      

Tax payments for equity award issuances

    582      

Excess tax benefits from share-based compensation

    (16,039 )    

Deferred income taxes

    (714 )   (230 )

Loss on disposal of long-lived assets

    116      

Impairment of long-lived assets

        109  

Loss on impairment of long-lived assets

        165  

Changes in assets and liabilities:

             

Accounts receivable

    (36,581 )   (18,638 )

Prepaid expenses and other current assets

    (1,628 )   (2,620 )

Income taxes receivable

    4,663     (1,547 )

Other assets

    (1,895 )   (822 )

Accounts payable

    4,890     1,455  

Accrued compensation

    18,691     3,513  

Other liabilities

    796     1,076  

Deferred rent

    (398 )   (153 )

Deferred revenue

    (938 )   (665 )

Net cash provided by operating activities

    44,156     49,848  

Cash flows from investing activities:

             

Acquisition, net of cash acquired of $4,037

    (114,015 )    

Escrow funding associated with acquisition

    (7,875 )    

Purchases of short-term investments

    (783,485 )    

Maturities and sales of short-term investments

    233,130      

Purchases of property and equipment

    (4,539 )   (6,347 )

Investment in capitalized software

    (14,557 )   (11,283 )

Proceeds from sale of property and equipment

    (24 )   22  

Net cash used in investing activities

    (691,365 )   (17,608 )

Cash flows from financing activities:

             

Proceeds from issuance of common stock, net of underwriters' discount

    362,082      

Proceeds from issuance of treasury stock, net of underwriters' discount

    282,172      

Payment of offering costs

    (5,182 )    

Proceeds from credit facility borrowings

        300,000  

Repayment of credit facility borrowings

    (15,000 )    

Repurchase of common stock

        (309,083 )

Dividends paid

        (2,852 )

Capital lease obligations paid

    (82 )   (101 )

Tax for equity award issuances

    (582 )    

Excess tax benefits from share-based compensation

    16,039     429  

Proceeds from exercise of stock options

    11,702     720  

Net cash provided by (used in) financing activities

    651,149     (10,887 )

Increase in cash and cash equivalents

    3,940     21,353  

Cash and cash equivalents, beginning of period

    162,567     110,594  

Cash and cash equivalents, end of period

  $ 166,507   $ 131,947  

Supplementary cash flow disclosure:

             

Cash paid during the period for:

             

Income taxes, net of refunds

  $ 34,705   $ 35,186  

Interest

    3,304      

Non-cash investing activities:

             

Capital lease obligations incurred

    175     14  

Accounts payable for purchases of and investment in property, equipment and capitalized software

    2,089     1,606  

Accrued compensation for investment in capitalized software

    910     189  

   

See notes to condensed consolidated financial statements.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND BASIS OF PRESENTATION

        Inovalon Holdings, Inc., (the "Company"), is a leading technology company that combines advanced cloud-based data analytics and data-driven intervention platforms to achieve meaningful impact in clinical and quality outcomes, utilization, and financial performance across the healthcare landscape. The value that the Company delivers to its clients is achieved by turning data into insights and those insights into action. Through the Company's large proprietary datasets, advanced integration technologies, sophisticated predictive analytics, and deep subject matter expertise, the Company delivers seamless, end-to-end platforms that bring the benefits of big data and large-scale analytics to the point of care. The Company's analytics platforms identify gaps in care, quality, data integrity, and financial performance, in its clients' datasets. The Company's data-driven intervention platforms enable clients to take the insights derived from the analytics and implement unique, patient-level solutions, drive impact and enhance patient engagement.

        On February 18, 2015, the Company completed its initial public offering of 22,222,222 shares of Class A common stock and, upon the underwriters' exercise of their option to purchase additional shares, issued an additional 3,142,581 shares of Class A common stock for a total of 25,364,803 shares issued (the "IPO"). All of the shares issued in the IPO were primary shares offered by the Company as none of the Company's stockholders sold any shares in the IPO. The offering price of the shares sold in the IPO was $27.00 per share, resulting in net proceeds to the Company, after the underwriters' discounts and commissions and other expenses, payable by the Company, of approximately $639.1 million.

        On September 1, 2015, the Company acquired Avalere Health, Inc. ("Avalere") and has included its financial position into the Company's condensed consolidated financial statements as of that date. The preliminarily estimated fair values of the tangible and intangible assets acquired and liabilities assumed in connection with the purchase of Avalere have been recognized in the accompanying condensed consolidated balance sheet as of September 30, 2015, based upon their preliminarily estimated fair values on September 1, 2015. The excess of the acquisition consideration over the preliminary fair values of the net tangible and intangible assets was recorded as goodwill. The preliminary fair values recorded were based upon estimates and assumptions used in the Company's valuation methodology. These estimates and assumptions are subject to change during the measurement period, (up to one year from the acquisition date), and such changes, if any, may have a significant impact on the condensed consolidated financial statements (See Note 3 for further information).

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

1. ORGANIZATION AND BASIS OF PRESENTATION (Continued)

        The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial reporting and as required by Rule 10-01 of Regulation S-X. Accordingly, the unaudited condensed consolidated financial statements may not include all of the annual information and notes required by GAAP pursuant to such rules and regulations. In the opinion of the Company's management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of items of a normal and recurring nature, necessary to present fairly the Company's financial position as of September 30, 2015 and the results of operations, comprehensive income for the three and nine month periods ended September 30, 2015 and 2014, and cash flows for the nine month periods ended September 30, 2015 and 2014. The results of operations for the three and nine month periods ended September 30, 2015 are not necessarily indicative of the results to be expected for the full year. The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets and liabilities, disclosures of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenue and expenses during the reported period. Significant estimates made by management include, but are not limited to: revenue recognition, specifically selling prices associated with the individual elements in multiple element arrangements and percentage of completion estimates on fixed price contracts; accounts receivable allowances; estimates of the fair value of the Company's pre-IPO common stock and the related estimates of the fair value of stock-based awards; fair value of intangibles and goodwill; depreciable lives of property, equipment and capitalized software; and useful lives of intangible assets. Actual results could differ from management's estimates, and such differences could be material to the Company's condensed consolidated financial position and results of operations. The Company's management considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated through the date of issuance of these condensed consolidated financial statements.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(in thousands)

        Deferred IPO Issuance Costs—The Company capitalizes IPO costs, which primarily consist of direct incremental legal and accounting fees relating to the IPO. The IPO issuance costs were offset against IPO proceeds directly following the consummation of the IPO that occurred during February 2015. As of September 30, 2015, there were no deferred IPO issuance costs, and as of December 31, 2014, there was $2,888 deferred as prepaid expenses and other current assets.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(in thousands) (Continued)

        Short-term investments—The Company classifies short-term investments as available-for-sale at the time of purchase and reevaluates such classification as of each balance sheet date. All short-term investments are recorded at estimated fair value. Unrealized gains and losses for available-for-sale securities are included in accumulated other comprehensive loss, a component of stockholders' equity. The Company evaluates its investments to assess whether those with unrealized loss positions are other than temporarily impaired. The Company considers impairments to be other-than-temporary if they are related to deterioration in credit risk, if it is more likely than not that the Company will be required to or if the Company intends to sell the securities before the recovery of their cost basis. Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported as components of other income and (expenses), in the condensed consolidated statements of income. Interest, amortization of premiums, and accretion of discount on short-term investments classified as available for sale are included as a component of interest income, in the condensed consolidated statements of income.

        The Company may sell short-term investments at any time, without significant penalty, for use in current operations or for other purposes, even if the short-term investments have not yet reached maturity. As a result, the Company classifies these investments, including securities with maturities beyond 12 months, as current assets in the accompanying condensed consolidated balance sheets.

        Recently Issued Accounting Standards—In May 2014, the Financial Accounting Standards Board ("FASB") issued updated guidance on revenue from contracts with customers. This revenue recognition guidance supersedes existing GAAP guidance, including most industry-specific guidance. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance identifies steps to apply in achieving this principle. On July 9, 2015, the FASB approved a one year deferral of the effective date of ASU 2014-09 to January 1, 2018. ASU 2014-09 may be applied either retrospectively or through the use of a modified-retrospective method. We are currently evaluating both methods of adoption as well as the effect ASU 2014-09 will have on the Company's condensed consolidated financial position, annual results of operations and cash flows.

        In April 2015, the FASB issued ASU No. 2015-03, "Simplifying the Presentation of Debt Issuance Costs." This standard amends existing guidance to require the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of a deferred charge. It is effective for annual reporting periods beginning after December 15, 2015, but early adoption is permitted. The Company is currently evaluating the impact that the adoption of this standard will have on the Company's financial disclosures and results.

        In September 2015, the FASB issued ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments ("ASU No. 2015-16"). ASU No. 2015-16 requires, for business combinations, that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. ASU No. 2015-16 is effective for fiscal years beginning after December 15, 2015.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

3. BUSINESS COMBINATIONS (in thousands, except share amounts)

        On September 1, 2015 (the "Acquisition Date"), pursuant to the provisions of the Share Purchase Agreement (the "Purchase Agreement"), the Company acquired 100 percent of the stock of Avalere. Avalere is a provider of data-driven advisory services and business intelligence solutions primarily to the pharmaceutical and life sciences industry. Certain portions of the stated purchase price of $140,000 are contingent upon the achievement of financial and operational objectives, and other portions are subject to continued employment provisions. The Company completed the acquisition of Avalere through the use of cash on hand and the issuance of 235,737 shares, subject to sale restrictions, of Class A common stock. The addition of Avalere, with its more than 200 pharmaceutical and life sciences clients, is expected to expand Inovalon's capabilities and client base into the expansive and adjacent markets of the pharmaceutical and life sciences industry.

        A summary of the composition of the stated purchase price and fair value of the stated purchase price is as follows:

Share Purchase Agreement purchase price

  $ 140,000  

Working capital adjustment

    2,300  

Subtotal

    142,300  

Fair Value Adjustments:

       

Restricted stock marketability discount

    (1,153 )

Performance objectives discount from maximum value

    (600 )

Post-acquisition compensation expense

    (16,249 )

Total fair value purchase price

  $ 124,298  

        The composition of the fair value purchase price is as follows:

Cash

  $ 118,051  

Issuance of Class A common stock

    3,847  

Contingent consideration

    2,400  

Total fair value purchase price

  $ 124,298  

Preliminary Recording of Assets Acquired and Liabilities Assumed

        Estimates of fair value included in the condensed consolidated financial statements, in conformity with ASC No. 820, Fair Value Measurements and Disclosures, represent the Company's best estimates and valuations developed with the assistance of independent appraisers and, where the following have not yet been completed or are not available, industry data and trends and by reference to relevant market rates and transactions. The following estimates and assumptions are inherently subject to significant uncertainties and contingencies beyond the control of the Company. Accordingly, the Company cannot provide assurance that the estimates, assumptions, and values reflected in the valuations will be realized, and actual results could vary materially. In accordance with ASC No. 805, Business Combinations, the allocation of the consideration value is subject to additional adjustment until the Company has completed its analysis, but not to exceed one year after the date of acquisition, which was September 1, 2015, to provide the Company with the time to complete the valuation of its assets and liabilities.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

3. BUSINESS COMBINATIONS (in thousands, except share amounts) (Continued)

        The following table summarizes the preliminary purchase price allocation to assets acquired and liabilities assumed:

Cash and cash equivalents

  $ 4,037  

Accounts receivable

    13,011  

Current assets

    1,958  

Property, equipment and capitalized software

    3,248  

Intangible assets(1)

    57,520  

Goodwill(2)

    74,238  

Deferred income taxes

    947  

Other assets

    224  

Total assets acquired

    155,183  

Current liabilities

    (11,054 )

Deferred tax liability

    (17,677 )

Deferred revenue

    (1,600 )

Other liabilities

    (554 )

Total liabilities assumed

    (30,885 )

Net assets acquired

  $ 124,298  

(1)
Identifiable intangible assets were measured using a combination of an income approach and a market approach.

(2)
Goodwill is the excess of the consideration transferred over the net assets recognized and represents the future economic benefits, primarily as a result of other assets acquired that could not be individually identified and separately recognized. Goodwill is not amortized and is not deductible for tax purposes.

        The preliminary amounts attributed to identified intangible assets are summarized in the table below:

 
  Weighted
Average
Useful Life
  Total  

Customer relationships

  10 years   $ 45,800  

Tradename

  10 years     8,300  

Technology

  5 years     2,600  

Non-compete agreements

  3 years     820  

Total intangible assets

      $ 57,520  

        Acquisition-related costs were expensed as incurred. For the three and nine months ended September 30, 2015, the Company incurred acquisition-related costs of $1,330 recognized within "General and administrative" expenses in the accompanying condensed consolidated statements of income.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

3. BUSINESS COMBINATIONS (in thousands, except share amounts) (Continued)

Avalere Results and Pro Forma Impact of Acquisition

        The following table presents revenue and income (loss) before taxes of Avalere since the acquisition date, September 1, 2015, included in the condensed consolidated statements of income:

 
  Total  

Revenue

  $ 4,195  

Income (loss) before taxes

  $ (278 )

        The following table presents pro forma information, based on estimates and assumptions that the Company believes to be reasonable, for the Company as if the acquisition of Avalere had occurred at the beginning of the earliest period presented:

 
  Nine Months Ended
September 30,
 
 
  2015   2014  

Pro forma revenue

  $ 349,222   $ 305,319  

Pro forma income before taxes

  $ 80,822   $ 78,178  

        The pro forma information provided in the table above is not necessarily indicative of the condensed consolidated results of operations for future periods or the results that actually would have been realized had the acquisition been completed at the beginning of the periods presented.

4. NET INCOME PER SHARE(in thousands, except per share amounts)

        During September 2014, the Company completed a holding company reorganization. As part of the reorganization, the Company implemented a multi-class stock structure. The Company has retrospectively presented the impact on net income per share (EPS) of this reorganization by calculating EPS based on the newly authorized, issued and outstanding shares of Class A and Class B common stock. Holders of all outstanding classes of common stock participate ratably in earnings on an identical per share basis as if all shares were a single class.

        The Company has issued restricted share awards of Class A common stock (RSAs) under the 2015 Omnibus Incentive Plan. The Company considers issued and unvested RSAs to be participating securities as the holders of these RSAs have a non-forfeitable right to dividends in the event of the Company's declaration of a dividend on shares of Class A and Class B common stock. Subsequent to the issuance of the participating securities, the Company applied the two-class method required in calculating net income per share of Class A and Class B common stock.

        Undistributed net income for a given period is apportioned to participating securities based on the weighted-average shares of each class of common stock outstanding during the applicable period as a percentage of the total weighted-average shares outstanding during the same period.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. NET INCOME PER SHARE(in thousands, except per share amounts) (Continued)

        Under the two-class method, net income attributable to common stockholders is determined by allocating undistributed earnings, calculated as net income, less earnings attributable to participating securities. The net income per share attributable to common stockholders is allocated based on the contractual participation rights of the Class A common stock and Class B common stock as if the income for the period has been distributed. As the liquidation and dividend rights are identical for both classes of common stock, the net income attributable to common stockholders is allocated on a proportionate basis.

        Basic net income per share of common stock is computed by dividing the net income attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period. All participating securities are excluded from the basic weighted-average shares of common stock outstanding. Unvested RSAs are excluded from the calculation of the weighted-average shares of common stock until vesting occurs, as the restricted shares are subject to forfeiture and cancellation until vested.

        Diluted net income per share attributable to common stockholders is computed by dividing net income attributable to common stockholders by the weighted-average shares outstanding, including potentially dilutive shares of common stock assuming the dilutive effect of potential shares of common stock for the period determined using the treasury stock method.

        For purposes of the diluted net income per share attributable to common stockholders calculation, unvested shares of common stock resulting from RSAs are considered to be potentially dilutive shares of common stock.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. NET INCOME PER SHARE(in thousands, except per share amounts) (Continued)

        The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows:

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2015   2014   2015   2014  

Basic

                         

Numerator:

                         

Net income

  $ 10,120   $ 13,666   $ 50,015   $ 51,853  

Undistributed earnings allocated to participating securities

    (5 )       (12 )    

Net income attributable to common stockholders—basic

  $ 10,115   $ 13,666   $ 50,003   $ 51,853  

Denominator:

                         

Weighted average shares used in computing net income per share attributable to common stockholders—basic

    148,871     131,779     144,000     133,640  

Net income per share attributable to common stockholders—basic

  $ 0.07   $ 0.10   $ 0.35   $ 0.39  

Diluted

   
 
   
 
   
 
   
 
 

Numerator:

                         

Net income attributable to common stockholders—diluted

  $ 10,115   $ 13,666   $ 50,003   $ 51,853  

Denominator:

                         

Number of shares used for basic EPS computation

    148,871     131,779     144,000     133,640  

Effect of dilutive securities

    2,964     2,759     3,409     2,195  

Weighted average shares used in computing net income per share attributable to common stockholders—diluted

    151,835     134,538     147,409     135,835  

Net income per share attributable to common stockholders—diluted

  $ 0.07   $ 0.10   $ 0.34   $ 0.38  

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. NET INCOME PER SHARE (in thousands, except per share amounts) (Continued)

        The computation of diluted EPS does not include certain unvested awards, for the three and nine months ended September 30, 2015 and 2014, because their inclusion would have an anti-dilutive effect on EPS. The awards excluded because of their anti-dilutive effect are as follows:

 
  Three Months
Ended
September 30,
  Nine Months
Ended
September 30,
 
 
  2015   2014   2015   2014  

Awards excluded from the computation of diluted net income per share because their inclusion would have been anti-dilutive

    137     650     92     650  

5. SHORT-TERM INVESTMENTS (in thousands)

        As of September 30, 2015, short-term investments consisted of the following:

 
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Estimated
Fair Value
 

Available-for-sale securities:

                         

Corporate notes and bonds

  $ 363,643   $ 68   $ (1,270 ) $ 362,441  

U.S. agency obligations

    102,981     69     (15 )   103,035  

U.S. treasury securities

    51,199     29         51,228  

Commercial paper

    22,946     1     (3 )   22,944  

Certificates of deposit

    7,930     3     (1 )   7,932  

Total available-for-sale securities

  $ 548,699   $ 170   $ (1,289 ) $ 547,580  

        As of December 31, 2014, the Company held no short-term investments.

        The following table summarizes the estimated fair value of our short-term investments, designated as available-for-sale and classified by the contractual maturity date of the securities as of the dates shown:

 
  September 30,
2015
  December 31,
2014
 

Due in one year or less

  $ 143,108   $  

Due in greater than one year

    404,472      

Total

  $ 547,580   $  

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

5. SHORT-TERM INVESTMENTS (in thousands) (Continued)

        The Company has certain available-for-sale securities in a gross unrealized loss position, all of which have been in such position for less than 12 months. The Company reviews its debt securities classified as short-term investments on a regular basis to evaluate whether or not any security has experienced an other-than-temporary decline in fair value. The Company considers factors such as the length of time and extent to which the market value has been less than the cost, the financial position and near-term prospects of the issuer and the Company's intent to sell, or whether it is more likely than not the Company will be required to sell the investment before recovery of the investment's amortized-cost basis. If the Company determines that an other-than-temporary decline exists, or if write downs related to credit losses are necessary, in one of these securities, the unrealized losses attributable to the respective investment would be reclassified to realized losses on short-term investments within the statement of income. There were no impairments considered other-than-temporary as of September 30, 2015.

        The following table shows the fair values and the gross unrealized losses of available-for-sale securities that have been in a gross unrealized loss position for less than 12 months, aggregated by investment category as of September 30, 2015:

 
  Estimated
Fair Value
  Gross
Unrealized
Losses
 

Corporate notes and bonds

  $ 337,214   $ (1,270 )

U.S. agency obligations

    27,583     (15 )

Commercial paper

    12,962     (3 )

Certificates of deposit

    2,642     (1 )

  $ 380,401   $ (1,289 )

6. FAIR VALUE MEASUREMENTS (in thousands)

        The carrying amounts of accounts receivable and other current assets, accounts payable and accrued liabilities approximate fair value due to their short-term nature. The Company's Credit Facilities (as defined in Note 9 below) approximate fair value because of their floating rate structure.

        Financial assets and financial liabilities recorded at fair value in the condensed consolidated financial statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, which are directly related to the amount of subjectivity associated with the inputs to the valuation of these assets or liabilities are as follows:

    Level 1—Observable inputs, such as quoted prices in active markets for identical assets or liabilities.

    Level 2—Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

    Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

6. FAIR VALUE MEASUREMENTS (in thousands) (Continued)

        Financial assets and financial liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgments and factors specific to the asset or liability.

        The following table presents the fair value hierarchy for financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2015:

 
  Level 1   Level 2   Level 3   Total  

Cash Equivalents:

                         

Money market funds

  $ 5,132   $   $   $ 5,132  

Corporate notes and bonds

        16,015         16,015  

U.S. agency obligations

        17,498         17,498  

Commercial paper

        27,296         27,296  

Certificates of deposit

        2,402         2,402  

Short-term investments:

                         

Corporate notes and bonds

        362,441         362,441  

U.S. agency obligations

        103,035         103,035  

U.S. treasury securities

        51,228         51,228  

Commercial paper

        22,944         22,944  

Certificates of deposit

        7,932         7,932  

Other Current Liabilities:

                         

Contingent consideration

            2,400     2,400  

Total

  $ 5,132   $ 610,791   $ 2,400   $ 618,323  

        The Company determines the fair value of its security holdings based on pricing from its pricing vendors. The valuation techniques used to measure the fair value of financial instruments having Level 2 inputs were derived from non-binding consensus prices that are corroborated by observable market data or quoted market prices for similar instruments. Such market prices may be quoted prices in active markets for identical assets (Level 1 inputs) or pricing determined using inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs). The Company performs procedures to ensure that appropriate fair values are recorded such as comparing prices obtained from other sources.

        On September 1, 2015, the Company recorded contingent consideration at its fair value in conjunction with the acquisition of Avalere. The Company determines fair value of its contingent consideration, using Level 3 inputs under the fair value hierarchy, consisting of information provided by observing certain operating metrics along with management's own assumptions. The Company adjusts the estimated fair value of its contingent consideration quarterly. The change in value is reflected in our Statements of Income as gain (loss) from contingent consideration valuation as a component of other income and expenses. During the three and nine months ended September 30, 2015 the fair value of the Company's contingent consideration did not change.

        As of December 31, 2014, the Company measured its money market investment balances, included in cash and cash equivalents, at fair value based on quoted prices that are equivalent to cost (Level 1);

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

6. FAIR VALUE MEASUREMENTS (in thousands) (Continued)

the Company did not have any assets measured at fair value on a recurring basis using significant other observable inputs (Level 2), or significant unobservable inputs (Level 3), or any liabilities measured at fair value as prescribed by ASC 820-10.

7. PROPERTY, EQUIPMENT AND CAPITALIZED SOFTWARE (in thousands)

        Property, equipment and capitalized software consisted of the following:

 
  September 30,
2015
  December 31,
2014
 

Office and computer equipment

  $ 26,451   $ 23,844  

Leasehold improvements

    12,428     11,999  

Purchased software

    11,320     9,916  

Capitalized software

    51,432     39,432  

Furniture and fixtures

    5,371     4,894  

Land

    390     390  

Building

    1,797     1,750  

Work in process

    7,960     2,917  

Total

    117,149     95,142  

Less: accumulated depreciation and amortization

    (56,392 )   (44,180 )

Property, equipment and capitalized software, net

  $ 60,757   $ 50,962  

        The Company leases certain office equipment under capital lease agreements, with bargain purchase options at the end of the lease term. Leased office equipment included in property and equipment and capitalized software, net, at September 30, 2015 and December 31, 2014 was $660 and $961, respectively.

        Depreciation expense for the three months ended September 30, 2015 and 2014 was $4,759 and $4,182, respectively, and $13,683 and $11,185 for the nine months ended September 30, 2015 and 2014, respectively. Amortization of the capital leases included in depreciation expense was $32 and $34 for the three months ended September 30, 2015 and 2014, respectively, and $85 and $102 for the nine months ended September 30, 2015 and 2014, respectively. At September 30, 2015 and December 31, 2014, the Company had unamortized capitalized software costs, including costs classified as work in progress, of $36,560 and $28,417, respectively.

        At September 30, 2015 and December 31, 2014, work in process consisted primarily of purchased software licenses, computer equipment, and capitalized software, which was not placed into service.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

8. GOODWILL AND INTANGIBLE ASSETS (in thousands, except years)

Goodwill

        The following is a summary of the change in goodwill from December 31, 2014 through September 30, 2015:

 
  Goodwill  

December 31, 2014

  $ 62,269  

Acquisition of Avalere

    74,238  

September 30, 2015

  $ 136,507  

Intangible Assets

        Intangible assets as of September 30, 2015 were as follows:

 
  September 30, 2015  
 
  Gross   Accumulated
Amortization
  Net   Weighted
Average Remaining
Useful Life (years)
 

Proprietary software technologies

  $ 16,077   $ (16,077 ) $      

Trademark

    360     (360 )        

Database

    6,500     (3,934 )   2,566     4.0  

Customer relationships

    13,650     (9,832 )   3,818     9.7  

Avalere acquisition (see Note 3):

                         

Customer Relationships

    45,800     (420 )   45,380     9.9  

Tradename

    8,300     (57 )   8,243     9.9  

Technology

    2,600     (7 )   2,593     5.9  

Non-compete agreements

    820     (23 )   797     2.9  

Total

  $ 94,107   $ (30,710 ) $ 63,397        

        Intangible assets as of December 31, 2014 were as follows:

 
  December 31, 2014  
 
  Gross   Accumulated
Amortization
  Net   Weighted
Average Remaining
Useful Life (years)
 

Proprietary software technologies

  $ 16,077   $ (15,796 ) $ 281     0.3  

Trademark

    360     (360 )        

Database

    6,500     (3,447 )   3,053     4.8  

Customer relationships

    13,650     (9,537 )   4,113     10.4  

Total

  $ 36,587   $ (29,140 ) $ 7,447        

        Amortization expense for the three months ended September 30, 2015 and 2014 was $767 and $861, respectively, and $1,570 and $3,827 for the nine months ended September 30, 2015 and 2014, respectively.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

8. GOODWILL AND INTANGIBLE ASSETS (in thousands, except years) (Continued)

        Estimated future amortization expense of intangible assets, based upon the Company's intangible assets at September 30, 2015, is as follows:

 
  Amount  

Year ending December 31:

       

Remainder of 2015

  $ 1,780  

2016

    3,473  

2017

    5,699  

2018

    6,365  

2019

    6,557  

Thereafter

    39,523  

Total

  $ 63,397  

9. CREDIT FACILITIES (in thousands)

        On September 19, 2014, the Company entered into a Credit and Guaranty Agreement, with a group of lenders including Goldman Sachs Bank USA, as administrative agent, to provide credit facilities in the aggregate maximum principal amount of $400,000, consisting of a senior unsecured term loan facility in the original principal amount of $300,000 (the "Term Loan Facility"), and a senior unsecured revolving credit facility in the maximum principal amount of $100,000 (the "Revolving Credit Facility"), (together with the Term Loan Facility, the "Credit Facilities").

        The Credit Facilities consisted of the following:

 
  September 30,
2015
  December 31,
2014
 

Revolving Credit Facility

  $   $  

Term Loan Facility

    285,000     300,000  

Total Credit Facilities

    285,000     300,000  

Less: current portion

    15,000     18,750  

Non-current Credit Facilities

  $ 270,000   $ 281,250  

        The Revolving Credit Facility, with a maximum principal amount of $100,000, became available to the Company on February 18, 2015, upon the consummation of its IPO.

        As of September 30, 2015 and December 31, 2014, the Company was in compliance with the financial covenants of the Credit Facilities.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

9. CREDIT FACILITIES (in thousands) (Continued)

        Scheduled maturity of the Credit Facilities as of September 30, 2015 follows:

 
  Amount  

Year ending December 31:

       

Remainder of 2015

  $ 3,750  

2016

    15,000  

2017

    30,000  

2018

    45,000  

2019

    191,250  

Total

  $ 285,000  

        During the nine months ended September 30, 2015, the Company paid $15,000 for the scheduled maturity of the outstanding principal on the Credit Facilities.

10. COMMITMENTS AND CONTINGENCIES (in thousands)

        Operating Leases—The Company leases office space under operating lease arrangements, some of which contain renewal options. Future non-cancellable lease payments as of September 30, 2015 were as follows:

 
  Amount  

Year ending December 31,

       

Remainder of 2015

  $ 2,079  

2016

    8,141  

2017

    7,960  

2018

    6,772  

2019

    2,778  

Total

  $ 27,730  

        Total expense under operating leases was $1,854, and $1,864 during the three months ended September 30, 2015 and 2014, respectively, and $5,054 and $5,663 for the nine months ended September 30, 2015 and 2014, respectively. Certain operating leases contain rent escalation clauses, which are recorded on a straight-line basis over the initial term of the lease, with the difference between the rent paid and the straight-line rent recorded as a deferred rent liability. Lease incentives received from landlords are recorded as deferred rent liabilities and are amortized on a straight-line basis over the lease term as a reduction to rent expense. The deferred rent liability was $3,420 and $3,186 at September 30, 2015 and December 31, 2014, respectively.

        Capital Leases—The total capital lease liability at September 30, 2015 and December 31, 2014 was $360 and $267, respectively, which approximates fair value due to the short duration of the obligations.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. COMMITMENTS AND CONTINGENCIES (in thousands) (Continued)

        Litigation—From time to time, the Company is involved in various litigation matters arising out of the normal course of business. The Company consults with legal counsel on those issues related to litigation and seeks input from other experts and advisors with respect to such matters. Estimating the probable losses or a range of probable losses resulting from litigation, government actions and other legal proceedings is inherently difficult and requires an extensive degree of judgment, particularly where the matters involve indeterminate claims for monetary damages, may involve discretionary amounts, present novel legal theories, are in the early stages of the proceedings, or are subject to appeal. Whether any losses, damages or remedies ultimately resulting from such matters could reasonably have a material effect on the Company's business, financial condition, results of operation, or cash flows will depend on a number of variables, including, for example, the timing and amount of such losses or damages (if any) and the structure and type of any such remedies. The Company's management does not presently expect any litigation matters to have a material adverse impact on the condensed consolidated financial statements of the Company.

11. STOCK-BASED COMPENSATION (in thousands, except share and per share amounts, and percentages)

        On February 18, 2015, the date of the completion of the Company's IPO, the Company's 2015 Omnibus Incentive Plan (the "2015 Plan") became effective. The 2015 Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), to the Company's employees and any parent and subsidiary employees, and for the grant of non-qualified stock options, stock appreciation rights, restricted stock, RSAs, RSUs, dividend equivalent rights, cash-based awards (including annual cash incentives and long-term cash incentives), and any combination thereof to the Company's employees, directors, and consultants and to employees, directors, and consultants of certain affiliated entities. The Company reserved for issuance under the 2015 Plan shares of its Class A common stock equal to the sum of: (i) 7,335,430 shares of Class A common stock; and (ii) the number of shares of its Class A common stock underlying awards granted under the Company's 2007 Long-Term Incentive Plan, which was terminated upon completion of the IPO, that are forfeited, canceled, or expire (whether voluntarily or involuntarily).

Restricted Stock Awards

        On May 28, 2015, the Company granted 71,946 RSAs pursuant to the 2015 Plan. RSAs granted to directors fully vest upon the one year anniversary of the award grant date, and RSAs granted to employees vest ratably over five years on each anniversary of the award grant date. Upon vesting, the Company will deliver shares of the Company's Class A common stock to the holders. Pursuant to the terms of the awards, any unvested shares terminate upon the RSA holders' separation from the Company. The grant date fair value of the RSAs was $2,000, in aggregate, or $27.80 per RSA. The Company will recognize share-based compensation expense following the straight-line method, net of estimated forfeitures, over the requisite service period. The Company estimates future forfeitures at the date of grant and revises the estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

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INOVALON HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

11. STOCK-BASED COMPENSATION (in thousands, except share and per share amounts, and percentages) (Continued)

Restricted Stock Units

        On March 5, 2015, the Company granted 76,273 RSUs pursuant to the 2015 Plan. The awards granted vest ratably over five years on each anniversary of the award grant date, and upon vesting, the Company will deliver to the holder shares of the Company's Class A common stock under the 2015 Plan. Pursuant to the terms of the awards, any unvested shares terminate upon the RSU holders' separation from the Company. The grant date fair value of the RSUs was $2,337, in aggregate, or $30.64 per RSU. The Company will recognize share-based compensation expense following the straight-line method, net of estimated forfeitures, over the requisite service period. The Company estimates future forfeitures at the date of grant and revises the estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Employee Stock Purchase Plan

        On February 18, 2015, the date of the completion of the Company's IPO, the 2015 Employee Stock Purchase Plan ("2015 ESPP") became effective. The 2015 ESPP provides for six-month purchase periods (commencing each March 1 and September 1) and that the purchase price for shares of Class A common stock purchased under the 2015 ESPP will be 85% of the fair market value of the Company's Class A common stock on the last day of the applicable offering period. Eligible employees are able to select a rate of payroll deduction between 1% and 15% of their base cash compensation subject to a maximum payroll deduction per offering period of $7,500. The 2015 ESPP is intended to qualify as an employee stock purchase plan under Section 423 of the Code. The Company reserved 1,833,857 shares of Class A common stock for issuance under the 2015 ESPP. During the three months ended September 30, 2015, the Company purchased and issued 30,689 shares of common stock to 2015 ESPP participants at a discounted price of $18.61 per share.

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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the Securities and Exchange Commission (the "SEC") on March 31, 2015. Unless we otherwise indicate or the context requires, references to the "Company," "Inovalon," "we," "our," and "us" refer to Inovalon Holdings, Inc. and its consolidated subsidiaries.

Note Regarding Forward-Looking Statements

        This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements contained in this Quarterly Report other than statements of historical fact, including but not limited to statements regarding our future results of operations and financial position, our business strategy and plans, market growth, and our objectives for future operations, are forward-looking statements. The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives and financial needs. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

        Factors that may cause actual results to differ from expected results include, among others:

    our future financial performance, including our ability to continue and manage our growth;

    our ability to retain our client base;

    the effect of the concentration of our revenue among our top clients;

    our ability to innovate and adapt our platforms and toolsets;

    the effects of regulations applicable to us, including regulations relating to data protection and data privacy;

    the effects of consolidation in the managed care industry;

    the ability to successfully integrate our acquisitions and the ability of the acquired business to perform as expected;

    the successful implementation and adoption of new platforms, products and solutions;

    the effects of changes in tax legislation for jurisdictions within which we operate;

    the ability to protect the privacy of our clients' data and prevent security breaches;

    the effect of competition on our business; and

    the efficacy of our platforms and toolsets.

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        Forward-looking statements are only current predictions and are subject to known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from those anticipated by such statements. These factors include, among other factors, those set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, under the heading Part I, Item 1A, "Risk Factors".

        You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to, and we disclaim any obligation to, update any of these forward-looking statements after the date of this Quarterly Report or to conform these statements to actual results or revised expectations.


Overview

        We are a leading technology company that combines advanced cloud-based data analytics and data-driven intervention platforms to achieve meaningful impact in clinical and quality outcomes, utilization, and financial performance across the healthcare landscape. We deliver value to our clients by turning data into insights and those insights into action. Currently, our clients include health plans, hospitals, physicians, patients, pharmaceutical companies and researchers.

        Our large proprietary datasets, advanced integration technologies, sophisticated predictive analytics, and deep subject matter expertise allow us to provide seamless, end-to-end platforms that bring the benefits of big data and large-scale analytics to the point of care. Our data analytics platforms identify gaps in care, quality, data integrity, and financial performance in our clients' datasets. Our data-driven intervention platforms enable our clients to take the insights derived from the analytics and implement unique, patient-level solutions, drive impact and enhance patient engagement. Through these capabilities, and those of our subsidiary Avalere, which offers data-driven advisory services and business intelligence to more than 200 pharmaceutical and life sciences enterprises, we are able to drive high-value impact, improving quality and economics for health plans, accountable care organizations ("ACOs"), hospitals, physicians, consumers and pharma/life-sciences researchers.

        We generate the substantial majority of our revenue through the sale or subscription licensing of our cloud-based data analytics and data-driven intervention platform services. Since our inception, we have experienced significant growth.

        Our revenue for the three and nine months ended September 30, 2015, was $105.5 million and $316.7 million, respectively, representing 23% and 17% growth over the three and nine months ended September 30, 2014, respectively. Net income for the three and nine months ended September 30, 2015 was $10.1 million and $50.0 million, respectively, representing 10% and 16% of revenue for the three and nine months, respectively. For the three and nine months ended September 30, 2015, we generated Adjusted EBITDA of $29.0 million and $113.8 million, respectively, compared with $28.7 million and $103.1 million for the same periods, respectively, in the prior year, and generated an Adjusted EBITDA margin of 27.5% and 35.9% for the three and nine months ended September 30, 2015, respectively. Non-GAAP net income for the three and nine months ended September 30, 2015 was $13.0 million and $55.6 million, respectively, representing 12% and 18% of revenue, respectively. Adjusted EBITDA, Adjusted EBITDA margin, and Non-GAAP net income are measures that are not presented in accordance with GAAP. For a reconciliation of net income to Adjusted EBITDA and Non-GAAP net income, and definitions of the measures including why they are useful, see "Non-GAAP Financial Measures," below.

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        On February 18, 2015, we completed our initial public offering of 22,222,222 shares of Class A common stock and, upon the underwriters' exercise of their option to purchase additional shares, issued an additional 3,142,581 shares of Class A common stock for a total of 25,364,803 shares issued (the "IPO"). All of the shares issued in the IPO were primary shares offered by us as none of our stockholders sold any shares in the IPO. The offering price of the shares sold in the IPO was $27.00 per share, resulting in net proceeds to us, after underwriters' discounts and commissions and other expenses payable by us, of $639.1 million. Our Class A common stock is currently traded on the NASDAQ Global Select Market under the symbol "INOV."

        On September 1, 2015, pursuant to the terms of a Share Purchase Agreement between the Company and Avalere (the "Purchase Agreement"), the Company acquired 100 percent of the capital stock of Avalere for an aggregate stated purchase price of $140.0 million, consisting of cash and 235,737 shares of the Company's Class A common stock which are subject to resale restrictions. Avalere is a provider of data-driven advisory services and business intelligence solutions primarily to the pharmaceutical and life sciences industry. Pursuant to the Purchase Agreement, certain portions of the stated purchase price of $140.0 million are contingent upon the achievement of financial and operational objectives, and other portions are subject to continued employment provisions. The addition of Avalere, with its more than 200 pharmaceutical and life sciences clients, is expected to expand Inovalon's capabilities and client base into the expansive and adjacent markets of the pharmaceutical and life sciences industry. See Note 3 (Business Combinations) to the accompanying condensed consolidated financial statements.

        During the quarter Inovalon announced the introduction of Data Diagnostics™ to the healthcare marketplace. This technology, the latest in Inovalon's product portfolio releases, provides a suite of hundreds of patient-specific analyses that can be ordered individually by clinicians on demand with the answer provided within seconds—all without leaving the clinician's workflow. The capability leverages vast amounts of data across billions of medical events, interconnectivity, and high-speed cloud-based analytics to allow physician organizations, health plans, accountable care organizations (ACOs), hospitals, integrated healthcare delivery systems, ASO employer groups, government programs, and individual physicians to achieve valuable clinical insights, strong clinical and quality outcomes, utilization efficiency, and overall financial performance on demand and in real time. The technology is delivered in collaboration with Quest Diagnostics, the nation's largest laboratory organization, providing large-scale distribution to clinicians through Quest's more than 200,000 Care360® provider portal installations and more than 400 integrated EHR platforms serving approximately half of the physicians and hospitals in the United States. As an increased investment was articulated during Inovalon's second quarter earnings call, Inovalon has been investing resources as part of the development and anticipated operation and support of Data Diagnostics™. This continued during the third quarter and is anticipated to accelerate significantly in the fourth quarter as the Company ramps for operational activity within the Data Diagnostic platform. While still in the early stages of this platform's introduction, initial feedback from the marketplace has been very positive.

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Quarterly Key Metrics

        We review certain metrics quarterly, including the key metrics shown in the table below. We believe that these metrics are indicative of our overall level of analytical activity and the underlying growth in our business.

 
  As of September 30,  
 
  2015   2014  

Quarterly Key Metrics (in thousands)(1):

             

MORE2 Registry® dataset metrics

             

Unique patient count(2)

    127,701     118,932  

Medical event count(3)

    10,366,340     9,112,175  

Trailing 12 month Patient Analytics Months (PAM)(4)

    20,405,108     15,513,903  

(1)
MORE2 Registry® dataset metrics and Trailing 12 month PAM, each of which is presented in the table, are key operating metrics that management uses to assess our level of operational activity. While we believe that each of these metrics is indicative of our overall level of analytical activity and the underlying growth in our business, increases or decreases in these metrics do not necessarily correlate to proportional increases or decreases in revenue, Adjusted EBITDA, net income or Non-GAAP net income. For instance, although increased levels of analytical activity historically have corresponded to increases in revenue over the long term, differences in fees charged for different analytical packages exist and differences in how analytics trigger the applicability of our cloud-based data-driven intervention platforms may result in increases in analytical activity that do not result in proportional increases in revenue, Adjusted EBITDA, net income or Non-GAAP net income (and vice versa). Accordingly, while we believe the presentation of these operating metrics is helpful to investors in understanding our business; these metrics have limitations and should not be considered as substitutes for analysis of our financial results reported under GAAP. In addition, we believe that other companies, including companies in our industry, do not present similar operating metrics and that there is no commonly accepted method of calculating these metrics, which may reduce their usefulness as comparative measures.

(2)
Unique patient count is defined as each unique, longitudinally matched, de-identified natural person represented in our MORE2 Registry® as of the end of the period presented.

(3)
Medical event count is defined as the total number of discrete medical events as of the end of the period presented (for example, a discrete medical event typically results from the presentation of a patient to a physician for the diagnosis of diabetes and congestive heart failure in a single visit, the presentation of a patient to an emergency department for chest pain, etc.).

(4)
PAM is defined as the sum of the analytical processes performed on each respective patient within patient populations covered by clients under contract. As used in the metric, an "analytical process" is a distinct set of data calculations undertaken by us which is initiated and completed by our analytical platform to examine a specific question such as whether a patient is believed to have a condition such as diabetes, or worsening of the disease, during a specific time period.

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Trends and Factors Affecting Our Future Performance

        A number of factors influence our growth and performance. We see many of these factors as being more quantitatively driven, such as the rate of growth of the underlying data counts within our datasets, the ongoing investment in innovation, and our level of analytical activity. Additionally, there are several factors that influence our growth and performance that are less quantitatively driven, including seasonality, macro-economic forces, and trends within healthcare (such as payment models, incentivization, and regulatory oversight), that can be driven by changes in federal and state laws and regulations, as well as private sector market forces.

        Growth of Datasets.    Healthcare costs in the United States have been increasing significantly for many years. This rise in healthcare costs has driven a broad transition from consumption-based payment models to quality and value-based payment models across the healthcare landscape. As a result, the specific disease and comorbidity status, clinical and quality outcomes, resource utilization, and care details of the individual patient have become increasingly relevant to the various constituents across the healthcare delivery system. Concurrently, the count and complexity of diseases, diagnostics, and treatmentsas well as payment models and regulatory oversight requirementshave soared. In this setting, granular data has become critical to determining and improving quality and financial performance in healthcare. Our MORE2 Registry® is our largest principal dataset and serves as a proxy for our general growth of datasets. The growth of our datasets that inform our analytical capabilities and comparative analytics is a key aspect of our provision of value to our clients and is indicative of our overall growth and capabilities.

        Innovation and Platform Development.    Our business model is based upon our ability to deliver value to our clients through the combination of advanced, cloud-based data analytics and cloud-based data-driven intervention platforms focused on the achievement of meaningful and measureable improvements in clinical and quality outcomes, utilization, and financial performance in healthcare. Our ability to deliver this value is dependent in part on our ability to continue to innovate, design new capabilities, and bring these capabilities to market in an enterprise scale. Our continued ability to innovate our platform and bring differentiated capabilities to market is an important aspect of our business success, and accordingly, we expect investment in innovation to increase as a percentage of revenue when examined on a full year basis, although, timing of investment may vary from quarter to quarter. Our investment in innovation includes costs for research and development, capitalized software development, and expenditures related to hardware and software platforms on which our data analytics and data-driven interventions capabilities are deployed as summarized in the following table (in thousands, except percentages).

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
Investment in Innovation:
  2015   2014   2015   2014  

Research and development(1)

  $ 6,283   $ 6,184   $ 17,198   $ 17,376  

Capitalized software development(2)

    5,359     4,080     15,104     11,758  

Research and development infrastructure investments(3)

    2,406     1,627     2,945     4,567  

Total investment in innovation

  $ 14,048   $ 11,891   $ 35,247   $ 33,701  

As a percentage of revenue

                         

Research and development(1)

    6 %   7 %   5 %   6 %

Capitalized software development(2)

    5 %   5 %   5 %   4 %

Research and development infrastructure investments(3)

    2 %   2 %   1 %   2 %

Total investment in innovation

    13 %   14 %   11 %   12 %

(1)
Research and development primarily includes employee costs related to the development and enhancement of our service offerings.

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(2)
Capitalized software development includes capitalized costs incurred to develop and enhance functionality for our data analytics and data-driven intervention platforms.

(3)
Research and development infrastructure investments include strategic expenditures related to hardware and software platforms under development or enhancement.

        Data Analytics and Data-Driven Intervention Mix.    Our business and operational models are highly scalable and leverage variable costs to support revenue generating activities. Our data analytic service costs are less variable in nature and require lower incremental capital expenditures. As a result, following initial development and deployment investments, our big data analytics platform and data technology capabilities allow us to process significant volumes of transactions with lower incremental costs. Conversely, our data-driven intervention service costs are generally variable in nature and require incremental costs to generate additional revenue. As a result, the mix of our data analytics and data interventions activities affects our financial performance. Over the past several years the percentage of our business which is derived from data and analytics subscription fees has been increasing, as has the portion of the data-driven intervention platform services that are fully automated. Key metrics and measures regarding data analytics and data-driven intervention mix are presented annually.

        Client and Analytical Process Count Growth.    Our business is generally driven by the number of underlying patients for which our analytics and data-driven intervention platforms are being utilized. In addition to this patient count, however, the number of specific analytical processes and data-driven interventions services for which any one specific patient population is engaged, is also a driver. As such, increasing the size, number, and analytical portfolio penetration of populations for which we provide our analytics and data-driven intervention platform services is important to the overall growth of our business. In general, as the application of our analytics and data-driven intervention platform services deliver value, our clients often engage with us to utilize additional analytics and data-driven intervention platform services. Our ability to deliver demonstrable value, retain clients, add new clients, and realize growth within existing clients affects our financial performance. On an annual basis we track the number of patient populations for which we are engaged to provide data analytics and provide data-driven intervention services (each engagement memorialized with a contracted statement of work, or SOW).

        In addition, we track the number of analytical processes that we run on patients each month in fulfillment of our client contracts, as totaled for the trailing 12 months. We believe that PAM is indicative of our overall level of analytical activity, and we expect our period-to-period comparisons of our PAM to be indicative of underlying growth of our business, although changes in levels of analytical activity do not always directly translate to changes in financial performance of our business. Differences in fees charged for different analytical packages exist and differences in how analytics trigger the applicability of our data-driven intervention platforms may result in increases in analytical activity that do not result in proportional increases in revenue, Adjusted EBITDA, net income or Non-GAAP net income (and vice versa). Therefore, in situations in which a new engaged client SOW is initiated for analytical processes that have a higher than average fee rate, revenue could expand disproportionately faster than the increase in PAM.

        Seasonality.    We typically experience the highest level of revenue in the second quarter of each year, which coincides with specific accreditation and regulatory deadlines. In particular, as a result of certain data filing deadlines established by CMS, state departments of health, and the National Committee for Quality Assurance, or NCQA, clients typically engage us to perform higher levels of data-driven analytics and data-driven interventions during the first two quarters of each year when compared to other quarters of the year. Conversely, the third quarter of the year has relatively few such deadlines and, as such, typically has lower levels of analytics engagement activity than other quarters of the year.

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        Macro-Economic and Macro-Industry Trends.    Our clients are affected, sometimes directly, and sometimes counter-intuitively, by macro-economic trends such as economic growth (or economic recession), inflation, and unemployment. Further, industry trends in federal and state laws and regulations, as well as emerging trends in private sector payment models, affect our clients' businesses and their need for technologies and services to support these challenges. These factors have various effects on our business, and on occasion have resulted in the slowing or cessation of the decision-making process by clients adopting our technologies and services. On the other hand, changes in macro-economic trends and the industry landscape have accelerated the need for our technologies and services from time-to-time, particularly as regulators introduce complex requirements with which our clients must comply.

        Shift to Fully Automated Data-Driven Intervention Platform Services.    We view the decreased proportion of revenue derived from partially automated data-driven intervention platform services as a positive reflection of our cloud-based interconnectivity and automation capabilities. The proportion of our revenue derived from pure cloud-based data analytics and fully automated data-driven intervention platform services revenue is expected to continue to expand over time as a percentage of total revenue as a result of our continued expansion of our cloud-based interconnectivity technologies and the continued expansion of interconnectivity within the healthcare landscape. In order to drive value for our clients and serve them irrespective of their level of connectivity, we continue to provide cloud-based partially automated data-driven intervention platform services, converting the performance of such services to cloud-based fully automated data-driven intervention platform services wherever possible. As the healthcare infrastructure becomes more interconnected and our integration and interconnectivity technologies continue to expand, we believe that we will be able to achieve more rapid implementation, and greater value impact, at more efficient costs.


Critical Accounting Policies

        Our discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with GAAP. In connection with the preparation of our condensed consolidated financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. We base our assumptions, estimates, and judgments on historical experience, current trends, and other factors we believe to be relevant at the time we prepare our condensed consolidated financial statements. The accounting estimates used in the preparation of our condensed consolidated financial statements will change as new events occur, as more experience is acquired, as additional information is obtained, and as our operating environment changes. On a regular basis, we review the accounting policies, assumptions, and evaluate and update our assumptions, estimates, and judgments to ensure that our condensed consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

        Critical accounting policies are those policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. For a more detailed discussion of our critical accounting policies, please refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, filed with the SEC on March 31, 2015.

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Components of Results of Operations

Revenue

        We earn revenue primarily through the sale or subscription licensing of our cloud-based data analytics and data-driven intervention platform services.

        Our cloud-based data analytics services are performed either at the beginning of a data-driven intervention process, which typically aligns with regulatory submission deadlines, or on a monthly basis, depending on the particular client's needs. Cloud-based data analytics revenue is driven primarily by the number of identified gaps in care, quality, data integrity, and financial performance identified in a client's dataset, the number of unique patients in a client's dataset, a minimum data analytics processing fee, and a contractually negotiated transactional price for each identified gap or unique patient. Subscription licensing revenue is driven primarily by the number of clients, the number of unique patients in a client's population dataset, the number of analytical services contracted for by a client, and the contractually negotiated price of such services.

        Cloud-based data-driven intervention platform service revenue represents revenue that is generated from fully automated processes (i.e., those processes that require no material variable-based labor components) and partially automated processes (i.e., those processes that require a degree of variable-based labor components). The Company expects the expanding emphasis on data-driven analytics services, and therefore the increased share of Inovalon revenue from such services, to continue on a year-to-year basis. As many of our analytical capabilities are designed to identify gaps in care, quality, utilization, compliance, and/or other gaps that may impact our clients' achievement of greater healthcare quality and financial performance, our cloud-based data driven intervention platform services revenue is driven primarily by the results of our cloud-based data analytics processes and our clients' desire to utilize our cloud-based data-driven intervention platforms to resolve such identified gaps. Informed by our analytics, our cloud-based data-driven intervention platforms are designed to enable the resolution of specific gaps through the aggregation of specific data or achievement of specific impact. Revenue from our intervention platform utilization is generally driven by the quantity and type of completed interventions enabled by our platform, and a contractually negotiated transactional price for each such intervention.

Cost of Revenue

        Cost of revenue consists primarily of expenses for employees who provide direct contractual services to our clients, including salaries, benefits, discretionary incentive compensation, employment taxes, severance, and equity compensation costs. Cost of revenue also includes expenses associated with the integration, and verification of data and other service costs incurred to fulfill our revenue contracts. Cost of revenue does not include allocated amounts for occupancy expense and depreciation and amortization. Many of the elements of our cost of revenue are relatively variable and semi-variable, and can be reduced in the near-term to offset any decline in our revenue.

        Our business and operational models are designed to be highly scalable and leverage variable costs to support revenue generating activities. While we expect to grow our headcount over time to capitalize on our market opportunities, we believe our increased investment in automation, electronic health record integration capabilities, and economies of scale in our operating model, will position us to grow our revenue at a greater rate than our cost of revenue, excluding the impact of stock-based compensation expense.

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Sales and Marketing

        Sales and marketing expense consists primarily of employee-related expenses, including salaries, benefits, commissions, discretionary incentive compensation, employment taxes, severance, and equity compensation costs for our employees engaged in sales, sales support, business development, and marketing. Sales and marketing expense also includes operating expenses for marketing programs, research, trade shows and brand messages, and public relations costs. Our sales and marketing expense excludes any allocation of occupancy expense and depreciation and amortization.

        We expect our sales and marketing expenses to increase as we strategically invest to expand our business. We expect to hire additional sales personnel and related support personnel to capture an increasing amount of our market opportunity. As we scale our sales and marketing activities in the short to medium term, we expect these expenses to increase in both absolute dollars and as a percentage of revenue.

Research and Development

        Research and development expense (one component of our investment in innovation) consists primarily of employee-related expenses, including salaries, benefits, discretionary incentive compensation, employment taxes, severance, and equity compensation costs for our software developers, engineers, analysts, project managers, and other employees engaged in the development and enhancement of our service offerings. Research and development expense also includes certain third party consulting fees. Our research and development expense excludes any allocation of occupancy expense and depreciation and amortization. Research and development efforts that meet certain GAAP criteria are reclassified from expense to capital assets as internal-use software in support of our continuous investment in innovation and platform development.

        We expect to continue our focus on developing new data analytics and data-driven intervention platforms and enhancing our existing data analytics and data-driven intervention platforms. As a result, and exclusive of any capitalizable amounts attributable to our continuous investment in innovation, we expect our research and development expense to continue to increase in absolute dollars, although it may vary from period to period as a percentage of revenue.

General and Administrative

        Our general and administrative expense consists primarily of employee-related expenses including salaries, benefits, discretionary incentive compensation, employment taxes, severance, and equity compensation costs, for employees who are responsible for management information systems, administration, human resources, finance, legal, and executive management. General and administrative expense also includes occupancy expenses (including rent, utilities, communications, and facilities maintenance), professional fees, consulting fees, insurance, travel, and other expenses. Our general and administrative expense excludes depreciation and amortization.

        We expect our general and administrative expense to increase as we expand our business and incur incremental costs associated with being a public company. However, excluding certain increases as a result of being a public company, we expect our general and administrative expense to grow at a lower rate than revenue, on an annual basis.

Depreciation and Amortization Expense

        Our depreciation and amortization expense consists primarily of depreciation of fixed assets, amortization of capitalized software development costs, and amortization of acquisition-related intangible assets.

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Provision for Income Taxes

        Provision for income taxes consists of federal and state income taxes in the United States and foreign income taxes from the territory of Puerto Rico, including deferred income taxes reflecting the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.


Results of Operations

        The following table sets forth our condensed consolidated statement of operations data for each of the periods presented (in thousands):

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2015   2014   2015   2014  

Revenue

  $ 105,459   $ 85,991   $ 316,710   $ 271,622  

Expenses:

                         

Cost of revenue(1)

    38,394     27,579     103,847     85,065  

Sales and marketing(1)

    3,946     2,410     8,173     5,355  

Research and development(1)

    6,283     6,184     17,198     17,376  

General and administrative(1)

    32,437     21,645     82,022     62,920  

Depreciation and amortization

    5,526     5,043     15,253     15,012  

Total operating expenses

    86,586     62,861     226,493     185,728  

Income from operations

    18,873     23,130     90,217     85,894  

Other income and (expenses):

                         

Realized losses on short-term investments

    (329 )       (329 )    

Interest income

    1,184     1     1,807     4  

Interest expense

    (1,110 )   (147 )   (3,318 )   (209 )

Income before taxes

    18,618     22,984     88,377     85,689  

Provision for income taxes

    8,498     9,318     38,362     33,836  

Net income

  $ 10,120   $ 13,666   $ 50,015   $ 51,853  

(1)
Includes stock-based compensation expense as follows:


Cost of revenue

  $ 28   $   $ 85   $  

Sales and marketing

    66         122      

Research and development

    292         952      

General and administrative

    1,619     518     4,540     1,340  

Total stock-based compensation expense

  $ 2,005   $ 518   $ 5,699   $ 1,340  

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        The following table sets forth our condensed consolidated statement of operations data for each of the periods presented as a percentage of revenue:

 
  Three Months
Ended
September 30,
  Nine Months
Ended
September 30,
 
 
  2015   2014   2015   2014  

Revenue

    100 %   100 %   100 %   100 %

Expenses:

                         

Cost of revenue

    36     32     33     31  

Sales and marketing

    4     3     3     2  

Research and development

    6     7     5     6  

General and administrative

    31     25     26     23  

Depreciation and amortization

    5     6     5     6  

Total operating expenses

    82     73     72     68  

Income from operations

    18     27     28     32  

Other income and (expenses):

                         

Realized losses

      *         *    

Interest income

    1         1      

Interest expense

    (1 )       (1 )    

Income before taxes

    18     27     28     32  

Provision for income taxes

    8     11     12     12  

Net income

    10 %   16 %   16 %   19 %

*
not meaningful

Three and Nine Months Ended September 30, 2015 and 2014

Revenue

 
  Three Months Ended
September 30,
  2014 to 2015
Change
  Nine Months Ended
September 30,
  2014 to 2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Total revenue

  $ 105,459   $ 85,991   $ 19,468     23 % $ 316,710   $ 271,622   $ 45,088     17 %

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    Revenue during the three months ended September 30, 2015 increased by approximately $19.5 million, or 23%, compared with the three months ended September 30, 2014. The increase was primarily attributable to an increase in revenue from new clients of $6.1 million along with a net increase of $13.4 million from existing clients.

        Revenue during the nine months ended September 30, 2015 increased by approximately $45.1 million, or 17%, compared with the nine months ended September 30, 2014. The increase was primarily attributable to an increase in revenue from new clients of $20.6 million along with a net increase of $24.5 million from existing clients.

        Avalere contributed revenue of $4.2 million to the three and nine months ended September 30, 2015.

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Cost of Revenue

 
  Three Months Ended
September 30,
  2014 to 2015
Change
  Nine Months Ended
September 30,
  2014 to 2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Cost of revenue

  $ 38,394   $ 27,579   $ 10,815     39 % $ 103,847   $ 85,065   $ 18,782     22 %

Cost of revenue as a percentage of revenue

    36 %   32 %               33 %   31 %            

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    During the three months ended September 30, 2015, cost of revenue increased by approximately $10.8 million, or 39%, compared with the three months ended September 30, 2014. The increase in cost of revenue was primarily due to the corresponding increase in revenue of $19.5 million, or 23%, during the period and also resulted from an increase in employee-related expenses, related partially to the newly acquired data-driven advisory services business and a greater volume of partially-automated data-driven intervention services as a percentage of total revenue.

        During the nine months ended September 30, 2015, cost of revenue increased by approximately $18.8 million, or 22%, compared with the nine months ended September 30, 2014. The increase in cost of revenue was primarily due to the corresponding increase in revenue of $45.1 million or 17%, during the period and also resulted from an increase in employee-related expenses related partially to the newly acquired data-driven advisory services business and a greater volume of partially-automated data-driven intervention services as a percentage of total revenue.

Sales and Marketing

 
  Three Months
Ended
September 30,
  2014 to 2015
Change
  Nine Months
Ended
September 30,
  2014 to 2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Sales and marketing

  $ 3,946   $ 2,410   $ 1,536     64 % $ 8,173   $ 5,355   $ 2,818     53 %

Sales and marketing as a percentage of revenue

    4 %   3 %               3 %   2 %            

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    During the three months ended September 30, 2015, sales and marketing expenses increased by approximately $1.5 million, or 64%, compared with the three months ended September 30, 2014. The increase was primarily attributable to increased employee related expenses of $1.9 million, which was driven by our investment in additional sales personnel to focus on adding new clients and capturing an increased amount of our market opportunity, as well as the addition of the sales and marketing personnel acquired with Avalere and was partially offset by a decrease of $0.4 million in marketing program spend.

        During the nine months ended September 30, 2015, sales and marketing expenses increased by approximately $2.8 million, or 53%, compared with the nine months ended September 30, 2014. The increase was primarily attributable to increased employee related expenses of $2.7 million, which was driven by our investment in additional sales personnel to focus on adding new clients and capturing an increased amount of our market opportunity as well as the addition of the sales and marketing personnel acquired with Avalere.

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Table of Contents

Research and Development

 
  Three Months
Ended
September 30,
  2014 to
2015
Change
  Nine Months Ended
September 30,
  2014 to 2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Research and development

  $ 6,283   $ 6,184   $ 99     2 % $ 17,198   $ 17,376   $ (178 )   (1 )%

Research and development as a percentage of revenue

    6 %   7 %               5 %   6 %            

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    During the three months ended September 30, 2015, research and development expense increased by approximately $0.1 million, or 2%, compared with the three months ended September 30, 2014. The increase was primarily attributable to an increase of $0.8 million in employee-related expenses and certain third-party consulting fees, which includes an increase of $0.3 million in stock based compensation expense, an increase in professional fees of $0.3 million and was partially offset by growth in the capitalization of internal-use software development costs of $1.0 million compared to the prior period.

        During the nine months ended September 30, 2015, research and development expense decreased by approximately $0.2 million, or 1%, compared with the nine months ended September 30, 2014. The decrease was primarily attributable to growth in the capitalization of internal-use software development costs of $2.9 million compared to the prior period, which was partially offset by an increase of $2.6 million in employee-related expenses and certain third-party consulting fees, which includes an increase of $0.9 million in stock based compensation expense.

General and Administrative

 
  Three Months Ended
September 30,
  2014 to 2015
Change
  Nine Months Ended
September 30,
  2014 to 2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

General and administrative

  $ 32,437   $ 21,645   $ 10,792     50 % $ 82,022   $ 62,920   $ 19,102     30 %

General and administrative as a percentage of revenue

    31 %   25 %               26 %   23 %            

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    During the three months ended September 30, 2015, general and administrative expense increased by approximately $10.8 million, or 50%, compared with the three months ended September 30, 2014. Throughout the second half of 2014 and first nine months of 2015, we increased our investment in incremental personnel to support our growth and our transition from a private to a public company. Our investment resulted in an increase in employee related costs of $8.0 million, which includes an increase of approximately $1.1 million related to stock-based compensation expense and an increase of $1.8 million from the acquisition of Avalere, for the three months ended September 30, 2015 compared to the prior year and an increase in professional fees of $0.4 million. In addition, general and administrative expenses for the three months ended September 30, 2015 includes incremental expenses that are not comparable to the prior year, comprised of $1.3 million for acquisition-related transaction costs, $0.7 million of post-acquisition contingent consideration expense related to the acquisition of Avalere, and $0.6 million for employer taxes related to stock option awards exercised by employees.

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Table of Contents

        During the nine months ended September 30, 2015, general and administrative expense increased by approximately $19.1 million, or 30%, compared with the nine months ended September 30, 2014. Throughout the second half of 2014 and first half of 2015, we increased our investment in incremental personnel to support our growth and our transition from being a private to a public company. Our investment resulted in an increase in employee related costs of $16.0 million, which includes an increase of approximately $3.2 million related to stock-based compensation expense and an increase of $1.8 million from the acquisition of Avalere, for the nine months ended September 30, 2015 compared to the prior year and an increase in professional fees of $1.0 million. In addition, general and administrative expenses for the nine months ended September 30, 2015 includes incremental expenses that are not comparable to the prior year, comprised of $1.3 million for acquisition-related transaction costs, $0.7 million of post-acquisition contingent consideration expense related to the acquisition of Avalere, and $0.6 million expense incurred to settle the employer taxes related to stock option awards exercised by employees. The increases in general and administrative expenses for the nine months ended September 30, 2015 were partially offset by capitalization of internal-use software development costs of $0.5 million compared to the prior period.

Depreciation and Amortization

 
  Three Months
Ended
September 30,
  2014 to 2015
Change
  Nine Months Ended
September 30,
  2014 to
2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Depreciation and amortization

  $ 5,526   $ 5,043   $ 483     10 % $ 15,253   $ 15,012   $ 241     2 %

Depreciation and amortization as a percentage of revenue

    5 %   6 %               5 %   6 %            

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    During the three months ended September 30, 2015, depreciation and amortization expense increased by approximately $0.5 million, or 10%, compared with the three months ended September 30, 2014. Depreciation and amortization expense as a percentage of revenue, decreased to 5% of revenue for the three months ended September 30, 2015, as compared with 6% of revenue for the three months ended September 30, 2014. The increase in depreciation and amortization expense is primarily attributable to additional amortization expense for intangible assets established from the Avalere acquisition.

        During the nine months ended September 30, 2015, depreciation and amortization expense increased by approximately $0.2 million, or 2%, compared with the nine months ended September 30, 2014. Depreciation and amortization expense as a percentage of revenue, decreased to 5% of revenue for the nine months ended September 30, 2015, as compared with 6% of revenue for the nine months ended September 30, 2014. The increase in depreciation and amortization expense is primarily attributable to additional amortization expense for intangible assets established from the Avalere acquisition.

        See Note 8, Goodwill and Intangible Assets, to the accompanying condensed consolidated financial statements for further information regarding the expected future amortization expense of the Company's intangible assets.

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Realized Losses on Short-Term Investments

 
  Three Months
Ended
September 30,
  2014 to
2015
Change
  Nine Months
Ended
September 30,
  2014 to
2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Realized losses on short-term investments

  $ 329   $   $ 329       *% $ 329   $   $ 329       *%

Realized losses on short-term investments as a percentage of revenue

      *%   %                 *%   %            

*
not meaningful

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    The realized investment losses for the three and nine months ended September 30, 2015 are attributable to sales of certain of the Company's available-for-sale short-term investments, prior to maturity, which the Company initiated and completed during the three months ended September 30, 2015. Funds generated from such sales of available-for-sale short term investments were used to fund the Company's acquisition of Avalere. Sales of the Company's available-for-sale, short term investments may be required from time-to-time to fund similar strategic initiatives.

Interest Income

 
  Three Months
Ended
September 30,
  2014 to 2015
Change
  Nine Months
Ended
September 30,
  2014 to 2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Interest income

  $ 1,184   $ 1   $ 1,183       *% $ 1,807   $ 4   $ 1,803       *%

Interest income as a percentage of revenue

    1 %     *%               1 %     *%            

*
not meaningful

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    During the three months ended September 30, 2015, interest income increased by approximately $1.2 million compared with the three months ended September 30, 2014. During the nine months ended September 30, 2015, interest income increased by approximately $1.8 million compared to the nine months ended September 30, 2015. Interest income for the three and nine months ended September 30, 2015 is attributable to earnings derived from the Company's available-for-sale short-term investments.

Interest Expense

 
  Three Months
Ended
September 30,
  2014 to 2015
Change
  Nine Months
Ended
September 30,
  2014 to 2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Interest expense

  $ 1,110   $ 147   $ 963       *% $ 3,318   $ 209   $ 3,109       *%

Interest expense as a percentage of revenue

    1 %     *%               1 %     *%            

*
not meaningful

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Table of Contents

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    During the three months ended September 30, 2015, interest expense increased by approximately $1.0 million compared with the three months ended September 30, 2014. During the nine months ended September 30, 2015, interest income increased by approximately $3.1 million compared to the nine months ended September 30, 2015. Interest expense for the three and nine months ended September 30, 2015 is attributable to interest paid on the Term Loan Facility (as defined below).

Provision for Income Taxes

 
  Three Months
Ended
September 30,
  2014 to 2015
Change
  Nine Months Ended
September 30,
  2014 to 2015
Change
 
 
  2015   2014   $   %   2015   2014   $   %  
 
  (dollars in thousands)
 

Provision for income taxes

  $ 8,498   $ 9,318   $ (820 )   (9 )% $ 38,362   $ 33,836   $ 4,526     13 %

Effective tax rate

    46 %   41 %               43 %   39 %            

        Three and Nine Months Ended September 30, 2015 compared with Three and Nine Months Ended September 30, 2014.    During the three months ended September 30, 2015, provision for income taxes decreased by approximately $0.8 million, or 9%, compared to the three months ended September 30, 2014. The growth of our operations and our continued investment in expanding our operations and infrastructure, to support current and expected future growth, resulted in lower income before taxes during the three months ended September 30, 2015 as compared to the three months ended September 30, 2014, which translated into lower income taxes for the three months ended September 30, 2015. In addition, the tax effect of non-deductible acquisition-related costs, attributable to our acquisition of Avalere, increased taxes by approximately $0.4 million.

        During the nine months ended September 30, 2015, provision for income taxes increased by approximately $4.5 million, or 13%, compared to the nine months ended September 30, 2014. The growth of our operations resulted in a $1.1 million increase in income taxes for the nine months ended September 30, 2015. In addition, expected state income taxes, net of federal income tax benefit and related deferred tax adjustments increased approximately $3.5 million resulting primarily from changes in revenue sourcing methodology passed into legislation by each of New York State and New York City, resulting in an increase in the Company's effective state tax rate. As a result of the statutory income tax rate change, the effective tax rate increased to 43% for the nine months ended September 30, 2015 from 39% in the same period of the prior year.


Liquidity and Capital Resources

    Sources of Liquidity

        Historically, our principal source of liquidity has been cash generated by operating activities. Our cash generated from operations has been sufficient to fund our growth, including our on-going investment in innovation and capital expenditures. In addition, during the first quarter of 2015, we received net proceeds from our IPO of $639.1 million. On September 1, 2015 we used approximately $126.2 million of cash to complete the acquisition of Avalere. As of September 30, 2015, we had a combined balance of cash, cash equivalents and short-term investments of approximately $714.1 million.

        We believe our current cash and cash equivalent balance, our short-term investment balance, expected cash generated by operating activities and availability of cash under the Credit Facilities (as defined below) is sufficient to fund our operations, finance our strategic initiatives, and fund our investment in innovation and new service offerings, for the foreseeable future.

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Table of Contents

    Debt

        As of September 30, 2015, we had outstanding indebtedness under our Credit Facilities and capital lease obligations of $285.0 million and $0.4 million, respectively. As of December 31, 2014, we had outstanding indebtedness under our Credit Facilities and capital lease obligations of $300.0 million and $0.3 million, respectively. As of September 30, 2015, we were in compliance with the covenants of the Credit Agreement.

Term Loan Facility

        The Term Loan Facility has a five-year term. The Term Loan Facility is an amortizing facility with principal payments quarterly and interest payments monthly. Scheduled principal payments of $15.0 million and interest payments totaling $3.3 million were paid during the nine months ended September 30, 2015.

Revolving Credit Facility

        Borrowings under the Revolving Credit Facility became available, subject to compliance with the terms and conditions set forth in the Credit Agreement, beginning (at our option) after the consummation of our IPO on February 18, 2015. No amounts were drawn against the Revolving Credit Facility during the nine months ended September 30, 2015. The Revolving Credit Facility is scheduled to mature on March 31, 2020. The interest rate for the Revolving Credit Facility is LIBOR plus 1.25% per annum or the base rate plus 0.25% per annum (at our election).

    Cash Flows—Comparison of the Nine Months Ended September 30, 2015 and 2014

    Operating Cash Flow Activities

        Net cash provided by operating activities during the nine months ended September 30, 2015 was approximately $44.2 million, a decrease of approximately $5.7 million compared with the nine months ended September 30, 2014. Cash provided by operating activities was driven by net income of approximately $50.0 million, as adjusted for the exclusion of non-cash expenses totaling approximately $6.5 million, which was partially offset by approximately $12.4 million related to the effect of changes in working capital and other balance sheet accounts, driven by payroll timing, customer payments and vendor payments.

    Investing Cash Flow Activities

        Net cash used in investing activities during the nine months ended September 30, 2015 was approximately $691.4 million, an increase in cash outflow of approximately $673.8 million compared with the nine months ended September 30, 2014. The increase in cash outflow primarily resulted from purchases of available-for-sale short term investments, net of sales and maturities of $550.4 million and $121.9 million related to the acquisition of Avalere, net of cash acquired of $4.0 million.

        Net cash used in investing activities primarily relate to cash used to acquire Avalere. We also use cash to invest in capital assets to support our growth and innovations and to purchase short-term investments. We make investments in innovation, including research and development expense, capital software development costs, and research and development infrastructure investments, on a recurring basis. We expect our investment in innovation to increase in the foreseeable future to support our continued growth and new service offerings.

39


Table of Contents

    Financing Cash Flow Activities

        Cash provided by financing activities during the nine months ended September 30, 2015 was approximately $651.1 million, an increase of approximately $662.0 million in cash inflow compared with the nine months ended September 30, 2014. The cash provided by financing activities during the nine months ended September 30, 2015 is primarily comprised of $639.1 million of proceeds from the issuance of common stock in the IPO, $11.7 million of proceeds received from the exercise of stock options, $16.0 million related to excess tax benefits from share-based compensation and was partially offset by repayments of borrowings under our Credit Facilities of $15.0 million.

    Contractual Obligations

        The following table summarizes our future payments in cash, excluding the effects of time value, on contractual obligations by period as of September 30, 2015:

 
  Payments Due by Period  
 
  (in thousands)
 
 
  Total   Less than
1 year
  1 - 3 years   3 - 5 years   More than
5 years
 

Credit Facilities(1)

  $ 285,000   $ 15,000   $ 67,500   $ 202,500   $  

Operating lease obligations

    27,730     2,079     16,101     9,550      

Total

  $ 312,730   $ 17,079   $ 83,601   $ 212,050   $  

(1)
We have cash interest requirements due on the Credit Facilities at variable rates which are not included in the above table.

        Our existing operating lease agreements may provide us with the option to renew. Our future operating lease obligations would change if we entered into additional operating lease agreements or if we exercised renewal options.

        Contractual obligations represent future cash commitments and liabilities under agreements with third parties, and exclude purchase orders for goods and services. Purchase orders are not included in the table above. Our purchase orders represent authorizations to purchase rather than legally binding agreements. The contractual commitment amounts in the table above are associated with agreements that are legally binding and enforceable, and that specify all significant terms, including fixed or minimum services to be used, fixed, minimum or variable price provisions and the approximate timing of the transaction.


Off-Balance Sheet Arrangements

        As of September 30, 2015, we did not have any off-balance sheet arrangements.


Non-GAAP Financial Measures

        We provide the measures Adjusted EBITDA, Adjusted EBITDA margin, and Non-GAAP net income as additional information for evaluating our operating results. These measures are not prepared in accordance with, or an alternative for, GAAP accounting and may be different from non-GAAP measures used by other companies.

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Table of Contents

        Investors frequently have requested information from management regarding depreciation, amortization other non-cash charges, such as stock-based compensation, as well as the impact of non-comparable items and management believes, based on discussions with investors, that these non-GAAP measures enhance investors' ability to assess our historical and projected future financial performance. While we believe these non-GAAP financial measures provide useful supplemental information to investors, there are limitations associated with the use of non-GAAP financial measures. For example, one limitation of Adjusted EBITDA is that it excludes depreciation and amortization, which represents the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our business. We compensate for these limitations by using these non-GAAP financial measures as supplements to GAAP financial measures and by reconciling the non-GAAP financial measures to their most comparable GAAP financial measures. Investors are encouraged to review the reconciliations of these non-GAAP financial measures to the comparable GAAP measures that are provided below.

        These non-GAAP measures include financial information that is prepared in accordance with GAAP and presented in our condensed consolidated financial statements and are used to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions and as an important factor in determining variable compensation. Reconciliations of net income, the most directly comparable GAAP financial measure, to Adjusted EBITDA and Non-GAAP net income are presented below.

Adjusted EBITDA and Adjusted EBITDA Margin

        We define Adjusted EBITDA as net income calculated in accordance with GAAP, adjusted for the impact of depreciation and amortization, interest expense, interest income, provision for income taxes, stock-based compensation, acquisition costs, tax on equity exercises, other non-comparable income and expenses, and certain legal costs. We have provided below a reconciliation of net income, which is the most directly comparable GAAP financial measure, to Adjusted EBITDA.

        Adjusted EBITDA margin is our calculation of Adjusted EBITDA divided by revenue calculated in accordance with GAAP.

        We use Adjusted EBITDA and Adjusted EBITDA margin as supplemental measures of performance to gain insight into operating effectiveness. We use Adjusted EBITDA and Adjusted EBITDA margin as key metrics to assess our ability to increase revenues while controlling expense growth and the scalability of our business model. We believe that the exclusion of the expenses eliminated in calculating Adjusted EBITDA and Adjusted EBITDA margin provides management and investors a useful measure for period-to-period comparisons of our core business and operating results by excluding items that are not comparable across reporting periods or that do not otherwise relate to our ongoing operating results. Accordingly, we believe that Adjusted EBITDA and Adjusted EBITDA margin provide useful information to investors and others in understanding and evaluating our operating results. However, use of Adjusted EBITDA and Adjusted EBITDA margin as analytical tools has limitations, and you should not consider them in isolation or as substitutes for analysis of our financial results as reported under GAAP. In addition, other companies, including companies in our industry, might calculate Adjusted EBITDA and Adjusted EBITDA margin or similarly titled measures differently, which may reduce their usefulness as comparative measures.

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Table of Contents

        The following table presents a reconciliation of net income to Adjusted EBITDA for each of the periods indicated (in thousands):

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2015   2014   2015   2014  

Reconciliation of Net Income to Adjusted EBITDA:

                         

Net income

  $ 10,120   $ 13,666   $ 50,015   $ 51,853  

Depreciation and amortization

    5,526     5,043     15,253     15,012  

Realized losses on short-term investments

    329         329      

Interest expense

    1,110     147     3,318     209  

Interest (income)

    (1,184 )   (1 )   (1,807 )   (4 )

Provision for income taxes

    8,498     9,318     38,362     33,836  

EBITDA

    24,399     28,173     105,470     100,906  

Stock-based compensation

    2,005     518     5,699     1,340  

Acquisition costs:

                         

Transaction costs

    1,330         1,330      

Contingent consideration

    706         706      

Tax on equity exercises

    582         582      

Professional service fees(a)

        (33 )       813