Vocera Communications, Inc.
Q3 2016 Earnings Call Transcript

Published: 29 Oct 2016

[Operator:]

Good day, ladies and gentlemen and welcome to the Vocera Communications, Inc. Third Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to now introduce your host for today’s conference, Ms. Susan Dooley. Ma’am, you may begin.

[Susan Dooley:]

Thanks very much. Hello, everyone. Welcome to Vocera’s conference call to discuss our third quarter fiscal 2016 earnings as well as the acquisition we announced today. This is Sue Dooley, Director of Investor Relations. Joining me are Vocera’s CEO, Brent Lang; and Justin Spencer, our CFO. We distributed two press releases detailing our two announcements earlier this afternoon. Both releases are posted on our website at investors.vocera.com and are also available from normal news sources. This conference call is being webcast live on the Investor Relations 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 and the impact on our business and financial results of the acquisition we are announcing today. 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. And with that, I would like to turn the call over to Brent.

[Brent Lang:]

Thanks, Sue. Good afternoon, everyone. Thank you for joining us. On today’s call, I will review the highlights of the third quarter and then I will provide commentary around today’s announcement regarding the acquisition of Extension Healthcare. I will then turn the call over to our CFO, Justin Spencer, who will go into detail around our Q3 financial results and discuss the financial aspects of the transaction. Finally, we will provide updated guidance and open up the call for your questions. The third quarter of 2016 was an outstanding quarter for our business. The market demand for our products is expanding as both new and existing customers seek solutions to address communication and collaboration challenges and to improve patient safety and staff experience. Our success in the market is confirmation that the Vocera software platform is resonating with customers. We see the market moving towards us as hospitals prioritize improving communications. We are executing well as a company and our sales, customer deployments and product development efforts are on track for continued success. Our progress across all aspects of our business was – our progress was considerable. We continue to achieve excellent year-over-year bookings growth with strength in both new customers and expansions, confirming the powerful differentiation of our communication software platform and Device of Choice strategy. The highlight of the quarter was a very large booking from the Department of Defense and I will go into that in more detail in a moment. For the second quarter in a row, we achieved revenue growth over 20%. Third quarter revenue was $33.8 million, up 28% over the same period last year. We had strong execution on our large deployments, our customer expansion and our supplies business. As a result of our revenue growth and efficient cost management during the quarter, adjusted EBITDA was also better than expected demonstrating the leverage in our operating model. We expect to be adjusted EBITDA positive for the full year, which is an important milestone for our company as we pursue profitable growth. Now, let me turn to some highlights from the third quarter, including some strategic wins in the federal market, exciting new hospital wins both in the U.S. and internationally and very strong expansions and supplies orders from existing customers. The highlight of the quarter was a $7.5 million booking from the Department of Defense, representing the first procurement of an overall $14 million contract awarded to Vocera by the U.S. Army Medical Command, known as MEDCOM. Our hands-free communication system is now the main standard for all MEDCOM medical treatment facilities. This contract includes a total of 23 MEDCOM facilities worldwide that will be adopting or expanding Vocera technology. We expect to receive a second booking in December for $6.5 million, which will complete this $14 million contract. Since we did not recognize any revenue from this win in Q3 and we don’t anticipate recognizing a material portion of it in Q4, this booking will contribute to our visibility going into 2017. This award is the largest procurement in Vocera’s history both in terms of dollars and number of sites. It demonstrates our market leadership position and the industry trend towards large-scale, system-level and standard-based decision-making. We believe future Vocera opportunities will follow in the Department of Defense with key platform integrations as well as the other branches of the military. In addition to the MEDCOM deal, we also had a large new customer win at the VA Medical Center in New Orleans. This new hospital will replace the one destroyed during Hurricane Katrina in 2005. At Dayton Children’s Hospital, we grew a discussion that started as a one department initiative into a whole new hospital deal that includes integration with both Hill-Rom and GetWellNetwork. This is an important win that will further bolster our presence in children’s hospitals. We also booked some significant expansions in the quarter, including a sizable deal at Lenox Hill Hospital in Manhattan on the Upper East Side. At Major Hospital in Indiana, which has had our badge in place for 9 years, we saw our second expansion since 2015, beating out the competition. Major is now adding Zebra MC40s running our Collaboration Suite and is broadening the platform to include software integration to their Rauland nurse call system. Our international business also had some solid wins in Q3. We had a great quarter in Canada where we signed Selkirk Hospital in Northern Manitoba as well as Toronto Grace Hospital. In the Middle East, Latifa Hospital in Dubai selected Vocera this quarter. Latifa is a hospital for women and children that is part of the Dubai Health Authority. This strategic win is our second new account in Dubai this year and the first Health Authority account. Outside of healthcare, we had a great quarter in the nuclear space, securing three new Florida Power nuclear plants. And finally, in the hospitality market, the historic Miami Surf Club, another Four Seasons property, chose Vocera to differentiate their 5-star guest experience. Our land-and-expand strategy is working as we are successfully adding new customers and extending our offerings with existing accounts. Our business with existing customers was particularly strong this quarter, with expansions and supplies delivering robust results and software maintenance and support services continuing to produce a very high renewal rate. Our overall bookings growth demonstrates balance and strong execution across the various growth drivers of our business. Our execution and progress on our strategic priorities continue to be very good in 2016. Q3 saw ongoing success in the deployments at our large enterprise customers. Franciscan Health has gone live with 7 more sites, including Chicago Heights, Michigan City and Crown Point and is expanding their use of our solution even more. In a compelling endorsement, they are adopting our Collaboration Suite for their 600 plus information services employees who support their 14 facilities. UNC Healthcare also continues to rapidly adopt our technology, with over 1,000 users now utilizing our communications platform after 9 months of deployment work. At Parkview, deployment is on schedule and we recently went live at the Parkview Regional Medical Center. We replaced several legacy products and a competitive smartphone solution with the Vocera Collaboration Suite, including several clinical integrations running on the MC40s. The focus we are placing on these large accounts is paying off. I’m gratified by our continued progress in Q3 and our positioning in the market. Strong momentum in our business is continuing with robust bookings, successful large scale deployments, high customer loyalty and improving profitability. We are executing well and making good progress towards our long-term operating model. I am confident in our ability to continue to drive double-digit revenue growth in the business while delivering increasing profitability over time. Now, I would like to turn the focus of our conversation to today’s acquisition announcement. We are delighted to announce Vocera has acquired Extension Healthcare for approximately $55 million in an all-cash transaction. Based in Fort Wayne, Indiana, the company is a leading provider of clinical, events-driven communication and workflow collaboration solutions for the hospital environment. We believe this is an excellent strategic fit for Vocera providing very complementary technology that builds upon our platform, increases our addressable market and enhances our customer traction. For sometime now, we have been describing our approach to M&A as a way to expand our software platform in order to achieve our mission of improving outcome, lowering cost and enhancing patient and staff experience. We look for businesses that either enable us to extend our reach across the care continuum or empower us to become more clinically relevant through deep integration with other clinical systems. The goal is to become the most complete clinical communications platform in order to empower care providers with the right information and access to the right people. As we consider M&A opportunities, we like software businesses that enjoy high gross margins and are consistent with our business model, which has the high degree of leverage. Today’s announcement is completely aligned with this strategy. Vocera is making this acquisition to create the most powerful healthcare communication and collaboration platform on the market to improve the lives of clinicians, patients and families. This transaction raises our profile and strengthens our software platform. With this acquisition, we are accelerating our transition from being badge driven to software enabled, from department level to system wide selling and from a point product to an entire platform solution. We have been executing well in this direction for some time and this move will get us there faster. We look at a lot of acquisition targets and act on very few. Extension is special, it checks all the boxes for us. Hospitals want voice communication, secure messaging, alarm management, clinical workflow and systems interoperability in one platform and Vocera is delivering. The most significant technology we are acquiring is the Engage platform, an advanced clinical rules engine that unifies data from multiple sources simultaneously, enables prioritization of notification, adds patient context and sends messages to the right care team members on their mobile devices in near real time. The product portfolio we are acquiring deepens our interoperability with clinical systems, including electronic health records. It will enable us to integrate with many clinical systems which previously required third-party middleware. We will now have integrations of more than 120 clinical systems. With this move, we are bringing together the best person-to-person and system-to-person communication and workflows into one platform from one vendor. This acquisition will also enable us to grow software revenues faster by providing us access to new customers and rich cross-selling opportunities. And through our ability to offer a complete solution, we believe we will be able to win more large system wide deals on the scale of MEDCOM, Franciscan, Parkview and UNC. Extension Healthcare has over 230 customers, a list that includes some marquee names we will be delighted to serve. This customer base is highly complementary to ours and represents an opportunity for us to offer system wide communications solutions, while the acquired technology will enhance Vocera’s customers with powerful device alarm integration. We are really delighted with the natural fits and the opportunity presented by this acquisition. We have also said we would consider M&A to bring scale to our business by spreading operating expenses over a larger, combined business. Incorporating this acquisition into Vocera will scale our business and accelerate our momentum towards our target operating model. With this addition, Vocera sets a new standard as the preferred software platform and leader in the clinical communication and collaboration market in terms of both scale and capability. With over 1,000 U.S. hospital customers and the market leading product capability, Vocera is unmatched in delivering improved communication and collaboration workflows for our customers. Now, I would like to give our CFO, Justin Spencer, a chance to cover the financial details around our Q3 results, the transaction and our guidance for the rest of the year. Justin?

[Justin Spencer:]

Thanks Brent. Hello, everyone. We had great financial results this quarter, highlighted by 28% revenue growth and significant improvement in adjusted EBITDA and earnings per share. We also grew our backlog in deferred revenue, setting us up for a strong Q4. Total revenue in Q3 increased to $33.8 million, with double-digit growth in both our product and services segment. Our revenue was very balanced across our new customers, including our large deployments that are progressing as expected and existing customers who are expanding their use of our solution to new users and new end facilities. Product revenue in the quarter increased 37% to $19.3 million, reflecting the increasing value of our platform and our mobile device strategy. Software revenue grew 40% and increased to $5.2 million, largely driven by our new customer deployments and the broadened capability of our platform. Year-to-date, our software revenue was up 32% compared to last year. Device revenue grew 35% to $14.1 million as our Device of Choice strategy is resonating with customers who want a comprehensive communication solution. Badge and accessory shipments continued to be robust, reflecting the enduring benefit of hands-free, speech recognition based communication among new and existing customers. Our unique platform is resonating in the market because users are able to select the mobile device that works best for their needs and leverage the features and functionality our software delivers. Services revenue in the quarter was $14.5 million, up 17% from last year. Our software maintenance and support revenue, which is all recurring, grew 12% as a result of an expanded customer base and a renewal rate which continues to be well above 95%. The growth of our customer base and the high maintenance renewal rates also resulted in deferred revenue of $41.8 million, up 23% over Q3 last year. Professional services revenue was $3.4 million, up 39% from last year, driven by a higher number of customer deployments and the completion of key revenue recognition milestones with our large deals. We have invested in professional services headcount over the last few quarters to meet the implementation timeframes requested by our customers and see strong demand for these services over the next several quarters. Overall, we continue to have solid revenue visibility, with our combined backlog and deferred revenue balance up substantially versus last year and at a record level for Q3. Non-GAAP gross margin was 64.6%, reflecting the leverage we have as we continue to grow revenue. Both products and services margins increased, reflecting our differentiation in the market and being able to deliver our solutions on a scalable cost platform. And as we build even more scale and drive more revenue, we see a path of even higher gross margin, longer term. Non-GAAP operating expenses were $19.7 million, up 13% from last year and included higher success based compensation expense associated with the higher bookings and revenue achievement. Even with this, non-GAAP OpEx was 59% of our total revenue, down from 66% last year, demonstrating the operating leverage we have in our business as revenue grows. Our strong revenue and improved operating performance resulted in $2.6 million of adjusted EBITDA, up from negative $400,000 last year. We also delivered positive non-GAAP earnings per share of $0.08 in Q3, continuing our commitment to expand profitability and deliver on our long-term operating model. Finally, our balance sheet continues to be very strong with a cash balance of over $121 million and no debt at the end of Q3. Now I would like to provide a quick summary of the financial aspects of today’s acquisition announcement. Effective today, we have acquired Extension Healthcare in an all cash, debt free transaction of approximately $55 million. Included in this amount is a $2.5 million management retention carve-out that will be earned and expensed over 2 years. We plan to fully integrate this business with Vocera by the end of January 2017 and expect to incur $3.5 million to $4 million of one-time transaction related expenses. The transaction value and one-time expenses will be fully funded from the cash and short-term investment balances currently on our balance sheet, leaving us with greater than $60 million in cash and no debt. We will be providing formal guidance for 2017 on our earnings call in early February. However, in the meantime, here are a few parameters to help evaluate the impact of this acquisition on our financials in 2017 and beyond. Given the robust sales pipeline combined with our sales enablement and management processes, we believe this acquisition will add roughly $15 million in revenue to 2017, with the majority of this incremental revenue coming in the second half of the year. The gross margin of the acquired business has been lower in the past primarily due to large revenue deferrals and investments in professional services, which will continue in the first half of 2017. However, we expect this software based acquisition to help us accelerate the expansion of our margins towards our target model over time. With the benefit of cost synergies and greater scale as one company, we expect the impact of the acquisition on adjusted EBITDA in 2017 to be neutral, with a dilutive effect in the first half of the year and positive in the second half. We expect the business to be accretive to earnings in 2018. Over the last couple of years, we have become a differentiated platform company with an increasing emphasis on software-enabled clinical communication and workflow through a variety of mobile devices and a financial model with meaningful operating leverage. Our target financial model, which we have stated publicly, is to achieve 20% adjusted EBITDA margins at roughly $200 million in revenue. In the last several quarters, we have demonstrated significant progress towards this goal with accelerated revenue growth and higher gross margin and operating expense leverage. We believe this acquisition will help us accelerate our momentum towards this target financial model. Extension Healthcare’s three key revenue streams are software, software maintenance and technical support and professional services. These map very cleanly to Vocera’s revenue stream and our SEC reporting segments. We are excited about the expanding opportunities this transaction provides to Vocera. With their loyal customer base and our shared commitment to providing a world class customer experience, this is a transaction that aligns closely with our existing financial story and has a compelling long-term financial profile. With our Q3 financial results and today’s acquisition as context, I will now turn to guidance. On the strength of Q3 and our current revenue visibility, we are seeing strong momentum in our business. Now that we have closed this acquisition, we are also including a small amount of revenue and the expected expenses of this business for the partial quarter in our estimates. As a result, we are raising our 2016 revenue guidance to a range of $126 million to $128 million. Our adjusted EBITDA for the full year is expected to be $2.5 million to $4 million. The implied revenue guidance for Q4 is $34.3 million to $36.3 million. The rest of the guidance details and a full reconciliation of GAAP to non-GAAP guidance can be found in the guidance table of our press release. We are very pleased with the financial results in the third quarter and our overall business momentum. I am really excited about today’s acquisition and the opportunity we have to accelerate our progress towards our long-term financial model. I will now turn the call back to Brent.

[Brent Lang:]

Thanks, Justin. Before opening up the call to your questions, I want to say how proud I am of our team’s execution and the excellent Q3 performance. We are excited to build on this momentum and look forward to a strong finish to the year. I would also like to welcome Extension Healthcare, its customers and employees to the Vocera family. We look forward to working in concert to deliver the best clinical communication and collaboration solution in one platform from one vendor. Our goal is to bring measurable benefits to hospitals, make a difference in our community and build lasting shareholder value. Finally, I would like to end today’s call with a story that is meaningful to all of us. It’s a timely and compelling example of how one of our customers, Halifax Health, is putting our solution to use in extreme circumstances. During Hurricane Matthew earlier this month, 3 Daytona Beach hospitals surrounding Halifax were closed. Halifax was the only hospital in the area that stayed open and this resulted in a large surge of patients who were evacuated from their homes and were in need of care. In response, the State of Florida deployed emergency response teams and set up a tent in the Halifax Health parking lot to support and deliver care to this surge of evacuees and patients. Halifax was able to extend its wireless network to this emergency tent and immediately put the Vocera solution into action. As a result, caregivers and support staff in the tent were able to instantly communicate with each other inside and outside the hospital using Vocera Badge. The difference our products can make in the pursuit of timely care is real and significant and we were delighted to be a part of the solution. I want to thank you for listening today. Operator, we are ready to open up the call for questions. Thank you.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Sean Wieland from WJB [ph]. Your line is open.

[Sean Wieland:]

Hey, thanks. It’s Piper Jaffray. How are you guys? Nice job on the quarter. So, the Extension Healthcare deal is – sounds interesting. I didn’t hear what is the 2016 contribution to revenue and EBITDA if anything from Extension Healthcare?

[Justin Spencer:]

Hi, Sean. We are currently working on the audited financials. What I can – and we will be putting those on file within approximately 70 days. What I – so we are not disclosing them at this time. What I can tell you is the business has been growing very quickly. It’s not EBITDA positive, which is why I mentioned that it’s dilutive to Q4 and in the first half of ‘17, but we expect it to be EBITDA neutral for the full year of ‘17, but it is growing quite quickly and we expect roughly $15 million of revenue in ‘17 from the business.

[Sean Wieland:]

Okay. So what I am still not sure of is you increased ‘16 revenue guidance considerably. Is any of that coming from Extension Healthcare or is that all organic to you?

[Justin Spencer:]

Very little. The majority of the guidance raise is the Vocera organic business.

[Sean Wieland:]

Okay. And then – so how does this – can you kind of compare and contrast this to the – was it mVisum acquisition that you guys did a couple of years ago? It sounds like there might be some overlap there or am I not thinking about that right?

[Brent Lang:]

Yes. Sean, this is Brent. It’s really very complementary. I think the mVisum acquisition actually exposed us to a side of the business that we previously had very little exposure to, but actually helped us win several large deals. I think the UNC deal and the Franciscan deal all – both really incorporated that technology from mVisum. That was a much less developed platform. The Extension Healthcare platform has a lot more capability to it, a lot more integrations, a lot more of the intelligence built into their rules engine and we will be leveraging pieces of the mVisum technology as we build out the Engage platform going forward, but you can kind of look at this as doubling down on it. What we are realizing is that clinical workflow is really the business that we are in. We are really moving beyond just communications and this idea of combining person-to-person and system-to-person workflows into a single platform is what our customers are demanding. And we really felt like adding the Extension Healthcare technology to the mix would be a way to really build out a much more capable platform.

[Sean Wieland:]

Okay. And one last and then I will – on this and then I will hop off. Is Extension Healthcare known for working particularly well with any kind of brand of EHR? Like if – when we do our work on this, are we going to hear, oh, they are good in Epic shops or Cerner shops or is it pretty much EHR-agnostic?

[Brent Lang:]

Yes, I think it’s pretty much HER agnostic. They have done work with most of the leading EHR companies. They have also done work with a lot of the other med devices, the ventilators, alarm systems, patient monitoring systems. So, they bring a whole portfolio of integrations that we personally didn’t have previous to this. And then I think the piece that’s really the most powerful part is this multi-variant rules engine, where they can actually use inputs from these various sources to drive decisions around which alerts and alarms are sent to which people and when they are sent. Some of the examples that really caught my eye – for example, we are tying into location-based services, where the Engage platform could sense whether the covering nurse was in the patient’s room and if the nurse was already in the room, where the alarm was being generated could actually prevent that alarm from being sent as another alert, so kind of using that context, the patient context and these multiple inputs in order to drive more intelligent routing of information and alarms.

[Sean Wieland:]

That’s great. Thanks so much.

[Operator:]

Thank you. And our next question comes from the line of Nicholas Jansen from Raymond James. Your line is open.

[Nicholas Jansen:]

Hey, guys. Congrats on all the good news tonight. My first question would just be centered on the large wins that you have had over the last 12 months. I think there was supposed to be a certain percentage of your revenue this year coming from them. I wasn’t sure if we have seen any change to that from a timeline perspective. And then how do we think about layering on the big $14 million Department of Defense contract as we think about that in ‘17?

[Justin Spencer:]

Hi, Nick, yes. The large deployments progressed pretty much as expected. We had stated that roughly 9% of our revenue would come from these large deals in ‘16. And as of where we are today and looking out through the end of the year, we are right on track with that estimate. So we feel really good about our progress there. It does leave some additional contract value that will convert to revenue in 2017 and beyond. And then in regard to the MEDCOM deal, as Brent mentioned in his prepared remarks, we didn’t have any revenue from that deal in Q3, very little if any revenue, in Q4. So the majority of that will really fall into 2017 and probably some of that even into the early part of ‘18. And it – of course that really helps, that will all – it hit our backlog and it’s an important contributor to our backlog and will be to our deferred revenue balances so that we enter ‘17 with good visibility in that regard.

[Nicholas Jansen:]

That’s very helpful. And then it looks like you guys have done a great job of really on this land and expand strategy and I just wanted to get a better sense of kind of how you think about the ultimate growth profile of this business, clearly we have seen a pretty sizable acceleration of growth lately, it seems like you have a pretty significant amount of visibility into ‘17 based on some of the wins to-date, you are layering on this $15 million or so of acquired revenue next year, I am just trying to get a sense of how quickly do we get to that $200 million bogey, if any broader thoughts there would be helpful? Thanks.

[Brent Lang:]

Hey Nick, it’s Brent. So I was really happy with the quarter in terms of the balance across the multiple parts of our business. We saw good strength in both new customer deployments as well as in our existing customers with expansions and supplies and maintenance. So with the strength across the board, obviously adding the additional revenue from the acquisition will help the growth rate. We still feel really good about the organic growth in the existing business and we will be heading into the next year with strong backlog and deferred revenue based on kind of how Q4 is shaping out. So we will set formal guidance for next year on our February call. But I would say that right now, we are feeling really good about the health of the business across the board.

[Nicholas Jansen:]

That’s very helpful. Just a quick accounting question, in terms of that $15 million, is there any sort of non-GAAP revenue or is that a pure number? Thanks.

[Justin Spencer:]

Yes. That’s a pure number, Nick. There is – it’s pretty straightforward accounting on that.

[Nicholas Jansen:]

Congratulations.

[Brent Lang:]

Thanks.

[Operator:]

Thank you. Our next question comes from the line of Mohan Naidu from Oppenheimer. Your line is open.

[Mohan Naidu:]

Thanks for taking my questions. Brent, on the Extension Health, what – I guess along the lines of where Sean was going with that, on the Engage platform, how different is it from your, for example, secure messaging solution or your alarm management in combination of your integrations with the clinical information systems compared to this platform, is it that the Engage platform has figured out to connect to more systems and devices, hence it’s more valuable at this point of time or am I thinking that totally different?

[Brent Lang:]

Yes. I think there is a couple of dimensions to this. Number one, they have got roughly 230 customers using the Engage platform. So in terms of market traction, market experience, it’s much more mature than anything that we have in this – in the alarm management space. Secondly, it adds a large number of additional integrations. As I mentioned in the prepared remarks, we are going to be up over 120 different clinical systems with the combined companies coming together, so the ability to tie into a wider range. And then as I mentioned to Sean, this intelligent rules engine, it’s really configurable to be able to create and route alarms to appropriate people. It’s something that is beyond what we had. Obviously, our strength has been in the communications side of things, the role based and group based calling both from a voice and a texting perspective and their focus has really been around the clinical integration side and clinical workflow side. And what we are hearing more and more from customers is that they want that to come together into a single platform. Some of the biggest complexities that we see in these large deployments have to do with the integrations and the number of other clinical systems that our customers want us to integrate with is growing and expanding all the time. And we really felt good about adding not only the technology, but the professional services experience that they brought to the table, really a strong team both on the engineering side as well as on the professional services side of things that will help us make that our strength rather than something that was fairly nascent technology with what we had up till now.

[Mohan Naidu:]

Okay, it makes sense. On the 230 customers you talked about, do you guys have any overlap at this point?

[Brent Lang:]

Yes. There is about 40 customers in common that we have identified that are currently using both the Vocera solution as well as the Extension solution. Many of those are VA Hospital customers that are using both of them. We also have some overlap within Kaiser and some of the other large health systems. So this is not a new partnership for us. We have worked with Extension in the marketplace in the past in a co-selling relationship, partnering at the point of a customer. And we really felt like it was a logical extension for us to bring that all into – under one roof so that we could really make it more seamless for the customer, make sure that the deployment teams were acting totally aligned with each other and the configuration and the setup of the software would prevent a unified front to the customer base.

[Mohan Naidu:]

That’s great. Maybe one question around the MEDCOM deal, that’s a sizable deal and now if we exclude that, can you remind us what’s your penetration rate now with DoD and VA and how much more is there to go?

[Brent Lang:]

Yes. So this certainly increases our penetration within the DoD. I think we are up to around – once we get the second portion of this order in the Q4 timeframe, I think our penetration will be up around 37 of the DoD facilities. And so that – we are starting to cross the gap into the majority of those DoD facilities. The other branches – because we are primarily in the Army. The other branches with the Navy and Air Force will be added to that. And then the integration opportunities are on top of that. On the VA side, we are in roughly 40 VA hospitals out of the 150 or so. So the penetration is a little bit lower there. It has been our stronger area until we are able to land this particular deal. So I think there is still definitely room to go, although we will be focusing our attention on the DoD side into the other branches of government at this point.

[Mohan Naidu:]

That’s great. Maybe if I can squeeze in one more, a numbers question. So Justin, when I look at the new guidance for 2016, it points to an excess of 20% growth, which is great and you are going to go into ‘17 with probably better bookings and backlog number than what we had at the end of 2015, what could make you feel less comfortable going into 2017, I guess without – for not reaching such similar growth on revenue side?

[Justin Spencer:]

Right now, we are feeling pretty good about the trajectory of the business. The key for us Mohan, is to continue to drive bookings growth. And obviously, with the Extension – with the addition of the Extension Healthcare revenue stream, that allows us to grow even more quickly. If we have – as you know, the Q4 is usually – from a seasonal standpoint, is usually our highest bookings quarter. So – and we are expecting a pretty strong bookings quarter in Q4, which would allow us to continue to expand our backlog and deferred revenue and then set us up for really, really solid start to 2017. There are always macroeconomic factors that could impact the business like everybody else, but at this point, the organic kind of execution side of things is working pretty well.

[Mohan Naidu:]

That’s great. Congratulations on a great quarter.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from the line of Matt Hewitt of Craig-Hallum. Your line is open.

[Matt Hewitt:]

Hi, I am sure others have said it, but congratulations on the strong quarter and the announcement on the acquisition.

[Brent Lang:]

Thanks Matt.

[Matt Hewitt:]

I want to make sure I just heard you correctly. It sounded like there is another part of the DoD agreement or more of that will be coming here in the fourth quarter. Is that correct?

[Brent Lang:]

Yes. Matt, this is Brent. So, the total award was $14 million. We received the purchase order for the first $7.5 million of that in Q3 and we expect to receive the remainder of that – the remaining $6.5 million in Q4 probably in the December timeframe. It had to do with the timeframe of when the DoD would actually like to see those facilities rolled out. We have been told that the full award has been given to Vocera, but in terms of the purchase order flowing through our government reseller, we received just the first portion of it. And just to provide a little bit more clarity, there were some questions that came up when the posting was originally put up on the government website. It was originally listed as a $15.5 million award. The delta between the $15.5 million and the $14 million has to do with the margin that the reseller takes as well as some third-party equipment and software that was not Vocera gear, but that’s required for the deployment of the system. So, the $15.5 million, $14 million of that comes to us. $7.5 million of the $14 million was the purchase order in Q3 and then we expect the remaining $6.5 million purchase order in Q4.

[Matt Hewitt:]

Okay, thank you very much for the clarification there. Two more from me and then I will hop back off. How quickly can you get the acquisition integrated as far as getting the software to tie in with all of your existing software? Is that going to take several quarters or can that happen pretty quickly given that you have had an existing relationship?

[Brent Lang:]

Yes, I think at a functional level, it can happen really quickly. As I mentioned, we have got 40 joint customers today that are using those pieces of technology together. They are interoperable today out of the door. The work that will go on over time will be creating more of an integrated platform, where the software is really running on a common architecture, a common platform, and the user interface is simplified. Some of the reporting capabilities and analytics capabilities are unified together. So, there is work that will go on probably for years to come as we – as the market continues to evolve and we continue to evolve the platform, but the good news is we can literally start quoting this in new deals immediately and we know that the products work together and we can start winning contracts in the marketplace today. So, it’s really a made-to-order situation.

[Matt Hewitt:]

Okay, thank you. And the last one from me. Franciscan, UNC, these large wins that you have had over the past year, the integrations seem to be going extremely well and I would think that would be helping on future sales. As you look at the large deal pipeline, I would think that you have got these great reference accounts now, maybe a little bit of color on how those discussions are going? You take Franciscan and layer that out to the broader market and kind of highlight the opportunity for potential customers. Are you having those discussions? How quickly are those wins from a year ago already translating into business? Thank you.

[Brent Lang:]

Yes, absolutely. I think the visibility that Franciscan and Parkview and UNC and some of these other large accounts has had – has certainly helped us generate references for other new accounts and it sort of builds momentum component. But as we have said before, these large deals are lumpy. They don’t necessarily come on a nice, regular cadence and so we tend to err on the side of being conservative in terms of when we expect them to come in. And the MEDCOM deal was no exception to that. The exact timing of it wasn’t known literally up until the end of the quarter. And so I think what Justin and I are really focused on is trying to drive predictability from a revenue standpoint. The bookings will be lumpy depending on the timing of these, but we are feeling good about the pipeline. We are feeling good about the quality of those customer deployments and the reference ability of those customer deployments going forward and we think that, that will help us on a go forward basis.

[Matt Hewitt:]

Great, thank you.

[Brent Lang:]

Matt, I didn’t really answer the second part of your integration question beyond the product. I just would like to comment briefly on the integrations at the company level. One of our core goals here with this acquisition is to push towards a very speedy integration of the two companies from a cultural perspective, from a branding perspective. We are working very quickly. And as Justin mentioned in his prepared remarks, we are hoping to have the vast majority of the integration work done by the end of January. We have hired an integration consultant to help us with some of the integration work and we are working very quickly on everything from brand to product rationalization and the full gamut of systems integration work that needs to be done. My goal really will be to get this to a one unified company as quickly as we possibly can so that we can focus on growing the business together.

[Matt Hewitt:]

Okay, thank you.

[Operator:]

Thank you. And our next question comes from the line of Jeff Garro from William Blair. Your line is open.

[Jeff Garro:]

Yes, good afternoon guys and thanks for taking the questions. Maybe a few more on the Extension deal focusing on the financial profile of the business. Maybe to start if you could give us any more detail on the revenue mix and revenue model, how bookings convert to revenue and again the mix between license and maintenance or subscription and services?

[Justin Spencer:]

Yes. Hi, Jeff, this is Justin. Let me start here. So, the – this is a software business. So, the three main elements of revenue that they have are software license that’s mainly perpetual software licenses and then they have software maintenance and support, which is a contract that the company has got software license and then professional services. And so the nice thing about this business is that we are very familiar with it, aligns very, very well with our profile and where we are taking Vocera. And they will map – the software element will map into our product segment that we report in our public financials and then the software maintenance and support in the professional services will map into the services segment. They have – because they are a young – a smaller company, they have had some larger deferrals on their balance sheet, but that will all normalize and we would expect software to represent a fairly meaningful portion of their overall revenue mix going forward. So, we are excited by that. One of the major thrusts of this acquisition was to bolster our software platform and so we see this as an opportunity to really accelerate the software enabled communication aspects of our portfolio.

[Jeff Garro:]

That’s great. And then a follow-up curious about the seasonality of the business, it certainly sounds like – we can’t extrapolate the 2 months from this year into a run-rate for 2017 just given the shortened period and maybe some of the deferrals there. But going forward, should they exhibit the same type of seasonality that Vocera has historically?

[Justin Spencer:]

Yes. So I think over the long run, they will mirror kind of the seasonality that we see in our business, but I think it will be a bit more pronounced in 2017 as we continue to jointly build pipeline. So, from a revenue standpoint, we historically over the last couple of years have been somewhere 47%, 48% in the first half; 52%, 53% in the second half, somewhere in there. They will be a little bit more back-end weighted than that in ‘17, but in – again, once we get to a level of pipeline, we will see that normalize to what we have historically seen.

[Jeff Garro:]

Understood. And then the last one I have is on the gross margin profile. It’s a software business which should imply a nice gross margin, but from some of your comments, my read-through was that it might be a lower software gross margin than Vocera has seen, but maybe that won’t be the case in the longer run. So, if you could provide any color there, it would be great?

[Justin Spencer:]

Yes, there are two – because they have been ramping their business and growing quickly – and they are smaller in size, they have been required to defer per GAAP. They have been required to defer a fairly substantial amount of their licensing revenue. And on top of that, they have been investing in professional services people to support some of their larger – or their customer deployments. Those are all positive indicators. And so as we adopt the business, what we will see in the very, very near-term is their gross margins will be a little bit lower than what ours have been historically. But in the long run, because it’s a software-driven business, they will actually have very, very attractive margins and will be part of the profile that we have to really accelerate and expand our overall gross margins.

[Jeff Garro:]

That’s great. Thanks for taking the questions.

[Operator:]

And our next question comes from the line of Dave Larsen from Leerink Partners. Your line is open.

[Matt Dellelo:]

Hey guys. It’s actually Matt in for Dave. First question is a – just a clarification on the large deals, excluding the DoD win, I think you said earlier there was some revenue flowing into 2017 or is it all in 2016?

[Justin Spencer:]

Hi Matt, for the – we had a few quarters ago, once we closed some of the larger deals, there were seven in particular that we had highlighted, including Franciscan and UNC and a few others. And we had given some public guidance that collectively, those would represent about 9% of our total revenue for the year. And we are right on track with that estimate. I think you are maybe also asking about the very recent MEDCOM transaction that we closed in Q3, the $7.5 million booking that Brent alluded to. That was just a booking. So it is in our backlog and we expect that to convert to revenue in 2017 and maybe some in 2018 as well.

[Brent Lang:]

Matt, do you want to know how much of the big seven grows into ‘17?

[Matt Dellelo:]

Yes. How much of the – yes, next year for the big seven.

[Justin Spencer:]

Okay, yes. So the majority of the revenue, over 50% of it is still yet to be realized in 2017.

[Matt Dellelo:]

Okay, that makes sense. And then switching gears to international, did you say how much that grew this quarter year-over-year, I think last quarter was like 30% growth?

[Brent Lang:]

We didn’t give a number. It is within that range. Again this quarter, we saw particular strength in Canada and the UK and in the Middle East. APAC was soft for us, it was good, definitely at this point relative to the other international markets, but we are pleased with new customer growth in the UK and in Canada as well as the wins that I mentioned in the Middle East.

[Matt Dellelo:]

Okay, great. And then just one last one on gross margins, nice expansion in the quarter, products up sharply, services down, any dynamics there you can highlight?

[Justin Spencer:]

So our – both our products and services margins were up year-over-year, product – both actually a function of higher revenue. We have – there are fixed costs in both of those parts of our business. So as we drive revenue up, we are able to absorb more of those fixed cost. So we are – it’s really nice to see the margin expansion and its part of our target financial model. We believe that as we continue to add revenue to our business, there is a fairly high proportion of that, that drops not only to gross margin but then down to EBITDA.

[Matt Dellelo:]

Okay. I thought I saw year-over-year service gross margin down, I want to double check that. Alright, that’s it. Thank you very much.

[Operator:]

Thank you. And there are no further questions. I would now like to turn the call back over to Mr. Brent Lang, CEO.

[Brent Lang:]

Thanks everyone. I appreciate your time today and we look forward to chatting with you on an ongoing basis. Have a great day.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect.