Health Catalyst, Inc. (HCAT) Earnings Call Transcript & Summary

All right. I guess we can get started. Hello, everyone. I'm Jailendra Singh, health care technology and distribution analyst at Crédit Suisse. Thanks, everyone, for joining us. Next up, we have Health Catalyst via a fireside chat conversation. From the company, we have Patrick Nelli, CFO; and Adam Brown, SVP, Investor Relations. I'll ask some of my prepared questions [Operator Instructions] Patrick, really appreciate you doing this. Thank you so much.

To begin, for those who are new to the story and among the audience who are trying to learn about the company, can you begin with a quick overview of the company, focus areas, stakeholders and some business segments?

Yes, for sure. So first of all, it's great to speak to everyone today. Sorry, we're virtual, but it's still great to speak with everyone. So Health Catalyst provides data and analytics software as well as services to health care organizations, primarily health care providers. There are 3 components to our solution. The first is a data platform. It integrates data from across all of the software systems that our customers use to run their business. So their inpatient EMR, ambulatory EMR, billing systems, time and attendance systems, patient satisfaction systems, laboratory, pharmacy, et cetera. A mature customer of ours pulls in a few dozen unique data sources into the data platform. And its primary purpose is to help our customers manage their data, organize it and then serve it up for analytics purposes. And it is self-service so customers can either build their own analytics on top of the platform and customers actually build more analytics on top of the platform than we do or they can serve up data to third-party applications or they can serve up data to the second component of our solution, which are analytics applications that we've built. These are web-based applications that help pinpoint areas of opportunity based on what the data is saying. And that leads to the third component of our solution, which are services expertise, primarily data analysts, data engineers, data scientists, as well as domain experts, essentially consultants, who will help our customers find insights in the data. And if they would -- customers would like, they'll -- we can help with the change management process to ensure they're not just putting up dashboards, but they're actually using those insights to drive meaningful improvement. And that's what we built our whole business around: it's helping our customers find insights in data; use that data to change their processes; and actually improve how they operate financially, clinically or operationally.

So you say -- I will say that your clients are providers and health plans or only providers?

It's primarily providers. Approximately 80% of our client base are hospitals and health systems as well as large physician groups. But we also serve risk-bearing entities. It's approximately 20% of our client base, which includes ACOs, health plans and other types of risk-bearing institutes.

Got it. Okay. So when we think about the long term, how do you think about long-term top growth story, margin profile of the company? Maybe spend some time on the key growth drivers you see for the company over the next 3 to 5 years.

Yes. Happy to share some thoughts. So we have a 20-plus percent long-term revenue growth target. That is driven from both expansion within our current client base and us adding new DOS subscription customers. DOS is the name of our data platform, so kind of core analytics customers. We have achieved between 107% and 109% dollar-based net retention. So -- and that's both actually technology as well as services. So we are typically -- so 7% to 9% of that annual revenue growth is typically driven from expansion within our current clients, both on the technology side as well as on the services side. The remaining 12% to 14-plus percent is from new client adds. We had 65 DOS subscription customers at the end of last year. We believe there's approximately 1,200 purchasing organizations for our solution in the U.S. So it means we're significantly under-penetrated. And we think we'll have -- we have a long runway of adding new customers as well. And those 2 components, expansion within our client base and new client adds, add up to the 20-plus percent long-term revenue growth target.

How about the margins? I mean where do you see that shaking out?

Yes. So from an overall gross margin perspective, we've shared a long-term target in the high 50s. We -- and we are currently in the low 50s. And the reason that it's kind of in that range is because we do believe we will have a significant portion of our revenue be services in the long run because we found time and time again that the combination of software and services is helpful in helping these organizations become more data-informed and more data-driven. That exact combination of software and services can vary a little bit over time. But generally, we see both being important. Most of the technology gross margin expansion, as we think long term, or a good portion of it, we expect to come from -- most of the overall gross margin, all right, I'm sorry, we expect to come from technology gross margin expansion. And that's essentially because the analytics application layer of the stack, the second thing we do, is at a higher gross margin than the data platform. And as we have more applications to cross-sell and upsell current clients, that means more of the revenue is weighted towards higher gross margin applications. So it kind of leads to natural gross margin expansion on a customer cohort basis and on an overall company basis.

Got it. Okay. So you guys reported earnings, I think, earlier this week. Do you want to provide a quick summary of your results? What were the key highlights there?

Yes. Let's see, quick summary of an hour-long call is always a little tough. But we -- I guess from a financial perspective, we outperformed the midpoint of our guidance on revenue and EBITDA prior to an acquisition that closed in the middle of the quarter. Obviously, with that acquisition, then we outperformed a good bit more. Also with and without the acquisition, we raised our full year guidance compared to where it was previously. So we feel good about that. We also announced some internal promotions. So we are promoting 3 individuals from the finance organization into various leadership roles including Adam Brown, who's on the call taking over both IR as well as FP&A; Jason Alger becoming our Chief Accounting Officer, he's been with the company 5-plus years; and Bryan Hunt becoming our future CFO as of January 1, and I will be taking on the President role at Health Catalyst. So we talked through that. And then, lastly, I would say, we talked a good bit about expected 2020 bookings numbers and how those flow on to 2021 GAAP revenue. Because we're a recurring revenue business, most of GAAP revenue in a forward year is driven by bookings performance in current year. And even though our crystal ball is not quite clear as it typically is since we're in the middle of this pandemic, even with that kind of added uncertainty around the environment, we thought it would be helpful to be transparent with investors to share exactly what we're seeing. And we thought that would help them understand exactly what we expect will occur with the business. So we talked a good bit about that as well.

Congratulations to you and Adam both and -- for the promotion, that's good. So let's talk about the impact of COVID. I mean, I think I probably have done 60 sessions at our conference. I never had any session where we didn't talk about COVID. So obviously, talk about the impact COVID has had on your business, both in terms of increased demand from new hospital clients, increased interest from expanding services from existing clients. Let's discuss that if possible.

Yes. For sure. So let's start with new client adds. So as you can imagine, health care systems were very focused on preparing for this pandemic in the late Q1/early Q2 time frame. And that slowed down our new client conversations, kind of appropriately so, like we understand. We were working with our customers to ensure they're prepared. That meant that we added fewer net new DOS subscription customers in the first half of the year than we would have expected to otherwise. Fortunately, those conversations picked up kind of late -- mid-late Q2 time frame. And we shared that our second half 2020 pipeline looks very similar to our second half 2019 pipeline, which means we would expect to add a high single-digit number of net new DOS subscription customers for the full year 2020. So that's on the new client side. On the current client side, we traditionally have had a professional services dollar-based net retention similar to our overall dollar-based net retention between 107% and 109%. However, we do expect our professional services dollar-based net retention this year to be lower, in the low to mid-90s. And this is from the fact that even though the vast majority of customers are leveraging -- continue to leverage the same number of resources on the analytics improvement side from us, there are select situations where customers are trying to find savings and they're using slightly fewer of our resources and there are slightly fewer expansion opportunities. On the current client side, from a technology perspective, that is quite positive news in the sense that data and analytics helps health care organizations understand how to deal with this pandemic, which means the usage of our software has actually increased 40-plus percent in just the last few months since the onset of the pandemic. That means our dollar-based net retention on the technology side is strong, similar to past years. And that also leads into the kind of the medium- to long-term tailwind that we believe COVID drives, which is there was already a secular trend towards health care organizations adopting more data and analytics and ingraining it in their operations, and COVID essentially is kind of a step function change to help with that -- help with accelerating that trend. So we do believe in the medium to long term, it helps accelerate the importance of data and analytics at these health care organizations.

And did you like roll out any like COVID-specific offering or tools, which were embraced by your hospital clients?

We did. It was a busy March and April, certainly. So we -- our platform is self-service. So first, customers built a lot of custom algorithms, dashboard to analytics, on top of the platform helping them with this pandemic, both get prepared as well as recover. We also built a number of applications and accelerators, dashboards, algorithms and the like. In the March-April time frame, it was focused on preparedness. So you can go on our website and there's a capacity planning tool, which helps predict supply shortfalls based on local infection rates. We also had an application to track -- or have an application that's been rolled out that tracks patients and clinicians through the health care ecosystem and what interactions they're having. So then clinicians can get tested appropriately if they came in contact with COVID-positive patients. So that was a whole -- it was a couple of few months exercise to help our customers be prepared. And then we have spent a number of months helping them think about recovery. So what elective procedures should they reschedule first back in the May time frame. What was the financial impact of that? What should staffing ratios look like under a virtual -- heavy virtual care outpatient kind of dynamic. So that focus on more looking forward and recovery is what a lot of those COVID solutions were focused on in the kind of the May-June time frame.

So when we think about your competitive landscape, who are the major competitors who you go head-to-head with when there are RFPs from these hospital companies?

Yes. So our competition is different depending on the layer of the stack. So there's the data platform, analytics applications and services. At the data platform layer, it's not that crowded. It's mostly homegrown solutions. So a CIO deciding to build their own -- kind of patchwork together analytics platform. And that's what most of the market is. At the applications layer of the stack, it's actually quite crowded and we try to be transparent about this. There are hundreds of analytics applications companies out there, a lot of them start-ups. We -- the positive to that is we believe we have a consolidation opportunity at the analytics or application layer of the stack. And then the third, at the services layer, it's oftentimes consulting firms that we're competing with. Importantly, no one, in our view, has a comprehensive solution across all 3 of those categories to help guide health care organizations towards being more data-informed and data-driven and driving meaningful improvement based on those insights.

And do you like leverage -- it looks like you leverage machine learning and AI pretty aggressively in your platform.

We do. Yes. I'm happy to talk through that if it would be helpful.

Yes, yes. If you don't mind, just to give us some examples and data points there.

Yes. Of course. So there's kind of 2 categories of how machine learning and AI is leveraged. The first is embedded in products, so in applications specifically, our applications. So we -- our product teams have data scientists and such and they embed predictive models or clustering into specific applications. So like our patient safety application suite can predict when patient harm events could occur and that helps with proactive care at our customers. That's an example. There's a number of other examples embedded in the products such as predicting what patients are likely to be readmitted or what patients could be most positively impacted from a care management program and then putting them in that care management program. That's one category. The other category is our platform is self-service. So that means we need to make machine learning tools available to customers so they can build their own machine learning models if they'd like. And we do that through enabling Python in our machine learning library, kind of built directly into the platform and then we kind of automate the data flow of running those models and then having the output show up wherever a customer would like them to show up, in a dashboard, in an EMR, wherever they see that.

Do you face, I mean, any challenges in terms of integrating with the hospital's EHR platform? It looks like to me it -- hospitals do require you to work in a very integrated way with this EHR platform. Do you face any challenges there? I mean, we always hear that from industry stakeholders that the Cerner/Epic have very closed-ended platform when it comes to data interoperability. Do you come across those challenges?

We -- so we have connectors to 300 of the most common health care software systems out there, Epic and Cerner being 2 of those 300. So we built connectors and make it very easy for data to flow from all those systems into DOS. That took a number of years of work because there's not exactly robust API documentation online for a lot of these on-premise, more antiquated software systems. So we've done that. We've also seen a very positive trend over the last few years in regards to the 21st Century Cures Act, which promotes data interoperability, and that's been a good trend in the industry. We very much believe that this information is our customers' information, and ultimately, it's the patients' information. And that means we want to be on the right side of the history and let data flow however our customers would like it to flow. So that's generally the approach we've taken and we've tried to support that through integrations that we've built over time.

Okay. That's fair. Can you provide color on your recent Data Operating System, DOS, deals signed to date with the health systems and some potential revenue opportunity?

Yes. Happy to. So we've shared that we've signed multiple new DOS subscription customers year-to-date even here in this pandemic. We are excited that we've announced at least a couple few of those publicly, including Northwell Health, we announced a couple of months ago. So we've certainly been active year-to-date. As far as kind of revenue opportunity, we've shared that we expect to sign a high single digits number of net new DOS subscription customers for the full year. And the average year 1 revenue for a new customer is a little north of $1.5 million a year, split roughly equally between tech and services. So obviously, if you kind of do that multiplication math, you get a sense for the kind of the new client revenue that's being added in 2020.

Okay. That's fair. Maybe also if you can provide some color on the Vitalware -- I think I just want to say Vitalware acquisition that was announced in August. What was the strategic rationale for making that purchase? And maybe if you can take a step back and discuss your whole capital deployment priorities, and what's your M&A focus in general?

Yes, happy to talk about it. So we've shared for years that we believe we have a consolidation opportunity specifically at the analytics application layer of the stack. And the reason we believe that is because everything we do is built on top of our data platform, so we can actually plug incremental applications on top of that platform fairly easily just with kind of data APIs for sharing data to those applications and receiving data back. So it makes the integration process fairly seamless. Also we believe that since we have an integrated data set in DOS, that means we can deliver insights into applications from data sets they usually wouldn't pull in from because of the complexity of managing kind of various disparate data sets. And that can provide incremental insights in those applications. And then also from a customer perspective, we are open. So customers are welcome to use other third-party applications, they don't have to use ours. But if they would like to use our applications, those applications can be supercharged from insights from DOS. And a customer is getting kind of a single source of truth, single view of their data, no matter what application they're using. So -- and then from a competitive dynamic perspective, the application layer, the stack, is very fragmented. So there's hundreds of companies out there, oftentimes kind of VC-backed or smaller companies. So that's some of the strategic rationale. What we -- so we want to make sure there's a data integration or data insights play that makes 1 plus 1 equals 3, and I'll walk through Vitalware as an example of that. So Vitalware, their flagship product is a chargemaster workflow and analytics SaaS application. Chargemaster is just a fancy term for price list. And price list data and managing the price list is actually pretty strategic. And the reason we view it as strategic is traditionally prices have been set based on kind of regulatory rules. And it continues to need to be -- there needs to be a band based on regulatory rules on how prices are set. But by combining cost data, which we have in our data platform; and clinical data, which we have in DOS, our data platform, with pricing information, we could help customers in the future drive margin and outcomes-informed pricing. So as their -- as health systems are renegotiating with payers, they can have -- they can know their margin, they can know their outcomes. If they have lower readmission rates in a certain -- for a certain procedure than others in their network, they can leverage that in those conversations. And/or if health systems want to move to value-based care arrangements, they can appropriately think through the risk that they're going to take by understanding their margin and their outcomes. So that's an example where it is a kind of chargemaster revenue analytics software business. But we are working over time to enhance the insights that, that application can drive based on the data we have in our data platform.

So do you think this -- all the push on -- push for more price transparency, has that any implication for this business model?

Yes. So Vitalware actually has a price transparency application because when you manage the chargemaster, that's the price list, so it's fairly straightforward to then provide a price transparency application for these health care systems. So yes, that is one of Vitalware's -- they have 3 primary applications. The chargemaster is the most -- kind of the flagship, but they also have a revenue integrity analytics application and a price transparency application.

Are there many clients who actually are Vitalware's clients, but not your clients? Just trying to understand the cross-sell opportunity available between the 2 companies.

For sure. The best way to think about this is we are -- we have -- we're fairly early in the maturity of this industry. So our penetration is still fairly low, approximately 5%. That means that as we look at application companies from an M&A perspective, it -- there's typically a little bit of overlap between customers, but quite a small amount just given that we're still fairly under-penetrated. That presents, to your point, cross-sell opportunities, which we are excited by and working on, but with the caveat that we're still selling into fairly large organizations. Sales cycles are still fairly long, so it can take a while for that cross-sell to play out, certainly.

Fair point. [Operator Instructions] You mentioned the sales cycle is fairly long. Do you think COVID has had impact there that the fact that your salespeople are not able to interact with your hospital clients in person, it's all done virtually, is that kind of making sales implementation cycle, sales cycle, much longer than usual?

So from a current client expansion perspective, we have very deep, close relationships with our customers. So we've certainly maintained very close relationships and very close -- we're in close communication with those customers. And we already know them pretty well. So that's been easier. To your point, with new client adds, it -- COVID has certainly introduced noise into the sales cycle. Like we shared the March and April time frame, there was a lot of noise in those conversations essentially, to a large extent, slowed down and halted. They've repicked back up. To your point, it's almost all virtual. That means that -- our observation would be that virtual is actually more efficient just from a time management perspective. But it is a little -- it's probably a little less effective from a rapport-building perspective and from a brainstorming perspective. If you want to sit down for half a day and think through all the ways the data can be used in an organization, it's harder to do that on Zoom. There's certainly Zoom fatigue for calls lasting longer than 90 minutes or a couple of hours. So what all of that has netted out, though, is our overall pipeline for the second half of the year looks very similar to 2019. And the reason we believe that is there's this noise from the financial uncertainty that COVID causes and from selling virtually and -- all those points. But COVID also highlights the need for data and analytics. So it is becoming a higher priority for organizations. And it's getting C level focused as it should because C-suite executives are looking at data every day to figure out how to operate under this new model. So those 2 forces kind of counteract each other. And overall, we have a similar pipeline to what we had a year ago for the second half of the year.

How has been your customer retention rate? I mean is it pretty high?

Yes. We've shared before that we like to think of our customer relationships certainly multiyear. We like to think of this as a multi-decade transformation at these organizations. So we have very high customer retention and engagement, and that's something we strive for constantly. It's not -- that doesn't come as a given. We try to build our whole company actually around adding incremental value to our customers every year. And we track the number of improvements we drive at our customers every year. A portion of every team member's bonus is tied to the number of meaningful, measurable improvements we drive at our customers every year. So having that laser focus on using data and analytics to drive value at customers, it certainly has helped us as far as customer satisfaction and customer retention.

Okay. That's a fair point. Anything else in last minute here you want to flag, which we did not cover in our conversation/discussion?

Anything else I can think of, I would just share that we appreciate everyone's support during this year and I hope everyone is doing well and continues to do well.

All right. Great conversation. We are out of time here, so we will leave it there. Thanks a lot for participating at our conference. Have a nice rest of the evening. Thanks. Take care, Patrick. Bye.

Thank you so much, Jailendra. Bye.