Health Catalyst - Q2 2023

Transcript

Operator (participant)

Welcome to the Health Catalyst Q2 2023 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star two. To get to as many questions as time permits, we kindly ask that you limit yourself to one question. If you have any follow-up questions, please reenter the queue. Others can hear your questions clearly, we ask that you pick up your handset for best sound quality. Lastly, if you should require operator assistance, please press star zero.

I would now like to turn the call over to Adam Brown, Senior Vice President of FP&A and Investor Relations. Sir?

Adam Brown (SVP of FP&A and Investor Relations)

Good afternoon, welcome to Health Catalyst's Earnings Conference Call for the Q2 of 2023, which ended on June 30th, 2023. My name is Adam Brown. I am the Senior Vice President of Investor Relations and Financial Planning and Analysis for Health Catalyst. With me on the call is Dan Burton, our Chief Executive Officer, and Bryan Hunt, 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 8-K 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 today's 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 macroeconomic challenges, including high levels of inflation and high interest rates, the tight labor market, our pipeline conversion rate, and the general anticipated performance of our 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 Q1 2023, filed with the SEC on May 10th, 2023, and our Form 10-Q for the Q2 2023, that will be filed with the SEC.

We will also refer to certain non-GAAP financial measures to provide additional information to investors. A reconciliation of these non-GAAP financial measures to their most comparable GAAP measures is provided in our press release. With that, I will turn the call over to Dan. Dan?

Dan Burton (CEO)

Thank you, Adam. Thank you to everyone who has joined us this afternoon. We are excited to share our Q2 2023 financial performance, along with additional highlights from the quarter. I will begin today's call with some summary commentary on our Q2 results and outlook. We are pleased with our Q2 of 2023 financial results, including total revenue of $73.2 million and Adjusted EBITDA of $3.5 million, with these results beating the midpoint of our quarterly guidance on each metric. Additionally, we are tracking slightly ahead of our previous full year revenue and Adjusted EBITDA guidance. As a result, we are raising our 2023 revenue and Adjusted EBITDA guidance.

Likewise, we are pleased with our strong first half bookings performance, and we are reiterating our full year 2023 bookings expectations, inclusive of net new subscription client additions and dollar-based retention rate. Let me highlight some additional items from the quarter. You will recall from our previous earnings calls that we measure our company's performance in the three 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 our clients to realize massive, measurable improvements while also maintaining industry-leading client and team member satisfaction and engagement. Let me begin by sharing an example of a client improvement from a recently published case study.

As Woman's Hospital in Louisiana faced increasing costs consistent with the broader health system end market, their leadership team understood that they needed a technology solution that would support strategic decision making and provide them with a detailed, comprehensive view of their costs. To achieve this goal, Woman's Hospital implemented our PowerCosting Analytics application, part of our Financial Empowerment Technology suite, to enable them to better manage their cost of care, leading to improvement in their revenue performance and enhancements in their strategic decision-making effectiveness. Our PowerCosting application allowed the Woman's Hospital team to analyze detailed cost data and look at the contribution margin for each of their services, enabling their leadership team to answer important strategic questions.

Ultimately, utilization of the detailed cost data from our PowerCosting application empowered the Woman's Hospital team to be awarded $10 million in additional funding from the Department of Health for their OBGYN residency program. Likewise, Woman's identified $2 million in labor cost savings opportunities. The result of decreasing contract labor costs while providing market-based salary adjustments for registered nurses and improving retention of highly qualified nursing staff. Also, in the improvement category, we have been fortunate to receive additional external recognitions related to our team member engagement. First, for the 11th year in a row, Health Catalyst has been named the Best Place to Work in Healthcare by Modern Healthcare. Additionally, Health Catalyst has been included in this year's Top Workplaces in the Healthcare Industry list by Energage.

Likewise, we are pleased to be, for the first time, Great Place to Work certified in India, a recognition of our high team member engagement in this region. Lastly, we are excited to share that Health Catalyst has been named as one of America's greatest workplaces for job starters in 2023 by Newsweek. Our next strategic objective category is growth, which includes expanding existing client relationships and beginning new client relationships. To summarize, our operating environment continues to align with what we have shared in prior quarters, with some slight improvement in recent months. This has translated to a strong first half bookings performance that was consistent with our expectations. During the second half of 2023, our pipeline continues to grow, and our anticipated second half bookings are also in line with our previously shared expectations.

As such, we are reiterating our full year 2023 bookings expectations, inclusive of a dollar-based retention rate between 102% and 110%, and net new DOS subscription client additions in the low double digits. As it relates to our current selling environment, we continue to experience similar tailwinds and headwinds that are consistent with what we have described over the last couple of quarters. While health system operating margins continue to be challenged relative to longer term historical levels, we are encouraged to see their operating margins improving slightly in recent months. Given the budgeting cycles of most health systems and the typical length of our sales cycles, we anticipate this will translate as a midterm bookings tailwind.

Related to our full year 2023 bookings expectations, a reminder that we continue to anticipate professional services bookings growth to be higher than technology bookings growth, driven by our Tech-Enabled Managed Services offering. From July 1st of 2022 through June 30th of 2023, our Tech-Enabled Managed Services ARR grew by more than 80% and represents nearly 50% of our total professional services ARR. To date, roughly 10% of our DaaS subscription clients have entered into a Tech-Enabled Managed Services relationship with Health Catalyst. These long-term partnerships include multiyear contracts with, on average, more than $8 million of total ARR per client, which is about four times larger than the average ARR for DaaS subscription client. Next, I'm excited to announce two recent Tech-Enabled Managed Services contracts.

First, we are pleased to have entered into an expanded relationship with a regional health system who has been a client of Health Catalyst for nearly a decade. This five-year, $50 million All-Access technology and services contract more than quintupled the size of the client's relationship with Health Catalyst and includes an opportunity for an additional shared success bonus based on improved client profitability. At approximately $10 million in annual recurring revenue before any shared success bonus, this health system has become one of Health Catalyst's 10 largest clients. This annual spend level also represents approximately 5% of this client's net patient revenue, highlighting the depth of this long-term partnership. Importantly, this relationship represents a new Tech-Enabled Managed Services offering area for us, in which we are managing the vast majority of the non-clinical staff across this health system's ambulatory clinics.

We anticipate this new Tech-Enabled Managed Service in ambulatory operations will provide us with another meaningful growth engine, in addition to our current Tech-Enabled Managed Services in analytics and chart abstraction. Additionally, I'm pleased to share another significant Tech-Enabled Managed Services expansion that was signed recently with another health system who has been a client of Health Catalyst for nearly a decade. This new 5-year contract is sized at approximately $60 million, and at roughly $12 million of annual recurring revenue, it represents approximately a doubling in the size of this client relationship relative to last year. The expansion is inclusive of an All-Access technology subscription, as well as an expansion to Tech-Enabled Managed Services within the chart abstraction and analytics domains, with an emphasis on clinical quality improvement and health equity.

We are excited to deepen this long-standing partnership. We are encouraged that it represents another meaningful example that demonstrates the strong value proposition of our Tech-Enabled Managed Services offering. To summarize, from a growth perspective, we had a strong first half bookings performance. Our pipeline continues to grow. We anticipate our second half bookings performance will be in line with our prior expectations. Likewise, we are excited to have announced multiple sizable Tech-Enabled Managed Services expansions as further evidence of our meaningful traction with clients. Lastly, as you'll hear from Bryan later in our prepared remarks, we are pleased to raise our revenue and Adjusted EBITDA guidance for the full year. We continue to feel confident in our long-term revenue growth target of 20%+ and our long-term Adjusted EBITDA margin target of 20%+.

Additionally, we continue to track well towards our midterm targets, including 10% Adjusted EBITDA margin in 2025 and meaningful positive adjusted free cash flow in 2025. We continue to see material operating leverage in our financial model, inclusive of significant Tech-Enabled Managed Services expansions that require little incremental operating expenses. Likewise, we anticipate seeing more material R&D operating leverage beginning in 2024 as we streamline and work to complete certain investments in our data platform. With that, let me turn the call over to Bryan. Bryan?

Bryan Hunt (CFO)

Thank you, Dan. Before diving into our quarterly financial results, I want to echo what Dan shared and say that I am pleased with our Q2 performance. I will now comment on our strategic objective category of scale. For the Q2 of 2023, we generated $73.2 million in total revenue. This represents an outperformance relative to the midpoint of our guidance, and it represents an increase of 4% year-over-year. Technology revenue for the Q2 of 2023 was $47.3 million, representing 4% growth year-over-year. This quarterly revenue performance was slightly higher than anticipated in our quarterly guidance due to a few technology environment go-lives that generated a deferred revenue catch-up occurring earlier than forecasted.

Professional services revenue for Q2 2023 was $25.9 million, representing 3% growth relative to the same period last year. For the Q2 of 2023, total adjusted gross margin was 50%, representing a decrease of approximately 500 basis points year-over-year. In the technology segment, our Q2 2023 adjusted technology gross margin was 68%, a decrease of approximately 270 basis points relative to the same period last year and in line with previously shared expectations.

This year-over-year performance was mainly driven by headwinds due to the continued costs associated with transitioning a small subset of our client base from on-premise to third-party cloud-hosted data centers in Microsoft Azure, as well as from costs associated with migrating a subset of our client base to our multi-tenant Snowflake and Databricks-enabled data platform environment, partially offset by existing clients paying higher technology access fees from contractual built-in escalators without a commensurate increase in hosting costs. In the professional services segment, our Q2 2023 adjusted professional services gross margin was 17%, representing a decrease of approximately 960 basis points year-over-year, and a decrease of roughly 330 basis points relative to the Q1 of 2023.

This quarterly performance was generally in line with the expectations we shared on our last earnings call and primarily driven by new Tech-Enabled Managed Services relationships that start out at a low gross margin and expand over time. In Q2 2023, adjusted total operating expenses were $32.9 million. As a percentage of revenue, adjusted total operating expenses were 45%, which compares favorably to 52% in Q2 2022. Adjusted EBITDA in Q2 2023 was $3.5 million, with this performance exceeding the midpoint of our guidance and which represents an increase of $1.5 million relative to the same period last year.

This Q2 2023 Adjusted EBITDA result was mainly driven by the quarterly revenue outperformance mentioned previously, along with the timing of some non-headcount expenses that we anticipate will be pushed out to the second half of the year. Our adjusted basic net income per share in Q2 2023 was $0.05. The weighted average number of shares used in calculating adjusted basic net income per share in Q2 was approximately 56 million shares. Turning to the balance sheet, we ended Q2 2023 with $343.8 million of cash, cash equivalents, and short-term investments, compared to $363.5 million at year-end 2022. Related to our cash balance, in Q2 2023, we came to a settlement in regards to our previously disclosed litigation with Pascals METRICS.

The total settlement amount was $18.8 million, which was within the anticipated range of outcomes we disclosed last quarter in our 10-K. In terms of liabilities, the face value of our outstanding convertible notes is a principal amount of $230 million due in 2025. As it relates to our financial guidance for the Q3 of 2023, we expect total revenue between $70.2 million and $74.2 million and Adjusted EBITDA between $0 and $2.5 million. For the full year 2023, we now expect total revenue between $290.5 million and $295.5 million. At their respective midpoints, this represents an increase of $0.5 million compared to the full year revenue guidance we provided last quarter.

We also expect full year 2023 Adjusted EBITDA between $10 million and $12 million. At their respective midpoints, this represents an increase of $1 million compared to the full year Adjusted EBITDA guidance we provided last quarter. Now, let me provide a few additional details related to our 2023 guidance. First, as it relates to our Q3 2023 revenue expectations, we anticipate that our revenue will be slightly down quarter-over-quarter, primarily driven by the previously mentioned first half one-time revenue items and go lives that generated a deferred revenue catch-up, as well as the timing of our revenue generation from net bookings in the first half. Next, in terms of our adjusted gross margin, we continue to anticipate that our adjusted technology gross margin will be in the high sixties in the Q3.

In the professional services segment, we anticipate that our Q3 adjusted professional services gross margin will be down a few points compared to Q2 2023. The result of new Tech-Enabled Managed Services revenue, which begins at a low gross margin before expanding over time. Lastly, we anticipate our operating expenses will be slightly up relative to Q2 2023, mainly the result of some non-headcount expenses that we now anticipate will occur in Q3 as opposed to Q2 2023. Lastly, let me share a few additional details related to our full year 2023 guidance. As Dan mentioned, we are pleased to be in a position to increase the midpoint of our guidance range for both revenue and Adjusted EBITDA. In terms of our adjusted gross margin, we continue to expect that our adjusted technology gross margin will be in the high sixties through 2023.

For our adjusted professional services gross margin, we anticipate it will be in the high teens for the year, primarily as a result of our mix of professional services being comprised of a larger % of Tech-Enabled Managed Services, given the strong growth in that segment of our business, with those relationships starting out at a lower gross margin and expanding over time. Lastly, we anticipate our adjusted operating expenses as a % of revenue will be down more than 700 basis points year-over-year, largely the result of our restructuring efforts and meaningful continued operating leverage, with the largest year-over-year reduction occurring in SG&A. That, I will conclude my prepared remarks. Dan?

Dan Burton (CEO)

Thanks, Brian. In conclusion, I would like to recognize and thank our clients and team members. Without their consistent engagement in and contributions to our shared mission, none of this would be possible. With that, I'll turn the call back to the operator for questions.

Operator (participant)

Thank you. The floor is now open for questions. At this time, if you have a question or comment, please press star one on your telephone keypad. If at any point your question is answered, you may remove yourself from the queue by pressing star two. Again, we kindly ask that you limit yourself to one question and that you also pick up your handset when posing your question to provide optimal sound quality. Thank you. Our first question will come from Elizabeth Anderson with Evercore ISI. Your line is open.

Sameer Patel (Research Analyst)

Thanks. Hi, guys. This is Sameer Patel on for Elizabeth Anderson. You know, one question I just wanted to get some more color into is: how do we read into this increased revenue guidance, given the reiterated net retention rates, at least that range? Does that imply, like, improving outlook on new customer wins, or are you just expecting to reach maybe a slightly higher point within that net retention range that you've shared?

Bryan Hunt (CFO)

Great question, Samir. The, the primary drivers of the increase to our revenue guidance range this year are, are mainly, mainly timing. We are a little bit ahead of schedule as it relates to, as I mentioned, some client implementations and go lives, and some of the, the bookings that have rolled through for the year. That's the primary kinda driver. What, what you're describing, Samir, around kind of the new client environment as well as the dollar-based retention rate, for us is a, is a little bit less impactful in year because of the kinda more back-end-weighted nature of our bookings this year, which is kinda what we expected coming into 2023. That growth will, will be more pronounced as we complete the year and drive toward 2024.

Sameer Patel (Research Analyst)

Got it. Super helpful. Thanks.

Bryan Hunt (CFO)

Thank you.

Operator (participant)

Thank you. Our next question will come from Vishal Patel with Piper Sandler. Your line is open.

Vishal Patel (Research Analyst)

Hi, this is Vishal Patel on for Jess Tassan. Thanks for taking our questions, and congratulations on the quarter. We wanted to ask about the recently proposed lump sum 340B remediation payments to hospitals. From your conversations with customers, are those payments shaping up to be a tailwind for U.S. Health Systems, perhaps further invest in data and analytics? Thank you.

Dan Burton (CEO)

... It certainly helps, yes. I think there are a couple of, of modest tailwinds that we're observing across our client base. That's one of the tailwinds. I think there's some other tailwinds in terms of inflationary pressures coming down a little bit as it relates to labor and supplies, all of which are, are contributing to a slightly better operating margin environment, which we believe will be a midterm tailwind for us.

Vishal Patel (Research Analyst)

Thank you.

Operator (participant)

Thank you.

Dan Burton (CEO)

Thanks, Vishal.

Operator (participant)

Next, we have a question from Daniel Grosslight with Citi. Your line is open.

Daniel Grosslight (Research Analyst)

Hi, thanks for taking the question. I'm curious how we should think about the services gross margins as we enter into a more normal environment in 2024 and beyond. Given the shift to Tech-Enabled Managed Services, has this turned into, like, a high teens, low 20s margin business going forward? You think you'll eventually get up to the margins that you have achieved prior to the recent downturn? As a part of that, can you just maybe give us a little bit more detail around kind of how that contributes to EBITDA? Because even though it's lower gross margin, you don't really have any of a lot of the setup costs, so it might be quicker to add to the EBITDA, even though gross margins are a bit lower in that product.

Dan Burton (CEO)

Yeah, well said, Daniel. I think, both of those points are, are important. On the first point, we are continuing to gather data, and obviously, we're excited to have seen, you know, as we mentioned in prepared remarks, from July 1 of last year through June 30 of this year, a really significant growth in Tech-Enabled Managed Services within our pro services segment. It's, it's, you know, growing very rapidly at, at more than 80%. That is encouraging to us. We see in our pipeline, further growth in that kind of opportunity, and as we've mentioned with the two examples that we went through, these can be very large contracts, and, and they're also long-standing contracts, typically 5 years locked in, which is really helpful.

To your point, there are many positives, and then there are a couple of challenges with regards to those kinds of contracts. One of the challenges is that, as Bryan mentioned early on, gross margin is quite low, you know, sometimes starting as low as around 0%, but then migrating over time up to the mid-20s, as we've shared in the past. That is different from, you know, what we talked about when we went public in terms of a long-term pro services gross margin target, more like in the mid-30s. We still do have other pro services that we continue to offer, that some of which do have a higher margin profile. I think we're early in the process of understanding exactly how this all plays out over time.

We're definitely encouraged by the fact that, to your second point, those Tech-Enabled Managed Services, as we sign these large contracts, we're seeing over and over again that they do not require meaningful incremental operating expenses. As such, even in that scenario where we're getting to more like a mid-20s gross margin profile for the professional services, it also includes meaningful tech subscriptions, usually migrating to All-Access, which is a much higher gross margin profile. The lack of a requirement of any incremental meaningful operating expenses leads us to have confidence, even in scenarios where Tech-Enabled Managed Services continues to be a real strong growth engine, that we can maintain that long-term EBITDA guidance of 20%+.

Bryan Hunt (CFO)

Yeah, I'd just add to that, Danny, I work- so we're- we are encouraged to see a little bit more EBITDA progress this year than what we had expected coming into the year. Then in terms of the long-term target commentary that, that Dan was referring to, well, that is an area on the pro services side that we're studying more, and we'll likely have more to, more to say as we learn more about the level of demand on the tech-enabled side. But what we do continue to feel confident in, related to our long-term targets that we set at IPO, are the long-term revenue growth rate of 20%+ and the long-term EBITDA profile, 20%+.

Daniel Grosslight (Research Analyst)

Yep, makes sense. Thanks for the color.

Dan Burton (CEO)

Thank you, Daniel.

Operator (participant)

Our next question will come from David Larsen with BTIG. Your line is open.

David Larsen (Managing Director and Analyst)

Hi. Congrats on the good quarter. You signed two very large deals, one for $50 million, one for $60 million, yet you described the hospital sort of environment as modest improvement and, and slight improvement. Just any more color there would be very helpful. I mean, as, as far as I can tell, that's... Those are very significant contracts. I'm assuming that even at the end of the five years, they'll probably renew again. Just any more color would be very helpful. Thank you.

Dan Burton (CEO)

Absolutely. Thanks for the question, David. We are definitely encouraged to see two more examples of really large Tech-Enabled Managed Services contracts. Of course, over the last nine months, we've seen several of these really meaningful expansions with our existing client base. We're very encouraged by that. Now, some of the reason for these large expansions is because Tech-Enabled Managed Services offers financial relief. It offers help with regards to financial pressures. Certainly that hard dollar ROI that we're able to offer has helped us to be part of the solution to, to health systems as they're facing financial pressure. As we know, you know, for decades now, health systems have had to operate with very low operating margins, see that changing in the foreseeable future at a, at a significant level. We continue to feel like...

That Tech-Enabled Managed Services value proposition of being better, faster, and cheaper, is very, very compelling and will be a really nice growth engine for us for many years. At the same time, we're also encouraged anytime, you know, our client end markets financial condition improves a little bit, it just becomes a little bit easier for us to, to keep moving forward and expanding the relationship, both with Tech-Enabled Managed Services, but also in other areas as well. That is nice to see some tailwinds and nice to see some improvements in their operating environment.

David Larsen (Managing Director and Analyst)

Okay, then just one more quick one. Did I hear you say that you're going to be managing nearly all of the non-clinical aspects of one of your hospital clients as part of one of these deals?

Dan Burton (CEO)

You did hear that in the ambulatory space. So all the ambulatory clinics, the non-clinical staff, the vast majority of them are now dual employed, including a primary employment relationship with Health Catalyst. We're really excited about that. We've talked in the, in the last couple of earnings calls about how important ambulatory operations are to our health system clients. So many of them have made strategic moves into the ambulatory space, purchasing clinics and physician practices, but so many are struggling from a financial and operational performance perspective. And we've, for a number of years, provided technology support to improve ambulatory operations, but this is really a deeper step in that direction of, of getting right into the trenches and managing most of the staff at these clinics.

We do view this as a really exciting new Tech-Enabled Managed Services offering area for us.

David Larsen (Managing Director and Analyst)

Great. Congrats on the quarter.

Dan Burton (CEO)

Thanks, David.

Operator (participant)

Thank you. Next, we have Jack Wallace with Guggenheim Securities. Your line is open.

Jack Wallace (Research Analyst)

Hey, congrats on the quarter, and thanks for taking my question. Y- you know, it sounds like we've got four pretty substantial client expansions in the TEMS agreements so far this year. In, in thinking about the TEMS deals, when we spoke earlier this year, you talked about having some pretty good visibility into when these types of deals might be signed, about one to two quarters out. As we're sitting here in August, with the meat of the selling season in the back half of the year, what kind of incremental visibility do you have into that 102%-110% net dollar retention range? And are we shading towards either end of that range at this point? Thank you.

Dan Burton (CEO)

Yeah, thank you, Jack. I appreciate the question. It's an important one. As you mentioned, we have signed several of these large Tech-Enabled Managed Services deals over the last 9 months. There have been 5, inclusive of the Carle Health deal, which was right at the end of last year, took effect at the beginning of this year. Across those, a few patterns that we have noticed have emerged. One, we do have good visibility as to the likelihood that we will win those contracts. In each case, a number of months before the actual signing of the contract, we had gotten really good indication that the client had decided that they're going to move forward with us.

What we have also realized is, it continues to be hard to precisely predict exactly when that, that contract signature will occur. Part of the reason for that is these are such large contracts and long-standing contracts in terms of being 5 years in nature, that, that often there's a need for us to, to go through a couple of additional, confirmatory steps, and often those are really positive. It's, it's like, for example, for me, to have the opportunity with multiple clients to interface with board members of these clients and get to know and build a relationship with them long term, which is, I think, long term, a wonderful thing. Those things take time.

We, we have tried to, to showcase and share that as we think about the back half of this year, we're excited that our pipeline is growing. We have really meaningful opportunities, and we have a sense that we're, we're tracking well, like we've seen in the past, in terms of the likelihood that, that we will win those contracts. As has been the case, and as we've shared in the past, almost all of these opportunities, we are the sole source vendor that's being considered. There's not an RFP process, and so it's really a matter of the client deciding we're going to move from, from managing these services in-house to, to partnering with Health Catalyst.

We've continued to see, like we've seen in these last five contracts that we've signed, it is difficult for us to precisely predict the timing of exactly when the contract signs and exactly when the revenue begins. That is one of the reasons why we've shared a wide range of dollar-based retention, because these are big, lumpy deals. As an example, last year, you know, the Carle Health deal alone swung our, our, our dollar-based retention by about four points. So, at that, at that level, you can see pretty significant impact of one deal from a timing perspective, you know, signing in December versus January or February.

So we, we haven't updated that, that range because that dynamic still exists, and, and, and yet, at the same time, we're so excited about the long-term benefits, strategic benefits of these Tech-Enabled Managed Services contracts. As we keep the relationship in a really good place, you know, they're signing five-year contracts, where they're locked in on both the technology side and on the service side. So it's, it's worth a little bit of near-term uncertainty, which we can manage over time.

Jack Wallace (Research Analyst)

Gotcha. That, that's helpful. Thank you.

Dan Burton (CEO)

Check there.

Operator (participant)

Thank you. Our next question comes from Scott Schoenhaus with KeyBanc. Your line is open.

Scott Schoenhaus (Equity Research Analyst)

Hi, team. Thanks for all that updated color on the hospital end markets. I thought that was a very nice color from where we talked 90 days ago, and very encouraging. I, I want to focus in on the margin. You know, you talked about the non-headcount headwind in the back half. Does that relate to the Q3 internal marketing event that you guys do annually? Built within that is outside of that non-headcount-related item, you're seeing a lot of leverage, operating leverage in sales and marketing. How should we think about that going forward? Should we continue to see that as we continue to see, you know, strong demand for expansion services, meaning that you won't need a robust sales and marketing team if your clients are just expanding their services? Thanks.

Dan Burton (CEO)

Thank you, Scott. I'll, I'll maybe address the second question, and then, Bryan, if you want to address the first question. As it relates to the, to the second question, there are a few examples now that we've gathered quite a bit more data on Tech-Enabled Managed Services contracts that are encouraging to us as it relates to operating leverage. The first, certainly, that you pointed out is there's meaningful sales and marketing leverage, where, like we have shared in the past, one really effective account executive can cover the waterfront of, of even a very deep and multifaceted existing client relationship. That was the case, for example, with Carle Health. We, we had one account executive before they expanded from $4 million to $16 million today.

We still have one dedicated, you know, account executive, and they're able to manage that relationship really effectively. There is really meaningful sales and marketing operating leverage, and we see that continuing through these other contracts that we've signed and existing client relationships that are expanding. That is one of the benefits of having the foundation of our growth long term be really focused on expanding existing client relationships. There's just a lot of leverage there, it's generally a very high leverage, high ROI kind of sales and marketing motion. That is our strategy long term. We are encouraged by that. As we also mentioned in the prepared remarks, that isn't the only place where we see operating leverage.

We've already seen some meaningful G&A operating leverage as well, where, we can take on these large contracts without needing to add a lot of G&A infrastructure. We also anticipate, starting in 2024, some really meaningful R&D leverage, as we mentioned in the prepared remarks. There's, there's multiple facets to, what feel encouraging to us as we, as we see TEMS as a growth engine, moving forward.

Bryan Hunt (CFO)

Yeah, that's well said. Just on your first question, Scott, so related to our EBITDA margin kind of trends for the year, we are encouraged to have been in a position to raise our EBITDA margin target for the year, slightly and continue to make progress on, as Dan mentioned, operating expense, efficiency and leverage. There is a little bit of seasonality in our, in our non-headcount spend. We had some non-headcount spend, so to your point, Scott, things like advertising spend, some event spend, things like, you know, contractor work on the R&D side that we think has just slipped to the back half of the year rather than the first half of the year, but, but less so related to the large marketing event.

Scott Schoenhaus (Equity Research Analyst)

Thank you so much for all that color. Appreciate it.

Dan Burton (CEO)

Thanks, Scott.

Operator (participant)

Thank you. Our next question will come from Richard Close with Canaccord Genuity. Your line is open.

John Penny (Associate Analyst)

Hi, this is John Penny on for Richard Close. Thanks for the question, congrats on the quarter. Just a question again, going back to the Tech-Enabled Managed Services. Just exactly like, what exactly is your expectation in terms of timing for, like, for the gross margins to ramp? Like, how long do you think it'll take to get to the 20% from the low single digits 0 that you're talking? Thank you.

Dan Burton (CEO)

Yeah. Thank you, John. As we've discussed in the prepared remarks and as we've discussed in prior quarters, often we begin these Tech-Enabled Managed Services relationships around 0% gross margin, give or take. Each contract is a little bit different. Typically, we start with quite a low gross margin, somewhere in that 0% plus range. Over the course of a typical 5-year contract, we see gross margin improvement in the Tech-Enabled Managed Services part of that contract, where that grows from 0% early in that first year, up to that 25% long-term target, towards the end of that 5-year contract term. It's important also to note that, we also benefit from the fact that there's a technology subscription that's also part of that client relationship.

In each of the cases that we've shared over the past nine months, our clients have migrated from a little bit more modular relationship to a more All-Access type of relationship, and that often involves some meaningful tech expansion at a high gross margin. The combination of the tech and the Tech-Enabled Managed Services is also what really contributes to our confidence level that with those kinds of relationships, we can still produce a 20-plus % EBITDA margin.

Bryan Hunt (CFO)

Yeah, just, just to add to that, we do have a couple of data points of clients who have been longer standing in terms of the Tech-Enabled Managed Services relationship with us, that have migrated toward that, or to that 25%-... Tech-Enabled Managed Services gross margin level. That's been encouraging. While it's been more of a recent focus for us on some of these newer deals, that does present a bit of a headwind in the second half and into 2024. As Dan shared, moving to these long-term, very deep strategic relationships that are locked in for 5 years provides us with great visibility as compared to kind of the more traditional model that we've seen, which has been more of a month-to-month model.

Sameer Patel (Research Analyst)

Perfect. Thank you.

Dan Burton (CEO)

John.

Operator (participant)

Our next question will come from Stan Berenshteyn with Wells Fargo Securities. Your line is open.

Stan Berenshteyn (Senior Analyst)

Hi, thanks so much for taking my questions. It looks like your conference has shifted from a typical 3Q to 1Q. A couple of questions on that. I guess 1, how should we think about the timing in terms of the associated expenses here? Then does that in any way shift your visibility into next year's bookings? Thank you.

Dan Burton (CEO)

Yeah, thank you, Stan, for the question. Yes, we did decide to, to make a shift in the timing of the Healthcare Analytics Summit from September to the wintertime. February of next year will be when we hold that. We do love that event as an opportunity for our existing clients to gather for a user group experience and, and for us to talk about ways in which we can expand and deepen those relationships. We also open it up to others who aren't clients of Health Catalyst to come and, and view it as an industry event and an opportunity to learn more about healthcare analytics. That is an important enabling factor in, in our ability to continue to keep moving forward with regards to pipeline conversion and, and bookings.

We, but we, rather anticipate that that will be a nice tailwind in early 2024, that will help us to continue the momentum that we see. As I mentioned in our prepared remarks, we feel encouraged by the fact that our pipeline is growing. We feel encouraged by the fact that we have the coverage that we need to have reiterated our confidence in the in the full year bookings expectations, both with, with existing clients from a dollar-based retention rate perspective, and with regards to net DOS, DOS subscription clients.

Bryan Hunt (CFO)

Just in terms of the, the timing of the expense, Stan. Most of that expense for the summit will occur in, in the Q1 timeframe. There, there is some, as you get kind of prepared for the summit, some work that leads up to that. There will be some expense for us this year in the back half, in particular in Q4, but most of that will kind of change, you know, in terms of a different quarterly cadence. And again, one of the areas that we continue to be very focused on in terms of operating expense, streamlining and leverage, will continue to be sales and marketing.

Stan Berenshteyn (Senior Analyst)

Great. Thank you.

Dan Burton (CEO)

Thank you.

Operator (participant)

Thank you. Our next question will come from Jeff Garro with Stephens. Your line is open.

Jeff Garro (Equity Research Analyst)

Yeah, good afternoon. Thanks for taking the questions. Wanted to follow up on the earlier question on the TEMS ambulatory win. I'll try to lump a few related questions together. Just curious what the, the kind of core focus will be for that non-clinical ambulatory staff that you'll be rebadging. You know, categories like data management, quality reporting, intake or revenue cycle come to mind, but curious to hear more from you there. Then also looking to get some color on the shared success possibility. Just, any detail on the KPI or type of KPIs that could lead to earning a shared success bonus? Lastly, just any color you could add on, on how the rebadge staff can better leverage technology to create the efficiencies and hard dollar ROI that you talked about. Thanks.

Dan Burton (CEO)

Excellent. Thank you, Jeff. We are very excited about this TEMS Ambulatory operations opportunity, and as I mentioned a few minutes ago, we've been, for a number of years, providing technology support and analytics support so that our clients can understand their ambulatory performance, both financially, operationally, and clinically. We've seen really meaningful opportunities for improvement that we showcase to our technology. It's been harder for us to help our clients actually realize the improvement that would lead to, you know, improved clinical outcomes, financial and operational outcomes. This is an opportunity for us to really go deeper.

To your point, as we pinpoint opportunities, whether they're on the revenue and volume side, which, you know, there are some greatest hits there that you would typically see in terms of opportunities for productivity improvement, or on the cost side in terms of efficiency management, whether that's labor utilization, supplies utilization, or other factors as well. We have been aware of those specific opportunities. We've highlighted those for clients, but now we're most of the team that can implement the changes necessary to see the improvement. That, that leads to your second question, as it relates to how is the shared success bonus structured? In this first case, it's quite simple. It is focused on us improving the operating income of those clinics.

As we do so, we'll share in the success of the improvement that we see in that operating profit. That is a great focusing mechanism for all of us to be aligned in terms of seeing that operational and financial performance, which also can often be driven by clinical improvement in terms of the way that we treat patients. That's how the shared success bonus is structured. Is focused. In terms of how we're managing the rebad staff, one of the things we love about Tech-Enabled Managed Services is it plays to some of our natural differentiated strengths as a best place to work with very, very high team member engagement.

Our last Gallup result put us in the 97th % in terms of our team member engagement relative to a very large benchmark set. We intend to leverage that engagement with these team members to enable them to really help drive the needed operational, financial, and clinical changes that will lead to that improved performance. We, we have seen that work in really effective ways in our other Tech-Enabled Managed Services relationships, and we're excited to see similar kinds of results as we move into this ambulatory operation space.

Operator (participant)

All right. Thank you. As a reminder, that is star one on your telephone keypad to ask a question. Our next question will come from Sarah James with Cantor Fitzgerald. Your line is open.

Sarah James (Research Analyst)

Thank you, and congrats on the quarter. It was really interesting earlier, you mentioned having the opportunity to talk to some board members of your provider clients around their strategy of budget setting. Were you able to glean any trends of what market conditions they're looking for, the longevity of those? If, if you could, give us a reference from the last margin expansion cycle that providers went through, what was sort of the lag that you saw between market conditions changing and an uptick in appetite for contract expansion?

Dan Burton (CEO)

Yeah, thank you for those questions, Sarah. As you would expect, my experience with interfacing with board members at health system clients is that they are appropriately long-term focused, strategically focused, want to make sure that, as you mentioned in the second part of your question, that these health systems are well prepared to make it through upward and downward cycles from a macroeconomic perspective and an inflationary perspective, et cetera. I think that's actually one of the really appealing elements of what we're offering as it relates to Tech-Enabled Managed Services. We're offering great visibility and great predictability, for an extended period of time that kind of works their way through some upward and downward cycles.

To one of the other comments, made a few minutes ago, our experience thus far, while, while we're excited to, to, to structure these contracts as 5 years, thus far we've, we've experienced, you know, renewal, for those clients that have been long-standing with us is a very likely option. These are, these are, we believe, more like 10-year, 15, 20-year kinds of decisions that our clients are making, that these boards are making, that provides them with that predictability and visibility through upward and downward cycles so that they can manage really effectively important costs and, and know that they're, they're receiving that cost efficiency from a partner who also cares deeply about those team members.

Because these boards are also very community-focused, and they care about the impact of employment in their local community, and our ability to keep those individuals deployed locally, keep them part of the community long term, is another really appealing element, while also helping the financial sustainability of these health systems. The last thing that I, I think is really appealing to these boards is that, that these team members become force multipliers. They become catalysts, pun intended, to enable improvement throughout the broader healthcare ecosystem within that health system. That leads to even more sustainability by improving clinical outcomes, improving patient outcomes, while also driving operational and financial improvement. I think those are the elements that, that these boards are looking for and, and senior leaders are looking for.

I've heard that personally face-to-face over and over again. I'm now up to over 150 visits with C-suite executives and board members of our top 100 clients, and that's really what they're looking for, is how do we ride through difficult economic cycles and get to the other side of those with real predictability? To your point, one of the benefits of healthcare is typically the highs aren't quite as high, and the lows aren't quite as low through economic cycles. I think having predictability through those cycles can be really helpful. As such, even some small improvements in operating margins can you know, enable more investment in strategic long-term areas.

To your last question, I think we do see the, the movement over the last several months as being positive, and, and we see some momentum in terms of the operating margin improvement yielding a little bit more movement in, in our pipeline. But it's usually a little bit more muted in healthcare in both directions than what you might typically see in other industries.

Bryan Hunt (CFO)

The data point I would just share, Sarah, is that, yeah, as you see some of that pipeline start to move, for us, traditionally, our sales cycles do tend to be longer. They're around a year on average, and they typically kind of align with fiscal years or budget cycles for health systems, are usually, July 1 or January 1. It certainly will, will take time for some of that kind of improvement to roll through our pipeline and into kind of a bookings cadence, cadence over the medium term.

Sarah James (Research Analyst)

Thank you.

Operator (participant)

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

Thomas Keller (Analyst)

Hey, good afternoon. This is Thomas Keller in for Sean Dodge. Thanks for taking the question. Just a quick follow-up on the analytics element. I want to make sure I'm clear on the timing. So the roughly $2 million-$3 million costs at scale across the next Healthcare Analytics Summit, that was already factored into the initial 2023 guidance, or was that more of a recent shift to 2024? Thanks.

Bryan Hunt (CFO)

Yeah, and it was a little hard to hear you, Thomas, but, yeah, the summit event we had, we had been working on early in the year in terms of timing, and so, generally contemplated that in terms of our guidance for 2023, and so that's kind of played out kind of in line with that expectation.

Dan Burton (CEO)

Okay. Great. Thank you.

Operator (participant)

All right. Thank you. At this time, there are no further questions in the queue. I would like to turn the floor back over to Mr. Dan Burton for any additional or closing remarks.

Dan Burton (CEO)

Thank you all for your time and for your interest in Health Catalyst. We appreciate it, and we look forward to staying in touch.

Operator (participant)

Ladies and gentlemen, thank you, and this does conclude today's Health Catalyst Q2 2023 earnings conference call. Please disconnect your line at this time and have a wonderful day.