Vocera Communications, Inc.
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q2 2013 Vocera Communications Inc. Earnings Conference Call. My name is Shalaine and I'll be your co-ordinator for today. At this time, all participants are in a listen-only mode. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Mr. Jay Sptizen, General Counsel. Please proceed.

[Jay M. Spitzen:]

Good afternoon everyone. I am Jay Sptizen, Vocera's General Counsel. Welcome to the Vocera Communications 2013 second quarter conference call. A press release detailing Vocera' second quarter results was distributed today at about 1.05 p.m. Pacific Time and is available on our website at www.vocera.com. This conference call is being webcast live on the Investor Relations page of our website where it will be archived on the Events and Presentations page. On this conference call, we will be referencing both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in our earnings release, which as I mentioned is available on our website. This conference call will contain forward-looking information including statements regarding our Company's operating results and market opportunities for our solutions. These forward-looking statements are subject to risks and uncertainties that could cause actual events or results to differ materially from our current expectations. These risks and uncertainties are described in Vocera's filings with the Securities and Exchange Commission. And now, I would now like to turn the call over to our President and Chief Executive Officer, Brent Lang. Brent?

[Brent Lang:]

Thank you, Jay. Good afternoon, everyone. Thank you for joining us to discuss our second quarter 2013 results. After 12 years of working in Vocera, I am honored and excited to be leading my first earnings call as CEO. I see great potential to grow revenues and shareholder value based on the opportunities in front of us. Bill Zerella, our Chief Financial Officer, and I, have some brief prepared remarks, and then we'd be joined by Bob Zollars, our Executive Chairman, as we open up the call to take your questions. Q2 was a solid quarter for us with results showing meaningful improvements compared with Q1. Q2 revenue was $25.3 million, adjusted EBITDA was $572,000, and non-GAAP EPS was $0.01. We were able to exceed our financial targets even as the hospital spending environment remained under pressure. Q2 had the highest bookings growth we've experienced in the last six quarters and also included the signing of all but one of the contracts we mentioned on the last call that has been pushed out from Q1 with the remaining deal still alive. I'm also pleased to announce that during the second quarter, we signed two sizable contracts with Veterans Administration, one is a new customer and the other is a meaningful expansion in an existing VA facility. For the new contract, the VA built a brand-new facility in Las Vegas dedicated to the next-generation of care for Veterans and selected Vocera as their communications partner. This contract was approximately $1 million and includes all three of our solutions, Voice, Messaging and our Care Transition solutions. While the strong bookings growth we experienced in the second quarter gives us reason to believe that hospitals are beginning to spend again, we remain cautious in our planning assumptions. Hospital spending continues to be highly scrutinised which resulted in a continuation of the extended sales cycle we experienced in the first quarter. As we mentioned on the previous call, we believe uncertainties surrounding healthcare reform as well as negative admissions trends industry-wide are resulting in budgetary pressures and conservative spending by hospitals. To this point, we have heard from our sales reps that a couple of our most loyal and dedicated Vocera customers have planned to expand or upgrade their Vocera installations but had to postpone them due budgetary pressures. We continue to see some deals taking longer to sign but to a lesser extent than in the first quarter. Despite these factors, our sales force continue to ramp and was able to identify and close enough business from the pipeline to slightly exceed the high end of our Q2 guidance. With half a year behind us and solid bookings growth in the second quarter, we are taking this opportunity to narrow our 2013 guidance range. We are bumping up the low end of our range to reflect these improving trends and we're also reducing the high end of the range due to the fact that bookings will take longer to convert to revenue. Bill will touch on this in more detail but one of the benefits of this trend is that we're replenishing our backlog which should help us in the future. On this call, and earnings calls in the future, I will continue to review our five growth pillars and I plan to focus my commentary on providing color around bookings trends in each area. My hope is that this will provide the investment community further insight into the future health of our business. Our first growth driver is the addition of new hospitals. We experienced another solid quarter of new customer additions to the Vocera footprint. In addition to the VA facility I mentioned, we added a large number of new hospitals from the private sector. In Q2, the number of new hospitals signed for our Voice solution was among the highest in our recent history, and in terms of absolute bookings dollars from new customers we experienced strong sequential increase helped by higher average deal size than the prior quarter. The second driver further penetrating our installed base is an area where we faced challenges in Q1 but I'm happy to report we experienced a nice bounce-back in the second quarter. The trade-up program we've put in place ahead of the B2000 end of life this past June contributed to a record number of badges shipped in the quarter. While the B3000 accounted for 88% of badges shipped in the quarter, we have just scratched the surface on this upgrade opportunity. In fact, less than 10% of our installed base of customers took advantage of the trade-up program in the quarter. We continue to hear positive reviews from customers who have deployed the B3000 and liked the improved user experience and increased durability. We believe this will result in happier customers who over time will buy more Vocera products as they expand their deployments. Despite continued market pressure, we saw strong sequential growth in bookings for both software expansions and devices compared with Q1. Our third area of growth is cross-selling additional solutions into our installed base. Vocera has long been viewed as an innovator in improving the patient experience. As our newer solutions gain traction in the market, we get the added benefit of diversifying our revenues across product lines. In the second quarter, both our messaging and patient discharge planning solutions produced solid bookings results. Messaging bookings growth was strong both sequentially and year-over-year and had its best bookings quarter since the fourth quarter of 2011. While still a small portion of our revenue, our patient discharge solutions Good to Go is gaining traction in the market and we signed four new health systems in the second quarter. We also signed the largest Good to Go deal in the Company's history at a prominent medical center in the Midwest. We believe that the Good to Go solution represents a tremendous opportunity within our existing customer base. Since this is a SaaS-based offering, it also provides us with a very attractive financial model with strong gross margins and enhancement visibility and predictability. The Good to Go solution received the Dorland Health Award in May as the top personalised multimedia technology for preventing hospital readmissions. Some hospitals using the Good to Go solution have experienced a reduction in readmissions and improvements in patient satisfaction scores for questions related to discharge communication. Innovative market-driven solutions like this enhance the patient experience and allow us to maintain our leadership position. Our fourth driver, international expansion, saw mixed results. International bookings were below our targets in Canada and the U.K. due to some deals being pushed out as a result of government spending delays. However, we expect improved tractions in these markets in the second half. Meanwhile, the additional sales and clinical resources we invested in the Asia-Pacific market appear to be paying off and that region had the best bookings quarter in our history. Total international bookings accounted for approximately 9% of second quarter bookings compared with 13% in Q2 2012 and 14% in Q1 2013. We expect international bookings to be a bit lumpier than U.S. bookings ranging from the high-single digits to low-double digits as a percentage of total bookings. Finally, in the non-healthcare market, our mobility business is still in the mode of building pipeline and we had a relatively light bookings quarter. We demonstrated our solution at some key industry events, in hospitality, nuclear power, and education, resulting in pipeline growth in excess of 30 new opportunities on hospitality and dozens more across our target markets, giving us positive momentum heading into Q3. To summarize, our overall performance in the second quarter showed solid results, strong bookings growth, and further progress with our U.S. government customers. We performed very well in our key growth areas, adding new hospitals and further penetrating our installed base, but we also have some areas where we plan to improve in future quarters. Since I've been CEO, many people have asked me to share my views on Vocera's mission and strategic vision. Our mission today is focused on improving patient care and humanizing healthcare with our integrated intelligent communication solutions. In the future, I firmly believe we can expand our presence to create value in other mission-critical environments as well. Over the past two years, we have enhanced and expanded our platform to provide a deeper level of value to a broader audience of customers. I see these improvements in three categories, content, devices, and people. In terms of content, we started with voice and expanded to text messaging, data, alerts and alarms. Our Good to Go solution added video content to the platform which can now intelligently deliver the right content depending on the situation and end user's needs. In devices, we have expanded beyond the badge to include smartphones and tablets as well as in-building wireless phones, and as we build up the ecosystem, we'll add additional mobile devices to integrate them with our platform. Finally, in terms of people we started by primarily serving nurses, then extended to ancillary staff, transport, tax and other mobile workers, now our smartphone apps have connected us with physicians and the Good to Go discharge planning solution has extended our reach to patients and family members. This ecosystem created by the integration between content, the devices, and the people, all brought together by our integrated intelligent communication platform, creates a network effect that differentiate us in the marketplace. We are empowering individuals and teams to maximize their impact by connecting them to the people and the information that they need to be effective. This strategic vision is part of what helped Vocera recently win the Best-in-Class award for our wireless communication solutions for the healthcare market. I'm sure that many of you are aware that the Annual Class Awards are based on customer rankings of product functionality, service and support, overall satisfaction, and strategic impact. To be deemed worthy of the best-in-class provider of wireless communications for healthcare reflects our dedication to a customer-centric approach in developing solutions to improve communication, patient experience, and staff workflow in mission-critical environments. At this point, I'll turn the call over to Bill to review our financial results. Bill?

[William Zerella:]

Thank you, Brent, and good afternoon everyone. I would now like to provide some commentary on our second quarter results and color on our 2013 outlook. Revenues for the second quarter were $25.3 million, slightly higher than our projected range of $23 million to $25 million. Taking a closer look, product revenue of $15.3 million in the quarter consisted of $12.3 million from device sales and $3 million from software sales. Although product revenue is down slightly on a year-on-year basis, we saw strong sequential growth of 18.4%. Device shipments were strong this quarter due to the B2000 end device in June 2013. As Brent mentioned, however less than 10% of our customers took advantage of the Q2 upgrade program, so we continue to see upgrades as a nice opportunity for future quarters. Software revenue for the second quarter was flat versus the first quarter of 2013 and was lower as a percentage of revenue than our historical norms due to the timing of revenue recognition on new custom orders. We expect this trend to reverse beginning in Q3 as new customers signed in the first half of the year are deployed. Service revenue of $10 million was comprised of $7.7 million in software maintenance and $2.3 million of professional services. Since service revenues are derived from maintaining and supporting existing customers, this revenue line was generally in line with our expectations. As I discuss gross margins and line items from the income statement, please note that these are non-GAAP figures and have been adjusted by exclude stock-based compensation and amortization of acquired intangibles. A reconciliation of GAAP to non-GAAP results can be found in our press release which is available on our website. Overall, gross margins were 63.6% in the second quarter compared to 62.6% in the first quarter and 63.4% in the second quarter of last year. Product gross margins were 66.2% for the second quarter compared to 65.6% for the first quarter of 2013. Product margins were driven by strength in device margins due to the high volume of badges shipped and associated proprietary accessories such as batteries, chargers and lanyards. In the second quarter, software accounted for 19.4% of product revenue compared to 23.3% last quarter and 23.8% a year ago. As I mentioned, we expect the percentage of software revenue to increase over the remainder of the year starting next quarter as we deploy our solutions at the new customer sites booked in the first half of 2013. Second quarter service gross margin increased 280 basis points versus the year ago period and increased 120 basis points sequentially from 58.5% to 59.7%. Service margins improved due to improved staff utilization and good cost controls. We continue to feel very good about overall gross profit margin and target model. Now turning to OpEx, during the second quarter, sales and marketing accounted for 39% of total revenues. As we have mentioned on previous calls, we expect the sales and marketing will be in the high 30% range of total revenue for the full year 2013 as we will increase sales efforts to capitalize on the growth opportunities in both healthcare and non-healthcare verticals. Research and development increased 23.4% versus the second quarter of 2012 reflecting our continued focus on driving innovation. Our GAAP net loss for Q2 was $2 million or $0.08 loss per diluted share. Our non-GAAP net income for Q2 was $175,000 or $0.01 per diluted share. Our non-GAAP net income excludes $2 million of stock-based compensation and $181,000 of amortization of intangibles. The cumulative impact of the adjustments totaled $2.2 million or $0.09 per share. Our non-GAAP adjusted EBITDA represents a profit of $572,000 in the quarter compared to a loss of $1.2 million last quarter and a profit of $3 million in the second quarter of 2012. While the decline versus last year is a result of the investments we are making in sales and marketing and engineering, we're pleased with the sequential improvement versus Q1 as we begin seeing a return from our investments. Turning to the balance sheet, as of the end of the second quarter, we had $125.3 million in cash and short-term investments and no debt. Cash flow from operating activities was $400,000. Deferred revenue on the balance sheet was $29.1 million at the end of the second quarter, the highest ever, which reflects a 7% increase sequentially and an increase of 16.3% year-over-year. Including deferred revenue elements associated with our customer leasing arrangements of $1.6 million, we view our total deferred revenue as $30.7 million as of the end of the second quarter, an increase of 8.2% sequentially from the first quarter of 2013 and 22.9% year-over-year. Finally, I would like to provide some more perspective on the updates for our outlook. While we had strong bookings growth in the second quarter, a growing portion of these bookings will not convert into revenue in the second half of 2013, instead will accumulate in either our backlog or deferred revenue. There are a number of factors causing us to recognize some of our recently signed bookings over the longer period of time. First, Good to Go contracts are subscription SaaS deals that could recognize ratably over time. Additionally, some of our messaging deals are assigned under subscription models which also result in ratable revenue recognition. Second, with two consecutive quarters of strong new customer bookings growth, we expect new customer bookings to comprise a higher percentage of our overall bookings in 2013 versus last year. New customers typically take longer to convert to revenue as compared to upgrades or expansions which are normally book-ship business. This is because new customers thoughtfully plan out the timing of the deployment and coordinate internal resources to complement the resources we provide with our professional services teams. Lastly, our evergreen leasing program is accounted for in a slightly different way than a straight sell with on average 50% of order value recognized upon shipments and the balance recorded as either a leased liability or deferred revenue which is recognized as revenue in future quarters. In Q2, we closed approximately $2 million in leasing deals and we expect future growth in this area. While each one of these factors by themselves may not be significant in a given quarter, combined they can extend the duration of time that our new bookings take to convert to revenue. While majority of the bookings we signed in the first half will translate into revenues in the second half of 2013, a percentage of our bookings are affected by the factors I just discussed and will have the benefit of strengthening our backlog and deferred revenue levels, improving our long-term revenue visibility going into 2014. For the full year of 2013, we now expect revenues between $102 million and $105 million, non-GAAP net income between a loss of $1 million and a profit of $0.9 million, non-GAAP earnings per share between a loss of $0.04 and a profit of $0.03 and non-GAAP EBITDA between a profit of $0.9 million and $2.8 million. Our guidance is reflective of three factors. First, we continue to maintain a cautious view of hospital spending until there is more certainty around healthcare reform and how our customers react to declining volumes and reimbursement rates. Second, while we have increased optimism that more government orders will begin to flow starting in Q3, because of uncertainty and our experience last year we are not assuming much revenue in 2013 from new government orders other than a portion of the VA order we received in Q2. Third, the factors I just described will result in lower revenue recognition in 2013 with the benefit however of driving higher backlog and deferred revenue entering 2014. Our full year 2013 non-GAAP guidance excludes stock-based compensation expense of $9 million to $9.5 million and amortization of intangibles of approximately $0.7 million. We expect income taxes of between $200,000 and $400,000 due to foreign taxes and add-backs in computing our U.S. taxable income. For the third quarter 2013, we expect revenues between $25.5 million and $26.5 million, non-GAAP earnings between a loss of $700,000 and breakeven, non-GAAP EPS between a loss of $0.03 and $0.00 per share, and non-GAAP adjusted EBITDA between a loss of $200,000 and a profit of $500,000. We expect income taxes in the third quarter to be approximately $100,000. I would also like to provide some color on software mix for the third quarter. As I mentioned earlier, we expect to see improved software mix based on the number of new customer deals we closed in the first half being shipped and recognized as revenue in Q3. We expect this will drive a 100 to 150 basis point sequential increase in gross margins. Our non-GAAP EPS projections are based on a fully diluted share count of 24.8 million in the event of a loss and 27.2 million in the event of a profit for the full year 2013, and a share count of 24.9 million in the event of a loss and 27.5 million in the event of a profit for the third quarter. That concludes my portion of the call, and with that, I'll turn it back over to Brent for some closing remarks.

[Brent Lang:]

Thank you, Bill. Before we open the call for questions, I want to share some key Company-wide initiatives we have launched to build our strong culture and help drive our long-term performance. The first initiative is sales execution. We are maniacally focused on opportunities I described earlier adding new customers, growing our installed base, cross-selling new products, and expanding internationally in other verticals. Our goal is to drive sales enablement and programs and instilling everyone's sales mindset across the organization, from engineering to marketing to services. Ultimately, it's about creating demand for our products and enabling our sales team to be successful in the marketplace. The second initiative is focused on innovation. This has been and always will be a key market differentiator and a game changer for us. The Vocera badge was a game changer, but even with the success of that initial breakthrough, we must continue to drive further innovation. We are creating a culture of innovation based on employee driven and customer sourced ideas for our products and for our Company I believe fostering an innovative environment will result in new products that will enhance our revenue and reduce our time-to-market. The third initiative is focused on preventing a cohesive brand identity to the market. Vocera is very well known in healthcare and customers know that our voice solution is unique and compelling, but Vocera also has a full portfolio of end-to-end integrated and intelligent communication solutions and that story needs to be clearly articulated to our core markets and to adjacent mission-critical environments, creating demand for our products that will increase our market awareness and help drive sales. The final initiative is centered on organizational agility and our ability to streamline and simplify decisions and processes within the Company. As we grow, we'll need processes and infrastructure, but we want to maintain a start-up atmosphere within the Company. Our market is dynamic and we need the agility to respond quickly to opportunities and emerging trends. In closing, I want to take this opportunity to thank all of our Vocera employees who work tirelessly to develop and deliver best-in-class solutions, and our customers who are also innovators looking for solutions to serve the needs of their staff, patients, and customers. I'm thrilled to have the opportunity to lead the Vocera team into its next exciting chapter, and with that, let's open up the call for questions. Operator?

[Operator:]

(Operator Instructions) The first question comes from Ryan Daniels. Please go ahead, your line is now open.

[Ryan Daniels:]

Bill, maybe I'll start with a quick one for you, given that you are anticipating revenue will take a bit of an uptick in the third quarter and you just mentioned the gross margin should improve on the improved software revenue recognition, why is the bottom line a little bit lighter, is that just continued investments in the sales force or anything specific you call out there?

[William Zerella:]

Thanks, Ryan, good question. So yes two factors, we'll see sales and marketing spend continue to increase in Q3 and R&D spend is a bit lumpy. You'll notice that in Q2 we were sequentially down a bit from Q1, that's due to the timing of outside project spend, and we see some lumpiness there with an increase in Q3 from Q2 levels. So a little bit of lumpiness combined with just continued growth in sales and marketing spend.G&A will be pretty comparable with Q2, but those are really the two drivers.

[Ryan Daniels:]

Okay, that's helpful comment. And then one around the sales topic, I know last quarter you identified some changes in the sales force leadership, and I was hoping we could get an update on where that hiring process stands and how close you might be to some of the leadership positions there?

[Brent Lang:]

We have interviewed several candidates for the EVP of Sales and Services, we have not extended an offer for that position yet, so we're continuing that search. We have filled some of the openings that existed lower in the organisation, for example the Regional Vice President in the central region and a couple of our national accounts positions, but we're continuing to search for the EVP of Sales and Services.

[Ryan Daniels:]

Okay, it's helpful. And then maybe just a couple of other ones, you mentioned during the quarter, you had about 10% uptake on the badge conversion initiative, can you give us an update of where you stand now as regards to your total installed base and how many have upgraded to B3000 already?

[Brent Lang:]

So our current estimate is less than 20% of the opportunity for upgrades has been captured by us at this point in time, so we've still got north of 80% opportunity out there in the coming couple of years or so.

[Ryan Daniels:]

Okay, perfect. And then maybe last one, I'll go back to Brent for this, a big picture question, you talked a little bit about how the organisation has advanced in product and technology and personnel, and I'm curious from a sales and marketing standpoint, how difficult it is for you to re-brand yourself as a larger organization with more offerings, given how powerful the brand recognition behind the pure badge is, is that almost to a certain extent a little bit of a curse because everyone just considers you a badge company, and if so how are you addressing that?

[Brent Lang:]

Yes, I think you're right, I think it's a bit of a blessing and a bit of a curse. We get amazing brand recognition associated with the badge, a lot of times you'll see us in industry publications or advertisements that we have nothing to do with and there'll be a nurse standing there wearing a Vocera badge, so we certainly capture some of the momentum from that. But I think our customers understand the vision that we're portraying for them in terms of this idea of a software platform and the idea of extending the ecosystem out to other devices and the ability to build other applications on top of that. So, I think what we're trying to do here is make it an end, so it is the badge and the platform and the other applications and other devices, so we're not walking away from our core but we're building on that momentum and expanding into some of these other areas, and for the most part, the customer reaction has been very positive when we've done our initial testing on some of the stuff we pulled together.

[Ryan Daniels:]

Okay, helpful color, thanks and congrats on the target performance this quarter.

[Operator:]

The next question comes from Sean Wieland. Please go ahead, your line is now open.

[Sean Wieland:]

Can you give us some kind of sense, more quantitative, around backlog in terms of either sequential growth or year-over-year growth or visibility, just something with a little more meat on it?

[William Zerella:]

Sean, the best we can do in terms of trying to give you color is the growth rate which as Brent described is the largest we've seen in six quarters. So all I can say is we're pretty pleased with the trends that we're seeing and that gets coupled with the factors that I mentioned in terms of driving more backlog and deferred revenue because of the timing associated with when these bookings actually convert to revenue through the balance of the year. So that's about as much color as we can give you. Other than that I would tell you that the three factors that I described in terms of impacting revenue recognition, roughly equate to about $7 million to $10 million of incremental backlog and/or deferred revenue that we estimate exiting the year beyond what kind of our normal conversion cycles are.

[Sean Wieland:]

Okay. Is backlog up quarter over quarter?

[William Zerella:]

Yes, absolutely. Again, that's a function of the growth rate that we talked about.

[Sean Wieland:]

Okay, good. The sun-setting of the B2000 badge, can you give us any more detail from a numbers perspective on the impact that that had in the quarter?

[Brent Lang:]

It did not have a real impact on the quarter, it was pretty much in line with what our original expectations were. As I mentioned, 88% of the shipments were the B3. That was up from 78% of shipments in Q1. So we're kind of on this glide path that we anticipated as part of that transition. As I mentioned, total badge shipments in the quarter was a record for us which we were pleased about and it's pretty much gone according to plan. So we're happy with the progress we're getting there, continue to have very positive reception from our customer base on the B3000 in terms of the durability and the ease-of-use, and I think at this point we're pretty much down to the government customers as being the primary users of the B2000 while we wait for the fifth certification on the B3000.

[Sean Wieland:]

And when does that come?

[Brent Lang:]

We're anticipating Q1, it's a little bit of a black box for us at this point. We've done all the work on our side and it's been submitted into the certification bodies and we're anticipating sometime in Q1 for that certification. A little bit will depend on how long it takes them to work through the queue of other products.

[Sean Wieland:]

Okay. And just one more, what are your thoughts around the overall expense structure of the business, total operating expenses comprise, I've got roughly that's 70% of revenues, given the revenue growth rate in the business now, is that the right expense structure for this business, any thoughts there?

[William Zerella:]

Well, in the short term, Sean, we're in investment mode, right, and obviously the top line at this point is not growing substantially as it had been previously, we're obviously hoping to return to high growth as we move forward, but I think you should view the kind of the short-term being through the rest of this year we're going to continue to invest, and then we should start seeing leverage as we get into next year and then our revenue growth starts to kick-in in a bigger way.

[Sean Wieland:]

Alright, super, thanks so much.

[Operator:]

The next question comes from Lisa Gill. Please go ahead, your line is now open.

[Lisa Gill:]

I know earlier you said that a apportion of your deals that were delayed in the first quarter had been converted into second quarter, but Bill, can you give us an idea of on a percentage basis where you are on that, and if still they are incomplete at this point, do you expect them to close at the end of the year and are they included in the guidance?

[William Zerella:]

Yes, so all but one of the deals that pushed from Q1 we closed in Q2, and that deal that we did not close is still alive. Our expectation is we'll be able to close that sometime in the second half of the year. So I would say as we discussed in Q1, it was really a matter of timing. We did not lose any of that business in Q1 to competitive alternatives. So it was just a matter of when those deals were going to come in and they did with the exception of that one, and in this quarter, we saw some similar activity where certain deals got pushed as well, but again I would characterize those in a similar fashion as deals that really it's a matter of just timing in terms of when we would close those.

[Lisa Gill:]

And then your comment on signing some of the VA business, sounds promising on the Dorland contracting side, can you maybe just give us an update there as far as what you're hearing from them, I think we're obviously in the middle of sequestration, but moving forward do you expect to see more of that activity as we move into the next couple of quarters?

[Brent Lang:]

Yes, we're optimistic that we're going to continue to see some growth there, particularly within the VA piece. We're not in the business of trying to forecast this government business because we've been burnt on it before, but the conversations that we're having with the VA facilities remain very positive. I think the fact that we were able to get the VA deal in Q2 is an indication that things are starting to move again, and we're optimistic that we'll be able to close some deals in Q3. As Bill highlighted, those will likely just end up being bookings and then the revenues from those new deployments will be delayed most likely out a year but we're fairly confident that we'll be able to get some additional government business, we're just cautious about it because we've gotten burned on this in the past.

[Lisa Gill:]

I understand. And then my last question would just be around you views on your longer-term margin guidance. Bill, you updated your guidance today, you talked about gross margins being better in the third quarter, but Brent or Bill, do you want to just give us an update as to where you stand on your longer term margin guidance, is it still the same, has timing or anything else changed during that?

[William Zerella:]

No, not really. I mean we maintain our view, I mean we believe we could drive to that target model and we have talked about getting there in a couple of years, we still think that that's a reasonable timeframe to execute against it, and again, we'll start to see some improvements in gross margins next quarter, as I mentioned. And then to one of the questions, earlier we'll start to see more OpEx leverage heading into next year. So, yes, I think we're still on target in terms of hitting that 70% gross margin target and actually 25% adjusted EBITDA target in the next couple of years.

[Lisa Gill:]

Okay, great, thank you.

[Operator:]

The next question is from the line of Jamie Stockton. Please go ahead, your line is now open.

[Jamie Stockton:]

I guess maybe one quick one, Bill. What was the sales force headcount at the end of the quarter?

[William Zerella:]

I think I've got that. We were pretty much at strength. We got a little bit of turnover in the sales force but we were pretty much at full strength as of June 30, maybe one or two position short as we were just cycling through a couple of folks, but pretty much at strength.

[Jamie Stockton:]

Okay, I think it was 70 last quarter, is it still in that vicinity?

[William Zerella:]

Yes, 70 was sort of the target for this year, if you will, for this class and I think actual sales quarter carrying headcount at the end of the year was 67, 68 somewhere around that – at the end of the quarter, sorry.

[Jamie Stockton:]

Okay, and then maybe one other just housekeeping one, Bill, I think you said that you guys did $2 million of leasing deals during the quarter, if that's correct, could you give us some sense for what the level was in the first quarter?

[William Zerella:]

Yes, it was correct, we did about half of that or so, a little less than half of that in the first quarter, about $0.75 million or so. So the second quarter was our biggest quarter yet in terms of leasing deals, so about half of those deals. So we've picked up a little steam there, but as I also mentioned on the call, roughly half of that gets either into deferred revenue or deferred lease liability versus recognized revenue.

[Jamie Stockton:]

Okay. And then, I'm assuming the answer to this is no, but just so everybody is clear, the big deal with VA in Las Vegas, the revenue that you're going to get from that is in future periods, there wasn't really any material revenue that flowed through during the quarter, right?

[William Zerella:]

There was no revenue at all in Q2 from that, we haven't shipped yet. So, yes, the expectation is we will ship that sometime in the second half with a portion of that as well being recorded into revenue, a portion being deferred.

[Jamie Stockton:]

And then I guess you guys said that 10% of your hospitals took advantage of the trade-up program during the second quarter, would that be 10% of hospitals that were not, and my guess is the answer is that it's not explicitly, but would that be 10% of the hospitals had not bought any B3000 in the past or these are a mixture of hospitals that had already started on the B3000 upgrade path and were maybe accelerating it during the second quarter ahead of the 2000 end of life and then also some hospitals that were kind of getting pushed over the hump because of the end of life?

[William Zerella:]

Yes, the latter, it was really a mixture of a combination of folks who had already done some deployments of the B3000 and had remaining departments left to go, and in some cases folks who had been delaying that upgrade, they went ahead and took advantage of it, so it was a mixture.

[Jamie Stockton:]

Brent, did you feel like the environment just without tight hospital CapEx budgets have then kept some hospitals from pushing forward with a more robust B3000 replacement cycle and maybe you saw a little stronger demand for the B2000 during the quarter as they hung onto that platform a little longer than you might have expected a quarter or two ago?

[Brent Lang:]

We didn't really see people hanging on to the B2000, we did continue to see some high levels of scrutiny on deals, and as Bill mentioned, we had a couple of million dollars of deals that got pushed out of the quarter similar to Q1. I think the difference was we were able to grow our way through it, and my hats off to the sales organisation that was basically able to find a way to close additional business in order to beat our financial numbers. And I'm not sure that the market conditions have changed dramatically, we're still seeing even amongst some of our most loyal and dedicated customers very high levels of scrutiny on additional expenditures, and until that uncertainty gets cleared up, I think it's going to continue to be a challenging environment. I think the good news though is that our sales reps, the more time the new guys have on the field, the more time they are able to build relationships with their customer base, get comfortable with the product and the value proposition and really fine-tune the ROI story associated with what we're offering, that's translating into their ability to be successful despite some of these headwinds.

[Jamie Stockton:]

That's great, thank you very much.

[Operator:]

The next question comes from David Larsen. Please go ahead, your line is now open.

[David Larsen:]

Did I hear you guys correctly, did you say the bookings growth rate in the quarter was the best that's ever been, did I hear that correctly?

[William Zerella:]

It was the best it's been in six quarters, David.

[David Larsen:]

Okay, and that's on a year-over-year basis?

[William Zerella:]

Correct.

[David Larsen:]

Okay great, thanks. And then can you just talk about is there any sort of seasonal trend in the business, like would you expect calendar 4Q to be maybe the best quarter of the year, I mean if hospitals have their capital budget processes going on in October in calendar 4Q, would you expect 4Qs to be best quarters of each year going forward or not necessarily?

[William Zerella:]

Yes, we typically see each successive quarter throughout the year is typically stronger, so Q4 is our strongest quarter, Q1 is usually our weakest quarter, and that has to do with the fact that there's a large number of hospitals that have their fiscal year end coinciding with the calendar year. Q3 has obviously the government facilities and fairly large number of private organizations also having their fiscal year-end, then there's a bunch who have June 30 as their year-end, but I think Q4 is typically our strongest quarter.

[David Larsen:]

Okay, I mean would you expect a little bit of a step-down in 1Q 2014 or it's just too early to tell?

[William Zerella:]

I think it's too early to tell at this point. Certainly if you look historically, bookings in Q1 are down, and obviously this year revenues were down, does well but I think we'll have to wait and see how the rest of the year plays out before we get ready to start setting the guidance for next year.

[David Larsen:]

Alright. And then can you just talk a little bit about the restructuring of the sales force, so if you guys split the team into like hunters versus gatherers, have you disclosed what the total sort of revenue bogie is for a hunter versus a gatherer and how that has impacted sales so far this year?

[William Zerella:]

Yes, we've given some high-level guidelines. Typically, a farmer is going to have a quota of between $2 million and $3 million whereas the hunter might have a quota of anywhere from say $800,000 to as much as $2 million. There are some guys who are a little bit of a hybrid where they have predominantly new account business but they may inherit a couple of large installed base customers as well, and so their quota is really driven by what the mix of their particular book of business is. In terms of the impact that it's had on our business, I think it's been very positive. The most positive element of it is that there's clear accountability and clear line of sight as to who's responsible for each element of a business. So, literally every customer in the country, every hospital in the country is associated with a single sales rep, whether they are a hunter or a farmer, and the hunters know exactly what they need to do in order to be successful. Because they have lower quotas, they are on a more leveraged model, and so to the extent that they can actually go out and close new business, we have the opportunity to make a lot of money on a highly leveraged plan, whereas the farmers have probably a higher predictability of being able to reach their number because they're farming installed base, but they've got a higher quota and also less leverage, so there's maybe less opportunity to completely blow out the top end of the range.

[David Larsen:]

Okay, great. Thanks a lot guys.

[Operator:]

The next question comes from [indiscernible]. Please go ahead, your line is now open.

[Unidentified Analyst:]

For the sales expansion, deals that got flipped out of the first quarter, were those all booked in the quarter or is still there some of that remaining?

[William Zerella:]

[Neil] (ph), we booked all but one of the deals that flipped, and the deal that we did not flip – that we did not book rather, we expect will probably come in sometime in the next one to two quarters. So we've closed all that business. I believe most of it has been shipped, some of it would have been deferred as well.

[Unidentified Analyst:]

Okay. I mean for the deal that's been not closed, was there anything unique to that or is there something kind of across the board more of an issue?

[William Zerella:]

No, I don't think there's anything unique, just the specifics of getting the budget approved and the spending approach of that particular hospital.

[Unidentified Analyst:]

Okay. And in terms of the sales leadership hiring, I don’t know if I missed this but is the plan still to hire SVP by the end of the third quarter?

[Brent Lang:]

Yes, absolutely, in fact I hope to get it done by now, we're going to hire the person as soon as we find the right person who meets the goals and the standards we're trying to set for the position. Based on the pipeline of candidates that we're looking at, I think it's a reasonable expectation that that person would be brought onboard during Q3.

[Unidentified Analyst:]

Okay. And then you mentioned sales execution initiative, what would that entail, I mean is there some sort of re-training of the sales staff involved in that or any other details on that?

[Brent Lang:]

Yes, a lot of it has to do with empowering the sales force and training the sales force, making sure that they understand the value proposition, particularly the new guys, making sure that they've got the tools that they need in order to be successful, whether it would be ROI tools or other sales tools that they can use. Some of it has to do with the mindset that I'm trying to instil within the Company where we really get into this idea that sales is not just about the sales department but sales is everyone's responsibility. And so partnering between services and sales, partnering between marketing and sales, is really important. And the other thing we're trying to do is best practice sharing where the guys who are more experienced, who've been here longer and had success, are doing more mentoring of the newer folks that are coming in. So it's really across the board, it's a number of different things, just trying to make sure that these folks we brought onboard who we're really excited about, we think they've got tremendous capability, are just getting the tools and training that they need in order to be successful.

[Unidentified Analyst:]

Okay that's helpful. One quick last question just in terms of the next shutdown, was there any update there as far as traction with the hospitality clients?

[Brent Lang:]

The short answer is, a lot of activity, not a lot of book business at this point. We had a very successful show in hospitality space in late June, generated a lot of leads, but we haven't got a lot of bookings to show forward at the point. It's generated a lot of interesting conversation. The competitive marketplace there has heated up a little bit. I think both Sprint and AT&T had also introduced new versions of push-to-talk that are out in the marketplace, but like a lot of technology shifts, when a new technology comes into a space, it opens up the opportunity for customers to evaluate the full market dynamic, and that's getting us in the door for some conversations with folks who otherwise probably would not have been open to those conversations, and for the most part they've been astounded by the functionality that we deliver because obviously the capability of the Vocera system is much greater than just simple push-to-talk, and I've witnessed that when these customers see the functionality of what Vocera offers, it's really an eye-opening conversation with them. So now it's just a function of us continuing to close those transactions.

[Operator:]

The next question comes from [Kevin Stovern] (ph). Thank you, your line is now open.

[Unidentified Analyst:]

I wanted to go back to some of the lease revenue and also the SaaS mix as well, if I think back to last year about this time when you introduced the lease program, I recall conversations around selling the lease to a third-party, and except for battery and warranty, the revenue recognition being largely similar to a traditional sale, and it sounds like that's maybe a little bit different, I think you referenced a bit of a deferred revenue headwind from the increased leasing traction, so that's my first question. And second, it sounds like Good to Go and messaging are seeing a little bit more traction, more SaaS mix there, what's the SaaS mix today and where do you see it trending in the next couple of years and is that meaningfully different I guess from where you stood a few quarters ago and your thought process there?

[William Zerella:]

Let me first talk about leasing. So you are correct in that we do sell off most of these leases to a financial institution. So, in a typical deal, we'll carve out anywhere from on average a quarter, maybe up to a third of revenue that gets deferred, versus the leasing deals that's more like half. We don't have battery refreshes in typical deals that we sell and we don't typically sell warranty, hardware warranty for the entire duration. So that's why they are bigger carve-outs. It really drives the deal to be a bigger deal to begin with and it locks in those revenues in future periods. So that's kind of the dynamic there, and if we sell the deal off then that deferral is what shows in the leased liability line on our balance sheet. So it's actually, it looks like debt on our balance sheet which is why in my prepared remarks I talk about that number plus deferred revenue in the balance sheet as really being effectively an indication of future revenues, right, and that grew substantially, it grew over 22% year-on-year when you look at that combined, deferred revenue view, okay. So that hopefully gives you some color on the leasing side. In terms of Good to Go and messaging, I mean we don't get to that level of granularity in terms of a portion of our bookings that are Good to Go deals and messaging subscription deals. It still is relatively small, but again as I mentioned in my prepared remarks, it's all of these factors when they add together in a given quarter start to become a bigger number. We like the fact that we're doing deals like this because it basically gives us increased visibility as we go forward, I mean these are effectively software deals, so it's very high margin, which is a nice way to be able to – if we can grow our business adding these kinds of revenue streams, again high-margin, very visible, very predictable, so over time it's really going to benefit our financial model. So that's why we like that kind of mix, but it still is relatively small but it's certainly growing more rapidly than the rest of our voice business.

[Unidentified Analyst:]

Alright, that's great. And I guess most of my questions have been addressed, so we can just touch on international real quick, Canada and U.K. a little weaker, I thought I remembered Canada being strong last quarter, I guess what's kind of the market outlook there, is this relatively transient or is there something a little bit more persistent here that we should think about?

[Brent Lang:]

I would describe it as transient or very lumpy. The Canadian and U.K. portions of our business are relatively small and can be influenced pretty dramatically by the timing of a few deals. Both in the U.K. and Canada we had government intervention slowing down some of these transactions, but our outlook in both of those regions, particularly in Canada, is quite strong for the rest of the year. So I think the way to look at our business maybe to step back to think about it a little bit more holistically, we give you a fair amount of granular detail across the different five pillars and break down the data into a fair amount of individual components, so I'm sure quarter-to-quarter it may look a little confusing what are the trend-lines here, and I think the way to look at it is that we've obviously got lots of different moving pieces of the business, you can sort of think of it as a portfolio, some of the smaller growth elements that are going to be particularly lumpy because of the deal size relative to the size of the overall business, but our outlook for international continues to be quite strong for the future.

[Unidentified Analyst:]

Great, thanks guys.

[Operator:]

The next question comes from David Larsen's line. Please go ahead, your line is now open.

[David Larsen:]

I just had one more follow-up, I'm looking on said bids out here and it looks like there was an award to you guys by a VA facility and there's just the description of Roxbury, is that the Las Vegas deal or is that a different one, so there was a deal on June 25, or if you don't want to disclose that I understand?

[Brent Lang:]

Yes, we left that one, we haven't disclosed that one in particular, we'll have to look the deal and we'll get back to you, okay.

[David Larsen:]

Okay.

[Operator:]

Thank you. You have no further questions. (Operator Instructions)

[Brent Lang:]

Okay, thank you, we appreciate your time today, and with that, why don't we wrap up the call. Thanks to the operator and for all of you who called in with questions. Thank you very much.

[Operator:]

This concludes the presentation. Thank you for your participation in today's conference. You may now disconnect your lines. Good day.