Health Catalyst, Inc. (HCAT) FY 2021 MD&A

Overview

We are a leading provider of data and analytics technology and services to healthcare organizations. Our Solution comprises a cloud-based data platform, analytics software, and professional services expertise. Our customers, which are primarily healthcare providers, use our Solution to manage their data, derive analytical insights to operate their organization, and produce measurable clinical, financial, and operational improvements. We envision a future where all healthcare decisions are data-informed.

Health Catalyst was founded in 2008 by healthcare analytics industry pioneers. Our founders and team developed the initial version of our Solution, consisting of an early version of our data platform, select analytics accelerators, and professional services expertise. From the beginning, our Solution has been focused on enabling our mission: to be the catalyst for massive, measurable, data-informed healthcare improvement. We currently employ more than 1,200 team members.

Highlights from the years ended December 31, 2021, 2020, and 2019 include:

•For the years ended December 31, 2021, 2020, and 2019, our total revenue was $241.9 million, $188.8 million, and $154.9 million, respectively. The growth in revenue was primarily due to revenue from new customers, including customers of our recent acquired entities, and existing customers paying higher technology access fees from contractual, annual escalators.

•For the years ended December 31, 2021, 2020, and 2019, we incurred net losses of $153.2 million, $115.0 million, and $60.1 million, respectively.

•For the years ended December 31, 2021, 2020, and 2019, our Adjusted EBITDA was $(11.2) million, $(21.3) million, and $(27.4) million, respectively.

See “Reconciliation of Non-GAAP Financial Measures” below for more information about this financial measure, including the limitations of such measure and a reconciliation to the most directly comparable measure calculated in accordance with GAAP. See “Key Factors Affecting Our Performance” for more information about important opportunities and challenges related to our business.

In August 2021, we completed an underwritten public offering of 4,882,075 shares (inclusive of the underwriters’ over-allotment option to purchase 636,792 shares) of our common stock at $53.00 per share. We received net proceeds of $245.2 million, after deducting the underwriting discounts and commissions and other offering costs.

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COVID-19 Impact

The COVID-19 pandemic and the related adverse public health developments, have adversely affected workforces, organizations, governments, customers, economies, and financial markets globally. It has also disrupted the normal operations of many businesses, including ours. COVID-19 has disrupted and we believe will continue to disrupt the normal operations of our customers, which are primarily healthcare providers. Given the unknown timeline and the near-term uncertainty of COVID-19 on our business, there continues to be uncertainty as to the extent to which the global COVID-19 pandemic may adversely impact our business operations, financial performance, and results of operations at this time. We believe that the ongoing waves of COVID-19, especially in light of the Delta and Omicron variants, coupled with the potential for new variants and vaccination rates in certain areas of the country, likely indicate that our country and national healthcare system will be under some amount of continued operational and budgetary strain over the coming months. Nevertheless, we continue to be encouraged as we witness meaningful evidence that the healthcare provider ecosystem is much better equipped and prepared to respond to the ongoing pandemic, including through treatment efficacy, supply chain logistics, capacity planning, and broader operational optimization.

We benefit from a highly recurring revenue model in which greater than 90% of our revenue is recurring in nature. As such, we expect that the near-term impact of COVID-19 on our total revenue will be relatively muted, as evidenced by our revenue performance for the years ended December 31, 2021 and 2020. Additionally, we benefit from a high level of technology revenue predictability, especially our DOS subscription customers whose contracts typically have built-in, contractual technology revenue escalators. We also have developed a number of technology and services solutions designed specifically to support healthcare providers during the COVID-19 pandemic. Importantly, since the onset of the COVID-19 pandemic, our customers’ overall usage of our data platform has increased meaningfully. Given these factors, our technology dollar-based retention has not been impacted as a result of COVID-19 and we would anticipate similar dynamics moving forward.

As we get through the COVID-19 pandemic and healthcare organizations' operations begin to normalize, we continue to be optimistic that the pandemic will serve as an overall medium-to-long term tailwind in the industry’s adoption of data and analytics. At the health system level, we are seeing meaningful evidence that COVID-19 is highlighting the need for a commercial-grade data and analytics solution to replace patchwork homegrown systems. Likewise, we have seen current and prospective customer interest strengthening in areas including revenue and cost optimization analytics and value-based care analytics, for which we think our technology and professional services offerings are well suited.

Our Business Model

We offer our Solution to a variety of healthcare organizations, primarily in the United States, including academic medical centers, integrated delivery networks, community hospitals, large physician practices, ACOs, health information exchanges, health insurers, and other risk-bearing entities. We categorize our customer count into two primary categories: DOS Subscription Customers and Other Customers. DOS Subscription Customers are defined as customers who directly or indirectly access our DOS platform via a technology subscription contract. Other customers generally include DOS non-subscription customers and other customers from historical acquisitions. As of December 31, 2021, 2020, and 2019, we had 90, 74, and 65 DOS Subscription Customers with active subscriptions, respectively. As of December 31, 2021, we served over 350 Other Customers compared to 300 as of December 31, 2020. The increase in Other Customers from 2020 to 2021 was primarily due to our acquisition of Twistle and new Vitalware customers.

We derive substantially all of our revenue through subscriptions for use of our technology and professional services on a recurring basis. In 2021, greater than 90% of our total revenue was recurring in nature. Customers pay for our technology primarily on a subscription basis for our entire technology suite or for pieces of our technology (e.g., DOS-only). We generally provide access to our technology and deliver professional services to customers on a recurring basis, with our technology invoiced upfront annually or quarterly and our professional services invoiced monthly. Most of our technology and professional services contracts with DOS subscription customers have up to a three-year term, of which the vast majority are terminable after one year upon 90 days' notice. As we increase the use cases we address at a given customer, we have the opportunity to upsell incremental technology and services. We have demonstrated an ability to upsell technology and services to our customer base over time as evidenced by a Dollar-based Retention Rate of 112%, 102%, and 109% for the years ended December 31, 2021, 2020, and 2019, respectively.

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The primary costs incurred to deliver our technology are hosting fees and headcount-related costs associated with our cloud services and support teams. Hosting fees are related to providing our technology through a cloud-based environment hosted primarily by Microsoft Azure. However, we also have deployed DOS on-premise to a small number of customers. Over time, we plan to migrate our on-premise and private data center customers to Azure-hosted environments, increasing our technology cost of revenue. We have experienced and expect to continue to experience operational inefficiencies associated with managing multiple hosting providers, resulting in a headwind against Adjusted Technology Gross Margin. The primary costs incurred to deliver our professional services are the salaries, benefits, and other headcount-related costs of our team members.

We delineate our sales organization by new customer acquisition and existing customer retention and expansion. Selling efforts to new customers vary. Many of our new customers engage with us broadly for multiple use cases, requiring buy-in during the sales cycle across the C-suite. Alternatively, in some instances, we engage with a customer in a single-use case. After we demonstrate measurable improvements, we work with our customers to expand the utilization of our Solution to other use cases or enterprise-wide. The average sales cycle for a new DOS subscription customer is estimated to be approximately one year, and that timeline can vary materially. Because of our vertical focus on the healthcare industry, we believe our sales and marketing resources can be deployed more efficiently than at horizontally-focused companies that provide technology and services to multiple industries. Over the past few years, we have invested in growth infrastructure by adding to our sales operations and marketing teams, which are built to help us scale over the long term.

We have demonstrated a consistent track record of innovation through research and development over time as evidenced by our new product features and new product offerings. This innovation is driven by feedback we glean from our customers, professional services teams, and the market generally. Our investments in product development have been focused on increasing the capabilities of our Solution and expanding the number of use cases we address for our customers.

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Key Business Metrics

We regularly review a number of metrics, including the following key financial metrics, to manage our business and evaluate our operating performance compared to that of other companies in our industry:

We monitor the key metrics set forth in the preceding table to help us evaluate trends, establish budgets, measure the effectiveness and efficiency of our operations, and determine team member incentives. We discuss Adjusted Gross Profit, Adjusted Gross Margin, and Adjusted EBITDA in more detail below.

Adjusted gross profit and adjusted gross margin

Adjusted Gross Profit is a non-GAAP financial measure that we define as revenue less cost of revenue, excluding depreciation and amortization, stock-based compensation, and acquisition-related costs, net, as applicable. We define Adjusted Gross Margin as our Adjusted Gross Profit divided by our revenue. We believe Adjusted Gross Profit and Adjusted Gross Margin are useful to investors as they eliminate the impact of certain non-cash expenses and allow a direct comparison of these measures between periods without the impact of non-cash expenses and certain other non-recurring operating expenses. We present both of these measures for our technology and professional services business. We believe these non-GAAP measures are useful in evaluating our operating performance compared to that of other companies in our industry, as these measures generally eliminate the effects of certain items that may vary from company to company for reasons unrelated to overall profitability.

See above for information regarding the limitations of using our Adjusted Gross Profit and Adjusted Gross Margin as financial measures and for a reconciliation of revenue to our Adjusted Gross Profit, the most directly comparable financial measure calculated in accordance with GAAP.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure that we define as net loss adjusted for interest and other expense, net, loss on debt extinguishment, income tax provision (benefit), depreciation and amortization, stock-based compensation, acquisition-related costs, net, and non-recurring lease-related charges. We believe Adjusted EBITDA provides investors with useful information on period-to-period performance as evaluated by management and comparison with our past financial performance. We believe Adjusted EBITDA is useful in evaluating our operating performance compared to that of other companies in our industry, as this metric generally eliminates the effects of certain items that may vary from company to company for reasons unrelated to overall operating performance.

See “Reconciliation of Non-GAAP Financial Measures” below for information regarding the limitations of using our Adjusted EBITDA as a financial measure and for a reconciliation of our net loss to Adjusted EBITDA, the most directly comparable financial measure calculated in accordance with GAAP.

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Other Key Metrics

We also regularly monitor and review the number of DOS Subscription Customers and Dollar-based Retention Rate as shown in the following tables:

DOS subscription customers

Since 2016, our primary contracting model is a subscription-based contract to our DOS platform, analytics applications, and professional services. Given how fundamental DOS is to our Solution and because the vast majority of our total revenue is derived from DOS Subscription Customers, we believe our DOS Subscription Customer count is the best representation of our market penetration and the growth of our business.

Dollar-based Retention Rate

We calculate our Dollar-based Retention Rate as of a period end by starting with the sum of the Annual Recurring Revenue (ARR) from customers as of the date 12 months prior to such period end (prior period ARR). We then calculate the sum of the ARR from these same customers as of the current period end (current period ARR). Current period ARR includes any upsells and also reflects contraction or attrition over the trailing twelve months but excludes revenue from new customers added in the current period. We then divide the current period ARR by the prior period ARR to arrive at our Dollar-based Retention Rate. We calculate ARR for each customer as the expected monthly recurring revenue of our customers as of the last day of a period multiplied by 12. Because our primary business model is to contract for our DOS platform, analytics applications, and professional services, acquired customers that have not subscribed to DOS, including legacy Medicity, Able Health, Healthfinch, Vitalware, and Twistle, are not included in the Dollar-based Retention Rate metrics.

Given our high level of technology revenue predictability, we would anticipate minimal impact on our technology Dollar-based retention as a result of COVID-19. As noted, our Dollar-based Retention Rate Key Metric excludes customers who are not DOS Subscription Customers, including customers added through acquisition, as the go-forward technology revenue growth profiles of these businesses may vary from our core DOS Subscription Customers. Specifically, Medicity customers have generated a lower Dollar-based Retention Rate than DOS Subscription Customers and we expect flat to declining revenue from Medicity customers in the foreseeable future.

The financial strain imposed by COVID-19 on a number of our customers led to a meaningfully lower professional services dollar-based retention in 2020 due to discounts provided to support our customers through the financial strain related to the initial outbreak. We did not provide similar discounts during 2021 and saw improvement in professional services dollar-based retention compared to 2020. Given that our customer base will be under some amount of continued pandemic-related financial and operational uncertainty over the coming months and the nature of our contract structure for professional services, we anticipate that there will be more variation to our professional services dollar-based retention in the near-term. While the vast majority of our professional services revenue are recurring in nature, we also provide customers with an option to engage with us for non-recurring, project-based professional services fees. These non-recurring, project-based fees are less predictable than our recurring services and can drive fluctuations in quarterly professional services revenues and in prior period comparisons.

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Reconciliation of Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance. We use the following non-GAAP financial information to evaluate our ongoing operations, as a component in determining employee bonus compensation, and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively, may be helpful to investors because it provides consistency and comparability with past financial performance. However, non-GAAP financial information is presented for supplemental informational purposes only, has limitations as an analytical tool and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. In addition, other companies, including companies in our industry, may calculate similarly-titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with GAAP. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures, and not to rely on any single financial measure to evaluate our business.

Adjusted gross profit and adjusted gross margin

Adjusted Gross Profit is a non-GAAP financial measure that we define as revenue less cost of revenue, excluding depreciation and amortization, stock-based compensation, and acquisition-related costs, net, as applicable. We define Adjusted Gross Margin as our Adjusted Gross Profit divided by our revenue. We believe Adjusted Gross Profit and Adjusted Gross Margin are useful to investors as they eliminate the impact of certain non-cash expenses and allow a direct comparison of these measures between periods without the impact of non-cash expenses and certain other non-recurring operating expenses. We present both of these measures for our technology and professional services business. We believe these non-GAAP measures are useful in evaluating our operating performance compared to that of other companies in our industry, as these metrics generally eliminate the effects of certain items that may vary from company to company for reasons unrelated to overall profitability.

The following is a reconciliation of revenue to our Adjusted Gross Profit and Adjusted Gross Margin in total and for technology and professional services for the years ended December 31, 2021, 2020, and 2019:

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(1) Acquisition-related costs, net includes deferred retention expenses following the acquisition of Twistle.

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(1)Acquisition-related costs, net includes post-acquisition restructuring costs following the acquisition of Medicity.

Adjusted Technology Gross Margin increased slightly from 68% for the year ended December 31, 2020 to 69% for the year ended December 31, 2021. This year-over-year performance was mainly driven by existing customers paying higher technology access fees from contractual, built-in escalators, without the corresponding increase in hosting costs, offset partially by headwinds due to the continued costs associated with transitioning a portion of our customer base to Azure hosted environments. We expect Adjusted Technology Gross Margin to fluctuate and potentially decline in the near term, primarily due to additional costs associated with the ongoing transition of a small number of customers from on-premise and our managed data centers to third-party hosted data centers with Microsoft Azure.

Adjusted Professional Services Gross Margin increased from 25% for the year ended December 31, 2020 to 27% for the year ended December 31, 2021, due primarily to the impact of prior year professional services discounts provided to support our customers through the financial strain they experienced related to COVID-19, greater non-recurring and project-based revenue, and a shift in the mix of professional services delivered. Our professional services are comprised of data and analytics services, domain expertise services, outsourcing services, and implementation services. The majority of our professional services revenue is generated from data and analytic services and domain expertise services, which are the highest gross margin professional services we provide. The delivery mix among all of our services in a given period can lead to fluctuations in our Adjusted Professional Services Gross Margin. Adjusted Professional Services Gross Margin may fluctuate on a quarterly basis due to changes in the mix of services we provide and the amount of operational overhead required to deliver our services.

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Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure that we define as net loss adjusted for interest and other expense, net, loss on extinguishment of debt, income tax provision (benefit), depreciation and amortization, stock-based compensation, acquisition-related costs, net, and non-recurring lease-related charges. We believe Adjusted EBITDA is useful in evaluating our operating performance compared to that of other companies in our industry, as this metric generally eliminates the effects of certain items that may vary from company to company for reasons unrelated to overall operating performance.

The following is a reconciliation of our net loss to Adjusted EBITDA for the years ended December 31, 2021, 2020, and 2019:

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(1)Acquisition-related costs, net includes third party fees associated with due diligence, deferred retention expenses, post-acquisition restructuring costs incurred as part of business combinations, and changes in fair value of contingent consideration liabilities for potential earn-out payments. For additional details refer to Note 2 in our consolidated financial statements.

(2)Non-recurring lease-related charges includes the lease-related impairment charge for the subleased portion of our corporate headquarters and duplicate rent expense incurred during the relocation of our corporate headquarters. For additional details refer to Note 9 in our consolidated financial statements.

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Key Factors Affecting Our Performance

We believe that our future growth, success, and performance are dependent on many factors, including those set forth below. While these factors present significant opportunities for us, they also represent the challenges that we must successfully address in order to grow our business and improve our results of operations

•Impact of COVID-19 pandemic. The COVID-19 pandemic has adversely affected workforces, organizations, governments, customers, economies, and financial markets globally, leading to an economic downturn and increased market volatility. It has also disrupted the normal operations of many businesses, including ours. The ongoing waves of COVID-19, especially in light of the Delta and Omicron variants, as well as intensified measures undertaken to contain the spread of COVID-19, could continue to decrease healthcare industry spending, adversely affect demand for our technology and services, cause one or more of our customers to file for bankruptcy protection or go out of business, cause one or more of our customers to fail to renew, terminate, or renegotiate their contracts, affect the ability of our sales team to travel to potential customers and the ability of our professional services teams to conduct in-person services and trainings, impact expected spending from new customers, negatively impact collections of accounts receivable, and harm our business, results of operations, and financial condition. It is not possible for us to predict the duration or magnitude of the adverse results of the outbreak and its effects on our business, results of operations, or financial condition at this time.

•Add new customers. We believe our ability to increase our customer base will enable us to drive growth. Our potential customer base is generally in the early stages of data and analytics adoption and maturity. We expect to further penetrate the market over time as potential customers invest in commercial data and analytics solutions. As one of the first data platform and analytics vendors focused specifically on healthcare organizations, we have an early-mover advantage and strong brand awareness. Our customers are large, complex organizations who typically have long procurement cycles which may lead to declines in the pace of our new customer additions.

•Leverage recent product and services offerings to drive expansion. We believe that our ability to expand within our customer base will enable us to drive growth. Over the last few years, we have developed and deployed several new analytics applications including PowerCosting (formerly known as CORUS), PowerLabor, Touchstone, Patient Safety Monitor, Pop Analyzer (formerly known as Population Builder), and others. Because we are in the early stages of certain of our applications’ lifecycles and maturity, we do not have enough information to know the impact on revenue growth by upselling these applications and associated services to current and new customers.

•Impact of acquisitions. We have acquired multiple companies over the last few years, including Medicity in June 2018, Able Health in February 2020, Healthfinch in July 2020, Vitalware in September 2020, and Twistle in July 2021. The historical and go-forward revenue growth profiles of these businesses may vary from our core DOS Subscription Customers, thus impacting our overall growth rate. Specifically, Medicity customers have generated a lower Dollar-based Retention Rate than DOS Subscription Customers and we expect declining revenue from Medicity customers in the foreseeable future. If our cross-sell efforts and technology integration strategies are successful related to the recent acquisitions, this could offset revenue declines from Medicity customers. As we integrate the teams acquired via our recent acquisitions, we have also incurred integration-related costs and duplicative costs that could impact our operating cost profile in the near-term.

•Changing revenue mix. Our technology and professional services offerings have materially different gross margin profiles. While our professional services offerings help our customers achieve measurable improvements and make them stickier, they have lower gross margins than our technology revenue. In 2021, our technology revenue and professional services revenue represented 61% and 39% of total revenue, respectively. Changes in our revenue mix between the two offerings would impact future Total Adjusted Gross Margin. Furthermore, changes within the types of professional services we offer over time can have a material impact on our Adjusted Professional Services Gross Margin, impacting our future Total Adjusted Gross Margin. See “Reconciliation of Non-GAAP Financial Measures” above for more information.

•Transitions to Microsoft Azure as DOS hosting provider. We incur hosting fees related to providing DOS through a cloud-based environment hosted by Microsoft Azure. We maintain a small number of customers that have deployed DOS on-premise. We are in the process of migrating customers who deployed DOS on-premise to Azure-hosted environments. The Azure cloud provides customers with more advanced DOS product functionality and a more seamless customer experience; however, hosting customers in Azure is more costly than on-premise deployments on a per-customer basis. This transition has resulted in higher cost of technology revenue and a reduced Adjusted Technology Gross Margin.

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Recent Acquisitions

Twistle, Inc.

On July 1, 2021, we acquired Twistle Inc. (Twistle), a healthcare patient engagement SaaS technology company that automates patient-centered communication between care teams and patients to transform the patient experience, drive better care outcomes, and reduce healthcare costs. We anticipate that Twistle’s leading clinical workflow and patient engagement platform, paired with the Health Catalyst population health offering, will enable a comprehensive go-to-market solution to address the population health needs of healthcare and life science organizations. The acquisition consideration transferred was $91.9 million, consisting of net cash consideration of $46.7 million, Health Catalyst common shares with a fair value of $43.1 million, and contingent consideration based on certain earn-out performance targets for Twistle during an earn-out period that ends on June 30, 2022, which had an initial estimated fair value of $2.1 million.

Vitalware, LLC

On September 1, 2020, we acquired Vitalware, LLC (Vitalware), a provider of revenue workflow optimization and analytics SaaS technology solutions to healthcare organizations, in a transaction accounted for as a business combination. Vitalware’s flagship offering is a chargemaster management solution that delivers analytics for the complex regulatory and compliance functions needed by healthcare provider systems. Additionally, Vitalware brings to bear newer product suites to help health systems capture lost revenue and to support compliance with expanding pricing transparency regulation. The acquisition consideration transferred was $119.2 million and was comprised of net cash consideration of $69.6 million, Health Catalyst common shares with a fair value of $41.3 million, and contingent consideration based on certain earn-out performance targets for Vitalware during an earn-out period that ended on March 31, 2021. The purchase resulted in Health Catalyst acquiring 100% ownership in Vitalware. The earn-out contingent consideration liability was settled during the second quarter of 2021.

Healthfinch, Inc.

On July 31, 2020, we acquired Healthfinch, Inc. (Healthfinch), which provides a workflow integration engine delivering insights and analytics into EMR workflows to automate physicians’ ability to close patient care gaps in real-time, in a transaction accounted for as a business combination. We believe this acquisition will strengthen our existing population health capabilities. The acquisition consideration transferred was $50.5 million and was comprised of net cash consideration of $16.9 million, Health Catalyst common shares with a fair value of $27.8 million, and contingent consideration based on certain earn-out performance targets for Healthfinch during an earn-out period that ended on July 31, 2021. The purchase resulted in Health Catalyst acquiring 100% ownership in Healthfinch. Approximately half of the earn-out was settled during the third quarter of 2021 and the remaining amount is expected to be settled during the first quarter of 2022.

Able Health, Inc.

On February 21, 2020, we acquired Able Health, Inc. (Able Health), a leading software-as-a-service provider of quality and regulatory measurement tracking and reporting to healthcare providers and risk-bearing entities, in a transaction accounted for as a business combination. We believe this acquisition will strengthen Health Catalyst’s Quality and Regulatory Measures capabilities. The acquisition consideration transferred was $21.5 million and was comprised of net cash consideration of $15.2 million, Health Catalyst common shares with a fair value of $3.3 million, and contingent consideration based on achievement of Able Health specified incremental customer billings for the year ended December 31, 2020. The purchase resulted in Health Catalyst acquiring 100% ownership in Able Health. The earn-out contingent consideration liability was settled during the first quarter of 2021.

Components of Our Results of Operations

Revenue

We derive our revenue from sales of technology and professional services. For the years ended December 31, 2021, 2020, and 2019, technology revenue represented 61%, 58%, and 54% of total revenue, respectively, and professional services revenue represented 39%, 42%, and 46% of total revenue, respectively.

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Technology revenue.    Technology revenue primarily consists of subscription fees charged to customers for access to use our data platform and analytics applications. We provide customers access to our technology through either an all-access or limited-access, modular subscription. Most of our subscription contracts are cloud-based and have up to a three-year term, of which the majority are terminable after one year upon 90 days' notice. The vast majority of our DOS subscription contracts have built-in annual escalators for technology access fees. Also included in technology revenue is the maintenance and support we provide, which generally includes updates and support services.

Professional services revenue.  Professional services revenue primarily includes analytics services, domain expertise services, outsourcing services, and implementation services. Professional services arrangements typically include a fee for making full-time equivalent (FTE) services available to our customers on a monthly basis. FTE services generally consist of a blend of analytic engineers, analysts, and data scientists based on the domain expertise needed to best serve our customers.

Deferred revenue

Deferred revenue consists of customer billings in advance of revenue being recognized from our technology and professional services arrangements. We primarily invoice our customers for technology arrangements annually or quarterly in advance. Amounts anticipated to be recognized within one year of the balance sheet date are recorded as deferred revenue and the remaining portion is recorded as deferred revenue, net of current portion on the consolidated balance sheets.

Cost of revenue, excluding depreciation and amortization

Cost of technology revenue.    Cost of technology revenue primarily consists of costs associated with hosting and supporting our technology, including third-party cloud computing and hosting costs, contractor costs, and salary and related personnel costs for our cloud services and support teams.

Although we expect cost of technology revenue to increase in absolute dollars as we increase headcount, cloud computing, and hosting costs to accommodate growth, and as we continue to transition customers to third-party hosted data centers with Microsoft Azure, we anticipate cost of technology revenue as a percentage of technology revenue will generally decrease over the long term. We expect cost of technology revenue as a percentage of technology revenue to fluctuate and potentially increase in the near term, primarily due to additional costs associated with transitioning a small number of customers from on-premise and our managed data centers to Microsoft Azure.

Cost of professional services revenue.    Cost of professional services revenue consists primarily of costs related to delivering our team’s expertise in analytics, strategic advisory, improvement, and implementation services. These costs primarily include salary and related personnel costs, travel-related costs, and outside contractor costs. We expect cost of professional services revenue to increase in absolute dollars as we increase headcount to accommodate growth.

Operating expense

Sales and marketing.    Sales and marketing expenses primarily include salary and related personnel costs for our sales, marketing, and account management teams, lead generation, marketing events, including our Healthcare Analytics Summit (HAS), marketing programs, and outside contractor costs associated with the sale and marketing of our offerings.

We plan to continue to invest in sales and marketing to grow our customer base, expand in new markets, and increase our brand awareness. The trend and timing of sales and marketing expenses will depend in part on the timing of our expansion into new markets and marketing campaigns. We expect that sales and marketing expenses will increase in absolute dollars in future periods, but decrease as a percentage of our revenue over the long term. Our sales and marketing expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

Research and development.    Research and development expenses primarily include salary and related personnel costs for our data platform and analytics applications teams, subscriptions, and outside contractor costs associated with the development of products. We have developed an open, flexible, and scalable data platform. We plan to continue to invest in research and development to develop new solutions and enhance our applications library.

We expect that research and development expenses will increase in absolute dollars in future periods, but decrease as a percentage of our revenue over the long term. Our research and development expenses may fluctuate as a percentage of our revenue from period to period due to the nature, timing, and extent of these expenses.

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General and administrative.    General and administrative expenses primarily include salary and related personnel costs for our legal, finance, people operations, IT, and other administrative teams, including certain executives. General and administrative expenses also include facilities, subscriptions, corporate insurance, outside legal, accounting, directors' fees, lease-related impairment charges, and the change in fair value of contingent consideration liabilities.

We expect our general and administrative expenses to increase in absolute dollars for the foreseeable future, but decrease as a percentage of our revenue over the long term. Our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

Depreciation and amortization.    Depreciation and amortization expenses are primarily attributable to our capital investment and consist of fixed asset depreciation, amortization of intangibles considered to have definite lives, and amortization of capitalized internal-use software costs.

Interest and other expense, net

Interest and other expense, net primarily consists of interest expense partially offset by income from our investment holdings. Interest expense in the current year is primarily attributable to the Notes and in prior years was primarily attributable to our now extinguished term loan and imputed interest on acquisition-related consideration payable. It also includes the amortization of discounts on debt and amortization of deferred financing costs related to our various debt arrangements. The adoption of ASU 2020-06 during the first quarter of 2022 is expected to reduce our reported interest expense as it relates to our convertible senior notes.

Income tax provision (benefit)

Income tax provision (benefit) consists of U.S. federal, state, and foreign income taxes. Because of the uncertainty of the realization of the deferred tax assets, we have a full valuation allowance for our net deferred tax assets, including net operating loss carryforwards (NOLs) and tax credits related primarily to research and development.

As of December 31, 2021, we had federal and state NOLs of $580.0 million and $465.7 million, respectively, which will begin to expire for federal and state tax purposes in 2032 and 2023, respectively. Our existing NOLs may be subject to limitations arising from ownership changes and, if we undergo an ownership change in the future, our ability to utilize our NOLs and tax credits could be further limited by Sections 382 and 383 of the Code. Future changes in our stock ownership, many of which are outside of our control, could result in an ownership change under Sections 382 and 383 of the Code. Our NOLs and tax credits may also be limited under similar provisions of state law.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (CARES) Act was enacted and signed into U.S. law to provide economic relief to individuals and businesses facing economic hardship as a result of the COVID-19 pandemic. On March 11, 2021, the American Rescue Plan Act of 2021 (ARPA) was enacted and signed into U.S. law to provide additional economic stimulus and tax credits. Changes in tax laws or rates are accounted for in the period of enactment. The income tax provisions of the CARES Act and ARPA do not have a significant impact on our current taxes, deferred taxes, or uncertain tax positions. The CARES Act also provided for the deferral of an employer’s portion of social security payroll taxes for the remainder of 2020. We began deferring the social security payroll tax match in April 2020 and fully paid all related deferred payroll taxes in December 2021.

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Results of Operations

The following tables set forth our consolidated results of operations data and such data as a percentage of total revenue for each of the periods indicated:

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(1)Includes stock-based compensation expense, as follows:

(2)Includes acquisition-related costs, net, as follows:

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(3)Includes non-recurring lease-related charges, as follows:

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Discussion of the Years Ended December 31, 2021 and 2020

Revenue

Total revenue was $241.9 million for the year ended December 31, 2021, compared to $188.8 million for the year ended December 31, 2020, an increase of $53.1 million, or 28%.

Technology revenue was $147.7 million, or 61% of total revenue, for the year ended December 31, 2021, compared to $110.5 million, or 58% of total revenue, for the year ended December 31, 2020. The revenue growth was primarily from new DOS Subscription Customers, acquired technology customers, and revenue from existing customers paying higher technology access fees from contractual, annual escalators, and new offerings of expanded support services.

Professional services revenue was $94.2 million, or 39% of total revenue, for the year ended December 31, 2021, compared to $78.4 million, or 42% of total revenue, for the year ended December 31, 2020. The professional services revenue growth is primarily due to implementation, analytics, outsourcing, and other improvement services being provided to new DOS Subscription Customers, greater non-recurring and project-based services, partially offset by lower professional services dollar-based retention achieved in 2020 relative to historical performance as a result of the COVID-19 pandemic.

Cost of revenue, excluding depreciation and amortization

Cost of technology revenue, excluding depreciation and amortization, was $47.5 million for the year ended December 31, 2021, compared to $35.6 million for the year ended December 31, 2020, an increase of $11.9 million, or 33%. The increase in cost of technology revenue was primarily due to $3.8 million in increased cloud computing and hosting costs largely from the recent acquisitions and the expanded use of Microsoft Azure to serve existing and new customers, $3.4 million of increased salary and related personnel costs from additional cloud services and support headcount, $2.4 million from increased dues and subscriptions, and $1.3 million of additional stock-based compensation.

Cost of professional services revenue was $76.8 million for the year ended December 31, 2021, compared to $62.5 million for the year ended December 31, 2020, an increase of $14.4 million, or 23%. This increase was primarily due to an $8.7 million increase in salary and related personnel costs from additional professional services headcount, a $4.6 million increase in stock-based compensation, and a $1.2 million increase in contractor and outside service fees.

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Operating Expenses

Sales and marketing

Sales and marketing expenses were $75.0 million for the year ended December 31, 2021, compared to $55.4 million for the year ended December 31, 2020, an increase of $19.6 million, or 35%. The increase was primarily due to additional stock-based compensation of $9.6 million and greater salary and related personnel costs from additional headcount of $8.8 million.

Sales and marketing expense as a percentage of total revenue increased from 29% in the year ended December 31, 2020 to 31% in the year ended December 31, 2021.

Research and development

Research and development expenses were $62.7 million for the year ended December 31, 2021, compared to $53.5 million for the year ended December 31, 2020, an increase of $9.2 million, or 17%. The increase was primarily due to a $4.8 million increase in salary and related personnel costs from additional development team headcount, a $2.1 million increase in stock-based compensation, and a $2.2 million increase in contractor and outside service fees.

Research and development expense as a percentage of revenue decreased from 28% in the year ended December 31, 2020 to 26% in the year ended December 31, 2021.

General and administrative

General and administrative expenses were $85.9 million for the year ended December 31, 2021, compared to $59.2 million for the year ended December 31, 2020, an increase of $26.7 million, or 45%. The increase was primarily due to increases of $9.6 million in stock-based compensation, $8.6 million in change in fair value of contingent consideration liabilities, $6.3 million in salary and related personnel costs from additional headcount, $1.8 million in lease-related impairment charges, and $1.2 million in dues and subscriptions, which were partially offset by a decrease of $1.4 million in duplicate headquarter rent expense and $1.3 million in decreased acquisition-related transaction costs.

General and administrative expense as a percentage of revenue increased from 31% in the year ended December 31, 2020 to 36% in the year ended December 31, 2021.

Depreciation and amortization

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Depreciation and amortization expenses were $37.5 million for the year ended December 31, 2021, compared to $18.7 million for the year ended December 31, 2020, an increase of $18.8 million, or 100%. This increase was primarily due to the amortization of acquired intangible assets from our recent business acquisitions.

Depreciation and amortization expense as a percentage of revenue increased from 10% in the year ended December 31, 2020 to 16% in the year ended December 31, 2021.

Loss on extinguishment of debt

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(1)Not meaningful.

On April 14, 2020, we used $57.0 million of proceeds from the Note Offering to prepay in full all outstanding indebtedness, including prepayment penalties, under the Credit Agreement and terminate the Credit Agreement. We recorded a loss on extinguishment of debt of approximately $8.5 million during the year ended December 31, 2020, including approximately $7.0 million of repayment fees and $1.5 million unamortized debt discounts and issuance costs related to the OrbiMed term loan.

Interest and other expense, net

Interest and other expense, net increased $4.9 million, or 42%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. The change is primarily due to an increase in non-cash interest expense of $4.2 million from the amortization of debt issuance costs and discounts related to our Notes Offering that occurred in April 2020. There was also a decrease in interest income of $1.3 million primarily due to lower market interest rates.

Income tax provision (benefit)

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(1)Not meaningful.

Our income tax provision consists of current and deferred taxes for U.S. federal, state, and foreign income taxes. The income tax benefit of $6.9 million and $1.2 million recorded for the years ended December 31, 2021 and 2020, respectively, is primarily related to the discrete deferred tax benefits attributable to the release of a portion of the valuation allowance during the respective periods. The releases of valuation allowance are attributable to the acquisition of Twistle and Able Health, which resulted in deferred tax liabilities that, upon acquisition, allowed us to recognize certain deferred tax assets that had previously been offset by a valuation allowance.

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Liquidity and Capital Resources

As of December 31, 2021, we had cash, cash equivalents, and short-term investments of $445.0 million, which were held for working capital and other general corporate purposes, which may include acquisitions and strategic transactions. Our cash equivalents and short-term investments are comprised primarily of money market funds, U.S. treasury notes, commercial paper, corporate bonds, and asset-backed securities.

Since inception, we have financed our operations primarily from the proceeds we received through private sales of equity securities, payments received from customers under technology and professional services arrangements, borrowings under our loan and security agreements, our IPO, the Note Offering, and the Secondary Public Equity Offering. Our future capital requirements will depend on many factors, including our pace of new customer growth and expanded customer relationships, technology and professional services renewal activity, and the timing and extent of spend to support the expansion of sales, marketing, development, and acquisition-related activities. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, or at all. If we are unable to raise additional capital when desired, our business, results of operations, and financial condition would be adversely affected.

We believe our existing cash, cash equivalents and marketable securities and amounts available under our credit facilities will be sufficient to meet our working capital and capital expenditure needs over at least the next 12 months, though we may require additional capital resources in the future.

Secondary Public Equity Offering

In August 2021, we completed an underwritten public offering of 4,882,075 shares (inclusive of the underwriters’ over-allotment option to purchase 636,792 shares) of our common stock at $53.00 per share. We received net proceeds of $245.2 million, after deducting the underwriting discounts and commissions and other offering costs.

The offering was made pursuant to an effective shelf registration statement (File No. 333-258625) filed with the Securities and Exchange Commission. We plan to use the proceeds for continuing operations and potential future acquisitions.

Convertible senior notes

On April 14, 2020, we issued $230.0 million in aggregate principal amount of 2.50% Convertible Senior Notes due 2025 (the Notes), pursuant to an Indenture dated April 14, 2020, with U.S. Bank National Association, as trustee, in a private offering to qualified institutional buyers. We received net proceeds from the sale of the Notes of $222.5 million, after deducting the initial purchasers’ discounts and offering expenses payable by us.

Capped Calls

On April 8, 2020, concurrently with the pricing of the Notes, we entered into privately negotiated capped call transactions (the Base Capped Calls) with certain financial institutions, or option counterparties. In addition, in connection with the initial purchasers’ exercise in full of their option to purchase additional Notes, on April 9, 2020, we entered into additional capped call transactions (the Additional Capped Calls, and, together with the Base Capped Calls, the Capped Calls) with each of the option counterparties. We used approximately $21.6 million of the net proceeds from the Note Offering to pay the option premium cost of the Capped Calls. The Capped Calls have initial cap prices of $42.00 per share, subject to certain adjustments. The Capped Calls are expected generally to reduce the potential dilution to our common stock upon any conversion of Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to the cap price.

Refer to Note 10 of our consolidated financial statements for additional details regarding the private offering of the Notes and the Capped Calls.

Initial public offering

On July 29, 2019, we closed our IPO in which we issued and sold 8,050,000 shares (inclusive of the underwriters’ over-allotment option to purchase 1,050,000 shares, which was exercised on July 25, 2019) of common stock at $26.00 per share. We received net proceeds of $194.6 million after deducting underwriting discounts and commissions and before deducting offering costs of $4.6 million.

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OrbiMed financings

On February 6, 2019, we entered into the Credit Agreement with OrbiMed that established a senior term loan facility of up to $80.0 million under certain conditions. The contractual interest rate is the higher of LIBOR plus 7.5% and 10.0%. On February 6, 2019, we borrowed $50.0 million under the Credit Agreement with principal payments due beginning in 2023, and we simultaneously repaid our $20.0 million term loan from SVB in full. In addition, we repaid in full the outstanding balance of $1.3 million under the SVB revolving line of credit. Additionally, on February 6, 2019, we sold 437,787 shares of our Series F redeemable convertible preferred stock for a purchase price of $12.2 million. The effect of the OrbiMed debt proceeds, the Series F stock issuance, and the repayment of the SVB term loan resulted in a net increase in cash, cash equivalents, and short-term investments of $38.7 million, net of fees and debt prepayment premiums. On April 14, 2020, we used $57.0 million of proceeds from the Note Offering to prepay in full all outstanding indebtedness, including prepayment penalties, under the Credit Agreement with OrbiMed, dated February 6, 2019, as amended, and terminate the Credit Agreement.

SVB revolving line of credit

In June 2016, we signed a Loan and Security Agreement with SVB which established a revolving line of credit based on a formula amount. On February 6, 2019, we amended the Loan Agreement with SVB which reduced the revolving line of credit to a current maximum of $5.0 million with an obligation to maintain a minimum of $5.0 million cash or cash equivalents on deposit with SVB to maintain the assurance of future credit availability. The line may be increased to $10.0 million upon request and approval by SVB. The maturity date of the revolving line of credit was amended to be February 6, 2021. On April 8, 2020, we entered into a Pay-Off Letter Agreement with SVB, pursuant to which we paid to SVB immaterial termination costs, representing all amounts due and owing under the Loan Agreement, dated as of October 6, 2017.

Cash Flows

The following table summarizes our cash flows for the years ended December 31, 2021, 2020, and 2019:

Operating activities

Our largest source of operating cash flows is cash collections from our customers for technology and professional services arrangements. Our primary uses of cash from operating activities are for employee-related expenses, marketing expenses, and technology costs.

For the year ended December 31, 2021, net cash used in operating activities was $23.1 million, which included a net loss of $153.2 million. Non-cash charges primarily consisted of  $65.1 million in stock-based compensation, $37.5 million in depreciation and amortization of property, equipment, and intangible assets, $20.0 million in change in fair value of contingent consideration liabilities, and $11.9 million in amortization of debt discount and issuance costs, reduced by the $7.1 million deferred tax benefit. The $9.1 million of payments in excess of the acquisition date fair value to settle the cash-based portion of contingent consideration liabilities was included in the net cash used in operating activities.

For the year ended December 31, 2020, net cash used in operating activities was $26.1 million, which included a net loss of $115.0 million. Non-cash charges primarily consisted of $18.7 million in depreciation and amortization of property, equipment, and intangible assets, $38.0 million in stock-based compensation, $14.1 million in change in fair value of contingent consideration liabilities, $8.5 million of loss from the extinguishment of debt, and $8.1 million in amortization of debt discount and issuance costs.

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For the year ended December 31, 2019, net cash used in operating activities was $32.2 million, which included a net loss of $60.1 million. Non-cash charges primarily consisted of $9.2 million in depreciation and amortization of property, equipment, and intangible assets, $17.8 million in stock-based compensation, $1.7 million of loss from the extinguishment of debt, and $1.1 million in amortization of debt discount and issuance costs.

Investing activities

Net cash used in investing activities for the year ended December 31, 2021 of $139.7 million was primarily due to purchases of short-term investments of $261.4 million, reduced by the sale and maturity of short-term investments of $186.9 million. There were also investing cash outflows of $46.8 million to acquire Twistle, $11.8 million in purchases of property, equipment, and intangible assets, including leasehold improvements and furnishings for our new corporate headquarters, and $6.6 million of capitalized internal use software development costs.

Net cash used in investing activities for the year ended December 31, 2020 of $82.6 million was primarily due to $189.5 million in purchases of short-term investments, $101.7 million used in current year business acquisitions, and $9.0 million in purchases of property, equipment, and intangible assets, reduced by the $219.1 million sale and maturity of short-term investments.

Net cash used in investing activities for the year ended December 31, 2019 of $209.6 million was primarily due to $256.0 million in purchases of short-term investments and $4.3 million in purchases of property, equipment, and intangible assets, reduced by the $50.7 million sale and maturity of short-term investments.

Financing activities

Net cash provided by financing activities for the year ended December 31, 2021 of $264.1 million was primarily the result of $245.2 million in public offering proceeds, net of underwriters' discounts and commissions, $20.4 million in stock option exercise proceeds, and $4.8 million in proceeds from our ESPP, reduced by the $6.3 million in payments of acquisition-related obligations.

Net cash provided by financing activities for the year ended December 31, 2020 of $182.6 million was primarily the result of $222.5 million in net proceeds from the private offering of the Notes, $36.3 million in stock option exercise proceeds, and $4.3 million in proceeds from our ESPP, reduced by the $57.0 million payoff of the OrbiMed Credit Facility, $21.7 million used to purchase Capped Calls, including issuance costs, and the $1.6 million in payments of acquisition-related obligations

Net cash provided by financing activities for the year ended December 31, 2019 of $231.4 million was primarily the result of $194.6 million in IPO proceeds, net of underwriters’ discounts and commissions, $47.2 million in net proceeds drawn under the OrbiMed Credit Facility, $12.1 million in net proceeds from the sale and issuance of Series F redeemable convertible preferred stock, $2.7 million in stock option exercise proceeds, and $3.0 million in proceeds from our ESPP, reduced by the $21.8 million payoff of the SVB debt, $4.6 million in payments of deferred offering costs, and $1.7 million in payments of acquisition-related obligations.

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Contractual Obligations and Commitments

The contractual commitment amounts summarized below are associated with agreements that are enforceable and legally binding and that specify all significant terms, including fixed or minimum services to be used, fixed, minimum or variable price provisions and the approximate timing of the transaction.

In the ordinary course of business, we enter into agreements of varying scope and terms pursuant to which we agree to indemnify customers or business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the breach of such agreements, services to be provided by us or from data breaches, or intellectual property infringement claims made by third parties. No demands have been made upon us to provide indemnification under such agreements and there are no claims that we are aware of that could have a material effect on our consolidated financial statements.

Convertible senior notes

On April 14, 2020, we issued $230.0 million in aggregate principal amount of 2.50% Convertible Senior Notes due in 2025. The Notes are senior, unsecured obligations and accrue interest payable semiannually in arrears on April 15 and October 15 of each year, beginning on October 15, 2020, at a rate of 2.50% per year. The Notes will mature on April 15, 2025, unless earlier converted, redeemed, or repurchased. The Notes are convertible into cash, shares of our common stock, or a combination of cash and shares of our common stock, with the form of consideration determined at our election. The conversion rate is initially 32.6797 shares of our common stock per $1,000 principal amount of Notes (which is equivalent to an initial conversion price of approximately $30.60 per share of our common stock).

Refer to Note 10 of our audited consolidated financial statements included within Item 8 in this Annual Report on Form 10-K for more information regarding our contractual obligations related to these convertible senior notes.

Operating lease obligations

We lease office space and certain equipment under operating leases that expire between 2022 and 2031. As of December 31, 2021, we had total future operating lease payment obligations of $29.8 million, with $3.4 million payable within the next 12 months.

Refer to Note 9 of our audited consolidated financial statements included within Item 8 in this Annual Report on Form 10-K for more information regarding our operating lease obligations.

Contingent consideration liabilities

The Twistle acquisition included a contractual obligation in the form of potential contingent consideration based on certain revenue-based earn-out performance targets for Twistle during an earn-out period that ends on June 30, 2022. The Twistle contingent consideration is capped at $65.0 million and will be paid in a combination of approximately 20% cash and 80% in shares of our common stock.

The Healthfinch acquisition included a contractual obligation in the form of potential contingent consideration based on certain revenue-based earn-out performance targets for Healthfinch during an earn-out period that ended on July 31, 2021. Approximately half of the Healthfinch earn-out contingent consideration liability was settled during the third quarter of 2021 for cash consideration of $1.7 million and the issuance of 78,243 shares of our common stock. The remaining Healthfinch contingent consideration liability is expected to be settled during the first quarter of 2022.

The outstanding contingent consideration liabilities are categorized as Level 3 fair value measurements and are remeasured as of each reporting period. The estimated fair value of the contingent consideration liabilities is $19.3 million as of December 31, 2021.

Refer to Notes 2 and 7 of our audited consolidated financial statements included within Item 8 in this Annual Report on Form 10-K for more information regarding these acquisition-related contingent consideration liabilities.

Off-balance sheet arrangements

As of December 31, 2021, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

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Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the applicable periods. We base our estimates, assumptions, and judgments on our knowledge and experience about past and current events and on various other factors that we believe to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our consolidated financial statements, which, in turn, could change the results from those reported. We evaluate our estimates, assumptions, and judgments on an ongoing basis.

The critical accounting estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements are described below.

Revenue recognition

We derive our revenues primarily from technology subscriptions and professional services. We determine revenue recognition by applying the following steps:

•Identification of the contract, or contracts, with a customer;

•Identification of the performance obligations in the contract;

•Determination of the transaction price;

•Allocation of the transaction price to the performance obligations in the contract; and

•Recognition of revenue when, or as, we satisfy the performance obligation.

We recognize revenue net of any taxes collected from customers and subsequently remitted to governmental authorities.

Technology revenue

Technology revenue primarily consists of subscription fees charged to customers for access to use our technology. We provide customers access to our technology through either an all-access or limited-access, modular subscription. The majority of our subscription arrangements are cloud-based and do not provide customers the right to take possession of the technology or contain a significant penalty if the customer were to take possession of the technology. Revenue from cloud-based subscriptions is recognized ratably over the contract term beginning on the date that the service is made available to the customer. Most of our subscription contracts have up to a three-year term, of which the vast majority are terminable after one year upon 90 days notice.

Subscriptions that allow the customer to take software on-premise without significant penalty are treated as time-based licenses. These arrangements generally include access to technology, access to unspecified future products and maintenance and support. Revenue for upfront access to the technology library is recognized at a point in time when the technology is made available to the customer. Revenue for access to unspecified future products included in time-based license subscriptions is recognized ratably over the contract term beginning on the date that the access is made available to the customer.

We also have certain perpetual license arrangements. Revenue from these arrangements is recognized at a point in time upon delivery of the software. Technology revenue also includes maintenance and support revenue which generally includes bug fixes, updates, and support services. Revenue related to maintenance and support is recognized over the contract term beginning on the date that the service is made available to the customer.

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Professional services revenue

Professional services revenue primarily includes data and analytics services, domain expertise services, outsourcing services, and implementation services. Professional services arrangements typically include a fee for making FTE services available to our customers on a monthly basis. FTE services generally consist of a blend of analytic engineers, analysts, and data scientists based on the domain expertise needed to best serve our customers. Professional services are typically considered distinct from the technology offerings and revenue is generally recognized as the service is provided using the “right to invoice” practical expedient.

Contracts with multiple performance obligations

Many of our contracts include multiple performance obligations. We account for performance obligations separately if they are capable of being distinct and distinct within the context of the contract. In these circumstances, the transaction price is allocated to separate performance obligations on a relative standalone selling price basis. We determine standalone selling prices based on the observable price a good or service is sold for separately when available. In cases where standalone selling prices are not directly observable, based on information available, we utilize the expected cost plus a margin, adjusted market assessment, or residual estimation method. We consider all information available including our overall pricing objectives, market conditions, and other factors, which may include the value of contracts, customer demographics, and the types of users.

Standalone selling prices are not directly observable for our all-access and limited-access technology arrangements, which are composed of cloud-based subscriptions, time-based licenses, and perpetual licenses. For these technology arrangements, we use the residual estimation method due to the limited number of standalone transactions and/or prices that are highly variable.

Variable consideration

We have also entered into at-risk and shared savings arrangements with certain customers whereby we receive variable consideration based on the achievement of measurable improvements which may include cost savings or performance against metrics. For these arrangements, we estimate revenue using the most likely amount that we will receive. Estimates are based on our historical experience and best judgment at the time to the extent it is probable that a significant reversal of revenue recognized will not occur. Due to the nature of our arrangements, certain estimates may be constrained until the uncertainty is further resolved.

Business combinations

The results of businesses acquired in a business combination are included in our consolidated financial statements from the date of the acquisition. Purchase accounting results in assets and liabilities of an acquired business generally being recorded at their estimated fair values on the acquisition date. Any excess consideration over the fair value of identifiable assets acquired and liabilities assumed is recognized as goodwill.

We perform valuations of assets acquired and liabilities assumed on each acquisition accounted for as a business combination in order to record the tangible and intangible assets acquired and liabilities assumed based on our best estimate of fair value. Determining the fair value of assets acquired and liabilities assumed requires management to use significant judgment and estimates including the selection of valuation methodologies, estimates of future revenue and cash flows, discount rates, and selection of comparable companies. Significant estimation is required in determining the fair value of the customer-related intangible assets and technology-related intangible assets. The significant estimation is primarily due to the judgmental nature of the inputs to the valuation models used to measure the fair value of these intangible assets, as well as the sensitivity of the respective fair values to the underlying significant assumptions. We typically use the income approach or cost approach to measure the fair value of intangible assets. The significant assumptions used to form the basis of the estimates included the number of engineer hours required to develop technology, expected revenue including revenue growth rates, rate and timing of obsolescence, royalty rates and earnings before interest, taxes, depreciation and amortization (EBITDA) margin used in the estimate for customer relationships, and backlog. Many of these significant assumptions were forward-looking and could be affected by future economic and market conditions. We engage the assistance of valuation specialists in concluding on fair value measurements in connection with determining fair values of assets acquired and liabilities assumed in a business combination.

Transaction costs associated with business combinations are expensed as incurred and are included in general and administrative expense in our consolidated statements of operations and comprehensive loss.

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Goodwill

We record goodwill as the difference between the aggregate consideration paid for a business combination and the fair value of the identifiable net tangible and intangible assets acquired. Goodwill includes the know-how of the assembled workforce, the ability of the workforce to further improve technology and product offerings, customer relationships, and the expected cash flows resulting from these efforts. Goodwill may also include expected synergies resulting from the complementary strategic fit these businesses bring to existing operations. Goodwill is assessed for impairment annually or more frequently if indicators of impairment are present or circumstances suggest that impairment may exist.

Our first step in the goodwill impairment test is a qualitative analysis of factors that could be indicators of potential impairment. Next, if a quantitative analysis is necessary, we compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered impaired. If the carrying amount of the reporting unit exceeds its fair value, we would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value.

Stock-based compensation

Stock-based awards, including stock options, restricted stock units (RSUs), performance-based restricted stock units (PRSUs), and restricted shares are measured and recognized in the consolidated financial statements based on the fair value of the award on the grant date. The grant date fair value of our stock-based awards is typically determined using the market closing price of our common stock on the date of grant; however, we also consider whether any adjustments are required as a result of material nonpublic information to which the market is likely to react positively upon announcement. The expense is recognized straight-line over the vesting period for awards with a service condition. The accelerated attribution method is used for PRSUs.

We record forfeitures of stock-based awards as the actual forfeitures occur. For awards subject to performance conditions, we record expense when the performance condition becomes probable. Each reporting period, we evaluate the probability of achieving the performance criteria, estimate the number of shares that are expected to vest, and adjust the related compensation expense accordingly.

We estimate the fair value of purchase rights issued under the 2019 Health Catalyst Employee Stock Purchase Plan (ESPP) as of the beginning of each offering period using the Black-Scholes option-pricing model. This requires the input of subjective assumptions, including the expected volatility of the price of our common stock, risk-free interest rates, and the expected dividend yield of our common stock. The assumptions used in our option-pricing model represent our best estimates. These estimates involve inherent uncertainties and the application of management’s judgment. The resulting fair value, net of actual forfeitures, is recognized on a straight-line basis over each six-month ESPP offering period.

The measurement date for non-employee awards is the date of grant. The compensation expense for non-employees is recognized, without changes in the fair value of the award, in the same period and in the same manner as though we had paid cash for the services, which is typically the vesting period of the respective award.

We will continue to use judgment in evaluating the assumptions related to our stock-based compensation on a prospective basis. As we continue to accumulate additional data related to our common stock, we may have refinements to our estimates, which could materially impact our future stock-based compensation expense.

Recent Accounting Pronouncements

See “Description of Business and Summary of Significant Accounting Policies” in Note 1 to our audited consolidated financial statements included within Item 8 in this Annual Report on Form 10-K for more information.

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