Vocera Communications, Inc.
Q4 2018 Earnings Call Transcript

Published: 10 Feb 2019

[Operator:]

Good afternoon, ladies and gentlemen and welcome to the Vocera Communications Conference Call. My name is Chris and I will be your coordinator for today. [Operator Instructions] Thank you. I would now like to turn the presentation over to your host for today’s call, Sue Dooley, Vocera’s Director of Investor Relations. Please proceed.

[Sue Dooley:]

Hello, everyone. Welcome to Vocera’s conference call to discuss our fourth quarter fiscal 2018 earnings. This is Sue Dooley. And joining me today are Vocera’s CEO, Brent Lang and our CFO, Justin Spencer. We distributed a press release detailing our quarterly results earlier this afternoon. The release is posted on our website at investors.vocera.com and is also available from normal news sources. This conference call is being webcast live on the IR page of our website where a replay will be archived. Before we begin our prepared remarks, I would like to take this opportunity to remind you that during the course of this call, we will make forward-looking statements regarding projected operating results and anticipated market opportunities. This forward-looking information is subject to the risks and uncertainties described in Vocera’s filings with the SEC and actual results or events may differ materially. Except as required by law, we undertake no obligation to update or revise these forward-looking statements. On this call, we will refer to both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings release. So with that, let me turn the call over to Brent.

[Brent Lang:]

Thanks, Sue. Good afternoon, everyone. Thank you for joining us. On today’s call, I will start by summarizing the highlights from the year and the fourth quarter. Then I will provide some details on key customer wins, some specifics on bookings in each area of our business and an update on some strategic deployments that occurred in the quarter. I will conclude my prepared remarks with commentary on the market environments and our priorities for 2019 before turning the call over to Justin for more details on our financials. 2018 produced record revenue and enhanced profitability, tremendous progress winning large enterprise accounts, significant expansions of our solution within existing customers and another good year in the federal space. We added a record number of new healthcare facilities during 2018 which is a strong leading indicator of future growth. We also made significant progress with our large customer deployments and maintained very high customer satisfaction as reflected by both our maintenance renewal and customer surveys. Another highlight was the completion of our Smartbadge, a new unprecedented advancement in product innovation for Vocera. The completeness of our solution remains a differentiator for us and customer desire for collaboration solutions and their need to mobilize data drove our business this year. We have validated our leadership position with several large customer wins and our solution continues to succeed against competitors. As we begin 2019, I’m excited by our large market opportunities, the increasing differentiation of our unified solutions, and our pipeline of large deals. Fourth quarter revenue was $49 million, up 11% over the same period last year, bringing revenue for the year to $180 million, an 8% increase over 2017. Full year bookings were $181 million, up 9% over last year. Despite a strong booking performance through the first three quarters of the year, we saw mixed results in our bookings in Q4. We had great success with some large strategic wins and strong software bookings. However, our federal and international bookings fell short of our expectations for Q4. We also saw decline in device bookings after record device bookings in Q2 and Q3. We attribute this to two factors. First, our bookings in the fed are particularly badge-heavy and second we believe that despite our best efforts to keep it a secret, news of the coming Smartbadge may have gotten out negatively impacting Q4 device bookings. Highlights for the fourth quarter included 3 large wins at Northwestern Medicine, Albany Medical Center and a very large hospital system in the Middle East. Our progress in cultivating and harvesting our pipeline of large deals continues to be a bright spot for our business. The large deals closed in the fourth quarter showcase our extensive market appeal, differentiated offering and solid sales execution in our strategic accounts. The highlight of the quarter was an impressive $6 million enterprise-wide win at Northwestern Medicine, which will be deploying our complete solution for physicians and other clinicians and integrating it with Epic. We also won a $2.9 million deal at Albany Medical Center in New York, where they will utilize our solution extensively, including multiple integrations across 55 departments. In the Middle East, we were pleased to win a large and strategic booking at a leading hospital system. In this $4 million booking, one of the region’s premier healthcare providers will initially deploy our engaged software on an enterprise level across 11 hospitals. We see significant potential for future cross-sell opportunities within the system and we believe this win augments our leadership in the region. Another important part of our business is expanding our solution to new departments and users at existing customers. One notable expansion was CHRISTUS Health in Texas where we are steadily expanding Healthwise into existing facilities and into new construction. Our value proposition matches the strategic goals of CHRISTUS resulting in Vocera becoming the enterprise standard. We also had significant expansions of our existing footprint at Adena Health and Methodist Hospital. While 2018 was another strong year for our federal business, Q4 government bookings were not as high as we had hoped due to the timing of specific federal purchases that we planned to close at the end of the quarter, prior to the government shutdown. Overall, we remain very optimistic about the large opportunity for both new customer wins and expansions within the federal space, because we are their de facto standard for hospital communications. We believe improved clinical communication and effective OR management are initiatives with rising importance in the DOD and the VA hospitals. On the international front, with the big win I mentioned earlier in the Middle East, our international business finished a strong year, reflecting our continued focus on improving our operations overseas. However, we had varied result in Q4 across the region with Canada, Australia and New Zealand down in Q4 compared to last year, while the UK and the Middle East were up substantially. International remains a big opportunity and a top priority for us. It’s an emerging part of our business and as we have previously stated will be lumpy from time-to-time. We are investing in the sales teams and marketing support to drive growth in these regions. Finally, our non-healthcare business had a good year. We achieved several strategic wins in the hospitality space where our brand is becoming well established. This quarter we signed a deal with the new Four Seasons Montréal, our 11th Four Seasons property. We are delighted to continue to help with this world-class brand deliver its renowned high level service. Now, I would like to talk some about our successful deployments during the quarter. As we continue to book large enterprise deals, our professional services expertise remains a meaningful differentiator in helping our customers achieve their goals. The experience and efficiency of our professional services organization continues to grow, and deployments of our solutions are numerous and remain on schedule. For example, the first go live at Hoag Hospital occurred in Q4. You’ll remember this was a large and strategic win for us several quarters ago, and a complex deployment involving numerous integrations. Hoag is using Vocera as a unifying platform to manage alerts, alarms and texts to all staff and care providers. I also want to highlight a deployment that shows how our solution is compelling for hospitals of all sizes. Hardin Memorial Hospital in Kenton, Ohio went live with our solution in Q4, including several integrations, replacing their legacy technology for all of their users. This 25-bed hospital illustrates how even a small customer can leverage our solution to meet their objectives for efficiency and patient experience. Also during Q4, OhioHealth in Columbus, Ohio completed an expansion of our solution that included integration with our new partner, QGenda. A seamless integration between Vocera and QGenda eliminates the need for most end users to manually access the on-call scheduling system and paves the way for greater workflow efficiency, scalability and end-user accessibility. Now, if I can talk for a moment about the market for our solution and share what we are hearing in our conversations with customers, as we begin 2019, cost savings and efficiency remain top priorities for IT spending. Customers are looking for a partner who can take a clinical approach to solving the workflow bottlenecks by mobilizing data to speed decision-making with improved context about patients and caregivers. Our unified solution combining real-time voice, secure texting and deep clinical integration is succeeding because it delivers on these challenges. While there are aspects of the market that are outside of our control, we remain focused on our opportunity. Government budget uncertainty, changes to healthcare policy and reimbursement, and even the economy overall are all of concern to enterprises and to companies everywhere, and they represent dynamics we always pay careful attention to. There are also plenty of things we know for sure, like our large market opportunity, our unique competitive advantage and our own execution. Our focus continues to be on developing our pipeline of strategic accounts, engaging with customers about the powerful new Smartbadge, advancing our ROI-based selling and working to elevate our solutions as a spending priority for hospitals. Regardless of what the macro environment may be in a given year, I believe that we are just getting started. We are managing the business for the long term, and we believe we are in the early stages of a market that is underserved. There is a large opportunity for us to continue to drive substantial growth in the business for years to come as we grow our footprint across the U.S. and expand internationally. Now, I would like to highlight a couple of our key priorities for the coming year. In 2019, the number one priority for us is to drive our bookings growth at a mid-teens rate by winning new hospital systems and driving system-wide expansions in our existing customers. We will also continue to focus on growth from our international markets while we are building strength in our local teams. We are making focused investments internationally providing compelling ROI based case studies to our teams to help them build pipelines and we feel confident in our ability to succeed in these markets. The introduction of the Smartbadge will also be a catalyst for growth. While maintaining the magic of our lightweight hands-free device, the Smartbadge is a game changer for our business, with its 2.4-inch touchscreen and enhanced features, designed to improve the workflow of the care team. Not only do I believe the Smartbadge will drive a hardware refresh, it will also drive software sales, particularly for integration and messaging licenses, as customers gain appreciation for the power of the device. With more users utilizing intelligent alerts and alarms through the Smart Badge, I believe it will drive demand for engaged software licenses over the long term. Four weeks into the launch, the striking new form factor of the wearable Smartbadges received a lot of attention from the industry. And it’s already catalyzing conversations with customers, who may have previously decided against the use of the badge. We believe the new Smartbadge will enable us to reengage with potential customers and displays legacy competitive solutions where screen size has been an inhibitor to our success. On the software front, while we believe our current platform can be sold as a complete solution today, we are always looking for ways to expand our offering across the care continuum by building, buying or partnering with solutions that further enable the real-time health system. We are investing in product innovation to extend our clinical relevance both within and outside the four walls of the hospital. We are bringing to life our vision of consolidating clinical data and delivering actionable information and context to the right care team member at the right time. We hit many milestones this year, and are pleased with our progress. It’s an exciting time for Vocera as we strive to grow the business and accelerate towards our profitability goals. I am proud of the work we have done to move closer to our target model, and I’m excited about our future. Now, I would like to give our CFO, Justin, a chance to cover the financial details around our Q4 results and our 2019 guidance. Justin?

[Justin Spencer:]

Thanks, Brent. Hello, everyone. Q4 capped a off positive year overall, highlighted by continued revenue growth and significantly higher profitability in 2018. Total revenue in Q4 grew 11% to $48.9 million, driven largely by the continued expansion of our software platform. For the full year, total revenue was $179.6 million, also up from 2017. As we enter 2019, the ASC 606 transition is now behind us, and we believe future results will have better year-over-year comparability. Product revenue in the quarter increased 11% to $27.2 million with very strong performance in software. Device revenue was below our expectation as we believe rumors of our new Smartbadge delayed some purchases in Q4. We believe this is a temporary issue and it’s tied to a natural enterprise product introduction cycle. We are really encouraged by the significant in interest that customers have already shown in the new Smartbadge since their launch in early January. We expect our device revenue to grow again in 2019. Our software revenue was exceptional at $11.8 million in Q4, representing growth of 41%. Software revenue alone represented 24% of total revenue in the quarter, and was 21% for the full year as we continue to make progress towards the revenue mix goal in our target model. As an additional reference, software and software maintenance revenue combined, which we view holistically as our software business grew 21% in 2018, exceeding 50% of total revenue. We expect another strong year of software growth in 2019, driven by continued cross-selling and now the wearable Smartbadge. We view this new device as a vehicle to effectively deliver the power and functionality of our software platform to a broader set of users. The Smartbadge is capable of delivering the full functionality of our software platform and will likely drive the sale of additional software licenses. Services revenue in the fourth quarter was $21.7 million, also up 11% from last year. Our professional services revenue was down year-over-year as we have focused on streamlining our implementation processes and driving down this cost for our customers, which has enabled us to shift more of the deal value to software. Having said that, we expect professional services to grow again in 2019 as we have a strong backlog of projects, several of which are tied to the large deals we closed in 2018. The other large portion of our services portfolio is software maintenance and support, which I touched on a bit earlier. With the sizable increase in our customer base this year and a renewal rate well above 95%, our software maintenance and support revenue grew 21% in Q4 compared to last year. This revenue is all recurring and is tied directly to the enhanced value and functionality our customers have been able to receive from our software platform. Now, I’d like to comment briefly on our backlog and deferred revenue. Our combined backlog and deferred revenue at the end of the year was $120.4 million. While up only slightly from last year, I’d like to provide some context around this number. First, we had a softer than expected device bookings quarter in Q4, and we attribute this to rumors of the new Smartbadge introduction in January. We believe our device backlog will grow by the end of 2019 as we drive bookings and revenue growth again in this category. Second, we are delivering on our goals to convert our backlog to revenue more quickly, something I talked about early last year. ASC 606 has shortened the revenue recognition on software and our streamlined implementation processes have reduced the time and cost that it takes to go live with our solution. So as we look to the full year of 2019, we don’t need as much backlog and deferred revenue to achieve our revenue goal as we needed going into prior years. Having said that, we always strive to build backlog and deferred revenue in conjunction with our revenue growth. On the profitability side, in Q4, we achieved adjusted EBITDA of $7.5 million. For the full year, our adjusted EBITDA accrued 29% to $21.2 million, exceeding our original expectations. We drove 35% operating leverage in 2018 and continued to make good progress towards our target profitability model. Now let me get into some more detail on our non-GAAP gross margins and operating expenses. Non-GAAP gross margin in Q4 exceeded 67%, driven largely by a higher mix of software and the associated software maintenance revenue. We were pleased with the product gross margin at 75%, buoyed largely by our software business. Our services gross margin increased compared to last year as we drove even more leverage in our software maintenance and technical support functions. For the year, our gross margin increased to a record of 66%, again tracking well towards our target model. As we now look forward to 2019, we expect our overall non-GAAP gross margin to be similar to 2018. The gross margin on our badge is quite healthy, and we expect similar margins for the new Smartbadge. Given our expected revenue seasonality in 2019, we believe that the gross margin percentage will be in the low 60s in the first half, and then in the high 60s in the second half. Non-GAAP operating expenses increased to $25.7 million in Q4, reflecting in part the investment in R&D and marketing to support our Smartbadge launch in early January. For the full year, operating expenses were $99.1 million or 55% of revenue which was down from 56% last year. We have remained very focused on becoming more efficient throughout our entire business as we scale. In the last 5 years, our operating expense to revenue ratio has declined from 77% in 2014 to 55% in 2018. And we expect this positive trend to continue in 2019 as our revenue growth rate outpaces our expense growth. In Q1 2019, we expect our non-GAAP operating expenses to be around $27 million, and then should remain at that quarterly level through the rest of the year. Now I’d like to make a few comments about our cash flow and balance sheet. We added $6.2 million of cash to our balance sheet in Q4 as a result of our profitability and working capital management. For the full year, our operating cash flow was $14.3 million, and we expect this to be even higher in 2019. Following our seasonal pattern, cash flow will likely be negative in the first half of 2019 and then positive in the second half of the year. Our CapEx is expected to be around $5 million in 2019 or roughly 3% of revenue. With our balance sheet, we believe we are well-positioned to capitalize on new growth opportunities. Turning to guidance, Brent spoke earlier about market dynamics related to the impact of government budget disputes and general uncertainty in macro environment, which we are watching carefully. In setting our guidance, we have also taken into account the Smartbadge introduction. Our guidance assumes a short-term, temporary decline in device revenue, including minimal revenue from the Smartbadge in the first half of the year. However, we expect our device revenue to grow again in the second half, fueled in large part by traction with the new Smartbadge. As a result we expect our revenue seasonality in 2019 to be more pronounced than usual, with roughly 40% of our revenue in the first half and 60% in the second half. During the second half of the year, we expect our revenue growth rate to be at or even exceed mid-teens. Our profitability is tied closely to our revenue, so we expect adjusted EBITDA to be negative in Q1, and then up significantly as we move into the second half of the year. For 2019, we expect revenue to be between $187 million and $197 million. With this annual revenue growth, we also expect to improve profitability and continue towards our target model. We expect adjusted EBITDA to be between $22 million and $26 million in 2019, improving each quarter as the year progresses. For the first quarter, we expect revenue to be between $32 million and $35 million, reflecting the impact of the lower device backlog and Smartbadge introduction I discussed earlier. Adjusted EBITDA is expected to be between negative $6.8 million and $4.5 million. As we look back on 2018, we believe we have a lot to feel good about. We are now laser focused on a successful smart Badge ramp, along with continuing to drive our software business even higher levels. With success in these areas, we expect to exceed mid-teens growth during the second half of the year, while also delivering even higher levels of profitability and cash flow in 2019. I will now turn it back to Brent.

[Brent Lang:]

Thanks, Justin. Overall, I believe 2018 was a year of tremendous accomplishment for Vocera. Demand for our products is on the rise, and we have further extended our competitive advantage. With the introduction of Vocera Smartbadge, we redefined wearable mobile communication and expanded the opportunity for new conversations with existing and prospective customers. The functionality and scalability of our differentiated software platform is unmatched in the marketplace, and our solution provides a compelling value proposition for hospitals of all sizes. We had a truly great year for large system wins and our continued success underscores the strategic importance customers are seeing in our products. The capability of our solutions and our ROI-based sales approach are resonating with a large underserved market that is primed for growth. Our financials and balance sheet are strong and our operating model has tremendous leverage. As we transition to being increasingly software-centered, our profitability is expanding. We are well-positioned for long-term revenue growth and expanding margins. And we are excited for the year ahead. Before opening up the call for questions, I’d like to personally invite all of you to our investor breakfast at HIMSS next Wednesday. Feel free to contact Sue if you have any questions about this and please stop by our booth at HIMSS to check out the new Smartbadge and see how it showcases our expanded software capabilities. Thank you for listening today. Operator, we are ready to open up the call for questions. Thank you.

[Operator:]

[Operator Instructions] Your first question is from Ryan Daniels with William Blair. Your line is open.

[Ryan Daniels:]

Yes, thanks for taking the questions. Given that you want us to stick to one, I will ask multipart question and it relates to the bookings in the fourth quarter, little bit more detail there if you could in regards to I guess international, why the few markets you thought were weak if there is any sales force turnover or anything unique there? And then with the federal weakness in bookings, I know that it should shutdown started I think December 20 or 21. So, were those deals that you thought would close in the last week of the year that are kind of still in the queue? And then lastly on the device sales more broadly, is it just your assumption that it leaked out or did you actually hear that from your sales team or clients? And I will stop there, sorry for the threefold question.

[Brent Lang:]

Thanks, Ryan. So I’ll take them one at a time. First of all on the international side, I think it was a combination of factors. As I mentioned in the prepared remarks, the international business is still in the early stages, and so these deals do come in a little bit lumpy. And so I think you’re going to see some variability from quarter-to-quarter. If you look at international for the year, we were pretty happy with the result. But if you look at it on a quarterly basis, you’re going to have more lumpiness in the results. I do think that there was some weakness caused by sales reps’ performance execution internationally, and we have made some changes there that we think will have improvements moving forward. And we’re still in the early stages of the investment we’re making into those regions, both in terms of the sales leadership in those regions, as well as the marketing support that we’re starting to drive into those regions. And so while it’s lumpy, I think we still remain very positive for the opportunity moving forward and the excitement that we saw from some of the larger deals we closed is an indication of the success we can have there. Secondly, with regard to the fed, you’re absolutely right. What we observed happening with the deals that we’d originally planned to close during that last week or so in the quarter, which is when a lot of our bookings come in, didn’t come in. And so with the shutdown occurring on December 22, it couldn’t really frankly have happened at a worse time for us. And we had a hard time getting people to return phone calls and get things done. We are starting to see the fed government business thaw, and things are returning back to normal. We’re hopeful that, that will continue. But it definitely lost some momentum at a critical time for us at the end of the year and some of the VA and the DOD bookings that we were anticipating happening right at the end of the quarter did not come through. And then specifically on the device sales, it’s a little hard to classify it. We do know that during the later part of the quarter, we were starting to have an increased number of beta sites that were using the new Smartbadge. We were doing sales training for our own sales force. We were – obviously, had a lot of activity that we’re running up to the ramp. And we saw a precipitous drop-off in device bookings that started to occur towards the end of the quarter. Clearly, the sales force knew about it at that point in time. And there is obviously a strong level of loyalty to their installed base. We anticipate some of that may have caused them not to maybe push quite as hard with the previous version of the badge towards the end of the quarter. And I think that within the marketplace with the beta testing that was going on, there was going to naturally be downstream effect with that. So I can’t give you a lot of specifics, but we saw the impact of that with the device bookings dropping off once we started doing those beta testing and sales training.

[Ryan Daniels:]

Okay, thank you for that detailed answer. That’s very helpful. Thanks.

[Operator:]

Your next question is from Sean Dodge with Jefferies. Your line is open.

[Sean Dodge:]

Good afternoon. Thank you. Thanks for taking the questions. On guidance and how you developed your revenue target, I guess Justin you mentioned continued improvements in the revenue conversion out of backlog and deferred revenue and we also have now the accounting changes, thinking about how you formulated guidance this year versus those in the past, are there any big changes there? Are the proportions of revenue that you still have to win this year and the amount expected to come from backlog in deferred revenue, are those still similar to kind of the proportion that we have seen in years past?

[Brent Lang:]

Yes, Sean, the framework is very, very similar. We start by looking at the amount of deferred revenue and backlog that we have at the end of the year and we estimate how much of that will convert to revenue in the year. And the good news as I mentioned in my prepaid remarks, is that we’re finding that in part due to 606 because of the software, the more favorable software revenue recognition rule and our streamlined process for implementation is we’ve now – particularly with the larger deals, we’ve been implementing these larger scale projects for a few years now, and we have learned and gotten better each time. And so we’re finding that we have significant opportunities for the streamlined processes, and we’re just getting a lot better and smarter at how we go about those. And so that’s enabling us to shorten the time for implementation. A long way of saying that the amount of revenue that we need from our backlog and deferred revenue is we don’t need as much backlog and deferred revenue to service our revenue goals in 2019 as we may have in prior years. We expect a continued strong base of supplies business in the year. That’s the other part of our kind of visible revenue to us. So we take those 2 pieces, that’s our – the deferred revenue, the backlog plus supplies, that’s our visible revenue. And that is right in line where it’s been in prior years as we think about our guidance range for 2019. The amount that remains is the amount of new revenue that needs to be sold in the year and converted to revenue both in terms of dollars as well as in percentages that is right in line with where our historical norms have been. So we feel comfortable with the guidance range. As we mentioned in our prepared remarks, we’re going through a new product introduction cycle here. We expect our device revenue to decline a little bit here in the first part of the year, and then reaccelerate and we expect growth in the device category overall for 2019. So as we turn and look forward into the second half of the year, we expect our growth rate to return to the mid-teens level that we have been more accustomed to.

[Sean Dodge:]

Okay, very helpful. Thank you.

[Operator:]

Your next question is from Matthew Gillmor with Robert Baird. Your line is open.

[Matthew Gillmor:]

Thanks. Thanks for the questions. I have got a two-parter as well. So on the first quarter guidance, can you sort of give any indication as to whether you have assumed the federal government side sort of frees up? I know you made some comments there, but I was curious if there was any assumption that the deals that slipped come into the first quarter or not? And then would you mind just giving us a little bit of overview of the up-sell opportunity with Smartbadges and sort of what’s the most immediate addressable area for up-sell? I would think it would be your clients that are just on voice and then they could buy a messaging license as well as the badge, but just how you are thinking about the cross-sell and what the priorities are?

[Justin Spencer:]

Hi, Matt. I will address first question and then I will turn it over to Brent to address the Smartbadge question. So in terms of our Q1 guidance, we are coming off a period where toward the end of the quarter, as Brent mentioned, we did see some impact in terms of slow decision-making around the federal government business. And we have seen a few of those orders actually come in, in the first part of this quarter, so that’s really good and we are starting to see things kind of return back to a normal level. Obviously, if there is an extended shutdown, I think then for not only Vocera, but pretty much any company, I think there could be an impact there. So we haven’t assumed in our Q1 guidance an extended type shutdown scenario. We know that like all of us, that there are discussions happening in Washington around that. But we’ve tried to be pretty conservative both in terms of our view of the macro level environment as well as our expectations for the new Smartbadge launch and ramp. But we don’t expect any significant revenue from Smartbadge in Q1. So I think if there’s an extended shutdown that that could impact Vocera as well as any other company to a large extent. But other than that, we don’t anticipate anything else.

[Brent Lang:]

And in terms of the badge up-sell opportunity, there is really several different buckets here. The most obvious is the refresh bucket. One of the things that we’ve seen with the B3000 and the current version of the badge is its durability and robustness in the marketplace has meant that it’s lasted much longer than prior versions of the device. And so several of the badges, many of the badges that are out there are quite old at this point, but have continued to work fine. We believe that the added functionality of the Smartbadge will be a catalyst for many of those customers starting to look at refreshes of their installed base. And it will take some time, as I have mentioned before that’ll probably start, with small orders in order to evaluate it in their environment, get used to the functionality, test it in their wireless networks. But we do think that that could drive a substantial refresh opportunity. Now it’s important to note that refresh is always a part of our business. Roughly 50% of our device sales are recurring sales into installed base users replacing it. So it’s not that this is a purely new incremental source of revenue. In many of our refreshes, it is a core part of our business. And I do think that the existence of the Smartbadge will be a further catalyst to drive those refreshes. I also think this will be an opportunity for us to go back to customers who may have held onto a legacy device, an in-building wireless phone or a pager or something because of the screens that they wanted with that, and this will be a real reason for them to finally make the transition. Now we’ve already heard feedback from some customers who have mixed environments where their intention is to start to use the Smartbadge as more of a bigger portion of their overall installed base. We continue to support the idea of Device of Choice and I think our customers will likely have environments where they have both the old B3000n badge as well as Smartbadge as well as smartphones. And depending on the user and their particular profile, you may see a mixture of those different devices. And I think the final piece I would point out here is that we do see a really interesting opportunity for this to drive software sales. Because of the increased screen size, the messaging capabilities and the ability to drive clinical integrations in alerts and alarms to the badge, we believe will drive more engaged software licenses. You asked the question in the context of what the relative timeframe of those? Obviously, I think the new software sales are going to probably take longer than the device sales, but each of those represents an interesting growth driver for the business over the long-term.

[Matthew Gillmor:]

Got it. Thank you.

[Operator:]

Your next question is from Sean Wieland with Piper Jaffray. Your line is open.

[Sean Wieland:]

Hi, thanks. So maybe we could just take it up a level or two. I am looking at these results and particularly the ‘19 guidance and the numbers seem to describe a business that’s decelerating and de-leveraging. I am not really hearing the commentary that matches the numbers. So I am trying to get an understanding of why that disconnect, because your commentary sounds quite optimistic despite some nips and tucks? And maybe if you could quantify put some numbers behind some of these specifics around how much revenue is going to come out of 2019, because of the badge transition, how much revenue specifically from international, government, just put some numbers behind that would be helpful?

[Brent Lang:]

Yes. So I will start with the up level answer to your question and then I will let Justin speak to some of the numbers. I think the first point I would make is we feel like this is a temporary transition period. Going through the new product introduction is something we have done in the past and we have modeled the impact that it has on device bookings, so largely the impact on the first half of the year and particularly the Q1 guidance is a function of that badge transition. But we are optimistic because in the longer term we believe the company is much better positioned with the Smartbadge than without the Smartbadge. And so we are sort of looking at the longer term growth trajectory of the business, this actually puts us in a better situation with a more differentiated offering. And we feel like we just have to sort of manage through this transition period as opposed to having it be something that’s sort of systemic with the business. The exact timeframe with which people are going to adopt the new Smartbadge is a little unknown. This is kind of unknown territory for us. We have never launched a product this substantial since the original launch way back at the beginning and the founding of the company. And so I think we’re trying to take a cautious stance in terms of that product transition. The government piece, again, we think is a temporary transition based on the dynamics that were going on in the federal government towards the end of the year. But we remain really, really bullish about our position within the federal government and continue to get very, very positive feedback from them, not only about their plans for the future but also their specific plans for Vocera. And so I think the optimism you’re hearing is really tied to the fact that we feel like there’s a short-term impact, which obviously affects the numbers for the year. But that both of those can be easily managed through, and if you look at the growth rates, that this really translates to in the back half of the year, it’s more in line with the expectations that we have for the business.

[Justin Spencer:]

And just to add to that, Sean, so as we think about the kind of four main categories of our revenue model, hardware and software in the product segment and then support and professional services in 2018, the software grew 25%. We were really pleased with that. And we expect another strong year of growth in 2019. Support revenue, maintenance – software maintenance and support revenue was up nearly 20% as well. Our professional services revenue was down in 2018, largely, as I mentioned, because we had shifted some of the deal mix to software, but we have a fairly large backlog of professional services projects, so we expect that category to grow. The one thing that we’re being a bit conservative on is our hardware business, given the Smartbadge introduction, as Brent alluded to. And so as we think about 2019, we think we’re being hopefully conservative and realistic about the timing and the ramp of the Smartbadge. But as we get to the second half, we think that will contribute more meaningfully to our revenue. And for the full year, the hardware revenue should turn from a decrease in – that we saw in 2018 to a net positive growth contributor in 2019.

[Sean Wieland:]

Okay. Thank you.

[Operator:]

Your next question is from David Larson with Leerink. Your line is open.

[David Larson:]

Hi. If I look at your 1Q revenue guide, I think it’s implying a decline of about 17% year-over-year, like in the guide for the year, the midpoint I think is up 7%. So, can you maybe just talk a little bit about sort of your expectations for the back half of the year, what percentage of revenue is covered now for the year and how does that compare to last year? Thanks.

[Justin Spencer:]

Hi, Dave. So as we look at our overall visibility, as I mentioned earlier, the overall amount of revenue that we see visible to us is on a percentage basis, as a percentage of our overall targeted, not too far off from where it’s been in recent years. So our visibility is pretty well in line there. And so as we think about our overall guidance range, we take into account the amount of deferred revenue and backlog that we have. And because that was a little softer than we’d expected as we exited 2018, we’ve adjusted that or factored that into our overall guidance for 2019. So what that does is it has more of a near-term impact on our overall revenue expectations, which is why our Q1 revenue expectation is down. That is very directly related to the softness that we saw inside of Q4, as well as the overall kind of device booking softness that we saw as a result of the rumors of the Smartbadge. We believe that, that’s going to correct. And so as we move through the year, our backlog and deferred revenue is going to increase. And as we get to the back half of the year, we believe that our bookings and our revenue growth is going to return to the mid-teens level. So what we see right now, our pipeline is very strong, the excitement within the company is very strong, we’re going through a new product introduction cycle, which is largely the cause of the near-term revenue trajectory. But then as we get to the back half of the year, we expect backlog and deferred revenue to once again really start growing along with the bookings and the revenue and deliver mid-teens growth in the back half.

[David Larson:]

Okay. And then just in terms of like your EBITDA margin expectations, any sense for how much you would expect those to grow on a year-over-year basis, 50 basis points, 100 basis points? Any color on that would be great?

[Justin Spencer:]

Yes. One of the things that we’re really pleased with is the momentum we have with our profitability. 2018 was a really solid year in that regard. We drove 35% incremental EBITDA margins. And at the high end of our guidance range, which is always what we’re targeting here internally, we’re driving around 30% incremental margins in 2019, even with this new product transition. I will say just in the event that it’s asked that our – the gross margin that we expect on our Smartbadge is very similar to our badge. And it’s in and of itself should not dilute our gross margins. It should be kind of right in line with where our historical device margins have been. So we expect again as we continue to drive revenue growth in 2019 to drive higher levels of EBITDA as we continue to achieve that revenue growth that exceeds the level of investment in our operating expenses.

[David Larson:]

Thanks very much, Justin. Appreciate it.

[Operator:]

Your next question is from Mohan Naidu with Oppenheimer. Your line is open.

[Mohan Naidu:]

Thank you very much for taking my questions. Brent, Justin, on the conversion from orders to revenue, how fast are you guys doing it now? And I am surprised to see such fast impact on revenue news from delays in Q4 bookings it just feels like Q1 should be drawing most of its revenue from bookings that happened far before Q4.

[Justin Spencer:]

Yes. So, our rough conversion on our backlog in deferred revenue is it varies, but it’s between 70% and as high as 80%. It’s been trending up over the last couple of years as we have become more proficient in implementing, particularly the large deals, because of the device softness that we saw in Q4 that tends to turn really quickly. So, any backlog – our device backlog was a little bit lower than we had expected as a result of the device booking softness in Q4. And so that has a direct impact on Q1, but as the bookings of our Smartbadge and our devices overall pickup here in the first half of the year, we expect that to convert to revenue fairly quickly as it historically has.

[Mohan Naidu:]

So the device weakness that you guys we are talking about is mostly the add-ons sales to existing customers?

[Brent Lang:]

Yes, I think that’s fair to say. I think that typically the fastest part of conversion would be expansions within existing customers. So the near-term impact is orders that – what can shift typically within a quarter or so. And a lot of the device replacement is obviously going to be within existing customers. The new customer sales have a longer sales process and we typically have visibility into those orders, not only in the pipeline from when they become an booking, but also once they becoming a booking until they convert to revenue, it’s further out into the future. And so I would say that the near-term impact is more in the category of expansion within existing customers.

[Mohan Naidu:]

Okay, thanks for taking my questions.

[Operator:]

Your next question is from Jamie Stockton with Wells Fargo. Your line is open.

[Jamie Stockton:]

Yes, thanks for taking my question. So I guess maybe just one more on kind of visibility and setting aside the full year, if we just look at the step up in business that you guys are talking about from Q1 to Q2. Can you talk about your level of confidence in that right now, given that we’re almost halfway through the first quarter?

[Justin Spencer:]

Yes. I think we feel the energy and the excitement in the sales force is really strong. A lot of what we book, Jamie, in the first quarter will translate to revenue in the second quarter. We’re still early on in the first quarter here. But what we can say is that our pipeline is really strong. The excitement overall in the sales force is really strong. We had some projects – some larger projects, Brent touched on a couple of large deals that we closed in Q4 that will start to convert to revenue in the second quarter. So at this stage, and it’s early, our primary focus is on Q1, but everything that we see at this point in terms of our heuristics suggest that Q2 will play out as we expect. Now we just got to go execute. And as we achieve our bookings target in Q1 and we build a backlog in the deferred revenue that we expect, then Q2 will come into form at that point.

[Jamie Stockton:]

Okay, thanks.

[Operator:]

Your next question comes from Stephanie Demko with Citi. Your line is open.

[Stephanie Demko:]

Hey, guys. Thank you for taking my questions. Just the big one I wanted to ask is given your heightened mix of software, what is driving the return to negative profitability in 1Q, especially in such a dramatic fashion?

[Justin Spencer:]

Hi, Stephanie. Yes, so our glare business largely works is it’s largely a function of the revenue base. So in our cost structure, there is a fairly significant portion of our cost structure that is fixed. So, we tend to see lower profitability in the first half and higher profitability in the second half, mostly driven by the level of revenue. So as we look back over the last several years, our profitability has pretty typically been much, much higher in the second half than the first half. And because our revenue seasonality is even more pronounced as a result of the new Smartbadge introduction in 2019, it causes a little bit larger swing in profitability from the first half to the second half. There’s nothing unusual in terms of the underlying cost structure. We’re actually going to be at about $27 million of operating expenses in Q1, and then will likely stay fairly flat with the – through the rest of the year. So we’re properly – we are trying to manage our expenses and be smart about where we invest. We are investing for growth in areas like international and new product development, so those continue to be important themes for us, but largely just driven by the revenue base that we have got and the seasonality that we typically seen in our business.

[Stephanie Demko:]

Alright. Understood. And one quick follow-up to that one, just looking at the 1Q revenue guide, is there a meaningful downtick in the recurring portion of your revenues that you are baking into the guidance just given it’s now making up over half your revs?

[Justin Spencer:]

No, I think the recurring portion of the revenue is right on track with what it’s been in the past. I mean typically the biggest portions of recurring revenue are the maintenance renewals and the supplies business. And we continue to have very, very high maintenance renewals through the end of the year. And so the revenue recognition associated with that maintenance and renewal continues in Q1, as it has in the past. And the supplies business also will continue, and we’ve seen continued strength in our supplies business so far this quarter that gives us reassurance that that portion of the business will continue. So it’s really the timing of the deployments, large deals that have been booked in prior quarters, obviously which is reflected in the backlog and deferred revenue coming into this year. And then our expectations for wins, larger booked, shipped deals will occur in Q1. And so if you look at the backlog of deals that are yet to ship that we would have booked last year and how many of those are planned to ship in the first quarter this year and then expectations for how quickly we think customers are going to evaluate and place book ship deals in Q1, those two factors really grow the number for the Q1 guidance, but the recurring piece is really rock solid and we have not seen any impact on that at all.

[Stephanie Demko:]

Alright, understood. Thank you for clarifying.

[Operator:]

[Operator Instructions] Your next question is from Matt Hewitt with Craig-Hallum Capital. Your line is open.

[Matt Hewitt:]

Good afternoon and I apologize if this was mentioned earlier, I jumped on late. But could you provide an update or maybe some visibility into your pipeline and the mix in particular? How much of that pipeline is government versus commercial business and maybe where that compared a year ago? Thank you.

[Brent Lang:]

Yes. Hey, Matt. So in general, our government business, if you look out on an annual basis is in the 15% to 20% of our business. It fluctuates a fair amount from quarter-to-quarter because the government business tends to be more concentrated in Q3 and Q4. But if you look at it on an annual basis, it’s in the 15%, 20% range. I would say that if you look at that trend over the last couple of years, it’s definitely increased from probably low teens up into the high teens range in general. So, it’s a growing piece of our business. And the pipeline also reflects that that it would remain in that sort of high teens range of our business. The good news here is that we’ve still got a large opportunity with the fed both on the VA side, where we’re only about 50% penetrated into those facilities and still have a large remaining cross sell opportunity. And then on the DoD side, again, there’s a lot of facilities that are not yet customers. We are starting to see better progress with the Air Force and the Navy, which was portions of the DoD that previously had not have lot of Vocera penetration. And so we can see the pipeline in that part of the DoD starting to come to fruition. And that’s what gives us confidence that the fed business will continue to be in that high teens range of the overall business.

[Matt Hewitt:]

Got it, great. Thank you.

[Operator:]

This concludes the Q&A portion of today’s call. I will now turn things back over to Brent Lang for any closing remarks.

[Brent Lang:]

Great, thank you and thank you to everyone for dialing in for the call today. We look forward to following up with you and seeing many of you at the end of next week. Thanks for your time.

[Operator:]

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