Health Catalyst, Inc

Thank you for standing by and welcome to the Health Catalyst third quarter 2021 earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1 on your telephone. As a reminder, today's program is being recorded. And now I'd like to hand the program over to Adam Brown.

Good afternoon, and welcome to Health Catalyst's earnings conference call for the third quarter of 2021, which ended on September 30th, 2021. My name is Adam Brown. I'm the Senior Vice President of Investor Relations and Financial Planning and Analysis for Health Catalyst. And with me on the call is Dan Burton, our Chief Executive Officer, and Brian 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 8K 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 the 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 COVID-19 pandemic on our business and results of operations, our pipeline conversion rates, and our general anticipated performance of the 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 outlooks. Actual results may materially differ. Please refer to the risk factors in our Form 10-Q for Q2 2021 filed with the SEC on August 6, 2021, and our Form 10-Q for the third quarter of 2021 that will be filed with the SEC today. 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, let me turn the call over to Dan prepared remarks, and then Brian will subsequently provide his prepared remarks. Dan and Brian will then take your questions. Dan?

Thank you, Adam, and thank you to everyone who has joined us this afternoon. We're excited to share our third quarter 2021 financial performance along with additional highlights from the quarter. I will begin today's call with some commentary on our third quarter 2021 financial results. by sharing that we're pleased with the company's overall financial performance. Our Q3 2021 total revenue was $61.7 million, and our adjusted EBITDA was a loss of $5.8 million, with these results beating the midpoint of our quarterly guidance on each metric. Additionally, our Q3 2021 technology revenue was $38.3 million, representing 37% growth year-over-year, And our Q3 2021 adjusted technology gross margin was 69.9%, representing an increase of approximately 150 basis points year over year. Now 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 customers to realize massive, measurable improvements while also maintaining industry-leading customer and team member satisfaction and engagement. Let me begin by sharing a couple of examples of customer improvements from recently published case studies. First, Carle Health and its affiliated Health Alliance health plan struggled with a largely manual approach to its population health and value-based contracting initiatives. In response, Carl and Health Alliance leveraged our DOS data platform and our new value optimizer analytics application, which we introduced on our last earnings call. This software allowed Carl to have real-time insight into a multitude of cost utilization and performance metrics from across 10 key population health areas. including inpatient and skilled nursing facility readmission, inpatient discharge disposition, and emergency department utilization. This integrated data and analytics technology solution enabled CARL to improve its risk-based contract performance, including greater than $10 million in cost and utilization opportunity identified, $100,000 in manual labor costs avoided, and a greater than 90% improvement in analytics efficiency. Next, UnityPoint Help recognized that its patients with complex chronic conditions were overutilizing its healthcare services, particularly when transitioning from hospital admission to an ambulatory care setting. Yet, despite having access to large volumes of data, its clinicians and care managers lacked timely insight into care provided across acute and ambulatory settings. In response, UnityPoint utilized our DAS data platform along with a robust suite of analytics applications and AI software to effectively identify patients with high risk of worsening health conditions that often result in non-urgent emergency department visits or unplanned hospital admissions and enrolled them in their care management program. The care management program then enabled UnityPoint's care managers to appropriately intervene, preventing unnecessary healthcare utilization and reduced spending. In the 30 months since undertaking this improvement initiative, UnityPoint has decreased healthcare spending by more than $32.2 million, the result of a 54% relative reduction in hospital admissions and a 39% relative reduction in ED visits. Likewise, its patients have gained more than 11,000 more days at home and had nearly 2,000 fewer ED visits. Also in the improvement category, I would highlight that we have been fortunate to receive multiple recent external recognitions related to our team member engagement. First, Health Catalyst achieved inclusion in Modern Healthcare's Best Place to Work list, the ninth year in a row achieving this distinction. ranking number 39 this year. We were also recognized by Great Places to Work and Fortune Magazine's 2021 Best Workplaces for Women list and were named to Inc.' 's 2021 Best-Led Companies list. Health Catalyst was also fortunate to have Holly Ramosh, Chief Clinical Officer, Senior Vice President and General Manager of Clinical Quality Analytics at Health Catalyst, be named to Modern Healthcare's 2021 Class of top 25 innovators for her work related to COVID-19. Likewise, Sadika Mahmood, General Manager and Senior Vice President of our Life Sciences Business Unit, received the Women Tech Council's 2021 Award for Transformational Leadership. We are thankful to have Holly and Sadika as two great examples of the benefits of having deep healthcare domain expertise and the differentiation that this provides our company. Our next strategic objective category is growth, which includes beginning new customer relationships while also expanding existing customer relationships. To begin, the current sales environment is largely consistent with commentary that we've shared throughout 2021. The COVID-19 pandemic continues to result in both headwinds and tailwinds as it relates to our growth. In terms of headwinds, Our provider end market has continued to be under some amount of financial strain while also experiencing operational distraction, the result of healthcare organizations dealing with the continued COVID-19 pandemic, especially with the rise in the Delta variant in the third quarter, alongside vaccine rollout logistics. And as it relates to tailwinds, we continue to see meaningful evidence that the healthcare provider ecosystem is much better equipped and prepared to respond to the ongoing pandemic in areas including treatment efficacy, supply chain logistics, capacity planning, and broader operational optimization. And as we've shared before, we continue to believe that the COVID-19 pandemic will serve as an overall tailwind in the industry's adoption of data and analytics, significantly highlighting the need for a commercial-grade data and analytics solution. to replace patchwork homegrown systems. In terms of our 2021 bookings expectations, our dollar-based retention continues to track in line with the expectations we shared at the beginning of the year. As a reminder, at the beginning of the year, we shared that we anticipate our 2021 technology dollar-based retention to continue to be robust in line with historical levels of 107 to 109%. And for professional services, we expected our full year 2021 performance to be significantly stronger than our 2020 performance, but that we would still experience some strain on this metric relative to historical levels. Next, related to our net new DAS subscription customer additions, let me provide a reminder that we typically experience seasonality in our new customer bookings. with Q2 and Q4 normally representing the majority of our sales, aligned with healthcare organization fiscal years. This fourth quarter will also represent an important new customer selling season, as most fourth quarters have been for our company throughout its history. As shared at the beginning of the year, we continue to expect mid-teens, net new DAS subscription, customer bookings achievements, We continue to be encouraged by our late-stage new customer pipeline, driven by strong demand in areas such as enterprise analytics, population health, and revenue and cost optimization analytics. Also in the growth category, and as a follow-up to our last earnings call commentary, in September we hosted our eighth annual Healthcare Analytics Summit, along with our annual customer-focused user group. This year's virtual conference was once again a success, welcoming a few thousand registrants representing more than 675 organizations in 18 countries. Attendee satisfaction was again greater than 97%, with participants having the opportunity to hear from many of the leading healthcare and analytics voices in the world provide their perspectives on this year's theme of multi-domain analytics. highlighting how the most successful healthcare organizations integrate data and analytics across multiple domains to achieve significant revenue costs and quality outcomes. This year's summit and user group also provided Health Catalysts with a meaningful opportunity to continue to provide thought leadership within the healthcare data and analytics ecosystem while further cultivating and deepening our relationships with customers and prospects. Next, as it relates to growth, we are excited to have publicly announced a few of our recent customer additions, including Mount Nittany Health and Oklahoma Heart Hospital. Mount Nittany Health, located in central Pennsylvania, plans to leverage our DOS data platform, along with key elements of our population health technology offering, to enable new performance insights, better manage its risk, and drive population health improvements across its system. Likewise, Oklahoma Heart Hospital one of the largest cardiovascular networks in the United States, partnered with Health Catalyst with the objective of accelerating the system's cost transparency goals, including helping executives and analysts better understand and evaluate the true cost of care delivered and empowering clinicians with the right data to inform their decision-making. To support this transformational work, Oklahoma Heart will leverage our DOS data platform and our power costing analytics application, delivering Oklahoma Heart with a comprehensive view of the true cost of their patient care. With that, let me turn the call over to Brian. Brian?

Thank you, Dan. Before diving into our quarterly financial results, I want to echo Dan's sentiment and say that I am pleased with our third quarter 2021 results. I will now comment on our strategic objective category of scale. For the third quarter of 2021, we generated $61.7 million in total revenue. This represents an increase of 31% year over year and was an outperformance relative to the midpoint of our guidance. This outperformance was driven mainly by new contracts signing earlier in the quarter than forecasted. Technology revenue for Q3 2021 was $38.3 million. representing 37% growth year-over-year. This year-over-year growth was driven primarily by recurring revenue from new customer additions, from existing customers paying higher technology access fees as a result of contractual built-in escalators, as well as from our Vitalware acquisition that closed September 1st, 2020, and our Twistle acquisition that closed on July 1st, 2021. In Q3, TWSL contributed 1.4 million of technology revenue, inclusive of a purchase accounting related deferred revenue write-down, which was in line with our expectations shared on our last earnings call. Professional services revenue for Q3 2021 was 23.5 million, representing 22% growth relative to the same period last year. This year-over-year performance was primarily due to our professional services being provided to new DOS subscription customers, along with a small amount of COVID-related temporary customer discounts that spilled into the third quarter of 2020, creating a more favorable year-over-year comparable. Also in line with the expectations we shared on our last earnings call, Q3 2021 professional services revenue was lower than our Q2 2021 revenue, given the modest amount of incremental non-recurring project-based professional services revenue that we recognized in Q2 2021. Total adjusted gross margin for the third quarter of 2021 was 50.9%, representing an increase of approximately 20 basis points year over year. In the technology segment, our Q3 2021 adjusted technology gross margin was 69.9%, an increase of approximately 150 basis points relative to the same period last year. This year-over-year performance was mainly driven by existing customers paying higher technology access fees from contractual built-in escalators without a commensurate increase in hosting costs, partially offset by headwinds due to the continued costs associated with transitioning a portion of our customer base to third-party cloud-hosted data centers in Microsoft Azure, which increases our hosting costs. In the professional services segment, our Q3 2021 adjusted professional services gross margin was 20%, representing a decrease of approximately 510 basis points year over year and a decrease of approximately 1,390 basis points relative to Q2 2021. This year-over-year and quarter-over-quarter decline was mainly the result of some shift in the mix of professional services delivered toward lower margin implementation and outsource services, higher medical claims costs as a self-insured company, and a more normalized utilization rate as compared to the first half of 2021 as we were able to catch up on professional services hiring plans. In Q3 2021, adjusted total operating expenses were $37.2 million. As a percentage of revenue, adjusted total operating expenses were 60%, which compares favorably to 64% in Q3 2020. In terms of the quarterly increase in operating expenses compared to Q2 2021, as mentioned on our last earnings call, this was mainly the result of sales and marketing expenses from our Healthcare Analytics Summit, and HIMSS conference attendance, incremental expense from our recent acquisition of TWSL, as well as increased travel expenses. Adjusted EBITDA in Q3 2021 was a loss of $5.8 million, beating the midpoint of our guidance and comparing favorably to an adjusted EBITDA loss of $6.4 million in the third quarter of 2020. This Q3 adjusted EBITDA result was mainly driven by the strong revenue performance mentioned previously, along with the timing of some non-headcount expenses that we anticipate will be pushed out into the fourth quarter of 2021. Our adjusted net loss per share in Q3 2021 was approximately 18 cents. The weighted average number of shares used in calculating adjusted net loss per share in Q3 was approximately 49 million shares. Turning to the balance sheet, we ended the third quarter of 2021 with $455 million in cash, cash equivalents, and short-term investments, compared to $271 million at year-end 2020. As a reminder, we conducted an equity follow-on offering in August 2021, which raised $245 million in net proceeds for general corporate purposes, including potential acquisitions. Also, as a reminder, in April 2020, we issued a private placement of convertible notes with a principal amount of 230 million. The net carrying amount of the liability component is currently 177.8 million. As it relates to our financial guidance for the fourth quarter of 2021, we expect total revenue between 61.4 million and 64.4 million. and adjusted EBITDA losses between $7.5 million and $5.5 million. And for the full year 2021, this implies we are raising our full year revenue outlook. We now expect total revenue between $238.6 million and $241.6 million. At the respective midpoints, this represents an increase of $1.9 million compared to the full year revenue guidance we provided last quarter. We also expect adjusted EBITDA losses between $12.5 million and $10.5 million. At their respective midpoints, this is in line compared to the full year guidance we provided last quarter. Now let me provide a few additional details related to our fourth quarter 2021 guidance. As it relates to our professional services revenue, we anticipate Q4 professional services revenue will be roughly in line with our third quarter revenue total. Additionally, I would mention that we anticipate our adjusted professional services gross margin for Q4 2021 will be similar to Q3 2021, with the fourth quarter seeing most of the same trends as Q3, including a similar mix of the professional services delivered, higher medical claims cost across our team member base than in the first half, and a more normalized utilization rate as compared to the first half of 2021, as well as planned one-time bonuses distributed to team members given the tight labor market and strong 2021 performance. Lastly, as implied by our guidance, we anticipate our Q4 2021 adjusted EBITDA quarterly performance to be slightly lower than our Q3 performance. While we won't incur the Healthcare Analytics Summit and HIMSS conference sales and marketing expense in the fourth quarter, this quarterly expense reduction is offset by multiple items, including certain operating expense non-headcount items that have been pushed out until the fourth quarter, the one-time investment in acquisition-related integration expenses that we described on our previous earnings calls, additional ramp and forecasted travel expenses, as well as one-time bonuses distributed to team members given the tight labor market and strong 2021 performance. With that, I will conclude my prepared remarks. Dan?

Thanks, Brian. In conclusion, I would like to recognize and thank our highly engaged team members. Without their consistent contributions to our mission and growth, none of this would be possible. And with that, I will turn the call back to the operator for questions.

Certainly. Ladies and gentlemen, if you have a question at this time, please press star then 1 on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Anne Sanyo from JPMorgan. Your question, please.

Hi, guys. Congrats on a great quarter, and thanks for taking the question. Anne, you have your phone on mute.

We can hear you, Annie.

Oh, okay, great. At your Healthcare Analytics Summit, you know, value-based care was a really big theme. And was wondering, you know, are you finding that the pace of change is accelerating there? And are you seeing more demand from your clients in that area?

Yes, great question, Annie. That was a major theme of the Healthcare Analytics Summit, and that was data-informed based on our interactions with both clients and with prospects in seeing a meaningful increase in interest and specific focus on value-based care and population health topics in general. That focus at has was informed by that data, and we continue to see an uptick and an acceleration both with existing clients and with prospective clients as it relates to that being one of the primary focus areas right now in the market.

The thing I would add, Annie, is that this has been an area that we've been thinking about and focusing on over the last several quarters in terms of our development strategy and our acquisition strategy as well. So you've seen recent acquisitions there with our Health Finch acquisition a year ago, and then the most recent acquisition of Twistle just in July, which helps to round out our population health suite of applications in a space, patient engagement specifically, that continues to be a focus for our health system customers and process. So we're encouraged by that alignment.

That's great, Collar. And then maybe one, we've been hearing a lot about labor inflation and shortages this quarter from probably some of your customers. Are you doing anything to help them, your customers, with finding solutions to mitigate some of that impact?

We are, and specifically our Power Labor application suite, which we talked about in the last earnings call, is very helpful as it relates to the management of the labor force in specific areas where our health system clients are facing shortages and need to optimize in very specific ways. So that technology solution, as well as our deep domain expertise services, have been highly utilized by our clients in helping them make it through this challenging environment.

That's great to hear. Thanks, guys.

Thanks, Danny. Thank you. Our next question comes from the line of Ryan Daniels from William Blair. Your question, please.

Hey, guys. This is Jack for Ryan Daniels. Congrats on the quarter and the continued success, and thanks for taking the question. You know, I guess kind of keeping on the trend of the labor pressures, and, you know, I think I believe last quarter you even mentioned a slower hiring than anticipated, but, you know, I expect that to pick up in the back half of the year. So, I guess, do you have any additional color on the labor pressures and, you know, kind of just how has that been trending so far in the second half? And I know, too, in the prepared remarks, you mentioned one-time bonuses. So any additional color here is really appreciated. Thanks.

Yeah, absolutely, Jeff. So as we alluded to in the prepared remarks, we did see some catching up as it relates to specifically our professional services hiring in this last quarter. We had referenced that we were behind in our last earnings call, so we've seen some catching up. And we continue to see this current environment as a very tight labor market and environment. And so we're cognizant of that. That's an important factor as we think about Q4 in the near term and as it relates to what we referenced in terms of one-time bonuses to recognize our team members' engagement and strong performance. And it'll be an important component as we think about our planning process, as we do every year for next year for 2022. As you all know, we put team members at the center of everything that we do, and their engagement drives our success. And so we want to make sure that we're always optimized as it relates to our team members and their engagement.

One thing I would add, Jeff, is that even with some of those delays that Dan referenced earlier in the year, We don't anticipate and shared previously that we didn't anticipate any material impacts to our product development roadmap and our ability to execute against that in 2021 or our ability to deliver on our bookings expectations that we mentioned on the mark. So no major impact to those.

Awesome. Thanks for that info. And then I guess just as a follow-up, I kind of want to pivot towards the Twistle acquisition. and just kind of how the integration is going. So I know you mentioned last quarter that one of the early phases for integration was kind of from a sales and marketing standpoint. Can you guys provide any additional color on how the integration is progressing? That would kind of be helpful. And I guess also as we think about the integration, how should we think about the contribution to guidance? I know you mentioned $3 million in EBITDA loss expected. But, you know, kind of how is that tracking relative to the plan? And I know I think you said $1.4 million of tech revenue, so anything is helpful here. Thanks.

Yeah, I'm happy to share a few comments, and then, Brian, please share as well. So as it relates to how the integration is going, I'm pleased with where we are relative to our integration goals and how we had forecasted where we would be moving I'll highlight I had an opportunity recently to travel to Albuquerque, which is the headquarters of TWISL, and we have an office there and spend time one-on-one with many of the TWISL team members. And we continue to be really impressed and excited with the talent level and the expertise in the area of patient engagement, which is so relevant for Pop Health and other areas of Health Catalyst focus as well in terms of clinical improvement, clinical analytics work, as well as our life sciences use cases. So we're excited about the level of integration. We are seeing very meaningful interest among our existing DAS subscription clients to find out more about Twistle. I've personally been asked, unprompted by a number of C-suite executives that are existing clients, to tell me more about Twistle. And obviously, patient engagement is a very important capability and capacity that our health system clients want to have. So we're excited about that. And I'll let Brian comment about the financial impact of Twistle.

Yeah, certainly. So in 2021, Jeff, we did mention on the last call that Twistle would contribute about $3 million of mostly technology revenue for the second half of the year, inclusive of a deferred revenue write-down on the top line. and then approximately $3 million of adjusted EBITDA burn in the second half of the year as well. When you think about going forward into 2022, on the top line we had shared at the time of the acquisition that you could think about 2021 standalone revenue for Twistle of about $8 million, and then growing approximately 35% in 2022. And then on the EBITDA side that we anticipated, $2.5 to $3 million of negative EBITDA contribution in 2022 on top of our kind of core business, inclusive of some integration-related expenses that we'll execute on through next year.

Awesome. Thanks, guys. Thank you. Our next question comes from the line of Jessica Tassin from Piper Sandler. Your question, please.

Hi. Thank you so much for taking the question. So I think just wanted to verify, does the mid-teens DOS ads for the year, does that refer to the kind of all-access DOS subscription and services customers that we've historically seen?

Yes, it primarily does. And with the note that as we discussed in prior earnings calls, when we defined what is included in that all-access subscription, there have always been certain things that are excluded. And importantly, elements like new technology that come to us through acquisitions are outside of that technology subscription. And so when we perform an acquisition, there is an incremental revenue opportunity. But when we talk about the mid-teens DOS ads, that incorporates that idea of a subscription-based model where they can access both DOS and some application capabilities as well.

Understood. So as you think about your existing all-access subscriptions, should we think about the technologies you've acquired year-to-date as being layered in or maybe incremental to that 7% to 9% annual price appreciation?

Yeah, they would represent incremental growth opportunity from that contractual built-in, those contractual built-in escalators on the technology side.

That's right. And we also, Jess, part of the thesis there of acquiring at the applications layer is one, as Dan mentioned, to have a broader portfolio to sell into our current DOS customer base and expand over time, but also to develop more places to land and meet a new customer or prospect where they'd like to start from an analytics standpoint. And so that breadth of the portfolio helps on both of those growth drivers.

Got it. And if I could just sneak in one quick just follow-up. I guess how much of the base have you gone through in terms of renegotiating the all-access subscriptions to account for the solutions you've acquired year-to-date?

So that's really a rolling topic of discussion, and mostly that happens as we acquire a new technology. So less of that happens at the end of a contract period, and more happens during the course of the relationship as we acquire a new technology than typically within six months we'll have a discussion with our existing client base. about their interest level in that newly acquired technology.

And we are seeing, Jeff, and anticipated to see in 2021, a moderate amount of contribution, in particular on our expansion metrics, where we're able to cross-sell an application to a DOS subscription customer. And that is a lower price point, and it is a faster sales cycle than the other direction of selling DOS into an app customer. But we've seen some early success there, which we're encouraged by.

Thank you again.

Thank you. Thank you. Our next question comes from the line of Elizabeth Anderson from Epicor. Your question, please.

Hi, this is Joe on for Elizabeth. I just wanted to ask a quick question on the life sciences offering that you guys hosted a webinar on a few weeks ago. Just wondering, in general, kind of who you see, you know, that offering sort of competing with, is it competing with? CROs are competing with another player in the space. And then on top of that, what tends to differentiate those solutions in the space? Thanks.

Yeah, thank you for that question, Joe. So as we think about the solution and the offering that we are able to bring to life sciences companies, we are excited about the possibility and the potential but we're very, very early on. And as we've described in prior earnings calls, we recognize there's a great deal that we're learning about this new market, this adjacent market. And one of the elements that helps us in that regard is to often partner with or complement another larger player like a CRO or another life sciences-oriented company where we can provide part of the overall solution, but then benefit from the experience base of and other players. So I would think of us as more complementing and strengthening a solution of some established players, especially as we're early in this adjacent market.

Just in terms of where we aim to differentiate, one aspect is we do, as part of our DOS offering, customers are able to contribute data from DOS, a subset of that data, into a de-identified centralized platform. And that data is very rich in terms of the breadth of clinical data and the depth of that data and the touch points across patients that that data represents. And so we do think that that data asset is a strength in terms of how we differentiate against other vendors, as Dan mentioned, coupled with our ability to build analytic applications on top of that data with the intent to drive improvement in any area that we're working on with life sciences companies.

Great, thank you.

Thank you. Our next question comes from the line. Stephanie Davis from SVB Lyric. Your question, please.

Hey, guys. Thank you for taking my question. I was going to pivot away from some of these labor shortage questions and ask some questions about that new strategic end market you guys are going for. So just another flavor of labor questions. Can you just tell us a little bit more about this pharma life sciences strategy and what sort of headcount build-out you would need to target this new arena? Is it primarily going to be sales folks and, you know, sales teams and managers that are more familiar with pharma and markets? Or are we going to see more of an R&D lift as well in order to get you bigger in that market?

Yeah, thank you for the question, Stephanie. So I think it's both. We need... you know, to build and strengthen our capacity as it relates to understanding go-to-market, understanding the end user, understanding the use cases. And then we've also recognized and learned over the last couple of years that we've started to modestly invest here, that there is some incremental R&D needed to take that core, you know, set of capabilities that is leverageable and that we are excited that we do believe we see evidence of some differentiation, but that there is some incremental R&D needed to suit the specific use cases of these life sciences companies. As you might imagine, in our core market, there isn't complete overlap between the kinds of use cases that we've been focused on, particularly as it relates to clinical improvement, pop health, operational and financial improvement of a health system, and then having that translate into contributing to data-informed registries or the support of specific clinical trial recruitment or real-world data, real-world evidence use cases. So we are recognizing the need to continue to make some investments from an R&D perspective. And as I mentioned just a few minutes ago, we're benefiting from learning from partners who have been in this space longer than we have and learning from through the hiring of experienced team members as well. But as we've shared many times, we're early in our investments in these adjacent markets. We're playing the long game as it relates to trying to build something that will be meaningful long-term, but that takes time, and we're still very early stage in that process.

Understood. The biggest tragedy of real-world evidence is I have a really hard time pronouncing it. It sounds like I'm not alone in that one.

Yeah, we share that.

I hear you. I hear you. Keeping in mind that buying assets in this very sexy sliver of the market right now is an incredibly high multiple prospect. Should I read into that and assume you guys will do more of a build versus buy as you expand to the side of the market? Or do you think there's enough opportunity that could justify the higher price tag for this?

Yeah, it's a great question. So As we've shared in the past, we include adjacent markets as one of the areas that we pay attention to from an M&A perspective. And we've also shared multiple times in the past, we believe in a disciplined process from a financial perspective, and we want to maintain that discipline. And so when there are opportunities and adjacencies, whether that's in life sciences or in international We do consider them. We carefully study them. And we apply the same discipline from a framework, a financial framework perspective that we apply across the board. And we think that's the right long-term strategy. So if there are opportunities that fit within that framework, we'll be pursuing them. If not, then we'll find other ways through our own investments to continue to build momentum in these adjacent markets.

Looking forward to see what you guys build out. Thank you.

Thanks. Thank you. Thank you. Our next question comes from the line of David Grossman from Stiefel. Your question, please.

Thanks. Good afternoon. I'm wondering if we could just go back for a minute just to the services gross margin, and perhaps you could just mention the three things that you mentioned which are most impactful for the margins in this back half of the year. And then secondly, you know, to what extent, can you pass through some of the more labor-related costs like benefits and wages? Just wondering just how much flexibility and latitude you have in passing that through.

Yeah, thanks, David. So good question. So we have seen over the last couple of years some fluctuation in our professional services gross margin. on a quarterly basis, much more so than our technology segment, as an example. And there are three primary factors that I mentioned in the prepared remarks that can contribute to that fluctuation. So just to kind of dig into those further, the first is that utilization rate of our team members, which, as we described, is a little higher than we would have anticipated in the first half of the year and has more normalized now. The second is the shift and mix of services that we provide. So some services are lower margin, some are higher, like our consulting services and analytic services, and that can fluctuate on a quarterly basis. And then the last was, to your point, kind of team member-related costs, like medical and other costs. You could think about the Q3 impact as being a few percentage points related to the labor-related costs that I mentioned on the prepared remarks, and then the remainder of that change being the other two factors, the utilization rate and the mix shift. That's how I describe Q3 as we kind of look forward to your point on kind of pricing power and passing that through. That's something that we're trying to think through and assessing over Q4. We have enough visibility now to provide that color that I mentioned on Q4 gross margin looking similar to Q3 just based on the mix that we see and our current cost profile. But that is something that we're thinking through as it relates to 2022. So we'll continue to provide updates there as we get more data in terms of the price points and then also the cost for a team member that we're seeing going into next year.

And the only thing I would add, David, is we continue to strive to be data informed as we're trying to understand pricing changes and pricing input changes that You know, we anticipate, as many others have shared from a macroeconomic backdrop perspective, that some of the pricing increases will be transitory. Others may be more long-lasting. But we're trying to study that data and be as informed as possible as we think about our own pricing strategy moving into 2022.

Great. Thank you for that. And then, you know, another somewhat forward-looking, you know, question is, You know, as I recall, your first tranche of customers, not the first tranche, but the kind of first tranche, if you will, in the existing era kind of renew, I think start renewing over the next 12 months. And this may have come up in an earlier question, but just curious with the increased portfolio of apps, you know, kind of going in your favor and perhaps the automatic escalators maybe not being as present in the renewals. How do you want us to think about, or what are you targeting in terms of what you think the retention rate will look like on renewals vis-a-vis where it's been historically?

Yeah, I'm happy to comment on that. So one element that's important to remember is that in the way that we structure all of our relationships with all of our clients, every year, any client who wishes to can always opt out of the relationship, including the technology subscription relationship. And so there isn't a significant buildup of contracts coming up in any given point in time. Every year, they all cycle through that opportunity. And so that's been a helpful mechanism for us to stay on our toes and make sure that each one of our clients is really receiving great value. And by doing that, we've seen that robust historical dollar-based net retention, particularly as it relates to the technology business, remaining robust all the way through the pandemic through today, and we anticipate that it will continue to be robust at those historical levels as well. And I think as it relates to discussions about moving forward, as Brian mentioned a little bit earlier, there's a modest amount, and we've mentioned this in prior calls as well, of of some of that cross-sell of those newly acquired technology capabilities that would fall outside of the traditional subscription built into our forecast for 2021. An overperformance of that modest amount of cross-sell would represent, you know, upside to the way that we forecast and model in 2021 and beyond.

Just to add to that, David, so we have seen, to your point, some of those contracts with the kind of a three to seven year original term in RAMP coming up for renewal. As Dan mentioned, the things that are helping with that are the broader portfolio, so the cross-sell opportunity with those new applications. The only other thing I would mention is that we do also have typically a contractual constraint on the amount of data and the computing power that our hosted environments for DOS can – at which they can perform. And as customers continue to grow and add data and go beyond that, there is an expansion mechanism even for those all-access customers as well. So that has helped us continue to drive that on average, similar dollar-based retention rate that you've seen historically.

So just activity levels alone will generate some same-store sales growth is what that last comment refers to?

There's a mechanism for that as well, yeah.

Right. Got it. Okay, very good. Thanks very much. Thanks, David.

Thank you. Our next question comes to the line of Daniel Grossling from Citi. Your question, please.

Hi. Thanks for taking the question. As you move further into pop health, this sales cycle, have you seen more traction outside of traditional health systems, i.e., with payers or risk-bearing providers? And have you had to invest in additional sales resources as you move outside the health system markets?

Yes and yes, Daniel. We are seeing generally increased interest in pop health offerings, and we're seeing that interest in broader places than just the core health system client or prospect environment. And so as part of our response to that, it's been helpful for us to expand our capacity and our capabilities there. One of the case studies that we referenced in our prepared remarks includes a good example of that, where in our relationship with Carle Health, included in that relationship is a meaningful payer capability with their health alliance organization. And we continue to benefit as a company from those experiences where we're working more directly with organizations broader than a traditional health system, and that informs our population health roadmap that also informs our go-to-market messaging and strategy and helps us continue to expand.

Okay. Got it. Very helpful. And then similar to David's question on professional services, gross margin, I understand you're not guiding yet to 2022, but I was wondering if directionally you could help us out and how we should think about that over the next 12 to 18 months. Um, do you anticipate getting back to the thirties or kind of the 2019 level? Or is there really more of a structural shift here that will keep you in the mid to high 20s for some time?

Good question. It is something that we're considering and thinking through and assessing that data on through the rest of the year. So we're not entirely ready yet to kind of make any, to your point, more formal 2022 color or guidance as it relates to professional services gross margin. I did mention there's some Some of that impact that we saw in Q3, some of that could be more run rate. Some could be more one time in nature. There's also in Q4 an impact to our margin related to the outsized team member compensation and bonuses that we described. Some of that will also impact our professional services gross margin that's more one time in nature. So we'll have more visibility as we get through the end of the year. And in particular, assess at the beginning of next year what mix of services have we sold in Q4, what that mix looks like in our first half 2022 pipeline, the utilization rate of our team members, and that's really what will drive that guidance and color that we'll provide in 2022. And then in terms of the long-term professional services target of mid-30s, no update to that at this point in time, something that we're, again, assessing and looking through over the next couple of quarters.

The only thing I would add, Daniel, would be... is when we think about the role of professional services at Health Catalyst and the purpose of our professional services, as we've mentioned a number of times in previous calls, we think of that as really being focused on providing the right mix of services that enable our clients to measurably improve. And when what they need changes based on what we're working on together, we optimize in favor of those measurable improvements, which can mean that the mix shifts meaningfully. And you've certainly seen that throughout the past 10 quarters that we've reported as a public company. And we anticipate that that will continue to be a dynamic that we're optimizing first and foremost for what our customers need in order to measurably improve. And we allow those needs to really dictate the kind of mix that we offer up to those clients. And we think that's the right long-term strategy.

Yep, makes sense. Thanks, guys.

Thank you. Our next question comes from the line on Dodge from RBC Capital Markets.

Hey, good afternoon. This is Thomas Keller. I'm for Sean. Thanks for taking the questions. So I wanted to talk about the lighter DOS offering and correct me if I'm wrong here, you all have been working on that type of offering prior to the pandemic, but accelerated sort of COVID specific version that you were selling at a discount. And so my question is, how many of those are in use and are you all continuing to offer a light version of the platform and has that offering evolved?

Yes, happy to comment on that, Thomas. So as you mentioned, we had begun conceptualizing the idea of a lighter DOS offering before the pandemic. As the pandemic hit in the spring of 2020, we accelerated some of our thought processes there and some specific use cases there that were most relevant for response to the pandemic. And we've continued to evolve and develop and refine that thought process. We do believe that enabling a lower price entry point for clients to begin a relationship with Health Catalyst is a good long-term strategy. We've seen a few successes in that regard, and we're encouraged to see more representation in our pipeline as it relates to this LIDAR offering and coupling that LIDAR offering with specific use cases at the apps layer, which we have more of now. through the introduction of our own built capabilities as well as through some of our M&A activities certainly is encouraging to us. We've built in a modest amount of that capacity and that capability into our forecasting, and more than a modest amount, like we've talked about before, of success there would represent some upside to our forecasting.

And so just to clarify, the mid-teens DOS target does include some lighter options?

At a modest level, yes.

Okay. All right. That's all for me. Thank you.

Thanks, Thomas. Thank you. Our next question comes from the line of Iris Long from Birnberg. Your question, please.

Hi. Thanks for taking my question. So first a question on pricing and escalator. So I'm wondering in this inflationary environment, how are you thinking about pricing for your solutions in general? Are you going to and would you be able to raise the price for some of the existing contracts? And then I guess for the newer contracts, are you able to increase the amount of the escalators?

Yeah, thank you for the question, Iris. So as you may recall, We have shared previously that on the technology subscription side, we do have built-in pricing escalators with those clients that have a subscription offering with Health Catalyst that includes DOS and some meaningful application access that are built-in double-digit percentage increases. And so those are already meaningful built-in expansion opportunities for us And we've been pleased to see that clients have accepted and chosen to continue to renew. And then in addition to that, we have some opportunity for additional expansion through the acquired technology that have come to us through M&A. As it relates to the way that we think about our existing contracts on both the technology side and the professional services side in the context of inflation, As I mentioned just a few minutes ago, I think we're continuing to study the data and we're continuing to try to more deeply understand which components of price and price increase that we're experiencing are transitory and which components are more long-lasting to inform the way that we think about pricing. And we're still gathering data. We want some more time and space to understand that data before we make any specific decisions as it relates to 2022 and beyond.

Got it. Appreciate your insight there. And then I guess a similar question on margins. How are you thinking about the margin expansion opportunity from the Q3 levels? And I'm also wondering, do you continue to expect a break even on the adjusted EBITDA from next year?

Yeah, thanks, Ira. So in terms of the gross margin dynamics, so I would share consistent with what we shared over the last couple of quarters, first on the technology segment. Our technology gross margin has ticked up over the last couple of years to the high 60s year to date, and we do expect that to be the case over the next few quarters as well. Technology gross margin is typically on a per customer basis expanding over time. as our technology revenue grows at a customer level, but our hosting and support costs don't grow at the same rate. However, that is offset by a headwind that we have of migrating some customers who are on-premise to a hosted solution, which adds technology. So that's the technology gross margin dynamic I would share. On the professional services side, I mentioned in the prepared remarks, but we have enough visibility into the Q4 phase professional services gross margin profile to be roughly in line with Q3. And then we're assessing, as I mentioned, kind of the 2022 impact on that, and we'll provide updates there early next year. And then in terms of our EBITDA trajectory, so I would just remind what we've shared publicly in prior conversations, where we had expected our core business to begin 2022. on a run rate adjusted EBITDA breakeven basis. And then with the TWSL acquisition, we shared that we expected TWSL to contribute two and a half to three million of incremental EBITDA losses in 2022. And at this point in time, we're not providing any specific updates or guidance or commentary related to 2022 EBITDA guidance and color. Main reason for that is we're still working through At this point in the year, our planning process and budget cycle, there are a lot of variables that go into that planning process. Our Q4 bookings performance, our first half sales pipeline, as Dan mentioned, thinking through areas of investment across growth and R&D and other factors. And so typically we don't share kind of specific guidance on that metric until we get into the beginning of next year.

And Iris, I might just add a couple of additional thoughts. So one element that we that we shared in the last earnings call that was certainly exciting for us as a company was that the company did achieve in Q2 and in actually the first half in total adjusted EBITDA positive territory. And so that was an exciting milestone to get to a little earlier than what we had described in terms of our timeline when we went public. And in terms of what Brian just shared in terms of the thought process of beginning 2022 on an adjusted EBITDA break-even run rate. And certainly we shared with you all that, you know, there's seasonality in our business and there are some specific expenses that hit like the healthcare analytics summit expense that happens in the back half of each year. So certainly for this year that applies. I would also share As we think forward, and as Brian mentioned, as part of the planning process for 2022, some of the highest priority items for me definitely include our financial sustainability as a company. They also include important R&D investments that we're very excited about making that can help us long-term to accelerate our growth and opportunities before us. I'm also sensitive, as we've discussed and as a few individuals have brought up in their questions, the very tight labor market that we have, and we're taking some specific actions in Q4 here. We want to be mindful of our team members as it relates to the 2022 planning process and ensuring that our compensation practices for our team members are positive and favorable and competitive, as we've benefited so much from team member engagement, team member retention, very low turnover rates, and we want that to continue to be the case at Health Catalyst as well. So I'm thinking about a number of priorities. As Brian shared, we're in the midst of that, even early in the planning process for 2022, but by our next earnings call, we'll be in a good position to share more of an update as it relates to how we think about 2022.

Got it. Thank you so much for the call.

Thanks, Iris. Thank you. Our next question comes from the line of David Larson from BTIG. Your question, please.

You mentioned a couple times that in the services area, the utilization rates normalized. So what I'm assuming that means is earlier in the year, your consultants were very busy billing 40 or 50 hours a week, and those utilization rates have slowed. Is that correct? And what drove that? What What were they working on earlier in the year? What was the nature of the demand, if you will, and what has changed or evolved as we get into the 3Q here?

Yeah, thank you, David, for the question. The primary element that was in play earlier in the year was we were just behind on hiring, and it relates to the tight labor market where we just experienced some delays in in hiring in the professional services staffing arena. And so we had existing commitments, and that meant we needed to ask our team members to stretch a little beyond what we would view from a health catalyst perspective to be a really sustainable utilization level. And so we're sensitive to that. We've partially caught up from a hiring perspective, as we shared in the prepared remarks earlier. And so that utilization level combined with the other major factors that Brian shared around the mix of services that we're providing and some other factors as well are what we watch and what contributed to kind of where we find ourselves today.

Okay. And then in terms of, like, projects that are in the pipeline and expected utilization rates or build hours per week per consultant, would you expect – I mean, would you expect, like, say, an 80% utilization rate in 2022? Just, like, any thoughts on, like, the margin profile per individual and expectations into 2022 would be very helpful.

Yeah, thanks, David. Yeah, so as I mentioned, we're not quite ready to provide specific guidance in color on 2022 professional services gross margin, but the main factors that contribute to that margin profile are are this item that you're referring to. So the utilization rate of our team members is a primary factor. We're hoping that that continues to stay at a normal level going into next year. But there are other factors as well, including the mix of services provided. And we'll have a better sense of that given that it can fluctuate on a quarterly basis as we get through our Q4 bookings performance and assess what services we're selling there, as well as our first half 2022 sales pipeline. and the mix of services that that represents. And so those are two of the main factors that will play into that, and we'll provide updates on that as we get through that data set in terms of the mix profile.

Okay, great. Thanks very much. Congrats on a good quarter.

Thank you. Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Dan Burton for any further remarks.

Thank you all for your continued involvement and interest in Health Catalyst, and we look forward to staying in touch in the months ahead. Take care, everyone. Thank you, ladies and gentlemen, for your participation at today's conference.

This does conclude the program. You may now disconnect. Good day.