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Castlight Health (NYSE:CSLT)
Q1 2019 Earnings Call
May. 02, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good afternoon. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Castlight Health Q1 2019 financial results conference call. [Operator instructions] Thank you.

Gary Fuges, head of investor relations, you may begin the conference.

John Doyle -- Chief Executive Officer

Thank you for joining us on the call today. The first quarter was a solid start to the year with results that we believe demonstrate the value of the product investments we've made over the last four years. Two of our goals in 2019 are to accelerate new business and further improve the health of our overall book and we made progress on both in Q1. We grew ARR by close to $4 million sequentially, with direct sales accounting for the majority of new business.

In parallel, we launched a record number of new customers, continued our customer migration and product innovation work and generated financial results that track to our full-year guidance. These results align with what benefit consultants and buyers communicated at recent industry conferences. There is increasing market need for personalized digital health navigation experience that drives user engagement, program utilization and healthcare cost savings. We believe our Q1 results further validate our product strategy and investments.

As we enter the prime selling season this quarter, we are focused on building on the good start from Q1. I'll discuss the first-quarter highlights and then Siobhan will provide more detail on our financial results. As I said, we ended the quarter with annualized recurring revenue, or ARR, of $154 million. Both direct to employer and channel sales were on plan as we closed deals in Q1 that were in the pipelines at year end.

Excluding ARR from the major customer that terminated last July, ARR increased 3% year over year. Looking inside the numbers, I'm encouraged by the contribution from direct-to-employer sales and the traction we saw for Castlight Complete in the market. These sales represented 60% of Q1 new sales, on target with our expectations. Additionally, more than 90% of new business in Q1 came from our combined care guidance and well-being platform products, illustrating the market demand for a comprehensive single-app health navigation solution.

One notable Castlight Complete win was at a major U.S. bank, which means we now serve five of the top 10 players in this vertical. Given the high bar financial institutions set for their technology vendors, we believe our penetration with U.S. banking industry is a proof point for our platform to reliability.

We believe the new business mix and our continued focus on customer retention is driving meaningful improvement in the health of our book of business. Platform customers now account for nearly 90% of total ARR, up from 81% in the year-ago period. Since the launch of Complete in September, we've seen the validation of our digital health navigation thesis through successful customer launches, industry commentary and testimonials from satisfied clients. First, our early data point support our view that a personalized digital front door for both healthcare and well-being benefits can drive levels of user engagement and healthcare cost savings that exceed what even well-being or care guidance have achieved on their own.

For example, Complete is driving 40% higher program utilization with stand-alone well-being and a 20% improvement from stand-alone care guidance in provider or condition search rates, which is a leading indicator to healthcare cost savings. These gains reflect strong engagement overall with average registration rates approaching 60% and monthly active users of approximately 40%. Second, at recent trade conferences, a number of employers and industry consultants reinforced the increasing market need for health navigation. At the recent conference hosted by the National Business Group on Health, they keep themes including those you've been hearing from us for some time such as increasing engagement, steering users toward high-quality cost-efficient care and personalization through data-driven insights.

However, the best validation of Complete comes from the customers that have launched it. Their feedback has been extremely positive and all launch clients are referenceable. In March and April, leadership of ArcBest, a premier logistics company, presented at The Conference Boards, employee healthcare conferences in San Diego and New York and discussed how they rely on Complete's personalized user experience to engage their entire employee population and drive value on their investment. This week, Ford participated in a webcast hosted by our EVP of product and customer experience, Maeve O'Meara, to discuss how Complete enables the interconnectivity of their healthcare resources, optimizes their benefits programs and supports individual well-being.

We appreciate these customers' willingness to share their respective Complete journeys, which we believe are very helpful to prospects and existing customers who are considering expanding into whole health navigation. Today, we are in the early stages of the prime selling season and our focus over the next two quarters is on accelerating sales of Castlight Complete. We believe we have the right pipeline opportunities in front of us, our focus squarely on execution. In addition to driving new business, we have important customer migration and product innovation goals to achieve over the balance of the year, and I'd like to give you an update on each.

The migration of legacy well-being customers to the platform is tracking to our plan. We've invested heavily in this process and believe we can generate a virtuous cycle of migrating clients by exceeding expectations with legacy well-being customers who've converted to the platform. Regarding product innovation, we've made very good progress toward standing up appointments, scheduling and bill pay pilots later this year. We're taking a partnership approach in both areas and currently expect to begin implementations and testing in the third quarter.

To us, adding end-to-end transactions to the platform, we'll take user value to a new level, which we believe will drive incremental engagement and ultimately greater ROI. Also, we're pleased with our progress this quarter and how we're positioned for the selling season. Our health navigation solutions are resonating with employers and delighting our users. Importantly, by the time of our Q2 call, we expect to have completed the large majority of the remaining migrations, which means that nearly all of Castlight's customers will be united on a single platform that is the most powerful solution in the market today.

It's an exciting time for the company and I appreciate the dedication of Castlighters across the entire organization whose efforts continue to drive the industry forward. With that, I'll turn the call over to Siobhan.

Siobhan Mangini -- Chief Financial Officer

Thanks, John. Good afternoon, everyone, and let me also thank all of you for joining us on today's call. I'll review our Q1 results and full-year outlook, and after that, we'll take your questions. The first quarter tracked according to our expectations and provided an early indication that our product strategy and platform investments are generating new business and a healthier ARR mix.

We ended the quarter with net annualized recurring revenue, or ARR, of $154.3 million. As John mentioned, total ARR increased $3.8 million sequentially. We're pleased to say our newest products, Complete and Engage, now represent over half of our ARR. Importantly, they are delighting and engaging our end users.

Total revenue for the first quarter was $35.5 million, down $6.6 million sequentially and in line with expectations we shared on our prior call. This is due to the impact of Q4 one-time revenue and 2018 notified churn becoming effective at year end, all while first-quarter customer launches ramp the revenue contribution. Reported revenue is a function of completed implementations and we had a record 46 new customers launched in Q1. Average implementation time for these customers was five months, which speaks to the strength of our new platform.

Subscription revenue was 95% of total revenue and increased 2% year over year. As expected, professional services revenue declined 52% year over year as the year-ago period included one-time development fees. Now let's turn to our first-quarter non-GAAP financials. Q1 non-GAAP gross margin was 63.%, essentially flat year over year and down sequentially.

This was expected and was a result of the investments required to support the record number of Q1 customer launches and legacy well-being customer migrations. Subscription gross margin was 78%, up from 76% in the year-ago period. We continue to expect to hit our long-term gross margin target range of 70% to 75% in the second of this year as we complete most of the legacy well-being customer migrations by midyear. Total non-GAAP operating expense in the first quarter was $27.7 million, down 10% year over year due primarily to continued efficiencies in sales and marketing.

Specifically, for full-year 2019, we continue to expect R&D investment to run above its long-term target range based on our conviction on the market opportunity for new platform offerings. We're pleased to continue to attract and hire high-quality technical talent that will drive future innovation. Based on the above, non-GAAP operating loss was $5.3 million, compared to a loss of $7.7 million in the year-ago period. Cash used in operations was $12 million.

The largest driver of this use was working capital requirements from users who're gaining points on our platforms. We expect to collect payments in Q2 and see the use of cash as a positive proof point of the levels of engagement we're driving on our platform. We ended the quarter with $66.3 million of cash and cash equivalents. And with that, I'll turn to our outlook.

Today, we are reiterating the 2019 guidance ranges we provided on our prior quarter. Revenue between $153 million and $158 million, non-GAAP operating income between breakeven and $5 million and non-GAAP earnings per share between zero cents and $0.03 based on 145 million to 146 million shares. We also continue to expect 2019 cash flow from operations to be between $3 million and $8 million with cash usage in the first and third quarters. In summary, the first quarter was a good start to the year.

In particular, we're very pleased with the successful launch of Complete at scale and the execution of our first migrations as we were generating early proof points on the power of a single integrated health navigation platform. I want to take a moment to thank Castlight's employees for their hard work and to our shareholders, customers, partners and users for their support on this journey. Thank you. And operator, we'll now take your questions.

Questions & Answers:


Operator

[Operator instructions] Your first question is from Jeff Garro with William Blair.

Jeff Garro -- William Blair -- Analyst

We'll start with a little housekeeping on the net new ARR. You mentioned last quarter that some deals had pushed from the fourth quarter and some had signed in Q1 but some are still expected to sign, so I wanted to ask if those closed. And then just use that as a jumping point to ask how sales cycles are trending? And how the pipeline is building for Q2 and Q3?

John Doyle -- Chief Executive Officer

Yes. Thanks, Jeff. So we did closed the sales in Q1 and that's important. We're excited about the sequential increase in ARR, it was a very solid quarter, one of the best we've had in a number of years.

But I think important, not to miss that we had deals come in from Q4. We also had a really strong performance on churn coming in at the lowest level of churn in more than three years. Those are really the big tailwinds we saw in Q1. We're just heading into the prime selling season in Q2 and Q3, and from a pipeline perspective, feel very good about the opportunities that we've got in front of us.

And as we've talked about on the last few calls, it's really about conversion rates, which have been improving in the business. And we think that's tied to a turn in the substance and tone in the market around what Castlight is delivering. So the Castlight Complete launches have been very successful. And we've seen customers like ArcBest at The Conference Boards in San Diego, New York and then recently, this week, Ford speaking on a webinar, I think illustrating very strongly that we're driving results and delivering a reliable product, which we think bodes well for closing deals over the next couple of quarters.

Jeff Garro -- William Blair -- Analyst

Great. That's helpful. And one more question for me as we think about growth even beyond this year. You talked about potential for new channel partners last quarter, so wanted to see if you had any update on that front.

John Doyle -- Chief Executive Officer

Yes, I do. And the headlines for Q1 certainly across the entire business is executing on track with our plans for the year. This is the one area where things have gone more slowly than I'd hoped. I think we will be in good shape with an expansion of our channel relationships for the 2020 selling season, and we'll keep you posted on that as time moves forward here but it has taken a bit longer than I anticipated.

Jeff Garro -- William Blair -- Analyst

Any expectation for second quarter or third quarter being able to announce one of those? Or is it more in flux?

John Doyle -- Chief Executive Officer

I feel good about our ability in that time frame to tell you more detail about the expansion of the channel relationships. I think that's a fair time line and certainly the one we need to hit to be in a good position to leverage a new relationship during the selling season next year. So that's certainly the goal.

Operator

Your next question is from Frank Sparacino with First Analysis.

Frank Sparacino -- First Analysis -- Analyst

Maybe to start with, just from a well-being perspective. It seem like there was an unusually high level of news in recent months around the ROI related to wellness programs, incentives, etc. And I don't know, John, if you have any thoughts in terms of kind of the feedback you've been getting from your clients and the maybe the impact that has from a sales perspective?

John Doyle -- Chief Executive Officer

Well, I certainly think that the -- first of all, skepticism historically about the ROI in the traditional wellness business was among the things that led us to think that combining well-being and care guidance made a bunch of sense, particularly from a employee and employer point of view. In other words, well-being is a very standard part of large employers overall offerings to employees and most of those employers are aware that that well-being investment hasn't been very productive economically, historically. At least not in the way that reducing medical spend and the care guidance framework is. I think there is a hypothesis that there are other benefits but the ROIs has not been clear.

By combining well-being and care guidance, we're able to drive engagement in the overall solution to higher levels than either of those solutions was able to generate before and what that has meant is that as we've talked to customers about results, we're seeing across the entire book of business for customers that have the combined product. You're seeing higher registration on average around 60%. You're seeing much higher monthly active use of the product and greater search rates, all of which lead to ROI. And so for Castlight customers, the portion of their overall investment with us that they allocate to well-being, we actually believe is quite demonstrably productive, which differentiates what we're doing in that area from the historical trends.

Frank Sparacino -- First Analysis -- Analyst

That's helpful. And maybe just one other question. As you look at the new sales activity for 2019, just trying to get a sense if the mix relative to direct and channel where you think that will be, I'm assuming -- obviously, last year was a little bit disappointing on the direct side of things. But just trying to get a sense of what that looks like.

John Doyle -- Chief Executive Officer

Yes. We're looking for a big change on the direct side of the business, much more in line with what we saw in Q1, where more than 60% of the new business was direct-to-employer sales. We want to see that continue. I think it will, we're on track across the business.

And it's not very surprising really, Frank, when you think about the context that our folks were selling into this time last year, where not only had we not launched Castlight Complete. So there wasn't a product that you could put in the hands of a prospect to test for themselves. But we were having -- we are in the kind of in the midst of resolving operational issues in the legacy well-being business, and so that just compounded the effects of not having a product in market that folks could test for themselves and get reference. Today, we're able to put a demo solution in the hands of any prospect that's interested.

We've got all of the Castlight Complete customers fully referenceable and excited about the launches that we've executed, stretching back to last September, some of which were with our most complex largest customers. And so the proof points to back up the product experience are another tailwind. So as we look forward and certainly even in Q1 when I think about the conversations that we have with customers then, it's a pretty big change in context and I think bodes well for our ability to do better on the direct business in 2019 than we did in 2018.

Operator

Your next question is from Charles Rhyee with Cowen.

Charles Rhyee -- Cowen and Company -- Analyst

On the other side with the Anthem Engage. If 60% of the sales in the quarter were direct, is that a sign -- is that a function of more focus there? Maybe talk about what's happening on the Anthem side or is that a -- or is the sort of the Engage selling season part of it more later in the year, maybe you can give us some sense on the characteristics of how do we think about maybe the ebbs and flows as we move through the selling season?

John Doyle -- Chief Executive Officer

Thanks, Charles. I'm not sure I caught your entire question because the first part of it didn't come through here but I think I can fill in the part I didn't hear, if I didn't, correct me. So overall, again, feeling good, we're on track, on plan from a sales point of view that includes the channel side of the business, which I think in terms of its stage of evolution is a more mature sales motion than we've got on the direct-to-employer business. And we feel good about how the channel business is progressing this year.

That's the part of our 2019 results that I think is easiest to predict, given the visibility, and again, the kind of time line relative to Castlight Complete that we've been in the market with that product. On the direct side of the business, the improvements we're seeing, I think, are less about focus because certainly in 2018, we spent a lot of time with prospects and customers and consultants and partners talking about Castlight Complete, and more about the availability of the product and in particular, the opportunity for prospects to speak to HR leaders who already deployed Castlight Complete. I really think that's the difference this quarter.

Charles Rhyee -- Cowen and Company -- Analyst

OK. That's helpful. And just when we think about channel then, you say it's more mature, more predictable. But if I remember like a year or so ago, or when it was first launching, it was sort of being like the sales forces over an Anthem were being trained.

I think what the national accounts first and then this year broadening out to more of their brokers. So it seemed at the time, and correct me if I'm wrong, that this -- the channel side is just still be sort of a strong growing side for you? When you see mature is it more that it's just more predictable or has the growth profile changed?

John Doyle -- Chief Executive Officer

Well, we've talked a couple of times about our expectations for run rate on that part of the business and coming into 2019, we expected a similar level of new business in 2019, as we've seen in 2018 in the channel side of things and that's our expectation. And so it contributes certainly new growth from an ARR point of view, but when I use a word like mature and it's probably overusing it certainly in a business as young as ours, but the point of that is that the absolute dollars of new business added there in '19, we expect will be similar to '18. It's really the direct side of the business, where we did -- less than half of the business we did in the channel side in 2018 where we expect a significantly better improvement and a better balance going forward between the two.

Charles Rhyee -- Cowen and Company -- Analyst

Great. And then maybe just a quick follow-up. How many customers do we end the quarter with?

Siobhan Mangini -- Chief Financial Officer

It's around 270, Charles, and continue to about 30% Fortune 500 customers.

Operator

Your next question is from Gene Mannheimer with Dougherty & Company.

Gene Mannheimer -- Dougherty and Company -- Analyst

Congrats on the good progress in Q1. With respect to the ARR that's still vulnerable so to speak, sounds like that's about 10% now, which is meaningfully less than this time a year ago. Is that more skewed to your transparency-only customers or legacy Jiff customers, how should we think about that population?

Siobhan Mangini -- Chief Financial Officer

Sure, Gene. So what we were talking about was the transparency-only business, it is to your point about 11% of ARR at this point in time. And this is a group of customers who have been through most of the renewal cycles and we are in -- it's a fundamentally different place. The great news is that migration conversations are conversations that really happened in 2018, and so those customers and we're talking in the mid-30s in terms of total number of well-being customers were migrating.

Those conversations were happening all through 2018 and were incorporated into the ARR numbers that we shared last year. And so that is -- we are now with committed customers who are migrating, some of them have already migrated and then are migrating through the rest of this year.

Gene Mannheimer -- Dougherty and Company -- Analyst

OK. Good. Very helpful to understand. Next question with respect to the loss of your then largest customer last year.

Can you now sort of share the breakout of your next four or five biggest customers? And what their contribution is to ARR and how many of those have committed to the platform approach?

Siobhan Mangini -- Chief Financial Officer

Well, here's what I'll share. I think we've talked about the concentration profile differs. There is only one other customer that is at the scale of what a Walmart was and that is one of the customers that launched Complete. We've talked about them, I think they've been an incredibly powerful proof point for us.

So this is the customer that has over 16 different integrations and is on the Complete, one of the first Complete launches that we had. After you go beyond that customer, there are no more eight-digit customers and so it's just a different profile. Most of those top customers do have Complete or are migrating to Complete, but I think that's about as much detail as we'll provide in terms of the actual ARR breakdown for the top four. Anything you want to add, John?

John Doyle -- Chief Executive Officer

Well, we can point out that the customer concentration of the top 10 has continued to be around 30% of the business, a little bit less than that at this point.

Operator

[Operator instructions] And this concludes the Q&A portion of the call. I will now turn things back to John Doyle for any closing remarks.

John Doyle -- Chief Executive Officer

Thank you for joining us on today's call. Q1 was a promising start to the year. We're encouraged by how well our new health navigation offerings are resonating with users and buyers. And we're confident in our platforms' demonstrated ability to put the right benefit in front of the right users at the right time.

We hope to see you in June at the Jefferies Healthcare Conference and William Blair Growth Conference, have a wonderful evening.

Operator

[Operator signoff]

Duration: 29 minutes

Call participants:

John Doyle -- Chief Executive Officer

Siobhan Mangini -- Chief Financial Officer

Jeff Garro -- William Blair -- Analyst

Frank Sparacino -- First Analysis -- Analyst

Charles Rhyee -- Cowen and Company -- Analyst

Gene Mannheimer -- Dougherty and Company -- Analyst

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