Cotiviti Holdings, Inc. - FORM 10-Q

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EX-32.2 - EX-32.2 - Cotiviti Holdings, Inc.	cotv-20170930ex322bbe728.htm
EX-32.1 - EX-32.1 - Cotiviti Holdings, Inc.	cotv-20170930ex32150d01c.htm
EX-31.2 - EX-31.2 - Cotiviti Holdings, Inc.	cotv-20170930ex312950cac.htm
EX-31.1 - EX-31.1 - Cotiviti Holdings, Inc.	cotv-20170930ex311fbe159.htm

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To wfan

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2017

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

Cotiviti Holdings, Inc.

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of incorporation)

001-37787 (Commission File Number)	46-0595918 (IRS Employer Identification No.)
115 Perimeter Center Place Suite 700 Atlanta, GA 30346 (Address of principal executive offices)	30346 (Zip Code)

(770) 379-2800

(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 ☒ No ☐

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 ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b‑2 of the Exchange Act. (Check one):

Large accelerated filer	☐	Accelerated filer	☐

Non-accelerated filer	☒ (Do not check if a smaller reporting company)	Smaller reporting company	☐
Emerging growth company	☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

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

The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of September 30, 2017 was 92,368,654.

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INDEX


		Page
PART I - FINANCIAL INFORMATION

ITEM 1.	Consolidated Financial Statements	1
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	36
ITEM 4.	Controls and Procedures	36

PART II - OTHER INFORMATION

ITEM 1.	Legal Proceedings	38
ITEM 1A.	Risk Factors	38
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
ITEM 3.	Defaults Upon Senior Securities	38
ITEM 4.	Mine Safety Disclosures	38
ITEM 5.	Other Information	38
ITEM 6.	Exhibits	39

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Definitions

As used in this Quarterly Report on Form 10-Q for the period ended September 30, 2017 (this “Quarterly Report on Form 10‑Q” or this “Report”), the following abbreviations and terms have the meanings as listed below. Additionally, the terms “Cotiviti,” “we,” “us” and “our” refer to Cotiviti Holdings, Inc. and its consolidated subsidiaries, unless the context clearly indicates otherwise. The term “Cotiviti Holdings” refers only to Cotiviti Holdings, Inc. and not to any of its subsidiaries. Unless and as otherwise stated, any references in this Quarterly Report to any agreement means such agreement and all schedules, exhibits and attachments in each case as amended, restated, supplemented or otherwise modified to the date of filing this Quarterly Report.

2016 Plan: refers to the Cotiviti Holdings, Inc. 2016 Equity Incentive Plan.

Adjusted EBITDA: refers to net income (loss) to Cotiviti before depreciation and amortization, interest expense, other non-operating (income) expense, income tax expense (benefit), transaction-related expenses and other and stock-based compensation.

Affordable Care Act: refers to the Patient Protection and Affordable Care Act of 2010.

ASC: refers to the FASB Accounting Standards Codification.

ASU: refers to Accounting Standards Update issued by the FASB.

CMS: refers to the Centers for Medicare and Medicaid Services, the United States federal agency which administers Medicare and Medicaid.

EPS: refers to earnings per share.

ESPP: refers to Employee Stock Purchase Plan

Exchange Act: refers to the United States Securities Exchange Act of 1934, as amended.

FASB: refers to the Financial Accounting Standards Board.

First Lien Credit Facilities: refers to the First Lien Term A Loan in the original principal amount of $250.0 million, the First Lien Term B Loan in the original principal amount of $550.0 million and the $100.0 million Revolver under the Restated Credit Agreement.

First Lien Term A Loan: refers to the first lien term A loan in the original principal amount of $250.0 million under our Restated Credit Agreement.

First Lien Term B Loan: refers to the first lien term B loan in the original principal amount of $550.0 million under our Restated Credit Agreement.

First Lien Term Loan: refers, collectively, to the First Lien Term A Loan and the First Lien Term B Loan under our Restated Credit Agreement.

GAAP: refers to generally accepted accounting principles in the United States.

HIPAA: we collectively refer to the United States Health Insurance Portability and Accountability Act of 1996, as amended by the HITECH Act, together with their implementing regulations including the Omnibus Final Rule, as “HIPAA”.

HITECH: refers to the United States Health Information Technology for Economic and Clinical Health Act of 2009, enacted as part of the American Recovery and Reinvestment Act of 2009, which amended HIPAA.

ICD-10: refers to the 10th revision of the International Statistical Classification of Diseases and Related Health Problems, a medical classification list adopted by the World Health Organization containing codes for, among other

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things, diseases, signs and symptoms, abnormal findings, complaints, social circumstances and external causes of injury or diseases.

iHealth Technologies: refers to iHealth Technologies, Inc., a predecessor name of a wholly-owned subsidiary.

Initial First Lien Credit Facilities: refers to the Initial First Lien Term Loan and the Initial First Lien Revolver.

Initial First Lien Term Loan: refers to the first lien term loan in the original principal amount of $810.0 million under our Initial Secured Credit Facilities.

Initial First Lien Revolver: refers to the $75.0 million first lien revolving facility under our Initial Secured Credit Facilities.

Initial Second Lien Credit Facility: refers to the second lien term loan in the original principal amount of $265.0 million under our Initial Secured Credit Facilities.

Initial Secured Credit Facilities: refers to the loans provided pursuant to the First Lien Credit Agreement, dated as of May 14, 2014, entered into by our subsidiary Cotiviti Corporation and certain of our other subsidiaries, as borrowers and/or guarantors, the lenders named therein, as lenders, and the agents named therein, pursuant to which the lenders agreed to provide the Initial First Lien Credit Facilities, comprising the $810.0 million Initial First Lien Term Loan and the $75.0 million Initial First Lien Revolver, and the $265.0 million Initial Second Lien Credit Facility. The Initial Secured Credit Facilities were refinanced in September 2016 with the First Lien Credit Facilities pursuant to the Restated Credit Agreement.

IPO: refers to an initial public offering of common equity.

IT: refers to information technology.

JOBS Act: refers to the United States Jumpstart Our Business Startups Act of 2012.

LIBOR: refers to the London inter-bank offered rate.

Medicaid: refers to the means-tested United States government health care insurance program for people of all ages, jointly funded by state and federal governments and managed by the states. The Social Security Amendments of 1965 created Medicaid by adding Title XIX to the Social Security Act of 1935.

Medicare: refers to the United States government health care insurance program providing health insurance to people age 65 and older, regardless of income or medical history, as well as people of all ages with disabilities and certain medical conditions. The Social Security Amendments of 1965 created Medicare by adding Title XVIII to the Social Security Act of 1935.

Medicare RAC: refers to a Medicare Recovery Audit Contractor; we are one of the Medicare RACs for CMS under the Medicare Recovery Audit Program.

NYSE: refers to the New York Stock Exchange, on which our shares are listed under the symbol “COTV.”

Omnibus Final Rule: refers to the Final Omnibus Privacy, Security, Breach Notification and Enforcement Rules, implemented in 2013, which amended the original Privacy, Security, Breach Notification and Enforcement Rules under HIPAA, as directed pursuant to the HITECH Act.

Restated Credit Agreement: refers to the Amended and Restated First Lien Credit Agreement, dated as of September 28, 2016, as amended on April 7, 2017, entered into by our subsidiary Cotiviti Corporation and certain other of our subsidiaries, as borrowers and/or guarantors, the lenders named therein, as lenders, and the agents named therein, pursuant to which the lenders agreed to provide the First Lien Credit Facilities comprising the First Lien Term A Loans in the original principal amount of $250.0 million, the First Lien Term B Loans in the original principal amount of $550.0 million and the $100.0 million Revolver.

iii

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Revolver: refers to the $100.0 million first lien revolving credit facility under our Restated Credit Agreement.

RowdMap Acquisition: refers to the July 2017 acquisition of RowdMap, Inc.

RSUs: refers to restricted stock units.

Sarbanes-Oxley Act: refers to the United States Sarbanes-Oxley Act of 2002.

SEC: refers to the United States Securities and Exchange Commission.

Securities Act: refers to the United States Securities Exchange Act of 1933, as amended.

SG&A: refers to selling, general and administrative.

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PART I - FINANCIAL INFORMATION

ITEM 1. Consolidated Financial Statements

Cotiviti Holdings, Inc.

Consolidated Balance Sheets

(In thousands, except share and per share amounts)



	September 30,		December 31,
	2017		2016
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	123,008	$	110,635
Restricted cash		8,438		9,103
Accounts receivable, net of allowance for doubtful accounts of $113 and $851 at September 30, 2017 and December 31, 2016, respectively; and net of estimated allowance for refunds and appeals of $30,996 and $41,020 at September 30, 2017 and December 31, 2016, respectively		83,462		67,735
Prepaid expenses and other current assets		16,985		14,957
Total current assets		231,893		202,430
Property and equipment, net		78,414		67,640
Goodwill		1,251,325		1,196,024
Intangible assets, net		507,823		533,305
Other long-term assets		2,770		2,864
TOTAL ASSETS	$	2,072,225	$	2,002,263
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt	$	18,000	$	18,000
Customer deposits		8,438		9,103
Accounts payable and accrued other expenses		36,410		23,162
Accrued compensation costs		40,123		58,589
Estimated liability for refunds and appeals		57,971		62,539
Total current liabilities		160,942		171,393
Long-term liabilities:
Long-term debt		753,592		762,202
Other long-term liabilities		5,656		8,799
Deferred tax liabilities		121,169		120,533
Total long-term liabilities		880,417		891,534
Total liabilities		1,041,359		1,062,927
Commitments and contingencies (Note 7)
Stockholders' equity:
Common stock ($0.001 par value; 600,000,000 shares authorized, 92,368,654 and 90,748,740 issued, and 92,368,654 and 90,741,340 outstanding at September 30, 2017 and December 31, 2016, respectively)		92		91
Additional paid-in capital		934,104		911,582
Retained earnings		101,452		33,917
Accumulated other comprehensive loss		(4,782)		(6,156)
Treasury stock, at cost (7,400 shares at December 31, 2016)		—		(98)
Total stockholders' equity		1,030,866		939,336
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	2,072,225	$	2,002,263

See accompanying notes to consolidated financial statements.

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Cotiviti Holdings, Inc.

Consolidated Statements of Comprehensive Income

(In thousands, except share and per share amounts)

(Unaudited)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
Net revenue	$	174,188	$	156,241	$	501,932	$	457,250
Cost of revenue (exclusive of depreciation and amortization, stated separately below):
Compensation		58,405		58,517		173,563		167,263
Other costs of revenue		6,676		6,658		19,485		17,331
Total cost of revenue		65,081		65,175		193,048		184,594
Selling, general and administrative expenses (exclusive of depreciation and amortization, stated separately below):
Compensation		29,162		32,496		79,419		74,782
Other selling, general and administrative expenses		17,313		13,978		49,492		44,152
Total selling, general and administrative expenses		46,475		46,474		128,911		118,934
Depreciation and amortization of property and equipment		6,070		5,218		17,541		14,864
Amortization of intangible assets		14,747		15,203		45,147		45,618
Transaction-related expenses		773		16		2,165		909
Total operating expenses		133,146		132,086		386,812		364,919
Operating income		41,042		24,155		115,120		92,331
Other expense (income):
Interest expense		9,101		9,625		26,060		40,345
Loss on extinguishment of debt		—		9,349		3,183		16,417
Other non-operating (income) expense		(449)		(113)		(1,458)		(771)
Total other expense (income)		8,652		18,861		27,785		55,991
Income before income taxes		32,390		5,294		87,335		36,340
Income tax expense		12,918		711		19,800		12,780
Net income	$	19,472	$	4,583	$	67,535	$	23,560
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments		433		14		942		(657)
Change in fair value of derivative instruments		301		(49)		432		(615)
Total other comprehensive income (loss)		734		(35)		1,374		(1,272)
Comprehensive income	$	20,206	$	4,548	$	68,909	$	22,288

Earnings per share:
Basic	$	0.21	$	0.05	$	0.74	$	0.28
Diluted		0.20		0.05		0.71		0.27

See accompanying notes to consolidated financial statements.

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Cotiviti Holdings, Inc.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Nine Months Ended
	September 30,
	2017		2016
Cash flows from operating activities:
Net income	$	67,535	$	23,560
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes		(3,277)		(8,682)
Depreciation and amortization		62,688		60,482
Stock-based compensation expense		10,290		21,544
Amortization of debt issuance costs		2,367		3,618
Accretion of asset retirement obligations		146		138
Loss on extinguishment of debt		3,183		16,417
Changes in operating assets and liabilities:
Restricted cash		665		539
Accounts receivable		(13,201)		(4,489)
Other assets		(730)		(1,141)
Customer deposits		(665)		(539)
Accrued compensation		(18,673)		(1,382)
Accounts payable and accrued other expenses		1,144		(4,352)
Estimated liability for refunds and appeals		(4,568)		2,821
Other long-term liabilities		337		146
Other		(78)		(335)
Net cash provided by operating activities		107,163		108,345
Cash flows from investing activities:
Expenditures for property and equipment		(23,610)		(22,578)
Business combinations, net of cash acquired		(69,731)		—
Other investing activities		—		1,181
Net cash used in investing activities		(93,341)		(21,397)
Cash flows from financing activities:
Net proceeds from issuance of common stock		—		226,963
Proceeds from exercise of stock options		12,349		56
Proceeds from issuance of debt		—		800,000
Dividends paid		—		(150,000)
Payment of debt issuance costs		(661)		(6,327)
Repayment of debt		(13,500)		(1,062,850)
Net cash used in financing activities		(1,812)		(192,158)
Effect of foreign exchanges on cash and cash equivalents		363		(385)
Net increase (decrease) in cash and cash equivalents		12,373		(105,595)
Cash and cash equivalents at beginning of period		110,635		149,365
Cash and cash equivalents at end of the period	$	123,008	$	43,770
Supplemental disclosures of cash flow information:
Cash paid for income taxes	$	22,357	$	24,377
Cash paid for interest		22,161		35,927
Noncash investing activities (accrued property and equipment purchases)		12,611		12,000
Noncash investing activities (business combinations)		286		—
Noncash financing activities (accrued debt issuance costs)		—		979

See accompanying notes to consolidated financial statements

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Cotiviti Holdings, Inc.

Notes to the Financial Statements

(In thousands, except shares and per share amounts)

(Unaudited)

Note 1. Description of Business

Cotiviti Holdings, Inc. (collectively with its subsidiaries, “we,” “our,” “Cotiviti” or the “Company”) is a leading provider of payment accuracy and analytics‑driven solutions that help risk-bearing healthcare organizations and retailers achieve their business objectives. Through a combination of analytics, technology and deep industry experience, our solutions create insights that unlock value from the complex interactions between clients and their stakeholders. We work with over 60 healthcare organizations, including more than 20 of the 25 largest U.S. commercial, Medicare and Medicaid managed health plans, as well as CMS. We are also a leading provider of payment accuracy solutions to approximately 35 retail clients, including eight of the ten largest retailers in the United States.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation

Our accompanying unaudited consolidated financial statements have been prepared in accordance with GAAP. All significant intercompany balances and transactions have been eliminated in consolidation. These consolidated financial statements are unaudited and have been prepared by us following the rules and regulations of the SEC. In our opinion they reflect all adjustments, including normal recurring items, that are necessary to present fairly the results of interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted as permitted by such rules and regulations; however, we believe that the disclosures are adequate to make the information presented not misleading. Operating results for the periods presented herein are not necessarily indicative of the results that may be expected for other interim periods or the entire fiscal year. Certain prior year amounts have been reclassified to conform to the current year presentation.

Estimated Liability for Refunds and Appeals and Unbilled Receivables

The estimated liability for refunds and appeals representing our estimate of claims that may be overturned related to revenue which had already been received was $57,971 and $62,539 at September 30, 2017 and December 31, 2016, respectively. The estimated allowance for refunds and appeals representing our estimate of claims that may be overturned related to amounts in accounts receivable was $30,996 and $41,020 at September 30, 2017 and December 31, 2016, respectively.

Unbilled receivables represent revenue recognized related to claims for which clients have received economic value that were not invoiced at the balance sheet date. Unbilled receivables of approximately $54,138 and $51,643 as of September 30, 2017 and December 31, 2016, respectively, are included in accounts receivable on our Consolidated Balance Sheets.

Certain unbilled receivables arise when a portion of our earned fee is deferred at the time of the initial invoice. At a later date (which can be up to a year after original invoice, and at other times during the year after completion of the audit period based on contractual terms or as agreed with our client), we invoice the unbilled receivable amount. Notwithstanding the deferred due date, our clients acknowledge we have earned this unbilled receivable at the time of the original invoice, but we have agreed to defer billing the client for the related services. Unbilled receivables of this nature were approximately $5,457 and $6,137 as of September 30, 2017 and December 31, 2016, respectively, and are included in accounts receivable on our Consolidated Balance Sheets.

We record periodic changes in unbilled receivables and refund liabilities as adjustments to revenue.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

Recently Issued Accounting Standards

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”), which simplifies the application of hedge accounting guidance and improves financial reporting of hedging relationships. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted. We are evaluating this guidance and do not believe it will have a material impact on our consolidated financial statements and related disclosures.

In April 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting (“ASU 2017-09”), which addresses what constitutes a modification when applying the guidance in ASC 718 Compensation- Stock Compensation in order to reduce diversity in practice. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted. We are evaluating this guidance and do not believe it will have a material impact on our consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), which is intended to simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of the goodwill. Instead, an entity should compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2019, including interim periods within those annual periods. We have early adopted the provisions of ASU 2017-04 as of April 1, 2017. As the fair values of our reporting units exceed their carrying values, there has been no impact on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business (“ASU 2017-01”), which assists entities with evaluating whether transactions should be accounted for as acquisitions of assets or businesses. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted. We are evaluating this guidance and do not believe it will have a material impact on our consolidated financial statements and related disclosures.

In November 2016, the FASB issued ASU 2016-18, Restricted Cash (“ASU 2016-18”), which requires that restricted cash be included with cash and cash equivalents when reconciling the beginning and end of period total amounts shown on the statement of cash flows. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted. We are evaluating this guidance and its impact on our consolidated financial statements and related disclosures and expect the adoption of this ASU could impact the disclosure of our cash flows from operations.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”) which addresses eight specific cash flow issues in order to reduce diversity in practice. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted. We are evaluating this guidance and do not believe it will have a material impact on our consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”) which changes the accounting recognition, measurement and disclosure for leases in order to increase transparency. ASU 2016-02 requires lease assets and liabilities to be recognized on the balance sheet and key information about leasing arrangements to be disclosed. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. Early adoption is permitted. We are evaluating this guidance and its impact on our consolidated financial statements and related disclosures.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”) which changes the current financial instruments model primarily impacting the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. We are evaluating this guidance and do not believe it will have a material impact on our consolidated financial statements and related disclosures.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which supersedes existing revenue recognition guidance and provides clarification of principles for recognizing revenue from contracts with customers. ASU 2014-09 sets forth a five-step model for determining when and how revenue is recognized. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Additional disclosures will be required to describe the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. The two permitted transition methods under ASU 2014-09 are the full retrospective method, in which case the new guidance would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of the initial application. The guidance is effective for public companies with annual periods beginning after December 15, 2017, including interim periods within that reporting period. The FASB will permit companies to adopt the new standard early, but not before the original effective date of annual reporting periods beginning after December 15, 2016.

In 2016, we formed an internal team to evaluate and quantify the potential impact of this new revenue guidance. As of the date of this filing, we have completed our contract review and policy drafting. Based on our review, we believe the timing of revenue recognition will not change from current practice. We are in the process of completing a contract review and evaluating the impact of this new guidance as it relates to the RowdMap Acquisition as discussed in Note 3. We plan to adopt as of January 1, 2018 using the modified retrospective method. Adoption of this standard will require changes to our business processes, systems and controls to support the additional required disclosures. We are in the process of identifying and designing such changes to ensure our readiness. We will provide additional information about the impact of this new guidance, including enhanced disclosure requirements, in future filings.

Note 3. Acquisition

On July 14, 2017, we acquired all of the outstanding equity of RowdMap, Inc. (“RowdMap”). Based in Louisville, Kentucky, RowdMap is a payer-provider, value-based analytics company that helps health plans and providers identify and reduce low-value care from inefficient and unnecessary services. We paid approximately $74,000 in cash, subject to certain adjustments and funded entirely with available liquidity. We also issued an aggregate of 768,021 shares of restricted common stock to certain employees of RowdMap in connection with their continued employment with us. Half of these shares are subject to continued employment and performance-based vesting requirements. The other half are subject to continued employment, with one-third vesting on each of the first three anniversaries of the closing of the acquisition. We will record stock-based compensation expense related to this restricted stock ratably over the vesting period or to the extent it is probable the performance criteria will be achieved. This stock-based compensation expense will not be deductible for income tax purposes.

As part of the RowdMap Acquisition, we allocated the purchase price to the identifiable net assets acquired, including intangible assets and liabilities assumed, based on the estimated fair values at the date of acquisition. The excess of the purchase price over the amount allocated to the identifiable assets and liabilities was recorded as goodwill.

Goodwill represents the value of acquired assembled workforce, specialized processes and procedures and operating synergies, none of which qualify as separate intangible assets. We believe these specialized processes and procedures will enhance our long history of innovation and help expand our solution offerings. We determined the estimated fair values of intangible assets acquired using estimates of future discounted cash flows to be generated by the business over the estimated duration of those cash flows. We based the estimated cash flows on our projections of future revenue, operating expenses,

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

capital expenditures, working capital needs and tax rates. We estimated the duration of the cash flows based on the projected useful lives of the assets acquired. The discount rate was determined based on specific business risk, cost of capital and other factors.

The purchase price allocation is preliminary and subject to change up to one year after the date of acquisition and could result in changes to the amounts recorded below. The preliminary allocation of the purchase price to the fair values of the assets acquired and liabilities assumed at the date of the acquisition was as follows:


	July 14, 2017
Cash	$	4,107
Accounts receivable		2,526
Prepaid expenses and other assets		1,212
Other long-term assets		12
Property and equipment		263
Intangible assets		19,510
Total identifiable assets acquired		27,630
Accounts payable and accrued liabilities		4,491
Deferred tax liabilities		3,688
Total liabilities assumed		8,179
Net identifiable assets acquired		19,451
Goodwill		54,673
Net assets acquired	$	74,124

The $19,510 of acquired intangible assets include acquired software of $6,310 (5 year useful life) and customer relationships of $13,200 (5 year useful life).

For federal income tax purposes, the RowdMap Acquisition was treated as a stock acquisition. The goodwill and the intangible assets recognized are not deductible for income tax purposes.

In connection with the RowdMap Acquisition, a preliminary liability of $1,068 was recorded in accounts payable and accrued other expenses on the Consolidated Balance Sheets as of September 30, 2017, for payments due to the former stockholders of RowdMap, some of whom are now our employees.

We recorded approximately $700 of transaction costs primarily related to professional services associated with the acquisition as transaction-related expenses within our Consolidated Statements of Comprehensive Income (Loss) during the three and nine months ended September 30, 2017.

The acquisition was not significant to our consolidated financial statements, therefore, pro forma results of operations related to this business acquisition have not been presented. The financial results of RowdMap have been included in our consolidated financial statements since the date of the acquisition.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

Note 4. Property and Equipment

Property and equipment by major asset class for the periods presented consisted of the following:


	September 30,		December 31,
	2017		2016
Computer equipment	$	48,522	$	40,349
Software		65,416		42,614
Furniture and fixtures		9,156		8,652
Leasehold improvements		5,255		4,392
Projects in progress		7,655		12,001
Property and equipment, gross	$	136,004	$	108,008
Less: accumulated depreciation and amortization		57,590		40,368
Property and equipment, net	$	78,414	$	67,640

In December 2015, we purchased a perpetual software license, which is included in the software total above. We are paying for this software over a two year period ending in January 2018. As such, there is approximately $3,319 and $3,351 included in accounts payable and accrued other expenses on our Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016, respectively, and $3,225 included in other long-term liabilities on our Consolidated Balance Sheets as of December 31, 2016.

Total depreciation and amortization expense related to property and equipment, including capitalized software costs, was $6,070 and $5,218 for the three months ended September 30, 2017 and 2016, respectively, and $17,541 and $14,864 for the nine months ended September 30, 2017 and 2016, respectively.

Note 5. Intangible Assets

Intangible asset balances by major asset class for the periods presented were as follows:


							Weighted
	Gross				Net		Average
	Carrying		Accumulated		Carrying		Amortization
	Amount		Amortization		Amount		Period
September 30, 2017:
Customer relationships	$	653,531	$	180,721	$	472,810	13.5	years
Acquired software		88,710		57,897		30,813	6.1	years
Connolly trademark		4,200		—		4,200	indefinite-lived
Total	$	746,441	$	238,618	$	507,823	12.6	years
December 31, 2016:
Customer relationships	$	640,052	$	144,768	$	495,284	13.7	years
Acquired software		82,400		48,579		33,821	6.2	years
Connolly trademark		4,200		—		4,200	indefinite-lived
Total	$	726,652	$	193,347	$	533,305	12.8	years

Amortization expense was $14,747 and $15,203 for the three months ended September 30, 2017 and 2016, respectively, and $45,147 and $45,618 for the nine months ended September 30, 2017 and 2016, respectively.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

As of September 30, 2017, amortization expense for the next 5 years is expected to be:


Remainder of 2017	$	14,455
2018		57,822
2019		57,822
2020		57,822
2021		53,499

Note 6. Goodwill

Total goodwill in our Consolidated Balance Sheets was $1,251,325 and $1,196,024 as of September 30, 2017 and December 31, 2016, respectively.

Changes in the carrying amount of goodwill by our Healthcare and Global Retail and Other segments for the nine months ended September 30, 2017 were as follows:


			Global Retail
	Healthcare		and Other
December 31, 2016	$	1,147,771	$	48,253
Acquisition		54,673		—
Foreign currency translation		—		628
September 30, 2017	$	1,202,444	$	48,881

There was no impairment related to goodwill for any period presented.

Note 7. Commitments and Contingencies

We may be involved in various legal proceedings and litigation arising in the ordinary course of business. While any legal proceeding or litigation has an element of uncertainty, management believes the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations, or liquidity.

Medicare RAC Contract Contingency

In August 2014, CMS announced it would allow providers to remove all eligible claims currently pending in the appeals process by offering to pay hospitals 68% of the original claim amount. This settlement was offered to the providers and it was unknown what, if any, impact there would be for the Medicare RACs. On July 1, 2015, CMS issued a Technical Direction Letter to the Medicare RACs, including ourselves, indicating that Medicare RACs will only be entitled to the contract contingency fee on the settled amounts of the claims, or 32% of the original inpatient claim amounts. Based on the initial lists of finalized settlements provided by CMS, we would be required to refund CMS approximately $22,308 due to the related adjustments in Medicare RAC contingency fees. CMS further advised that as the hospital settlement project continues, additional settlement lists will be matched to Medicare RAC claims which may result in updated refund amounts to those initially provided. While there are uncertainties in any dispute resolution and results are uncertain, we have disputed CMS’s findings based on our interpretation of the terms of the Medicare RAC contract and our belief that the backup data provided by CMS is inaccurate and/or incomplete. Our liability for estimated refunds and appeals includes amounts for these settled claims based on our best estimates of the amount we believe will be ultimately payable to CMS based on our interpretation of the terms of the Medicare RAC contract. We believe that it is possible that we could be required to pay an additional amount up to approximately $13,000 in excess of the amount we accrued as of September 30, 2017 based on the claims data we have received from CMS to date. As CMS completes its settlement process with the providers and updated files are provided to us, the potential amount owed by us may change.

On September 28, 2016, CMS announced a second settlement process to allow eligible providers to settle their inpatient claims currently under appeal beginning December 1, 2016. This second settlement process could result in additional amounts owed to CMS. CMS has not yet provided us with any information and accordingly the amount of any

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

such additional claims cannot presently be determined.

Our original Medicare RAC program contract, including any liability for appeals, ends on January 31, 2018.

Note 8. Long‑term Debt

In April 2017, we entered into and executed the First Amendment Agreement to the then outstanding Restated Credit Agreement, which, among other things, provided for a 25 basis point reduction in applicable interest rate spread over LIBOR associated with the First Lien Term B Loan. As a result, we recognized a loss on extinguishment of $3,183 during the nine months ended September 30, 2017, which consists of fees paid and write-offs of unamortized debt issuance costs and original issue discount.

Long‑term debt for the periods presented was as follows:


	September 30,		December 31,
	2017		2016
First Lien Term A Loan	$	237,352	$	246,694
First Lien Term B Loan		541,846		544,345
Revolver		—		—
Total debt		779,198		791,039
Less: debt issuance costs		7,606		10,837
Less: current portion		18,000		18,000
Total long-term debt	$	753,592	$	762,202

The Restated Credit Agreement includes certain binding affirmative and negative covenants, including delivery of financial statements and other reports, maintenance of existence and transactions with affiliates. The negative covenants restrict our ability, among other things, to incur indebtedness, grant liens, make investments, sell or otherwise dispose of assets or enter into a merger, pay dividends or repurchase stock. There is a required financial covenant applicable only to the Revolver and the Term A Loan, pursuant to which we agree not to permit our Secured Leverage Ratio to exceed 5.50:1.00 through September 2018, 5.25:1.00 through September 2019 and 5.00:1.00 through June 2021. In addition, the Restated Credit Agreement includes certain events of default including payment defaults, failure to perform affirmative covenants, failure to refrain from actions or omissions prohibited by negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults and a change of control default. We were in compliance with all such covenants as of September 30, 2017 and December 31, 2016, respectively.

The Restated Credit Agreement requires mandatory prepayments based upon our leverage ratio at the time payment is required and an annual excess cash flow calculation commencing with the year ended December 31, 2017. The mandatory prepayment is contingently payable in the second quarter of each year based on an annual excess cash flow calculation for the preceding year as defined within the Restated Credit Agreement.

As of September 30, 2017, the aggregate maturities of long‑term debt (excluding any amounts that may become payable with respect to the aforementioned mandatory prepayment provision for annual excess cash flows) for each of the next five years are expected to be $4,500 for the remainder of 2017, $18,000 in 2018, $24,250 in 2019, $30,500 in 2020 and $183,625 in 2021.

Note 9. Derivative Instruments

We are exposed to fluctuations in interest rates on our long‑term debt. We manage our exposure to fluctuations in the 3‑month LIBOR through the use of interest rate cap agreements designated as cash flow hedges. We are meeting our objective by hedging the risk of changes in cash flows related to changes in LIBOR by capping the interest on our floating rate debt linked to LIBOR to approximately 3%. We do not utilize derivatives for speculative or trading purposes.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

As of September 30, 2017 and December 31, 2016, we had $540,000 in notional debt outstanding related to these interest rate caps, which cover quarterly interest payments through September 2019. The notional amount decreases over time.

All of our outstanding interest rate cap contracts qualify for cash flow hedge accounting treatment in accordance with ASC 815, Derivatives and Hedging. Cash flow hedge accounting treatment allows for gains and losses on the effective portion of qualifying hedges to be deferred in accumulated other comprehensive income (loss) until the underlying transaction occurs, rather than recognizing the gains and losses on these instruments in earnings during each period they are outstanding. When the actual interest payments are made on our variable rate debt and the related derivative contract settles, any effective portion of realized interest rate hedging derivative gains and losses previously recorded in accumulated other comprehensive income (loss) is recognized in interest expense. We recognized interest expense of $605 and $56 related to interest rate caps during the three months ended September 30, 2017 and 2016, respectively, and $1,204 and $200 during the nine months ended September 30, 2017 and 2016, respectively.

Ineffectiveness results, in certain circumstances, when the change in total fair value of the derivative instrument differs from the change in the fair value of our expected future cash outlays for the related interest payment and is recognized immediately in interest expense. There was no ineffectiveness recorded during the nine months ended September 30, 2017 and 2016, respectively. Likewise, if the hedge does not qualify for hedge accounting, the periodic changes in its fair value are recognized in the period of the change in interest expense. All cash flows related to our interest rate cap agreements are classified as operating cash flows.

Any outstanding derivative instruments expose us to credit loss in the event of nonperformance by the counterparties to the agreements, but we do not expect that the counterparty will fail to meet their obligations. The amount of such credit exposure is generally the positive fair value of our outstanding contracts. To manage credit risks, we select counterparties based on credit assessments, limit our overall exposure to any single counterparty and monitor the market position of any counterparty.

The table below reflects quantitative information related to the fair value of our derivative instruments and where these amounts are recorded in our consolidated financial statements as of the period presented:


	September 30,		December 31,
	2017		2016
Liability fair value recorded in other long-term liabilities	$	1,255	$	1,729
Liability fair value recorded in accounts payable and accrued other expenses		984		1,065
Estimated amount of existing losses expected to be reclassified into earnings in the next 12 months		(2,519)		(1,783)

We record deferred hedge premiums which are being paid over the life of the hedge in accumulated other comprehensive (loss) income until the related hedge ultimately settles and interest payments are made on the underlying debt. As of September 30, 2017, we have made payments of $3,661 related to these deferred premiums. We expect to pay an additional $2,733 in deferred premiums through 2019 related to our outstanding interest rate cap agreements which is reflected in the fair value of these derivatives in the table above.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

Comprehensive income includes changes in the fair value of our interest rate cap agreements which qualify for hedge accounting. Changes in other comprehensive income for the periods presented related to derivative instruments classified as cash flow hedges were as follows:


	Three Months Ended September 30,
	2017		2016

Balance at beginning of period, July 1	$	(3,203)	$	(3,534)
Reclassifications in earnings, net of tax of $229 and $21, respectively		376		35
Change in fair value of derivative instrument, net of tax of $46 and $45, respectively		(75)		(84)
Balance at end of period, September 30	$	(2,902)	$	(3,583)


	Nine Months Ended September 30,
	2017		2016

Balance at beginning of period, January 1	$	(3,334)	$	(2,968)
Reclassifications in earnings, net of tax of $455 and $76, respectively		749		124
Change in fair value of derivative instrument, net of tax of $208 and $463, respectively		(317)		(739)
Balance at end of period, September 30	$	(2,902)	$	(3,583)

Note 10. Fair Value Measurements

We measure assets and liabilities at fair value based on assumptions market participants would use in pricing an asset or liability in the principal or most advantageous market. Authoritative guidance on fair value measurements establishes a consistent framework for measuring fair value whereby inputs are assigned a hierarchical level. The hierarchical levels are:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.

Level 2: Observable prices, other than quoted prices included in Level 1 inputs for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Unobservable inputs for the asset or liability used to measure fair value to the extent observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.

The following table summarizes our financial instruments measured at fair value within the Consolidated Balance Sheets:


	September 30, 2017						December 31, 2016
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Liabilities:
Long-term debt	$	—	$	—	$	779,198	$	—	$	—	$	791,039
Interest rate cap agreements		—		2,239		—		—		2,794		—
Total	$	—	$	2,239	$	779,198	$	—	$	2,794	$	791,039

The fair value of our private debt is determined based on fluctuations in current interest rates, the trends in market yields of debt instruments with similar credit ratings, general economic conditions and other quantitative and qualitative factors. The carrying value of our debt approximates its fair value. Refer to Note 8 for more information on our long-term debt.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

The fair value of the interest rate cap agreements is determined using the market standard methodology of discounting the future expected variable cash receipts that would occur if interest rates rose above the strike rate of the caps. The analysis reflects the contractual terms of the derivatives, including period to maturity and remaining deferred premium payments, and uses observable market‑based inputs, including interest rates and implied volatilities. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rates. As such, the estimated fair values of these liabilities are classified as Level 2 in the fair value hierarchy. Refer to Note 9 for more information on our interest rate cap agreements.

Note 11. Income Taxes

The following table presents our income tax provision and effective income tax rate:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2017			2016			2017			2016
Income tax expense	$	12,918		$	711		$	19,800		$	12,780
Effective income tax rate		39.9	%		13.4	%		22.7	%		35.2	%

Our effective income tax rate was 39.9% and 13.4% for the three months ended September 30, 2017 and 2016, respectively. The increase in income tax expense of $12,207 was primarily the result of an increase in pre-tax income for the three months ended September 30, 2017 and the impact of $2,358 related to the nondeductible restricted stock issued in connection with the RowdMap Acquisition, partially offset by a $1,833 tax benefit related to stock option exercises and a $481 net tax benefit primarily related to tax returns filed during the quarter. The impact of this additional tax expense and tax benefits relative to the pre-tax income for the three months ended September 30, 2017 resulted in the increase to the effective tax rate. Additionally, during the three months ended September 30, 2016, we recorded a $1,300 tax benefit primarily related to the settlement of an uncertain tax position recorded in a prior period. The effective tax rate for the three months ended September 30, 2016 was impacted by this tax benefit relative to the pre-tax income for the three months ended September 30, 2016.

Our effective income tax rate was 22.7% and 35.2% for the nine months ended September 30, 2017 and 2016 respectively. The decrease in the effective tax rate is primarily due to a $14,874 tax benefit related to stock option exercises, a tax benefit of $337 related to the settlement of an uncertain tax position due to the closure of our audit with the Internal Revenue Service, a tax benefit of $660 related to the filing of amended state tax returns as a result of certain tax planning and a $481 net tax benefit primarily related to tax returns filed during the quarter. These tax benefits were partially offset by additional tax expense of $2,358 related to the nondeductible restricted stock issued in connection with the RowdMap Acquisition.

We file income taxes with the U.S. federal government and various states and foreign jurisdictions. We operate in a number of state and local jurisdictions and as such are subject to state and local income tax examinations based upon various statutes of limitations in each jurisdiction. We are currently under audit by the State of New York for the tax year ended December 31, 2014 and for iHealth Technologies for the tax years ended December 31, 2012, December 31, 2013, May 13, 2014 and December 31, 2014.

Note 12. Stockholders’ Equity

Secondary Offerings

On August 7, 2017, we completed a secondary offering of 10,000,000 shares of our common stock by certain of our stockholders at an offering price of $37.00 per share. All of the shares offered were sold by selling stockholders. Accordingly, we did not receive any proceeds from the sale of shares. In connection with this offering, we incurred approximately $700 in professional services expenses, which are included in transaction-related expenses on our Consolidated Statements of Comprehensive Income for the nine months ended, September 30, 2017.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

On March 7, 2017, we completed a secondary offering of 9,683,000 shares of our common stock by certain of our stockholders, including 1,263,000 shares sold to the underwriters pursuant to their option to purchase additional shares, at an offering price of $36.00 per share. All of the shares offered were sold by selling stockholders. Accordingly, we did not receive any proceeds from the sale of the shares. In connection with this offering, we incurred approximately $600 in professional services expenses, which are included in transaction-related expenses on our Consolidated Statements of Comprehensive Income for the nine months ended September 30, 2017.

Note 13. Earnings per Share

Basic EPS is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period. For all periods presented, potentially dilutive outstanding shares consisted of equity incentive awards. Restricted stock issued in connection with the RowdMap Acquisition was also included in the calculation of dilutive potential common shares for the three and nine months ended September 30, 2017. Our potential common shares consist of the incremental common shares issuable upon the exercise of stock options or vesting of RSUs and restricted stock. The dilutive effect of outstanding equity incentive awards is reflected in diluted earnings per share by application of the treasury stock method. For all periods presented, all outstanding common stock consisted of a single class.

Basic and diluted earnings per share are computed as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
Net income available to common stockholders	$	19,472	$	4,583	$	67,535	$	23,560

Weighted average outstanding shares of common stock		92,273,105		90,170,462		91,813,864		83,275,206
Dilutive effect of stock-based awards and restricted stock		2,992,632		3,783,441		3,337,591		3,582,720
Adjusted weighted average outstanding and assumed conversions for diluted EPS		95,265,737		93,953,903		95,151,455		86,857,926

Earnings per share:
Basic	$	0.21	$	0.05	$	0.74	$	0.28
Diluted		0.20		0.05		0.71		0.27

Employee stock options, RSUs and restricted stock that were excluded from the calculation of diluted earnings per share because their effect is anti‑dilutive for the periods presented were as follows:


	Three Months Ended		Nine Months Ended
	September 30,		September 30,
	2017	2016	2017	2016

Employee stock-based awards and restricted stock	1,155,968	35,737	699,629	327,880

The criteria associated with all of our outstanding performance-based stock options as defined in the terms of the applicable award agreements, were satisfied as of September 30, 2016 and, as a result, 2,746,592 outstanding performance-based stock options were included in the calculation of diluted earnings per share for the three and nine months ended September 30, 2016. Performance-based restricted stock of 76,802 shares were not included in the calculation of diluted earnings per share for the three and nine months ended, September 30, 2017 as the vesting conditions were not probable of occurring.

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

Note 14. Stock‑Based Compensation

Stock Options

The following is a summary of stock option activity under the Plans:


				Weighted
		Weighted		average
		average		remaining	Aggregate
	Outstanding	exercise price		contractual life	Intrinsic Value
	Options	per share		(Years)	(in thousands)
Outstanding at December 31, 2016	5,997,372	$	10.18	7.30	$	145,270
Granted	577,690		34.77
Forfeited	(191,890)		18.75
Exercised	(1,562,590)		7.34
Expired	(2,893)		13.79
Outstanding at September 30, 2017	4,817,689	$	13.70	6.93	$	107,478

Vested and exercisable at September 30, 2017	3,313,087	$	10.34	6.28	$	84,939

Aggregate intrinsic value represents the difference between our estimated fair value of common stock and the exercise price of outstanding in‑the‑money options. The fair value per share of common stock was $35.98 as of September 30, 2017 based upon the closing price of our common stock on the NYSE. The total intrinsic value of stock options exercised was $6,025 and $47,915 for the three and nine months ended September 30, 2017, respectively, and insignificant for each of the three and nine months ended September 30, 2016.

Restricted Stock Units

The following is a summary of RSU activity under the 2016 Plan:


		Weighted
		average
		grant date fair value
	Number of Awards	per share
Outstanding at December 31, 2016	67,295	$	25.88
Granted	275,726		34.98
Forfeited	(32,796)		31.03
Vested and converted to shares	(38,302)		29.88
Outstanding at September 30, 2017	271,923	$	33.93
Expected to vest at September 30, 2017	271,923	$	33.93

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

Restricted Stock

We issued an aggregate of 768,021 shares of restricted common stock to certain employees of RowdMap at a fair market value of $43.27 per share. Half of these shares are subject to continued employment and performance-based vesting requirements and, if achieved, will vest on the one year anniversary of the closing date of the RowdMap Acquisition. The other half are subject to continued employment with us, with one-third vesting on each of the first three anniversaries of the closing of the RowdMap Acquisition.

Employee Stock Purchase Plan

We have an ESPP, which became effective January 1, 2017, for US and non-US employees (collectively, “ESPP”), both of which have a series of six month offering periods, with a new offering period beginning on the first day of January and July each year. The ESPP was adopted by our Board of Directors in August 2016 and approved by shareholders in May 2017. Employees may contribute up to 10% of their pay towards the purchase of common stock via payroll deductions to a maximum of $10 per year, or $5 per offering period. Purchase dates occur on the last business day of June and December of each year and shares are purchased at a 10% discount off the closing price on the NYSE on the date of purchase. On June 30, 2017, 29,668 shares were purchased at a price of $33.43. Employees must hold the shares purchased for a minimum of 90 days.

Stock Compensation Expense

We used the weighted average assumptions to estimate the fair value of stock options granted for the periods presented as follows:


	Nine Months Ended September 30,
	2017			2016
Expected term (years)		6.25			6.25
Expected volatility		40.00	%		50.00	%
Expected dividend yield		0.00	%		0.00	%
Weighted average risk-free interest rate		1.92	%		1.34	%
Weighted average grant date fair value	$	14.60		$	9.39

Total fair market value related to the restricted stock issued in connection with the RowdMap Acquisition is $33,232 based on the closing price of our common stock on the date of grant. For the time-based shares, stock-based compensation expense is being recorded ratably over the three year vesting period. For the performance-based shares, stock-based compensation expense will be recorded over the one year vesting period to the extent it is probable the performance criteria will be achieved. As of September 30, 2017, we recorded approximately $2,769 in stock-based compensation expense related to the performance awards that we estimate are probable of achieving the performance criteria.

We recorded total stock‑based compensation expense of $5,752 and $17,042 for the three months ended September 30, 2017 and 2016, respectively, and $10,290 and $21,544 for the nine months ended September 30, 2017 and 2016, respectively. Stock-based compensation expense for the three and nine months ended September 30, 2016 includes $15,898 related to the vesting of substantially all then outstanding performance based stock options. Stock-based compensation expense during the nine months ended September 30, 2016 also includes $2,257 related to the accelerated vesting of certain stock options as a result of our IPO. As of September 30, 2017, we had total unrecognized compensation cost related to 2,467,744 unvested stock options and RSUs under the Plans as well as restricted stock of $46,658 which we expect to recognize over the next 2.6 years.

Note 15. Segment Information

We conduct our business through two reportable business segments: Healthcare and Global Retail and Other. Through our Healthcare segment, we offer prospective and retrospective claims accuracy solutions to healthcare payers in the United States. We also provide analytics-based solutions unrelated to our healthcare payment accuracy solutions, on a limited

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Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

basis in the United States and a network efficiency solution to payers and providers. Through our Global Retail and Other segment, we provide retrospective claims accuracy solutions to retailers primarily in the United States, Canada and the United Kingdom, as well as solutions that improve efficiency and effectiveness of payment networks for a limited number of clients.

We evaluate the performance of each segment based on segment net revenue and segment operating income. Operating income is calculated as net revenue less operating expenses and is not affected by other expense (income) or by income taxes. Indirect costs are generally allocated to the segments based on the segments’ proportionate share of revenue and expenses directly related to the operation of the segment. We do not allocate interest expense, other non-operating (income) expense or the provision for income taxes, since these items are not considered in evaluating the segment’s overall operating performance. Our Chief Operating Decision Maker does not receive or utilize asset information to evaluate performance of operating segments. Accordingly, asset-related information has not been presented.

Our operating segment results for the periods presented were as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
	(unaudited)				(unaudited)
Net Revenue
Healthcare	$	156,219	$	138,470	$	447,581	$	403,643
Global Retail and Other		17,969		17,771		54,351		53,607
Consolidated net revenue	$	174,188	$	156,241	$	501,932	$	457,250
Operating Income
Healthcare	$	38,094	$	22,544	$	107,944	$	85,879
Global Retail and Other		2,948		1,611		7,176		6,452
Consolidated operating income	$	41,042	$	24,155	$	115,120	$	92,331

Operating segment net revenue by product type for the periods presented was as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2017		%	2016		%	2017		%	2016		%
	(unaudited)						(unaudited)
Healthcare
Retrospective claims accuracy	$	88,396	50.7	$	78,133	50.0	$	252,538	50.3	$	224,335	49.1
Prospective claims accuracy		62,628	36.0		57,233	36.6		184,365	36.8		169,632	37.1
Other		5,195	3.0		3,104	2.0		10,678	2.1		9,676	2.1
Total Healthcare		156,219	89.7		138,470	88.6		447,581	89.2		403,643	88.3
Global Retail and Other
Retrospective claims accuracy		17,470	10.0		17,039	10.9		52,529	10.5		51,730	11.3
Other		499	0.3		732	0.5		1,822	0.3		1,877	0.4
Total Global Retail and Other		17,969	10.3		17,771	11.4		54,351	10.8		53,607	11.7
Consolidated net revenue	$	174,188	100.0	$	156,241	100.0	$	501,932	100.0	$	457,250	100.0

Note 16. Subsequent Event

On October 31, 2017, we announced that the Board of Directors approved a share repurchase program under which we may repurchase up to $100,000 of common stock. This authorization permits us to repurchase shares from time to time until October 31, 2018 through a variety of methods, including open market repurchases and in privately negotiated transactions subject to debt covenants and other customary legal, contractual, regulatory and market considerations and may be discontinued at any time. All share repurchases will be implemented in accordance with Rule 10b-18 of the Exchange Act with respect to the timing, pricing and volume of such transactions. There can be no assurance as to the amount, timing or prices of repurchases, which may vary based on market conditions and other factors.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the financial condition and results of our operations should be read together with the financial statements and the related notes of Cotiviti Holdings, Inc. included in Item 1 of this Quarterly Report on Form 10-Q and with our audited financial statements and the related notes included in our Annual Report on Form 10-K, filed with the SEC.

This discussion and analysis contains forward-looking statements regarding the industry outlook, our expectations for the performance of our business, our liquidity and capital resources and other non-historical statements. These forward-looking statements are subject to numerous risks and uncertainties, including but not limited to the risks and uncertainties described in “—Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors.” Our actual results may differ materially from those contained in or implied by these forward-looking statements.

Overview

We are a leading provider of payment accuracy and analytics-driven solutions, focused primarily on the healthcare sector. Our integrated solutions help clients enhance payment accuracy in an increasingly complex healthcare environment. We leverage our robust technology platform, configurable analytics, proprietary information assets and expertise in healthcare reimbursement to help our clients enhance their claims payment accuracy. We help our healthcare clients identify and correct payment inaccuracies, which resulted in approximately $3.3 billion in savings in 2016. We work with over 60 healthcare organizations, including more than 20 of the 25 largest U.S. commercial, Medicare and Medicaid managed health plans, as well CMS. We are also a leading provider of payment accuracy solutions to approximately 35 retail clients, including eight of the ten largest retailers in the United States. We operate in two segments, Healthcare and Global Retail and Other.

Our growth strategy for healthcare includes:

expand within our existing client base by increasing the volume of claims we review with our solutions; expanding adoption across the depth and breadth of our solutions; and cross-selling our prospective, retrospective and network efficiency solutions.

expand our client base;

innovate to improve and develop new solutions to expand the scope of our services; and

pursue opportunistic acquisitions and strategic partnerships in payment accuracy and adjacent markets.

As a result of the meaningful savings we deliver to our clients, we have increased our client base and strengthened our long-standing relationships with many of the leading healthcare payers in the United States. In 2016, we added four new clients and two cross-sell clients which we believe will drive revenue growth in 2017 and beyond. In 2017, we added four new clients and four cross-sell clients. The average length of our relationships with our ten largest healthcare clients is over ten years. We have also substantially increased the annual savings captured by our healthcare clients over time.

We are also a leading provider of payment accuracy solutions to the retail market. Retailers process and validate extremely high volumes of transactions with disparate suppliers on varying terms. We work with retail clients in the United States, Canada and the United Kingdom to realize their negotiated allowances, concessions, rebates and other incentives associated with merchandise procurement, logistics and other service transactions. In 2016, we generated over $500 million in savings for our retail clients.

For a further discussion of our two operating segments, (i) Healthcare and (ii) Global Retail and Other, refer to “—Our Segments” and Note 15 to the consolidated financial statements.

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Factors Affecting Our Results of Operations

Recent Developments – 2017 Highlights

We continued to execute on our strategy, increasing volume and expanding the adoption of our solutions within our existing healthcare clients which contributed to healthcare revenue growth of 11% during the nine months ended September 30, 2017.

Growth in our healthcare business also continues to benefit from the addition of new clients and our successful cross-sell efforts. During the nine months ended September 30, 2017, we generated $20.0 million in revenue from eight new clients and from an additional six existing clients who have adopted either prospective or retrospective solutions, all of which were added in 2016 and 2017.

Our fourth quarter 2017 healthcare revenue is expected to be impacted by certain timing-related delays. Due to system changes at a few clients within our retrospective claims accuracy solutions, revenue conversions are taking longer than anticipated to be realized which is resulting in revenue shifting out of the fourth quarter of 2017. Additionally, certain new and cross-sell client implementations within our prospective claims accuracy solutions have been delayed longer than we anticipated. These new opportunities are expected to be implemented for the contracted scope, but due to the timing delays will likely not generate revenue in 2017.

During the nine months ended September 30, 2017, approximately 1.6 million shares of common stock were issued upon the exercise of stock options. The stock option exercises resulted in a $14.9 million tax benefit and significantly contributed to an effective tax rate of 22.7% for the nine months ended September 30, 2017.

In October 2017, the Board of Directors approved a share repurchase program under which we may repurchase up to $100 million of common stock. This authorization permits us to repurchase shares from time to time until October 31, 2018 through a variety of methods, including open market repurchases and in privately negotiated transactions subject to debt covenants and other customary legal, contractual, regulatory and market considerations and may be discontinued at any time. All share repurchases will be implemented in accordance with Rule 10b-18 of the Exchange Act with respect to the timing, pricing and volume of such transactions.

In July 2017, we completed our acquisition of RowdMap, Inc., a payer-provider, value-based analytics company that helps health plans and providers identify and reduce low-value care from inefficient and unnecessary services. We paid approximately $74.0 million in cash, subject to certain adjustments and funded entirely with available liquidity. We also issued an aggregate of 768,021 shares of restricted common stock to certain employees of RowdMap as a material inducement to their employment with us. Half of these shares are subject to performance-based vesting requirements. The other half are subject to continued employment with us, with one-third vesting on each of the first three anniversaries of the closing of the acquisition.

In April 2017, we entered into and executed the First Amendment Agreement to the then outstanding Restated Credit Agreement, which, among other things, provided for a 25 basis point reduction in applicable interest rate spread over LIBOR associated with the First Lien Term B Loan. As a result, we recognized a loss on extinguishment of debt of $3.2 million during the nine months ended September 30, 2017.

In March 2017, we began auditing under our two new Medicare RAC contracts awarded in October 2016. These contracts have been ramping slower than anticipated and we expect they will contribute minimal revenue in 2017.

Dollar Amount of Claims Reviewed

Revenue in our Healthcare segment in a given period is impacted by the dollar amount of claims we review for our clients, which impacts inaccurate payments that we identify for our clients and the amount of revenue we receive under our performance fee-based contracts. The dollar amount of claims that we review is driven by the scope of claims submitted to us by our clients. The dollar amount of inaccurate payments we identify is also dependent upon the type and number of our solutions used by our clients.

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In our Global Retail and Other segment, our revenue is dependent on (i) the amount of payments that we review for our retail clients and (ii) the timing of our payment reviews, which typically are completed on a batch processing basis following the lapse of a period of time after payment.

Healthcare Industry and General Economic Conditions

A majority of our business is directly related to the healthcare industry and is affected by healthcare spending and complexity in the healthcare industry, as follows:

Healthcare Spending by Payers. Changing demographics, the shift to managed care plans within government healthcare and increased healthcare coverage may lead to an increase in healthcare spending by our payer clients. From 2004 to 2014, healthcare costs in the United States grew at a 4.8% CAGR to $3.0 trillion and increased 5.8% in 2015 to $3.2 trillion. According to CMS, healthcare costs are expected to continue to grow at an average annual rate of 5.6% through 2025. Our revenue is impacted by the expansion or contraction of healthcare coverage and spending, which directly affects the number of payments available for our review.

Complexity in the Healthcare Industry. We believe reimbursement models will continue to become more complex as healthcare payers accommodate new markets and lines of business and as advancements in medical care increase the number of testing and treatment options available. The adoption of the ICD-10 coding framework in October 2015 has resulted in a nearly five times increase of possible diagnosis codes to approximately 68,000, further complicating the claims process. As reimbursement models grow more complex and healthcare coverage increases, the complexity and number of claims may also increase, which could impact the demand for our payment accuracy solutions. In addition, lawmakers in Washington, D.C. continue to consider proposals to repeal and replace all or parts of the Affordable Care Act.

In addition, our Global Retail and Other segment is impacted by general economic conditions. For example, in a difficult economy, consumers may be willing to spend less and retailers may reduce their purchasing accordingly, thereby reducing their overall payments available for review. Alternatively, in an expanding economy, retailers may increase their purchasing to meet expected increasing demand resulting in increased payments subject to review using our solutions.

Components of Results of Operations

Net revenue

Our net revenue is generated from contracts with our clients. Our client contracts generally provide for performance fees that are based on a percentage of the inaccurate payments that we prevent through our prospective claims accuracy solutions or the payment recoveries received by our clients that use our retrospective claims accuracy solutions. We derive less than 3% of our revenue on a “fee-for-service” basis whereby billing is based upon a flat fee or a fee per hour. Our clients may request a refund or offset if their providers or vendors ultimately reject the payment inaccuracies we find or if our clients determine not to pursue reimbursement from their providers or vendors even though we may have collected fees. We record an estimate for refund liabilities at any given time based on actual historical refund data by client type. In such cases, we record any such refund as a reduction of revenue.

Historically, there has been a seasonal pattern to our healthcare revenue with the revenues in the first quarter generally lower than the other quarters and revenues in the fourth quarter generally being higher than the other quarters. We cannot provide assurance this pattern will continue. Accordingly, the comparison of revenue from quarter to quarter may fluctuate and is dependent on various factors, including, but not limited to, reset of member liability, timing of conversions and implementations, timing of special projects and timing of inaccurate payments being prevented or recovered as well as the aforementioned seasonal considerations. Consequently, you should not rely on our revenue for any one quarter as an indication of our future performance. Additionally, we record an estimated liability for refunds and appeals which is subject to management’s assumptions. These assumptions may change from time to time and result in adjustments to revenue. Historically, our adjustments of these estimates on a quarterly basis, to reflect actual results or updated expectations, have not been material to our overall business, and have resulted in either a net increase or a net decrease in revenues.

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Cost of revenue

Our cost of revenue is comprised of:

Compensation, which includes the total compensation and benefit-related expenses, including stock-based compensation expense, for employees who provide direct revenue generating services to clients; and

Other costs of revenue, which primarily include expenses related to the use of subcontractors and professional services firms, costs associated with the retrieval of medical records and facilities-related costs associated with locations that are used strictly for revenue generating activities. Cost of revenue does not include depreciation and amortization, which is stated separately in our Consolidated Statements of Comprehensive Income.

Selling, general and administrative expenses

Our selling, general and administrative expenses are comprised of:

Compensation, which includes total compensation and benefit-related expenses, including stock-based compensation expense, for our employees who are not directly involved in revenue generating activities including those involved with developing new service offerings; and

Other selling, general and administrative expenses, which include all of our general operating costs. These costs include, but are not limited to, rent and occupancy costs for facilities associated with locations that are used for employees not serving in revenue generating roles, telecommunications costs, information technology infrastructure costs, software licensing costs, advertising and marketing expenses, costs associated with developing new service offerings and expenses related to the use of certain subcontractors and professional services firms. Selling, general and administrative expenses do not include depreciation and amortization, which is stated separately in our Consolidated Statements of Comprehensive Income.

Depreciation and amortization of property and equipment

Depreciation and amortization of property and equipment consists of depreciation related to our investments in property and equipment, including claims accuracy solutions software, as well as amortization of capitalized internal-use software and software development costs.

Amortization of intangible assets

Amortization of intangible assets includes amortization of customer relationships and acquired software.

Transaction-related expenses

Transaction-related expenses consist primarily of professional services and other expenses associated with our IPO and other offerings as well as certain expenses associated with corporate development activity, including the RowdMap Acquisition.

Interest expense

Interest expense consists of accrued interest and related payments on our outstanding long-term debt as well as the amortization of debt issuance costs. Additionally, interest expense includes any effective portion of realized interest rate hedging derivative gains and losses previously recorded in accumulated other comprehensive income (loss) when the actual interest payments are made on our variable rate debt and the related derivative contract settles.

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Loss on extinguishment of debt

Loss on extinguishment of debt consists of fees paid and write-offs of unamortized debt issuance costs and original issue discount in connection with the 2017 repricing of our First Lien Term B Loan, the 2016 early repayment of a portion of our long-term debt and the 2016 refinancing of our long-term debt.

Other non-operating (income) expense

Other non-operating (income) expense primarily consists of foreign exchange gains and losses. In addition, income received for certain sub-leases, interest income and realized gains and losses are included in other non-operating (income) expense.

Income tax expense

Income tax expense consists of federal, state, local and foreign taxes based on earnings in multiple jurisdictions. Our income tax expense is impacted by the pre-tax earnings in jurisdictions with varying tax rates and any related foreign tax credits or deductions that may be available to us. Our current and future provision for income taxes will vary from statutory rates due to the impact of income tax incentives and holidays, certain non-deductible expenses, valuation allowances in certain countries, withholding taxes, excess tax benefits on the exercise of stock options and other discrete items.

Stock-based compensation expense

We grant equity incentive awards to certain employees, officers and non-employee directors as long-term incentive compensation. As part of the RowdMap Acquisition, we issued restricted stock to certain employees. We recognize the related expense for these awards ratably over the applicable vesting period or as achievement of performance criteria become probable. Such expense is recognized in either cost of revenue or selling, general and administrative expenses based upon the function of the optionee. The following table shows the allocation of stock-based compensation expense between our expense line items for the periods presented (in thousands):


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
	(unaudited)				(unaudited)
Cost of revenue	$	638	$	4,153	$	1,598	$	4,738
Selling, general and administrative expenses		5,114		12,889		8,692		16,806
Total	$	5,752	$	17,042	$	10,290	$	21,544

As of September 30, 2017, we had total unrecognized stock-based compensation expense related to unvested stock options, RSUs and restricted stock of $46.7 million, which we expect to recognize over the next 2.6 years. Stock-based compensation expense during the three months ended September 30, 2016 includes approximately $15.9 million as a result of the vesting of performance awards, of which approximately $3.9 million is included in cost of revenue above and the remaining $12.0 million is included in selling, general and administrative expenses above. Additionally, during the nine months ended September 30, 2016, stock-based compensation expense includes approximately $2.3 million related to the accelerated vesting of certain stock options as the result of the IPO.

Foreign currency translation adjustments

The assets and liabilities of our foreign subsidiaries with a functional currency other than the U.S. Dollar are translated into U.S. Dollars using applicable exchange rates at the balance sheet date. Revenue and expenses are translated at average exchange rates effective during the year. The resulting foreign currency translation gains and losses are included as a component of other comprehensive income (loss). We had upward foreign currency translation adjustments of $0.4 million for the three months ended September 30, 2017 compared to insignificant foreign currency translation adjustments for the three months ended September 30, 2016. We had upward foreign currency translation adjustments of $0.9 million for the nine months ended September 30, 2017 and downward foreign currency translation adjustments of $0.7 million for the nine months ended September 30, 2016. The translation adjustments were the result of the strengthening of the U.S. Dollar against the Canadian Dollar and British Pound over the corresponding period.

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Change in fair value of derivative instruments, net of related taxes

We are a party to interest rate cap agreements that hedge the potential impact fluctuations in interest rates may have on payments we make pursuant to our long-term debt. We had a upward net change in fair value of derivative instruments, net of related taxes, of approximately $0.3 million for the three months ended September 30, 2017 and a downward net change in fair value of derivative instruments, net of related taxes, of approximately $0.1 million for the three months ended September 30, 2016. We had a upward net change in fair value of derivative instruments, net of related taxes, of approximately $0.4 million for the nine months ended September 30, 2017 and a downward net change in fair value of derivative instruments, net of related taxes, of approximately $0.6 million for the nine months ended September 30, 2016. The changes were the result of fluctuations in three-month LIBOR.

How We Assess Our Performance

Adjusted EBITDA

We believe Adjusted EBITDA (a non-GAAP measure) is useful to investors as a supplemental measure to evaluate our overall operating performance. Management uses Adjusted EBITDA as a measurement to compare our operating performance to our peers and competitors. We define Adjusted EBITDA as net income before depreciation and amortization, interest expense, other non-operating (income) expense such as foreign currency translation, income tax expense, transaction-related expenses and other and stock-based compensation. See the notes to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information regarding these adjustments. Management believes Adjusted EBITDA is useful because it provides meaningful supplemental information about our operating performance and facilitates period-to-period comparisons without regard to our financing methods, capital structure or other items that we believe are not indicative of our ongoing operating performance. By providing this non-GAAP financial measure, management believes we are enhancing investors’ understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing our strategic initiatives. Management believes that Adjusted EBITDA is frequently used by securities analysts, investors and other interested parties as a supplemental measure of financial performance within our industry. In addition, the determination of Adjusted EBITDA is consistent with the definition of a similar measure in our First Lien Credit Facilities.

Adjusted EBITDA has important limitations as an analytical tool and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

Although depreciation is a non-cash charge, the assets being depreciated will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;

Adjusted EBITDA does not reflect the impact of stock-based compensation upon our results of operations;

Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our debt;

Adjusted EBITDA does not reflect our income tax expense or the cash requirements to pay our income taxes; and

Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses similar to those eliminated in this presentation.

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The following table presents a reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP measure, for the periods presented:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
(in thousands)	(unaudited)				(unaudited)
Net income	$	19,472	$	4,583	$	67,535	$	23,560
Depreciation and amortization		20,817		20,421		62,688		60,482
Interest expense		9,101		9,625		26,060		40,345
Other non-operating (income) expense(a)		(449)		(113)		(1,458)		(771)
Income tax expense		12,918		711		19,800		12,780
Transaction-related expenses and other(b)		773		16		2,165		909
Stock-based compensation(c)		5,752		17,042		10,290		21,544
Loss on extinguishment of debt(d)		—		9,349		3,183		16,417
Adjusted EBITDA	$	68,384	$	61,634	$	190,263	$	175,266

^(a)

Represents other non‑operating (income) expense that consists primarily of interest income and gains and losses on transactions settled in foreign currencies. Income received for certain sub‑leases is included herein.

^(b)

Represents transaction‑related expenses that consist primarily of certain expenses associated with our secondary offerings and our IPO and other offering costs in 2016 as well as certain corporate development activity, including the RowdMap Acquisition.

^(c)

Represents expense related to equity incentive awards granted to certain employees, officers and non‑employee directors as long‑term incentive compensation and restricted stock issued in connection with the RowdMap Acquisition. We recognize the related expense for these awards ratably over the vesting period or as achievement of performance criteria become probable.

^(d)

Represents loss on extinguishment of debt that consists primarily of fees paid and write-offs of unamortized debt issuance costs and original issue discount in connection with the 2017 repricing of our First Lien Term B Loan, the 2016 early repayment of a portion of our long-term debt and the 2016 refinancing of our long-term debt.

Dollar Amount of Inaccurate Payments Prevented or Recovered

The majority of our net revenue consists of performance fees earned under our client contracts. Our performance fees generally represent a specified percentage of inaccurate payments that are either prevented prior to payment using our prospective claims accuracy solutions or recovered by our clients after they are identified using our retrospective claims accuracy solutions. For those clients where we identify any payment inaccuracies in advance of payment to the providers, the clients reduce the amount paid to the providers based upon the inaccuracies that we have identified. For those clients where we identify payment inaccuracies using our retrospective claims accuracy solutions after the client has made payment, clients generally recover claims either by taking credits against outstanding payables to healthcare providers or retail vendors, or future purchases from the related retail vendors, or receiving refund checks directly from those healthcare providers or retail vendors.

The dollar amount of inaccurate payments prevented or recovered in a given period is impacted by the dollar amount of claims or payments reviewed, the scope of claims or payments that we review, the success of our cross-selling efforts, our ability to retain existing clients and obtain new clients and our ability to enhance our existing solutions or create new solutions.

We believe the dollar amount of inaccurate payments prevented or recovered is useful to measure our overall operating performance and how well we are executing on our client contracts.

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Factors Affecting the Comparability of our Results of Operations

As a result of a number of factors, our historical results of operations may not be comparable to our results of operations in future periods and our results of operations may not be directly comparable from period to period. Set forth below is a brief discussion of the key factors impacting the comparability of our results of operations.

Debt Refinancings, Repayments and Repricing

In connection with our various debt refinancings, we incurred significant debt issuance costs, primarily associated with the new indebtedness. These debt issuance costs are amortized utilizing the effective interest method over the associated life of the related indebtedness and recorded as interest expense. Unamortized debt issuance costs were $7.6 million as of September 30, 2017.

In June 2016, we repaid $223.0 million in outstanding principal under our then outstanding second lien credit facility using proceeds from our IPO. We also made a voluntary prepayment of $13.1 million of outstanding principal under the second lien credit facility. As a result of these repayments, we recognized a loss on extinguishment of debt totaling $7.1 million during the nine months ended September 30, 2016 primarily related to the accelerated recognition of the unamortized portion of debt issuance costs and original issue discount.

In September 2016, we completed a refinancing of our then existing first and second lien credit facilities and entered into the Restated Credit Agreement, which provides for the First Lien Credit Facilities consisting of a (a) Term Loan A in the amount of $250.0 million, (b) Term Loan B in the amount of $550.0 million and (c) Revolver in the amount of up to $100.0 million, reducing our total debt principal outstanding by $22.7 million and reducing the interest rates. As a result of this refinancing, we recognized a loss on extinguishment of debt of $9.3 million during the three months ended September 30, 2016, primarily related to the payment of certain fees and the accelerated recognition of the unamortized portion of debt issuance costs and original issue discount related to indebtedness that was repaid to certain lenders.

In April 2017, we entered into the First Amendment Agreement to the then outstanding Restated Credit Agreement, which, among other things, provided for lower applicable interest rates associated with the First Lien Term B Loan. As a result, we recognized a loss on extinguishment of $3.2 million during the nine months ended September 30, 2017.

Our Segments

We report our results of operations in two segments, (i) Healthcare and (ii) Global Retail and Other. Through our Healthcare segment, we offer prospective and retrospective claims accuracy solutions to healthcare payers in the United States. We also provide analytics-based solutions unrelated to our healthcare payment accuracy solutions, on a limited basis in the United States and a network efficiency solution to payers and providers. Through our Global Retail and Other segment, we provide retrospective claims accuracy solutions to retailers primarily in the United States, Canada and the United Kingdom, as well as solutions that improve efficiency and effectiveness of payment networks for a limited number of clients.

We evaluate the performance of each segment based on segment net revenue and segment operating income. The cost of revenue for each segment is based on direct expenses associated with revenue generating activities of each segment. We allocate selling, general and administrative expenses to each segment based on the segments’ proportionate share of revenue and expenses directly related to the operation of the segment as determined by management. The following table

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sets forth the net revenue and operating income for our Healthcare and Global Retail and Other segments for the periods presented (in thousands).


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
	(unaudited)				(unaudited)
Net Revenue
Healthcare	$	156,219	$	138,470	$	447,581	$	403,643
Global Retail and Other		17,969		17,771		54,351		53,607
Consolidated net revenue	$	174,188	$	156,241	$	501,932	$	457,250
Operating Income
Healthcare	$	38,094	$	22,544	$	107,944	$	85,879
Global Retail and Other		2,948		1,611		7,176		6,452
Consolidated operating income	$	41,042	$	24,155	$	115,120	$	92,331

The following table sets forth our segment net revenue and percentage of consolidated net revenue by product type for the periods presented (in thousands):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2017		%	2016		%	2017		%	2016		%
	(unaudited)						(unaudited)
Healthcare
Retrospective claims accuracy	$	88,396	50.7	$	78,133	50.0	$	252,538	50.3	$	224,335	49.1
Prospective claims accuracy		62,628	36.0		57,233	36.6		184,365	36.8		169,632	37.1
Other		5,195	3.0		3,104	2.0		10,678	2.1		9,676	2.1
Total Healthcare		156,219	89.7		138,470	88.6		447,581	89.2		403,643	88.3
Global Retail and Other
Retrospective claims accuracy		17,470	10.0		17,039	10.9		52,529	10.5		51,730	11.3
Other		499	0.3		732	0.5		1,822	0.3		1,877	0.4
Total Global Retail and Other		17,969	10.3		17,771	11.4		54,351	10.8		53,607	11.7
Consolidated net revenue	$	174,188	100.0	$	156,241	100.0	$	501,932	100.0	$	457,250	100.0

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Results of Operations

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016


	Three Months Ended September 30,						Percentage
			Percentage of			Percentage of	Change
			Net Revenue			Net Revenue	Period to
	2017		(%)	2016		(%)	Period (%)
Net revenue	$	174,188	100.0	$	156,241	100.0	11.5
Cost of revenue (exclusive of depreciation and amortization, stated separately below):
Compensation		58,405	33.5		58,517	37.5	(0.2)
Other costs of revenue		6,676	3.8		6,658	4.3	0.3
Total cost of revenue		65,081	37.3		65,175	41.8	(0.1)
Selling, general and administrative expenses (exclusive of depreciation and amortization, stated separately below):
Compensation		29,162	16.8		32,496	20.8	(10.3)
Other selling, general and administrative expenses		17,313	9.9		13,978	8.9	23.9
Total selling, general and administrative expenses		46,475	26.7		46,474	29.7	0.0
Depreciation and amortization of property and equipment		6,070	3.5		5,218	3.3	16.3
Amortization of intangible assets		14,747	8.5		15,203	9.7	(3.0)
Transaction-related expenses		773	0.4		16	—	4,731.3
Total operating expenses		133,146	76.4		132,086	84.5	0.8
Operating income		41,042	23.6		24,155	15.5	69.9
Other expense (income):
Interest expense		9,101	5.2		9,625	6.2	(5.4)
Loss on extinguishment of debt		—	—		9,349	6.0	(100.0)
Other non-operating (income) expense		(449)	(0.2)		(113)	(0.1)	297.2
Total other expense (income)		8,652	5.0		18,861	12.1	(54.1)
Income before income taxes		32,390	18.6		5,294	3.4	511.8
Income tax expense		12,918	7.4		711	0.5	1,716.9
Net income	$	19,472	11.2	$	4,583	2.9	324.9

Net revenue

Net revenue was $174.2 million for the three months ended September 30, 2017 as compared to $156.2 million for the three months ended September 30, 2016. The increase of $18.0 million was the result of increased Healthcare segment revenue of $17.7 million and increased Global Retail and Other segment revenue of $0.2 million. See “−Segment net revenue and operating income.”

Cost of revenue

Cost of revenue related to compensation was $58.4 million for the three months ended September 30, 2017 as compared to $58.5 million for the three months ended September 30, 2016. The decrease of $0.1 million was primarily the result of a net decrease in stock-based compensation of approximately $3.5 million as a result of the vesting of performance-based stock options during the three months ended September 30, 2016 partially offset by additional equity grants. This decrease was partially offset by an increase of approximately $2.8 million in additional payroll related expenses due to increased headcount and growth of our Healthcare segment. Additionally, employee benefit costs increased approximately $0.6 million due to rising healthcare coverage costs and an increase in the number of our employees.

Other costs of revenue were $6.7 million for each of the three months ended September 30, 2017 and 2016. Professional and consulting fees increased $0.6 million as we have leveraged external resources and expertise. Personnel-related costs increased $0.2 million due to an increase in the number of employees. Rent and occupancy increased approximately $0.1 million as a result of new and expanded locations. The increase was partially offset by a $0.9 million decrease in other variable costs.

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Selling, general and administrative expenses

Selling, general and administrative expenses related to compensation were $29.2 million for the three months ended September 30, 2017 as compared to $32.5 million for the three months ended September 30, 2016. The decrease of $3.3 million was primarily related to a $7.8 million net decrease in stock-based compensation due to the vesting of performance-based stock options during the three months ended September 30, 2016 partially offset by additional equity grants. The decrease was partially offset by a $4.0 million increase in compensation related expenses due to an increase in the number of employees to support our growing operations, particularly as we continue to invest in technology, analytics and go-to-market. In addition employee benefit costs increased approximately $0.4 million due to rising healthcare coverage costs and the increase in number of employees.

Other selling, general and administrative expenses were $17.3 million for the three months ended September 30, 2017 as compared to $14.0 million for the three months ended September 30, 2016. The increase of $3.3 million was primarily due to an increase of $1.5 million in IT infrastructure and telecommunication expenses. Professional and consulting fees increased $1.0 million as we have leveraged external resources and expertise. Additionally, personnel expenses increased $0.6 million and other variable costs increased $0.2 million due to increased headcount.

Depreciation and amortization of property and equipment

Depreciation and amortization of property and equipment was $6.1 million for the three months ended September 30, 2017 as compared to $5.2 million for the three months ended September 30, 2016. The increase of $0.9 million was due to continued investments in capital expenditures over the past year.

Amortization of intangible assets

Amortization of intangible assets was $14.7 million for the three months ended September 30, 2017 as compared to $15.2 million for the three months ended September 30, 2016. The decrease was due to certain acquired software becoming fully amortized during the three months ended September 30, 2017 which was partially offset by the addition of $19.5 million in intangible assets in connection with the RowdMap Acquisition.

Transaction-related expenses

Transaction-related expenses were $0.8 million for the three months ended September 30, 2017 primarily related to expenses incurred in connection with our secondary offering as well as certain expenses related to corporate development activity, including the RowdMap Acquisition. Transaction-related expenses for the three months ended September 30, 2016 were insignificant.

Interest expense

Interest expense was $9.1 million for the three months ended September 30, 2017 as compared to $9.6 million for the three months ended September 30, 2016. The decrease of $0.5 million was primarily due to the significant decline in outstanding principal over the past year in connection with the September 2016 refinancing, which resulted in a $0.4 million decrease in interest expense. Additionally, interest rate reductions in connection with the September 2016 refinancing and the April 2017 repricing of our First Lien Term B Loan resulted in a $1.1 million decrease in interest expense. This decrease was offset by a $0.6 million increase in interest expense related to our interest rate cap agreements.

Loss on extinguishment of debt

Loss on extinguishment of debt was $9.3 million for the three months ended September 30, 2016 related to the payment of fees and write-off of unamortized debt issuance costs and original issue discount as a result of the refinancing of our long-term debt.

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Other non-operating income

We had other non-operating income of $0.4 million for the three months ended September 30, 2017 as compared to $0.1 million for the three months ended September 30, 2016. The increase of $0.3 million was primarily the result of additional interest income as a result of our growing cash balance.

Income tax expense

Income tax expense was $12.9 million for the three months ended September 30, 2017 as compared to $0.7 million for the three months ended September 30, 2016. The increase of $12.2 million was primarily the result of an increase in pre-tax income for the three months ended September 30, 2017 and the impact of $2.4 million related to the nondeductible restricted stock issued in connection with the RowdMap Acquisition. This increase was partially offset by a $1.8 million tax benefit related to stock option exercises and a $0.5 million net tax benefit primarily related to tax returns filed during the quarter. The effective tax rate for the three months ended September 30, 2017 was 39.9% compared to 13.4% for the three months ended September 30, 2016. The impact of this additional tax expense and tax benefits relative to the pre-tax income for the three months ended September 30, 2017 resulted in the increase to the effective tax rate.

Segment net revenue and operating income

Healthcare segment net revenue was $156.2 million for the three months ended September 30, 2017 as compared to $138.5 million for the three months ended September 30, 2016. The increase of $17.7 million was primarily the result of a net increase of $5.5 million due to increased penetration and extended scope of services provided to our existing client base and a $12.2 million increase due to the addition of new clients and the success of our cross-sell efforts, including the impact from the RowdMap Acquisition.

Global Retail and Other segment net revenue was $18.0 million for the three months ended September 30, 2017 as compared to $17.8 million for the three months ended September 30, 2016. The increase of $0.2 million was primarily the result of the timing, nature and size of the claims reviewed.

Healthcare segment operating income was $38.1 million for the three months ended September 30, 2017 as compared to $22.5 million for the three months ended September 30, 2016. The increase in operating income of $15.6 million was primarily the result of an increase in net revenue noted above and a $10.2 million decrease in stock-based compensation expense due to the vesting of performance-based stock options during the third quarter of 2016 partially offset by additional equity grants. The net increase in operating income was partially offset by an increase in compensation expense of $7.8 million related to an increase in the number of employees in our growing Healthcare segment. Professional and consulting fees increased $1.7 million as we have leveraged external resources and expertise. Our ongoing investment in strategic initiatives contributed an additional $1.4 million in expense primarily related to an increase in IT infrastructure costs. Transaction-related expenses increased $0.7 million primarily related to our secondary offerings as well as certain expenses related to corporate development activity, including the RowdMap Acquisition. Personnel-related expenses increased $0.6 million due to the increase in number of employees. Rent and occupancy related costs increased $0.2 million as a result of new and expanded locations.

Global Retail and Other segment operating income was $2.9 million for the three months ended September 30, 2017 as compared to $1.6 million for the three months ended September 30, 2016. The increase in operating income of $1.3 million was the result of an increase in net revenue noted above as well as a $1.1 million decrease in stock-based compensation primarily related to the vesting of performance-based stock options during the three months ended September 30, 2016.

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Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016


	Nine Months Ended September 30,						Percentage
			Percentage of			Percentage of	Change
			Net Revenue			Net Revenue	Period to
	2017		(%)	2016		(%)	Period (%)
Net revenue	$	501,932	100.0	$	457,250	100.0	9.8
Cost of revenue (exclusive of depreciation and amortization, stated separately below):
Compensation		173,563	34.6		167,263	36.6	3.8
Other costs of revenue		19,485	3.9		17,331	3.8	12.4
Total cost of revenue		193,048	38.5		184,594	40.4	4.6
Selling, general and administrative expenses (exclusive of depreciation and amortization, stated separately below):
Compensation		79,419	15.8		74,782	16.4	6.2
Other selling, general and administrative expenses		49,492	9.9		44,152	9.6	12.1
Total selling, general and administrative expenses		128,911	25.7		118,934	26.0	8.4
Depreciation and amortization of property and equipment		17,541	3.5		14,864	3.2	18.0
Amortization of intangible assets		45,147	9.0		45,618	10.0	(1.0)
Transaction-related expenses		2,165	0.4		909	0.2	138.2
Total operating expenses		386,812	77.1		364,919	79.8	6.0
Operating income		115,120	22.9		92,331	20.2	24.7
Other expense (income):
Interest expense		26,060	5.2		40,345	8.8	(35.4)
Loss on extinguishment of debt		3,183	0.6		16,417	3.6	(80.6)
Other non-operating (income) expense		(1,458)	(0.3)		(771)	(0.2)	89.1
Total other expense (income)		27,785	5.5		55,991	12.2	(50.4)
Income before income taxes		87,335	17.4		36,340	8.0	140.3
Income tax expense		19,800	3.9		12,780	2.8	54.9
Net income	$	67,535	13.5	$	23,560	5.2	186.7

Net revenue

Net revenue was $501.9 million for the nine months ended September 30, 2017 as compared to $457.3 million for the nine months ended September 30, 2016. The increase of $44.6 million was the result of increased Healthcare segment revenue of $43.9 million and increased Global Retail and Other segment revenue of $0.7 million. See “−Segment net revenue and operating income.”

Cost of revenue

Cost of revenue related to compensation was $173.6 million for the nine months ended September 30, 2017 as compared to $167.3 million for the nine months ended September 30, 2016. The increase of $6.3 million was primarily the result of approximately $7.6 million in additional payroll related expenses due to increased headcount and growth of our Healthcare segment. Employee benefit costs increased approximately $1.8 million due to rising healthcare coverage costs and the increase in the number of our employees. These increases were partially offset by a $3.1 million decrease in stock-based compensation due to the vesting of performance-based stock options during the nine months ended September 30, 2016 partially offset by additional equity grants.

Other costs of revenue were $19.5 million for the nine months ended September 30, 2017 as compared to $17.3 million for the nine months ended September 30, 2016. The increase of $2.2 million was primarily the result of an increase of approximately $1.5 million in professional and consulting fees as we have leveraged external resources and expertise. Personnel-related costs increased approximately $1.1 million due to an increase in the number of employees. Rent and occupancy increased approximately $0.5 million as a result of new and expanded locations. These increases were partially offset by a $0.9 million decrease in other variable costs.

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Selling, general and administrative expenses

Selling, general and administrative expenses related to compensation were $79.4 million for the nine months ended September 30, 2017 as compared to $74.8 million for the nine months ended September 30, 2016. The increase of $4.6 million was primarily related to a $11.8 million increase in compensation related expenses due to an increase in the number of employees to support our growing operations, particularly as we continue to invest in technology, analytics and go-to-market. Employee benefit costs increased approximately $0.9 million due to rising healthcare coverage costs and the increase in number of employees. This was partially offset by a decrease in stock-based compensation of $8.1 million due to the vesting of performance-based stock options and the accelerated vesting of certain stock options as a result of the IPO during the nine months ended September 30, 2016 partially offset by additional equity grants.

Other selling, general and administrative expenses were $49.5 million for the nine months ended September 30, 2017 as compared to $44.2 million for the nine months ended September 30, 2016. The increase of $5.3 million was primarily due to an increase of $3.2 million in IT infrastructure and telecommunication expenses. Personnel-related expenses increased approximately $1.4 million due to an increased number of employees. Professional and consulting fees increased $1.3 million as we have leveraged external resources and expertise. These increases were partially offset by a $0.6 million decrease in certain variable costs.

Depreciation and amortization of property and equipment

Depreciation and amortization of property and equipment was $17.5 million for the nine months ended September 30, 2017 as compared to $14.9 million for the nine months ended September 30, 2016. The increase of $2.6 million was due to continued investments in capital expenditures over the past year.

Amortization of intangible assets

Amortization of intangible assets was $45.1 million for the nine months ended September 30, 2017 as compared to $45.6 million for the nine months ended September 30, 2016. The decrease of $0.5 million was due to certain acquired software becoming fully amortized during the nine months ended September 30, 2017 partially offset by the addition of $19.5 million in intangible assets in connection with the RowdMap Acquisition.

Transaction-related expenses

Transaction-related expenses were $2.2 million for the nine months ended September 30, 2017 primarily related to expenses incurred in connection with our secondary offerings as well as certain expenses related to corporate development activity, including the RowdMap Acquisition. Transaction-related expenses were $0.9 million for the nine months ended September 30, 2016 primarily related to expenses incurred in connection with our IPO.

Interest expense

Interest expense was $26.1 million for the nine months ended September 30, 2017 as compared to $40.3 million for the nine months ended September 30, 2016. The decrease of $14.2 million was primarily due to the significant decline in outstanding principal over the past year in connection with the use of our IPO proceeds and the September 2016 refinancing, which resulted in a $6.3 million decrease in interest expense. Additionally, interest rate reductions in connection with the September 2016 refinancing and the April 2017 repricing of our First Lien Term B Loan resulted in an $8.9 million decrease in interest expense. This decrease was offset by a $1.0 million increase in interest expense related to our interest rate cap agreements.

Loss on extinguishment of debt

Loss on extinguishment of debt was $3.2 million for the nine months ended September 30, 2017 related to the payment of fees and write-off of unamortized debt issuance costs and original issue discount as a result of the repricing of our First Lien Term B Loan. Loss on extinguishment of debt was $16.4 million for the nine months ended September 30, 2016 related to the payment of fees and write-off of unamortized debt issuance costs and original issue discount as a result of the refinancing of our long-term debt in September 2016 and the early payment on our outstanding borrowings under our then outstanding second lien credit facility in June 2016.

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Other non-operating income

We had other non-operating income of $1.5 million for the nine months ended September 30, 2017 as compared to $0.8 million for the nine months ended September 30, 2016. The increase of $0.7 million was primarily the result of additional interest income as a result of our growing cash balance.

Income tax expense

Income tax expense was $19.8 million for the nine months ended September 30, 2017 as compared to $12.8 million for the nine months ended September 30, 2016. The increase of $7.0 million was primarily the result of an increase in pre-tax income and the impact of $2.4 million related to the nondeductible restricted stock issued in connection with the RowdMap Acquisition. This increase was partially offset by a $14.9 million tax benefit related to stock option exercises, a tax benefit of $0.3 million related to the settlement of an uncertain tax position due to the closure of our audit with the Internal Revenue Service, a tax benefit of $0.7 million related to the filing of amended state tax returns as a result of certain tax planning and a $0.5 million net tax benefit primarily related to tax returns filed during the quarter. The effective tax rate for the nine months ended September 30, 2017 was 22.7% compared to 35.2% for the nine months ended September 30, 2016. The effective tax rate for the three months ended September 30, 2017 was primarily due to the tax benefits noted above. During the three months ended September 30, 2016, we recorded a $1.3 million tax benefit primarily related to the settlement of an uncertain tax position recorded in a prior period. The effective tax rate for the three months ended September 30, 2016 was impacted by this tax benefit relative to the pre-tax income for the three months ended September 30, 2016.

Segment net revenue and operating income

Healthcare segment net revenue was $447.6 million for the nine months ended September 30, 2017 as compared to $403.6 million for the nine months ended September 30, 2016. The increase of $44.0 million was primarily the result of a net increase of $21.3 million due to increased penetration and extended scope of services provided to our existing client base and a $22.7 million increase due to the addition of new clients and the success of our cross-sell efforts, including the impact from the RowdMap Acquisition.

Global Retail and Other segment net revenue was $54.4 million for the nine months ended September 30, 2017 as compared to $53.6 million for the nine months ended September 30, 2016. The increase of $0.8 million was primarily the result of the timing, nature and size of the claims reviewed.

Healthcare segment operating income was $107.9 million for the nine months ended September 30, 2017 as compared to $85.9 million for the nine months ended September 30, 2016. The increase in operating income of $22.0 million was the result of an increase in net revenue noted above and a $10.2 million decrease in stock-based compensation expense due to the vesting of performance-based stock options and the accelerated vesting of certain stock options due to the IPO during 2016 partially offset by additional equity grants. Additionally, there was a $1.2 million decrease in other variable costs. This net increase in operating income was partially offset by an increase in compensation expense of $21.2 million related to an increase in the number of employees in our growing Healthcare segment. Professional and consulting fees increased $3.1 million as we have leveraged external resources and expertise. Our ongoing investment in strategic initiatives contributed an additional $2.9 million in expense primarily related to an increase in IT infrastructure costs. Depreciation and amortization expenses increased by $2.2 million due to our continued investments in capital expenditures. Personnel-related expenses increased $1.9 million due to an increase in the number of employees. Transaction-related expenses increased $1.2 million primarily related to our secondary offerings and the RowdMap Acquisition. Rent and occupancy related costs increased $0.9 million as a result of new and expanded locations.

Global Retail and Other segment operating income was $7.2 million for the nine months ended September 30, 2017 as compared to $6.5 million for the nine months ended September 30, 2016. The increase in operating income of $0.7 million was the result of the increase in revenue noted above and a decrease of $0.2 million in certain variable costs partially offset by an increase in personnel-related expenses of $0.3 million.

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Liquidity and Capital Resources

Overview

Our primary sources of liquidity are our existing cash and cash equivalents, cash provided by operating activities and borrowings under our credit facilities. As of September 30, 2017, we had cash and cash equivalents of $123.0 million and availability under the Revolver of $99.5 million. Our total debt principal outstanding was $782.0 million as of September 30, 2017.

In April 2017, we repriced our First Lien Term B Loan, reducing the interest rate by 25 basis points.

Our principal liquidity needs have been, and we expect them to continue to be, debt service, capital expenditures, working capital and potential mergers and acquisitions. Our capital expenditures support investments in our underlying infrastructure to enhance our solutions and technology for future growth. Our capital expenditures were $23.6 million and $22.6 million for the nine months ended September 30, 2017 and 2016, respectively. The increase is primarily due to expenditures associated with enhancing our IT platform. We do not expect our capital expenditures to continue to increase. However, our strategy includes the expansion of our existing solutions and the development of new solutions, which will require cash expenditures over the next few years and will be funded primarily with cash provided by operating activities. During the nine months ended September 30, 2017, we paid approximately $74.0 million in connection with the RowdMap Acquisition. We believe this network efficiency solution is a complement to our payment accuracy solutions.

We believe that our cash flow from operations, availability under our First Lien Credit Facilities and available cash and cash equivalents will be sufficient to meet our liquidity needs for at least the foreseeable future. We anticipate that to the extent that we require additional liquidity, it will be funded through the incurrence of additional indebtedness, the issuance of equity financings, or a combination thereof. We cannot assure you that we will be able to obtain this additional liquidity on reasonable terms, or at all. Additionally, our liquidity and our ability to meet our obligations and fund our capital requirements are also dependent on our future financial performance, which is subject to general economic, financial and other factors that are beyond our control. Accordingly, we cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available from additional indebtedness or otherwise to meet our liquidity needs. If we decide to pursue one or more significant acquisitions, we may incur additional debt or sell additional equity to finance such acquisitions, which could possibly result in additional expenses or dilution.

Summary of Cash Flows

The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented (in thousands):


	Nine Months Ended
	September 30,
	2017		2016
	(unaudited)
Net cash provided by operating activities	$	107,163	$	108,345
Net cash used in investing activities		(93,341)		(21,397)
Net cash used in financing activities		(1,812)		(192,158)

Operating Activities

Net cash provided by operating activities was $107.2 million and $108.3 million for the nine months ended September 30, 2017 and 2016, respectively. The decrease in cash provided by operating activities for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 primarily was due to a $26.1 million increase in net income adjusted for the exclusion of non-cash expenses, offset by approximately a $27.3 million decrease related to the effect of changes in operating assets and liabilities.

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Net income adjusted for the exclusion of non-cash expenses was approximately $142.9 million for the nine months ended September 30, 2017 as compared to $116.7 million for the nine months ended September 30, 2016. The increase was primarily due to the growth in our Healthcare operations and the reduction in interest expense.

The effect of changes in operating assets and liabilities was a decrease of $35.7 million for the nine months ended September 30, 2017 compared to an decrease of $8.4 million for the nine months ended September 30, 2016. The most significant drivers contributing to this decrease relate to the following:

Changes in accounts receivable primarily driven by increased revenue and timing of collections. Accounts receivable, net of the allowance for doubtful accounts, increased $13.2 million during the nine months ended September 30, 2017 as compared to a increase of $4.5 million during the nine months ended September 30, 2016; and

Changes in accrued compensation primarily driven by timing of payments and an increase in the number of employees. Accrued compensation decreased $18.7 million during the nine months ended September 30, 2017 as compared to a decrease of $1.4 million during the nine months ended September 30, 2016.

Investing Activities

Net cash used in investing activities was $93.3 million and $21.4 million for the nine months ended September 30, 2017 and 2016, respectively. The increase in cash used in investing activities during the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 was due to the RowdMap Acquisition for $69.7 million. Additionally, capital expenditures increased $1.0 million due to our ongoing investments, particularly as it relates to enhancing our information technology infrastructure and platforms to support our growing operations.

Financing Activities

Net cash used in financing activities was $1.8 million and $192.2 million for the nine months ended September 30, 2017 and 2016, respectively. The decrease in cash used in financing activities during the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 was primarily due to $12.3 million in proceeds from the exercise of stock options, partially offset by scheduled debt principal payments of $13.5 million during the nine months ended September 30, 2017 as compared to $4.1 million during the nine months ended September 30, 2016. Additionally, the use of cash during the nine months ended September 30, 2016 was driven by the payment of a special cash dividend of $150.0 million, the repayment of $236.1 million of outstanding borrowings under our Second Lien Credit Facility and the net payment of $22.7 million of outstanding indebtedness as a result of the September 2016 refinancing of our long-term debt. These cash outflows were partially offset by net cash proceeds from our IPO of $227.0 million.

Off-Balance Sheet Arrangements

Except for operating leases and certain letters of credit entered into in the normal course of business, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Contractual Obligations

Except as set forth below, there have been no material changes to our contractual obligations as described in the Annual Report on Form 10-K for the year ended December 31, 2016.

In April 2017, we repriced our First Lien Term B Loan reducing the interest rate by 25 basis points.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts and disclosure of contingent assets and liabilities. There have been no significant changes in the

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critical accounting policies and estimates described in our Annual Report on Form 10-K for the year ended December 31, 2016 except for the below critical accounting policy.

Valuation of Goodwill and Acquired Intangible Assets

We have recorded goodwill and acquired intangible assets through acquisitions accounted for as business combinations. When identifiable intangible assets, including technology platforms are acquired, we determine the fair values of these assets as of the acquisition date. Discounted cash flow models are typically used in these valuations if quoted market prices are not available, and the models require the use of significant estimates and assumptions including but not limited to:

•estimating future revenue and cash flows expected to be collected; and

•developing appropriate discount rates, long-term growth rates and probability rates.

The determination of the above inputs involves significant estimates and assumptions about several highly subjective variables. Our estimates and assumptions may be based, in part, on the availability of market data. We base our fair value estimates on assumptions we believe are reasonable, but recognize that the assumptions are inherently uncertain.

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination which are not individually identified and separately recognized. We do not amortize goodwill. We review goodwill for impairment at least annually by assessing qualitative factors or performing a quantitative analysis in determining whether it is more likely than not that the fair value of net assets are below their carrying amounts.

Intangible assets with definite lives are initially recorded at fair value and are amortized on a basis consistent with the timing and pattern of expected cash flows used to value the intangible assets, generally on a straight-line basis over the estimated useful life. Intangible assets with definite lives are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. If required, the impairment test for intangible assets with definite lives is completed by comparing an updated undiscounted cash flow model to the carrying value of the intangible asset.

Jumpstart Our Business Act of 2012

We are an “emerging growth company” as defined in the JOBS Act. We will remain an emerging growth company until the earlier of (1) the last day of our fiscal year (a) following the fifth anniversary of the completion of our IPO, (b) in which we have total annual gross revenue of at least $1.0 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our Common Stock that is held by non-affiliates exceeds $700.0 million as of the last business day of our most recently completed second fiscal quarter, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period. An emerging growth company may take advantage of specified reduced reporting and other burdens that are otherwise applicable generally to public companies.

At the end of our second fiscal quarter ending on June 30, 2017, our aggregate worldwide market value of voting and non-voting common equity held by non-affiliates was over the $700 million threshold. As such, as of December 31, 2017, we will be considered a large accelerated filer and therefore will lose our status as an emerging growth company.

Recently Issued Accounting Pronouncements

See “Recently Issued Accounting Pronouncements” in Note 2 of the unaudited consolidated financial statements.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects” and similar references to future periods, or by the inclusion of forecasts or projections. Examples of forward-looking statements include, but are not limited to, statements we make regarding the outlook for our future business and financial performance.

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are

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subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national or global political, economic, business, competitive, market and regulatory conditions and the following: our inability to successfully leverage our existing client base by expanding the volume of claims reviewed and cross-selling additional solutions; improvements to healthcare claims and retail billing processes reducing the demand for our solutions or rendering our solutions unnecessary; healthcare spending fluctuations; our clients declining to renew their agreements with us or renewing at lower performance fee levels; inability to develop new clients; delays in implementing our solutions; system interruptions or failures, including cyber-security breaches, identity theft or other disruptions that could compromise our information; our failure to innovate and develop new solutions for our clients; our failure to comply with applicable privacy, security and data laws, regulations and standards; changes in regulations governing healthcare administration and policies, including governmental restrictions on the outsourcing of functions such as those that we provide; loss of a large client; consolidation among healthcare payers or retailers; slow development of the healthcare payment accuracy market; negative publicity concerning the healthcare payment industry or patient confidentiality and privacy; significant competition for our solutions; our inability to protect our intellectual property rights, proprietary technology, information, processes and know-how; compliance with current and future regulatory requirements; declines in contracts awarded through competitive bidding or our inability to re-procure contracts through the competitive bidding process; our failure to accurately estimate the factors upon which we base our contract pricing; our inability to manage our growth; our inability to successfully integrate and realize synergies from any future acquisitions or strategic partnerships including our acquisition of RowdMap; our failure to maintain or upgrade our operational platforms; our failure to renew our Medicare Recovery Audit Contractor program contracts or if the terms of the Medicare RAC program contracts are substantially changed; litigation, regulatory or dispute resolution proceedings, including claims or proceedings related to intellectual property infringements; our inability to expand our retail business; our inability to manage our relationships with information suppliers, software vendors or utility providers; fluctuations in our results of operations; changes in tax rules; risks associated with international operations; our inability to realize the book value of intangible assets; our success in attracting and retaining qualified employees and key personnel; general economic, political and market forces and dislocations beyond our control; risks related to our substantial indebtedness and holding company structure; volatility in bank and capital markets; our status as an emerging growth company; and provisions in our amended and restated certificate of incorporation.

For the reasons described above, as well as factors identified in the section of the Annual Report on Form 10-K entitled “Risk Factors,” we caution you against relying on any forward-looking statements. Any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Except as set forth below, there have been no material changes to our quantitative and qualitative disclosures about market risk compared to the quantitative and qualitative disclosure about market risk described in the Annual Report on Form 10-K for the year ended December 31, 2016.

We are exposed to interest rate risk on our First Lien Credit Facilities, which bear interest at variable rates. As of September 30, 2017, we had $782.0 million outstanding principal under our long-term debt and $540.0 million notional debt outstanding related to interest rate cap agreements. Based on our outstanding debt as of September 30, 2017, and assuming that our mix of debt instruments, interest rate caps and other variables remain the same, the annualized effect of a one percentage point change in variable interest rates would have an annualized pre-tax impact on our earnings and cash flows of approximately $7.4 million.

ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management has evaluated, with the participation of our Chief Executive Officer and Interim Chief Financial Officer, the effectiveness of our disclosure controls and procedures, as defined in Rule 13(a)-15(e) of the Exchange Act, as of

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the end of the period covered by this Quarterly Report on Form 10-Q pursuant to Rule 13a-15(b) of the Exchange Act. Based on that evaluation, our Chief Executive Officer and Interim Chief Financial Officer have concluded that our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q are effective at a reasonable assurance level in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner and (2) accumulated and communicated to our management, including our Chief Executive Officer and Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. While our disclosure controls and procedures are designed to provide reasonable assurance of their effectiveness, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

Changes in Internal Control over Financial Reporting

There were no changes to our internal control over financial reporting during the nine months ended September 30, 2017 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

An audit of our internal control over financial reporting as of any balance sheet date or for any period reported in our financial statements has not been required through September 30, 2017. Our independent public registered accounting firm will first be required to attest to the effectiveness of our internal controls over financial reporting for our Annual Report on Form 10-K for the year ended December 31, 2017 as we will no longer be an “emerging growth company.” In addition, as a newly public company, our management will be required to perform an annual assessment of the effectiveness of our internal controls over financial reporting in our second Annual Report on Form 10-K which is for the year ending December 31, 2017.

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PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings

None.

ITEM 1A. Risk Factors

For a discussion of potential risks and uncertainties related to our Company and our business see the information in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2016. There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

In connection with the RowdMap Acquisition in July 2017, we issued an aggregate of 768,021 shares of restricted common stock to certain employees of RowdMap in connection with their continued employment with us. Half of these shares are subject to continued employment and performance-based vesting requirements. The other half are subject to continued employment, with one-third vesting on each of the first three anniversaries of the closing of the acquisition. These issuances were made in reliance on an exemption or exclusion from the registration requirements of Regulation D promulgated under the Securities Act.

ITEM 3. Defaults Upon Senior Securities

Not applicable.

ITEM 4. Mine Safety Disclosures

Not applicable.

ITEM 5. Other Information

None.

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ITEM 6. Exhibits

See accompanying Exhibit Index for a list of the exhibits filed or furnished with this Quarterly Report on Form 10-Q.

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EXHIBIT INDEX


Exhibit No.		Description of Exhibits
31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*		Certification of Interim Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2*		Certification of Interim Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

**101.INS		XBRL Instance Document.

**101.SCH		XBRL Taxonomy Extension Schema Document.

**101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document.

**101.DEF		XBRL Taxonomy Extension Definition Linkbase Document.

**101.LAB		XBRL Taxonomy Extension Label Linkbase Document.

**101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document.

* Filed herewith.

** Submitted electronically with this Report.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	COTIVITI HOLDINGS, INC.

Date: November 1, 2017	By:	/S/ ADRIENNE CALDERONE
		Name:	Adrienne Calderone
		Title:	Vice President and Interim Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

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Cotiviti Holdings, Inc. Reports

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