Definitive Healthcare Corp. (DH) Earnings Call Transcript & Summary

Great. There we go. All right. Thank you, everyone, and welcome to Day 2 of the 25th Annual Needham Growth Conference. I'm Ryan MacDonald. I lead our digital health research efforts here at Needham. And with me today, I'm pleased to be joined by Definitive Healthcare's CFO, Rick Booth. Thanks for joining, Rick.

Good to be here.

So we've got 40 minutes. We'll do about a 30-minute fireside chat here and then leave the final 5 to 10 for audience Q&A. So if you do have questions for Rick, make sure they leave some time at the end to get those asked and answered.

But maybe to start, Rick, we've got some likely new faces in the crowd that are -- don't know the Definitive story. So why don't we start with a brief overview of the business?

Yes, certainly. Our reason for existing is that the U.S. health care system is massive and it's complex. It's only getting more complex. And so if you're seeking to commercialize a solution into the health care system from a sales and marketing perspective, it's extraordinarily difficult to figure out who are the right people with the economic decision making and organize all of your efforts around that. So really, Definitive Healthcare enables commercial intelligence for the U.S. health care system, for anyone who is selling into or competing within that ecosystem. That's about a $10 billion market with a strong underlying, secular, long-term growth rate because the health care, as we all know, is growing in double digits and the information generated by the health care business is growing significantly faster. I've seen estimates of 20-plus percent annual growth over the next few years. So a big market space, with a clearly defined problem. And then what we do is we've built a unique map of the U.S. health care system, building up from the care providers, which is a different approach than others have taken. Others start with claims data. They start with claims data because it's easy to get. We actually started with physician data because it's not easy to get. So we began building this up in 2011. We are, to our knowledge, the only one that has the Definitive Healthcare ID, which maps all of the interconnections here. So that powers our SaaS application, which has a variety of modules that we sell into 4 key verticals. So as you can imagine, life sciences, as of the time of our IPO, which is still pretty indicative, was about half of our -- was about half of our annual run rate revenue. Hospital providers, almost 10%. So you think about hospital providers, they are not only customers that people seek to sell to, but they're also seeking to attract and retain the right physicians, get referrals, et cetera, et cetera. So that's around 10%. And then the remainder is equally split between health care IT companies and other diversified. What all of these companies have in common is, if health care is a meaningful portion of your business, it's very important to identify in the narrow window of time that you have the right person to talk to and to walk into their office with a clear and compelling value proposition. So if you want to earn time to talk to a Chief Medical Officer about your knee replacement technology, whether it'd be a device or a therapeutic software, et cetera, et cetera, you better know how many knee replacements they're doing per year, what their readmission rate is, what their Medicare reimbursements are and therefore, how much Medicare money they're leaving on the table with those reimbursements. In an ideal world, you can also prove out the results of hospitals that do use your tech versus those that don't. So you can say, on average, we reduced that readmission rate by X and then marry that all with the insights to, a no, by the way, when we looked into your data, here are the physicians that are results -- that have the highest readmission rates that we think we would be helping. So you really -- if you -- and we all know that the decreasing windows of availability to have those sales conversations, when you get that add back, you can't miss. And that means a lot more prep upfront. The days of glad handing and walking the halls are totally gone. So we make those sales professionals even more efficient. Likewise, earlier, upstream, we help size the markets, direct the overall territory development, et cetera, et cetera. So in some ways, you can think of us as being analogous to ZoomInfo, where for every sales force instance, there should be a Zoom Info instance, feeding the right information into that intelligence. Likewise, for every Veeva instance, there should be a Definitive instance, feeding the right information and for every Salesforce that's focused on health care. So that's what we're all about. Where we are circa, little north of $200 million run rate revenue. We have near 90% gross margins. And from a free cash flow perspective, we're incredibly cash flow efficient. So we translate our roughly 28% adjusted EBITDA margins directly into unlevered free cash flow. We've actually been little north of that, but I expect that to normalize closer to 1:1 level. So big market, clear competitive differentiation, profitable and capital-efficient model. That's why I hope you'll listen to the rest of the questions.

That's an extremely thorough overview. I like that. That's very helpful. I think a good way to set the stage for us. Now we were going to have a chance to talk to Robert a little bit but the FDA had other plans this morning. But I'd love to, at least for the audience, maybe just get a quick update on the management change from last year because Jason Krantz took a sort of a step back into more of a product-focused role, Robert Musslewhite became the CEO. Just curious what drove those changes? And maybe just your thoughts on what's changed internally if that anything at all, since the transition?

Yes. So Robert Musslewhite, for those of you that have not had the pleasure of his acquaintance sends his regrets. He's most recently joining us from Optum Insights, which he's been leading, that is a multibillion-dollar part of Optum. He joined when his prior company, blanking on the name, you probably know it...

From Optum Insights.

No. He grew his prior company from roughly $100 million to roughly $800 million before selling it into Optum Insights. So he's deep in health care information. He sits on the board of CoStar, which is a real estate information-based vertical application. So if you had cast out, okay, who's the right person that understands this space, almost as well as Jason and also has the experience running organizations from $100 million, growing, them primarily, organically to $800 million. And then running an enterprise at the $2 billion level, that's Robert. And then from a personal characteristic perspective, he joined -- he started his career at McKinsey, as Jason did. I'm also a former management consultant. So we all think from a data-driven and analytic perspective with outcome-based orientation, developing hypotheses, driving those hard and fast and adjusting as we need to. So from a management style perspective, him, moving from a Board member into the CEO, has been very seamless.

Excellent. Now as you talked about in sort of the overview, obviously, there's a really rich data platform that Definitive has built. And while there are others on the market, there are a lot of data platforms and data sets out there. We have yet to see one that really offers the breadth and depth of Definitive. And you talked a bit about how that platform was built. But as you think about today in a competitive market, the importance of keeping that data fresh and sort of making sure it's up to date, how do you do that and maintain the accuracy? And then how do you work to sort of link those data sets together to create sort of that platform approach?

Yes. We talked about the innovation flywheel. And the easiest way to start to think about it is we built up, leveraging hundreds of thousands of sources in our own proprietary first-person research, this data set on U.S. health care physicians. We've also appended to that 13 different sources or so of claims data. All of this comes in, in the form of raw data. And anyone who's worked in the information-based businesses knows that any information source that you get is going to have missing values and conflicting values. And the more complex the information that is being acquired, the more problematic those are. So the good news is it makes that information relatively inexpensive because it's a commodity. The bad news is it's hard to work with. So what we've done, we've established those relationships and we've built our own proprietary processes for: step 1, reconciling the information to identify the gaps and the conflicts; step two, leveraging our predictive intelligence in order to resolve those. And as part of doing that, we kick out both a confidence score in the answer that we've provided and a value score in terms of the likelihood of that information to be changing over time. That then kicks into, so if you think about that as the AI-driven portion, that kicks into workflow to our first-person research, which does millions of outreaches per year. So those researchers walk in and the highest value, most dynamic information is routed to them first in terms of prioritization, for them to reach out and validate it. So the algorithm kicks out. We infer this is the correct answer, but there were 3 others in the data. And then the researcher reaches out and says, okay, it was either #1, as we expected or 2 or 3, or even, hey, it was something completely different. That kicks back into the algorithm. That information is now confirmed, which increases its accuracy but then it improves the algorithm. So I get nervous about anything that's based entirely on technology or entirely on people. But if you can combine those 2 in a mutually supportive fashion, that's really hard to do. And so that's part of what I think of as sustainable, competitive advantage for us going forward. And because we've done this over time, you can't just go back and do that process as of 2011. Can you imagine calling and trying to figure out where a physician was practicing on any given date? So you've got this cumulative history that for any sort of predictive analytics is incredibly valuable and also the trending is incredibly valuable. So there's no substitute for elapsed time in doing this because the insights are sequential. That matters because we're competing in this large space, against larger, slower incumbents that have more money on their balance sheet. So if they could just throw money at this problem and solve it, that wouldn't be a very stable platform for us to drive.

And I think that's such an important point, too, because when you think about the broader business context, the vendors in the space and being a software analyst, so we see this with ZoomInfo or sometime with the, Dun & Bradstreet numbers, that data is not always as up-to-date as it needs to be. And then when you're a buyer in that environment, just feels like wasted spend than...

Yes. And that's what you'll hear in your channel checks because people really prize a couple of things about this solution. One, it's accurate information. We take more care with that than anyone else is able to do. It tends to be fresh and it's presented in a very easy-to-use way. We have -- I don't have the capability of doing a demo in this room but you can see demos on our website. It's clean. It's fresh. It's easy to use. And so you can quickly navigate and experiment in real-time with the clean data as opposed to, if you're buying from a legacy provider, someone like an IQVIA or Clarivate. You submit a request for information. It takes them time to send you the file. And then often, as part of that, they're looking for a pro services arrangement to do some analysis, which gives you information but it's stale as opposed to dynamic. It's not being updated in real-time as ours is.

Makes sense. So let's shift to the macro environment. I think that's on everybody's minds. Like others, you've seen an elongation of sales cycles that started first in new logos last year, spilled over a bit into renewals and upsells. Just wondering, if you could kind of comment on what you've been seeing in the market over the last 6, 12 months. And sort of how that's impacting your outlook for sort of the trajectory of the business, growth trajectory of the business.

Absolutely. My comments that follow do not -- I won't be providing any new information in between earnings calls. Nobody wants us to do that, even though it's being webcast for us. But what we saw, we were among the first in Q2 to call out some elongation of sales cycles. And therefore seeing some softness in new logos. In Q3, we saw that spread and also begin to update upsells. At the time that we did that, we were pretty early in the cycle. I think you've seen virtually, all enterprise software companies now make similar commentary. I know ZoomInfo was not seeing the same thing in their commentary, in their earnings call, but 2 weeks later, that was significantly revised. And they lowered their estimates. I think that's reflective of the way in which Definitive communicates with the Street. I've been doing this a long time. Lots of gray hair appear, unlike the handsome man to my left. We are a -- just the facts, very analytical, call things as we see them. And so we can get as deep as anyone would like into sales pipeline, sales pipeline slowdown. Nothing that we're seeing indicates that, that's a secular, long-term trend, but I'm open to questions on it.

That's the nicest compliment I've got think so for this week. Go with that.

Considering the end market should be a lot less effective by the economy, why do they tend to see a trend?

That's a fantastic question. So I think if we break it down across the 4 major customer streams that we have as of IPO, I'll use those sizings but they're still broadly indicative. About 50% of our ARR comes from life sciences. Break that half into medical devices and half into bio and pharma. Within bio and pharma, half of that comes from companies of 500 employees or fewer and half from the larger. So I think we've all seen the kind of funding and the dynamics that are impacting life sciences overall. We're seeing the greatest impact in those companies of up to 500 employees. So they seem to be having the greatest impact. We're still seeing some impact in larger companies, and we're certainly seeing some impact in medical devices as well. And I'm speaking here of Q2 into Q3. So there, you've got about 50% of our business which is impacted by the combination of changes in biotech funding, rising interest rates, that sort of thing. They're also -- they are then selling into health care providers to a large extent. Health care providers, which are directly about 10% of our revenue stream as of IPO, they're going through their own round of challenges. So lower nonoperating income, real cost pressures, they continue to struggle with productivity, et cetera, et cetera. So those 2 kind of go together. And now you're talking about 60% of the revenue run rate. The remaining 40% split equally between health care, IT and how they're diversified. They're just dealing with normal macroeconomic challenges. Health care IT is, of course, subject to all the same vagaries of enterprise software. So you're hearing all the big guys talk about slowdown pipeline and decision-making in this care, the health care case, the health care IT is generally trying to sell into the other 60% of our business that we see. And then the diversified, the everything from flooring manufacturers, lease disposal, cafe operators, they're selling into primarily the health care systems as well. So those are the places where, although at first glance, you think about it and you say, health care, that should be recession-resistant. You then say, okay, well, let me get into really the fastest growing, most dynamic parts of health care, where they're not just already embedded. That's where we see the biggest impact has been in new logos. But then in the third quarter, we began to see some pressure on upsell as well. Those 2 factors combined create the growth pressure, which is creating this wonderful entry opportunity in terms of share price.

If I could just talk through quickly. As you may not -- this company Veeva has talked about, the young sales reps are just being introduced [indiscernible] quickly. How much of it is factor to company?

Not a factor for us at all. Veeva had -- they're moving away from a really seat-based economic model. Whereas ours is more platform-based in terms of access to the platform. The number of seat is a factor but it's a tertiary factor in our pricing. Our pricing is primarily driven by company size and vertical. So we'll charge more for access to our platform, if you were a pharma company than a flooring company because you'll derive a lot more value from it. So industry segment, size of company, then the number of modules that you're subscribing to. Our kind of core modules are called our view set, so HospitalView, PhysicianView, Nursing View, et cetera. The more of those you use, the higher the price. And then finally, there are analytics that layer on those modules to make them even faster and easier to use. So those factors all go into our pricing.

I'm curious, maybe upon just kind of continuing along that point of spend and sort of spend initiatives. When we talk to agency partners, it seems like in markets where marketing budgets for health care companies are tighter, the transition from more traditional forms of spend in sales and marketing to some of more of the digital native and data assets tend to slower that pace of transitions though. So we saw a really strong move in 2020, 2021 because of the pandemic. And in these type of budgets, if there's not maybe a comfort level with new level of investment tends to be on the data side, that seems to be cut first. I mean, have you seen or gotten any pushback on sort of this is a new investment. We're just not -- we need more time to sort of evaluate. We're not comfortable with it yet or anything along those lines?

So let's see. I think it's really interesting. I think I agree with the outcomes that you're seeing, but isn't it ironic that in a tougher sales environment, people cut back on data? In the long term, you know where that was going to play out. What we see is people get reluctant to make incremental new investments, but they continue to renew as long as they're financially able to. They continue to renew their existing, high ROI assets. So that's where we saw the pressure first in new logos and then in incremental spending within existing customers for new modules, saying, "Hey, we love what we've got, but let us continue to enjoy that ROI for another 6 months." And then the navigate all question that I don't have a better answer than you do is, how long does that trend continue? And when do we get back on the larger longer-term trend?

Makes sense. I'm curious, you talk about sort of demonstrating ROI and how important that is to the product and sales motion for Definitive. Can you just kind of walk through when a salesperson is kind of going into a prospective customer or even in a renewal, what are they looking to really demonstrate to sort of prove out that ROI? What's sort of the standard or the approach that your sales are taking there?

Yes. This -- I have the pleasure to sit in on sales calls occasionally. And the most powerful thing to me as we start with what's keeping you up at night. And then in real-time, the sales engineer start modeling out the approach that we can take to solving that problem. So I was on one recently where someone was looking to increase their referrals from the Tampa region. And so to my knowledge, there were no pre-coordination between this prospect and the sales engineer in order to make them -- to create a nice opportunity for the CFO. So in real-time, we started pulling up the existing referrals from the Tampa region that are going into this health care provider and then saying, okay, so here's where you're getting business today. Let's flip that. Let's look at where you're underrepresented relative to the region. You could look at it by the physician level. You can look at it by the practice level. You can look at it by the hospital level and start to discern like, hey, if you were to look to make incremental upstream marketing investments, here are the places where there's a high volume that you're underrepresented. So you've got a toehold but you're not getting a lot. That's where you want to focus your attention. And that's the wonderful thing and the frustrating thing about the ROI story is it's a little different for each customer. Like back in the day, when I was selling medical transcription software, I had a little calculator that I built in Excel. And it was like, you tell me how many lines of transcription you're generating and I can calculate out the ROI. This is different. So on our investor website, you'll see we've got about 40 different case studies illustrating the ways in which our solution provides value. Some of those that stand out for me are ones where identifying just 1 or 2 more patients for an orphan drug will more than pay for the subscription. So within drug cohort development, clearly a massive ROI activity. The example that I used around knee replacement and the importance of being well-prepped, targeting the right people and being well-prepped for those discussions, that's another one. Professional service firms are well represented there, the ways in which they use it both to identify customers and also to execute on projects. There's a fascinating variety.

And then so you're helping to demonstrate that ROI in the sales process. Is it -- is the solution then easy from a self-service perspective for customers? So once they adopt, they don't require a lot of professional service, so easy ramp time to it?