Stryker Corporation (SYK) Q2 2018 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Welcome to the Vocera Communications conference call. My name is Gabriel and I will be your coordinator today. At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the presentation over to your host for today's call, Sue Dooley from Vocera investor relations. Please proceed.

Hello, everyone. Welcome to Vocera's conference call to discuss our second quarter fiscal 2018 earnings. This is Sue Dooley 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 normal news sources. This conference call is being webcast live on the IR page of our website where a replay will be archived. Before we begin our prepared remarks, I'd like to take this opportunity to remind you that during the course of the call, we will make forward-looking statements regarding projected operating results and anticipated market opportunities. These 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 the 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. With that, I'd like to turn the call over to Brent.

Thanks, Sue. Good afternoon, everyone. Thank you for joining us. On today's call, I'll start by summarizing the highlights from the quarter. Then, I'll provide some details on key customer wins and product development achievements in Q2. I'll conclude my prepared remarks with some commentary on the market environment and hospital spending priorities, before turning the call over to Justin for some more detail on the quarter. Second quarter revenue was $43 million, up 8% over the recast financial results from the same period last year. The completeness our unique solution remains a strong differentiator for us and several large wins this quarter validated our leadership position. Our software platform, including the integrated Engage software, continues to succeed against competitors at both new and existing customers. Our Badge also remains a key differentiator, vital to care team members at the patient bedside. Our market opportunity remains robust and we're pleased with our large deal pipeline. We had an impressive lineup of large customer wins, including four deals each over $2 million with particularly strong momentum in the federal space. We had two big wins in the Veterans' administration. VA Puget Sound was a $3 million booking and VA Houston was a $2 million booking. We also had a very important $2 million win at the new Walter Reed Military Medical Center. VA Puget Sound healthcare system is expanding from a small departmental application of our solution to a house-wide deployment including both our messaging and Engage integration software. VA Houston was suffering from too many communication silos, including landlines, pagers, and loud customers. The customer cited missed pages and excessive noise, commenting that it was taking up to three hours to locate a bed due to communication breakdowns. Our unified software platform and wearable badge are expected to eliminate silos and dysfunctional communication, thereby delivering timely patient updates and crucial lab results and also helping to prevent falls. Walter Reed, a joint army-navy facility, is the largest military medical center in the United States. This substantial win will showcase our solution as we pursue further penetration within the federal space. On the commercial side, we booked an impressive $2 million cross-sell at Allina Health in Minnesota. Allina has a long-standing Badge installation at their heart hospital. This large expansion with our Engage software is designed to ensure connectivity from their patient monitors and nurse call system to our Badges as well as Spectralink phones and smartphones. The completeness of our solution and our forward vision were paramount to this win. As you can see, we are succeeding with our cross-selling and expansion efforts. Suppliers are delivering growth and we continue to produce a very high renewal rate in software maintenance and support services. One notable expansion was at the Department of Mental Health for the State of Minnesota. At the existing Anoka-Metro Treatment Center, our handsfree communication solution has proven vital for staff safety. A year after the initial sale into Anoka, we're literally replacing plastic whistle across nine additional hospitals in what we hope will be transformational for the safety of the state mental health department. We also won key strategic expansions at Northwestern University, UNC and at the Mayo Clinic where will be sending badge alerts to anesthesiologists to streamline the process around radiation treatment and reduce sedation time for patients. Now, I'd like to talk about our international business, which was up substantially over last year, reflecting our increased focus there. In Canada, we had a $1 million win at the Interior Health Authority in Western Canada. The CEO of IHA personally witnessed Vocera helped save the lives in the emergency department at one of their sites and has since become a strong Vocera champion. The IHA has plans to continue to roll out our solution across 10 additional community hospitals. Once this phase is complete, they will have over 5,000 active licenses. In the UK, we won a large Badge refresh from Northwest Anglia, one of our longest-standing customers in the NHS. We're also excited about an expansion win at Queensland Health in Australia, which involves the use of our Badge to optimize overall communication and even includes patients and their family members. We continue to invest in international and are gratified by our success and pipeline growth this year. International remains a big opportunity and a top priority for us in 2018. Our professional service expertise remains a meaningful differentiator in helping our customers address their communications and workflow challenges. The expertise and scalability of our personal service organization continues to grow and deployments of our solution continue on schedule. In a highly strategic go-live, Vocera is proud to be one of the technologies being used by NYU Langone Health Systems in both its flagship Tisch Hospital as well as the brand-new, state-of-the-art Kimmel Pavilion. Vocera is the middleware solution integrating eight third-party vendors and creating 120 workflows that send alarms and alerts to nearly 1,400 newly deployed iPhones. Also during Q2, our teams deployed Vocera at the Ohio Department of Mental Health. Our solution is now in use across all six sites, standardizing workflows, improving patient care and addressing at increasing staff safety. The Panic feature is of particular importance to this customer as they strive to keep staff safe while caring for their patient population. In the UK, we had a deployment showcased on the BBC's The One Show. This was a behind-the-scenes look at the relocation of the children's board to a brand-new wing at the 141-year-old Sheffield Children's Hospital. We replaced pagers with our Badge and communications solution, saving nurses' time and creating a quieter healing environment for patients. In terms of new product development, we continue to have a busy year. In May, we brought to market our newest analytics and reporting offering. Vocera Analytics is a monitoring and diagnostic tool that provides visibility to all the traffic that goes through the Vocera platform. As a new core feature of the platform, Vocera Analytics offers a broad selection of intuitive dashboards and reports that enable clinical and IT users to quickly find the information they need to improve operational and clinical efficiencies. This offering is available to Vocera customers today and bolsters the functionality of their existing installations. By leveraging the data captured by our platform, hospital leaders can measure call patterns and interruption fatigue to gain valuable insights and drive further efficiencies, while eliminating sources of stress and fatigue for caregivers. Following the announcement in late Q1, our new collaboration suite now provides actionable, patient-specific clinical and operational data, including demographics, lab data and care team rosters. By making this information part of the communications flow and informing clinical decisions from within our app, we've made the patient the central focus for all communications. Sutter Health is one of our customers leading the way in their adoption of collaboration suite. We're having productive conversations with new and existing customers about the benefits of this offering. Finally, as part of my product commentary, I want to give you an update on an exciting development that move us further towards our longer-term goal of enabling the smart health system. Predictive analytics is one of the technologies that I have mentioned in the past that we view as a critical part of our smart hospital vision. Earlier this month, we began a referral partnership with Qventus, a leading healthcare artificial intelligence and predictive analytics company that is using analytics to help care teams optimize workflow and prevent bottlenecks before they occur. Vocera plays an important role in making these analytics actionable by delivering the recommendations to the right care team members at the right time. Now, I'd like to talk for a moment about the market and share what we're hearing in our conversations with customers about their budget priorities. In my interactions with hospital executives, budgets are always tight, but improving margins and quality of care consistently rise to the top of their spending priority list. Hospitals need to reduce cost and waste by eliminating friction and bottlenecks and streamlining operations. These goals are increasingly aligned with our mission to deliver the quadruple aim. The impact our solutions can have on these executive level priorities is resulting in larger and more centralized deals as evidenced by our large deal success this quarter. In my observation of our large deal pipeline and the associated sales cycles, no two deals are like. And each of these large new customer wins and expansions has its own unique journey. As hospitals define and pursue their strategic initiatives, the timing of a specific deal can be harder to predict and the lumpiness associated with these large deals continues to be a fact of life. In some instances, this larger deal profile, combined with a cautious approach to spending, can elongate sales cycles. However, it is clear from our success that the market is very interested in what we have to offer and many customers are seeing the value in our solutions. As a result, we have a sizeable large deal pipeline and we remain laser focused on closing these deals. To help our sales force close these deals, we commissioned some research to mine and organize our case studies and third-party research into an ROI-based sales enablement tool. There are three takeaways from this work. First, we identified 11 categories of quantifiable use cases that demonstrate the value of our solution. These include ED and OR throughput, patient satisfaction, inpatient efficiency and throughput, physician and nurse turnover, staff safety, inpatient falls, and time to treatment. Second, we concluded that the link between communications and efficiency is very strong. And third, we found economic impact of improving communications can be significant. The research also concluded that the impact of patient experience has real financial consequences. We found hospitals with better patient ratings earned disproportionately more revenue per patient day than those with low ratings. And hospitals with highly-engaged staff can boost patient experience and profitability. We are excited to put these findings drawn from our customer case studies to work right away in a new ROI sales tool. We believe the economic and operational pressures on hospitals and care teams are only mounting. Hospitals are increasingly looking for ways to avoid burnout and retain vital care team members. Our vision to deliver workflow solutions to eliminate friction points along the patient journey is resonating in the market because of its helping them solve some of their most pressing challenges. The marketplace is demanding a unified solution that combines real-time voice, secure texting and deep clinical integration wrapped into a single platform. Our complete platform, combined with our large customer footprint and unparalleled experiences implementing communications solutions is unmatched in the industry. It's an exciting time for Vocera as we grow the business and progress towards our profitability goals. I'm excited by our large market opportunities and our strong competitive position. Our progress continued this quarter with several strategic new customer bookings, successful large-scale deployments, exciting new product offerings and high customer loyalty. Now, I'd like to give our CFO, Justin, a chance to cover the financial details around our Q2 results and our guidance. Justin?

Thanks, Brent. Hello, everyone. Vocera's second quarter results represented another period of year-over-year growth in revenue and improved profitability. Total revenue in Q2 was $42.7 million, up 8% compared to last year. Keep in mind, and as previously disclosed, the revenue impact from recasting our 2017 financials under 606 was largest in Q2 and Q3, raising the comparable numbers from a year ago and lowering the year-over-year growth rates for Q2 and the upcoming third quarter. Even with this, our product revenue increased to $21.8 million. Device revenue was $15 million, similar to last year, but sequentially up from Q1, as we had expected. I mentioned during our Q1 call that our device revenue in the first half of the of last year benefited from a large portion of hardware associated with the US Army MEDCOM deal that we booked in 2016. We continued to have healthy device bookings in Q2 with our highest yet volume of Badges booked in any quarter. Software revenue was $6.8 million, up 13% from last year. Our enhanced software platform is a key driver of our growth, highlighted by continued cross-selling and accelerated adoption of our mobile smartphone solutions across a broader base of users. A significant number of our new customer bookings now include Engage and/or our smartphone software. We see this as an ongoing trend and believe our broadened software platform, coupled with our focus on larger enterprise deals, will continue to expand our deal sizes. Services revenue in the quarter was $20.9 million, up 12% from last year. Our professional services revenue was $5.4 million, down slightly from last year. As we have seen in past quarters, our professional services growth rate can fluctuate with the timing of deployment. Additionally, as disclosed previously, the largest revenue adjustment in Q2 2017 due to ASC 606 was in professional services. The other large portion of our services portfolio is software maintenance and support. Due to our growing customer base using our expanded software platform and a renewal rate well above 95%, our software maintenance and support revenue grew 22% to $15.5 million. As a reminder, this revenue is recurring and was approximately 36% of our total revenue. Our software business in aggregate including in both the revenue from software and software maintenance now exceed 50% of our total revenue. Our combined backlog and deferred revenue balance at the end of the second quarter was $108.8 million, flat compared to Q1, reflecting a similar pattern to last year. One of the positive trends we're seeing our business is that we are converting our bookings to revenue more quickly as we have become more proficient at deploying the large enterprise deals. We're also seeing faster revenue conversion of our software bookings as these now generally be recognized upon shipment under the new accounting standard. Thus, the amount of backlog we need entering a quarter to achieve our expected revenue is lower than historic levels. I'd like to now turn to profitability, another bright spot for the quarter. GAAP and non-GAAP profitability improved substantially compared to last year. Specifically, adjusted EBITDA was $3.5 million, ahead of our expectations. We also achieved positive non-GAAP net income in the second quarter, even after including the impact of the interest expense from our recently issued convertible notes. Here is some more detail on our non-GAAP gross margins and operating expenses. Non-GAAP gross margin in Q2 was 64%, better than we expected and driven by a favorable revenue mix, particularly in software and software maintenance and support. Product margin increased year-over-year to 73% on the strength of our software revenue. Our services gross margin increased to nearly 55%, reflecting the higher operating leverage and resource utilization we achieved in this part of our business. Non-GAAP operating expenses were $24.1 million in Q2, flat compared to last year. Our operating expenses dropped to 56% of revenue as we scale and continue to remain focused on becoming more efficient throughout our entire business. And we believe that our demonstrated operating leverage is an attractive part of our financial profile. I'd like to wrap up my Q2 remarks with a brief comment on our balance sheet. In May, we raised capital from the issuance of roughly $144 million of convertible note that mature in 2023. The net proceeds after the purchase of a capped call and debt issuance cost were approximately $130 million. Our GAAP presentation of this debt appears as approximately $107 million as it is presented net of the equity component of this security in our financial statements. With that, let me turn to guidance. As we now look forward to the second half of the year, we believe our pipeline will enable us to achieve seasonally higher bookings than the first half, consistent with prior years. With these expected bookings and our current backlog and deferred revenue position, we reiterate our previously issued annual revenue guidance of $175 million to $183 million and adjusted EBITDA guidance of $14 million to $20 million. We have updated our net income and earnings per share guidance to reflect the impact of the new interest expense from the notes. For the third quarter, we expect revenue to be between $43 million and $47 million and adjusted EBITDA to be between $3.5 million and $6 million. As I mentioned earlier, the largest adjustment to last year's financials from the adoption of ASC 606 was in Q3. Revenue in that quarter was adjusted up by over $3 million due to the timing of some largest software shipments and net income increased by over $4 million. In summary, we were pleased with our Q2 financial results and continue to stay focused on strong execution as we transition now to the second half of the year. I'll now turn it back to Brent.

Thanks, Justin. I'm pleased with our progress in Q2 and I believe our success underscores the strategic importance customers are seeing in our products. I'm also excited to announce that Dr. Ron Paulus has joined our Board of Directors. Ron has both an MD and an MBA and serves as the chief executive officer and president of Mission Health, one of our nation's top 15 health systems. His experience in understanding the priorities and inner workings of large health systems, as well as previously being the CEO of a software analytics company listed on the NASDAQ will provide great insight to our company as we grow our business. His leadership in advancing cultural transformation in healthcare has led to improved patient outcomes and care team resiliency in an age of clinician burnout. His work fits well with our drive to deliver the quadruple aim. We welcome Ron and look forward to his service on our board. In summary, with highly differentiated solutions, a large market opportunity and a large pipeline of enterprise deals in front of us, we are excited to build upon our momentum. We are driven to help make a difference to the bottom line as well as to the quality of care and staff experience of our customers. Thank you for listening today. operator, we are ready to open up the call for your questions. Thank you very much.

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

Yeah, guys. Congrats on the strong performance. I wanted to ask a little bit more about the ROI-based tool set. It sounds like that's a important development for the sales team. So, number one, is that in the market at present or was it launched in the last quarter? And if so, can you give us a little bit of feedback of what clients are saying or what your sales force is hearing they move to more of this ROI-based pitch?

Hey, Ryan. Thanks. Appreciate it. We really believe that ROI-based selling is going to be a critical component for deals moving forward both because of the economic environment as well as because of the fact that this decision-making is now moving to more a centralized role within the corporate headquarters. The model was developed using research that we had done with case studies with previous customers as well as some third-party data that was available. We've done initial training with our clinical executive teams. And you may remember, these are a group of individuals who formerly worked as nurses and other clinical leaders inside of hospitals and they assist the sales team in working with our customers and closing deals. So, we started by training them literally just a couple of weeks ago. And they are now rolling that out into the customers. So, it's too early to have had any impact on bookings or revenue, but because the tool was developed in conjunction with some of our existing customers, we've been able to get some feedback on the viability and the believability of the tool and we've gotten some really favorable comments and feedback on that. So, we expect it to have a very meaningful impact on our ability to sell to these larger enterprises.

Okay. And that was kind of my follow-up. Is it really something that you have developed, given pushback or hesitation to move forward from the larger enterprises, systemwide sales, if you will, or is more of an economic environment or is it more the fact that you're now moving towards systemwide deployments versus individual department? And maybe it's a component of all three. And if that's the case, maybe which of those does this address most fully? Thank you.

Yeah. I think it is a combination of all three. We're certainly seeing a centralization of decision-making. More RFPs are being issued. Fewer departmental level decisions are being made and more health systems are looking to standardize on a clinical communication and collaboration solution platform at a centralized basis, so then standardized across their environment. And in conjunction with that, I think that the C suite in these health systems is very focused on cost just because of the overall economic environment and reimbursement levels and cost pressures that they're facing. So, they're prioritizing their expenditures on solutions where they can see more of a hard ROI. And a lot of what we're able to do with the tools was take some of the learnings and findings that we've had in some of our existing customer deployments and try to actually put a numeric dollar amount on that. So, at some point, I can show you the tool that the tool is really a giant spreadsheet with a number of different inputs that can be customized for a particular hospital customer and actually uses both the data from that specific hospital as well as what we've found in previous customers to be able to predict the amount of ROI cost savings or revenue enhancements that we can generate through the deployment of our solutions. And so, I think it's a combination of the economic environment, plus the decision-making process that our customers are going through.

Okay, great. Thank you. I'll hop back in the queue.

Your next question comes from the line of Matthew Gillmor from Robert Baird. Your line is open.

Hey, thanks for the question. I wanted to ask about the federal business. You talked about the momentum there and some of the wins. This is sort of a two-parter, but part number one is can you give us some insight in terms of what's driving that? Is that related to the budget increases under the new administration? And then, part two, given that the federal side, I guess, the last couple of years, there's tended to be a lot more activity in the third quarter. As that momentum builds, would it be reasonable to assume that you'd see even more activity in terms of bookings from the federal side next quarter?

Yeah. Both good questions, Matt. So, I think with regard to your first question, what's really driving this is a combination of the fact that both the VA and DOD are seeing really strong results from the deployments that they've already made with our solutions. And that positive word is spreading across the rest of these system. We have met a number – as you and I talked about, a number of certification requirements, security requirements, product qualification requirements, Vocera effectively is the vendor of choice for both of those parts of the federal government. Clearly, a more stabilized budget environment is helping them make purchase decisions, but I think that more of it has to do with just the track record that we've established there. With regard to your second question, you're absolutely right. typically, we see the bulk of our federal bookings in Q3. And so, we take it as a very positive sign that we were able to land these substantial bookings in Q2. I think it's really a result of not just being kind of a last-minute purchase, but really something that they're looking more strategically at and planning for further in advance. We still anticipate having a very strong Q3 of federal bookings as well. We've got a number of deals in the pipeline that are teed up for the Q3 timeframe as well. Just really a very positive trend line for us in the federal government.

Got it. That's helpful. And then, my follow-up question, I did want to ask about the guide, especially in the full year. And I just want to make sure I understood the dynamics. So, the revenue in the last two quarters has come in at the high end. I think your EBITDA has been above the high end of the quarterly ranges as well. You also mentioned that the pipeline is really strong. So, I guess, those would all be indicators that you're tracking, I guess, closer to the high-end of guidance versus the low end. But you also mentioned that, with the pipeline having bigger deals, there's also some lumpiness. And is that the factor that's, I guess, causing you not to at least raise the low-end or are there other factors that we should be thinking about in terms of your maintaining the current ranges?

Hi, Matt. I think you're thinking about those in the right way. The primary thing that we focus on here at the midpoint of the year is we're right on track with kind of where the business is at this point. But as we look now to the second half of the year, our bookings are seasonally up quite significantly and that's a typical pattern that we've seen over the last couple of years. So, we feel really good about where we are. We still have a lot of work to do in terms of generating new bookings in Q3, Q4. We feel really good about where the pipeline is, but those are seasonally higher. And so, we're trying to take a conservative view of trying to make sure that we set ourselves up to be successful and be in the best position possible to exceed expectations. All of the core revenue conversion metrics are progressing really, really well. And as we continue to deliver on our bookings targets in the second half, we feel like we'll be in a good position to hopefully come in in a strong place in the guidance range.

Got it. Thanks very much.

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

Thanks for taking my questions. Firstly, a quick follow-up to Matt's question and then I have a question on the international market. Brent, the Walter Reed booking that you got this quarter, is it the first venture into the navy hospitals. And I don't think you guys have done much in the navy. Can you remind us, like, what's the opportunity in the navy?

Hey, Mohan. Yeah, you're right. This was one of the most substantial wins. It's a joint army-navy facility. So, we had a little bit of help there. But I do think that we're excited about the fact that this potentially could accelerate our business in the other two branches. And anytime we can get visibility with a facility like Walter Reed, it's goodness for our business. We expect that to be a very high profile account and we have a lot of excitement associated with it.

Got it. So, on the international market, so great data points in this quarter. As you look out, do you expect the grow rate on the international side to outpace domestic growth? And a few years back, you tried to enter into non-English-speaking regions. What are you thinking about that? Any outlook that you can talk about on the international side would be great.

Yeah. I think it's fair to say we absolutely the expect the growth rate in international would be higher than our domestic growth rate. As you heard me say before, we'd like to see international grow to be 20% to 25% of our business from where it is today in the low teens. And, obviously, in order to do that, it's going to need to grow faster than our domestic business. And the reason we believe that's the realistic goal is because we have very low penetration in the international markets that we're in. There is a much larger greenfield opportunity in those and we're starting from a smaller base. And so, as a result, the opportunity to drive growth there is very substantial. One of the things that we're learning, and I think we started this process last year and it's continuing is that, in order to be successful in these international market, it requires the same level of commitment that we would make to the domestic market here. What I mean by that is that it's not just a matter of having a sales rep in country, we need clinical executives, we need sales engineers, we need professional services folks, we need to be able to establish commitment to the region. And that's some of the investment we started making last year. And we're starting to see the dividends from that. The other piece of it are things like marketing support, lead generation, the air cover that leads to driving increased pipeline and increased deal flow, and that's something that I think you'll see us doing more investment in over the coming years – or month and years. Right now, we don't see a strong need to expand out beyond the English-speaking markets. And you could say on one hand, why not be greedy and go after it all? Basically, the assessment that we've made is that there is such a large opportunity within our existing international markets that we would rather sort of double down our investment in those regions rather than going through the process of opening up another international market that may not have as attractive of a growth profiles of the markets that we're already in. And so, in markets like the UK, we're seeing good success after some of the changes we made there. Canada has been performing really, really well. I think there's an enormous opportunity in Australia where most of our business today has been in long-term care. We've only got a handful of hospital customers there. So, there's a great growth opportunity there. And then, as I've mentioned before, the Middle East is really the potential explosive growth opportunity. And we continue to see some success there as well. So, I don't think you'll see a lot of expansion outside of our existing markets in the near-term, but you will see increased investment and, hopefully, accelerating growth there.

And just a quick follow-up, Brent, on the international markets. You're still relying on the resellers for those countries, right?

Correct. It's kind of a hybrid model. We typically have feet on the street there locally, but we're also partnering with local partners who have the relationships and can help with the lay of the land in those geographies. Absolutely.

That's great. Thanks a lot for taking my questions.

Yeah, thank you.

Your next question comes from the line of Sean Wieland from Piper Jaffray. Your line is open.

Hi. Thanks so much. So, on the large deal pipeline, I understand the difficulty to predict the timing of these, but what do you think your outlook is on the cadence of these deals? And in terms of timing, is this pipeline shaping up to be 2018, 2019, maybe beyond? Just any more commentary you could provide there?

Yeah. So, Sean, as you can imagine, we've got that large deal pipeline staged by quarter and stage of sales cycle. And we cut the data a lot of different ways. So, there are certainly large deals that we're expecting to close here remaining in 2018. Some of them were forecasted to close through 2019 as well. And the cadence quarter-to-quarter is going to vary, but I think we should expect to see a couple every quarter. And that's why we're pleased with the success in Q2 to have four deals over $2 million apiece. It was a really good accomplishment for us this quarter. I'd love to repeat that kind of on going forward basis. And as we look out into the future, we've got plenty of deals in the pipeline to be able to support that. My comment around just predicting – making it hard to predict when a particular deal is going to close, simply just points to the fact that we need to have multiple planes in the area to be given time, so that we can have a handful coming in every quarter without necessarily worrying about putting all of our eggs into one particular basket. And I think that was the comment I was just trying to make there.

Okay. And then, given your track record to date in the enterprise segment or the large deal segment, what's been your win rate in that segment?

Very high. I don't know that we've got a specific number. I don't think we've classified the deals by deal size. But, if anything, the larger the deal, the more success we have because, typically, when these enterprises are looking to make a larger purchase, they try to take a more risk-free choice by going with the market leader. The breadth of our solution, being able to be kind of one platform that combines voice and messaging and alerting and alarming altogether tends to work in our favor, and so I would say our success rate amongst the enterprise deals is higher. We've quoted in the past a win rate in the 70% to 80% range. I would expect the enterprise win rate to be at that level or higher.

Okay. And then, one final follow-up is, do you have the existing sales and implementation consultants kind of on hand and ready to handle the pipeline?

We do, yeah. Absolutely. We ended up with capacity, extra capacity as a result of the acquisition we made and we've sort of been growing into that. But the efficiency of the teams has also gotten much greater. And I think Justin actually references in his script our ability to install these more efficiently has been proved over time because we've done more of them. And we kind of know where the potential potholes are and so we're able to project-manage around those. And I would say, at this point, the team is really well positioned to be able to handle an inflow of additional large deals.

All right. Thanks so much.

Thank you.

Your next question comes from the line of Jamie Stockton from Wells Fargo. Your line is open.

Good evening. Thanks for taking my questions. I guess, maybe the first one, just on the convert that you guys issued, you showed a lot of discipline for a long time, letting cash sit on the balance sheet before you pulled the trigger on the extension deal. Can you just talk about – should we be expecting other transactions of that size and that's going to ultimately be the use of the proceeds? Obviously, we've gone through a period here where valuations got really frothy for a lot of private companies, but I assume they've come down recently. Just what are your thoughts around the use of the proceeds and kind of the environment right now?

Hey, Jamie. I would start by saying that we didn't raise the money with a specific deal in mind. So, it wasn't like we already had a deal in the works and we were just going to look to fund it. It was really the opportunity to put some dry powder into the bank, so that we would be prepared if and when the right opportunity came along. Secondly, I would say that, at any given moment in time, we're looking at a range of different deals and there are a number of companies that are coming on to market in our broader space, I think looking for consolidation opportunities and finding how hard it is to survive as an independent company. But, as you know, we tend to be pretty selective, pretty disciplined about which opportunities we're going to engage in. I think the sweet spot for us starts with, does it match our strategic vision around enabling the smart hospital or the digital hospital. From there, obviously, it has to pass through a number of financial hurdles to make sure that it's going to match with our business model. In terms of size, I think the sweet spot for us is sort of in the $5 million to $40 million in revenue, but that's, obviously, a pretty wide range. And then, obviously, cultural fit and all the other considerations that go into it. One of the things we've found is that we want to make sure that we were in the pipeline or we were in the consideration zone for the opportunities that came on the marketplace and certainly raising the money in advance is a signaling to the market that we can be an active participant in any of these many processes that might start up.

Okay, that's great. And then, maybe just a quick one, maybe for Justin, the services gross margin is pretty good. It had a pretty healthy uptick sequentially. Should we assume that this is a level that can be easily built off of? Or is there a need – maybe touching on Sean's questions earlier for you to invest in expanding the headcount to be able to deal with maybe some of these larger deals that are in the pipeline?

Hi, Jamie. The services margin is a function of really the leverage that we have in our fixed cost as we deliver two main revenue streams – the professional services revenue stream as well as the software maintenance and support. The biggest driver in Q2 was clearly the higher growth in software maintenance and tech support and the utilization of being able to provide those services on a relatively constant fixed cost. So, there's a lot of leverage there. We do think that Q2 represents a solid baseline. We typically see, again, as the revenue continues to increase in the second half, following our normal seasonal pattern, we would expect our gross margins overall, including the service margins, to increase in conjunction with that revenue increase.

All right. That's great. Thank you.

Your next question comes from the line of Matt Hewitt from Craig-Hallum Capital. Your line is open.

Good afternoon. And thank you for taking the questions. First one, I was hoping you could go into the predictive analytics offering with Qventus. Maybe provide a little bit more color on how that model works from a revenue perspective and maybe if you have any color on how big of an opportunity you can see that being? And is it initially more of a cross-selling opportunity into the install base or will that be more greenfield type opportunities, something to go into initial customer visit and bring that up right off the bat?

Yeah. So, let me provide some context. So, first of all, Qventus, for those not familiar with them, is a start-up company here in Silicon Valley. There are about six years old as a company. They have about 100 customers. And they are kind of the prototypical big data play where they take hospital data, they put it through a machine learning algorithm and they're able to identify key insights and learnings from that, everything from throughput bottlenecks in the emergency department based on looking at bunch of data or staffing challenges or patients with high fall risks. The technology can really be applied to a range of different kinds of solutions. The work that we've done with them up to date has primarily been around falls, reducing falls in hospitals and delivering that information out to the care provider quicker. The business relationship that we've established with them is a referral agreement. So, we're actually leveraging our existing sales force with those existing customers and new prospects to make introductions to Qventus, who will ultimately be responsible for closing those deals. So, it's not a lot of money associated with it because the referral fee is smaller than what might have been if we were a full reseller or if it was, obviously, our own product. The strategic reason for doing it is really more around highlighting the capabilities of the platform and the vision around getting to the sizing of the smart hospital that's enabled through data. So, it's not something that we're anticipating is going to have a huge topline impact because of the sale of the Qventus piece itself, but we think that it will help drive platform deals and help us actually win more of these enterprise accounts that will ultimately lead to the sale of more Vocera software licenses and client devices and professional services. So, hopefully, that gives you some context.

Yeah. That does help. Thank you very much. And then, maybe one last one here. The four $2 million wins this quarter, obviously, a great number. Is that kind of an average we should be thinking about when you talk about these large enterprise deals in the pipeline or is there still a lot of variability where you could have a couple under $2 million, couple that are $7 million, $8 million, how should we be thinking about your average enterprise type of deal? Thank you.

Yeah. Part of it is just definitional. We're arbitrarily chosen to say that anything over $1 million, we're going to classy as one of these larger deals that we're going to track essentially in a separate pipeline just essentially for our own tracking purposes. The actual size of the deal, like you say, will vary quite a bit from $1 million to $2 million to much larger than that in some cases. So, it's hard to give a specific average, but, typically, it's going to be a function of the size of a hospital and then the brunt of the solution that they're deploying. Is it an Engage only? Is it a Vocera Communications piece only? Is it the combined platform? What's the level of penetration? And in some cases, it depends on whether they're buying for one hospital facility or multiple facilities. So, we are going to see quite a bit of variability in the deal size? The Franciscan example at $9 million versus some of these at $2 million to $3 million, obviously, shows that variability. So, it's hard to put a specific number on it, but I think it's more the way that they're being tracked and the way the hospital systems are thinking about doing their budgeting and approval process.

Got it. All right. Thank you very much.

Yep, thank you.

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

Hey, guys. Thank you for taking my question. Congrats on the solid quarter.

Thank you.

So, I've got another one on margin piece. Just given the margin beats the last few quarters, it seems like it's mostly been driven by the strong software growth. What is driving your more conservative second half margin expansion expectation?

Yeah. Hi, Stephanie. So, our revenue mix is a key driver of our overall kind of gross margin structure. And sometimes that can be a bit difficult to predict. So, we tend to be a bit conservative with not just our revenue guidance, but as well as our profitability because, with the gross margin piece, the variables are not only the amount of revenue, but also the mix of our revenue, and that tends to kind of ebb and flow. Having said all that, we're really pleased with the gross margin structure so far this year. We've really been focused on improving that. It's an important part of our overall financial story. Our target model, we're tracking really well and on track to be able to march towards our 68% plus gross margin structure, and that is, in large part, driven by the evolution of our revenue business towards more of a software organization. So, the mix of the business this quarter was driven by a strong software revenue, as well as from maintenance and software maintenance and support. Those are our highest margin contributors and it can ebb and flow. The second thing, as you say, is that, typically, from a seasonal standpoint, we tend to see higher gross margins in the second half. So, we do expect that pattern to recur again and our implied guidance for the second half does reflect that normal seasonal increase.

All right. Understood. Thank you. And unrelated follow-up just on the recent VA wins, given a lot of the VA operations tend to move in tandem with each other, would there be anything preventing you guys from getting full penetration in the VA opportunity?

I don't think so. No. In fact, that's our goal. Most of the purchasing decisions in the VA are made amongst the regional business and the budgets are typically controlled at the division level. But at this point, we expect to eventually be deployed across all of those VA facilities.

All right. Good to hear. Well, thank you so much.

Thank you.

Your next question comes from the line of Gene Mannheimer from Dougherty & Company. Your line is open.

Hey, good afternoon. Thanks, guys.

Hi, Gene.

I joined the call a bit late. So, sorry, if this has been asked, but on the international side, clearly, some optimism around your prospects there. Sounds like this year, international will be better than last. When you think about your pipeline there, is it comprised of some fewer very large deals that are in play or is it a composition of multiple smaller deals? How should we think about international versus domestic in terms of size and scope of those contracts?

Hey, Gene. I think I would separate it into two buckets. If you looked at the Middle East, I would classify it as a fewer number of quite large deals, enterprise, multimillion dollar deals. If you look at the opportunity in the UK and Australia and, to some extent, in Canada, it's more typical that it's going to be singles and doubles. They're going to be smaller, but more of them that we're interacting with. And the reason for the difference there, I think, is that typically in the Middle East, in many cases, we're going into new hospital construction and they're making a decision to go house-wide upon the initial opening of the hospital. Whereas in the UK or in Australia, typically, what we're seeing is, maybe a wing or a department, it's growing more virally from there. So, a little bit of a difference depending on which of the international markets we're talking about.

Okay. All right. Very good. Thanks. That's all I had for now. Thank you.

Your next question comes from the line of David Larsen from Leerink. Your line is open.

Hi. Congrats on the good quarter. Can you talk a little bit about your ability to sell Engage in the UK? Is there any sort of approval process that you need to get from the UK in order to be able to sell a solution over there?

Yeah. Hi, Dave. In fact, there is. And we just passed through at about three months ago. And it was a big deal actually. We had to go through some very specific approvals. I can't remember of the certification off the top of my head. But that has actually been accomplished now and the team in the UK is actually using that as part of selling into new opportunities as well going back into the install base of customers there in the UK and doing it as a cross-sell.

Is there anything about the UK market that – can it be as attractive and as lucrative as the US market? Is there anything about the technologies that are deployed at those UK facilities that maybe would cause there to be less demand from Engage or would you expect the level of demand to be just the size of the US?

So, I would say two things. One of the biggest challenges of the UK market is that many of the hospitals are very, very old buildings that are made out of thick stone. And so, one of the biggest challenges is getting really strong wireless coverage throughout the facility. And it actually has become challenging even to run cabling because many of them are protected buildings and that kind of thing. So, that affects not just the Engage part of our business, but just the overall growth of wireless solutions. I think in terms of the demand for Engage, there's probably a little less integration demand in UK today than there is here in the US in terms of the number of different systems that they're trying to bring together. The workflows are actually very similar, but I would say that they are a few years behind in terms of the demand for wanting to bring all that data together into one flow. But I would say that, so far, since the certification, we've gotten a real positive feedback from the customer base. So, I think we'll see some nice growth there. It may not be at the same rate that we're seeing here in the US.

Okay. And then, with the strategic account deals, do you have a separate group of sales guys and ladies that focus on these large strategic accounts? And, like, of your 75 reps, how many are in a strategic group? And is that a new group or not? Any color around that would be very helpful?

Yeah. So, we created this strategic account group, basically, at the beginning of the year and there are now four people who are in that group. They act as a bit of an overlay. So, they don't own a geographic territory. They work in conjunction with our geographic based sales force. So, when the geography-based sales reps identify opportunities that are larger in nature and likely have more complexity in order to get the deal closed and to navigate the organization, then one of the strategic accounts team members will come in and assist with that. And then, independently of that, the strategic accounts folks are also calling directly on some of the larger self-help systems at the headquarters level. We would anticipate that we're going to continue to grow the strategic accounts group. It's, obviously, very small today, but we see more and more the market moving in that direction and see an opportunity to continue to have more resources in that area.

Okay. And then, just one more for me. Justin, with regards to the deferred revenue and backlog amount, is that in line with your expectations? And is the trend of the past two quarters consistent with the previous years? Thanks.

Hi, Dave. Yeah, the backlog and deferred revenue pattern that we've seen being potentially flat is very similar and consistent with prior years. The other thing that I mentioned earlier is that because of our greater proficiency at being able to convert our bookings to revenue a bit more quickly, with regard to large deals, as well as benefiting a little bit from the ASC 606 adoption, we don't require as much backlog going into a quarter as we have in the past. So, the backlog and the deferred revenue balance, where it is currently, provides an adequate level of visibility to our second half revenue objective.

Great. Thanks very much.

The next question comes from the line of Steven Wardell from Chardan Capital Markets. Your line is open.

Hey, guys. Thanks for taking my questions.

Sure.

Can you give us some additional color on the demand you're seeing from buyers in the marketplace? What segments of the markets are you seeing more or less demand in and what mix of products are they interested in and would you say the demand you're seeing now is greater or less than last year?

Yeah. I think the way I would characterize it is that there is a growing awareness of a category here. So, the category of clinical communications and collaboration is a defined category that Gartner and others have identified it as a category, they've identified it as a key component towards the evolution that they see hospitals needing to go through over the next couple of years. And that's relatively new for us. For much of the history of the company, it was much more of a missionary fail for us where we were having to go out and generate awareness and generate demand for our solutions. What, I think, we're seeing now is more proactive interest with an increasing recognition of the impact that communication can have on the efficiency and on patient safety and patient satisfaction. And so, we're seeing an increase in the number of RFPs that are being submitted into the marketplace and we're seeing an increased focus from decision-makers who have probably invested a lot of money in their electronic health record in past years and are now looking for ways to mobilize that data and get that data into the hands of caregivers at the point of care. There's a lot of frustration that the workflows that have resulted from the implementation in the EHR has created more difficult situations for both nurses and doctors, and so we often hear requests from health systems to help them rethink their clinical workflows and rethink how they're going to leverage the data in the EHR. The other thing that I would say is that, as we've evolved from being primarily about voice communication to now focusing on both voice and text messaging and the alerts and alarms, the growing interest in the database communication, whether that's messaging or alert and alarming in conjunction with voice communication, I think, is on the rise. And what we're seeing in the marketplace is an appreciation of a vendor that can deliver a complete solution rather than having to get various pieces of the solution from a variety of different vendors and then having to force the systems integration to be done at the customer site. So, broadly, I would say that the level of interest in our category of solution is up and that's, obviously, a tailwind for our business.

Great, thank you.

We have no further questions at this time. I will turn the call back over to the presenters.

Okay. Thanks, everybody, for dialing in today. We really appreciate your time. And we look forward to following-up with you. Have a great day.