Health Catalyst, Inc. Q3 FY2021 Earnings Call

Thank you for standing by and welcome to the Health Catalyst Third Quarter 2021 Earnings Conference Call. 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 30, 2021. My name is Adam Brown. I am 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 Bryan 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 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 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 outlook. 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 for his prepared remarks and then Bryan will subsequently provide his prepared remarks. Dan?

Thank you, Adam, and thank you to everyone who has joined us this afternoon. We are 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 are 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. 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 three strategic objective categories of improvement, growth, and scale. We will 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 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, Carle and Health Alliance leveraged our DAS data platform and our new value optimizer analytics application, which we introduced on our last earnings call. This software allowed Carle 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 readmissions, inpatient discharge disposition, and emergency department utilization. This integrated data and analytics technology solution enabled Carle to improve its risk-based contract performance, including identifying greater than $10 million in cost and utilization opportunities, avoiding $100,000 in manual labor costs, and achieving a greater than 90% improvement in analytics efficiency. Next, UnityPoint recognized that its patients with complex chronic conditions were over-utilizing healthcare services, particularly when transitioning from hospital admissions to an ambulatory care setting. However, 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 DOS data platform, along with a robust suite of analytics applications and AI software to effectively identify patients with a high risk of worsening health conditions that often result in non-urgent emergency department visits or unplanned hospital admissions. They 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 reducing spending. In the 30 months since undertaking this improvement initiative, UnityPoint has decreased healthcare spending by more than $32.2 million, resulting in a 54% relative reduction in hospital admissions and a 39% relative reduction in ED visits. Likewise, patients have gained more than 11,000 additional 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 for the 9th year in a row, achieving this distinction and ranking #39 this year. We were also recognized by Great Places to Work in Fortune Magazine’s 2021 Best Workplaces for Women List and were named to Inc.’s 2021 Best-Led Companies list. Additionally, Health Catalyst was fortunate to have Holly Rimmasch, Chief Clinical Officer, Senior Vice President, and General Manager of Clinical Quality Analytics at Health Catalyst, named to Modern Healthcare’s 2021 class of top 25 innovators for her work related to COVID-19. Likewise, Sadiqa Mahmood, General Manager and Senior Vice President of our Life Sciences business unit, received a Women Tech Council’s 2021 award for transformational leadership. We are thankful to have Holly and Sadiqa as 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 and expanding existing customer relationships. To begin, the current sales environment is largely consistent with commentary that we have shared throughout 2021. The COVID-19 pandemic continues to result in both headwinds and tailwinds regarding our growth. Our provider end market has been under some financial strain while experiencing operational distraction, as healthcare organizations deal with the continued COVID-19 pandemic. Especially with the rise in the Delta variant in the third quarter, alongside vaccine rollout logistics. Conversely, we continue to see meaningful evidence that the healthcare provider ecosystem is much better equipped and prepared to respond to the ongoing pandemic regarding treatment efficacy, supply chain logistics, capacity planning, and broader operational optimization. We 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 anticipated our 2021 technology dollar-based retention to continue to be robust, consistent with historical levels of 107% to 109%. For professional services, we expected our full-year 2021 performance to be significantly stronger than that of 2020, but we would still experience some strength on this metric relative to historical levels. Next, concerning our net new DOS subscription customer additions. I would like to remind you 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 we shared at the beginning of the year, we expect mid-teens net new DOS subscription customer bookings. 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. Furthermore, as a follow-up to our last earnings call commentary, in September, we hosted our 8th 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 leading healthcare and analytics voices in the world, providing their perspectives on this year’s theme of multi-domain analytics. This theme highlights how the most successful healthcare organizations integrate data and analytics across multiple domains to achieve significant revenue, cost, and quality outcomes. This year’s summit and user group also provided Health Catalyst 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. Additionally, we are excited to have publicly announced a few of our recent customer additions, including Mount Mitane Health and Oklahoma Heart Hospital. Mount Mitane 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 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 to accelerate 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 a comprehensive view of the true cost of their patient care. With that, let me turn the call over to Bryan.

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 due to contractual built-in escalators, as well as from our Vitalware acquisition that closed on September 1, 2020, and our Twistle acquisition that closed on July 1, 2021. In Q3, Twistle 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 the professional services provided to new DOS subscription customers, along with a small amount of COVID-related temporary customer discounts billed into the third quarter of 2020, creating a more favorable year-over-year comparison. 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 nonrecurring 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 shifts in the mix of professional services delivered toward lower-margin implementation and outsourced services, higher medical claims costs as a self-insured company, and a more normalized utilization rate 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, this was mainly due to sales and marketing expenses from our Healthcare Analytics Summit and HIMSS Conference attendance, as well as incremental expenses from our recent acquisition of Twistle and 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 $0.18. 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, 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. Regarding 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. 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 their respective midpoints, this represents an increase of $1.9 million compared to the full-year revenue guidance 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 with the full-year guidance provided last quarter. Now, let me provide a few additional details related to our fourth quarter 2021 guidance. Regarding 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. The fourth quarter will see most of the same trends as Q3, including a similar mix of professional services delivered, higher medical claims costs across our team member base than in the first half, and a more normalized utilization rate 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 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 in forecasted travel expenses, and one-time bonuses distributed to team members due to the tight labor market and strong 2021 performance. With that, I will conclude my prepared remarks. Dan?

Thanks, Bryan. 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. With that, I will turn the call back to the operator for questions.

Our first question comes from the line of Anne Samuel from JPMorgan. Your question, please.

Hi, guys. Congrats on a great quarter and thanks for taking the question.

Ma’am, you may have your phone on mute?

We can hear you, Anne.

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

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

The thing I would add, Anne, 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. You’ve seen recent acquisitions there with our healthfinch 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 processes. So we’re encouraged by that alignment.

That’s great color. 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 your customers with finding solutions to mitigate some of that impact?

We are. Specifically, our power labor application suite, which we talked about in the last earnings call, is very helpful in managing the labor force in specific areas where our health system clients are facing shortages and need to optimize in very specific ways. Our 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, Anne.

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

Hey, guys. This is Jeff on for Ryan Daniels. Congrats on the quarter and the continued success, and thanks for taking the question. I guess kind of keeping on the trend of the labor pressures. I think I believe last quarter, you even mentioned the slower hiring than anticipated. But you don’t 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 just how that has been trending so far in the second half? I know in your prepared remarks, you mentioned one-time bonuses. So any additional color here would be really appreciated.

Yes, absolutely, Jeff. 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. We have seen some catching up. We continue to see this current environment as a very tight labor market environment. We’re cognizant of that. That’s an important factor as we think about Q4 in the near-term. As it relates to what we referenced in terms of one-time bonuses to recognize our team members’ engagement and strong performance, that will be an important component as we think about our planning process for next year.

The only thing I would add, Jeff, is that even with some of those delays that Dan referenced earlier in the year, we don’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 in the remarks. So no major impact to those.

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

Yes, I’m happy to share a few comments and then, Bryan, please share as well. 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. I’ll highlight that I had an opportunity recently to travel to Albuquerque, which is the headquarters of Twistle, and we continue to be really impressed and excited with the talent level and expertise in the area of patient engagement, which is so relevant for pop health and other areas of Health Catalyst focus, including clinical improvement and analytics work, as well as our life sciences use cases. We’re excited about the level of integration. We are seeing very meaningful interest among our existing DOS subscription clients to find out more about Twistle. I’ve personally been asked unprompted by a number of C-suite executives at our existing clients to tell me more about Twistle. Patient engagement is a very important capability and capacity that our health system clients want to have. We’re excited about that. I’ll let Bryan comment about the financial impact of Twistle.

Yes, certainly. 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, at the time of the acquisition, you could think about 2021 stand-alone revenue for Twistle of about $8 million, growing approximately 35% in 2022. We anticipated $2.5 million to $3 million of negative EBITDA contribution in 2022 on top of our core business, inclusive of some integration-related expenses that we will execute on through next year.

Awesome. Thanks, guys.

Thank you. Our next question comes from the line of Jessica Tassan from Piper Sandler. Your question please.

Hi, thank you so much for taking the question. I just wanted to verify, does the mid-teens DOS adds for the year refer to the all-access DOS subscription and services customers that we’ve historically seen?

Yes, it primarily does. With the note that, as we’ve discussed in prior earnings calls, when we define what is included in that All Access subscription, there have always been certain things that are excluded. Importantly, elements like new technology that come to us through acquisitions are outside of that technology subscription. When we perform an acquisition, there is an incremental revenue opportunity. However, when we talk about the mid-teens DOS adds, that incorporates the idea of a subscription-based model where they can access both DOS and some application capabilities as well.

Understood. 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?

Yes, they would represent incremental growth opportunity from that contractual built-in escalator on the technology side.

And we also, part of the thesis there of acquiring at the application 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 new customer prospects where they’d like to start from an analytics standpoint. So that breadth of the portfolio helps on both of those growth drivers.

Got it. If I could just sneak in one quick follow-up. 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?

That’s really a rolling topic of discussion. Most of that happens as we acquire new technology. So less of that occurs at the end of a contract period and more happens during the relationship as we acquire a new technology. Typically within 6 months, we will have a discussion with our existing client base about their interest level in that newly acquired technology.

We are seeing, Jess, and anticipate to see in 2021, a moderate amount of contribution, especially regarding our expansion metrics, where we’re able to cross-sell an application to a DOS subscription customer. This has a lower price point and 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.

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

This is Joe on for Elizabeth. I just want 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, who you see that offering sort of competing with? Is it competing with CROs? Is it competing with another player in the space? And what tends to differentiate those solutions in the space?

Thank you for that question, Joe. As we think about the solution and offering that we can bring to life sciences companies, we are excited about the potential but we’re very early on. We recognize there is a great deal that we are learning about this new market, this adjacent market. 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 and then benefit from the experience base of another player. 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, customers are able to contribute data from DOS into the identified centralized platform. That data is very rich in terms of the breadth of clinical data and the depth of that data and the touchpoints across patients that, that data represents. We think 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 to drive improvement in any area we’re working on with life sciences companies.

Great. Thank you.

Thank you. Our next question comes from the line of Stephanie Davis from SVB Leerink. 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 about the new strategic end market you guys are going for. Can you tell us a bit more about the pharma life sciences strategy and what sort of headcount build-out you will need to target for this new arena? Will it be primarily sales folks, or will management be looking for sales teams and managers more familiar with the pharma end markets or will we see more of an R&D lift as well to get you bigger in that market?

Yes. Thank you for the question, Stephanie. I think it’s both. We need to build and strengthen our capacity concerning understanding the go-to-market, understanding the end-users, and understanding the use cases. We’ve also recognized 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 set of capabilities that is leverageable. We are excited to see some evidence of differentiation, but that there is some incremental R&D needed to suit 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 we’ve focused on, particularly regarding clinical improvement, pop health, operational and financial improvement of a health system, and translating that into contributing to data-informed registries or supporting specific clinical trial recruitment or real-world data use cases. We recognize the need to continue to make some investments from an R&D perspective. 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 through hiring experienced team members as well.

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

Yes, it’s a great question. As we’ve shared in the past, we treat adjacent markets as one of the areas to pay attention to from an M&A perspective. We’ve also shared multiple times that we believe in a disciplined process from a financial perspective and want to maintain that discipline. When there are opportunities in adjacencies, be it in life sciences or international, we do consider them. We study them carefully and apply the same financial discipline that we apply across the board. We believe that’s the right long-term strategy. If there are opportunities fitting within that framework, we will pursue them. If not, we will find other ways through our own investments to continue to build momentum in these adjacent markets.

Looking forward to seeing what you build out. Thank you.

Thanks.

Thank you.

Thank you. Our next question comes from the line of David Grossman from Stifel. Your question please.

Thanks. Good afternoon. I’m wondering if we could just go back for a minute to the services gross margin and perhaps you could just dimension of the three things that you mentioned, which were most impactful for the margins in the back half of the year? To what extent can you pass through some of the more labor-related costs? I was just wondering how much flexibility and magnitude you have in passing that through?

Yes. Thanks, David. Good question. We’ve seen fluctuations in our professional services gross margin on a quarterly basis, much more so than our Technology segment. There are three primary factors that contribute to that fluctuation. The first is the utilization rate of our team members, which has been a little higher than anticipated in the first half of the year and has now more normalized. The second is the shift in the mix of services that we provide. Some are lower margin, some higher like our consulting and analytics services, and that can fluctuate on a quarterly basis. The last one, to your point, are team member-related costs like medical and other costs. You can think about the Q3 impact as a few percentage points related to the labor-related costs mentioned in the prepared remarks. The remainder of that change can be attributed to the other two factors, utilization rate, and mix shift. As we look forward to your point on pricing power and passing that through, we are trying to think through how that will play out in Q4. We have enough visibility now to provide the color I mentioned regarding Q4 gross margin looking similar to Q3, just based on the mix we see and our current cost profile.

The only thing I would add, David, is we continue to strive to be data-informed as we try to understand pricing changes and input changes we anticipate, many have shared from a macroeconomic backdrop that some pricing increases will be transitory, and others may be more long-lasting. We are trying to study that data and be as informed as possible as we think about our own pricing strategy for 2022.

Great. Thank you for that. Another forward-looking question, as I recall, your first tranche of customers at the end, I think those contracts start renewing over the next 12 months. Just curious with the increased portfolio of apps going in your favor, and perhaps the automatic escalators might not be as present in the renewals. How do you want us to think about the retention rate on renewals relative to historical levels?

Yes, I’m happy to comment on that. One element that’s important to remember is that we structure all our relationships with clients annually, as clients can opt out at any time, including the technology subscription. This has been a helpful mechanism for us to stay on our toes and ensure each client receives value. Through that, we’ve seen robust historical dollar-based net retention, particularly for technology business, remaining robust throughout the pandemic and anticipate it will continue at those historical levels. Regarding discussions on moving forward, as Bryan mentioned earlier, we see a modest amount of cross-sell of newly acquired technology capabilities that fall outside the traditional subscription, built into our forecast for 2021. Over-performance of that modest amount would represent upside to how we forecast and model 2021 and beyond.

We’ve seen, to your point, contracts with a 3-year to 7-year original term ramping up for renewal. As Dan mentioned, the things helping with that are the broader portfolio, aiding cross-sell opportunities with those new applications. Typically, we also have a contractual constraint on the amount of data and computing power that our hosted environments for DOS can perform. As customers continue to grow and add data, reaching beyond that expands that mechanism even for all-access customers. That helps us drive that similar dollar-based retention rate 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, yes.

Right. Got it. Very good. Thanks very much.

Thanks, David.

Thank you. Our next question comes from the line of Daniel Grosslight from Citi. Your question please.

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

Yes and yes, Daniel. We are seeing generally increased interest in Pop Health offerings, and we’re seeing that interest broaden beyond traditional health system clients or prospects. It’s been helpful for us to expand our capacity and capabilities there. One of the case studies we referenced in our prepared remarks highlights our relationship with Carle Health, which includes a meaningful payer capability with its Health Alliance organization. We continue to benefit as a company from those experiences where we’re working more directly with organizations beyond a traditional health system. That informs our population health roadmap and go-to-market strategy, helping us expand.

Got it. Great. Very helpful. Similar to David’s question on professional services gross margin, I understand you are not guiding yet to 2022, but could you give us directional thoughts on how we should think about that over the next 12 months to 18 months? Do you anticipate getting back to the 30s or is there really more of a structural shift here that will keep you in the mid to high-20s for some time?

It’s something we consider and assess that data throughout the year. We aren’t quite ready to provide formal guidance for 2022 regarding professional services gross margin. I mentioned the impact we saw in Q3 could be more run rate, while some may be more one-time in nature. Q4 will also see an impact related to team member compensation and bonuses. We have enough visibility into the Q4 professional services gross margin profile for it to be roughly in line with Q3. We’ll provide updates early next year regarding 2022.

The role of professional services at Health Catalyst focuses on providing the right mix of services that enable our clients to measurably improve. When client needs change, we optimize services for measurable improvements, possibly shifting the mix accordingly. You’ve seen these shifts throughout the past 10 quarters of reporting as a public company, and we anticipate that this dynamic will continue to prioritize what customers need for measurable improvement.

Yes, makes sense. Thanks, guys.

Thank you. Our next question comes from the line of Sean Dodge from RBC Capital Markets. Your question please.

Hi, good afternoon. This is Thomas Keller on for Sean. Thanks for taking the questions. I want to talk about the lighter DOS offering. Correct me if I am wrong here, but 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. My question is, how many of those are in use? Are you continuing to offer a light version of the platform? Has that offering evolved?

Yes. Happy to comment on that, Thomas. As you mentioned, we had begun conceptualizing the idea of a lighter DOS offering before the pandemic. As the pandemic hit in spring 2020, we accelerated our thought processes there and specific use cases relevant for responding to the pandemic. We continue to evolve that thought process. Enabling a lower price entry point for clients to begin a relationship with Health Catalyst is a good long-term strategy. We’ve seen some successes and are encouraged by seeing more representation in our pipeline. Coupling the lighter offering with specific use cases at the apps layer, which we have more of now through both our built capabilities and M&A activities, is certainly encouraging. We have built in a modest amount of that capacity into our forecasting, and more success there would represent upside.

And just to clarify, the mid-teens DOS target includes some lighter options?

At a modest level, yes.

Okay, that’s helpful. That’s all for me. Thank you.

Thanks, Thomas.

Thank you. Our next question comes from the line of Iris Long from Berenberg.

Hi. Thanks for taking my question. First, a question on pricing and escalators. In this inflationary environment, how are you thinking about pricing for your solutions in general? Would you be able to raise the price for some of the existing contracts? For newer contracts, are you able to increase the amount of the escalators?

Yes. Thank you for the question, Iris. We’ve shared previously that on the technology subscription side, we have built-in pricing escalators with clients that have a subscription offering that includes DOS and some meaningful application access. Those are already substantial built-in expansion opportunities. We’ve been pleased to see clients have accepted and chosen to continue to renew. Additionally, we have expansion opportunities through recently acquired technology. Regarding existing contracts and the context of inflation across the technology and professional services side, we are continuously studying data and deeply understanding which pricing increase components we experience are transitory and which are more long-lasting as we approach pricing for 2022.

Yes. That's right. Our technology gross margin has ticked up to the high-60s year-to-date. We expect this to continue for the next few quarters. Gross margin typically expands on a per-customer basis as our technology revenue grows, but our hosting and support costs grow at a slower rate. Additionally, we’re migrating some customers to a hosted solution, which adds technology costs. That’s the dynamic for technology gross margin. With respect to professional services, we anticipate Q4 professional services gross margin to be in line with Q3. We’re assessing 2022 impacts and will provide updates based on our Q4 bookings performance and first-half sales pipeline, including the mix of services sold in Q4.

Got it. I appreciate your insight there. I was wondering about margin expansion opportunities from the Q3 level. Do you continue to expect breakeven adjusted EBITDA next year?

Yes. In terms of gross margin dynamics, our technology gross margin has been increasing, and we expect this to continue. Professional services gross margin is something we’ll assess for 2022 but are not ready to provide specific updates yet. In terms of EBITDA trajectory, we had expected our core business to begin 2022 on an adjusted EBITDA breakeven basis.

As we think about financial sustainability this company will continue to be a priority. Our R&D investment and ensuring competitive compensation for our team members are also priorities in our planning for 2022. We’re in progress with the budgeting process for 2022, and we’ll share more updates on our next earnings call as we get more clarity.

Got it. Thank you so much for the color.

Thanks, Iris.

Thank you. Our next question comes from the line of David Larsen from BTIG. Your question please.

You mentioned a couple of times that in the services area, the utilization rates normalized. I assume that means earlier in the year, your consultants were billing many hours per week. Now that has slowed. Is that correct? What drove that, and what has changed or evolved as we get into Q3?

Yes, thanks, David. The primary element that contributed to this earlier in the year was we were behind in hiring. It was a tight labor market, and we experienced hiring delays in professional services staffing. We had commitments to existing work, and this necessitated asking team members to stretch beyond a sustainable utilization level from our perspective. We are making progress in catching up on hiring, which should allow us to normalize utilization.

In terms of projects in the pipeline and expected utilization rates or billed hours per week, do you expect an 80% utilization rate in 2022? Any thoughts on the margin profile per individual and expectations for 2022 would be helpful.

As I mentioned, we’re not ready to provide specific guidance on 2022 professional services gross margin but the main factors contributing to that profile are the utilization rate of our team members. We hope that continues to stay normal going into next year, but the utilization and mix of services provided are critical considerations. We will provide updates based on our Q4 bookings performance and our first-half 2022 sales pipeline.

Great, thanks very much. Congrats on a good quarter.

This does conclude the question-and-answer session of today’s program. I would 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. We look forward to staying in touch in the months ahead. Take care, everyone.

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.