Health Catalyst, Inc. Q2 FY2023 Earnings Call

Welcome to the Health Catalyst Second Quarter 2023 Earnings Conference Call. I would now like to turn the call over to Adam Brown, Senior Vice President of FP&A and Investor Relations.

Good afternoon, and welcome to Health Catalyst's earnings conference call for the second quarter of 2023, which ended on June 30, 2023. 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 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 today's 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 macroeconomic challenges, including high levels of inflation and high interest rates, the tight labor market, our pipeline conversion rate and the general anticipated performance of our business. These forward-looking statements are based on management's current views and expectations as of today and should not be relied 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 Q1 2023 filed with the SEC on May 10, 2023, and our Form 10-Q for the second quarter 2023 that will be filed with the SEC. 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, I will turn the call over to Dan.

Thank you, Adam, and thank you to everyone who has joined us this afternoon. We are excited to share our second quarter 2023 financial performance, along with additional highlights from the quarter. I will begin today's call with some summary commentary on our second quarter results and outlook. We are pleased with our second quarter 2023 financial results, including total revenue of $73.2 million and adjusted EBITDA of $3.5 million, with these results beating the midpoint of our quarterly guidance on each metric. Additionally, we are tracking slightly ahead of our previous full year revenue and adjusted EBITDA guidance. And as a result, we are raising our 2023 revenue and adjusted EBITDA guidance. Likewise, we are pleased with our strong first half bookings performance, but we are reiterating our full year 2023 bookings expectations, inclusive of net new subscription client additions and dollar-based retention rate. 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 clients to realize massive, measurable improvement while also maintaining industry-leading client and team member satisfaction and engagement. Let me begin by sharing an example of a client improvement from our recently published case study. Women's Hospital in Louisiana faced increasing costs, consistent with the broader health system end market, and their leadership team understood that they needed a technology solution that would support strategic decision-making and provide them with a detailed comprehensive view of their costs. To achieve this goal, Women's Hospital implemented our power costing analytics application, part of our financial empowerment technology suite, to enable them to better manage their cost of care, leading to improvement in their revenue performance and enhancements in their strategic decision-making effectiveness. Our power costing application allowed the Women's Hospital team to analyze detailed cost data and look at the contribution margin for each of their services, enabling their leadership team to answer important strategic questions. Ultimately, utilization of the detailed cost data from our power costing application empowered the Women's Hospital team to be awarded $10 million in additional funding from the Department of Health for their OB/GYN residency program. Likewise, Women's identified $2 million in labor cost savings opportunities, the result of decreasing contract labor costs while providing market-based salary adjustments for registered nurses and improving retention of highly qualified staff. Also in the improvement category, we have been fortunate to receive additional external recognition related to our team member engagement. First, for the 11th year in a row, Health Catalyst has been named the Best Place to Work in healthcare by Modern Healthcare. Additionally, Health Catalyst has been included in this year's top workplaces in the healthcare industry list by Intergage. Likewise, we are pleased to be, for the first time, Great Place to Work certified in India, a recognition of our high team member engagement in this region. Lastly, we are excited to share that Health Catalyst has been named as one of America's greatest workplaces for job starters in 2023 by Newsweek. Our next strategic objective category is growth, which includes expanding existing client relationships and beginning new client relationships. To summarize, our operating environment continues to align with what we have shared in prior quarters, with some slight improvement in recent months. This has translated to a strong first half bookings performance that was consistent with our expectations. And during the second half of 2023, our pipeline continues to grow, and our anticipated second half bookings are also in line with our previously shared expectations. As such, we are reiterating our full year 2023 bookings expectation, inclusive of a dollar-based retention rate between 102% and 110% and net new subscription client additions in the low double digits. As it relates to our current selling environment, we continue to experience similar tailwinds and headwinds that are consistent with what we have described over the last couple of quarters. While health system operating margins continue to be challenged relative to longer-term historical levels, we are encouraged to see their operating margins improving slightly in recent months. Given the budgeting cycles of most health systems and the typical length of our sales cycles, we anticipate this will translate into a midterm bookings tailwind related to our full year 2023 bookings expectations. A reminder that we continue to anticipate professional services bookings growth to be higher than technology bookings growth, driven by our tech-enabled managed services offering. From July 1, 2022, through June 30, 2023, our tech-enabled managed services annual recurring revenue grew by more than 80% and represents nearly 50% of our total professional services annual recurring revenue. To date, roughly 10% of our subscription clients have entered into a tech-enabled managed services relationship with Health Catalyst. These long-term partnerships include multiyear contracts with, on average, more than $8 million of total annual recurring revenue per client, which is about four times larger than the average annual recurring revenue for subscription clients. Next, I'm excited to announce two recent tech-enabled managed services contracts. First, we are pleased to have entered into an expanded relationship with a regional health system that has been a client of Health Catalyst for nearly a decade. This 5-year $50 million all-access technology and services contract more than quintupled the size of the client's relationship with Health Catalyst and includes an opportunity for an additional shared success bonus based on improved client profitability. At approximately $10 million in annual recurring revenue before any shared success bonus, this health system has become one of Health Catalyst's 10 largest clients. This annual spend level also represents approximately 5% of this client's net patient revenue, highlighting the depth of this long-term partnership. Importantly, this relationship represents a new tech-enabled managed services offering area for us, in which we are managing the vast majority of the nonclinical staff across this health system's ambulatory clinics. We anticipate this new tech-enabled managed service in ambulatory operations will provide us with another meaningful growth engine in addition to our current technical managed services in analytics and chart extraction. Additionally, I am pleased to share another significant tech-enabled managed services expansion that was signed recently with another health system that has been a client of Health Catalyst for nearly a decade. This new 5-year contract is sized at approximately $60 million and at roughly $12 million of annual recurring revenue, it represents approximately a doubling in the size of this client relationship relative to last year. The expansion is inclusive of an all-access technology subscription as well as an expansion to tech-enabled managed services within the churn of traction and analytics domain with an emphasis on clinical quality improvement and health equity. We are excited to deepen this long-standing partnership, and we are encouraged that it represents another meaningful example that demonstrates the strong value proposition of our tech-enabled managed services offering. To summarize from a growth perspective, we had a strong first half bookings performance. Our pipeline continues to grow, and we anticipate our second half bookings performance will be in line with our prior expectations. Likewise, we are excited to have announced multiple sizable tech-enabled services expansions as further evidence of our meaningful traction with clients. Lastly, as you'll hear from Bryan later in our prepared remarks, we are pleased to raise our revenue and adjusted EBITDA guidance for the full year, and we continue to feel confident in our long-term revenue growth target of 20% plus and our long-term adjusted EBITDA margin target of 20% plus. Additionally, we continue to track well towards our midterm targets, including a 10% adjusted EBITDA margin in 2025 and meaningful positive adjusted free cash flow in 2025. We continue to see material operating leverage in our financial model, inclusive of significant tech-enabled managed services expansions that require little incremental operating expenses. Likewise, we anticipate seeing more material R&D operating leverage beginning in 2024, as we streamline and work to complete certain investments in our data platform. With that, let me turn the call over to Bryan.

Thank you, Dan. Before diving into our quarterly financial results, I want to echo what Dan shared and say that I'm pleased with our second quarter performance. I will now comment on our strategic objective category of scale. For the second quarter of 2023, we generated $73.2 million in total revenue. This represents an outperformance relative to the midpoint of our guidance, and it represents an increase of 4% year-over-year. Technology revenue for the second quarter of 2023 was $47.3 million, representing 4% growth year-over-year. This quarterly revenue performance was slightly higher than anticipated in our quarterly guidance due to a few technology environment go-lives that generated a deferred revenue catch-up occurring earlier than forecasted. Professional services revenue for Q2 2023 was $25.9 million, representing 3% growth relative to the same period last year. For the second quarter of 2023, total adjusted gross margin was 50%, representing a decrease of approximately 500 basis points year-over-year. In the Technology segment, our Q2 2023 adjusted technology gross margin was 68%, a decrease of approximately 270 basis points relative to the same period last year and in line with previously shared expectations. This year-over-year performance was mainly driven by headwinds due to the continued cost associated with transitioning a small subset of our client base from on-premise to third-party cloud-hosted data centers in Microsoft Azure, as well as from costs associated with migrating a subset of our client base for our multi-tenant Snowflake and Databricks enabled data platform environment, partially offset by existing clients paying higher technology access fees from contractual built-in escalators without a commensurate increase in hosting costs. In the Professional Services segment, our Q2 2023 adjusted professional services gross margin was 17%, representing a decrease of approximately 960 basis points year-over-year and a decrease of roughly 330 basis points relative to the first quarter of 2023. This quarterly performance was generally in line with the expectations we shared on our last earnings call and primarily driven by new service relationships that start out at a low gross margin and expand over time. In Q2 2023, adjusted total operating expenses were $32.9 million. As a percentage of revenue, adjusted total operating expenses were 45%, which compares favorably to 52% in Q2 2022. Adjusted EBITDA in Q2 2023 was $3.5 million, with this performance exceeding the midpoint of our guidance and which represents an increase of $1.5 million relative to the same period last year. This Q2 2023 adjusted EBITDA result was mainly driven by the quarterly revenue outperformance mentioned previously, along with the timing of some non-headcount expenses that we anticipate will be pushed out to the second half of the year. Our adjusted basic net income per share in Q2 2023 was $0.05. And the weighted average number of shares used in calculating adjusted basic net income per share in Q2 was approximately 56 million shares. Turning to the balance sheet. We ended Q2 2023 with $343.8 million of cash, cash equivalents and short-term investments compared to $363.5 million at year-end 2022. Related to our cash balance, in Q2 2023, we came to a settlement in regards to our previously disclosed litigation with PASCAL metrics. The total settlement amount was $18.8 million, which was within the anticipated range of outcomes we disclosed last quarter in our 10-Q. In terms of liabilities, the face value of our outstanding convertible note is a principal amount of $230 million due in 2025. As it relates to our financial guidance, for the third quarter of 2023, we expect total revenue between $70.2 million and $74.2 million and adjusted EBITDA between $0 million and $2.5 million. And for the full year 2023, we now expect total revenue between $290.5 million and $295.5 million. At their respective midpoints, this represents an increase of $0.5 million compared to the full year revenue guidance we provided last quarter. We also expect full year 2023 adjusted EBITDA between $10 million and $12 million. At their respective midpoints, this represents an increase of $1 million compared to the full year adjusted EBITDA guidance we provided last quarter. Now, let me provide a few additional details related to our 2023 guidance. First, as it relates to our Q3 2023 revenue expectations, we anticipate that our revenue will be slightly down quarter-over-quarter, primarily driven by the previously mentioned first half one-time revenue items and go-lives that generated a deferred revenue catch-up as well as the timing of our revenue generation from net bookings in the first half. Next, in terms of our adjusted gross margin, we continue to anticipate that our adjusted technology gross margin will be in the high 60s in the third quarter. In the Professional Services segment, we anticipate that our Q3 adjusted professional services gross margin will be down a few points compared to Q2 of 2023. The result of new tech-enabled managed services revenue, which begins at a low gross margin before expanding over time. Lastly, we anticipate our operating expenses will be slightly up relative to Q2 2023, mainly due to some non-headcount expenses that we now anticipate will occur in Q3 as opposed to Q2 2023. Lastly, let me share a few additional details related to our full year 2023 guidance. As Dan mentioned, we are pleased to be in a position to increase the midpoint of our guidance range for both revenue and adjusted EBITDA. In terms of our adjusted gross margin, we continue to expect that our adjusted technology gross margin will be in the high 60s through 2023. For our adjusted professional services gross margin, we anticipate that we'll be in the high teens for the year, primarily as a result of our mix of professional services being comprised of a larger percentage of tech-enabled managed services, given the strong growth in that segment of our business with those relationships starting out at a lower gross margin and expanding over time. Lastly, we anticipate our adjusted operating expenses as a percentage of revenue will be down more than 700 basis points year-over-year, largely the result of our restructuring efforts and meaningful continued operating leverage, with the largest year-over-year reduction occurring in SG&A. With that, I will conclude my prepared remarks. Dan?

Thanks, Bryan. In conclusion, I would like to recognize and thank our clients and team members. Without their consistent engagement in and contributions to our shared mission, none of this would be possible. And with that, I'll turn the call back to the operator for questions.

Thank you. The floor is now open for questions. Our first question will come from Elizabeth Anderson with Evercore ISI.

This is Samir Patel on for Elizabeth Anderson. One question, I just wanted to get some more color into is how do we read into this increased revenue guidance given the reiterated net retention rates, at least that range, does that imply an improving outlook on new customer wins? Or are you just expecting to reach maybe slightly higher point within that net retention range that you've shared?

Yes. Great question, Samir. So the primary drivers of the increase to our revenue guidance range this year are mainly timing. So we are a little bit ahead of schedule as it relates to, as I mentioned, some client implementations and go-lives and some of the bookings that have rolled through for the year. So that's the primary kind of driver. What you're describing, Samir, around kind of the new client environment as well as the dollar-based retention rate for us is a little bit less impactful in a year because of the kind of more back-end weighted nature of our bookings this year, which is kind of what we expected coming into 2023, but that growth will be more pronounced as we complete the year and drive towards 2024.

Our next question will come from Vishal Patel with Piper Sandler.

This is Vishal Patel on for Jeff Hainan the quarter. You wanted to ask about the recently proposed lump-sum 340B remediation payments to the hospitals. From our conversations with customers, are those payments shaping up to be a tailwind for U.S. health systems perhaps further investing in data and analytics?

It certainly helps, yes. And I think there are a couple of modest tailwinds that we're observing across our client base. That's one of the tailwinds. I think there are some other tailwinds in terms of inflationary pressures coming down a little bit as it relates to labor and supplies, all of which are contributing to a slightly better operating margin environment, which we believe will be a midterm tailwind for us.

Next, we have a question from Daniel Grosslight with Citi.

I'm interested in understanding how we should approach the services gross margins as we move into a more typical environment in 2024 and beyond. Considering the transition to tech-enabled managed services, do you anticipate this will result in margins in the high teens or low 20s in the future? Or do you believe you'll eventually return to the margins you had achieved before the recent downturn? Additionally, could you provide more details on how this impacts EBITDA? Even though the gross margins may be lower, you might not have many of the setup costs, which could allow for a quicker contribution to EBITDA compared to products with higher gross margins.

Yes. Well said, Daniel, I think both of those points are important. So on the first point, we are continuing to gather data. And obviously, we’re excited to have seen, as we mentioned in the prepared remarks, from July 1 of last year through June 30 of this year, a really significant growth in tech-enabled managed services within our professional services segment. It’s growing very rapidly at more than 80%. That is encouraging to us. We see in our pipeline further growth in that kind of opportunity. And as we’ve mentioned with the two examples that we went through, these can be very large contracts. And there are also long-standing contracts, typically 5 years locked in, which is really helpful. To your point, there are many positives, and then there are a couple of challenges with regards to those kinds of contracts. One of the challenges is that, as Bryan mentioned, early on, gross margin is quite low, sometimes starting as low as around 0%, but then migrating over time up to the mid-20s, as we’ve shared in the past. That is different from what we talked about when we went public in terms of the long-term professional services gross margin target more like in the mid-30s. We still do have other professional services that we continue to offer, some of which do have a higher margin profile. I think we’re early in the process of understanding exactly how this all plays out over time. We’re definitely encouraged by the fact that, to your second point, those technical managed services, as we sign these large contracts, we’re seeing over and over again that they do not require meaningful incremental operating expenses. And as such, even in that scenario where we’re getting to more like a mid-20s gross margin profile for the professional services, it also includes meaningful tech subscriptions usually migrating to All Access, which is a much higher gross margin profile. And the lack of a requirement of incremental meaningful operating expenses leads us to have confidence, even in scenarios where tech-enabled managed services continues to be a strong growth engine, that we can maintain that long-term EBITDA guidance of 20% plus.

Yes. And I'll just add to that, Danny, so we are encouraged to see a little bit more EBITDA progress this year than what we had expected coming into the year. And then in terms of the long-term target commentary that Dan was referring to, well, that is an area on the professional services side that we're studying more and we'll likely have more to say as we learn more about the level of demand on the tech-enabled side. But what we do continue to feel confident in related to our long-term targets that we set at IPO are the long-term revenue growth rate of 20% plus and the long-term EBITDA profile of 20% plus.

Our next question will come from David Larsen with BTIG.

Congrats on the good quarter. So you signed two very large deals, one for $50 million, one for $60 million. Yet you described the hospital sort of environment as modest improvement and slight improvement. Just any more color there would be very helpful. I mean, as far as I can tell, those are very significant contracts. I’m assuming that even at the end of the 5 years, they’ll probably renew again. Just any more color would be very helpful.

Absolutely. Thanks for the question, David. So we are definitely encouraged to see two more examples of really large tech-enabled managed services contracts. And of course, over the last 9 months, we've seen several of these really meaningful expansions with our existing client base. We're very encouraged by that. Now some of the reasons for these large expansions is because tech-enabled managed services offers financial relief. It offers help with regards to financial pressures. And so certainly, that part dollar ROI that we're able to offer has helped us to be part of the solution to help systems as they're facing financial pressure. And as we know, for decades now, health systems have had to operate with very low operating margins, so that changing in the foreseeable future at a significant level. So we continue to feel like that tech-enabled services value proposition of being better, faster and cheaper is very, very compelling and will be a really nice growth engine for us for many years. At the same time, we're also encouraged any time our client end markets' financial condition improves a little bit, it just becomes a little bit easier for us to keep moving forward and expanding the relationship, both with technical services but also in other areas as well. So that is nice to see some tailwinds and nice to see some improvements in their operating environment.

Okay. And then just one more quick one. Did I hear you say that you’re going to be managing nearly all of the nonclinical aspects of one of your hospital clients as part of one of these deals?

You did hear that in the ambulatory space. So all the ambulatory clinics, the nonclinical staff, the vast majority of them are now dual employed, including a primary employment relationship with Health Catalyst. We're really excited about that. We've talked in the last couple of earnings calls about how important ambulatory operations are to our health system clients. So many of them have made strategic moves into the ambulatory space, purchasing clinics and physician practices, but so many are struggling from a financial and operational performance perspective. And we've, for a number of years, provided technology support to improve those operations, but this is really a deeper step in that direction of getting right into the trenches and managing most of the staff at these clinics. And we do view this as a really exciting new tech-enabled services offering area for us.

Thank you. Next, we have Jack Wallace with Guggenheim Securities.

Congrats on the quarter. It sounds like we've got four pretty substantial client expansions in the Teams agreements so far this year. In thinking about the 10 deals, when we spoke earlier this year, you talked about having some pretty good visibility into when these types of deals might be signed about one to two quarters out. As we're sitting here in August with the meta selling season in the back half of the year. What kind of incremental visibility do you have into that 102 to 110 net dollar retention range? And are we shading towards either end of that range at this point?

Thank you, Jack. I appreciate the question; it's an important one. We have signed several large service contracts in the past nine months, including five that encompass the Karl Health deal, which was finalized at the end of last year and took effect at the beginning of this year. From these contracts, we have observed some emerging patterns. Firstly, we have good visibility regarding our chances of winning these contracts. In each instance, we received strong indications several months before the actual signing that the clients had decided to proceed with us. However, we have also recognized that it remains challenging to predict exactly when the contract signatures will occur. This is partly because these contracts are substantial and tend to be long-term, often spanning five years, which requires us to go through additional confirmatory steps. These steps are generally positive; for example, it has been beneficial for me to interact with Board members from various clients, allowing us to build long-term relationships. Nevertheless, these processes take time. Looking at the latter half of this year, we are excited about our growing pipeline and the meaningful opportunities ahead. We feel we are on track, similar to what we have experienced in the past, concerning our chances of winning these contracts. Historically, almost all of these opportunities have made us the sole source vendor under consideration, without a competing RFP process. Therefore, it comes down to the clients deciding to shift from managing these services in-house to partnering with Health Catalyst. However, we continue to find it difficult to predict precisely when the contracts will be signed and when revenue will start, which is why we’ve provided a wide range for dollar-based retention due to the size and variability of these deals. For instance, last year, the Karl Health deal alone impacted our dollar-based retention by about four points. The timing of signing in December versus January or February shows significant effects. We have not updated our retention range because these dynamics still hold. Yet, we are optimistic about the long-term strategic benefits of these tech-enabled service contracts as we maintain strong relationships; the clients are committing to five-year contracts, locking them into both the technology and services. Therefore, we find the near-term uncertainty manageable in the long run.

Our next question comes from Scott Schoenhaus with KeyBanc.

Thanks for all that updated color on the hospital end markets. I thought that was very nice color from where we talked 90 days ago, and very encouraging. I want to focus in on the margin. So you talked about the non-headcount headwind in the back half. Is that related to the third-quarter internal marketing event that you guys do annually? And then built within that is outside of that non-headcount-related item, you’re seeing a lot of leverage, operating leverage in sales and marketing. How should we think about that going forward? Should we continue to see that as we continue to see strong demand for expansion services, meaning that you won’t need a robust sales and marketing team if your clients are just expanding their services?

Thank you, Scott. I'll address the second question, and then Bryan can handle the first. Regarding the second question, we have gathered more data on tech-enabled managed services contracts that encourage us about operating leverage. One key point is that we see significant leverage in sales and marketing, as we've mentioned before. For instance, one effective account executive can manage a complex and extensive relationship with a client. A case in point is the Karl Health deal, where we started with one account executive, and their contract grew from $4 million to $16 million, all while maintaining the same account executive who manages the relationship effectively. This highlights the meaningful sales and marketing operating leverage we are experiencing, and we expect this trend to continue with other contracts and expanding client relationships. Focusing on expanding existing client relationships provides us with substantial leverage, making our sales and marketing efforts yield high returns. This long-term strategy encourages us. Additionally, as stated in our prepared remarks, we see operating leverage not only in sales and marketing but also in G&A, allowing us to handle large contracts without significantly increasing G&A infrastructure. Starting in 2024, we expect to experience meaningful R&D leverage as well. Overall, these various aspects are encouraging as we view tech-enabled managed services as a growth engine moving forward.

Yes. And to just answer your first question, Scott. So related to our EBITDA margin trends for the year, we are encouraged to have been in a position to raise our EBITDA margin target for the year slightly and continue to make progress on, as Dan mentioned, operating expense efficiency and leverage. There is a little bit of seasonality in our non-headcount spend. We had some non-headcount spend that, to your point, has got things like advertising spend, some event spend, and things like contractor work on the R&D side that we think has just slipped to the back half of the year, rather than in the first half of the year, but less so related to the large marketing event.

Our next question will come from Richard Close with Canaccord Genuity.

This is John Penny on for Richard Close. Congrats on the quarter. Just a question, again, I'm going back to the tech-enabled managed services. Just exactly like what exactly is your expectation in terms of timing for like for the margins to ramp? Like how long do you think it will take to get to the 20% from the low single-digit data?

Yes. Thank you, John. So as we’ve discussed in the prepared remarks and as we’ve discussed in prior quarters, often we begin these tech-enabled services relationships around 0% gross margin, give or take, and each contract is a little bit different. But typically, we start with quite a low gross margin, somewhere in that 0% plus range. And then over the course of a typical 5-year contract, we see gross margin improvement in the tech-enabled services part of that contract where that grows from 0% early in that first year to that 25% long-term target towards the end of that 5-year contract term. It’s important also to note that we also benefit from the fact that there’s a technology subscription that’s also part of that client relationship. In each of the cases that we’ve shared over the past 9 months, our clients have migrated from a little bit more modular relationship to a more all-access type of relationship. That often involves some meaningful tech expansion at a high gross margin. And so the combination of the tech and tech-enabled services is also what really contributes to our confidence level that with those kinds of relationships, we can still produce a 20% plus EBITDA margin.

Yes. And just to add to that, we do have a couple of data points of clients who have been longer standing in terms of the tech-enabled managed services relationship with us that have migrated toward that technical managed services gross margin level. So that’s been encouraging. While it’s been more of a recent focus for us on some of these newer deals, that does present a bit of a headwind in the second half and into 2024. But as Dan shared, moving to these long-term, very deep strategic relationships that are locked in for 5 years provides us with great visibility as compared to kind of the more traditional model that we’ve seen, which has been a more month-to-month model.

Our next question will come from Stan Berenson with Wells Fargo Securities.

It looks like your conference has shifted from a typical 3 to 1Q. A couple of questions on that. I guess, one, how should we think about the timing in terms of the associated expenses here? And then does that, in any way, shift your visibility into next year's bookings?

Yes. Thank you, Stan, for the question. Yes, we did decide to make a shift in the timing of the Healthcare Analytics Summit from September to the wintertime. So February of next year will be when we hold that – we do love that event as an opportunity for our existing clients to gather for a user group experience and for us to talk about ways in which we can expand and deepen those relationships. And we also open it up to others who aren’t clients that help Catalyst to come and view it as an industry event and an opportunity to learn more about healthcare analytics. So that is an important enabling factor in our ability to continue to keep moving forward with regards to pipeline conversion and bookings. But we rather anticipate that that will be a nice tailwind in early 2024 that will help us to continue the momentum that we see. As we mentioned in our prepared remarks, we feel encouraged by the fact that our pipeline is growing. We feel encouraged by the fact that we have the coverage that we need to have reiterated our confidence in the full-year bookings expectations, both with existing clients from a dollar-based retention rate perspective and with regards to net subscription clients.

Yes. And just in terms of the timing of the expense, Dan, so most of that expense for the summit will occur in the Q1 timeframe. There is some, as you get prepared for the summit, some work that leads up to that. There will be some expense for us this year in the back half, in particular in Q4. But most of that will kind of change in terms of the different quarterly cadence. And again, one of the areas that we continue to be very focused on in terms of operating expense, streamlining and leverage will continue to be sales and marketing.

Our next question will come from Jeff with Stephens.

I wanted to follow up on the earlier question on the TEMS ambulatory win. I'll try to lump a few related questions together. Just curious what the kind of core focus will be for that nonclinical ambulatory stuff that you'll be rebadging; categories like data management, quality reporting intake, or revenue cycle come to mind, but curious to hear more from you there. And then also looking to get some color on the shared success possibility. Just any detail on the KPI or type of KPIs that could lead to earning a shared success bonus? And lastly, just any color you could add on how the rebadging can better leverage technology to create the efficiencies and hard dollar ROI that you talked about.

Excellent. Thank you, Jeff. So we are very excited about this ambulatory operations opportunity. And as I mentioned a few minutes ago, we have been, for a number of years, providing technology support and analytics support so that our clients can understand their ambulatory performance, both financially, operationally and clinically. And we've seen really meaningful opportunities for improvement that we showcased through our technology, but it's been harder for us to help our clients actually realize the improvement that would lead to improved clinical outcomes, financial and operational outcomes. So this is an opportunity for us to really go deeper. And to your point, as we pinpoint opportunities there on the revenue and volume side, which there are some greatest hits there that you would typically see in terms of opportunities for productivity improvement or on the cost side in terms of efficiency management, whether that's labor utilization, supplies utilization, or other factors as well. We have been aware of those specific opportunities. We've highlighted those for clients, but now we're moving most of the team that can implement the changes necessary to see the improvement. And that leads to your second question as it relates to how the shared success bonus structure works. In this first case, it's quite simple. It is focused on us improving the operating income of those clinics. And as we do so, we'll share in the success of the improvement that we've seen in that operating profit. And so that is a great focusing mechanism for all of us to be aligned in terms of seeing that operational and financial performance, which also can often be driven by clinical improvement in terms of the way that we treat patients. So that's how the shared success bonus is focused. And then, in terms of how we're managing the rebadged staff, one of the things we love about technical managed services is it plays to some of our natural differentiated strengths as the best place to work with very high team member engagement. Our last Gallup survey put us in the 97th percentile in terms of our team member engagement relative to a very large benchmark set. And we intend to leverage that engagement with these team members to enable them to really help drive the needed operational, financial and clinical changes that will lead to that improved performance. And so we have seen that work in really effective ways in our other tech-enabled managed services relationships, and we're excited to see similar kinds of results as we move into this ambulatory operations space.

All right.

And our next question will come from Sarah James with Cantor Fitzgerald.

And congrats on the quarter. It was really interesting earlier you mentioned having the opportunity to talk to some Board members of provider clients around their strategy of budget setting. Were you able to glean any trends of what market conditions they're looking for the longevity of those? And if you could give us a reference from the last margin expansion cycle that providers went through, what was sort of the lag that you saw between market conditions changing an uptick in appetite for contract expansion?

Thank you for your questions, Sarah. My experience with Board members at health system clients shows that they are focused on long-term strategic goals. It's important for these health systems to be prepared for economic ups and downs. One compelling aspect of our technical managed services is the visibility and predictability we provide over an extended period, which helps them navigate these cycles. Although we aim to structure contracts for five years, we've found that clients with long-standing relationships with us are likely to renew, indicating that their decisions span more like 10 to 20 years. These decisions grant them the predictability needed to manage costs effectively while ensuring they receive cost efficiency from a partner who cares about their team members. Additionally, these Boards are community-focused and value the long-term employment impacts on their local areas. Keeping employees engaged locally while supporting the financial sustainability of health systems is an attractive aspect of our offering. Importantly, the team members we integrate can become catalysts for improvement throughout the healthcare ecosystem, enhancing clinical and patient outcomes while driving operational and financial gains. From numerous face-to-face interactions with C-suite executives and Board members, I’ve learned that they seek ways to navigate challenging economic conditions with predictability. In healthcare, the fluctuations are typically less extreme compared to other sectors. Therefore, having this predictability can be beneficial, as even small increases in operating margins allow for greater investment in long-term strategic initiatives. Regarding your last question, we see positive movement in recent months, and we are noticing some momentum in our operating margin improvement and pipeline expansion. However, the changes in healthcare are usually less pronounced in both directions compared to other industries.

And the data point I would just share, Sarah, is that as you see some of that pipeline start to move for us, traditionally, our sales cycles do tend to be longer. So they're around a year on average, and they typically kind of align with fiscal years or budget cycles for health systems, which are usually July 1 or January 1. So certainly, it will take time for some of that kind of improvement to roll through our pipeline and into a bookings cadence over the medium term.

Our next question comes from Sean Dodge with RBC Capital Markets.

This is Danielle for Sean. I just want to confirm whether the $2 million to $3 million cost stability was already included in our initial 2023 guidance, or if it represents a shift more recently to 2024.

Yes. And it was a little hard to hear you, Thomas. But yes, the Summit event we had been working on early in the year in terms of timing. And so generally contemplated that in terms of our guidance for 2023. And so that's kind of played out in line with that expectation.

All right. At this time, there are no further questions in the queue. So I would like to turn the floor back over to Mr. Dan Burton for any additional or closing remarks.

Thank you all for your time and for your interest in Health Catalyst. We appreciate it, and we look forward to staying in touch.

Ladies and gentlemen, thank you, and this does conclude today's Health Catalyst Second Quarter 2023 Earnings Conference Call. Please disconnect your lines at this time, and have a wonderful day.