Start Time: 17:00 January 1, 0000 5:45 PM ET
Model N, Inc. (NYSE:MODN)
Q2 2019 Earnings Conference Call
May 07, 2019, 17:00 PM ET
Jason Blessing - CEO
David Barter - CFO
Conference Call Participants
Jackson Ader - JPMorgan
Kevin Ruth - Raymond James
Koji Ikeda - Oppenheimer
Chad Bennett - Craig-Hallum
Ilya Grozovsky - National Securities
Alex Henderson - Needham & Company
Joe Goodwin - JMP Securities
Gene Mannheimer - Dougherty & Company
Greetings. Welcome to Model N Second Quarter Fiscal Year 2019 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. David Barter, Model N’s Chief Financial Officer. Thank you. Sir, you may begin.
Good afternoon. Welcome to the earnings call for Model N's second quarter fiscal year 2019, which ended on March 31, 2019. This is David Barter. I’m Model N's Chief Financial Officer, and with me on the call today is Jason Blessing, Model N's Chief Executive Officer.
Our press release was issued after close of market and is posted on our Web site where this call is being simultaneously webcast. The primary purpose of today's call is to provide you information regarding our second quarter of fiscal year 2019 performance and our financial outlook for our third quarter and full year fiscal 2019.
Commentary made on this call may include forward-looking statements. These forward-looking statements are based on management's current views and expectations as of today and should not be relied upon as representing our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. Actual results may differ materially. Please refer to the risk factors in our most recent Form 10-K and 10-Q filed with the SEC.
In addition, during today's call, we will discuss non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to, not as a substitute for, or in isolation from GAAP results. Reconciliations of the non-GAAP metrics to the nearest GAAP metric are included in the earnings release issue today, which is available on our Web site. I encourage you to visit our Investor Relations Web site at investor.modeln.com to access our second quarter fiscal year 2019 press release, periodic SEC reports, and the webcast replay of this call.
Finally, unless otherwise stated, all financial comparisons in this call will be to our results for our second quarter fiscal year 2018.
With that, let me turn the call over to Jason.
Thank you, David. Good afternoon and thank you for joining us today. We had another well-executed quarter and delivered results that once again came in above our guidance. We are now three full quarters into running our more focused, go-to-market plan, and I’m pleased with the progress we continue to make. Our focus on Life Sciences and High Tech and the alignment of our sales teams around new logo acquisition and customer sales continues to show positive results.
Q2 bookings built on the momentum we’ve enjoyed over the last three quarters and are growing in excess of 25%. The new customer trend in particular continues to be encouraging. We’ve now booked as many new logos in the first half of 2019 as we did all of last year. As we’ve shared in the past, we are less than 10% penetrated from a logo perspective in our target markets and this represents a significant opportunity. I think we can continue to accelerate the velocity of new customer acquisition as our account executives have more time to develop their territories.
We also expect that as the secular trend towards SaaS plays out that Model N as the leader in our space will disproportionately benefit as has happened in other markets. Our sales activity is also complemented by our focus on improving the time and cost to deliver our solutions. The cost to implement our SaaS solutions is now typically between 1x and 1.5x the cost of the annual subscription. This is very competitive for a mission-critical SaaS application and another reason for our positive outlook.
The company also achieved other important milestones in Q2 that show we continue to get leverage and improve the overall management of the company. Our non-GAAP subscription margin is now 70%, an increase of 6 percentage points from last year and a sign that we continue to get benefit from scale in our cost-to-serve customers. While we are happy with the gross margin progress over the last couple of years, we continue to see a path for improvement into the mid-70s.
The company was also cash flow positive in Q2. We are at an important inflection point in our ability to generate cash, and I expect we will continue to improve in this area as the year progresses. And finally, we paid down our debt in Q2 by nearly $5 million and the company is in a positive net cash position, which serves to further strengthen our balance sheet. All of this points to the progress we’ve made as a company and the improved execution across the business.
Trust and customer success are the cornerstones of great SaaS companies and in early Q3, we hit a major milestone in this area with Gilead Sciences successfully transitioning to our SaaS offering. I thought it would be helpful to provide some additional background on the project and why we consider this to be such an important event in our evolution as a SaaS company.
Gilead began their SaaS transition in October 2017, and their motivations for doing so came down to three important factors. First, the changing compliance environment and risk management; second, incorporating automation to streamline processes and reduce revenue leakage; and third, modernizing their application environment to significantly enhance performance while lowering overall operating cost.
Gilead went live on our SaaS solution in April on time and as expected. I was recently with Gilead and the Model N project teams to celebrate their success with go-live, and we’d like to personally congratulate everyone involved. In particular, this project was a high-visibility event within the Model N community given Gilead’s size, scale and reputation as a top 15 global pharmaceutical company. This project will serve as a template for how our other large pharmaceutical customers can retire their legacy systems and transition to SaaS in an effective manner.
In March, we held our annual user conference, Rainmaker, and enjoyed tremendous participation from customers in our growing partner ecosystem. We also had a record number of prospects that attended this year’s event. There were three themes that stood out to me after attending this year’s event. First, customers continued to view Model N as one of their top strategic partners when it comes to software used to run their businesses. Two, customers are supportive of the strategic adjustments that we made last year to refocus the company and our resources on our key verticals.
I believe these first two points are important to us earning the right to expand our footprint with existing customers. Our focus on key verticals also resonated well with the prospects who were in attendance. The last and perhaps most important takeaway is the increasing prominence of our software in Life Sciences, given the recent changes to pharmaceutical pricing being proposed by the Department of Health and Human Services.
Let me elaborate more on this final point. This proposed regulatory update will change the pricing model from Medicare Part D and Medicaid managed care plans. The goal of the update is to encourage price reductions that have a greater benefit to the patient through discounts given at the point-of-sale.
This is an important topic with the American public, particularly as we head into the 2020 presidential elections. The prevailing wisdom is these changes will be enacted, but how is still being discussed. We are actively engaged in these discussions, along with our customers, which as a reminder includes the top 10 largest pharmaceutical companies in the world.
The Department of Health and Human Services is planning on issuing its final guidance this summer, and I do believe this will be a net positive for our business given that we are the pricing and contracts system of record for the global pharmaceutical industry.
The first half of our fiscal year was well executed. I am pleased with our performance and financial results. With that in mind, I would like to share some thoughts on what you can expect from us in the second half of the year. One, you should expect our growth to be driven by improving sales execution.
The strategic adjustments we made last year are showing positive returns. Rainmaker was well attended by prospects, which is also a positive sign for demand. And the adoption of SaaS and the changing regulatory landscape will serve as a tailwind for us over the next several quarters and years.
I expect that this will allow us to continue to drive healthy customer sales as well as accelerate new logo acquisition, which in turn will drive new customer sales in the out years. Second, I’m very excited to have Chris Lyon join as Model N’s new Chief Revenue Officer.
I have known Chris for over 15 years, first as a coworker at PeopleSoft and then as a Workday customer of his at my last company. Chris was a key leader that built the sales engines at both PeopleSoft and Workday, and we are very lucky to have a sales executive of his caliber join the team. I expect that Model N will benefit from his experience in the form of profitable growth over the next several years.
Finally, the first half of 2019 shows that scale is driving leverage in all areas of our business; leverage in sales due to more focused go-to-market planning, leverage in our operations as evidenced by our improving gross margins and cash flow, and perhaps most importantly, leverage in our solutions as evidenced by the successful SaaS transition at Gilead Sciences. I am pleased with the company’s progress so far in 2019. Our focus is leading to quality results and setting us up for profitable growth in 2020.
Now, I would like to turn the call over to David to elaborate on our results and our financial outlook. David?
Thank you, Jason. The company executed well in Q2 driven by healthy subscription revenue growth. As a reminder, we started running a more focused go-to-market plan three quarters ago. Since then, bookings from both new and exciting customers have increased significantly.
We’re also scaling the business, which is leading to healthy subscription gross margin, adjusted EBITDA and cash flow. I’m particularly pleased with our cash flow generation and our positive net cash position, which reflects that we paid down almost 10% of our term loan this quarter.
Let’s now turn to some second quarter highlights. As a reminder, the results for Q2 are based on the modified retrospective adoption of ASC 606. In the second quarter, total revenues were $34.8 million and above our Q2 guidance range of $34.3 million to $34.7 million.
The outperformance was driven by our subscription revenues, which were $25.9 million in the second quarter, ahead of our guidance of $25.4 million to $25.8 million and representing steady sequential growth.
Subscription revenues now comprise almost 75% of total revenues. This is a meaningful improvement from last year. During Q2 and the first half of fiscal year 2018, subscription revenues represented approximately 60% of total revenues.
Professional services were $8.9 million for the quarter or approximately 25% of total revenues. This represents meaningful progress as the company drives down the cost and time of our implementations and further leverages partners.
Before I move on, I want to remind you that my commentary will be focused on non-GAAP results, which excludes the impact of stock-based compensation and the amortization of the intangible assets. A reconciliation of non-GAAP to GAAP results is provided with our earnings press release issued earlier today.
Non-GAAP gross profit for the second quarter was $19.6 million or 56%. Gross margin for subscription revenues was 70%, a substantial improvement over the 64% in Q2 of fiscal year 2018. Reaching 70% is an important milestone for us.
We expect to see subscription revenue gross margin remain at these improved levels as we move through the year, and we expect to achieve our full year target of 70%. Gross margin for professional services was 18%, which is better than our expectations.
Non-GAAP operating profit for the period was $1.5 million. This exceeded our guidance of a non-GAAP operating loss of $100,000 to an operating profit of $300,000 and reflects our focus on scaling the business.
Non-GAAP net income in the second quarter was $353,000. We produced a non-GAAP net income per share of $0.01 based on 32 million shares. This was ahead of our guidance of a non-GAAP net loss per share of $0.05 to $0.03.
Adjusted EBITDA for the second quarter was $1.8 million, which is well ahead of our guidance of $300,000 to $700,000. This reflects improved mix of subscription revenues and the strength in our gross margin.
At the end of the second quarter, total deferred revenue was $36.3 million. As I’ve shared on prior calls, deferred revenue is not a perfect measure for our business based on the invoicing terms across our customers.
Approximately 30% of our customers are not on our standard annual prepaid payment terms. This quarter’s balance was also impacted by deals with escalating payment structures and a few late renewals.
We ended the second quarter with $54.1 million of cash and cash equivalents compared with $52.2 million at the end of the first quarter. Free cash flow generated was $4.7 million in Q2. Through the first six months of the year, we are free cash flow positive. It’s the first time as a public company we’re free cash flow positive at the end of the first half.
We remain confident in our ability to generate $8 million to $10 million of free cash flow this fiscal year. During the quarter, we paid down our term loan by $4.75 million. We are now in a positive net cash position. As our free cash flow continues to improve, we expect to further reduce our outstanding debt and increase our net cash position.
Before I provide guidance, I’d like to share a little perspective on how we are thinking about the remainder of fiscal 2019. With the conclusion of the first half of the fiscal year, we have improved visibility into the outlook of our subscription revenues. This reflects our sales execution as a company focused on Life Sciences and High Tech and the go-to-market changes we’ve made a couple of quarters ago. We will continue scaling the company to drive meaningful growth and profitability, and we expect profit to increase in Q4.
Professional services revenues will come in at the lower end of our range of 25% to 28%. This is in line with what I shared on our last earnings call. It reflects the progress we’ve made leveraging partners and driving down implementation cost to a range of 1x to 1.5x the annual subscription amount.
For Q3, I expect the gross margin for professional services to be in the teens and then climb back into the 20s in Q4. We also expect professional services revenues to increase in Q4 given the volume of engagements.
For the third quarter ending June 30, 2019, we expect total revenues to be in a range of $33.9 million to $34.3 million. And within this, we expect total subscription revenues to range from $26 million to $26.4 million. This guidance does reflect the impact of an escalating deal structure.
We’re confident the quantity of deals we’re booking with new and existing customers will continue to lead to strong sequential and multiyear growth. We’re also confident in the quality of the deals we’re booking based on the very low churn we’re seeing with our Life Sciences customers using our cloud platform.
Non-GAAP income from operations is expected to be in the range of $1.4 million to $1.8 million. This would lead to a range of a non-GAAP net income per share of $0.00 to $0.02 based on a weighted average share count of 32.6 million shares. Adjusted EBITDA is expected to be in the range of $1.8 million to $2.2 million.
While we do not provide cash flow guidance on a quarterly basis, please note our third quarter ends on a weekend. We can already see customers scheduling payments for July 1. While this might weigh on Q3 cash flow, it clearly will not impact our full year estimate.
For full year fiscal 2019, we are raising the midpoint of our subscription revenues guidance. We now expect total subscription revenues to range from $103 million to $105 million. We expect total revenues to range from $138.5 million to $140.5 million. This implies professional services will be approximately 25% of total revenues, a meaningful improvement over fiscal year 2018.
We expect non-GAAP income from operations in the range of $8 million to $11 million and non-GAAP income per share in the range of $0.10 to $0.17 based on a weighted average share count of 32.2 million shares.
Adjusted EBITDA is expected to be in the range of $9.5 million to $12.5 million. We continue to expect free cash flow to be in the range of $8 million to $10 million, a meaningful 4x increase on the fiscal year 2018 free cash flow of approximately $2 million.
The first half of fiscal year 2019 was well executed. Our sales execution is strong, which reflects the focus of the company. Gilead Sciences is live on our platform, which demonstrates that we can serve all companies on our SaaS platform, emerging, mid-sized and large enterprise.
We will build on our momentum in the second half of the year, and we remain focused on delivering growth and profitability.
With that, let me turn the call over to the operator for questions. Operator?
Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Jackson Ader with JPMorgan. Please proceed with your question.
Great. Thanks. Good evening, guys. Thanks for taking the questions. First one; so Gilead going 100% SaaS, how many other top 15 pharma are currently in that pipeline to go from on-premise to full SaaS?
Hi, Jackson. This is Jason. Good evening. Thanks for the question. The simple answer to that is all of them. We just got back from Rainmaker, and I’ve personally met with over 20 different customers. And as you might expect the heavy concentration on the top 10, top 20 customers. And this was absolutely a topic of discussion with all of them. And I would say, it was really also important that the Gilead project go live on time, on budget, which it did, because it’s a very important milestone and benchmark for all of these other customers as they map out their move to the cloud over the next couple of years. So it is top of the mind for everyone. We are engaged with all of our top customers, and we continue to feel confident about the guidance that we’ve given in the past. This is something that will – it is happening right in front of us and is going to continue to evolve over the next two to three years. One final thought I would offer on the topic is, we have probably a half dozen other large SaaS transition projects underway right now. I think as the year progresses, as the calendar year progresses, you will continue to see big announcements of customers like Gilead that have gone live on our solution.
Okay, great. That is helpful color. Quick follow up. So you’ve given us additional color on logos, new logos signed this year. And I believe the comment was that it’s equal to or more than the amount of new logos you signed last year. So what about the totality of that business, not just logos, but the volume of business booked in the first half versus the new business booked last year?
Well, as you might expect, it’s become a material part of our bookings. And when I started this job, I talked about growth in three different areas. One was SaaS transitions, one was selling more into our customer base and one was selling new logos. And we’re only about 10% penetrated from a logo perspective in our target market. So it just seemed like a large opportunity that with focus and more focus from a vertical perspective as well as go-to-market and sales deployment perspective, an opportunity for us to capitalize on. And I think now that we’re three, four quarters in to running this more focused go-to-market plan, we’ve shared the logo, year-over-year the logo comparison to really prove out that there is definitely a big opportunity, a big market there that responds when we focus on it.
All right. Thank you.
Our next question comes from the line of Brian Peterson with Raymond James. Please proceed with your question.
Hi, guys. Kevin here on for Brian. Thanks for taking my call. I was hoping to get a little more color on your pricing strategy as it relates to maintenance fees and the cloud subscription model. It would seem that you’re adding a lot of value for customers as you make any potential platform changes related to the regulatory landscape. And I’m curious how you’re viewing that balance between making sure the existing platform does what it needs to do while still encouraging customers to drive cloud adoption?
Hi, Kevin. Thanks for the questions. So, yes, we continue to feel good of the guidance that we’ve given in the past where we convert maintenance over to recurring revenue and the uplift. So that continues to be about a 3x uplift for customers on their maintenance. And perhaps the question behind your question I think is a very important one. There are obviously a lot of changes that are being proposed right now around pharmaceutical pricing and it is a major driver for our customers to, one, consume our solutions; and two, be current so that they are able to respond to those changes as they’re implemented in the marketplace.
Got it. And then maybe secondly it sounds like you’re working to drive down the implementation cost. Can you talk about when you began to make those changes and would you expect that to be a driver I guess to accelerate transitions going forward?
Yes, I think there’s a couple of things happening with the professional services business. The first is, as we’ve started to sell and implement more standard SaaS solutions, as you would expect the services attach rate has come down a bit as we’re able to do more templatized implementations. I do think there is a lot of great IP harvested out of the Gilead SaaS transition that will allow us to – that we can reuse on future SaaS transitions that will make that type of project more effective. The other trend that we continue to see in our business is just more interest from the partner community. And so we have embraced that interest because we believe long-term partners will be a driver for us in demand generation. And so even on some of these big projects, we’ve had significant partner footprint. Gilead, as an example, had Model N professional services and two other partners that participated in it. So it’s really this combination of getting more efficient in our services business as we evolve to a SaaS company and being more partner friendly that’s driving some of the dynamics that you can see in our results.
That’s very helpful. Thanks, guys.
Our next question comes from the line of Koji Ikeda with Oppenheimer. Please proceed with your question.
Great. Congrats on the quarter and thanks for taking my questions. A quick question here on the guidance, the subscription revenue guidance. So based on the subscription revenue guidance for the rest of the year, by my math it looks like the fourth quarter may have a sequential decrease in subscription revenue. I guess the question here is, does that sequential decrease have something to do with the maintenance part of that mix, or any sort of color there would be helpful?
Sure. Koji, great question. Thank you very much. When we thought about the guidance, obviously we raised the midpoint through tightening up the bottom. I think we offered, again, and I think I alluded to in my remarks some of the qualities of the deal structure that are starting to come through. And so that was reflected a little bit into Q3 and then arguably we left ourselves a little bit more room to work in Q4. And so I think what we’re seeing right now is obviously very quality strength as Jason had shared in terms of the cloud subscriptions and that’s propelling growth. And then we’re continuing to see maintenance to be flattish to maybe slightly down. So I’d say the qualities of the year are still playing out. Obviously, this is – we’re halfway through the game this year and I think what you can expect is that we’ll kind of continue driving the business forward.
Got it. Thank you for that. Okay. So congratulations on Gilead making the transition to the cloud. And now that they’re live and are a great use case in a referenceable account, have you seen any pickup in cloud increase from customers that were on the fence before about SaaS transitions?
Yes, Koji. Good evening. This is Jason. I would say that the demand and the inquiries has been building. And Gilead was just another milestone on the journey, albeit a very important one to prove out that our solution is ready for a top 15 pharma company. So I don’t think Gilead in and of itself accelerates demand. It’s just another important milestone on the journey we’re on.
Great. And then maybe one more from me, and I’ll hop back into queue. So when we were talking to customers at Rainmaker, the general consensus from everyone that we talked to was revenue management was clearly one of their top priorities. But it’s also a complex integration too. So my question is, where do you find organizations usually placing revenue management really in terms of a digital transformation deployment schedule? Is it one of the first things that they do or is it something maybe in the middle or is it more towards the end? Thank you for taking my questions.
Thanks, Koji. It is certainly one of the top things in the customers that we deal with because as customers are reinventing themselves and reinventing their products and how they take them to market that almost always if not without exception has an impact on how those products are priced and how they recognize revenue. So we’re a cornerstone in helping with those digital reinventions.
Our next question comes from the line of Chad Bennett with Craig-Hallum. Please proceed with your question.
Great. Thanks for taking my questions. Nice job on another great execution quarter, guys.
So, David, maybe a quick one for you on the deferred rev line. I know you explained it kind of why it was down sequentially. I guess, is there anything – I guess can you quantify the slippage on the renewal side? And I assume it was maintenance renewals not SaaS or cloud renewals that impacted deferred revs?
That’s correct. Most of it was us waiting for a PO to come out of a rebuff in line with some of our older contracts. I can’t actually book it until I get a PO which obviously most of that has happened at this point. I think we have all of our POs. And so your intuition is right. Most of it was maintenance. I think we had a couple of cloud subscriptions well across the line as well. And then the last part was also some of these escalating deal structures that we saw and we won’t invoice them until either this quarter or the beginning of next quarter. So those were some of the moving pieces. I’d say the other element is, Chad, we’ve gotten to that point where for some of our quarterly structures, almost 10% of our recurring revenue we actually bill and collect. We bill at the start of the quarter and we collect at the end of the quarter. And so as we’ve adopted some of these larger arrangements with certain customers, that also has impacted some of the seasonality on deferred revenue. So overall – yes, go ahead, please.
Sorry, David. Even your larger SaaS cloud customers, you’re on quarterly billing terms or is that kind of your legacy base?
Well, some of its the legacy base and then as I’ve compared notes with some of the other software companies that sell into Life Sciences, I think we find quarterly terms with some of the same common customers. So as I benchmarked I think somewhere in the neighborhood of somewhere around 30% is not atypical for Life Sciences.
And so I think we’re – our goal is actually obviously to contract the way our customers like to contract as long as it produces good economics in cash, and I think that’s what we’re seeing in our cash flow is that it’s working out pretty well for us.
So all else equal, David, should we expect a sequential improvement in recovery would do you think this quarter in deferreds?
I would. I’d say the one thing that I’m keeping a close eye on obviously is June 30 is a Sunday and so I hope not to find the same issue with DOs. So that would probably be the one thing that I’m thinking about. But all-in-all, I’m feeling actually pretty good about the deferreds and more importantly, I’m feeling pretty good about our ability to generate cash. And so despite some of these issues or challenges with getting POs that have a rebound, I think we’re feeling pretty good about how to convert contracts into cash flow.
Okay, great. And then maybe a couple for Jason. Jason, so the new logo dynamic I think is something that we’ve been kind of waiting to hear about for a long time and you’ve done a good job of increasing focus there and executing on it, probably most importantly. Is there a way to quantify as a percentage of bookings year-to-date what new logo has been versus last year kind of same time period? Is there any way to put numbers around that at least kind of macro-wise?
Yes. Chad, we haven’t broken out the mix yet of our bookings, install base versus new logos, from a dollar or a transaction perspective. As we come to close on this year and get a little bit more scale on the SaaS business, we are thinking about how to thoughtfully disclose some more metrics around that so you can get a sense for the velocity. But one thing I will say we’re in our third quarter now running a more focused go-to-market plan, and our bookings which are essentially all SaaS bookings are up 25% year-over-year – little over 25% in the same period as a year ago. So it kind of gives you a little bit of additional color because new logos have been an important part of that growth.
Perfect. Great color. And then maybe last one for you, Jason, new head of sales that you’ve added looks like a very good guy in background, very accomplished. I guess looking at the glass half empty side of things, which we have to do, I guess would – the risk is always a new guy comes in and kind of changes go-to-market or feels a need to kind of increase the investment profile around sales and marketing. I guess any type of playbook there and kind of what you think changes will be made without reading his mind.
Well, luckily I don’t have to read his mind because we’re in touch multiple times a day. But what I will say, Chad, this is a great question and we’ve talked about disruption to sales, potential disruption to sales since I joined the company and I’ll go back to a few things I’ve said pretty consistently. One, when I joined the company, I said I was committed to the profitable growth path that Zack had set the company on a couple of years ago when he came back. Secondly, I said I was very committed to running a more focused go-to-market play and realigning back around our core verticals of healthcare and life sciences and driving better sales productivity, and then investing in a very thoughtful measured way as we see demand. So those core tenants of things that I’ve shared on past calls have absolutely not changed and they were very important in the conversation that I had with Chris as he was joining the company. And so the way I would encourage you to think about Chris’ joining is it’s just another in our set of evolutionary changes that we’ve been making in sales that each one of them continues to build and drive better profitable growth of the company.
Perfect. Thanks, again. Nice job, guys.
Thank you, Chad.
Our next question comes from the line of Ilya Grozovsky with National Securities. Please proceed with your questions.
Thanks, guys. Just on the professional services, I get that you guys are more efficient than you had been. But I’m trying to square that with last quarter’s professional services’ gross margins versus this quarter’s professional gross margins. Because I would think more efficient would probably improve gross margins, not decrease them. Thanks.
Great question. Thanks, Ilya. I think when we were thinking about efficiency of professional services, I think we were thinking about it relative to the quantum of professional services that get attached to a $1 of new cloud subscription. And so we think about, one, just what’s that magnitude required to set up a new subscription. And then obviously with our customers, we think a lot about that time. And so when we use efficiency, it’s really around that time between signing a contract and go live where the customers accruing value from the cloud subscription and then obviously what was the cost to make that happen. So that was our view on efficiency. In terms of utilization, I think what I had shared in my prepared remarks is we certainly ended up with a higher margin on our professional services. And then I think I also highlighted that we’re at that point where we’ve really focused on delivery and given the volume of engagements, we’re starting to see professional services revenues climb as we exit the year. And so I think we’re feeling good about how we’ve aligned the delivery model. Again, I think as Jason shared, we had a couple of partners involved in the Gilead project and we’ve had key partners involved in other projects. So I think we feel very good about how professional services has unfolded as a strategy and ultimately supporting customer success.
Got it. Thank you.
Thanks for your question.
Our next question comes from the line of Ryan MacDonald with Needham & Company. Please proceed with your questions.
Hi. This is Alex on for Ryan. I just wanted to know, are you seeing any changes in spends from customers in preparation for the potential regulatory changes around drug pricing?
Yes. Good evening, Alex. This is certainly – this is going to be a very important event for the pharmaceutical industry and it is definitely I would say top of mind for every customer that we meet with. And I do think there is going to be a positive effect as pharmaceutical – positive effect on spending as pharmaceutical companies need to adopt some of the new rules and regulation around pharmaceutical pricing. There has been a common period where everyone from Model N to our customers has been able to weigh in and provide some guidance to Health and Human Services about how some of these changes get made. And then we’re really going to find out here over the next six to nine weeks on precisely what the final ruling is and the effect that that’s going to have. But I do firmly believe that this is going to be a tailwind for providers in our industry, particularly around services and possibly product.
Okay. Thanks for that. And as you’ve been talking to customers, what has their reaction been to the strategic changes that have been highlighted at the Rainmaker?
Overall, it’s been positive. I think as I’ve shared on past calls and in some of the color commentary I’ve shared, there was a sense by customers in our core verticals that drive nearly 100% of our business between Life Sciences and High Tech that as a company we had some great solutions and great domain expertise, but as we started to go into other verticals and spread ourselves out and go after some horizontal markets that that was diluting our efforts. And so the feedback from customers is, honestly, it’s been overwhelmingly positive as we redoubled our focus on those two key strategic verticals.
Great. Thank you.
[Operator Instructions]. Our next question comes from the line of Patrick Walravens with JMP Securities. Please proceed with your questions.
Hi. This is Joey on for Pat. Thank you for taking my questions. Do you guys see anything changing on the competitive front? Thank you.
This is Jason. No. That continues to be one of the more favorable aspects for us in the market. We’re very well positioned in Life Sciences, and I would say the same in High Tech as well. The competitive landscape remains one of the most favorable aspects of the market for Model N.
Our next question comes from the line of Gene Mannheimer with Dougherty & Company. Please proceed with your questions.
Thanks. Good afternoon. Congrats also on a good quarter. Most of my questions actually have been answered. So if I could just follow up on the prescription drug reform proposal that’s on the table. Jason, you said it will be positive for you and I’m just – you said maybe on the product side, maybe on the services side. Would there be possibly some major tweaks to the platform that would – to accommodate the change from a rebate to more of an upfront discount? Would there be a lot of wraparound services that you’ve been selling to these customers, maybe a little more on how you think it will impact you? Thanks.
Yes. Thanks, Gene. So what’s been proposed is that for Medicare and Medicaid, rebates will be eliminated and passed on to patients in the form of discounts at point-of-sale. And the pharmacy benefit managers, or PBMs as they’re often known, instead of being able to charge a fairly complicated, exotic set of rebates will be allowed to charge a flat administrative fee. And so that’s kind of the essential. It’s hard to boil down a lot of complexity and politicians that’s – if you were to boil it down kind of what’s been proposed. And so for us, we see a couple of things. Yes, there probably will be some product enhancements and we’re currently working to scope that out. And then most likely there will be some services attached to this as we have to work with customers to reconfigure their systems to address the changes. I should mention that this also does apply specifically to government pricing in the U.S. So it is – that’s a huge market obviously but it is limited to that for now. I do think over time, there is a possibility that these changes could leak over into the commercial world as well, but we’ll have to wait and see on that.
Okay. And just on that note, Jason, thanks for the color there, would all this potentially slow down or pause your customers’ SaaS transition plans or accelerate them or no impact? Thanks.
Well, I think it’s one more – the way I would describe it, Gene, based on the discussions I’ve had is it’s one more reason for our customers to get current and beyond the latest release. So as some of these changes get rolled out, regulatory changes, they’re in a better position to respond quickly. At least what’s been proposed today, these changes are going to have to be implemented very early next year. So this is an industry that’s not used to reacting to that kind of change as quickly as is being proposed. And so as I said if anything, I think it’s just one more great reason for customers to get current and stay current.
Got you. Thanks again.
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