Castlight Health, Inc.
Q3 2019 Earnings Call Transcript

Published: 25 Oct 2019

[Operator:]

Good afternoon. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Castlight Health Q3 2019 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]Thank you. I would now like to turn the call over to Mr. Gary Fuges, Head of Investor Relations. Sir, please go ahead.

[Gary Fuges:]

Good afternoon and welcome to the Castlight Health third quarter 2019 conference call. Leading the call today are Maeve O’Meara, Chief Executive Officer; and Siobhan Nolan Mangini, President and Chief Financial Officer. Also joining today’s call is Will Bondurant, our new Chief Financial Officer, effective November 15. Maeve and Siobhan will offer their prepared remarks and then we will take your questions.Press release, webcast, and other related materials are available on our website. This call contains forward-looking statements regarding our trends, strategies and the anticipated performance of our business, including but not limited to our guidance for full-year 2019, new sales, retention of existing customers, gross margin and operating expense trends, future cash position, and the impact of management changes and changes in our growth strategy on the company’s performance.These statements were made as of October 24, 2019, and reflect management’s views and expectations at that time, and are subject to various risks, uncertainties and assumptions. If this call is replayed after October 24, 2019, the information in the call may no longer be current or accurate. We disclaim any obligation to update or revise any forward-looking statements.We provide guidance in this call, but we will not provide any further guidance or updates on our performance during the quarter unless we do so in a public 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 our forward-looking statements.Finally, today’s presentation also includes certain non-GAAP metrics, such as non-GAAP gross margin, operating expense, operating loss, and net loss per diluted share that we believe aid in the understanding of our financial results. A reconciliation to comparable GAAP metrics, on a historical basis, can be found in the appendix section of our earnings release filed before today’s call.With that, I’ll turn the call over to Maeve O’Meara, CEO of Castlight. Maeve?

[Maeve O'Meara:]

Thank you for joining us on today’s call. We are pleased to update you on the positive steps we have taken toward stabilizing our current business and building a foundation for future growth.Over my first 90 days, I outlined four priorities for the year

[Siobhan Nolan Mangini:]

Thanks, Maeve. Good afternoon everyone and let me also thank all of you for joining us on today’s call. The Castlight team has had a very productive quarter and I look forward to reviewing our Q3 results and full-year outlook. After that, I’ll introduce you to Will, who will be taking over CFO responsibilities on November 15. Then, we’ll take your questions.We ended Q3 with $137.4 million in annualized recurring revenue, or ARR. Our Complete platform product grew to nearly 30% of ARR with a diverse set of customers expanding toComplete. While Q3 sales were below our plan, approximately half of our Q3 bookings camefrom existing customers who upgraded to our full navigation products. This is a proof point that large employer customers value our technology.We again saw churn from customers who are not on our full health navigation offerings. This continues to emphasize the importance of co-innovation and partnership on our direct-to-employer business and our ability to stabilize our book of business with our health navigation products going forward. Our focus on high quality and durable revenues makes us particularly excited to announce our new enterprise license with Anthem.With this license, non-cancellable backlog at the end of Q3 would have been around $250 million versus the $122 million we will be reporting as of September 30 in the 10-Q. With this enterprise license, we will now have over 45% of our ARR with Anthem, offering our highly scalable, industrial strength technology to its members. It’s important to note that the ARR at the end of Q3 that I just shared does not include the impact of new Anthem licensing agreement, which was signed in October.Incorporating both the benefit of the Anthem contract, as well as our expectations for seasonally light Q4 sales, we expect to end 2019 with approximately $140 million to $145 million in annual recurring revenue. We could not be more pleased with the Anthem enterprise license structure as it provides Castlight with high quality revenue visibility, improved economics, and a proof point for our growth strategy.Third quarter revenue was $35.5 million, in-line with our expectations and year-to-date revenue tracking for our full-year guidance range. Reported revenue is a function of completed implementations and Q3 is a seasonally light quarter for launches. Subscription revenue was 98% of total revenue, while services revenue was 2%.In particular, we saw services revenue decline 83% year-over-year. Q3’s revenue reflects the growing mix shift of our revenue base with Anthem, as Anthem customers do not have professional services revenue, coupled with a reduction in some one-time services fees. Given these dynamics, we expect professional services revenue to be in a similar range as it was in Q3 going forward.Now, let’s turn to third quarter non-GAAP financials. Q3 non-GAAP gross margin was 62%, which primarily reflects professional services costs associated with Q3 legacy well-being customer migrations, as well as investments we are making to maintain support service levels as we move to our new Customer Center of Excellence in Salt Lake City. We expect the support investments to continue through Q1.Overall, subscription gross margin remained healthy at 78%. In the near-term, as we made critical infrastructure investments both in our Customer Center of Excellence, as well as in our high touch Castlight Care Guides offerings, we expect to see subscription gross margins in the mid-70’s and total gross margin to remain closer to current levels in Q4.Overall, we continue to maintain discipline in our expenses across Castlight, while setting a foundation to restore sustainable growth. Total non-GAAP operating expenses were $27.4 million, up about $600,000 year-over-year. Sales and marketing expense was elevated, due to one-time expenses, but remained within its 20% to 24% of revenue target range, while G&A reflects some increase spending as we prepare for 404B adoption at the end of this year.Overall, we continue to invest aggressively in R&D to drive innovation for future growth. Based on these factors, third quarter non-GAAP operating loss was $5.4 million. Cash used in operations was approximately $7.4 million, and we ended the quarter with $56 million in cash, cash equivalents and marketable securities. We expect to end the year with more than $60 million in cash.With that, I’ll now discuss our outlook. Our full-year 2019 guidance is as follows

[Operator:]

[Operator Instructions] Your first question comes from the line of Jeff Garro with William Blair.

[Jeff Garro:]

Yes, good afternoon and thanks for taking the questions. Lot in the release today, I think I will start with the Care Guidance though, you are announcing this project at a fairly early stage, which I think implies you want to signal to clients that this is a service that will be available from Castlight soon, so hoping you could summarize some of the client feedback you have received before or after the announcement and also help us with the time line kind of bridging the gap between the charter program now and then general availability for sometime in 2020 as you mentioned?

[Maeve O'Meara:]

Sure, absolutely. Hi, Jeff. Thanks for the question. So, first just to take a step back. So, Castlight’s mission is to help make healthcare as easy as humanly possible and get people to the right care at the right provider program. So, for us, we very much view this as the next natural step on our journey and given what we’ve dealt with our personalization engine and navigation technology, there is just a very clear opportunity for us to identify populations with more complex care needs and help them with their next best action.So, to your point on understanding the market, we saw a really big gap around bringing a tech first approach that doesn’t force the customer to chose between a digital or a high touch model, which is one of the reasons that we are moving to fill that gap. So, in terms of just from a timeline perspective as you mentioned, we’ve kicked off our charter customer group which is actually a way that we’ve co-innovated in the past.So, we are excited to bring that back to Castlight and we do have our first customer launching next month, which is the Fortune 500 manufacturing company and really what we’re looking to do with the charter customer group set in Q4 and through Q1 is really evolve and expand the 2020 roadmap. From a timeline perspective, we plan to enable our sales team and sales kick-off in January, that’s typically when we do all of our training and enablement. With the product being GA in mid-2020. So, we do expect to be actively in the market with this in the Q2, Q3 sales cycle.

[Jeff Garro:]

Good to hear. A follow-up on the Care Guidance by asking about the margin impact essentially, can you explain a little bit further how Castlight will use technology there, existing or in development to deliver this higher touch service with maybe greater efficiency than some similar services.

[Siobhan Nolan Mangini:]

Absolutely. It is great to talk to you Jeff. I think what’s really exciting here is what Maeve was highlighting. We’re moving from technology and an incredible tech asset and data infrastructure asset into service versus the other way around and so we’re being very thoughtful about the investment and this is an investment, not just in people, but actually in technology and manifesting that APIs into the tech and that our support that use.In the near-term, as I said in my prepared remarks, we do expect subscription gross margins to decline a little bit into the mid-70s as we are making that investment, but then we do expect after than investment we’re going to see margins begin to progress again because of the investments we are making in technology and the expectation that we are going to see. Frankly more efficiency with our Tier 1 [indiscernible] even outside of the high-tech services and then what we are going to be able to see with the clinical support.I think one of the things that’s really exciting and frankly will, Maeve and I are out in the market with customers all the time is that this is going to meet the market where they are. We hear customers frequently say that there is a need for health navigation and they don’t want to chose between services or technology and we’re really being able to deliver one package now at a frankly a very cost effective price point and I think we’re being really, really smart in terms of how we are investing in that right now.

[Jeff Garro:]

Great. That helps us well. I’ll ask a question on the Anthem renewal and expansion as well. Hoping for a little more color on what the changes might be on the economics to the renewed portion and then any framework you can provide on the revenue model and potential scope on the expanded license agreement, it sounds essentially like a term license agreement that will be recognized ratably, but also looking for a little more color there.

[Maeve O'Meara:]

Sure. Well, before we speak to the economics, I just want to start by sharing just how honored we are to be a long-term Anthem partner and we are thrilled to be expanding the relationship. So, stepping into this role solidifying and strengthening our Anthem partnership was my number one priority, and after over 5 years of working so closely with the Anthem team it is particularly gratifying to be able to share this.So, I think we could talk more about the actual structure, but I think your question was on the economics. So, Siobhan do you want to start off and then Will maybe can talk through the mechanics.

[Siobhan Nolan Mangini:]

Sure. Yes. So, I think Jeff you are right. I think what is really exciting here is, we are seeing a move into an enterprise license agreement. It dramatically simplifies frankly where we were before and Will can touch upon the mechanics of the deal. To your point, just in terms of the tier economics and what we are seeing here is Anthem was about 40% of ARR at the end of Q3 and we are seeing 20% growth from that and in terms of when this will go into effect it will be 1/1/2020 and so you will start to see that contribute then.I think what we are – I think what’s very different here is and I mentioned this in my prepared remarks, this is now going to be a non-cancelable contract, so we are seeing a non-cancelable backlog double as a result as I mentioned. And then just finally, I will rethink about what happens once the contract doesn’t just set. You are right, you basically start to see revenue over the following 30 months given its one enterprise license agreement with Anthem. Maybe, I’ll just let Will very quickly touch upon kind of the [from-to] of where we went and underline the mechanics of the deal.

[Will Bondurant:]

Sure. Thanks, Siobhan and Jeff great to talk. So, if you think about the previous relationship with Anthem, you had multiple products and multiple contracts and you heard and at the complexities sometimes in our financials. Going forward is a single enterprise license, one stable standard revenue base. That encompasses all of the products we’ve been offering historically clearly engaging market of course, as well as the new engage API’s and we are excited to simplify the relationship and also to expand it going forward.

[Siobhan Nolan Mangini:]

Just a final note…

[Jeff Garro:]

Great, appreciate the comments.

[Siobhan Nolan Mangini:]

This is for everybody that’s on the phone. It sounds like EDGAR was down, and – while we are trying to solve this, so there will be an 8-K, given the materiality of disagreement that should be populated after this call. I think, there's just some issues on EDGAR right now.

[Jeff Garro:]

Got it. We’ll keep an eye out for them. I'll jump back in the queue. Thanks, again.

[Siobhan Nolan Mangini:]

Thanks.

[Maeve O'Meara:]

Thank you.

[Operator:]

Your next question comes from the line of Charles Rhyee with Cowen.

[Charles Rhyee:]

Yes. Hi, thanks for taking the question. Maybe talking about the bookings in the quarter, you said, they’re a little bit light here than you expected. If I missed it, it sounds like you're all saying you're expecting 4Q sales to also be a little light as well, apart from the Anthem deal. Can you kind of go into sort of your expectations here in the sales process for the fourth quarter as well, at the year-end?

[Siobhan Nolan Mangini:]

Yes. Absolutely, Charles. I'll take a – talk a little bit about what we're expecting in Q4. I think it's also – want to make sure that Maeve can talk some of the early observations in terms of direct sales performance overall. So, in Q4, it's seasonally a very light sales quarter. We've got a handful of deals that have slipped from Q3 that we're tracking, but we're not expecting much conversion at this point in time. And then I think the other dynamic here is just renewals are typically concentrated in Q4.So, we've got about 30% of our renewal is still up in the fourth quarter. And so, we're being thoughtful in terms of how we incorporate them into the ARR guidance that we shared today for year-end. Maeve, would you like to maybe talk a little bit about the direct sales in particular?

[Maeve O'Meara:]

Sure. Yes. So, in my first 90 days, I did a deep review of our commercial strategy. And based on that diagnosis, I believe that despite having tenured and talented reps in the field that we do have lots of room for improvement. So, we're laser-focused on bringing in the right commercial leadership across both sales and marketing. And we're moving with urgency to ensure that we're well-positioned for the Q2 and Q3 2020 selling season.Just to provide a little bit more color, the opportunities that we're seeing around improved execution are really falling into two buckets. Number one is the go-to-market strategy and enablement and our gaps there around – are around clear resonant messaging and actual tactical plays. And then secondly, deal execution. So, better diagnosis of pipeline conversion rates by stage. Specifically, we're focused on how we unstick some of our later stage deals. But those are some of our early observations from a direct sales point of view.

[Charles Rhyee:]

Great. That’s helpful. I’ve got one more follow-up question on the Care Guides – I’m sorry, Castlight Care Guides. You talked about [indiscernible] investment here as you build it out, is there anything that you're going to be staffing clinicians? And is it right to think that as this ramps up relative to the current market profile, as this becomes really a service business, right, so that's sort of lower operating margins on a steady state basis?

[Siobhan Nolan Mangini:]

Yes. So, you're right, there is going to be some level of clinical support here. We're not talking large numbers of people. And actually, the most significant investment right now is really in the technology and not to get too specific, but we're literally exposing the underlying APIs into sales force, which is what our support guides use. And so that's really what I'm talking about in terms of investment of technology.The expectation here is to drive efficiencies, both in terms of, frankly, Tier 1, Tier 2 support. We will see more efficiencies as we drive improvement there, and then, frankly, a much more efficient service model with the clinicians that you're asking about. But in the near-term, do expect that you'll see some drop in the subscription gross margin – subscription margin, specifically, as I said, mid-70s for Q4 2019. And Maeve, do you want to maybe talk about the used cases of like how a clinician might use the technology.

[Maeve O'Meara:]

Sure, absolutely. So – and I think it's actually worth noting that the used case actually spans both administrative, so how do we help people remove basic barriers to care, such as appointment scheduling to some more complex clinical used cases. So, a very simple example would be right now in our data, we identify polychronic patients and are able to see if they don't have a primary care physician.So, we would be able to both do an outbound touchpoint to connect them with a provider who treats patients like them, or if they came in for a question about their benefits or insurance card or HAS, actually proactively treat that used case. So, it's really leveraging a lot of the work that we've done around personalization and understanding the conditions of the population to recommend next best action.

[Charles Rhyee:]

Thanks. That’s helpful. And just one – sorry, one follow-up question on the numbers here. With the – Maeve, you're saying sort of mid-70s margin subscription side. Would these kind of investments you're making, how – should – are these some of these sort of one-time investment that we should expect to kind of roll back off? So, that as we're thinking further out in our model, let’s say, next year and beyond, we should get some of this back? And I guess that also translates into the operating income loss? How should we think about sort of the pace of that, or is this sort of a new baseline as we can then kind of grow back up? Thanks.

[Siobhan Nolan Mangini:]

So, let me talk about Q4 specifically, and then just general trends, we’ll obviously update 2020 guidance in February. But in terms of the investment levels in technology and people, I do expect that will continue beyond Q1. Maeve said, we're expecting a product to be generally available mid next year.So, there will be that investment, both in the tech build out as well as people. And I think we'll have more information around what kind of efficiency can we drive with support overall, given we're wanting – the Care Guides that also doing this move commensurate right now. So, what kind of efficiency are we expecting to see.So, there will be some level of duration. I don't expect it to be like a multi-year investment. If you can imagine, this is going to be a frozen level of R&D build to get this up and launch. And then there's some level of people that will support the bias. But we're being, I think, pretty thoughtful around what level of investment in terms of clinicians do we need. But yes, I do think there's some level duration in terms of the margin side of things.In terms of OpEx, which I think was the second piece of what you were saying. On the sales and marketing side, there was some one-time expenses that translated into the P&L this quarter. So, I do expect to see a little bit more efficiency in that line item in Q4 and beyond.R&D, I think we're operating closer to a steady state right now. G&A [indiscernible] long-term target of 8% to 12%, in particular, because we have 4% being need to be stock compliance for year-end. I expect that we'll see some efficiencies as we look forward. But when you look into like the next quarter, we're going to see a little bit efficiencies in OpEx, but not a huge amount just based off of where we are.

[Charles Rhyee:]

Great. Thanks a lot.

[Operator:]

Your next question comes from the line of Brian Peterson with Raymond James.

[Alex Sklar:]

Hi, this is Alex Sklar on for Brian. I just had a couple other follow-up questions on the Anthem deal. First is, are there any additional investments needed on your part to enable that ARR step up? And then also, are there any variable revenue components that could provide upside to the TCV [ph] announced either in terms of savings goals or something else along those lines? And then I have a follow-up. Thank you.

[Siobhan Nolan Mangini:]

You bet. Great. I'll dive into some of the components in terms of variable. But first, I think it'd be great to have Will hit on the first question.

[Will Bondurant:]

Yes, absolutely. So, as we think about the relationship, we’ve obviously been working with Anthem for a long time and I've worked together to build the products and have the knowledge in the market. And so, the products encompassed in the enterprise license are all deployed today. And we don't expect them to require additional build and are really excited actually deploy them to additional folks and don't expect increased investment or that will be product build out.In terms of the kind of the upside. When you have a chance to see it, we have thought it would be filed at this time and apologies that EDGAR currently is down. We are filing the entire agreement because of the materiality. And so, you will see that the agreement is structured with a set number of seats. And so, there is upside above that number potentially. We don't necessarily expect Anthem to hit that number in the near-term.

[Siobhan Nolan Mangini:]

Yes.

[Alex Sklar:]

Okay, great. And then one other one on the deal. Could you talk about how the ARR to revenue conversion post Anthem? How we should see then the numbers?

[Siobhan Nolan Mangini:]

Yes, absolutely. That's a great question. So, ARR ultimately is our best predictor for subscription revenue. And That's why we gave guidance on it today, expecting to end the year at $140 million to $145 million in ARR. Effectively, what drives conversion is implementation timelines to rev rec and then turn headwinds. Typically, we see about 90% of our ARR convert into subscription revenues the following year. And right now, we're expecting a very similar trend for 2020 in that 90-ish percentage range. Overall, we're super pleased with the progress that we've made to stabilize current revenues and the stability that the Anthem contract provides us.

[Alex Sklar:]

Okay, great. Thank you.

[Operator:]

[Operator Instructions] And your next question comes from the line of Jeff Garro with William Blair.

[Jeff Garro:]

Yes, couple more from me. Thanks. So, I guess, the first is, you mentioned the meaningful advances in jumpstarting the health plan growth initiatives and all the meetings and how you're feeling good about the progress there, I was hoping you could frame that discussion a little bit in terms of the pipeline kind of in terms of relationships or dollar value of pipeline kind of what was there before and what’s been added to it now and some type of outlook on how that might convert to ARR over the next 12 months or beyond.

[Maeve O'Meara:]

Sure. So, I’ll start off, and I know Siobhan wants to add a couple of comments around the pipeline as well. So, Candidly Jeff when we started off, the first thing that we did was a diagnosis of the current state and what we did determine was that the pipeline really was effectively empty. So, we didn’t have any qualified deals at any stage of maturity that we thought could move forward. So, a big step was actually putting in place that organization that we talked about. So, having a dedicated team pulling from both internal leaders as well as recruiting the external leaders.And so, as you mentioned, I have been on the road with health plans and I think the excitement around the assets to just add a little detail there have been primarily I would say in three areas, so transparency, ton of interest around provider directory, certainly getting some tailwinds from some of the Washington conversations as you can imagine. Personalization specifically Care pathways gaps in Care, lot of interest there as well and then finally integration so bringing together all of the clinical resources and external programs. So, the good news is we got a lot of interest. The kind of challenging news is that these are long sales cycles, so we are thinking in creatively about frankly how to move things more quickly through the pipeline.We do believe that the Anthem agreement is going to be substantively important for us both as a referenceable customer, but also the fact that the model is about exposing some of the external APIs, and I think one of the key insights in the time that we spent with clients is, how important it is to meet them where they are on their technology journey and being able to be more plug and play. So, in terms of qualifying the pipeline, Siobhan I know that you wanted to add a couple of comments, but Jeff I would say that this was, we are 90 days in, is kind of the high level and I would say that we have moved deals in through, you know through into a stage one phase, but we are definitely early in qualification.

[Siobhan Nolan Mangini:]

And what I was just going to add is, when I think about how that translates into the model what you are thinking about here is, obviously we now have a proof point which is super exciting with the enterprise license of how we can work with other plans. Translating that to ARR is much more like a 2020 exercise where that then contributes to revenues in 2021 is how I would actually think about that of where we are at this state.

[Jeff Garro:]

Got it. That helps, and one last one from me. Given the comments about the expansion of health plan relationships and also the new Anthem model maybe you could give a little more commentary on how you are going to balance those efforts with reinvigorating the direct-to-employer because it seems like you know the incentives that shifted in the Anthem business and the similar model is rolled into future health plan relationships. I know the direct-to-employer market is very wide, but I want to hear your thoughts on how to balance those varying incentives.

[Maeve O'Meara:]

Well, I’m happy to start and Siobhan should certainly add. I mean, I think that the truth is the type of partnership that we have with Anthem is about two things. It is about a great products meeting that real market need and then trust and respect between leadership teams. So, I understand your comment on incentive, but as we think about building a long-term business it is very important to us to continue to meet the needs of Anthem customers and membership. And given the way that we’ve architected the technology as we continue to innovate on the direct-to-employer side, we are able to role that in to benefit, engage customers as well. So, I guess my first comment would be, as a partner with Anthem and as a valued member of their ecosystem we do have a strong commitment to our existing customers and membership and then the second piece is really just a product architecture commentary which is, our innovation on our direct to employer side. We have the ability to turn that on or off into our health plan business as well.

[Siobhan Nolan Mangini:]

Yes. And I think the thing that’s really important is actually what Maeve was emphasizing. The way the technology is built to single short architecture and you know really is, how do we innovate with both Anthem and employers and it is a win-win and frankly right now the way I think about it is, we’ve created stability in growth with the Anthem relationship. We’ve put into place a bunch of initiatives for our direct employer in business and obviously Care Guidance being one of the most concrete new product that we are putting to place. And then it is around diversifying further in terms of adding additional health plans that are benefitting from that tech [indiscernible] and so, I think it honestly is a testament to the technology that we are able to – be able to service both lines of business I think as well as we can.

[Jeff Garro:]

Got it. Thanks again.

[Siobhan Nolan Mangini:]

Sure.

[Operator:]

Your next question comes from the line of Charles Rhyee with Cowen.

[Charles Rhyee:]

Hi, thanks. Just a quick follow-up question, what was the ending customer number for the quarter?

[Siobhan Nolan Mangini:]

We are expecting about to have around 250 customers at the end of the year, and so [40%] Fortune 500.

[Charles Rhyee:]

And as per the quarter-end was about the same.

[Siobhan Nolan Mangini:]

Around the same, I would say there is a slightly higher ad works that seem to have effective customer count be lower at year-end with the ARR dynamics I was talking about.

[Charles Rhyee:]

Great. Thank you.

[Operator:]

There are no further questions at this time. I would now like to turn the call over to Maeve O'Meara for closing remarks.

[Maeve O'Meara:]

Thank you all for joining us today. The team is energized and focused on building on the progress we’ve made over the last 90 days. We look forward to speaking with your over the quarter and I hope to see you at the health conference in Las Vegas next week. Have a good evening.

[Operator:]

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