Castlight Health, Inc.
Q2 2020 Earnings Call Transcript

Published: 29 Jul 2020

[Operator:]

Good afternoon and welcome to the Castlight Health’s second quarter 2020 conference call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Leading today’s call are Maeve O’Meara, Chief Executive Officer, and Will Bondurant, Chief Financial Officer. Maeve and Will will offer their prepared remarks and then they will take your questions. The Castlight press release, webcast link and other related materials are available on the Investor Relations section of Castlight’s website. This call contains forward-looking statements regarding trends, strategies and anticipated performance of the Castlight business, including – but not limited to – guidance for full-year 2020, new sales, our ability to bring new innovation, the opportunities and impact of COVID on our own operations, our ability to sell and our operating results, opportunities and the impact of COVID on our customer’s businesses and their decisions to buy certain benefits or institute workforce reductions, retention of existing customers, gross margins and operating expense trends, cash use, future cash positions, and the changes in the growth strategies on the company’s performance. These statements are made as of July 27, 2020, and reflect management’s views and expectations at this time, and are subject to various risks, uncertainties and assumptions. If any of these risks or uncertainties develop or if any of the assumptions prove incorrect, actual results could differ materially from those expressed or implied by our forward-looking statements. The company disclaims any obligation to update or revise any forward-looking statements. This call contains financial guidance, but the company will not provide any further guidance or updates on performance during the quarter unless in a Regulation FD compliant forum. Please refer to today’s press release and the risk factors included in the company’s filings with the Securities and Exchange Commission for discussion of important factors that may cause actual events or results to differ materially from those contained in Castlight’s forward-looking statements. Today’s call and presentation also includes certain non-GAAP metrics, such as non-GAAP gross margins, operating expenses, operating income (loss), and net income (loss) per share that Castlight believes aid in the understanding of Castlight’s financial results. Disclosures regarding non-GAAP metrics and reconciliation to comparable GAAP metrics, on a historical basis, can be found under the heading “Reconciliation of GAAP to Non-GAAP Financial Measures” of the earnings release that was filed before the call. With that, I’ll turn the call over to Maeve O’Meara, CEO of Castlight Health. Maeve?

[Maeve O’Meara:]

Thank you all for joining us today. This year continues to challenge all of us with the ongoing spread of COVID-19 and the systemic social justice and equity issues that face our country. We are privileged to be at a company that has an opportunity to help support our customers and our communities during this trying time, and are focused on ensuring that we stay heads down on execution and heads up on innovation as the landscape is changing quickly. I’m pleased with our strong second quarter 2020 results, and as a result of the predictability of our subscription-based business model, we are on track to achieve our annual guidance for the full year. We have demonstrated operational discipline, with a priority on financial sustainability, resulting in a non-GAAP operating profit and positive cash flow ahead of plan. We entered 2020 energized and ready to build upon the foundation we had solidified during my first six months as CEO. At the beginning of this year, I outlined four strategic priorities

[Will Bondurant:]

Thanks, Maeve. As we look back at the quarter, we are pleased with the progress in our health plan strategy, the market momentum for Care Guides and the immediate impact of our fiscal discipline on our financial health. I’ll start today with a review of the financials. Annualized recurring revenue, or ARR, totaled $139 million at the end of the quarter, down approximately $3.2 million sequentially. As Maeve mentioned, retention was in line with our expectations for Q2 and the sequential decline was primarily driven by limited employer sales due to COVID-19, in particular potential customers that have delayed signing agreements in some cases. In terms of retention, we are fighting to retain our renewing customers in Q3, even as COVID-19 has introduced risk and budgets are constrained. I also want to highlight the early traction we’ve seen with our Working Well solution, as Maeve mentioned. At this point, we’ve signed several customer contracts worth around $500k on an annualized basis for Working Well and implemented one customer, but these customer contracts are not included in our 6/30 ARR. Revenue was $35.5 million in the second quarter, a decline of 1% year-over-year. Revenue in the quarter benefited from membership levels that exceeded our conservative forecasts around potential COVID-related lay-offs or user count decreases for our employer clients. Subscription revenue accounted for 97% of total revenue, as expected. Professional Services revenue of $1.2 million was in line with our expectations. Turning to our non-GAAP financials in the second quarter, gross margin of 68% was favorably impacted by the Q2 cost management actions that we discussed in our last call, and by COVID-related savings and compared to 63% a year ago. Our subscription gross margin of 77% was in-line with the expectations we shared earlier in the year. Non-GAAP operating expenses of $22.1 million were down about 14% compared to a year ago and declined as a percentage of revenue from 71% in Q2 of 2019 to 62% this year. The year-over-year improvement is primarily a result of our planned efficiencies for 2020 due to completed migrations and the additional cost management measures we implemented during Q2 and discussed on our last call. Based on these factors, second quarter non-GAAP operating income was $2.1 million compared to a loss of $2.9 million in Q2 of 2019. Notably, this quarter represented the best non-GAAP operating margin in the company’s history. I’m pleased to share that our cash provided by operations was a positive $3.1 million in the second quarter. Our non-operating cash used was $2.5 million, which principally reflected the final build- out of our Utah Customer Center of Excellence. On our last quarterly call, we shared our goal of approaching cash-flow breakeven in the second half of the year. As a result of our proactive cost structure actions, as well as customer payment timing and COVID-related cash deferral programs, we were pleased to achieve a cash flow positive quarter and continue to anticipate the second half of the year will approach cash flow breakeven, even as the customer payment timing and COVID-related deferrals benefitted Q2. We ended the second quarter with approximately $44 million in cash. As a reminder, on our last call, we updated our outlook to reflect the uncertainty of the duration and overall impact of COVID-19 on our customers and the economy. At this time, our outlook for the year remains unchanged and for 2020, we continue to expect

[Operator:]

[Operator Instructions] Your first question comes from Jeff Garro with William Blair & Company. Your line is open.

[Jeff Garro:]

Yes. Good afternoon, and thanks for taking the questions. I would like to ask about ARR performance and expectations for the employer business and I’ll lay it out into three parts. The first is whether the nearly papered deals are expected to sign in Q3. The second part is whether historical seasonality for more decisions in the marketplace is expected to hold for the third quarter this year. And third is just as – for comment specifically around Castlight’s pipeline for the employer business for the remainder of the year?

[Maeve O’Meara:]

Hey, Jeff. Good to hear your voice and thank you for the very detailed set of questions. So I’ll start actually by taking a step back and just talking about growth in ARR, which is really a function of three things. So certainly, our employer business from a sales and retention perspective as well as our health plan growth. And given the climate, we’ve been focused on controlling what’s in our control, which you’ve seen evidence of that in our successful delivery of Care Guides and then the operational discipline we’ve shown on the cost side. Outside of our four walls, as you can hear, we feel very good about the progress we’re making on the health plan side, whereas the employer business is definitely more impacted by COVID, which leads me to your set of questions. So, I think you started by mentioning the slip deals, so I’ll begin there. So, there’s really two reasons that deal slipped. Number one is the focus of HR and benefits teams being pulled into the COVID response. And then number two is really getting log jammed at the procurement and contracting phase. And so while we do continue to see both of these creating headwinds, these deals haven’t gone away. We’re certainly hopeful to see them close and are working hard to make that happen. Your second question, I think, was around are people still making decisions, and is Q3 operating like a normal sales cycle? And so what I would say is we’ve already talked about the headwinds. One of – a key point to make here is that we can launch customers really anytime throughout the year and increasingly, employers are launching solutions off the one/one cycle. We also are in a window where we can absolutely still launch for one/one. We’re also able to rapidly turn on Care Guides. So, I think it remains to be seen, I think employers’ approaches are varied in terms of whether the sales cycle has simply been elongated or shifting into next year. So, we’ll certainly have more visibility in October, but we’re very much in a window, where we are able to implement anything that’s sold and implement it quickly. Your final question, I believe, was on pipeline. And so just to address that. So, a bright spot here certainly has been that we continue to see new opportunities coming in at the top of the pipeline. We actually, just as a data point, saw more RFPs in July than we have the year before. So that would certainly be an indicator that the sales cycle has shifted as opposed to shift it out a full year. And many of these are for high-tech, high-touch solutions, so navigation, and aligns well with our set of capabilities. So, the pipeline is indeed actually pretty healthy. But kind of per the previous comments, obviously, we’re waiting to see kind of how that – how things actually move through the pipeline.

[Jeff Garro:]

Understood. And appreciate you guys trying to focus on what’s in your control and doing the best to respond to what’s out of your control. So just another question to change gears a little bit. Very nice outperformance in the quarter, but the guidance is reiterated. So curious what’s driving the conservatism there? And I guess, even more specifically, even at the high end of the guidance range, there’s a bit of a drop-off implied for the second half of the year in revenue. So maybe, you could help us there by quantifying some of the retention risk that you mentioned?

[Will Bondurant:]

Yes, Jeff, absolutely. As a reminder, in May we did update our 2020 outlook for the year to reflect conservatism, given the potential impact of COVID on our business, especially as it relates to our large employer clients where layoffs or furloughs are real possibilities, and ultimately, our customer pain is our pain. Looking forward, we chose to take a pragmatic approach and want to reflect the continued uncertainty in the economic situation that our customers face and in the broader economy, especially as COVID continues to impact the day-to-day of each of our lives. And so as we look forward, we do see risk and uncertainty in that on the revenue side, specifically the top line, and the employment within our large employer customer base.

[Jeff Garro:]

So, to follow up there a little bit. I think there were some comments around clients that are up for renewal in the third quarter. So maybe, some more color around whether COVID is influencing those decisions versus general customer satisfaction and kind of where you see the outlook? And again, any quantification of the risk to the revenue projections for the back half of the year?

[Will Bondurant:]

Yes, absolutely. I’ll go quickly on the 2020 numbers, and then I’ll let Maeve talk about renewals. So as we think about 2020 outlook, our revenue is fairly predictable. We have long-term customer contracts. The risk to achieving the guidance and to our top line for 2020 is really related to customer layoffs, furloughs with a worsening of the economic situation in the country. The renewal we talked about – renewal dynamics we talked about relates to customers that are in a renewal cycle and would impact 2021 and 2022. So maybe, I’ll let Maeve talk about kind of the renewal conversation more broadly.

[Maeve O’Meara:]

Sure. So, as Will mentioned, yes, there are renewals, the majority of renewals, to be clear, in the second half of the year. And Jeff, to your direct question, we expect that COVID’s introduction of budgetary constraints is going to play a role in churn. Overall, our customer satisfaction, our value across the book of the business is up. So we’ve talked in the past about what do you need to have to have a healthy book of business. We actually feel very good about our execution across those as well as our execution in terms of the levers that we have to pull in the context of COVID. But kind of to your point, I think we have to flag that COVID has introduced budgetary constraints as it has, obviously, for many solutions, and that is a risk factor for our second-half renewals.

[Jeff Garro:]

Understood. Thanks for the color. I’ll jump back in the queue.

[Operator:]

Our next question comes from Charles Rhyee with Cowen. Your line is open.

[Charles Rhyee:]

Yes. Thanks for taking the question. If I could ask on the health plan side, maybe you talked about the confidence or comfort in that you’ll get health plans signed within the next six months. Can you talk about timing then as we think about – once a deal gets penned how long implementation typically takes for a health plan customer? And just trying to think about if you get something signed, let’s say, in the next month, is that something that can contribute to 2021? If it’s by the end of the year, does that really push it out to 2022? Just trying to get a sense on timing on, I’d imagine health plans are fairly large implementation cycles here. Maybe start there?

[Maeve O’Meara:]

Yes. No, thanks, Charles. All great questions. And so I’ll actually just provide a little bit of color and substance around those questions. So number one, it is – it does feel good to be on a call talking about the positive traction with health plans in addition to the strong financial quarter. And so talking a little bit about timing and kind of why the confidence, so we have a very healthy pipeline. We now have several mid- to late-stage opportunities. And to your specific question, many of those actually have early 2021 implementation time lines or mid-2021, I should say, implementation time lines across the set of those opportunities. So given that, certainly, I think that there’s an opportunity to contribute to 2021. The other thing I would just add by way of color is that a lot of these conversations are with larger plans, where the intent is to start with a portion of the population, where there’s a clear path to expansion, both from a product and population perspective, but kind of to your overarching question, we do believe that we can get the – an opportunity closed in the next six months and that it would contribute in 2021.

[Charles Rhyee:]

Okay, that’s helpful. And then Will, if I could ask a question about the cash flow. It sounds like you’re seeing the second quarter benefit, because there were some deferrals that occurred in Q2 from customer sides that actually benefited the quarter itself. If those didn’t occur, what would the cash flow look like? Because it sounds like you’re saying back half is going to be more breakeven? And is that – should we be modeling more like a third quarter use of cash and then positive again? Or is it kind of – we’re just kind of running breakeven in the back half of the year?

[Will Bondurant:]

Yes. Thanks, Charles. And you’re right. We’re really pleased to see the quick impact of the cost management changes and a cash flow positive quarter, but we did benefit from two items. First is payment timing, so the customer payments we expected in Q3 that came in Q2, and the second is some COVID-related cash deferral programs as we participated in some of the options offered to us under the CARES Act and other measures. If you kind of take out those items, we would have been cash flow positive on the operating cash flow side, but it would have been at a lower scale. And so as you look at the second half of the year, we do expect to approach cash flow breakeven. But clearly, there’s a timing benefit to Q2 that then turns around and hurts 3Q and 4Q.

[Charles Rhyee:]

Okay. So for modeling purposes, I understand like other companies have been talking about deferred taxes, cash taxes in 2Q because of the CARES Act, is that – that’s kind of what you’re talking about? And does that get paid out in 3Q for you? Or is that spread out over both quarters?

[Will Bondurant:]

It varies across the different places where we have a tax burden, tax liability. In general, we expect to see kind of those pay out in fourth quarter and then into 2021 so we’ll see kind of an impact actually over the next four to six quarters from those deferrals.

[Charles Rhyee:]

Okay. And then lastly, around the non-operating use of cash, right, in CapEx, you talked about finishing out your center of excellence. Should we be thinking about CapEx in the back half, similar to the second quarter? Or does that drop off?

[Will Bondurant:]

Yes. The second quarter was a heavy CapEx, non-operating cash quarter for us as we finished the Utah Customer Center of Excellence. It is an important strategic priority for the year, and we are now done. That facility is open, and we have folks actually in the office that are working. We don’t expect to see that degree of CapEx in the second half of the year. There’s going to be a small measure as we think about preparing our offices to reopen and items like that, but see a substantial decrease in the non-operating cash.

[Charles Rhyee:]

Okay, great. Thanks.

[Operator:]

Our next question comes from Richard Close with Canaccord Genuity. Your line is open.

[Richard Close:]

Great. Thank you. Congratulations on the progress. Just a little piggybacking here off of Jeff and Charles’ questions. On the ARR and the implied revenue guidance, I just want to be clear, it sounds like you guys are being conservative during this renewal process. But there’s nothing like a couple of years ago when you had Walmart not renew and you actually had a quick step down in ARR after the second quarter. There’s nothing necessarily known at this point, you’re just being conservative with the guidance?

[Maeve O’Meara:]

Yes. No. Richard, thanks for the question. So just kind of taking a step back in terms of just looking at the composition of our ARR and of our revenue, so about 50% is coming from Anthem. So that provides us quite a bit of stability. 75% of our customers are also on the full platform. So kind of to your point, as I said, we do want to be thoughtful about highlighting that we do think we have increased risk of churn during COVID, just as obviously, many companies do. But to your point, around kind of a Walmart, that is not what we would be – there is not a customer like that, that we are anticipating. But certainly, we think that during this time that we do have a lot of renewals and COVID is absolutely putting pressure on budgets.

[Richard Close:]

Yes. I wasn’t meaning necessarily Walmart from a size perspective, but I think they had – when you announced second quarter, I think that was a couple of years ago, you already knew that they weren’t renewing, so that was immediately taken out of ARR. There’s nothing that – I guess what I’m asking, there’s nothing necessarily known at this moment that you still have to go through the renewal process and see how that shakes out?

[Will Bondurant:]

Yes, Richard, that’s exactly right. So our renewal book for this year was slightly smaller than 2019, but represents about a third of our ARR. We’ve seen – we still have the majority of those renewals to do. They typically happen in the summer and we’re somewhat delayed because of COVID this year. So we’re just representing the fact that we have renewals to execute on in 2020, not that there’s anything known at this point in time.

[Richard Close:]

Okay. That’s good to hear there. And then I guess following up on Charles’ question on the health plan side. I thought it was interesting. You said several late-stage discussions or opportunities and mentioned large plans, when you say large plans, was curious if you could put any like maybe bookends on that? Is that national in scope? Is it just large states? Any thoughts there? And as you think about health plan customers and gaining new logos, I guess, on that side. Is there anything to think about – for us to think about in terms of like what the size of those opportunities are? I know probably about 50% of revenue like Anthem, anything like that, but just any magnitude there?

[Maeve O’Meara:]

Sure. So I’ll start, and Will can talk a little bit more specifically on sides. But what I would say is that the mid- to late-stage conversations do encompass both larger Blues and national plans. The intent, however, is to start with a portion of the population, which I know I mentioned earlier. But I think that all of these would start with the portion. And certainly, we believe that there are clear pathways to expansion. So that’s how I would think about it just from a size perspective. Will, do you want to add anything else to that?

[Will Bondurant:]

Yes. And what we said, Richard, before, I think it’s still true, is that we would expect health plans to be on the order of one of our very large employer customers from an AR perspective, up to something that is a portion of Anthem. We don’t expect to sign a health plan, if anything, on the order of Anthem, we will grow to that, but you’d be thinking about something in the several-million-dollar range on the small side.

[Richard Close:]

Okay. Great. And my final question is on Care Guides. Obviously, that’s relatively new. And you’re obviously making some progress there. But is there any way we should think about like the size of those types of contracts, is it – starts off small and then expands? Any clarity there would be helpful for us.

[Maeve O’Meara:]

Sure. Yes, we are really feeling good about the decision to invest in high-tech, high-touch. And to your point, I think that certainly, as we look at where a lot of the growth is coming from, it is in navigation and both of those, including high-tech and high-touch. In terms of actual size and kind of how it fits in, I mean, the customers that we’ve launched, we mentioned that we have three live, they were existing customers. I think it actually showed the ease of the implementation and just how much this is a natural extension of the platform. And one of the big advantages that we have is that we’re able to provide this, frankly, at a lower price point because of the technology advantage. So Will, do you want to talk a little bit about the size or excuse me, the economics?

[Will Bondurant:]

Yes, absolutely. So the way to think about Care Guides for us, Richard, is that it is an upseller, an additional price on top of the core technology platform. We think they go together, high-touch, high-tech and the Care Guides, candidly, are made more efficient and more effective by being built on top of the platform. So it’s an upsell that looks similar to the size of the original purchase, clearly driving both additional value and with the real cost of delivering it. So that helps you think about size. And to Maeve’s point, kind of the first set of customers have come from our existing book, where it’s been a step-up as opposed to a net-new conversation, although the net-new conversations we’re having, many of the deals in the pipeline do include both Castlight Complete and Care Guides.

[Richard Close:]

Okay. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Gene Mannheimer with Colliers Securities. Your line is open.

[Gene Mannheimer:]

Thanks. Good afternoon. Congrats on the good quarter. My question was partially answered before with respect to the renewal risk, and I’m just trying to get a handle on, if you could quantify the level of renewals that is exposed in the back half. I think you said the renewal book is a third of the ARR and you still have some more to do. So is that to say that 10% or 15% of your ARR is at risk here? How should we think about that?

[Will Bondurant:]

Yes, Gene, absolutely. The best way to think of it is that our client contracts are typically about three years. And so – and every year, we have about a third of our direct employer ARR up for renewal. And so you can kind of back into what that looks like. We’ve done, certainly some renewals we talked in the last call about signing a couple of very large customers to renewals, which is important and did close a couple of important renewals in Q2, but have, I’d say, slightly above 50% of the renewal book yet to do for 2020. And so as you think about kind of what that risk looks like, it’s about half of a third of our ARR entering the year.

[Gene Mannheimer:]

Gotcha. Okay. Very helpful. Thanks Will. And I want to ask, Maeve, the optimism that I’m hearing over signing another health plan before year-end. Is it feasible that you would sign more than one? Or am I asking for too much there? Thanks.

[Maeve O’Meara:]

Gene, nice to hear your voice. So my focus is on meeting the goal that we articulated at the beginning of the year, which is signing our first health plan partner beyond Anthem, but as I mentioned, we have a healthy pipeline, and I certainly look forward to building on that goal. So we’ll look forward to updating you in October.

[Gene Mannheimer:]

All right. Sounds good. Thank you.

[Operator:]

There are no further questions at this time. I’ll now turn the call back over to Maeve O’Meara for closing remarks.

[Maeve O’Meara:]

Thank you all for being here today. We’re energized by the momentum we’re seeing in the business, particularly in the health plan market, and I look forward to updating you on our progress in October.

[Operator:]

This concludes today’s conference call. You may now disconnect.