Health Catalyst - Earnings Call - Q2 2020

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by, and welcome to the Health Catalyst Inc. Q2 twenty twenty Earnings Conference Call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer session. Please be advised that today's conference is being recorded.

I would now like to hand the conference to your first speaker today, Adam Brown, Senior Vice President of Investor Relations. Please go ahead, sir.

Speaker 1

Good afternoon, and welcome to Health Catalyst's earnings conference call for the second quarter of twenty twenty, which ended on 06/30/2020. My name is Adam Brown. I'm the Senior Vice President of Investor Relations for Health Catalyst. And with me on the call is Dan Burton, our Chief Executive Officer and Patrick Nelly, our Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today as well as in our related Form eight ks furnished to the SEC, both of which are available on the Investor Relations section of our website at ir.healthcatalyst.com.

As a reminder, today's call is being recorded and a replay will be available following the conclusion of the call. During the call, we will make forward looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 regarding trends, strategies, the impact of the COVID-nineteen pandemic on our business and results of operations, our pipeline conversion rates, customer discounts on professional services and our general anticipated performance of the business. These forward looking statements are based on management's current views and expectations as of today and should not be relied upon as representing our views as of any subsequent date. We disclaim any obligation to update any forward looking statements or outlook. Actual results may materially differ.

Please refer to the risk factors in our Form 10 Q for the 2020 filed with the SEC on 05/13/2020, and our Form 10 Q for the 2020 that will be filed with the SEC. We will also refer to certain non GAAP financial measures to provide additional information. A reconciliation of these non GAAP measures to their most comparable GAAP measures is provided in our press release. With that, let me turn the call over to Dan for his prepared remarks and then Patrick will subsequently provide his prepared remarks. Dan and Patrick will then take your questions.

Dan?

Speaker 2

Thank you, Adam, and thank you to everyone who has joined us this afternoon. Let me first start by expressing our ongoing gratitude to our heroic national health systems and their frontline workers. We are both grateful and honored that our health system customers have continued to trust us to meaningfully support them in this time of great need. Next, let me share that the current COVID-nineteen surge likely indicates that our country and national healthcare system will be under some amount of strain over the coming months. With that said, we are highly encouraged as we continue to witness meaningful evidence that the healthcare provider ecosystem is significantly more well equipped and well prepared in responding and operating effectively in the midst of our new normal.

Lastly, by way of introductory comments, I would share that racial inequities remain at the forefront of our national conversation. Health Catalyst is committed to not only joining the many voices calling for justice and change, but also to using our data and analytics to create equitability in healthcare. Specifically, we are committed to continuing to play a meaningful role in using data and analytics to support our customers and their efforts to better understand and resolve these disparities in healthcare. I'll begin today's call by communicating our second quarter twenty twenty financial results. First, let me share that I am pleased with our performance across the board, especially in light of the macroeconomic backdrop.

To start, I'm happy to report that our total revenue for Q2 twenty twenty was $43,300,000 This represents an outperformance relative to the midpoint of our guidance. Total adjusted gross margin in the second quarter was 49%, an increase of approximately 20 basis points compared to the first quarter of twenty twenty. This quarter over quarter gross margin growth was achieved despite providing the COVID-nineteen related professional services discounts we discussed on our last earnings call. And our Q2 twenty twenty adjusted EBITDA was a loss of $4,200,000 which also represents an outperformance relative to the midpoint of our guidance and shows an improvement from a loss of $5,700,000 for the same period in the prior year. Now let me transition to some of the highlights from the quarter.

You'll recall from our previous earnings calls that we measure our company's performance in three primary strategic objective categories of improvement, growth and scale. And we'll discuss our quarterly results with you in each of these categories. The first category, improvement, is focused on evaluating our ability to enable massive measurable improvements for our customers while sustaining industry leading satisfaction and engagement. I'll first share two examples of recently documented customer improvements from newly published case studies. The first improvement vignette highlights our work with one of our customers supporting their journey to financial and operational recovery from COVID-nineteen, while the latter demonstrates the customers have widened their apertures and are back to leveraging our technology and services to do meaningful improvement work outside of their COVID-nineteen responses.

First, Community Health Network, desire to understand the overall impact of COVID-nineteen related declines in elective surgeries. The data that Community Health Network needed to understand that impact and prioritize the organization's elective surgery restart plan resided in disparate systems and would have required hundreds of hours of manual data review. As Health Catalyst customer, however, Community Health Network leveraged DOS, our data platform, along with our COVID-nineteen specific financial impact recovery elective surgery application to gain insight and visibility into procedure trends. Specifically, our solution allowed Community Health Network to visualize surgical case backlogs by the facility, specialty and procedure. This enabled the identification of the number and type of procedures that are recoverable, the ability to model the estimated revenue impact of cancellations and the use of analytics to understand the implications of different restart elective surgery strategies, enabling Community Health Network to optimally meet its patients' needs and also effectively help it recover from COVID-nineteen revenue losses.

Next, let me highlight a recent improvement at Banner Health from their work outside of the realm of COVID-nineteen. Banner Health identified considerable variation in surgical supply use across its facilities. The health system desired a data informed strategy that would allow it to maintain high quality outcomes while simultaneously decreasing costs across its procedures system wide. To standardize supply use, Banner utilized DOS along with a robust suite of analytics to help identify variation in high volume, high cost surgical procedures. Banner then leveraged those analytics to build standardized surgical preference cards for specific high volume procedures, allowing them to quickly realize 3,200,000 in surgical supply cost savings.

Lastly, within the improvement category, I'd like to highlight our team member engagement. Every six months, we utilize the Gallup organization to measure our team members' engagement levels. In our most recent results, we once again achieved a team member overall satisfaction score in the ninety ninth percentile. While we have consistently ranked between the ninety fifth and ninety ninth percentile in overall team member satisfaction scores, this past period score, the second highest in the company's history, was particularly encouraging as we adapted to a remote only culture. As a leadership team, we continued to make a deliberate decision to double down on our team member engagement efforts after the onset of the pandemic.

Our hypothesis was that if our team members can feel listened to and cared for at an extraordinary level in this time of unique challenge, they will continue to produce outstanding work on behalf of our customers. These Gallup results coupled with our customers' high satisfaction levels throughout the pandemic are heartening confirmation of our hypothesis coming to fruition. Our next performance measurement category is growth, which we define as adding new customers while also deepening existing customer relationships. In the growth category, with COVID-nineteen as a backdrop, I'll share a detailed update on the state of our company along with some broader perspectives about the healthcare delivery ecosystem as we witness an adjustment to the temporary new normal operating environment. First, I would underscore that the current COVID-nineteen surge likely indicates that our country and national healthcare ecosystem will be under some amount of continued strain over the coming months.

That said, a lot has changed since we spoke with you three months ago. Indeed, are encouraged as we continue to witness meaningful evidence that the healthcare provider ecosystem is significantly better equipped and better prepared to respond to the ongoing pandemic, including its treatment efficacy, supply chain logistics, capacity planning and broader operational optimization. Likewise, we have observed that the majority of our customers and prospects have started to also focus meaningful mindshare beyond their COVID-nineteen response as they've effectively adjusted financially and operationally and have started to refocus on broader clinical, financial and operational improvement work once again. Now let me provide some commentary on what this new normal operating environment means for our business in the near term. First, we're fortunate to have a highly recurring revenue model in which greater than 90% of our revenue is recurring in nature.

This model means that the impact of COVID-nineteen on our top line will be relatively muted in 2020. To that effect, you will hear more from Patrick later in the call when he shares our updated full year 2020 guidance. As it relates to our existing customer relationships, let me first share some color as it relates to our technology. To start, I would highlight that we benefit from a high level of technology revenue predictability, especially our All Access DOS subscription customers that have built in contractual technology revenue escalators. I'm pleased to report that since the onset of COVID-nineteen, our customers' overall usage of our data platform has never been higher.

Of particular note, our foundational analytics applications, which are crucial components of our COVID-nineteen technology response, have seen a significant increase in usage averaging a roughly 30% increase since the onset of the pandemic. Additionally, I would share that we have seen usage of our COVID-nineteen specific products meaningfully shift from those focused on COVID-nineteen preparedness to those focused on financial recovery and planning analytics in areas such as elective procedures, ambulatory care and revenue cycle. Given all these factors, we would anticipate minimal impact on our technology dollar based retention as a result of COVID-nineteen. Moving on to professional services, we continue to see extremely high levels of engagement of our team member base, many of which are engaged on COVID-nineteen recovery focused work, but also many of which are back to focusing on more general clinical, financial and operational improvement work. As mentioned on our last earnings call, we anticipated providing some proactive and temporary professional services discounts to our existing customers, helping to support them through their short term COVID-nineteen related financial strain in the spirit of a long term partnership.

I'm happy to share that we have worked through those discussions and that they were very well received. As you'll hear more from Patrick, as anticipated, we experienced a decline in our professional services gross margin in Q2 as a result of those temporary discounts and we'd expect a smaller spillover impact on our Q3 professional services gross margin. Given this, we'd anticipate our near term professional services dollar based retention to be lower than our expectations at the beginning of the year. Now let me transition to providing some commentary on new DOS subscription customer additions in 2020. First, I would share that we were pleased to sign multiple new customers year to date, including after the onset of COVID-nineteen.

In particular, I would highlight that we recently added one of the 20 largest health systems in the country as a new DOS subscription customer. We are honored that this health system has chosen Health Catalyst as their enterprise analytics solution. While we were excited to add multiple new customers during the first half of twenty twenty, I would share that more generally we saw a purchasing pause starting in late Q1. Given this, consistent with the color that we shared on our last earnings call, our first half twenty twenty number of net new DOS subscription customer additions was meaningfully lower than we originally anticipated entering the year. As we enter the second half of twenty twenty, we are encouraged by our pipeline.

We would characterize our pipeline as being as robust as the same period last year, with the overall tone of the conversations and momentum of our sales processes being positive. Given this data, we would anticipate strong bookings conversion in the 2020 similar to last year's levels, while also acknowledging that the COVID-nineteen situation means that we are in unprecedented times and thus our historical conversion rates may be less predictive than in the past. Moving on to the longer term impact of COVID-nineteen, I would reiterate our sentiment from our last earnings call. First, I would share that we cannot think of any event in recent history that has galvanized the awareness and importance of data and analytics more than COVID-nineteen. And thus, we believe it will serve as a meaningful tailwind in the industry's adoption of data and analytics.

At the health system level, we are seeing COVID-nineteen highlighting the need for a commercial grade data and analytics solution to replace patchwork homegrown systems. I would also share that we are seeing the potential for meaningful government investment in healthcare data and analytics infrastructure modernization over time. Lastly, I'd share that we anticipate a meaningful long term impact on our life sciences business as we leverage one of the largest clinically rich repositories of health data in the world for real world insights. Also in the context of our growth efforts, let me next mention that we are looking forward to hosting our seventh Annual Healthcare Analytics Summit in September. While the format will be virtual this year, we continue to believe that this conference represents a meaningful opportunity for Health Catalyst to continue to provide thought leadership within the healthcare data and analytics ecosystem, while carefully listening to our customers and prospects as we further cultivate and deepen those relationships.

The theme of this year's conference will be Healthcare Analytics in the New Normal, and we are fortunate to feature many of the leading voices in the country as our keynote speakers. Next, I'd like to make a few comments on our recent acquisition of HealthFinch, which we are happy to announce is officially closed. First, I would share that this deal is consistent with the rationale that we provided for our convertible debt raise in April. HealthFinch is a SaaS technology provider of an integration engine delivering insights and analytics into EMR workflows in real time. This acquisition highlights Health Catalyst's ability to integrate and scale software applications on top of our DOS platform.

The HealthFinch technology will serve up actionable insights derived from DOS and other Health Catalyst analytics applications into the EMR at the point of care. Of particular importance and excitement is the strong mission and cultural alignment with the HelpFinch team. We are thrilled to welcome the talented and diverse HealthFinch team to Health Catalyst, further enabling our mission to be the catalyst for massive measurable data informed healthcare improvement. Next, let me make some comments on our announcement today of our definitive agreement to acquire VitalWare. VitalWare offers a revenue workflow optimization and analytics SaaS technology solution to healthcare providers.

The acquisition contemplates a $120,000,000 purchase price consisting of $70,000,000 in cash from the balance sheet and $50,000,000 in Health Catalyst common stock plus the potential for an earn out. We are extremely excited to announce this transaction. First, VitalWare provides us with another analytics application offering us a strategic anchor technology in the revenue space, expanding our CFO value proposition. VitalWare's flagship offering is a best in class chargemaster solution that solves a complex regulatory and billing function needed by all health systems. Additionally, VitalWare brings to bear a meaningful upsell opportunity with new product suites in revenue integrity and price transparency.

Ultimately, DOS will further enhance these revenue insights by seamlessly integrating billing, claims, pharmacy and supply data. We also would highlight the value of VitalWare's compelling financial profile, which includes greater than 90% recurring technology revenue with approximately $19,000,000 in 2020 estimated standalone full year recurring revenue and a 20 plus percent annual historical growth rate. Additionally, VitalWear has approximately 75% gross margins and is adjusted EBITDA breakeven. Lastly, would highlight that our integration of VitalWare will reinforce our continued commitment to our shared mission, operating principles and cultural attributes, which is a requirement for every acquisition. Please refer to our press release furnished to the SEC on Form eight ks for additional information related to the VitalWare acquisition announcement.

Additionally, please note that our guidance figures that will be shared by Patrick at the end of our prepared remarks do not include any anticipated contribution from VitalWare as the transaction has not yet closed. Lastly, let me note that the 2020 and 2021 GAAP revenue and adjusted EBITDA contribution from VitalWare will be impacted by the timing of the close of the transaction and the purchase accounting impact of a deferred revenue write down. I would also share that following the close of the VitalWare transaction, we anticipate having greater than $250,000,000 of cash on our balance sheet and we continue to be active in considering other strategic acquisition opportunities both at the analytics applications layer of our stack and in our adjacent markets of life sciences and international. Lastly, before I turn the call over to Patrick, I'd like to share that Todd Cousins will be completing his service on our Board of Directors effective September 1. I want to take this opportunity to share my heartfelt gratitude for Todd and his eight years of impactful service on our Board.

Without Todd's countless contributions to our company over many years, starting in its early stages, I am certain that we would not be where we are today. Patrick?

Speaker 3

Thank you, Dan. Before diving into our quarterly financial results, I would like to echo Dan's sentiment and say that I am pleased with our second quarter results, especially in light of the macroeconomic backdrop. For the second quarter of twenty twenty, we generated $43,300,000 in total revenue. As Dan mentioned, this represents an outperformance relative to the midpoint of our guidance, and it represents an increase of 18% year over year. The year over year growth was driven primarily by recurring revenue from new customer additions, from existing customers paying higher technology access fees as a result of contractual built in escalators, from existing customers expanding their services relationships with us.

Technology revenue was $25,500,000 an increase of 27% compared to the same period last year. And professional services revenue was $17,800,000 an increase of 6% year over year. As Dan mentioned previously, our professional services growth rate was meaningfully impacted by the temporary COVID-nineteen professional services discounts we provided to a portion of our customer base in the second quarter. For Q2 twenty twenty, we achieved total adjusted gross margin of 49.1%, a decrease of approximately three thirty basis points year over year. On the technology side, our adjusted gross margin was 68.6%, an increase of approximately three sixty basis points year over year.

This year over year increase was mainly driven by existing customers paying higher technology access fees from contractual built in escalators without the corresponding increase in hosting cost, partially offset by headwinds due to the continued cost associated with transitioning a portion of our customer base to third party cloud hosted data centers in Microsoft Azure. And on the professional services side, our adjusted gross margin was 21%. This represents a decrease of approximately 1,600 basis points year over year and a decrease of approximately three eighty basis points relative to Q1 twenty twenty. As previously mentioned, this decrease was mainly the result of selected temporary discounts of our professional services as a result of COVID-nineteen. As Dan mentioned, we believe we have worked through those discount discussions.

We anticipate their financial impact will have a partial spillover to Q3 twenty twenty, but to a lesser extent than in Q2. In Q2 twenty twenty, adjusted operating expenses totaled $25,400,000 As a percentage of revenue, adjusted total operating expenses were 59%, which compares favorably to 68% in Q2 twenty nineteen. Adjusted EBITDA in Q2 twenty twenty was a loss of $4,200,000 which compares favorably to an adjusted EBITDA loss of 5,700,000 in the second quarter of twenty nineteen. As Dan mentioned earlier, we are pleased to report that we outperformed the midpoint of our guidance. This adjusted EBITDA performance was mainly driven by the revenue outperformance mentioned previously as well as some non headcount expenses that we anticipate will be pushed out to the second half of twenty twenty.

Our adjusted net loss per share in Q2 twenty twenty was $0.15 The weighted average number of shares used in calculating adjusted net loss per share was $38,100,000 Turning to the balance sheet. We ended the 2020 with $353,000,000 of cash, cash equivalents and short term investments compared to $228,000,000 at year end 2019. As a reminder, in April 2020, we issued a private placement of convertible notes with a principal amount of $230,000,000 After deducting the unamortized debt discount related to the conversion feature of $61,000,000 and unamortized issuance cost of $5,000,000 As of 06/30/2020, the net carrying amount of the liability component is 163,500,000 As it relates to our financial guidance, for the third quarter of twenty twenty, we expect total revenue between $43,000,000 and $46,000,000 and adjusted EBITDA losses between $8,900,000 and 6,900,000.0 In terms of our Q3 twenty twenty guidance, I wanted to reiterate that our annual Healthcare Analytics Summit that occurs in Q3 results in a material sales and marketing expense that will impact our adjusted EBITDA performance for the quarter. For the full year 2020, we are providing guidance as follows: total revenue between $177,200,000 and $181,200,000 and adjusted EBITDA losses between $25,500,000 and $22,500,000 I'll conclude my prepared remarks by echoing Dan's comments that we are honored that our health system customers have continued to trust us to meaningfully support them in this time of great need, and we take that responsibility very seriously.

Dan?

Speaker 2

Thanks, Patrick. I'll conclude my commentary by thanking our committed and highly engaged team members. These teammates and colleagues have worked tirelessly over the last several months in support of our heroic health system customers in response to COVID-nineteen. And I've never been more proud to be associated with these teammates as we work together to fulfill the company's mission, a mission that is more relevant and important now than ever. And with that, we are ready for questions.

Speaker 0

Thank you. Our first question comes from Robert Jones with Goldman Sachs. Your line is now open.

Speaker 4

Great. Thanks for the questions. I guess maybe just to start, clearly hearing from hospital systems and other hospital facing IT companies that there's a slowdown in decision making. I don't think that would come as a huge surprise to anyone. So I'm just curious kind of what your line of sight is through the end of the year.

Clearly, the numbers call for some sequential improvement. And then I

Speaker 5

guess related to that, Dan,

Speaker 4

you commented about DOS adds this year being expected to be below where you previously would have thought them to be. Any sense you can give us as far as how we should think about that and the impact it might have on 2021 revenue?

Speaker 2

Yes, happy to address those items, Bob. First, as it relates to the pipeline that we have been observing today, and I would say over the past few months, as I mentioned in our prepared remarks, we are experiencing a pipeline now that feels much like in prior years in the absence of a pandemic like COVID. So we're seeing movement in our pipeline. We're seeing the robustness of the pipeline. As I mentioned in the second half of this year that feels a great deal like it felt the second half of last year, for example.

Now as it relates to your second question, specifically around the number of net new DOS subscription clients, as I mentioned in my prepared remarks, we were pleased to sign multiple new DOS subscription clients in the first half of the year. But the total was meaningfully lower than what we would normally anticipate in that first half. As we think about the second half of the year, all of the indications that we see now and even that we've seen over the last couple of months would suggest that we'll have a very similar performance in the second half of this year as compares to the second half of last year. And so if you combine those two, we might expect a net number of DOS subscription clients in 2020 given the pandemic in the high single digits.

Speaker 4

Okay. That's helpful. And then I guess maybe just one on VitalWare. You mentioned it's in over 150 hospitals today. So just curious if you could talk a little bit about the cross sell roadmap opportunity.

And then as you think about what they bring to the table relative to legacy Health Catalyst, do you think this is an area now as you think about servicing the hospital CFO that you have a full offering? Or is this an area where you feel like we should expect maybe further build out either by or bill as it relates to things servicing more on the financial revenue side?

Speaker 2

Yes, absolutely. So as it relates to our strategic rationale for VitalWare, we view DOS as a data platform that can help across all of the major drivers of value that a health system CEO and C suite executive team needs to care about. Now our foundation, our beginnings as a company focused a lot on quality improvement, clinical improvement, and that's clearly going to be a continued focus. And we have a number of beachheads if you think about our technology capabilities to enable through data and analytics real meaningful quality improvement. Also from a cost perspective, we've benefited from the Chorus line of activity based costing as a meaningful anchor or beachhead in cost related drivers that C suite executives and health systems need to care about.

We view VitalWare as an important beachhead from a technology application suite perspective in the revenue side of that equation. We've had some complementary capabilities at the data platform layer and capabilities at the services expertise layer, but we've lacked that technology application beachhead that VitalWear really provides us. And importantly, with that beachhead in place and coupling that with our expertise in the revenue space, we can now leverage much more significantly the power of DOS where we can deliver clinical insights, cost insights into the revenue decision making process in an integrated way leveraging the power of DOS and do things that couldn't be done before this integration. And that's one of the reasons we're most excited about this integration and why we believe from a cross sell perspective that there will be meaningful cross sell opportunities in both directions, both our Health Catalyst DOS subscription base being very excited about adding real capabilities, real technology capabilities in that revenue side of the equation. And likewise with Vitalware clients, now we have an opportunity through the power of DOS to offer more use cases where we can integrate data in the cost and the quality realms and help them in other ways from a revenue perspective.

So we do believe this is a significant step forward and we're really excited about it. Patrick, anything you'd add?

Speaker 3

And as far as the overlap between our two customer bases, Since we had 65 DOS subscription customers at the end of last year, Health Catalyst DOS is still fairly underpenetrated in the market. And it means there's relatively little customer overlap and significant bidirectional cross sell opportunity.

Speaker 4

Got it. That's all very helpful. Thank you.

Speaker 0

Thank you. Our next question comes from Ann Samuel with JPMorgan. Your line is now open.

Speaker 6

Hi, guys. Thanks for taking the question. Just following up to Bob's question on pipeline conversion. For those that are pushing their decisions out, have they indicated at all what metrics would catalyze them to move forward with you? And then just thinking about the model for next year, do you expect any of those delayed conversions to come through in the first half of next year to kind of help with that 2021 growth?

Speaker 2

Yes, certainly, Annie. As it relates to the pipeline conversion, we certainly saw a pause in many of our conversations starting in late Q1 and continuing in early Q2. But I would characterize our conversations over the last few months across our pipeline as being very productive and positive and moving at a rate that we would typically see in a normal year. And so we have seen from a health system financial health perspective, their financial performance improved meaningfully as they've rescheduled these elective procedures. And in many cases, their improvement in terms of their revenue performance and overall performance has been ahead of what was originally forecasted.

And as a result, we believe that has already catalyzed the pipeline to be behaving much more like what we would experience absent a pandemic. And as it relates to the way that this might play out, while there may be some catch up in late twenty twenty and perhaps into early twenty twenty one, where we see an acceleration and some time made up during that pause point of a few months, there will likely be many other cases and our default assumption is that essentially we just experienced a couple of month delay in most conversations that then has picked up and will follow a normal conversion timeline that we've experienced historically.

Speaker 6

That's really helpful. Thank you. And then I guess maybe is there any more color you can provide around professional services, the discounting kind of improving in the third quarter and should that be gone by the fourth quarter? Thanks.

Speaker 2

Yes, absolutely. We do view the conversations that we had where we were proactively offering limited near term discounts usually for a month or a couple of months as being largely behind us. Now the impact of those as Patrick mentioned in his prepared remarks, we'll have some spillover effect in Q3, although much less than what we've experienced in Q2. But those conversations have completed. They've been completed.

And now we're moving forward across our client base in a much more typical normal fashion from a pricing perspective.

Speaker 0

Very helpful. Thanks guys. Thank you. Our next question comes from Ryan Daniels with William Blair. Your line is now open.

Speaker 7

Hey guys, thanks for taking the question and congratulations on the Gallup scores regarding the employee engagement. Want to ask another follow-up on the DOS adds. I know you said you expect high single digits this year. Historically, in a year like this, we might be looking for low to mid teens. But I think the hard part for us as analysts and investors is gauging the size of those potential relationships is you've mentioned that one is with a top 20 health system, and obviously, that's much larger than perhaps a single client.

So Patrick, can you maybe speak to the potential kind of revenue signed versus what a typical year might look like versus just simple number of clients? Thanks.

Speaker 3

Yes, of course, happy to. We've shared previously that an average new DOS subscription customer starts out at a little more than $1,000,000 a year of recurring revenue, split roughly equally between technology and services. To your point, Ryan, the exact price point will be dependent on the range of applications they would like to have access to and range of services as well as the size of that customer. So there can be some variability on a year to year basis. As of now, we would expect our pipeline from a new customer annual recurring revenue size perspective to be roughly similar to what it was in prior years.

Speaker 7

That's very helpful color. And then are you seeing any momentum towards the different type of models? I know you offer kind of an all in Netflix type model versus the DOS and then digital software applications. Are you seeing any trends towards either one of those from the client base converting up in your conversations or new clients looking to maybe start at different levels? And I'm talking more about the pipeline given your answer to the prior question, but what are you kind of seeing for the future here?

Thanks guys.

Speaker 2

Yes, absolutely. So I think we would characterize the current pipeline and the discussions that we're having as very similar to what we've experienced historically with one note. And that is that as we acquire new capabilities, those new capabilities that we're bringing largely at the apps layer are typically outside of the All Access DOS subscription contract. And so they do represent an incremental opportunity for expansion.

Speaker 7

Great. Thank you for the color.

Speaker 0

Thank you. Our next question comes from Sean Wieland with Piper Sandler. Your line is now open.

Speaker 8

Hi, thanks. One more if I could on the deals that you signed so far to date. Are any of these DOS Lite clients and in particular was that large one, was that a full DOS or was that DOS Lite?

Speaker 2

They've been full DOS subscription clients including that top 20 health system.

Speaker 8

Okay. That's helpful. Thank you. And then a question on the new version of the Population Health platform that came out just about a month ago or six weeks ago. Just curious any early feedback on this?

And there was some chatter out there on challenges with the prior version and maybe some revelations made to clients as a result. Just curious what the extent of that was and how the launch of the new platform is going?

Speaker 2

Yes, absolutely. Thanks for the question, Sean. As it relates to our care management application suite and maybe in the broader context, about four or five years ago, Health Catalyst began in earnest to build applications at that application suite level. And actually the first application suite that we started with was care management. And so in many ways we feel grateful for all the learnings that we've had as it relates to version one of the care management solution.

And there certainly were a number of learnings as we started the rollout of care management version one with alpha and beta clients, we discovered a few issues that we felt we needed to address before a more broad rollout. And we identified those issues before they were apparent to our clients. But consistent with the Health Catalyst way, the mission operating principles and cultural attributes of the company, we felt that absolutely the right thing to do would be to be transparent with these alpha and beta clients in highlighting some of the shortcomings that we were seeing and in standing behind our commitment to help them by addressing those issues in our second version. And all along the way, some of those challenges that we face in care management have informed our work in other application suite categories that have successfully rolled out since that first version of care management. And really across the other application suites, we've been really pleased with the robustness of the technology and the significance of the adoption and we can trace a lot of that success back to the learnings that we applied from care management.

Version two point zero is already being rolled out to those alpha and beta clients as a replacement to Version one. And we've also seen meaningful interest across our existing client base as well as with regards to prospects. And we're excited about a significant step forward in capabilities that Version two of care management represents.

Speaker 8

That's great and congrats on that. Thank you.

Speaker 2

Thanks, Tom.

Speaker 0

Thank you. Our next question comes from Sandy Draper with Truist Security. Your line is now open.

Speaker 9

Thank you very much. Maybe a question on the I guess two questions on the margin side, so probably for Patrick. On the professional services, understandably a pretty big drop through on the discounting and that makes sense. But as you come back up, do you think is it realistic to by the fourth quarter of this year get back up to the more normalized margin? Or should we think about that in 'twenty one?

And can you remind me, as I'm just looking back, the professional margins were close to 35% non GAAP in 'nineteen. That was up from 'twenty nine. What have you said in terms of what would be a normal type gross margin to think about once you move through the past the sort of discounting space?

Speaker 3

Yes, of course. Happy to provide some color. So our professional services gross margin is primarily driven by a few factors. One, the near term professional services discounts that we provided to a portion of our customers that as we mentioned has a GAAP revenue gross margin impact in Q2 of this year and a smaller GAAP revenue and gross margin impact in Q3 of this year. And then we'll be through those professional services discounts.

Another main driver of our professional services gross margin is the mix between a few different professional services revenue streams. There's higher gross margin, data and analytics and improvement services. And then there's lower gross margin, implementation and outsourced services. The mix between those types of services we shared earlier this year is the reason why we expected our professional services gross margin this year to be in the 20s. Obviously, the near term professional services COVID related discounts in Q2 and Q3 brought or Q2 brought that down to the low 20s.

And for the rest of the year, we would expect it to increase slightly due to the COVID related discounts rolling off. And the mix would have it be somewhere in the 20s. As far as our long term professional services gross margin target, it's in the mid-30s. And we continue to feel good about those long term targets.

Speaker 9

Okay, great. That's helpful. And then on the technology side, it's actually coming in a little bit better. I may have misunderstood some prior comments. I sort of thought with the Azure hosting etcetera that we weren't really going to see much of any gross margin expansion on the technology side.

And it looks like we're tracking to see some. So maybe just was there anything different there that things are playing out better or maybe I just mis modeled it and then thinking about longer term? I know you're still a couple of years away but could we actually see margin expansion continue without until you fully get off the having the multiple the higher cost of Azure plus the private cloud and all that?

Speaker 3

Yes, Sandy. Thanks for noticing. We've certainly been working hard on to our provide our technology in a scalable of a way as possible to our customers. That has led to strong technology gross margins over the last couple of quarters. We will continue to try to do our best to achieve strong technology gross margins.

But I would highlight that the headwind is still ahead of us of continuing to move a handful of customers that are in our private cloud and on premise to the Microsoft Azure environment.

Speaker 9

Got it. Thanks for the questions.

Speaker 2

Thanks.

Speaker 0

Thank you. Our next question comes from Elizabeth Anderson with Evercore. Your line is now open.

Speaker 10

Hi, guys. Thanks for the question. I had a question about the VitalWare acquisition. So in terms of integration, can you

Speaker 0

talk to us a little

Speaker 10

bit more about how you see the integration in terms of like timeline and then sort of how you then can sort of what's the timeline for sort of the cross sell opportunity?

Speaker 0

Thanks.

Speaker 2

Absolutely. As we think about the approach to integration, our organizational structure helps us to move forward in an expedited fashion. And the fact that we're making these acquisitions at the apps layer, where our apps are designed to work really well with our open, scalable, flexible data platform, It enables technology and data integration to also be seamless and straightforward. From an organizational perspective, a few years ago we shifted towards a business unit oriented structure. And we have a business that is focused on the value proposition for the CFO and the financially oriented solutions that we can bring.

And this VitalWare acquisition will fit within that business unit function and really accelerate and strengthen the value proposition that we can offer to CFOs on the revenue and the cost side of the equation. So that's how we're going to approach integration. We've already done a great deal of work in planning that integration from a team member perspective. And we've already also begun the process of thinking about client communication and the way in which we can enable clients both of Health Catalyst DOS subscription capabilities

Speaker 3

as well as VitalWare clients to tap into what is now more broadly available. And as one data point on the open adaptable nature of DOS, we closed the Able Health acquisition earlier this year. And just a few months later, we were feeding Able Health data and insights from DOS at a customer where we implemented Able Health. So in a very short amount of time, we were able to seamlessly integrate data and insights between those two products.

Speaker 10

Perfect. That's really helpful. And I know you've spoken, in several of the other questions about sort of the post COVID demand, and how you're seeing that inflect. Could you also is there any changes to sort of the reasons that customers come to you post COVID? Or would you say it's sort of similar to what you saw pre COVID?

Speaker 2

So many of the same reasons still apply. I would say there are a couple of amplified reasons that COVID has highlighted, and particularly at the DOS platform layer. I think we've seen an increase in awareness that a patchwork homegrown data warehouse solution just does not scale in situations like a pandemic response. And the need for a commercial grade data platform that is built on scalable technology and that can flexibly enable lots of hypotheses to be tested and developed at the APS layer is required. It's not optional anymore.

So that's probably the most meaningful shift that I think COVID has highlighted and enabled. But still many of the other use cases prior to COVID still apply as well.

Speaker 0

Okay, perfect. Thank you. That's very helpful. Thank you. Our next question comes from Stephanie Davis with SVB Leerink.

Your line is now open.

Speaker 11

Hey guys, congrats on the quarter and thank you for taking my question. You reinstated 2020 growth guidance, but it's effectively in line with your core growth for the year excluding new wins despite calling out some new wins in the first half. So is this because the discounting is offsetting the wins? Is there a longer ramp up period, conservatism or something else? What would help me reconcile this?

Speaker 2

Yes, I'll share a few thoughts and then Patrick please feel free. The guidance that we provided as part of the prepared remarks and the press release, as you I'm sure notice is quite close to the original full year guidance that we provided before the COVID-nineteen pandemic, only within a few percentage points from an overall revenue perspective. So the updated guidance post COVID is very close to the overall level. And so we have experienced, as we mentioned, a couple of month impact and delay. We've spoken to the impact on net new DOS subscription clients and tried to provide some visibility and guidance as to how we would think about that playing out in 2020.

And then we've also shared some commentary with regards to existing clients where we've seen continued robustness as it relates to the technology, dollar based net retention. And we've absolutely experienced due to those near term discounts that we provided to our professional services rates with existing clients and a negative impact as it relates to the professional services dollar base with net retention. Those would be the two components that would drive the lowering of the 2020 forecast. But I would also just harken back that it's within just a couple of percentage points of the original revenue guidance.

Speaker 11

Put another way oh, Patrick, continue and then I'll keep badgering you guys.

Speaker 3

The only item I would add is as we think about our revenue streams in the second half of the year, we would continue to believe that our technology revenue stream will be very robust. Given that our technology dollar based net retention has been minimally impacted from COVID, we would expect sequential quarter over quarter growth in the second half of the year. And primarily, the lower second half year over year revenue growth is driven by lower professional services year over year revenue growth in the second half of the year.

Speaker 11

All right. Understood. So I think I know the answer to this follow-up question. But it is your guidance is close to the original guide, but comes after a very healthy first half fee. So it implies single digit growth in your fourth quarter.

Is that entirely on the professional services side? Or is there anything else rolling off to get you there?

Speaker 3

The vast majority of that implied year over year lower growth is from lower professional services year over year growth. I would just reiterate that our technology revenue stream from a second half perspective, expect to be very robust. And if you think about the reasons why professional services year over year revenue growth is lower in the second half of the year, It is a little bit in Q3, the COVID related professional services discounts. It's the lower dollar based net retention that we spoke about. And it's also lower implementation revenue from signing fewer new DOS subscription customers throughout 2020.

Speaker 11

Okay. That's helpful. Thank you,

Speaker 0

guys.

Speaker 2

Thanks, Stephanie. Thank you.

Speaker 0

Thank you. Our next question comes from Richard Close with Canaccord. Your line is now open.

Speaker 12

Great. Thanks. Congratulations on the quarter and the acquisitions. So first on the new DOS, just to go back there. I think last quarter you mentioned based on the level of your discussions of people in the pipeline, you thought you maybe may have the opportunity to pull forward some deals from 2021 into the fourth quarter.

And so I'm curious whether that can occur and is that part of the expectations for the second half DOS new clients?

Speaker 2

Absolutely, Richard. So as we did mention that that is a possibility and that could happen, I would reiterate that that could happen. But our default position would be an expectation that the primary impact that we'll experience is more just a couple months delay. And then a re engagement that follows the same kind of pattern. So while there could be a case or a couple of cases where we do experience an acceleration, our default forecast assumption is that really we've just experienced a delay.

And that's how we're thinking about it.

Speaker 12

Okay, that's helpful. And then as we think about VITALWARE, assuming no overlap in the 150 clients with Health Catalyst's base, And then you got Medicity's 60 clients that I think you said were in your sweet spot there. I guess the combination gives you 200 more than 200 plus clients to cross sell. Are we thinking about that correctly? And then, what do you think the time line is to be enabled to sell DOS into, VitalWare?

And then any update on Medicity's success?

Speaker 2

Yes, thank you for that question, Richard. So we at a strategic level at Health Catalyst, believe that a number of the acquisitions that we have pursued have a common characteristic in that they offer us a relationship with a broader number of health system clients and by virtue of that relationship, interesting opportunities both with our core existing client base to expand within those existing relationships as well as an open door now to cross sell other solutions into these clients that we've acquired their solutions to be part of Health Catalyst. So this is not only the case with VitalWear, it's the case with HealthFinch, with Able Health and really an important part of the thesis statement of much of our M and A activity, especially at the apps layer in those two categories that we've described where we can make an acquisition accelerates an existing application suite or we can make an acquisition that brings us into a new application suite still within our core market. And so we do believe that the general thesis of cross sell is very important and it's an area of focus for us to execute well against both with VitalWear but with every acquisition that contemplate.

Speaker 4

Okay. Thank you.

Speaker 0

Thank you. Our next question comes from David Grossman with Stifel. Your line is now open.

Speaker 8

Thank

Speaker 12

You've already been asked a lot about pipeline and conversion and you've given us some very helpful data points. But I was just wondering as we look at that fourth quarter run rate, should we be factoring in just the cadence of signings and just the timing of when they're coming on and how that may impact the fourth quarter run rate vis a vis what it would be in prior years? And as we think about that professional services business going into next year, is there any reason to believe that if we are returning to a more normalized environment, even if it's a new one, that the professional services revenue retention wouldn't return again to a more normalized rate in 2021?

Speaker 2

Yes. I'll comment on the second question and then Patrick, if you want to add anything to that question and address the first question as well. As we think about the professional services business, as Patrick mentioned, there are some near term impacts related to those COVID discounts that we anticipate go away. We'll see some spillover in Q3, but largely as we think about Q4 and moving forward, as I mentioned before, those conversations have been completed and we've returned to a normal state. So that first factor should go away and we'll be back to a more normal set of variables in Q4 and beyond.

The second set of variables, however, will remain with us and be a dynamic that we believe will play out in multiple ways across a range of outcomes relative to the mix of services. And we try to keep our focus on what we need to do to enable massive measurable improvement at our clients. And sometimes that dictates more of a mix of the higher end, higher gross margin data science and analytics services. And in other cases, it dictates us to shift more of the mix towards the lower end implementation and outsource services. And we allow the mission orientation of the company and the focus on our clients' long term success to really dictate what that right mix might look like in each period of time.

And so when we've talked historically, and I would just restate and reemphasize the way we think about professional services as a facilitator of measurable improvement. And as such, continue to provide a perspective that we may see meaningful changes quarter to quarter in terms of the gross margin of professional services, mainly driven by mix all the way from the 20s from a gross margin perspective up to the mid-30s. And you have seen that across these last several quarters as we've been a public company that we've experienced that full range.

Speaker 3

Patrick? And on your first question, David, you are thinking about it correct that obviously our fourth quarter GAAP revenue run rate is dependent on the timing of new customer adds throughout the year. On our last earnings call, we shared that in a typical year, our weighting of new client adds is weighted towards Q2 and Q4. Approximately 40% of our new client adds occur in Q2, approximately 40% in Q4. And importantly, those new client adds are typically at the end of a quarter.

So the GAAP revenue benefit of new client adds typically doesn't occur until the following quarter. And that is the case in our guidance as well. As in the twenty twenty new DOS customers that we are expecting that in the second half of the year, the vast majority of revenue contribution from those new customers will not flow onto our income statement until 2021.

Speaker 13

All right. Great. Got it.

Speaker 12

Thanks very much for that color.

Speaker 0

Of course. Thank you. Our next question is from Daniel Grosslight with Citi. Your line is now open.

Speaker 5

Hi, guys. Thanks for taking the question. I'll pile on to the questions around DAS adds this year and next. You mentioned in your prepared remarks or maybe it was an answer to a question that you expect to close a similar amount of clients in the back half of this year versus 2019, which if I kind of apply the cadence that Patrick just mentioned to 2019 would mean probably adding around six or seven new clients in the back half of this year. Am I thinking about that correctly?

Does that mean you added around two to three DOS clients in the first half of this year? And as we think about DOS clients added in the aggregate over 2020 and 2021, how does that compare to your expectations pre COVID?

Speaker 2

Absolutely, Daniel. So I think the framing that you described is a good framing. Last year that in the year 2019, we shared that we added 15 net new DOS subscription clients. So and as Patrick mentioned, that's fairly equally weighted typically historically between the first half and the second half. So a reasonable assumption will be somewhere around half of that would have been experienced through the second half of last year.

As we mentioned, we see the pipeline likely playing out similarly this second half as what we experienced last second half. And in the first half, as we shared, we were pleased to sign multiple new DOS subscription clients, but that number of new DOS subscription clients was meaningfully lower than what we would typically experience. So that's where we get to an overall guide in the high single digits for 2020. And as it relates to 2021, given what we're experiencing now in terms of the pipeline behavior being very consistent with what we have experienced in previous years, we would think about future years in a similar way that we thought about prior years.

Speaker 5

Got it. Okay. And then maybe just a modeling follow-up for you, Patrick. You mentioned that you expect some non headcount expenses to be pushed out to the second half of this year. Can you go into a little more detail on what that is and what line item that will show up in the income statement?

Speaker 3

Of course. So the vast majority of our expenses are associated with headcount, salary, wages and benefits. But we do have a minority, but material portion of our expenses that are associated with non headcount. This includes third party consultants, sales and marketing and the like. And those non headcount expenses generally show up across our various OpEx categories.

So you'll see the movement from some non headcount expenses from the first half to the second half across all three of those categories.

Speaker 1

Got you. Thanks.

Speaker 0

Thank you. Our next question comes from David Larson with Baird. Your line is now open.

Speaker 14

Hi. Just one more question on the professional services. Sorry about that. With the sequential decline in professor service, was there any decline in like the number of hours billed or the amount of work done? Or was it all entirely due to a temporarily reduced price?

So when that price comes back up, the revenue should sort of normalize. Thanks.

Speaker 2

Yes, absolutely, David. I would characterize the level of work that our team members were performing over the timeframe of COVID as being very similar to the level of work and utilization that we normally experience. So really what is showing up from a financial perspective is the impact of those discounts.

Speaker 14

Okay. So it didn't have anything to do with like being able to access the hospitals themselves because of social distancing or what have you. Was simply price, which will come back up. Okay. Then with the Great.

Okay. And then with the VitalWare acquisition, like Chargemaster is obviously of high interest to CFOs, but it sounds to me like you're getting deeper or could get deeper into rev cycle. You have denials management, patient access, managed care contracting. There's a whole bunch of different solutions that can add cash to the hospitals from the CFO's perspective. Is that the direction that you're moving in, which quite frankly, I think makes a lot of sense?

Speaker 2

We agree with your assessment, David. One of the elements that we found really attractive about the Vitalware acquisition is it does give us a beachhead in an area where we could acquire a company with a best in class product in a category like Chargemaster that is a must have for CFOs, but an area where we could be the industry leader with the best product in this space. And then the opportunity presents itself for us to do more. And this is where we can bring some of that complementary capability, especially when you think about our native strengths as a company at integrating data from many different sources and the impact that that capability can have in other areas of revenue and revenue cycle coupled with our domain expertise, it felt like having that beachhead of technology capability would open up other use cases, other opportunities for us to be very helpful to a CFO.

Speaker 14

Okay, great. Thanks very much.

Speaker 2

You bet.

Speaker 0

Thank you. Our next question comes from Sean Dodge with RBC Capital Markets. Your line is now open.

Speaker 1

Thanks. Good afternoon. Maybe just a quick

Speaker 5

one on Medicity. Has there been anything over the last few months that's changed your view there? Is the expectation still for long run flat to declining revenue? Has the pandemic done anything to either help stabilize or accelerate the deterioration you were expecting there?

Speaker 2

We continue to see integration is proceeding according to our planning and forecasting. The relationships are maintaining in a very similar way to what we had forecasted as well. We do believe that the pandemic at a long term level highlights the importance of interoperability, the importance of data sharing across organizational boundaries. And so that is a tailwind as it relates to really highlighting the value of those interoperability capabilities. We certainly want to be in a position long term, having embedded those interoperability capabilities into our data platform to offer a very compelling industry leading solution in that regard.

So long term, we do see some meaningful tailwinds there.

Speaker 5

Great. Thanks again.

Speaker 0

Thanks, Todd. Thank you. And our next question comes from John Ransom with Raymond James. Your line is now open.

Speaker 13

Hey, just kind of stepping back, what do you think your biggest ask will be from your customers over the next six to twelve months versus say what it was in better times?

Speaker 2

Yes, thank you for that. What I would share would be that in many ways I feel like we've already had that conversation and I personally had that conversation with many C suite executives at many of our clients. And what I would share would be that we tried to be proactive in anticipating what our customers needed both in terms of the solutions that we quickly developed. As we've shared previously, we have well over 100 instances of our COVID-nineteen specific solutions being adopted and implemented across our client base, but also anticipating the financial strain that they were experiencing really in late Q1 and early Q2 and proactively offering up those professional services discounts. As I mentioned in my prepared remarks, that decision was very mission consistent, very consistent with this long term customer focus.

And it was very warmly received. It strengthened and reinforced the relationship between us and our clients. And I think it's one of the reasons why we found that they appreciated that near term help. And they also were ready to move back to the more sustainable pricing for professional services, for example, we had pre COVID-nineteen and didn't ask for more, which we appreciated. And I think I would anticipate, that we're also trying to really deeply understand how each of our clients' financial situation is evolving.

And as I mentioned before that in many cases, we are seeing our clients outperforming their adjusted forecasts in terms of how quickly they were able to relaunch those elective procedures and we tried to help them very specifically with COVID-nineteen specific elements like I shared in my prepared remarks. And they're ahead of schedule and the recovery has been better than what we all would have anticipated back in the April timeframe or even the early May timeframe. As a result, we are seeing a robust pipeline of opportunity both with existing clients and with prospects. And those conversations seem to be progressing at about the same pace that we've seen before.

Speaker 12

Right.

Speaker 13

So just a follow-up. So in the age of Zoom and staying at home, I mean, you've got this big new cross sell opportunity. But how do you close that sale when you're just meeting a stranger on an Internet connection and you don't have the vital person to person contact? Do you think the cross sell will happen as quickly? Or are you thinking that this Zoom world is temporary and you'll be back on planes and face to face over time?

Speaker 2

Yeah, great question. I think one of the benefits that we have, first with our existing client base is we have multi year deep relationships and often across many functional areas, many C suite executive relationships. And so in a situation where you can't get on a plane, you already have really significant meaningful relationships already built. The other piece that is helpful is through these acquisitions, one of the elements that we care a lot about is the strength of the customer relationships that these companies that we consider acquiring have developed. And as is the case, for example, with VitalWear, they were the highest rated product in their space from a customer satisfaction perspective.

And so being able to leverage those existing relationships in a situation where you can't travel is really helpful. The last thing I might share is our delivery model on the pro services side before the pandemic was already almost all remote based. And as a result, back to David's question just prior to yours, we really didn't experience any interruption in our ability to provide the services to our clients that other services models might have experienced. And then the last thing I might share is, as I mentioned in my prepared remarks, this year's Healthcare Analytics Summit, which is our seventh annual summit that we'll be hosting, for the first time will be virtual only. And we will miss that experience of everyone coming to Salt Lake City and having a shared experience together.

But there are some upsides as well. So the hotel venue that we typically use has a fire marshal imposed limit to the number of people that can fit in their largest halls, which is typically around that 1,500 level, which was the attendance, you know, was sold out last year and it typically sells out. We're already with the virtual Health Analytics Summit well above that registrant total, well above 2,000 registrants. And so this Health Care Analytics Summit will be, I think, by far the highest attended summit that we've ever had because it's virtual. And so we're trying to make lemonade and understand ways in which we can leverage our capabilities in this new normal environment and still really meaningfully move forward.

Speaker 8

Thanks so much.

Speaker 13

Of course.

Speaker 0

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to CEO, Dan Burton, for closing remarks.

Speaker 2

Thank you. And thank you to all of those who have attended our earnings conference call. We appreciate your interest. We appreciate your support. And we look forward to keeping you apprised of our developments in the future.

Take care.

Speaker 0

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.