Good day ladies and gentlemen, and welcome to the Health Catalyst Incorporated Second Quarter 2019 Earnings Conference Call. And at this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. [Operator Instructions] I would now like to introduce your host for today’s conference, Mr. Adam Brown, Senior Vice President of Investor Relations for Health Catalyst. Sir, you may begin.

Good afternoon, and welcome to Health Catalyst’s earnings conference call for the second quarter of 2019, which ended on June 30, 2019. My name is Adam Brown. I am the Senior Vice President of Investor Relations for Health Catalyst and with me on the call is Dan Burton, Health Catalyst’s Chief Executive Officer and Patrick Nelli, Health Catalyst’s 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, and 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 days. We disclaim any obligation to update any forward-looking statements or outlook. Actual results may differ materially. Please refer to the risk factors in our most recent Form S1 and Form 10-K and 10-Qs to be filed with the SEC. We will also refer to certain non-GAAP financial measures to provide additional information to investors. A reconciliation of non-GAAP to GAAP measures is provided in our press release. During the call, we may offer incremental metrics to provide greater insights into the dynamics of our business. These details maybe one-time in nature and we may or may not provide updates in the future. With that, let me turn the call over to Dan for his prepared remarks and then Patrick will provide prepared remarks, as well as provide the outlook for Q3 and full year 2019. Dan and Patrick will then take your questions. Dan?

Thank you, Adam and thank you to everyone who has joined us to discuss our second quarter 2019 performance. We are excited to hold our first earnings call as a public company. For those of you that Patrick and I had the opportunity to visit with during our IPO road show, let me express appreciation for your interest in our company. For those on this call who are new to Health Catalyst, welcome. Given that this is our first quarterly call as a public company, I’d like to make some introductory comments about Health Catalyst. We are a leading provider of data and analytics technology and services to healthcare organizations. Our solution is comprised of a cloud-based data platform, analytics software and professional services expertise. Our customers who are primarily healthcare providers use our solution to manage their data, divide analytical insights to operate their organizations and produce measurable clinical, financial and operational improvements. Health Catalyst was founded in 2008 by pioneers within the healthcare data and analytics industry. From the beginning, the Health Catalyst Solution has been focused on enabling our mission to be the catalyst for massive measurable, data-informed healthcare improvement. We accomplish our mission with each of our customers by delivering on the three components of our solutions, the data platform, analytics applications and services expertise, which together drives measurable improvements for our customers. We describe this process collectively as the Health Catalyst flywheel. At the center of our flywheel is the engagement of our team members. Team member engagement is foundational to everything we do at Health Catalyst and it’s the highest priority of our leadership team. When team members feel connected to our mission and are listened to, cared for and respected at an extraordinary level, they produce outstanding work, which enables our customers to…

Thank you, Dan. As Dan mentioned, I will be discussing our company’s performance in the strategic objective category of scale. Our scale performance category is focused on enabling greater contribution to our mission by sustainably scaling our organization. Before diving into our second quarter financial results, I want to echo Dan’s sentiment and say that I am pleased with our second quarter results and the momentum we are seeing across our business. Additionally, given that this is our first public earnings release, I am going to provide some explanatory remarks for significant components of our operating results prior to providing the detailed numbers for the quarter in order to highlight some of our key income statement drivers and trends. In terms of revenue, the vast majority is recurring in nature and we segment our reporting by Technology and Professional Services revenue. Technology revenue consists primarily of subscription fees related to our data platform and analytics applications. Professional services revenue includes access to analytics and domain expertise services, typically provided on a recurring FTE basis. We expect Professional Services to continue to be a meaningful portion of our revenue over the long run, because such professional services are critical in enabling our customers to drive to data-informed improvements. In terms of revenue growth, we primarily grow through one, the addition of new DOS subscription customers, two, technology revenue expansion as a result of annual built-in contractual escalators, and three, professional services revenue expansion as customers choose to access additional services experts under a recurring FTE model. Lastly, as it relates to revenue, we acquired Medicity at June 2018 for immaterial consideration. Current Medicity customers represent approximately $25 million of flat to declining annual revenue and thus starting in Q3, we will have a negative impact on overall revenue growth compared to…

Thanks, Patrick. In summary, we are pleased with the performance of the company. We could not have made this progress including the successful execution of our IPO without all the hard work, commitment and dedication of our Health Catalyst team members who work each day to enable our customers to realize improvement and success. We are looking forward to keeping you updated on our progress. And with that, let’s open it up for questions.

[Operator Instructions] And our first question comes from Robert Jones with Goldman Sachs. Your line is now open.

Hi, this is Jack on for Bob. Thanks for taking the question. Any chance you can update us on your view of net new DOS subscription customer adds for the year versus a few months ago? Generally, do you guys feel like things are better or worse since you last spoke?

Yes, happy to address that, Jack. We are going to be disclosing the number of net new DOS subscription clients on an annual basis. We will not be providing that update on a quarterly basis. What I would share is, we feel comfortable that we are on track with regards to our guidance and with regards to the discussions we’ve had with research analysts for the year.

That’s helpful. Thanks guys. I’ll hop back in the queue.

Thanks, Jack.

Thank you. And our next question comes from Anne Samuel with J.P. Morgan. Your line is now open.

Hi guys. Thanks for taking the question. Could you speak for the Medicity conversion opportunity? How many of the convert is DOS so far? What’s in your pipeline? And then how should we be thinking about the longer-term opportunity? Thanks.

Happy to address that Anne. As we have previously discussed, when we thought about the strategic benefits of acquiring Medicity, one of the primary benefits that we focused on was the cross-sell opportunity where Medicity had an existing client relationship with 60 health systems that we consider to be right in the bull's eye the kind of health system that we would target as a customer. So that was an important part of the decision to move forward with the acquisition of Medicity in the first half of 2018. At the same time, we recognized that there would be significant operational items that we would need to address and we focused first on getting those operational items addressed which we knew it take six to nine months in order for us to be in a position to go to those customers with a stable core product in the HIE space that we could then have demonstrated that stability and that commitment to them to bridge then to a cross-sell discussion. As we’ve also discussed in prior meetings and in the IPO road show, our average sales cycle is around one year. So we also knew that it would take time for that cross-sell message to develop through our pipeline and for us to see actual results. As a result, we’ve just really begun in the second quarter in earnest that process of significant cross-sell discussions and as a result, we would expect more of the cross-sell results to show up within the next 12 to 18 months in particular. We have signed earlier this year our first cross-sell deal with a Medicity customer. We are excited about the momentum that we see in the pipeline and we feel good about how we believe that pipeline will materialize over time. But we do feel that it will take a meaningful amount of time given the sales cycle.

That’s very helpful. Thanks. And then maybe just one for Patrick, can you speak us some of the moving pieces in the gross margin? You’ve had two quarters now of pretty substantial expansion in professional services. So, just, how should we think about the dynamics in the back half and then longer-term, where should that level out at?

Yes, of course, so, we will break it up between technology and professional services. On the technology side, as we mentioned in the prepared remarks, because we deploy DOS at all DOS subscription customers, and our applications very scalably plug on top of DOS, as our technology access fees increase with the customer as they mature, most of that increased revenue drops to bottom-line and those are technology access fees expand as the customer matures with us, that means in the long run, we would expect technology gross margins to get into the mid-70s. However, we sell the few remaining on-premise and private cloud datacenter customers that we need to move to the Microsoft Azure environment and thus we expect technology gross margins to remain roughly flat over the next couple of years. So really that increase starts a couple of years out. On the professional services side, we would expect our long-term professional services gross margins to be in the mid-30s. As you pointed out, it has fluctuated over the past and we would expect it to continue to fluctuate some based on hiring patterns and some one-time professional services revenue. But over the next several quarters, we would expect it to be getting close to that 35% or mid-30s long-term professional services gross margin target. When you take those two combined, over the long-term, we would expect overall gross margins to get into the high 30s.

Can I make one comment, also, I agree with everything Patrick shared, just on the professional services gross margin, I would note that we are concerned and we want to ensure the sustainability of the pace of the delivery of our professional services organization and as such, we are focused on making sure we are balanced in the utilization metrics that we track. So that our team members can sustain the work that they do over longer periods of time. We got a little ahead of ourselves in Q2 as Patrick mentioned earlier that, that our hiring took a little bit longer than what we had projected, which means that our existing team members needed to stretch a little bit beyond what we would view as sustainable. So, we are working to get that balanced out and that’s one of the reasons why we want to make sure we are clear about that long-term expectation that that is in the mid-30s.

Very helpful. Thank you.

Thank you. And our next question comes from Ryan Daniels with William Blair. Your line is now open.

Yes, gentlemen, thank you for taking the question. I want to start with something about the addressable market. I know you highlighted both in inaugural pharmaceutical manufacture and international sales, can you speak a little bit more beyond the $8 billion core addressable market you laid out on the road show to what those novel avenues of growth could mean for the organization over the next three to five years?

Yes. Happy to address that, Ryan. As we discussed on the IPO road show, we take an approach to forecasting which includes the way that we forecast our total addressable market to be very data-informed and we try to be disciplined in waiting until we have enough data points to be data-informed. That’s why we chose the $8 billion addressable market to be a U.S.-based market and focused on the core markets where we have significant traction already demonstrated. As a result, we excluded international and we excluded life sciences. And while we have been excited to see some early momentum and our first few contracts being signed both internationally, as well as in the life sciences space, we are certainly too early from our perspective to project forward how that might change the total addressable market. We would need to see quite a few more data points before updating a TAM calculation or having an informed perspective there. But we are continuing to invest in those adjacencies as we see early momentum and some specific areas where we feel that there is differentiation at the hypothesis that we are excited to pursue.

Okay, very helpful color. And then, Dan, another one for you and I’ll hop off. I know the culture is really of utmost importance for the organization and you provided a nice data point about the 98% engagement in gallop pool. But I am curious if you noticed any changes since the IPO and your status as a public company given all the press and kind of eminence you are seeing since the successful offering? Thanks.

Thank you for the question, Ryan. I appreciate it. Which has been an area of focus for our company for many, many years and our particular focus as we have gone through the process of transitioning from a private to a public company, as all of you, no doubt, are aware a number of companies do change materially from a culture perspective as they make that transition from private company to public company and we’ve been aware of this. We try to be good learners, good students of what has happened in the past. And as such, we felt that the management team it was important to put counterbalances in place to reassure our team members first that we would continue to be mission-focused, mission-centered and focused on the execution of the flywheel, that’s our primary company strategy which has team member engagement at the center of our flywheel. So we’ve taken a few actions to try to reinforce the team members that those areas of commitment will continue. One example of this is, in the past, I have had a personal goal of having 100 skip level one-on-one discussions with team members per year. We doubled that goal for 2019 and beyond to 200 skip level discussion with team members. We have also continued practices that we’ve held for a long period of time like the practice of having all team member meetings every two weeks where we share detailed information with our team mates and continuing the practice of making every team member and owner and treating them like owners in the company. So, we are trying to make sure that we can consistently reinforce that focus on team member engagement as it is my number one priority and we believe it’s part of the long-term differentiation of the company moving forward.

I really appreciate that color, Dan. Thank you.

Thank you. And our next question comes from Sean Wieland with Piper Jaffray. Your line is now open.

Hi, thanks guys. So, a little different twist on Ryan’s question. How has the – what have been the effects of the IPO as it relates to your discussions with clients and in particular prospects as you continue to build your pipeline?

Yes, good question, Sean. So, what I would share is, we’ve also tried to be thoughtful in our discussions with clients and prospects about why Health Catalyst’s decision to remain an independent company is beneficial to our customers. And part of the way that we tried to frame all of the activities surrounding the move from being a private company to being a public company is, that this is a demonstration of Health Catalyst earning the right to stay independent as a company. And that independence allows us to keep the flywheel at the center of everything that we do to keep the mission at the center of everything that we do and that flywheel is all focused on enabling our clients to measurably improve. So the message to our clients and even the prospects has been this is the past that has enabled us to maintain our independence which also enables us as leaders and as team members to make and then keep commitments to our customers and have the authority to keep those commitments and that is now is the case in other scenarios like when a company becomes acquired. So, we are pleased with the receptivity of our clients to understanding the value of Health Catalyst maintaining its independence as a means of continuing to make and then keep commitments.

The other item I would add is, we, often times have fairly large either customers or prospects and are curious about our current financial situation. So I actually have had calls recently with potential prospect CFOs and we added transparency and actually CFOs who read the S1 and noticed the flywheel in our core principles and that we are mission-focused. That added transparency as at least I’ve seen in the last couple weeks has been helpful.

That’s great. Thanks so much.

Thank you. And our next question comes from Ross Muken with Evercore. Your line is now open.

Hey, guys. This is Susy on for Ross. Congrats on the quarter and thanks very much for the questions. I’ve got a couple if that’s okay. So, on the tech side of DOS subscription customers, how much is the growth is coming from contractual escalators versus expansion of new apps? And then, when we think about modeling forward, how should we think about the churn rate?

Yes, good questions, Susy. So, I’ll address a couple of components and then Patrick if you have anything to add, please feel free. So one of the other metrics that we will be disclosing on an annual basis is the dollar-based net retention rate. We won’t be disclosing that on a quarterly basis, but we will update at the end of this year. As we think about how we are tracking as company relative to where we have been historically and we disclosed in the IPO road show process. But our 2018 dollar-based net retention rate was a 107%, our 2017 dollar-based retention rate was 108%. We feel comfortable that we are tracking well against that kind of performance from a dollar-based net retention rate, which is net of churn. And it is a good way to think about the expansion within our existing plans. Then a reasonable way of thinking about the other aspects of growth that are produced from an organic perspective would be the addition of new clients in both our core markets and our adjacent markets. Anything you would add, Patrick?

Yes, of course, and so the only couple items I’d add is, most of that expansion on the technology side, to your question, Susy is from the annual built-in escalators and that’s because greater than 70% of our customers are under that all access model where customers are adopting new and additional analytics applications as they mature with us. But the way we charge them for that are through those annual contractual escalators. Then the other item I’d add in regards to churn is another good way to think about the business is, services. So that 107% that they had mentioned in 2018, our dollar-based retention rate includes both technology as well as services. And services can have some more up as well as downs. So we can have more meaningful expansion potential with the customer, but we can also have churn potential on the services side.

And just a note on that last point, we tried to make it simple and easy for our customers to interact with us from a contractual perspective and that includes both the technology subscription contract which is simple and straightforward, as well as the services contract which is an FTE-based contract is also simple and straightforward and we make it straightforward for clients to choose the dial up or down the number of FTEs that they would like to access. And that’s what drives those fluctuations. We still see that that clients choose to dial up more than they choose to dial down. But we do make it easy for them to choose the right level of FTE assistance for them.

Got it. That’s extremely helpful. And then, I’d like to dig a little bit more on the TAM. You’ve talked about the $8 billion TAM and also an assumed price per customer for fully penetrated customer for your different product lines. Can you talk about the assumptions behind a fully penetrated customer? For example, in the data platform, you assume 1.7 million for the data platform. What are you assuming there in terms of contract life, type of contract?

Yes, good questions. So, I’ll offer a couple thoughts and then Patrick, feel free to offer some additional thoughts. So, first I would mention, we try to be data-informed and careful in the way that we think about TAM and all other forecasting. As we think about a fully penetrated customer a couple of data points that maybe of use, when a customer begins their relationship with Health Catalyst, they typically began their total relationship which is inclusive of both tech and services at $100 million, $200 million a year from a recurring revenue basis. Our longest standing client cohort spends more than twice that amount with us. And so, the fully penetrated client perspective could – you could think of roughly correlated to a client cohort that’s much more mature with us like those longest standing clients. And we understand how that progression works over a number of years. Importantly, our longest standing client, for example is Allina Health. We are in year eleven of that relationship and they just recently signed a five year extension to that relationship. Likewise, as Patrick mentioned a few minutes ago, for the 70% of our client that choose the all access technology subscription model, we’ve never lost an all access technology subscription client. So, when we think about the duration of the relationship, we certainly hope that that duration is forever and obviously, when you think about modeling, you’d have to choose a number less than forever. But we do see it – that those clients that have been with us the longest are also the clients that are choosing to spend the most with us.

And the only other item I’d add in regards to TAM is noting that at the analytics application layer of the stack in particular, we are relatively newer there. We just started building those analytics applications a few years ago. Most of them were generally available over the last couple of years or so and there is still a few more to go generally available. So we are still relatively early on the analytics applications side. And on the associated services side, we just actually got into the services business around five years ago and there are especially services that are coupled with those analytics applications that were still earlier in their maturity.

Okay. And I’ll just squeeze one more in there. I know you are relatively new in the apps layer. But when you think about the competitive landscape in that market, what it is our market look like? I think we could call out a few competitors on the surface have apps that look so much similar or sound so much similar. What are some competitors you can call out there?

Yes, good question, Susy. So, it really depends on the specific application category that you are talking now. So overall, we keep a very close watch in the apps layer and there are over a thousand companies that has some form of analytical application that cuts across the clinical, financial and operational categories. And we believe that highly fragmented space will represent a meaningful M&A opportunity for us in the future. But a couple of examples to your question, in the benchmarking space for example, you could think of Truven as a good example. Another example, physician performance and reporting would be the Clinton product for example. And there are many, many others as well. Like I said, there are over a thousand and we do track this space carefully along with the specialty services space, because we do believe there will be some important M&A opportunities for us moving forward and partly because, the company is a best place to work. It has industry-leading customer satisfaction. We believe many of those companies will actually want to be acquired by Health Catalyst in the future.

Okay. That’s very helpful. Thank you and congrats.

Thank you.

Thank you.

Thank you. [Operator Instructions] Our next question comes from Daniel Grosslight with SVB Leerink. Your line is now open.

Hi, guys. Thanks for taking the question and congrats on hitting the top-end and exceeding your IPO flash numbers. It’s great to see. We’ve heard from one of your competitors that they’ve had a little trouble selling into the health system market because of some provider margin pressure. Obviously, this makes your solutions more powerful. But you are also trying to convince a C-suite to invest a couple million bucks in your solutions. So, I just wonder to get a better sense of how you have that initial conversation with C-suite? And how you convince them to take that leap of feast with you?

Yes, good question, Daniel. So that’s been a dynamic of the provider space for many, many years where when you look at the economics across the healthcare delivery ecosystem, providers have been operating with thin margins for many, many years and often time themselves strategically being squeezed across the value chain. And so, this is a topic we’ve discussed with providers for many, many years. I would characterize our current discussions as not different from what we’ve been experiencing in the past, not the better, nor worst, it’s very similar. The kinds of discussions that we have. Part of the benefit of our solution as you pointed out is, that we actually help with cost savings. And because we are built from the ground up as a company to enable measurable improvements including measurable financial and operational improvements, we are often in a great position to help the CFO in particular to understand the value and the return on the investment. One near-term element that helps us as well, at the data platform layer is our own internal analysis of the fact that our commercial-grade data platform really is better faster and cheaper than the home grown alternative that’s by far the most common competitor that we face at the data platform layer. Our internal estimates come to about a 2 x to 4 x ROI from a cost savings perspective by transitioning from that home grown solution to our commercial-grade solution. So that initial ROI often helps CFOs, CIOs and other C-suite executives feel really good about the initial investment. It also provides us the time to get the flywheel spinning with regards to the measurable improvement projects across clinical, financial and operational domain areas that then help our clients continue to feel good about renewing and expanding the relationship with us over time. The last thing I would share is, we do try to maintain balance however between those three categories, clinical, financial and operational, because, it’s important for us to maintain the engagement of each of those C-suite categories and functional areas we want to achieve quality officers, achieve medical officer, to achieve nursing officer on the clinical side to be very motivated to continue to improve. And so, we advocate a balance between those clinical projects, as well as financial and operational projects over the course of our relationship with our clients every year. And we found that that balance really helps the entire organization feel great about being mission-driven and improvement focused.

Got it. And just one more on the professional services hiring that was pushed out a quarter. Obviously, it’s a very competitive market for these folks. Are you seeing any – are you having any trouble recruiting or are you seeing any wage pressure on the services side?

It is a tight labor market, absolutely. One of the benefits of our focus on team member engagement and our focus on enabling team members to work at a best place to work is that there is a significant demand to come and work at Health Catalyst, typically on average, based on our internal estimates. When we post a position, we average about 50 applicants per position and when we extend an offer to a team member to join Health Catalyst. Over 90% of the time they accept that offer even relative to other offers with other companies. So, we do benefit greatly from the fact that our engagement levels are very high and team members often refer their friends and their colleagues who are also very talented to Health Catalyst. That said, it is still a tight labor market and when we experience significant growth, it is challenging to keep up with that growth. And from a forecasting perspective, especially on the services side, as we discussed earlier, we do make it easy for clients to dial up and down, the level at which they want to access our FTEs. Clients love that, but one of the challenging elements for us is, we don’t always have a lot of lead time in understanding when clients are going to dial that up. And so, we do have to manage the hiring process in a pretty quick turn environment and situation. So, it’s something that we are constantly focused on and I feel good about where we are, but we did get a little bit behind in Q2.

And operationally, the other thing we’ve been doing to help with that dynamic is building a bigger bench. So that we can be flexible with client needs.

Got it. Thanks again guys.

Thank you.

Thank you. And our next question comes from Sandy Draper with SunTrust. Your line is now open.

Thank you very much. Most of my questions have been asked. So I’ll just limit on to one for time. Maybe on the Medicity side, project is probably cheap Patrick. Just to make sure I got it right. The Medicity flat to declining revenue, there is no tie to as you sign up – cross-sell Medicity customers that when they switchover that you necessarily lose any Medicity revenue. And then, I guess the follow-up to that is, it seems like it’s been declining but Dan, you talked about, I think you feel better about the product now. Should we read into that that you think you can stabilize the Medicity revenue base? Thanks.

Let me take the second question first and then Patrick will go to you for the first question. Good questions, Sandy. As it relates to how we feel about the core product from a Medicity HIE perspective, we do feel good that it is stable and we are working to ensure that our customers are satisfied and delighted with the experience that they are having with that core product. I think as it relates to that core market, the general macroeconomic environment, as it relates to the HIE market is more than it’s flat to slightly declining. And so we expect those market conditions to continue. We do want and are striving to keep stable that client base. But we do recognize the broader market trends that we are operating within as it relates to the core HIE offering. However, one of the elements, strategically that was exciting to us about the potential of an acquisition was that, many of those same customers are asking for more help with regards to analytics. They want to understand what all the data that’s been passed from one place to another really means they can tell those organizations and how they can make better decisions and improve. And that’s at the core of what we do as a company. And we continue to believe that that adjacent opportunity with a complementary solution will generate meaningful growth for the company.

Yes, just to build on that, from a financial perspective, since, we are aiming to provide incremental value to the Medicity customers by providing them analytics, then we expect that to result in incremental revenue as opposed to cannibalization when we cross-sell.

Okay, great. That’s really helpful. Thanks and congrats on the quarter.

Thanks, Sandy.

Thanks, Sandy.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the call back over to Dan Burton for any closing remarks.

Thank you, Daniel, and thank you to all of you for your interest in Health Catalyst. We appreciate the opportunity to provide you an update as to our performance and we look forward to continuing this discussion in the months and years ahead. Take care.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program and you may all disconnect. Everyone, have a wonderful day.