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

Folks, thank you for joining Day 3 of the Barclays Global Healthcare Conference. It is my absolute pleasure to introduce one of my top picks for 2 years running now, Health Catalyst. We have a special treat because we have CEO, Dan Burton here today. And we have the brand-new CFO, look at that. It's Jason Alger, just announced very recently. Welcome to the stage, guys.

Thank you. It's great to be here.

So glad to have you.

We hosted events, must have been like a little bit over a year ago, and you were so effusive on the TAM's opportunity. You were -- I wanted to title the name of the note, Mormon on a Mission, in my essay, and that's the most appropriate note title, I thought -- I was like, this is it, he's very excited. And now we're talking about tech again. Walk me through the balance of this.

Yes. So I do sometimes have that missionary zeal. So I appreciate that call out, Stephanie. And we continue to be really excited about the tech-enabled managed services opportunity that our clients have tapped into. And that part of our business, over the last couple of years, has grown tremendously. And that the value proposition to the client of giving us end-to-end responsibility for certain processes, where they feel and we've demonstrated we can do it better, faster and cheaper through the use of tech as well as by pooling resources, improving processes and increasingly using AI, that the process becomes better, faster and cheaper. That was exactly what health systems needed, really, especially from the summer of 2022 through Q4 of 2023, when they were facing some of the worst financial pressure that they had seen in decades, with inflation causing labor costs and supplies costs to often be at 8%, 9%, 10% year-over-year growth. And the revenue side was only growing 1% or 2%. So all of them -- bad -- yes, that math does not work well. So almost all of our clients were underwater from an operating margin perspective. And what we found is we needed to pivot towards those parts of our portfolio that offered tangible cost savings. And with tech enable managed services, we guarantee 10% or 15% savings is written right into the contract. And so our clients knew that they'd get some financial relief. And we demonstrated that it wasn't just cheaper, but it was also better and faster. That continues to be a great value proposition for our clients. Now that skews more towards services. And by virtue of giving those cost savings, those are low gross margin revenue dollars. And so while we were really grateful to have that part of our portfolio to offer to our clients as they were facing that financial pressure, as the pressure has started to subside and things have started to improve in our end market, our clients have become more open to our full portfolio, which includes tech, which for us, is a lot higher gross margin, it's a lot higher EBITDA margin. And so we have -- while we continue to talk about tech enabled managed services, and I think for many, many years to come that will be a huge positive value proposition for our clients. We're appreciative of the chance to talk about our tech and all the while during that 18-month period of real significant financial pressure, we kept investing from an R&D perspective in our next-generation data platform. And we're ready now with the next-gen data platform. We're really excited about that. And so the timing of our end market improving, such that both with existing clients and increasing with new clients, there's much more of an openness to talk about the full portfolio, including our tech, including our next-gen data platform that's just allowed us to expand some of those other tech-oriented discussions. And I think as we look forward for the next few years, we like the shareholder value creation that comes from balanced growth. So we probably could grow disproportionately on the services side, if that became our primary focus. But profitable growth is really important to us as well. And we shared in our last earnings call that as we grow in a balanced way, and we see that tech growth pick up and really reaccelerate that, that increases our confidence in really profitable growth and really meaningful EBITDA progression. We've been on a nice EBITDA progression path. We want to stay on that path and having tech growth balanced out with the services growth, really increases our confidence level. That's why we've been able to shift to be a little bit more balanced in terms of what we're talking about with clients. Their financial pressure has subsided. We've got really good tech to talk about in addition to tech-enabled managed services. I think both are going to grow in a robust way, but we'd like to stay balanced because of our ability to execute well against increased profitability.

So when you first [Indiscernible] , maybe this is a question about the evolution of your platform. I know it has a lower gross margin profile. But from an EBITDA standpoint, it's immediately profitable, which is not the profile of many of your prior DOS wins. But you have been replatforming, you have been kind of scaling up in that way. Can you talk about how that looks different now than maybe it did around the IPO?

Yes, yes, absolutely. So there are some exciting profitability tailwinds that we see, both on the services side and tech-enabled managed service is an example of that, where even though the gross margin starts out really low, often at 0% gross margin when we signed the deal because we're giving them that guaranteed cost savings, but it ramps to about a 25% gross margin over the course of the contract. And we have a playbook that we've developed and demonstrated over a decade now of how to get there. So we have increased confidence in that gross margin progression. And then there's so much operating leverage. There's almost no incremental operating costs associated with those tech-enabled managed services contract.

You have to be a DOS client to do this.

They're almost all existing clients. Now increasingly, with the next-gen data platform, we're actually seeing more new clients that want to couple next-gen with TAM. So we'll see how that plays out, but that may become a little bit more of a thing in the future. So that tech-enabled managed services tailwind is meaningful. You see the gross margin progression, very little operating expense. So a lot of that gross margin drops to the bottom line. So we're excited about that. It's still a really low gross margin, though. And so even with a lot of operating leverage, what we shared from a services EBITDA perspective for 2028 is we might expect 10-plus percent EBITDA margins in the services business. And that's robust, solid. That's a lot of progression.

Lot better than the negative margin...

Lot better than negative, right? So that's great. But on the tech side, the tailwind that we see with the next gen data platform is about a 10-point improvement in our gross margin profile versus the old DOS gross margin. And so whereas the old DOS gross margin, where years ago, we had to build all the componentry that was needed for a health care data warehouse to really function well. There weren't some of the third-party capabilities that were coming out of Silicon Valley 5, 6, 7 years ago. So we had to build it ourselves. That's expensive. It's expensive to build. It's expensive to maintain. Now there are incredible, really scalable third-party technologies. And the next-gen data platform takes advantage of that. And so what we see on the data platform side is going from a 60% gross margin to more of a 70% gross margin. Now that will take a little time to show up on the P&L because we've got to migrate our existing clients over the next couple of years. But the steady state there is a 10-point uplift in the data platform gross margin. So we're also excited about that gross margin tailwind. It's another reason why we want to talk whenever we can about next-gen data platform.

Yes. Now we're all about DOS. So here's the question, philosophy-wise, having 2 platforms is never cheap, right? It's always one of those things where it's great to have a new platform. But the new platform means the old platform still exist, and now you just have a lot of engineers. So how are you balancing that? And is there a point in time where you would say, you know what, enough people are on next-gen, let's force the migration or sunset that platform?

Yes, absolutely. And we've got a really high-quality problem right now, which is all of our existing clients are excited about the next-gen data platform. So that's good.

You're hyping it right?

Yes, we're hyping it. We're struggling a little bit to make sure we can keep up with all of that. So it will take a couple of years for us to get all of our clients to the next-gen data platform. We have enough confidence that all new clients are going to go straight to the next-gen data platform. So we're turning off the spigot of new additions to DOS, which is really good. And I think over the next couple of years, we'll get almost everyone that's on DOS, to the next-gen data platform. And then I think we'll be in a position to start thinking about really meaningful sunsetting. We're already...

How many migration is that -- just to quantify the work?

So we have a little over 100 DOS subscription clients today. So...

And they're all -- old platform.

They're all -- All but a couple of them are on -- we do have a couple of our largest clients already on the next-gen data platform. And over the next 2 years, you'll see the vast majority of those 100, 110 migrated over to the next-gen and then all new clients from now on are going on to the next-gen. So I think we will, within 2 or 3 years, really meaningfully start sunsetting. And we're also proactively moving much more towards offshore in our R&D, and that's further leverage. And a lot of the offshoring that we can start with is kind of the maintenance of the old platform.

We had Microsoft on the stage yesterday, they talked a lot about how they want to get bigger in health care via partnerships. They don't think this is going to be like Nuance where they keep prosecuting each opportunity alone, and they are a partner of yours. When you think about how to streamline your R&D costs? How are you thinking about opportunities in that partnership versus opportunities in just labor [indiscernible]?

Yes. I think it's a huge part of the future. And...

I have them on the stage...

They've been a great partner to us. And all of our all of our existing platform clients are hosted in the Azure cloud environment. The next-gen data platform is built with important Azure componentry as well. We also leverage some other really important partnerships with Snowflake, with Databricks. And in general, our technology architecture is much more modular. It's much more flexible. So if a client has made a meaningful investment in one of those cross-industry technologies, we can help them leverage that, get a great ROI on that. Many of them have chosen Microsoft as a key partner. And so this is music to their ears, in that they can leverage that investment even more with the next-gen data platform. I think Microsoft is doing what I believe makes economic sense long term for these cross industry players, that there's a really important role for them to play, lower in the tech stack, that makes economic sense. And I think one of the reasons you heard from Microsoft, and we hear this as well from them in our discussions is when you start migrating up the tech stack and you get into health care-specific content, health care specific use cases, there isn't the economic leverage that Microsoft is looking for. That's where partners come in. And I think we're thrilled to have had a 15-year partnership with Microsoft. We think we have a very complementary relationship with them, where we leverage great cross-industry technology, we are committed to making those health care specific investments, so they don't have to. And that really is a win-win. It's a win for them. It's a win for us. And it's a win for our clients. Part of what our clients realize is it won't ever make sense for these cross industry players to do that health care-specific content work, that health care-specific R&D. And so if they don't have Health Catalyst, they're going to have to do that themselves. And they just can't replicate. Now we work with over 600 health care organizations. We support 100 million patients. So we should have a commercial-grade version of that investment that's way better, faster and cheaper than what any one client could produce.

Fantastic. Jason, a little quiet here. I know you're only 2 weeks into the role as CFO, but you've had a pretty long career here at Health Catalyst. So I'd love to hear a little bit more about your arc and I mean what kind of fingerprint you want to put on the role as you think about your future?

Yes. Definitely appreciate the question. Stephanie, it's fantastic to be here. It has been a busy first couple of weeks in the role. I've had the opportunity to meet a number of our investors, potential investors, clients, team members, which has been fantastic. I'm really excited about the opportunity for Health Catalyst. A little bit of my background. I come from a public accounting background. I started my career at Ernst & Young and worked across multiple roles in their audit organization and then joined Health Catalyst while it was still a start-up and have been able to see the growth at Health Catalyst and work through the IPO and most recently worked as the Chief Accounting Officer of the company, and I'm very excited about this CFO opportunity. As far as priorities that I'm thinking about, I would say that they're very much aligned with some of the messaging that you've heard from Dan and Brian previously over the last few weeks, which I guess, first priority that I would call out would be the reacceleration of technology bookings. It is a major focus of ours, and it is good timing with our next-generation platform to really focus on tech and focus on profitable growth opportunities. The second priority that I would mention would be professional services or namely TAM's margin improvement. We did focus a lot, as you mentioned in your first question, we focused a lot on TAM over the prior 12 to 18 months, and we're able to establish some great relationships on the TAM side. So it is watching that cohort of TAM's relationships and make -- ensuring that they continue to ramp on that margin profile that we expect that they're hitting constant milestones to be expected. And we've been able to see that thus far. And so we'd expect that to continue. And then the third item that I'd call out, Stephanie, would be a focus on profitability. We did set some recent targets. We set our 2024 guidance as well as targets in 2025 and 2028 that to focus on profitability. And we do view those as targets that we expect to meet or exceed. But it will take some work on our ends to get there on the growth side, on the margin, improvement side and then through operating leverage. But I would mention those as primary focus is, at least initially.

And if I could add, Stephanie, just a thought or two. So I remember when Jason joined Health Catalyst about 11 years ago. It's a fantastic hire. And we were a really small company back then. He's been an incredible partner to me and to our Board, to our leadership team for the duration of that time. And as Jason described, those 3 areas of focus for the next chapter of the company. And when I think about the next chapter of the company, I think Jason is perfectly suited to help us achieve what we're really excited to achieve. When we shared those mid- and longer-term targets, that implies really meaningful progression, including meaningful profitability progression. And Jason has demonstrated, and I have seen first-hand, his ability to understand the levers to profitability. He's been a lot of the reason we've made such progress over the last 5 years. And I think when I think forward to the next 5 years plus, I'm really excited and grateful to have Jason as a partner. Our Board is so supportive and excited to have him. Really grateful that he spent so much time at Health Catalyst and has such a strong presence already with our team members, with investors and with our clients as well.

Let's pull on that guidance, Dan. So I remember, since the IPO, you guys always have a very conservative guidance philosophy. I used to tease you, like you need like a cup of coffee or beer before the call. It's just -- you always sound -- like obviously, neither. But we've had some missteps lately. And we're also putting out very bold guidance for kind of your longer-term margin targets. What have we learned and what gives us confidence in that new long-term targets?

Yes. So I'll share a few thoughts, and then Jason, please share as well if I miss anything. So I think we do take every metric that we share seriously, and we've tried to do that throughout the course of our time pre-IPO, as part of the IPO nearly 5 years ago now. We're coming up on a 5-year anniversary in July, yeah, kind of hard to believe.

Do you ever feel like just everyone -- time keep spinning.

Yes. It's kind of crazy.

How have I done this sector for this long.

Yes, exactly, exactly. And when we went public, we shared some near-term, midterm and longer-term guidance and perspective. One of the things that we shared was that we felt we would grow 20-plus percent over a long period of time. And for those -- that 5-year period through the end of last year, our average growth was 21% on an annual...

And it included COVID.

And it included COVID, it included record high inflation. It wasn't the easiest time. We also shared a time line to profitability, and we did what we said we would do. And the last 2 years, we've been ahead of schedule in terms of our profitability. When we give annual guidance, I'll share the pattern that happened last year, that we've driven to have happen each year, which is we provide revenue and EBITDA guidance. A year ago. One of the challenges with regards to our relationship with equity analysts, for example, and we've had this back and forth is -- sometimes equity analyst think we're being conservative, and so consensus might be different than what we've guided to or consensus develops over something we have not guided to. And a year ago, for example, consensus developed around a revenue growth trajectory that was more, but we had -- we hadn't shared any guidance for that year yet. We shared guidance. It was less than where consensus was at the time. Then what we worked really hard to do is stay a little ahead of schedule, and we raised guidance in the middle part of the year, then we beat that raise guidance by the end of the year. Now at the start of the year, folks were saying something similar to what you just said, like, wow, consensus was here, you guided to a little bit lower number. And some would say, well, that's a miss. We don't think of that as a miss. We never said -- yes, consensus will be what consensus is. But when we guide to a number, we do take it really seriously. We follow the same framework and the same approach for our guidance this year. Now this year, again, from a revenue perspective, that revenue guide was lower than consensus. We never guided, right? To the consensus number for this year. But we're excited to hopefully meet or exceed that -- those revenue targets. And our EBITDA was actually well ahead of consensus. The midpoint of our EBITDA guidance for this year was meaningfully higher than where consensus was. And we're excited with the EBITDA to stay ahead of schedule and hopefully meet or exceed that as well. That's the pattern we want to follow. Now I do want to acknowledge that from a forward-looking bookings perspective, that's a different kind of a perspective that we share. And we did share that our dollar-based retention metric for last year came in at 100%, which in a difficult time frame, was still something that we felt good about. But we did have a couple of deals that took a little bit longer. At the earnings call, we shared that one of those deals had signed just recently. And we're excited to still see that pipeline progression. But I think as it relates to revenue and EBITDA, we'll continue the same approach, where we strive to provide guidance that we then can meet or exceed.

Perfect. Well, that's all the time we have. Guys, thank you so much for coming to the stage. And hopefully, see you. We'll make some accomplishments against those guidance targets.

Sounds great. Thank you, Stephanie.

Thank you.

Thanks, everyone.