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

Welcome to the Health Catalyst Second Quarter 2026 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Stephanie St. Clair, Senior Vice President of Finance and Investor Relations. Please go ahead, ma'am.

Good afternoon, and welcome to Health Catalyst's earnings conference call for the second quarter of 2026, which ended June 30, 2026. My name is Stephanie St. Clair, Finance and Investor Relations, Senior Vice President. With me on the call today are Ben Albert, our Chief Executive Officer; and Jason Alger, our Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today, as well as in our latest 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, including regarding our future growth and priorities, financial outlook and expectations for the third quarter and full year 2026, market conditions, AI initiatives, bookings, retention, operational priorities, strategic and restructuring initiatives, cost savings, debt elimination, client migrations, the impact of the Vitalware divestiture 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 on 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 most recent Form 10-K for the full year 2025 filed with the SEC on March 12, 2026, and our Form 10-Q for the second quarter of 2026 filed today. We will also refer to certain non-GAAP financial measures to provide additional information to investors. Non-GAAP financial information is presented for supplemental purposes only, has limitations as an analytical tool and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. A reconciliation of non-GAAP financial measures to the most comparable GAAP measures is provided in our press release. We will provide forward-looking guidance for certain non-GAAP financial measures in this earnings call and are not providing forward-looking guidance for the most directly comparable GAAP measures and therefore, have not provided reconciliations because there are items that may impact the comparable GAAP measures that are not within our control or cannot be reasonably forecasted. With that, I'll turn the call over to Ben.

Thank you, Stephanie, and thank you to everyone for joining us today. We had a very productive second quarter, exceeding the high end of our revenue guidance and the midpoint of our adjusted EBITDA guidance. But the headline is that we closed the Vitalware divestiture on July 31 and fully repaid our credit facility debt. On our Q1 earnings call, I talked about simplifying our business, focusing on our highest conviction technology opportunities and putting the right capital structure in place to execute. This is exactly that. It's the next step in the strategy I described 3 months ago. Let me walk through why we made this decision and what it means going forward. Then Jason will take you through the numbers. Vitalware is a strong business, but it sits outside our highest conviction technology opportunities. The RCM market has gotten more competitive, and we believe growing the business would have required significant incremental investment. We determined that we should focus and invest in our core business while transforming our balance sheet. The divestiture delivered immediate benefits. We used the proceeds plus cash on hand to retire roughly $160 million in credit facility debt and going forward, eliminate approximately $19 million in annual GAAP interest expense based upon annualizing the first half of 2026. That's not just a cleaner balance sheet. It provides us with the time to get the fundamentals right and the capacity to validate where our conviction is highest and invest behind it. Put simply, we are prioritizing the foundation for what we believe is durable long-term transformation rather than chasing short-term results. As we have stated consistently, we will continue to operate with discipline and as of close of the Vitalware divestiture without expensive interest payments and restrictive debt covenants. One of our priorities is to stay in a strong cash position throughout our transformation. The restructuring, the divestiture and the debt repayment are the same plan executed in sequence under Project Nexus, our strategic initiative designed to fundamentally transform our operating model and to deliberately reposition the business. As we consider what's happening in the market, health systems are under immense pressure, eroding margins, a less favorable payer mix and rising labor and clinical costs. These challenges are structural, not cyclical and increasingly urgent. Systems must move quickly to reduce costs, improve clinical quality, accelerate ambulatory growth and win consumers in parallel. We believe our deep domain expertise and 18 years of improvement data position us well to address these pressing areas of need through our intelligence products, pairing analytics and expertise with improvement agents to identify the biggest opportunities, prioritize where to act and help execute. Each change can compound into sustainable improvement. We believe the result is what one client calls a culture of improvement that converts into outcomes. Consistent with what we have said on prior calls, we'll continue the evaluation of our revenue outlook and expense structure and sharpen where our conviction is highest. We're not afraid to make difficult decisions and move quickly when needed. Before I hand it to Jason, I want to set expectations for what's ahead. We are early in a multiyear transformation, and we're continuing to evaluate the best path forward. Two things are true at the same time right now. One, we're hearing real enthusiasm about where we are headed, and we're deliberately investing in the products and the people needed to turn that enthusiasm into high conviction bets. And two, we're working through previously discussed revenue headwinds primarily related to our platform migrations and some of the lower-margin services work. We're prioritizing target investments in what we believe are our most promising opportunities, doing so in a measured, disciplined way that keeps us in a strong cash position while focusing on driving long-term shareholder value. While there is plenty of work ahead, we are making real progress. I would like to thank the Health Catalyst team and clients for their hard work and partnership. Together, we can have a tremendous impact on health care's biggest challenges. With that, I'll turn it over to Jason.

Thank you, Ben. Before we get into the details of the Vitalware divestiture and our updated guidance for the second half, let me start with a quick review of our second quarter results. Overall, our results came in at or ahead of our expectations. Project Nexus is starting to take hold, and our bookings are tracking as we anticipated. For the second quarter of 2026, total revenue was $70.5 million, exceeding the high end of our guided range of $68 million to $70 million. Technology revenue was $48.8 million and professional services revenue was $21.7 million. Adjusted gross margin for the second quarter was 51% compared to 50% in the prior year period. Adjusted technology gross margin was 63% compared to 66% and adjusted professional services gross margin was 22% compared to 18%. The year-over-year change in technology margin continues to reflect costs associated with migrating clients to Ignite and deployment costs incurred prior to the commencement of revenue recognition. We expect this to continue fluctuating in the near term as that work continues. Adjusted operating expenses in Q2 were $25.9 million, representing 37% of revenue compared to $30.6 million or 38% of revenue in the prior year period. Project Nexus is tracking to plan with partial month savings reflected this quarter and the full quarterly run rate still to be realized in the back half of the year. Adjusted EBITDA for the second quarter was $9.9 million, coming in at the high end of our guided range of $9 million to $10 million. Adjusted net income per share was $0.04 with the weighted average share count of 74 million. Turning to the balance sheet. We ended the quarter with approximately $103.4 million of cash, cash equivalents and short-term investments, down slightly from the first quarter, but still above where we ended last year. Due to the timing of client billings, we generally expect to see working capital improvement early in the year and working capital usage around midyear in the second and third quarters. As Ben said, cash discipline remains front and center for us, and that carries through in our rationale for the Vitalware transaction. We divested Vitalware to Med-Metrix for $147 million in total cash consideration with net proceeds of $145.5 million after transaction costs, each subject to customary adjustments. We used those proceeds together with cash on hand to fully retire approximately $160 million in credit facility debt plus accrued interest and prepayment premium. Going forward, this eliminates approximately $19 million of annual interest expense on a GAAP basis and approximately $16.5 million of annual cash interest payments based on annualizing the first half of 2026. On a pro forma basis, giving effect to the transaction and the credit facility repayment, we would have ended the quarter with cash, cash equivalents and short-term investments of approximately $82 million and 0 debt. We also have a transition services agreement in place with Med-Metrix for up to 6 months, which will provide a modest income offset during that period. Additional transaction details can be found in our recently filed 8-K. Now let me turn to guidance. As a result of the divestiture, we are updating our full year 2026 outlook. For full year 2026, we now expect total revenue of $246 million to $249 million and adjusted EBITDA of $18 million to $18.5 million. For the third quarter, we expect total revenue of $55 million to $56 million and adjusted EBITDA of breakeven to $500,000. I want to walk through what's behind this guidance. The largest single driver of the guidance update is the removal of Vitalware's revenue and adjusted EBITDA contribution following close. Our updated guidance reflects the removal of 5 months of Vitalware revenue, consistent with the July 31 close. Vitalware is a carve-out and doesn't carry the cost of a stand-alone RCM business. As such, it was a higher adjusted EBITDA margin business with a first half adjusted EBITDA of $11.4 million. That said, we did not expect this elevated margin to continue. As we assess the Vitalware business, we validated that significant investment would be needed to grow the business, which we believe would negatively impact adjusted EBITDA and put pressure on our ability to meet our debt covenants and invest in core areas of the business. As we move forward post divestiture, we are continuing to invest in the transformation of our business, and we are continuing to work through the current churn dynamics, both show up in our numbers. On the investment side, guidance reflects continued investment across several fronts, new products and the proprietary intelligence layer that they're built on, AI-driven automation and efficiency initiatives, continued build-out of our Ignite and interoperability platform and the migration efforts already underway. Our investment in the migration efforts includes, at times, the overallocation of resources in performing migration efforts, duplicate hosting costs in running 2 environments side by side and processing costs for the loading of historical data. This creates near-term cost pressure that we wouldn't expect following the migrations. As we focus on team member retention in a period of significant transition, we're making deliberate investments to retain and motivate the team. This is our direct investment in the talent that leads us through this transformation. We believe it's the right call for the business over the long-term. Digging into gross margin, we expect overall adjusted gross margin to come in below 50% for the full year. Vitalware was a higher-margin business and removing it brings the full year average down even as the underlying trends in our continuing business are consistent with our prior commentary. Within that, we expect adjusted technology gross margin to finish the year in the low 60s, slightly below what we communicated pre-divestiture and adjusted professional services gross margin to finish in the low to mid-teens, in line with our previous commentary. Both continue to be impacted by the migrations with technology margin also carrying the heavy data loading costs associated with HIE client deployments, consistent with what we've discussed on prior calls. As our revenue mix continues to shift towards technology, we expect overall adjusted gross margin to trend higher over the long-term relative to adjusted gross margin levels seen in the second half of 2026. On the expense side, we've made significant progress on Project Nexus and are on track to exceed our original savings target. Factoring in the intentional team-related investments that brings our net expectation down slightly to the lower end of our original $3 million to $4 million estimate for cost savings. This is separate from the additional OpEx reduction we'll see from no longer carrying Vitalware's cost base. We also continue to make progress in reducing stock-based compensation. We expect it to be down significantly in 2026 in absolute dollars and to be in the mid-single digits as a percentage of revenue for the full year, which is in line with prior commentary. Coming back to the DOS to Ignite migration. There's no material change to what we shared with you last quarter. As a reminder, we had $12.5 million of notified ARR down-sell and churn related to the migration and had identified approximately $52 million of additional at-risk ARR, of which we expected to retain $22 million. We were hopeful to be able to improve upon the information provided as we've continued our client-by-client retention work, we continue to see significant pressure in this area. We are not updating the framework previously outlined this quarter, but we'll continue to monitor progress. Some of the migration churn, including associated services revenue has pulled forward, which has put pressure on our second half numbers. As we've said before, we expect to generally be through the migration-related churn headwinds by the end of 2027. On services, we're also evaluating this part of the business and aligning it to our highest areas of conviction. We believe there may be high conviction areas of services in partnership with our technology. And part of what's informing that view is what we're seeing from clients who continue to bring certain managed services work back in-house. As we've continued to work closely with our clients and gather data, we now anticipate that we'll exit the year at the lower end of the range we previously discussed, closer to $55 million in services revenue annually. Finally, on bookings. We're holding our full year target of $22 million to $26 million, which includes Vitalware bookings through the transaction date. Stepping back, we recognize the challenges of this multiyear transformation that is underway, but look forward to the business that we're building, one that is currently debt-free, has a strong balance sheet and is focused on providing solutions that solve the biggest challenges facing health systems today. With that, I'll turn the call back to Ben.

Thanks, Jason. Our team has put in real work this quarter through the divestiture, through Nexus and everything in between, and it reflects real conviction in and commitment to our transformation. In summary, we're currently debt-free with capacity to invest in what we believe in. We're working on validating our highest conviction bets before we scale them, and we're focused on creating durable value creation, working through short-term pressure as part of a multiyear transformation we're still early in. Operator, we are now ready to take questions.

[Operator Instructions] Our first question will come from Daniel Grosslight with Citi.

This is [ Luis ] on for Daniel. I guess the Vitalware was the biggest driver for the move in guidance, I just wanted to confirm something real quick. Excluding that divestiture, how would guidance would have been reiterated?