Stryker Corporation (SYK) Q1 2019 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen and welcome to the Vocera Communications conference call. My name is Chris and I will be your coordinator for today. 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, Vocera's Director of Investor Relations. Please proceed.

Hello everyone. Welcome to Vocera's conference call to discuss our first quarter fiscal 2019 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 Investor Relations page of our website where a replay will be archived. Before we begin our prepared remarks, I would like to take this opportunity to remind you that during the course of this call, we will make forward-looking statements regarding projected operating results and anticipated market opportunities. This forward-looking information is subject to risks and uncertainties described in our filings with the SEC and actual results or events may differ materially. Except as required by law, we undertake no obligation to update or revise these forward-looking statements. On this call, we will refer to both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings release. And with that, let me turn the call over to Brent.

Thanks Sue. Good afternoon everyone. Thank you for joining us. The first quarter of 2019 was an extremely busy quarter for Vocera and provided a strong and strategic start to the year. First quarter revenue was $35 million and we beat our goals for both revenue and profitability. There are five key accomplishments from the quarter that I will highlight of the call today. First, we achieved strong bookings including our largest non-healthcare booking in the history of the company. We also won some large expansion deals and had healthy supplies and maintenance renewals in the quarter. Second, our performance in the fed was excellent, refreshing our confidence after Q4 and setting us up well for the year ahead. We reached a major milestone in our federal business with the award of an authority to operate with the Navy and Air Force. Third, we had a successful launch of the new Vocera Smartbadge and we believe we are right where we wanted to be after the first few months of this major product introduction. Customer feedback has been very positive. Fourth, we had another successful quarter of customer go-live installations. I am proud of our team. Our professional services expertise remains a meaningful differentiator in helping our customers achieve real improvement in their communications and workflow challenges. Finally, we had our best ever HIMSS conference with great booth traffic, a record number of leads and a successful investor breakfast. Let me go into more detail on each of these areas before discussing what we are seeing in the market and giving Justin an opportunity to cover our financial results. From a bookings perspective, the highlight of the quarter was a large multimillion dollar win at Nordstrom, one of the world's largest premium retailers which will use our solution to connect employees in the majority of their full-line stores around the U.S. It was a watershed accomplishment for our non-healthcare group and illustrates the opportunity that we see outside of healthcare as well as the diverse sources of growth that support our company. Beginning this quarter, Nordstrom will outfit their teams with our unique wearable communication badge and leverage our full software platform to create several integrations and workflows. The goal is to enable sales associates and customers to experience luxury retail with an enhanced technology layer of service and efficiency. We are delighted to help Nordstrom deliver exceptional service to their customers as they innovate around the retail experience. We also won another Four Seasons property, a meaningful honor from an outstanding brand. In healthcare, our business with existing customers was healthy this quarter with several important expansion orders. Notably, we had a $1.3 million booking at Reading Hospital, a sizable batch refresh from Banner Health and an expansion deal at NYU Langone for Winthrop University Hospital, where they are rolling our Engage. In another significant development for the quarter, we received an authority to operate, known as ATO, from the U.S. Department of Defense. This DoD certification based on compliance with strict security requirements and risk assessment is a required part of authorizing, securing and managing healthcare technology systems across the DoD. You may recall, we already had an ATO for the Army, which helped drive our MEDCOM wins in prior years. This expanded ATO applies to all branches of the U.S. military worldwide for the purchase of our hands-free Vocera Badge. Combined with our previously announced SATOC contracting vehicle, we now have the fundamental building blocks that allow us to sell and deploy our voice solution healthcare facilities in the U.S. Army, Air Force and Navy. With the authority to operate in hand, our federal team kicked off 2019 strong by bringing in some great wins including a deal at the Air Force Academy in Colorado Springs, our first Air Force facility. We also secured bookings from the Ann Arbor VA, the Phoenix VA and the Robert Dole VA medical facility in Wichita. It was a great Q1 in the fed and our team is preparing for an exciting year ahead. As most of you know, the biggest activity for Vocera in Q1 was the launch of the new Vocera Smartbadge. Based on our experience in the market so far, we are confident that the product introduction is proceeding according to our expectations. We shipped our first pilot units during Q1 and many customers are evaluating the new Smartbadge. Early indications are validating our view that this new and unique product furthers our competitive lead, showcases more of the functionality of our solution and has the potential to accelerate our software revenues in the long run. We have only shipped a small number of Smartbadges as it's still very early in this product introduction cycle. However, we are really encouraged by the sizable pipeline we have built to-date. I am particularly pleased that early feedback on the Smartbadge has been positive in terms of its pricing, size and weight. And we are seeing a lot of excitement around putting some of our software to work in a hands-free environment. As an aside, April is Workforce Violence Awareness Month. You will remember from our past commentary that the panic call feature on our hands-free device is a widely popular safety feature. I believe the Smartbadge, with its dedicated panic button, takes this concept a step further to effectively ensure the safety of mobile workers. During Q1, we had another very successful quarter of customer go-lives. Deployments of our solution continue on schedule. One notable deployment in Q1 was at Sutter CPMC Van Ness in San Francisco. You will remember, we went live last fall with Sutter CPMC Mission Bernal. So this is our second full solution Sutter deployment in just a few months. This brand-new showcase facility on Van Ness Avenue in San Francisco is leveraging our full solution across 3,000 users, including many different operating departments and units. They are using several integrated clinical workflows and the power of Vocera Analytics to transform their organization. We also went house-wide at CHRISTUS Health in Texas as they prepare to move to a new tower which will be the largest ER and trauma center in South Texas. We replaced in-building wireless phones at Mount Sinai St. Luke's in New York and we expanded our footprint at UNC Nash General replacing a paper process with Vocera Rounds. Finally, we had a nice deployment of our Engage solution at Masonic Villages long-term care facility in Pennsylvania. The other big Q1 event was HIMSS and I would like take a moment to recap our experience at the conference. HIMSS is always a critical lead generation and customer event for us and this year that momentum continued. We had a big presence this year and our booth was constantly busy with customers and integration partners eager to see the Smartbadge and hear about our solutions. While HIMSS attendance was reported as down, our booth traffic was up about 30% and we grew qualified leads at a similar rate. We conducted a record number of customer meetings and built substantial pipeline for our sales team. We were pleased to see many of you at our investor events where our CNO, Rhonda Collins, led a fireside chat with Mary Beth Mitchell of Texas Health Resources. They discussed the importance of leveraging IT systems in clinical work as well as the long-term strategic nature of our expanding relationship. A recording of this event is available on our Investor Relations website for anyone who hasn't heard it. Overall, Vocera commanded a strong presence at HIMSS sending the message loud and clear that we are the leading player in the healthcare communication and collaboration space. With Q1 solidly behind us, we have a lot to look forward to in Q2 and beyond. In the healthcare market, spending always requires rigorous prioritization. My interactions with hospital executives continue to demonstrate that improving margins and quality of care consistently rise to the top of their priority list. Hospitals need to reduce costs and improve throughput by eliminating friction and bottlenecks and streamlining operations. These investment priorities remain top of mind and they play right into our strengths. Another trend I continue to see is larger deal sizes. With this, the decision-making is becoming more centralized, adding layers of the approval process and requiring more enterprise sales acumen. While this can be challenging, it also can work to our favor. The marketplace is demanding a unified platform that has a demonstrated capability to support the patient journey across the health system. Our complete platform combined with our large customer footprint and our unparalleled experience in implementing communication solutions has become a meaningful differentiator for us. And from my seat, while the competitive environment is always crucial to monitor, I believe our differentiated leadership position continues to grow. One topic that is gaining a lot of attention in the market right now is cognitive overload for nurses. Over 250,000 people die each year from medical errors in the U.S. and several recent studies have pursued this topic further. In one study, distraction has been shown to play a role in the majority of medical errors. Another study cites cognitive overload as a cause in 80% of medical device user errors. The cost of nurse turnover amounts to millions of dollars per year and the American Nurses Association reports that three out of four nurses describe the effects of stress and overwork as a top health concern. We have known these factors to be a significant problem in healthcare for some time and they are core to our mission to help organizations achieve the quadruple aim. Vocera technology helps reduce cognitive overload for clinicians by attaching information about a patient to the communication thread so it's easy to access. It helps deflect distractions to allow focus on critical tasks. Our solutions offload the need to retrieve, retain and record information allowing nuisance notifications to be filtered out and making it easier to communicate and stay focused. It's an exciting time for Vocera as we strive to grow the business and accelerate towards our profitability goals. I am gratified by our continued progress in Q1 and our enhanced position in the market. While we still need to execute well as we progress with the Smartbadge introduction, we feel momentum in the businesses building with strategic customer bookings, successful large-scale deployments and high customer loyalty. Now I would like to give our CFO, Justin, a chance to cover the financial details around our Q1 results and our guidance for Q2. Justin?

Thanks Brent. Hello everyone. Overall, we had a solid start to our year. Our first-quarter revenue came in as expected and we beat our profitability goals. Importantly, Q1 set us up for a return to revenue growth and improve profitability in Q2. Total revenue in Q1 was $35.3 million, compared to $40.2 million in the same period last year. Since the details of our revenue comparisons are in our earnings release, I will focus my commentary on the context for these metrics and how we think about growth going forward. Q1 revenue played out just as we expected, reflecting the impact of our backlog position entering the period as well as the effect of some customers slowing their expansions for badge refresh purchases temporarily while they evaluate the new Smartbadge. These dynamics impacted both our device and software revenue streams in the quarter and were entirely expected. We are really encouraged by the initial feedback from customers about the Smartbadge and expect several of them to begin making larger volume purchases of the new product over the next several months. And we have a rapidly growing pipeline that we think will fuel healthy growth of the Smartbadge and associated software revenue over the next several quarters. As further context on our software revenue, it is worth noting that we face a difficult comparison in Q1 last year as more of our business has transitioned to larger deals, which is a very positive trend for our business. We have experienced software revenue lumpiness on a few occasions. For example, in Q1 last year we shipped over $2 million of software to a single customer representing roughly 25% of that quarter's software revenue. As a result, we encourage investors to evaluate our software revenue performance over a period of several quarters. We had a healthy software backlog exiting Q1 and we expect software revenue to grow in 2019, particularly in the second half of the year. Our revenue pattern for software maintenance and support revenue is predictable because it is recurring and is recognized over an extended period of time. As a result of large software revenue growth over the last several quarters, our software maintenance and support revenue grew 17% in Q1 compared to last year. Also fueling this was our high customer renewal rate, which continued to be in excess of 95%, well above industry standard and reflect the benefits our customers experience from using our solution. Professional services was down slightly compared to last year as a result of our continued efforts to streamline our implementation process. This enables us to be even more competitive with the delivery of these deployment related services and shift more of the revenue to our software. However we have a healthy backlog of professional services that should fuel growth in this part of our business in 2019. Lastly and as expected our combined backlog and deferred revenue increased to roughly $119 million in Q1, up from $109 million in the first quarter last year. Compared to Q4, this combined balance decreased only slightly, which is much better than we have seen during Q1 in prior years. We continue to encourage investors to evaluate backlog and deferred revenue on a combined basis as well as on a year-over-year basis. On the profitability side, our adjusted EBITDA loss was $3.5 million, better than we expected as we continue to optimize our spending for growth and scalability. Our GAAP net loss for the quarter was $11.7 million. Now let me get into some more detail on our non-GAAP gross margins and operating expenses. Non-GAAP gross margin Q1 was 60%, right where we expected and followed our typical seasonal pattern for the first quarter. Product margin decreased compared to last year as a result of the lower device and software revenue. Services margin improved year-over-year as a result of the higher mix of software maintenance and support revenue. Q1 has traditionally been our lowest gross margin quarter, so we expect it to improve in Q2 on higher revenue and a more favorable revenue mix. Non-GAAP operating expenses of $25.8 million were flat sequentially and up roughly 6% compared to last year. The investments we have made over the last few years to enhance our scalability have enabled us to keep our operating expense growth quite modest overall, while continuing to invest meaningfully in the areas that we believe will drive long-term growth. As a result, we continue to believe that there is more opportunity to drive operating leverage as we grow. To cap off my Q1 commentary, we again added to our cash balance ending at just over $222 million. With our strong balance sheet, we believe we are well positioned to capitalize on new growth opportunities. Turning now to guidance for the second quarter. We are off to a solid start to the year and expect to return to year-over-year revenue growth and improved profitability in Q2. For the second quarter, we expect revenue to be between $41 million and $45 million and adjusted EBITDA to be between $500,000 and $3 million. We anticipate our second quarter GAAP net loss to be between $8.9 million and $5.9 million. For the year, we reiterate our previously issued annual guidance. Q1 was an important and encouraging quarter for us on many fronts. We expect higher levels of bookings and revenue in Q2 to help set us up for stronger growth in the second half of 2019. I will now turn it back to Brent.

Thanks Justin. In summary, I am pleased with the start that Q1 provides to 2019. I believe our success underscores both our leadership position in this large, growing market and the strategic importance customers are seeing in our products. I want to take this opportunity to formally introduce two new Board members who we announced a couple weeks ago in a press release. As of our Annual Stockholder Meeting on May 31, 2019, we plan to add Julie Iskow and Bharat Sundaram to our Board. These additions are of strategic value to our company because they bring important expertise and insight to our leadership group in the areas of cloud-based software, data analytics and AI as well as tremendous knowledge of the healthcare industry. Julie is the Chief Technology Officer of Medidata Solutions. With a long history of product development and cloud-based solutions, Julie's background will be a tremendous benefit to our solution roadmap and engineering team. Bharat is President of Performance Improvement Services at Vizient and his experience with advanced analytics and healthcare market insights will strengthen our operational perspective and business strategies. I am thrilled to be partnering with these two new Board members and believe they will add tremendous value to the company. These new members of our Board will replace John Grotting and Jeff Hillebrand who are stepping down after many years of service. I want to thank both gentlemen for providing strong leadership and valuable industry perspectives throughout their tenure as Board members. I look forward to collaborating with our entire Board as Vocera delivers healthcare innovation to a broadly underserved market and strives for long-term growth and accelerating profitability. Q1 gave us a strong and strategic start to 2019. With our differentiated solutions and a large market opportunity in front of us, we are excited to build upon this momentum. I am really proud that Vocera is the quadruple aim company. We look forward to making a difference to the hospital bottomline as well as to quality of care and staff resilience as we drive towards enabling the real-time health system. With that, we are ready to conclude our formal remarks. Thank you for listening today. Operator, we are ready to open up the line for questions. Thank you very much.

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

Hi guys. Thanks for taking the questions and I appreciate the commentary that you are getting positive feedback from the new badge. I guess my question is, given that that is still in process and most of the badge sales are in pipeline, I am curious if there is anything you can do from a promotional front to employ to try to drive some sense of urgency to make sure that that pipeline is converted to sales to drive the back half ramp?

Hi Ryan. Thanks for the question. There are a couple of things that we are doing. We did run a promotion in Q1 that gave people a bit of a discount on the purchase of their first five sample units. So they were able to get them in in-house and get them qualified. We have also been doing what we think is kind of a white-glow install treatment where we are really bear-hugging the customers, these initial customers as they are doing the deployment and installation to make sure that we are getting immediate feedback on what they like or anything that needs to be fixed or improved as they move forward. We are helping them with the software upgrade that has to be done in order to be able to use the new badge. So we are definitely putting effort and focus on it. I am really encouraged by size of the pipeline. It's growing faster than I expected and I think we are going to start the meaningful revenue coming from the Smartbadge, particularly in the second half of the year. And this is more just a traditional natural cycle of evolution. I think customers have to take time to evaluate the product. They have to evaluate the mix that they are likely going to see in their particular instance. Which users are going to use the B3000n and which users will use the new Smartbadge. And so that's just a natural evolution process. But we are definitely providing both financial incentives as well as support and services incentive to help them with that transition and evaluation.

Okay. Very helpful. And then my follow-up, maybe a little bit more detail, if you could, on the Nordstrom win? I am curious, just a little bit more on background there? Is that something you been actively pursuing? Was that some sort of RFP? Did they come to you to try to better compete with the digital marketplaces of the world? And then any color on the actual number of stores? I know they have about 115 or so across the U.S., Canada and Puerto Rico. But I am curious how many badges that might be, given this is U.S. full-line only? Thanks.

Yes. We are really excited about it. This is a deal that we have been working on for about 18 months. Actually, first we were reached out by Nordstrom. They initially heard about us from someone who used to work at one of our hospital customers. And when he joined their IT group and was looking at various communications solutions that might be able to be used in the retail environment, they heard about our solution and reached out to us. They actually have done a fair amount of work with us already. They did a pilot in two different stores in the back half of last year. And they have also done some work in one of their warehouses to evaluate these products. So they are very comfortable with the functionality and they got really positive reviews from the people in the stores. And that's what gave them the confidence to go ahead and move forward with this. We are displacing a competitive solution that they had used in the past that was not meeting their expectations. And so they were looking to improve upon that. Your estimate in terms of number of stores is right on. I think it's right in the mid-100 and teens level and the vast majority of those full-line stores will be getting a deployment, not necessarily to all employees initially, but over time we hope to grow that deployment. We are not able to share the exact number of badges or the dollar amount of the deal, but we were thrilled that Nordstrom was willing to allow us to issue a press release to at least dip the name out there and very appreciative of that. But we are somewhat limited in terms of what we can say about the size of the deal in terms of number badges or dollars.

Okay. Fair enough. That's great color. Thank you.

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

Thanks. So the device revenue is actually a little better than I was expecting. I think you had mentioned, guided us for that number to be about cut in half. And so I wanted to just understand what was that upside? Where did that come from? Was it from better sale of Smartbadges? Or what?

Yes. Hi Sean. The badge business performed relatively well. I think the area that was impacted the most as we had expected was the expansion of refresh. The supplies came in really quite well and we even had some new badge wins including, well, from a revenue standpoint, the Nordstrom deal has not started for revenue but that part of our business was okay as well. The badge business continued to be really healthy. I think we had expected when we launched the Smartbadge that several customers would pause and defer purchases of the original badge for refresh purposes or expansions until they had the opportunity to evaluate the Smartbadge. And that's exactly what has happened. So as we transition now to Q2, we expect some more of those decisions to be made. And so we will likely see our device revenue increase sequentially, both of the original badge as well as the beginnings of the ramp of revenue from the Smartbadge.

Okay.

And specifically as it relates to Smartbadge revenue in Q1, it was pretty minimal. Most of the shipments of the Smartbadge were just small quantities of evaluation units. So it didn't represent a significant amount of revenue in Q1.

Okay. And now that clients have had about 90 days to evaluate this, what do you expect the attach rate will be for Engage when one of your clients goes all-in on a Smartbadge?

It's a great question. I don't think we have enough data points at this point to really know. The attach rate of Engage across our installed base is still relatively low. We are still working a lot of cross-sell opportunities and even a couple years into this. While that portion of our business has grown really nicely, we are still at very low penetration rates across the installed base. I think the Smartbadge will help accelerate that but there is more to embracing Engage than just the Smartbadge. I think in many cases, it represents really a fundamental shift in how workflows are created inside the hospital. And so that takes time as they define those processes and create policies around them. But I don't see a reason why over the long-term the majority of our hospital customers wouldn't go ahead and leverage that capability. So I think the attach rate over time is going to be quite high, but I don't think it's going to be necessarily upfront and I don't think it's going to be necessarily with the initial purchase.

Okay. Thanks. And just one quick one. What's the year-over-year compare on the backlog plus deferred revenue? What was it?

Year-over-year, yes, it's up 9% total.

Got it. Thanks so much.

Okay.

Your next question comes from Sean Dodge with Jeffries. Your line is open.

Hi. Good afternoon. Thanks. Maybe going back to Ryan's question on kind of the evaluation process of the new badge. I think you had initially said, we would get some test size order quantities. People would take maybe a month, two months to evaluate that and that should be followed by some orders. So the evaluation process to order time taking a maybe a quarter or two, is that right? And is there anything, I guess, as we have kind of gotten to the first couple of months of this that have caused you to think that maybe that timeline could shorten or conversely lengthen?

I think it's right on track. As I mentioned in the prepared remarks, the pipeline has grown faster than I originally anticipated. The timeframe for converting that to bookings and revenue is, I think, still consistent with where we thought it was going to be. In reality, it was pretty close to the end of the quarter when we first started making these initial shipments. So there still hasn't been a ton of time for them to be in the evaluation mode. But we have been really encouraged by the volume of the pipeline, the number of deals. And it's important to point out that the pipeline that gets generated from these Smartbadge evaluations have both a hardware component to it for the Smartbadge plus batteries and chargers, but it also has a software component and services component to it, because in many cases there will be drag along revenue associate with that. So we are tracking pipeline, both from pure hardware perspective as well from a total dollar value and very encouraged by what we have seen so far. Again, just to mention, our expectations and financial model remain pretty low for the first half of the year in terms of recognizing revenue from that. And it's part of what helps us drive the second half seasonality in the business.

Okay. And then on the international front, you guys had mentioned seeing a little bit of a wall there in the fourth quarter. Is there any update you can provide on the initiatives that you had talked about there and how those are going and then maybe the trajectories through the first quarter?

Yes. So revenue from international in the first quarter was right on par with where it has been over the last couple of years, just right around 10%. We continue to be encouraged by the activity that's going on there in building out the teams in the local markets. From a marketing perspective, we are starting to do more localized collateral, more localized marketing campaigns, some field marketing activity to drive pipeline. So it's in process. I don't think there has been any dramatic shift yet, but we are hopeful that that will continue to drive growth in the businesses as we move forward. International, because it's a small piece of our business, can be a little lumpier than the business overall. And so we monitor that on an extended timeframe. But I am pleased with the activity that we have had and I am pleased with the investment that we have made there both on the sales side and services as well as on the marketing side to drive demand there.

Okay. Very good. Thank you.

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

Hi. Can you talk about the competitive environment? I think Cerner has the CareAware solution and Hill-Rom recently acquired, I think, Voalte. What does your win rate look like and are you seeing any sort of change in that, given these two other competitors? Thanks.

Hi Dave. Thanks for the question. We really have not seen much of a change in our competitively win rate. It remains up in the 70% to 80% of the deals that we are involved in, we end up winning. Obviously, the Cerner CareAware product has been in the market for some time. It hasn't been a big impact on the market dynamics. And the Voalte, Hill-Rom transaction actually hasn't even closed yet. So that certainly hasn't had any impact yet on the marketplace. We think that the competitive activity here is actually good news. It's really validating a market that we have essentially created. And I think a validation that it's a large market that it's a growing market that it's a strategically important market. I still feel really comfortable with our competitive differentiation, both in terms of our technology, our clinical expertise, the breadth of our product offering, the device of choice aspect of our business as well as the one-stop shop aspect of being able to get the complete solution from a single vendor. So I encourage the competitive aspect of it. I think it's a good thing for the overall market. And so far, we continue to see very, very high win rates in the market and continue to be the clear market leader.

Okay. And then just any color on the sales force? Have there been any changes there or not? Any changes in the commission rates? Any color around, like the activities of the sales force would be very helpful or structure of the sales force would be helpful? Thanks.

Yes. Hi Dave. No significant changes in our sales force. We continue to have an incentive structure that we think is well aligned with where we are wanting to take the business strategically. We continue to invest in the strategic accounts part of our sales force and enhancing our capability there because that's where the market is continuing to evolve as more of the decision-making is taking place at the C-Suite. And we have also been making investments in international. But the overall size of our sales force continues to be relatively unchanged, a few additions here and there. What we have done in our broader sales organization and particularly in the international markets is we have added both to complement the salesperson, so clinical specialist, sales engineers, even support personnel in market in our international region to really bolster our ability to close deals and grow market share in those regions.

Okay. Thanks very much.

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

Hi. Thanks for the question. I wanted to follow-up on the Hill-Rom acquisition. And I guess I would assume you have a lot of integrations with that company through Engage and I just wanted to see if you thought there was any risk that they could make those integrations harder in the future? Or would that just not make sense for anyone? I just wanted to understand that as a risk factor.

Yes. We have a long-standing relationship with Hill-Rom from an integration standpoint. We integrate with their nurse call system as we integrate with all the leading nurse call systems in the market. I think it would be highly unlikely that they would disable that. I think there is a large number of customers in our installed base and their installed base to leverage that nurse call integration and it's a very sticky integration, something that their customers and our customers rely upon. We have always prided ourselves on being agnostic and sort of the Switzerland of this market in terms of being willing to connect to a variety of different clinical systems. We are leveraging pretty standard open APIs unless they try to design them out in the future version of the product would be continue to be accessible to us and I am fairly confident that we will be able to maintain that relationship. So we will see, I guess, in the future. But I think from a customer relationship standpoint, that would be not a smart move on their part to try the block that integration.

Got it. And then following up on the Nordstrom deal. I appreciate you are not in a position to provide many details, but I was curious if you could just remind us for a general retail client, not Nordstrom, sort of what the unit economics are?

On a store basis or a personnel basis or what?

I guess I was thinking on a user basis or a per device basis.

Q - Matthew Gillmor Got it. And then following up on the Nordstrom deal. I appreciate you are not in a position to provide many details, but I was curious if you could just remind us for a general retail client, not Nordstrom, sort of what the unit economics are. A - Brent Lang On a store basis or a personnel basis or what --? Q - Matthew Gillmor I guess I was thinking on a user basis or a per device basis.

Yes. The model works very similar to our healthcare business where we price the badges on a unit basis as well as the software licenses. And then Nordstrom has purchased maintenance contract in conjunction with the software and then there are some professional services work. The roll-out now, we are going to be deploying this across a majority of their stores. So we will begin with the shipment of the badges, one tranche of the badges and the software here in Q2. And then some of the professional, some of those deployments and go-lives will start to happen in Q2 and then progressing for the next several quarters. But the model is very similar to what we, the economic model is very similar to what we have on the healthcare side.

Got it. That's helpful. Thank you.

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

Thanks for taking my questions. A couple of quick ones on the ATO from DoD. Can you help us understand what's the additional market opportunity that we can go after with this one? And since most of these contracts are sole source to you, do you have any insights in when they will materialize?

Yes. Hi Mohan. So if you look at the total number of medical centers which are the big medical facilities that are in the DoD, by our estimate, about half of them are within the Army and about half of them are within the Navy and the Air Force. So it's essentially doubling the size of the market opportunity. We have had a little bit of success in the Navy in the past, but it was on an exception basis. What this ATO does is basically gives us the ability to sell into any of those Air Force and Navy facilities. It's gotten good visibility across the federal government budgeting process and decision making process. But it's always really hard to predict the timing of when something might happen on a broader basis. We are really encouraged by the ongoing conversation that we are having with those various branches of the DoD. And I think that our track record has been very positive. One of the things about the win at the Air Force Academy, which I think is particularly interesting, is that they are planning to do a study to measure some of the impacts at that facility similar to the work that was done with the Army facility in Colorado several years ago before the Army started rolling out to the rest of their facilities. And we think that that will be a great tool for us to then use as we go to additional Air Force facilities. So I can't really make a prediction of when this might happen but I would tell you that it's very encouraging conversations and our level of visibility and our level of comfort that we will continue to win that business increases every day.

Thanks Brent. And maybe a quick one on general federal deals that got pushed out of Q4. You had given 2019, I guess so far how many have closed? And do you think that you will have an year-over-year growth in those deals?

Yes. So the federal bookings in Q1 were a combination of some of the deals that had moved out of Q4 and then some deals that were new that had been forecasted for Q1 from a prior forecasting. I think we are feeling really good about the fed business. I don't want to put a forecast in for the full year, but I would tell you that we feel like there's increasing momentum there.

All right. Thanks a lot, Brent.

Your next question is from Vikram Kesavabhotla with Guggenheim Securities. Your line is open.

Hi. Thanks for taking the question. I want to ask about your deferred revenue and backlog balance. It looks like it was down about $2 million from the fourth quarter. Can you give us a sense for what that sequential trend has been like in prior years so we can understand the impact of the Smartbadge versus maybe the typical seasonality in the business? And then as a follow-up, I know in the past you have talked about achieving a faster conversion of the backlog and deferred revenue. Can you give us a sense for what that timeline is typically like and if there's been any change there given the recent business you have won? Thanks.

Yes. Hi Vikram. Yes, we were really pleased with how the combined backlog and deferred revenue ended up in Q1. That's just a benchmark here. So we were up year-over-year. That's the more appropriate way to evaluate the backlog and deferred revenue. So it was really nice to see that in our actual product backlog, which is what converts to revenue the most quickly, was up nicely here in Q1 year-over-year as well as sequentially. As a result of the strength in our bookings from a sequential standpoint, meaning from Q4 to Q1, we saw the lowest decline that we have seen in a few years. So we were pleased to see that, meaning that on the revenue and the bookings that we generated in Q1, we were able to keep our backlog and deferred revenue at a solid level that sets us up with good visibility as we head into the second quarter. In terms of actual conversion, the thing that has changed over the last 12 to 18 months or so is with the adoption of the accounting standard 606, our software revenue recognition has been able to convert a bit more quickly, meaning we have been able to convert our software backlog and our deferred revenue in certain instances to revenue a bit more quickly than we could under the old standards. And so as a result, as we look into a quarter or a longer period of time and we touched on this a little bit on our last call when we issued our 2019 guidance, we are actually able to convert our backlog and deferred revenue a bit more quickly than we were two, three, four years ago under the old standard. So nothing's changed in the last quarter, but over the last year or so since we have been operating under ASC 606, that's a new paradigm for not just us but all companies that are perpetual, have a large component of their software that is perpetual.

Great. Thanks.

Your next question is from Matt Hewitt with Craig-Hallum Capital. Your line is open.

Yes. Thanks for taking the questions. This is Lucas, on for Matt Hewitt. Really just one quick one here. Operating expenses, it looks like those came in a bit lower than we were expecting this quarter. Should we kind of expect those to tick back up starting next quarter?

Yes. There will be a little bit of a, first of all, Q1 is usually, we did have some bigger expenditures in Q1 particularly around HIMSS and this new Smartbadge. But we have purposely wanted to manage our expenses tightly so that we could invest in the areas that are going to drive growth. As we look forward to Q2 and in the second half, we do expect our operating expenses to be a little bit higher than they were in Q1, mostly because we continue to hire in the growth parts of our business, namely in R&D and sales and marketing. So there will likely be a little bit more operating or spending, I should say, overall in our business in Q2 and in Q3 and Q4. Not a huge amount, but certainly in all likelihood over and above what we saw in Q1.

Okay. And then just one last question here. Non-GAAP gross margin, it sounds like that will be ticking up again in Q2, in line with the historical pattern. But I mean, when we look at last year, it was kind of, call it a smaller uptick, maybe 50 basis points. I mean should we expect maybe a little more of an increase than that this year?

Yes. And our gross margin and to a large extent our overall profitability because of the leverage that we have in our business that affects the gross margin and profitability, so large increases in revenue which we expect in Q2 sequentially. The top end of our guidance range is $45 million and so a $10 million increase will generate more leverage in the model both at the gross margin level and the profitability level. And that will inherently drive more, higher percentage gross margin and a higher percentage of profit. Additionally, the product components of our revenue, namely our device and software, we expect to even be stronger in Q2 than they were in Q1 and those inherently have higher margins as well. And so to the extent that we are successful at driving a solid product and revenue mix, that would be another important contributor for us to seeing not just our gross margin, but our operating margins will also improve.

Okay. Thank you very much. That's all I had.

[Operator Instructions]. Your next question comes from Stephanie Demko with Citi. Your line is open.

Hi guys. Thank you for taking my question. Now I know we touched on this a lot in the last quarter's call, but could you give us some more color on the ramp to the second half of the year? We have got the moving pieces with the Smartbadge that you said would be previously back-end weighted. There is a lumpiness of large software deals. Is there any potential that we see some improvement in 2Q and 3Q?

Hi Stephanie. Thanks for the question. So if you think about the ramp in the second half, there's really four components that I would point you to. The first was the one that you mentioned which is the ramp of the Smartbadge which will have an increase in both hardware and software revenue tied to it as we see that as driving some incremental growth. The second is the fed business which is always strongest in Q3 and typically will generate higher bookings and revenue in the back half of the year. The third element would be the Nordstrom revenue. And as Justin mentioned, the revenue from the Nordstrom's deployments will start in Q2 and then proceed through Q3 and in the back half of the year. So you will see some impact from that. And then the fourth component would be international where we typically see more strength in international in the back half of the year. And if we hit our plan, that will be a driver for the growth in the second half of the year.

And when you gave the original guidance, were you expecting this level of software lumpiness?

This level of, I am sorry, software lumpiness?

Yes. The software lumpiness in the first quarter. Like, is it safe to assume that the ramp is now steeper? Or has it just shifted around from device versus software revenue?

Yes. Hi Stephanie. No, right as expected. We knew we had the difficult compare. Compared to Q1 last year with a large $2 million shipment and that happens from time to time with some very large customers and tying the software shipments there. So software and device for that matter kind of played out right as we expected and we built a nice healthy backlog on both device and software. So we feel comfortable with what we expect and assume in Q2 to roll-up to the guidance. And then Nordstrom is one of a few different deals that we think will help contribute to further ramp as we head into the back half of the year, as Brent described.

All right. That's super helpful. Thank you. And then one quick one on the Nordstrom deal. It sounds like that's a solution that would be better on the Smartbadge. Is it just timing that prevent them from going for that? Or is there anything else?

It's primarily timing, yes. They had been evaluating the previous version of the badge, the B3000n. They ran their pilots and trials using that and they budgeted for it based on the B3000n. So we were virtually at the finish line of that particular deal when we made the announcement of the Smartbadge. And they were perfectly comfortable moving forward. They like the sleek aspect of the previous B3000n badge. They are not doing a lot of text messaging or messaging alerts to the badge. They are doing some but not as extensive as some of the healthcare customers. So I think the B3000n is a great device for them and it met their budget criteria and was what they were very comfortable with based on the pilots that they had run.

All right. That's it from me. Thank you guys.

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

Thank you. I appreciate all of the questions and the participation today and we look forward to following up with you with more detailed questions and seeing you out on the road. Thanks for your time today.

This does conclude today's conference call. You may now disconnect.