Vocera Communications, Inc.
Q4 2016 Earnings Call Transcript

Published: 10 Feb 2017

[Operator:]

Good day, ladies and gentlemen and welcome to the Vocera Communications Conference Call. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to introduce your host for today’s conference, Ms. Sue Dooley. Ma’am, please go ahead.

[Sue Dooley:]

Thank you. Hello, everyone. Welcome to Vocera’s conference call to discuss our fourth quarter and full year fiscal 2016 earnings. I am Sue Dooley, Director of Investor Relations. And joining me today are Vocera’s CEO, Brent Lang; and Justin Spencer, our CFO. We distributed a press release detailing our quarterly results earlier this afternoon. The release is posted to our website at investors.vocera.com and is also available from the 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’d 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 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, let me turn the call over to Brent.

[Brent Lang:]

Thanks, Sue. Good afternoon, everyone. Thank you for joining us. For the third quarter in a row, we achieved revenue growth of over 20%. Fourth quarter revenue was $36 million, up 27% over the same period last year. Revenue for the year was $128 million, up 23% over 2015. We have record bookings of $143 million for the year. Backlog and deferred revenue also finished a record level of $125 million, providing us with increased visibility into future revenue. We had strong execution across the company with solid progress on our large deployments, healthy customer expansions and a growing supplies business. During 2016, we also reached an important milestone for the company, having now been selected by over 1,100 U.S. hospitals. In addition, we have over 230 international customer facilities. Our success in the market is confirmation that the Vocera software platform is resonating with customers. We also completed what we believe is a game-changing move in 2016, the acquisition of Extension Healthcare. This has broadened our market opportunity, extended our software capability and is accelerating our progress towards our target model. We are on track with the integration of the acquisition into our business and saw sales wins right out of the gate in Q4. Our mission is to improve cost, quality, patient experience and staff resiliency and we refer to these aspirations as the quadruple aim. In a market landscape, driving hospitals to become more competitive and patient-focused, the demand for our products is expanding as both new and existing customers seek unified solutions to address communication and clinical workflow challenges. Now, let me turn to the highlights from the fourth quarter, including strategic wins in the federal market, exciting new hospital deals, strong sales execution and cross-selling and very healthy expansions in supplies orders from existing customers. The highlight of the quarter was a $6.5 million booking from the Department of Defense. This was a second procurement of the $14 million contract awarded to Vocera by the U.S. Army Medical Command, known as MEDCOM, originally mentioned on our third quarter conference call. Our hands-free communication system is now the main standard for all MEDCOM medical treatment facilities. This contract encompasses a total of 23 MEDCOM hospitals worldwide that will be adopting or expanding Vocera technology. This award demonstrates our market leadership position and the industry trend towards large scale, system level and standard based decision-making. We won this business, thanks to powerful research, documenting the ROI associated with our solution at Evans Army Hospital. They expect an annual savings of almost $100,000 per year in a single facility due to decreased patient falls and over $150,000 in higher reimbursements to the hospital, thanks to higher patient satisfaction. We had several other large new customer wins in Q4. In the first major win from our newly acquired business, we secured a $1.9 million order at Hoag Hospital in Newport Beach. Hoag will deploy the Engage integration platform and the Engage mobile plans on iOS and Android devices, including 15 clinical integrations. Hoag was seeking a way to unify desperate and colliding alarm events by deploying alarm management and secure messaging in a single platform across their system. In a competitive evaluation, our Engage platform proved the most robust and complete solution. We also had a big new communications platform win at St. Elizabeth Healthcare in Northern Kentucky and a highly competitive win at Swedish American Hospital in Rockford, Illinois. Thanks to a great sales effort and a CMIO champion at the customer. During the quarter, we began work at UCLA Medical Center, a Q3 win for the Engage platform. The choice of Engage was driven by the CMIO’s desire to work with a single provider, who has the most scalable platform. They chose Engage over competitors because of an extensive list of integrations that would have otherwise required multiple vendors to call together similar functionality. Our business with existing customers was particularly healthy this quarter with expansions and supplies delivering robust results and software maintenance and support services continuing to prove a very high renewal rate. In addition to the compelling ROI-based expansion at Island Health, highlighted in the press release a few weeks ago, we also booked several other significant expansions in the quarter, including University of North Carolina, University of Colorado, Health First, Arkansas Children’s and North Shore University. One expansion I would like to feature today is Oconee Hospital, part of the Greenville Health System in South Carolina, where we demonstrated early success cross-selling the Engage platform into our installed base. Greenville Health is a long-time Vocera customer with over 2,000 enterprise software licenses. They recently added Oconee Hospital and we are expanding our communication solution into the new facility. The acquisition occurred right at the time we were selling this expansion, creating a great opportunity to include our Engage integration platform as a critical element of the deal. Our international business also had some solid wins in Q4. In Australia, we added 5 more Anglican long-term care facilities. We also had a great quarter in the Middle East. We saw sizable expansion as Sidra Medical Center opened the doors to its day surgery center. They have begun on-boarding staff for a larger openings midyear. We continue to believe in the long-term promise of our solutions in Saudi Arabia, where after a period of austerity since early 2015, we are seeing some early signs of a positive shift in spending. Outside of healthcare, we had a great win at Point Beach Nuclear, which now takes Vocera companywide across every nuclear power plant owned by Florida Power & Light. We are now in more than 20 U.S. plants helping these customers refuel safer and more efficiently. Our execution on our strategic priorities was very good in 2016. The focus we placed on the deployments at our large accounts is paying off. The big 7 deals we spoke about last year are moving forward on schedule with go-live taking place at a regular pace. I am gratified by our continued progress in Q4 and our enhanced position in the market. Strong momentum in the business is continuing with robust bookings, successful large scale deployments, high customer loyalty and improving profitability. We are making good progress towards our target 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 take – I would like to provide some context about how we are looking at 2017. What we are seeing on the horizon and how this is impacting our strategic priorities? Similar to the approach that we took at the JPMorgan Healthcare Conference, I am going to break down this into external and internal factors that influence our view of the marketplace. Regarding external factors, obviously, the question around everyone’s mind is the new political landscape, healthcare policy and how this impacts hospital budgeting. We are listening carefully to industry sources as well as our customers about their budget priorities and spending levels. While there are some indications hospitals are being careful with discretionary spending, so far we have heard it is generally business as usual for technology purchases. Most customers have indicated that their spending priorities are in place and they are not anticipating any major changes at this time. More importantly, for us though, is the fact that most hospitals have their EHR in place today. This means that there is a shift back towards other spending priorities and a search for ways to optimize their EHR data. The goal is to improve throughput and productivity for the organization, so hospitals are coming to Vocera asking us to help to solve their communication and collaboration problems, which in some cases have been introduced as a result of EHR. Face-to-face conversations have actually diminished and the need of coordination and communication has increased. So what was the headwind for us at the outset of the ACA is now actually a tailwind. On the technology side, several conventional competitive concerns have played out in our favor. BYOD or Bring Your Own Device has turned out to have very little limited application for hospital based clinical workers. Concerns around patient privacy, security, cost of device management and infection control have led hospitals to decide it makes a lot more sense to have enterprise owned devices. Whether it’s a wearable badge or smartphone, the hospital wants to control the devices on their network. Regarding text messaging, the market has essentially decided it is a feature, but it does not deliver a complete communication strategy in a time sensitive, life critical environment. In many cases the need for a combination of real-time voice, secure texting, deep clinical integration and alarm and alert management wrapped into a single platform is the solution they are looking for. Ultimately, that has led demand from the marketplace for a more unified platform that delivers this functionality across the health system. Within Vocera, a couple of things are really important to think about as we enter 2017. As we deployed larger installations, more focus is on the scalability of the platform and the increasing number of integrations. We now integrate with over 120 different clinical systems, which are essential to clinical decision making further differentiating us from our competitors. The idea of bringing all this together into a unified platform, so that the customer can work when a single vendor takes a lot of a pain and suffering out of buying and deployment process. It’s another way we are further elevating our position as the market leader. On the sales and marketing side, one of the key aspects of our sales evolution over the last couple of years has been around ROI based selling techniques. We have thought our sales organization to do discoveries part of a clinical assessment in order to understand the pain points the customers are facing. We then apply the ROI case studies and the proof points we have already demonstrated with existing customers. This is transforming the sales dialogue. This sales approach is giving us access to the C-suite and will continue to be a core element of our sales process. Another thing I am really excited about as we head into 2017 is the cross selling opportunity to sell our products into the acquired customer base. We also see an opportunity to deliver even greater clinical workflow capability to our customers by selling the Engage platform into the Vocera customer base. A unified sales organization focused on cross-selling is a critical priority for us this year. All of this will lead to a continued focus on system level deals and while it won’t preclude us from selling at the departmental level, our emphasis is to sell – is to – our emphasis is to sell at the department level, we are going to continue to sell at the health system level for system wide deployments that translate into multi-million dollar sales opportunities. With this context in mind, we have the following priorities for the coming year. First, continue the ongoing successful integration of the acquired company, unifying our brand, systems, organization, culture and product. Second, focus on success at our large deployments and penetrate large idioms and health systems with strategic ROI based system level selling. Third, capture revenue synergies by effective cross-selling, new customer acquisition and international growth. And fourth, further expand our leadership position as the number one clinical communication and collaboration platform by delivering a unified software platform, simplified mobile app and differentiated device of choice strategy. Overall, 2016 was a pivotal year for Vocera. We have transitioned the business to being more software centric. We have added more functionality and scalability to our highly differentiated software, which is now unmatched in the marketplace today. We are delivering a complete solution that can empower single department or to be deployed enterprise wide to enable enhanced clinical communication and collaboration to deliver a compelling ROI. We believe we are in the early innings, as we bring our solutions to an underserved market. Now, I would like to give our CFO, Justin Spencer, a chance to cover the financial details around our Q4 results and our guidance for Q1 and 2017. Justin?

[Justin Spencer:]

Thanks Brent. Hello everybody. Vocera’s fourth quarter results demonstrated great momentum, highlighted by strong revenue growth, positive adjusted EBITDA and record backlog and deferred revenue. Total revenue in Q4 grew 27% to $36 million, reflecting the continued success and momentum we are seeing as a result of our broadened platform strategy and the strategic importance of communication and collaboration. The majority of this growth came from our core voice and messaging business, with less than $1 million of revenue from the acquired business, which we expected. For the full year, total revenue was $127.7 million, an increase of 23% compared to 2015. Product revenue in the quarter increased 26% to $19.9 million with double-digit growth for both devices and software. Our device revenue grew 18% in Q4 and was driven primarily by the strength of expansions and supplies within our install base, including at our large customer sites that deployed this year, where they have already begun to expand the use of our badge to more users. Our unique ability to deliver our solution across the range of devices continues to be a key differentiator for us. Software revenue grew 46% in Q4 and represented roughly 18% of our total revenue. Software was largely driven from our – from new customer implementations that we had closed and were in backlog. Our large customer implementations, including Franciscan, OSF and others continue to move forward at a good pace and we carry a sizable amount of software backlog, including now the MEDCOM deal from these larger deals into 2017. We are also excited about the addition of Extension Healthcare, which we expect to contribute to our software growth in 2017, particularly in the second half. Services revenue in the quarter was $15.2 million [ph], up 28% from last year. Our professional services revenue grew over 72% to $4.5 million, as a result of a record volume of implementations. With the existing backlog and new deals that we expect to close this year, we believe that we will see another strong year of growth for Professional Services in 2017. The other large portion of our services portfolio is software maintenance and support. With the sizable increase in our customer base this year and a renewal rate well above 95%, our software, maintenance and support revenue grew 17%. This revenue is all recurring and was approximately 32% of our total revenue. This also led to a healthy increase in our deferred revenue, which was $55 million at year end. Our bookings performance in the quarter also resulted in a healthy increase in backlog, reaching roughly $70 million at year end. Our backlog includes a sizable amount of remaining revenue to be recognized from the large deals we announced in late 2015 and the first half of 2016, and it now includes the $14 million MEDCOM deal. Based on the current deployment schedule, we expect to recognize the majority of this MEDCOM revenue in 2017. The first of these facilities went live in January in Monterey, California and we expect a fairly steady pace of implementations throughout the year. A key focus of ours over the last few years has been to drive a higher level of revenue visibility from backlog and deferred revenue, which now stands at $124.5 million. We have been able to do this on the strength of our bookings and tighter processes around our backlog to revenue conversion cycle. This will continue to be a focus for us in 2017. Overall, we believe we have good visibility to our revenue target for 2017. With roughly 65% to 70% coming from the combination of existing backlog, deferred revenue and expected supplies orders. On the profitability side, we were pleased to deliver positive adjusted EBITDA higher than Q4 last year even after absorbing two months of operating costs from the acquisition with a relatively small amount of revenue. Now let me get into some more detail on our non-GAAP margins and operating expenses. Non-GAAP gross margin in Q4 was 63% in line with our expectations. Product margin increased to 71% on the strength of both our device and software revenue. Services margin decreased to 53%, reflecting the impact of the acquisition. We brought over 55 people in professional services and technical support from the acquired business, so we see significant margin expansion opportunity in 2017, as we ramp this revenue and we align the utilization of these resources with Vocera’s model. In 2017, even with this transition, we expect our gross margin percentage to increase slightly to over 64%. Given the normal revenue seasonality of our business, coupled with the revenue trajectory of the new business, we expect the gross margin percentage to be in the low 60s in the first half and then above 65% in the second half on higher revenue and software mix, which aligns with the trajectory of our target model. Non-GAAP operating expenses were $22.1 million, including 2 months of expenses from the acquired business. For the full year, operating expenses were $78.7 million or 62% of revenue compared to over 67% last year. 2017 will include a full year of expenses with the acquired business as compared to 2 months in 2016. Despite this, we expect to continue to drive down our operating expenses to below 60% of revenue this year. Operating expenses will increase in Q1 compared to last quarter as we will now have 3 months of cost for the acquired business, but then it’s expected to remain relatively flat throughout the year. We plan to maximize the utility of our combined workforce and made good progress towards our target model this year, with significantly higher operating leverage and therefore, profit expansion in the second half. In terms of the integration of Extension Healthcare with Vocera, we feel really good about where we are. The organizational and process integration is largely complete. And so we are now focused on aligning the product portfolio and ramping sales. As I mentioned last quarter, we expect the acquired business to be adjusted EBITDA breakeven for the full year, dilutive in the first half and accretive in the second half. We also completed the purchase accounting in Q4 and our financials now reflect the combined business. One thing I did want to point out is that included in our Q4 GAAP net loss is a $2.7 million non-cash charge relating to the sellers distribution of proceeds that was not included in our Q4 guidance. After completing the purchase accounting, we determined that the correct accounting treatment for this deal term was to expense it immediately in Q4. Our balance sheet continues to be very strong with roughly $74 million in cash and short-term investments and no debt. We generated $3.6 million of operating cash flow in Q4 and over $11 million in 2016. Looking forward into 2017, we expect to be cash flow positive for the full year, with cash flow being lower in the first half and then higher in the second half following our revenue and profitability pattern. Now, let me turn to guidance. There is good momentum in our business and you just heard Brent review some of the market dynamics as we see them today. While there is some uncertainty associated with the potential refuel of the ACA, which we are watching closely, we believe our solutions have a unique and enduring value proposition that is of great value for our customers regardless of what ultimately happens as a result of a change in this legislation. Internally, we are continuing to drive even greater sales productivity and a more efficient organization in all areas and higher levels of backlog in deferred revenue give us good visibility to our revenue in 2017. For 2017, we expect revenue to be between $154 million and $161 million. Following a similar seasonal pattern as last year, we expect roughly 45% of our revenue to occur in the first half and 55% to occur in the second half. With this annual revenue growth, we also expect to improve profitability. We expect adjusted EBITDA to be between $5 million and $10 million. Adjusted EBITDA will likely be negative in Q1 on lower sequential revenue and the added costs from the acquisition but then is expected to improve throughout the year as the revenue increases. Importantly, we expect to make significant progress this year towards our target model. For the first quarter, we expect revenue to be between $33.5 million and $35.5 million and adjusted EBITDA to be between negative $2.5 million to a negative $1 million. In summary, we were very pleased with the financial results in the fourth quarter and 2016 and the momentum we carry into 2017. We begin the year on very solid financial footing with substantial backlog in deferred revenue and a robust pipeline. With the broadened platform and the increased strategic importance of improving communication and collaboration, we are excited about the growth potential of our business in 2017 and beyond. I will now turn it back to Brent.

[Brent Lang:]

Thanks, Justin. I would like to take this moment to welcome our Fort Wayne employees to our call today. I am so pleased with the enthusiasm and energy this group brings to Vocera and I am proud of all of the work that all Vocera employees contributed to make 2016 such a standout year. I would also like to encourage you to RSVP to attend our HIMSS Investor Breakfast on Tuesday, February 21. The highlight of this session will be a discussion with the Chief Information Officer of Halifax Health, Tom Stafford, who will be discussing their rollout of our solution across their entire medical staff. We will also hold a Q&A with a broader set of my management team. If you are interested in attending, you can get in touch with Sue Dooley as she hasn’t already reached out to you. We look forward to seeing you there. In summary, 2016 was a year of pulling away from the pack and demonstrating value to our customers, but I believe our success underscores the strategic importance customers are seeing in our products. We believe the market needs for our solutions is rising and customers are recognizing the unique value of our solutions to their long-term operational success. But we think we are just getting started. With highly differentiated products and a large market opportunity in front of us, we are excited to build on this momentum. We look forward to delivering powerful solutions that make a difference in the hospitals bottom line as well as to the quality of care and staff resiliency. We believe these are core values and should be a top priority in any environment. We are well prepared for a successful 2017. I want to thank you all for listening today. Operator, we are ready to open up the call for questions. Thank you.

[Operator:]

[Operator Instructions] Our first question comes from the line of Ryan Daniels with William Blair.

[Ryan Daniels:]

Yes, congrats on the strong end of the year and thanks for taking the questions. Justin, one for you. I missed this and I know you said it, so I apologize. But can you walk through again based on your backlog, recurring revenues and kind of visible replacement sales, what portion of your annual guidance you feel you have high visibility on at this point?

[Justin Spencer:]

Sure. Hi, Ryan. The different pieces of our visibility, we start with our total backlog and deferred revenue and based on – for the backlog, we look at the schedule of deployments and we estimate the timing of when those deployments or implementations are going to occur, but that gives us a sense of how the backlog is going to unfold. The deferred revenue is the other piece of that that is pretty much scheduled based on the deferral when it was set out. So we take our backlog in our deferred revenue, those two pieces and then we add to that the expected supplies, which will likely be in excess of $20 million for the full year. And when you add the backlog, deferred revenue and the expected supplies, which come in very predictably almost everyday, business day, we get to about between 65% and 70% visibility and that’s right where we kind of want to be anything in excess of 65%, we feel comfortable with. So the guidance that we put out there at this point reflects that kind of visibility.

[Ryan Daniels:]

Okay, that’s very helpful. And then you talked about the successful integration with Extension and it sounds like that’s mostly complete and also large sale they had during the quarter. But more broadly, are there any big positive or negative surprises that have emerged or any other kind of early successes whether it be culturally or operationally that you have seen from the organizations combining?

[Brent Lang:]

Hey, Ryan. This is Brent. So I would just say that most of the things we have got excited by coming into the deal has proven to be true. The customer reaction has been really positive. The cultural fit has been really positive. I guess, the biggest surprise frankly for me was on the products and technology side. And I think once we had a chance to really get into the details of the product capability, I was pleasantly surprised by some of the functionality and capability that was there that we were totally exposed to prior to the deal and we are excited about leveraging some of that on a go-forward basis as we put together our longer term product roadmap. Obviously, closing some deals right out of the gate was really encouraging for us. And I think that the sales teams will build on that success. They tend to see successful wins and that kind of breeds success amongst other deals. And so to have the Hoag deal come through and some of the cross-selling activities to demonstrate the value there, I think it’s just building momentum everyday.

[Ryan Daniels:]

Okay, that’s great. And then maybe a final one for Justin, I don’t know if you want to get into this. But just if we think about the EBITDA pressure from the Extension transaction in the first half of the year then turning accretive in the second half, do you have any thoughts on cadence of that or how much EBITDA pressure we might see in 1H and then how much accretion in 2H, just so that we can calibrate our models appropriately?

[Justin Spencer:]

Sure. Consistent with what we said when we announced that deal last quarter. We indicated that the EBITDA contribution from the Extension Healthcare acquisition will be essentially breakeven in 2017. And as implied by the negative EBITDA guidance in Q1, it’s obviously having an impact in Q1, which we expected. It will just gradually get better as largely the revenue ramps. So I mentioned in my prepared remarks that the revenue from Extension Healthcare was less than $1 million in Q4 that will gradually increase. We have got good backlog, a decent pace of deferred revenue and a really robust pipeline. So what will likely happen with the trajectory of the revenue is we will definitely be back end weighted, but there will be a gradual progression in revenue from Q1 to Q2 and then into the second half and the profitability will follow that pattern. So expect for our profitability just to get gradually better from Q1 then to Q2 and then certainly in Q3 and Q4. And we are really excited about the potential in the second half, because if that occurs, which we expect, we are starting to make really meaningful progress towards our target model, which was why one of the primary financial things behind doing acquisition to begin with.

[Ryan Daniels:]

Okay, great. Thanks a lot guys. I will hop be back in the queue.

[Operator:]

Our next question comes from line of Mohan Naidu with Oppenheimer.

[Mohan Naidu:]

Thanks for taking my questions. Congratulations on a great up to the year. On the hospital spending Brent, thanks for all of the color there. I just want to pick your brain a little bit more around understanding, we are hearing similar commentary, but we are also talking to hospitals who are kind of skeptical about what investments they need to do, when you look at your pipeline and the traction in the pipeline, any changes that have happened since the elections or any type of deals that are looking to slip or tracking faster or any color that you can provide there will be really useful?

[Brent Lang:]

Hey, Mohan. How are you doing? I appreciate the question and congratulations. I would continue to classify it as kind of business as usual. We are not seeing a lot of disruption in the decision making processes or the budgeting processes. I am feeling good about the pipeline. I am feeling good about the sales force’s approach to doing more ROI based selling and the clinical assessments that I talked about in the prepared remarks. Obviously, there is a lot of questions being asked around what the structure is going to look like and what the future is going to look like. But my sense is that many of the budgets for 2017 were actually set prior to the election and they really don’t change those budget priorities once they get into the year. We have enough various deals in the pipeline that it’s not reliant upon a single win. We have very low customer concentration. And so our numbers are not reliant upon landing a singular deal, it tends to be looking at a close rate across a large number of opportunities that are being tracked by the sales organization. And we are not seeing a shift in the macro spending environment. And as I mentioned before, I think that the focus and the level of attention being placed on communication collaboration is certainly higher than it was a few years ago and there is actually more interest and investigation going on to look at what hospitals can do to improve both communication and the clinical workflow side things. The technology side of this is really transitioning. If you think about it, not too long ago, the main focus here was pagers and in-building wireless phones and the opportunity to bring smartphones and wearable devices in and the opportunity to really use intelligent software to not just replace the existing workflows and processes, but really to rethink how work is being done, that represents a great opportunity for hospitals to create cost savings and improve patient experience and better productivity overall. And I think that’s going to continue to be a tailwind for us and good business.

[Mohan Naidu:]

That’s great. And then maybe along the same lines, 2016 was a good federal government deal flow year for you, any thoughts or indications around the change of pace in these deal flows going into the New Year with new administration?

[Brent Lang:]

I think it’s too early to know. Most of the government spending with the VA and DoD typically occurs in the Q3 timeframe, which is the end of their fiscal year. The Q1 – Q4 and early Q1 timeframe is generally a quieter period for them. So we haven’t seen anything that would indicate a change there. As I mentioned last quarter, the penetration that we now have within the Army side of the DoD is quite high, the most of the work that we are going to be doing is going to be deploying the bookings we have already received. The focus within DoD now will shift over on to the Navy and the Air Force side. On the VA side, we still feel like we have got a lot of Greenfield opportunity, yet to progress and the combination of the Engage platform and the Vocera platform together in those environments, I think will have strong presence. Engage – the Extension-Engage platform had good traction within the VA system. Ironically, it’s different facilities than where we have historically been successful. And so the opportunity to bring those together and to cross-sell the various components into those other locations represents an interesting opportunity for us. But it’s too early to say whether the spending environment has changed on those departments.

[Mohan Naidu:]

Thanks Brent. Maybe one quick one for Justin, so you guys are approaching your target model a little bit on the top line, any comments around your profitability targets that you had put forth before on 20% EBITDA margins, how should we look at that progression now?

[Justin Spencer:]

Yes. We are definitely making – we have made good progress in 2016. In early 2017 just given the impact of the acquisition, we will see the impact of that, but as we get into second half of 2017, with the revenue increase and pretty significant operating leverage, we expect it to make a meaningful progress towards that. One of the opportunities associated with the acquisition was really to accelerate our progress and we feel like we are right on track with, at this stage with where we want to be there. So as we look into 2018 and 2019, we are getting awfully close in that timeframe to that target model.

[Mohan Naidu:]

That’s great. Thanks a lot for taking my questions. Congratulations again.

[Brent Lang:]

Thanks.

[Operator:]

Your next question comes from Matt Hewitt with Craig-Hallum Capital.

[Charles Haff:]

Hi, this is Charlie on for Matt. Congrats on the great quarter.

[Brent Lang:]

Thank you.

[Charles Haff:]

First question, obviously, lots of wins, increased backlog, record backlog, from an implementation standpoint, does that mean – can you talk a little bit about staffing and what your expectations are there for the next couple of years?

[Brent Lang:]

Yes. Hi, Charlie. We have been investing – as we have closed both the larger deals and seen a larger base of expansion business, we have been hiring in our professional services area to make sure that we can drive those implementations and meet the customer requirements associated with those projects. And so we saw our headcount increase in 2016 and then we have added additional people from the Extension Healthcare business. I mentioned in my prepared remarks that we brought over roughly 55 people from Extension Healthcare, the professional services and the tech support organization. So we have got a really good base of capacity there. We do augment from time-to-time with external resources. So, I think we feel good about where the overall headcount is. We may add, kind of, one or two people here and there. But overall, the organization size is about where we wanted in support of our 2017 revenue. Now, our focus is really to continue to improve the efficiency and the utilization of that business and our Head of Professional Services is really focused on continuing to drive that going forward. So in terms of what that means for the financials, we don’t expect significant increases in cost in 2017 beyond where we are at right now in professional services rather we are going to essentially fill up that capacity by utilizing it more efficiently. And that is one of the key drivers of what we expect will be margin expansion. We expect to be in the low 60s in the first half and then above 65% in the second half.

[Charles Haff:]

Okay, great. That sounds great. And then my second question is kind of about international expansion. Can you touch on where you go – obviously success in the Middle East, success in Australia where does that go from there?

[Brent Lang:]

I think in the near-term, the focus is going to be on continuing to penetrate the markets that we are already serving. We feel like there is a large underserved opportunity in the Middle East, in Australia, in Canada, in the UK. These are markets where we have already got feet on the street. We already got traction with referenceable customers. So we don’t anticipate in the near term why to go into a new region. That’s something that we are constantly assessing and looking at and we will be doing that work again in the first half of this year to look at whether there is a new country or new region that we would want to go into, but if you just look across the regions that we are in right now sort of going east to west. In Australia, our historical business has been largely in the age care and long-term care facilities. Our penetration amongst the hospitals there is actually quite low. And we see an opportunity for much greater growth within the hospital market there in Australia. In the Middle East, most of our growth over the last couple of years has been in the UAE and in Qatar and we have got some great reference accounts in Dubai and Abu Dhabi and Qatar, but the penetration – the real big opportunity there is actually in Saudi. And as a result of the price of oil over the last 2 years, the austerity measures that were taken in Saudi really limited the bookings, the wins that we could have in that market. But we are starting to see some opening up there and that’s an enormous market that we would like to tap into and we feel like we are well positioned based on the sales organization we have on the ground there, the reference accounts we have in the region and some of the proof points we can touch on. And then both Canada and the United Kingdom are also underserved at this point and there continues to be growth opportunities in those regions. So, we still expect international to grow faster than our business overall. And I am remaining committed to having international be 20% to 25% of the overall business, but I don’t anticipate needing to add a bunch of new geographies in order to be able to achieve that.

[Charles Haff:]

Okay, great. Thank you.

[Operator:]

Your next question comes from Nina Deka with Piper Jaffray.

[Nina Deka:]

Hi, thanks for taking the questions.

[Brent Lang:]

Hi, Nina.

[Nina Deka:]

I was wondering – could you please clarify the bookings metric? It looks like bookings grew by 9% versus the number you provided this time last year, which is smaller than your revenue growth and that’s counter intuitive. Could you please explain that?

[Justin Spencer:]

Sure. There are two different metrics that we monitor. We feel like we had a very strong year in 2016 and if you will notice, the absolute dollar amount of bookings was obviously above the revenue amount, so that translated to an increase in backlog and deferred revenue during the year. Obviously, bookings tend to be lumpier than revenue because of the timing of when deals come in, but we are happy with the overall bookings growth. We are happy with the backlog. And we are comfortable of committing to the 20% plus growth rate that we are seeing coming into 2017 based on the midpoint of our guidance. And we anticipate accelerating our bookings growth rate into 2017.

[Nina Deka:]

Okay, thank you. That’s helpful. And then how much of the guidance has the extension acquisition factored into it?

[Justin Spencer:]

Hi, Nina. When we disclosed the deal last quarter, we had talked about that contributing roughly $15 million of revenue in 2017 and we are – that’s currently factored into the 2017 guidance and we feel good about where that is about at this point. It’s going to come through a combination of backlogs that exist from the Engage product and solution plus some deferred revenue that remained after the purchase accounting and then the remainder will come from new deals that are in the pipeline that we expect to close in 2017.

[Nina Deka:]

Okay, great. Thanks a lot.

[Operator:]

Your next question comes from Nicholas Jansen with Raymond James.

[Nicholas Jansen:]

Hey, guys. Just wanted to touch base a little bit more on the acquisition, to that last point that you just made, any way you can frame the breakdown between what’s already kind of very visible from the back half of the year as we think about the revenue growth from expansion, just wanted to get more comfort surrounding that $15 million where you stand today? Thanks.

[Brent Lang:]

Well, clearly, the businesses – hi, Nick, as the business is ramping, as we look at kind of the overall, so the question that was raised earlier as we look at the overall revenue visibility that we have, 65% to 70%. We have a little bit more visibility for backlog and deferred revenue in our kind of, if you will, the non-extension portion of our business, but that’s purely a function of a newer business that is ramping. We did bring over – we are not disclosing the amount, but we did bring over and add to our backlog and deferred revenue position in Q4 for the extension or for the Engage – I should say the Engage solution. But the majority of that revenue will likely come from what we call traditionally book shift. Now, as we get into the second half of the year, we expect the Engage revenue and visibility profile to more closely align with Vocera’s traditional kind of visibility model.

[Nicholas Jansen:]

Great. And then just in terms of the balance sheet with $74 million of cash still even after a pretty sizable chunk of transaction in the third quarter or early in the fourth quarter, how do we think about your desire to perhaps further leverage that strength on the M&A side? How willing would you be given the extension integration ongoing? Thanks.

[Brent Lang:]

Yes. I would say that absolutely our top priority in the near-term is integrating the extension business and making sure that, that’s successful and that we are getting – putting together the one company, one brand, buying the sales organization, buying the products. So, that’s absolutely a top priority. But given the cash balance and given the market opportunity that we see in front of us, we do continue to look for acquisition opportunities that we think might help us in our strategic path moving forward. And we always have a pipeline of opportunities that we are looking at and evaluating. So I don’t think that, that will change. And I think that as we learn through doing acquisitions, we become better at doing it over time. So, it will be a pathway that will help us get to our long-term vision and where we are trying to take the company.

[Nicholas Jansen:]

Great. Thanks for the questions.

[Operator:]

Your next question comes from David Larsen with Leerink Partners.

[Matt Dellelo:]

Hey, guys. This is Matt in for Dave. Question on the revenue, device revenue came in a little lower than we expected, wondering if that’s the reflection of the mix shift towards better software or fewer badge and accessory sales or the Bring Your Own Device trend taking place?

[Justin Spencer:]

Hi, Matt. Actually from our perspective, the device – we are really pleased with device revenue, it grew 18% year-over-year. And so we were really happy with that. What has been really good to see over the last few quarters is particularly with some of these larger deals, we have had customers buy kind of a combination of badge and smartphone and they would love both of those things, but they especially love the badge and so they are coming back and ordering more badges. We have notable strengths. I would say one of the things that really was a highlight and Brent alluded to this in his prepared remarks. We did have an especially strong year from our existing installed base customers, customers who are expanding use of our solution as well as the supplies revenue stream. And both of those contributed to a really healthy device growth in 2016 and also in Q4.

[Matt Dellelo:]

Okay. Thanks. And then on the service side, the dip in gross margins in Q4, was that entirely due to the acquisition?

[Justin Spencer:]

Yes, it was. So we added about 55 people from Extension Healthcare in Q4 in tech-support and also professional services. Our products margins, the net of revenue margins from software and devices was actually up and then the services margins were down because of that. But what will happen in 2017, it will be – we will continue to see a little bit lower services margins in early 2017 and then that is expected to increase and be back to the normal place in the back half of the year.

[Matt Dellelo:]

Okay. So total gross margin should be back to pre-Q4 levels in the second half?

[Justin Spencer:]

Yes.

[Matt Dellelo:]

Okay, great. And then gross margin trajectory guidance, that you guys have walked through earlier in the prepared remarks, that was total gross margin and that was non-GAAP, correct?

[Brent Lang:]

Correct.

[Matt Dellelo:]

Okay. Thanks a lot.

[Operator:]

[Operator Instructions] Our next question comes from the line of Gene Mannheimer with Dougherty & Company.

[Gene Mannheimer:]

Thanks. Good afternoon and congrats on a good finish to 2016. Hey Justin, on the Extension deal, your comments earlier, you said that most of the backlog, if not all of it, heading into this year is from sort of core Vocera, how about the deferred revenue number that jumped up a bunch, I know a lot of that’s due to new clients and maintenance associated with those, but how much of the deferred revenue is Extension?

[Justin Spencer:]

The majority of the deferred revenue is – the total deferred revenue, which was $55 million you ran is Vocera. There is a small portion that we carried over post purchase accounting a few million dollars, but the majority of that is Vocera. And that deferred revenue that we did, this part of purchase accounting unfortunately one thing that happened is what was large deferred revenue balance gets ground down a bit to a much smaller number. But that’s part of the revenue contribution. That will be part of revenue contribution for Extension in 2017 and beyond.

[Gene Mannheimer:]

Okay, great. And then another question just on the some of the large deployments that are in progress, why did that revenue looks like it’s coming in 2017, do you feel some pressure to keep signing these large, let’s say, $10 million plus implementations to keep your growth in double-digits or is the pipeline broad enough where you are not reliant on these big megadeals? Thanks.

[Brent Lang:]

Hey Gene, it’s Brent. I feel a good about the pipeline and I think it will be a combination of both large and small deals. I think that a core part of our business will always be selling at the departmental level and then seeing Expansion business as customers expand the use of the product to other departments and other facilities within the organization. And then the larger deals on top of that, I don’t think we need $10 million deals. We definitely want to see some of these larger enterprise deals, couple of million dollars at a time to help drive the overall top line growth. You are correct that about half of the large deals that were closed in late ‘15 and early ‘16, about half of that revenue was recognized in ‘16. The other half will roughly be recognized in ‘17. So we will still see good traction for that and then we want to continue to fill the funnel with additional new deals coming in. But the model is not predicated on seeing another $14 million MEDCOM type of deal or $9 million or $10 million Franciscan type deal. We feel like we can drive growth in the business by having success with the ideas and then both at the system level as well as the departmental level.

[Gene Mannheimer:]

Great. Thanks guys. I appreciate it.

[Operator:]

And we have a follow-up question from line of David Larson from Leerink Partners.

[Matt Dellelo:]

Hi guys. Congratulations on a good quarter, can you talk a little bit about the growth rate in the deferred revenue and backlog and sort of line items, I think it’s up 27% year-over-year, that’s I guess more consistent with your top line growth and it’s obviously much more higher than the bookings growth rate, can you just sort of reconcile the growth rate and the bookings with the growth rate in the deferred revenue and backlog? Thanks.

[Justin Spencer:]

Hi, Dave. Yes. So you are right, our overall kind of combined deferred revenue backlog position grew 27% year-over-year. As Brent alluded to earlier ago, our goal is to try and ensure that our bookings outpace our revenue. And so that was a major piece of the growth. We also did acquire and add to the backlog and deferred revenue – let me start with the backlog from Extension Healthcare. So that’s now part of the $124.5 million and then we have a resulting deferred revenue amount from Extension Healthcare as well. But by and large, the significant portion of that growth really came from the non-Extension Healthcare part of the business. So we feel – and you will see this as we kind of continue to evolve our commentary. We don’t really kind of view the Extension Healthcare and the Vocera business as a separate thing. We actually view them together, because that’s how we are selling the solution in the market today. So we look at the combined amount of $124.5 million and feel like our objective is to continue to drive that balance up. Following our normal seasonality, we see our backlog and deferred revenue drop a little bit in Q1 and Q2 and then it increases again in Q3 and Q4 and that’s just the normal seasonality of our bookings.

[Matt Dellelo:]

Okay, great. And then I am sorry if this was already asked, but for MEDCOM, how much revenue do you expect that deal to add in 2017?

[Justin Spencer:]

Yes. So the total deal for MEDCOM is – the deal size is about $14 million. And we expect the majority of that likely in excess of $10 million to occur in 2017.

[Matt Dellelo:]

Okay. It seems to me like your revenue guidance is conservative, which is typical for you Justin, which I like, I mean you have $14 million of MEDCOM, you get another $15 million from Extension, that’s $30 million right there, it seems to me like you can beat your revenue guidance pretty easily, I guess what am I missing?

[Justin Spencer:]

Well, we have – I mean, we have established company a practice of trying to guide conservatively and be in a position to beat those expectations. I mean I think I guess I would point – that point us back to the commentary earlier around visibility where we are somewhere between 65% and 70% visible in terms of our revenue target for 2017. So it’s kind of what right in line with where we were at this point last year. And as long as our visibility is in that zone that’ kind of where we want to be. And as things, we hope and expect will continue to evolve and accelerate, we will then update our guidance accordingly.

[Brent Lang:]

And Dave, this is Brent. I will just add to that, I think it’s appropriate to look at the additional revenue from Extension Healthcare being incremental to our normal growth rate. But the MEDCOM piece is just in the normal course of the business. So the $10 million or so of the MEDCOM deal that we expect to recognize in revenue in 2017 is no different from the bookings of Franciscan or UNC or any of the other large deals that we would have booked prior that would have been part of base of revenue that was captured in 2016. So I think as you look at growth rates, I would just caution not to look at that $10 million from MEDCOM is being somehow incremental to the core business. It is a core business.

[Matt Dellelo:]

Okay, great. And then just one quick last question here, can you remind us what Extension does exactly and how is that going to help you sell new deals in the future?

[Brent Lang:]

Yes. So what Extension Healthcare product line does is, the platform is called the Engage platform and it is an alarm and event management platform. And the value proposition is all around delivering the right information to the right end user without creating interruption fatigue or alarm fatigue. So they create interfaces to things like the electronic health record, to physiologic monitors, to nurse call systems, to ventilators, to pumps, to a large number of clinical systems and when events are occurring within those clinical systems that software platform is then able to determine where to send that information and when to send that information based on roles that are created within the software. So you can use other contextual information about the patients, about the care team, about the environment and the workflow that’s going on to make an intelligent decision about whether or not to escalate that alarm. And as you know, alarm fatigue is a major source of potential risk and potential safety issues inside a hospital. And so the ability to do a better job of managing that is critical towards patient safety and towards resiliency amongst the care team. The reason it’s significant for us and the reason why it’s such a great fit for us is because it really combines and adds to the communication side that we brought to the table already in terms of voice communication and text messaging communication with the whole series of communication that’s tied to system generated information coming from these other clinical systems. And we can now use a unified intelligent platform to route not only the voice and text message information, but now also this clinical information, clinical events. What it essentially does is makes the clinical staff more productive and able to triage their more time effectively by only being exposed to the information that most urgent or most critical and it allows them to make more informed decisions about how to operate within their clinical environment. So from a hospital’s perspective, what they really want is a unified platform that brings together these various components. They want to be able to make assignments and they want to be able to create workflows and escalation path once and how that be applied, not just to the voice communication and we are not just to the text messaging communication, but to all these other events and alerts that are occurring in the organization.

[Matt Dellelo:]

Okay. So will it make your deployments to that new large client sites more rapid, more effective and smoother, since Extension connects to all of these different devices throughout the hospital and throughout the facility?

[Brent Lang:]

Well, it sort of depends on what the customer is interested in doing. To some extent, the number of integrations that are involved could actually increase the complexity of the deployment. But certainly, having a platform that is as flexible and capable as the Engage platform makes our life easier. Historically, we were trying to do some of these integrations without a sophisticated platform. So in that regard, you are right. It will make an apples-to-apples comparison. It will make that same deployment easier in the future. But I think it’s also worth indicating that this is getting us much more deeply integrated than the clinical workflow. We are not being viewed as just an overhang or an overflow just purely communication. We are now being deeply embedded into the clinical workflow of the hospital based on these integrations and touch points.

[Matt Dellelo:]

Okay, great. Thanks a lot. Congrats on a good quarter.

[Brent Lang:]

Thank you, Dave.

[Operator:]

Your next question comes from Jamie Stockton with Wells Fargo.

[Jamie Stockton:]

Hi, good afternoon. Thanks for taking my question. Maybe just a couple of quick ones again on Extension, I guess first of all, are you guys – I guess maybe first, how have you done within their customer base, I think there were like 200 facilities that were using their solution, but weren’t using Vocera, have you seen any initial traction with those facilities. And then maybe as a follow-on to that, are you banking on any traction with those facilities or improve traction in the guidance that you have given for 2017?

[Brent Lang:]

Hey Jamie, it’s Brent. So absolutely, I think that the conversations that are occurring are working in booth directions. Both coming into the Vocera installed base as well as the other direction. There is an opportunity for us to cross-sell that. We don’t – we didn’t quantify a specific number in terms of what we estimate that cross-sell opportunity to be. But I guess the thing I would highlight for you is that a large portion of the installed base that’s using the Engage platform is using that on a building wireless phones from Spectralink or Cisco or other in-building wireless phone manufacturers. Many of those customers recognize that it’s really time to upgrade to a smartphone solution or to a wearable, more judging device. And so we see that as a prime opportunity for us to continue to drive cross-selling opportunities. And both our hunters and farmers [ph] will be in power to be able to sell those solutions into the installed base for new customers as well as into the existing customer base.

[Jamie Stockton:]

And I guess maybe just the ‘17 guidance and I don’t know Justin, if you want to jump in here, is there anything special that you are assuming as far as gaining traction of that base or is that potential upside to the numbers that you have given?

[Justin Spencer:]

I think it’s – again, we haven’t quantified it specifically in terms of having kind of a cross-sell target. But certainly there are some benefits that we think we will get just in the normal course. And if we do think that there is upside they can potentially come, there is – as Brent alluded to, there is a cross-sell opportunity in both directions and one of the things that it’s really exciting is the potential to have, our overall deal sizes expand even within our own installed base being able to now take the Extension Healthcare, excuse me, the Engage product into the Vocera customer base. So it’s something that is clearly a benefit and a revenue synergy that is there, but in terms of actually factoring it into our guidance, it’s one of several variables that we have considered as we ultimately arrived at what kind of that visibility, target visibility looks like.

[Brent Lang:]

One I would point you to in my prepared remarks I talked about Oconee Hospital, which is part of the Greenville Health System, that was the case that those [indiscernible] customer who was interested in expanding and adding the Engage platform to it. And I think we are going to see more examples of that. We have completely unified the sales organization now there is one sales organization that’s geographically disbursed across the country, around the world really. And all of those sales reps are getting paid on selling the full product line. So they have been trained on in the case of legacy, was there a people they have been trained on the new Engage platform and vice versa. And so I think you are going to start to see more integrated deals where both components are being sold together as a unified offer.

[Jamie Stockton:]

Okay, thank you.

[Operator:]

I am showing no further questions in queue at this time. I would like to turn the call back to Mr. Lang for any closing remarks.

[Brent Lang:]

Okay, great. Thanks everybody for dialing in this morning – this afternoon. I appreciate your time and we look forward to seeing you here in a couple of weeks. Take care.

[Operator:]

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