Logo of jester cap with thought bubble.

Image source The Motley Fool.

Vocera Communications Inc  (NYSE:VCRA)
Q4 2018 Earnings Conference Call
Feb. 07, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen, and welcome to the Vocera Communications Conference Call. My name is Chris and I'll 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 Intructions). Thank you.

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.

Sue Dooley -- Director, Investor Relations

Hello everyone, welcome to Vocera's conference call to discuss our fourth quarter fiscal 2018 earnings. This is Sue Dooley and joining me today are Vocera's CEO, Brent Lang; and our CFO, Justin Spencer. We distributed a press release detailing our quarterly results earlier this afternoon. The release is posted on 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 this call we will make forward-looking statements regarding projected operating results and anticipated market opportunities. This forward-looking information is subject to the risks and uncertainties described in Vocera's filings with the SEC, and actual results or events may differ materially. Except as required by law, we undertake no obligation to update or revise these forward-looking statements. On this call, we will refer to both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings release.

So with that, let me turn the call over to Brent.

Brent D. Lang -- Chairman and Chief Executive Officer

Thanks, Sue. Good afternoon, everyone. Thank you for joining us. On today's call I will start by summarizing the highlights from the year and the fourth quarter. Then I'll provide some details on key customer wins, some specifics on bookings in each area of our business and an update on some strategic deployments that occurred in the quarter. I will conclude my prepared remarks with commentary on the market environment and our priorities for 2019 before turning the call over to Justin for more details on our financials.

2018 produced record revenue and enhanced profitability, tremendous progress winning large enterprise accounts, significant expansions of our solution within existing customers and another good year in the federal space. We added a record number of new healthcare facilities during 2018, which is a strong leading indicator of future growth. We also made significant progress with our large customer deployments and maintained very high customer satisfaction as reflected by both our maintenance renewals and customer surveys.

Another highlight was the completion of our Smartbadge, a new unprecedented advancement in product innovation for Vocera. The completeness of our solution remains a differentiator for us and customer desire for collaboration solution and their need to mobilize data drove our business this year. We validated our leadership position with several large customer wins and our solution continues to succeed against competitors. As we begin 2019, I'm excited by our large market opportunities, the increasing differentiation of our unified solutions and our pipeline of large deals.

Fourth quarter revenue was $49 million, up 11% over the same period last year, bringing revenue for the year to $180 million, an 8% increase over 2017. Full year bookings were $181 million, up 9% over last year. Despite strong bookings performance through the first three quarters of the year, we saw mixed results in our bookings in Q4. We had great success with some large strategic wins and strong software bookings. However, our federal and international bookings fell short of our expectations for Q4. We also saw a decline in device bookings after record device bookings in Q2 and Q3. We attribute this to two factors. First, our bookings in (inaudible) were typically Badge heavy and second, we believe that despite our best efforts to keep it a secret news of the coming Smartbadge may have gotten out negatively impacting Q4 device bookings.

Highlights for the fourth quarter included three large win at Northwestern Medicine, Albany Medical Center and a very large hospital system in the Middle East. Our progress in cultivating and harvesting our pipeline of large deals continues to be a bright spot for our business. The large deals closed in the fourth quarter showcase our extensive market appeal, differentiated offering and solid sales execution in our strategic accounts.

The highlight of the quarter was an impressive $6 million enterprise wide win at Northwestern Medicine which will be deploying our complete solutions for physicians and other clinicians and integrating it with epic. We also won a $2.9 million deal at Albany Medical Center in New York, where they will utilize our solution extensively including multiple integrations across 55 departments. In the Middle East, we were pleased to win a large and strategic booking at a leading hospital system. In this $4 million booking, one of the region's premier healthcare providers will initially deploy our Engage software on an enterprise level across 11 hospitals. We see significant potential for future cross-sell opportunities within the system and we believe this win augments our leadership in the region.

Another important part of our business is expanding our solution to new departments and users at existing customers. One notable expansion was CHRISTUS Health in Texas where we are steadily expanding house wide into existing facilities and into new construction. Our value proposition matches the strategic goals of CHRISTUS resulting in Vocera becoming the enterprise standard. We also had significant expansions of our existing footprint at Adena Health and Methodist Hospital.

While 2018 was another strong year for our federal business, Q4 government bookings were not as high as we had hoped due to the timing of specific federal purchases that we had planned to close at the end of the quarter, prior to the government shutdown. Overall, we remain very optimistic about the large opportunity for both new customer wins and expansions within the federal space because we are there (inaudible) standard for hospital communications. We believe improved clinical communication and effective alarm management are initiatives with rising importance in the DoD and the VA hospitals.

On the international front, with the big win I mentioned earlier in the Middle East, our international business business finished a strong year, reflecting our continued focus on improving our operations overseas. However, we had vary result in Q4, across the region with Canada, Australia, New Zealand down in Q4 compared to last year, while the UK and the Middle East, were up substantially. International remains a big opportunity, and a top priority for us. It's an emerging part of our business and as we've previously stated, will be lumpy from time-to-time. We are investing in the sales teams and marketing support to drive growth in these regions.

Finally, our non-healthcare business had a good year. We achieved several strategic wins in the hospitality space where our brand is becoming well established. This quarter, we signed a deal with the new Four Seasons Montreal, our 11th Four Seasons property. We are delighted to continue to help this world-class brand deliver it renown high level of service.

Now I'd like to talk some about our successful deployments during the quarter. As we continue to book large enterprise deals, our professional services expertise remains a meaningful differentiator in helping our customers achieve their goals. The Experience and efficiency of our professional services organization continues to grow and deployments of our solution are numerous and remain on schedule.

For example, the first go live at Hope Hospital occurred in Q4. You'll remember this is a large and strategic win for us several quarters ago in a complex deployment involving numerous integrations, Hope is using Vocera as a unifying platform to manage alerts, alarm to text to all staff and care providers.

I also want to highlight a deployments to show how our solution is compelling for hospitals of all sizes. Hardin Memorial Hospital in Kenton, Ohio went live with our solution in Q4, including several integrations, replacing their legacy technology for all of their users. This 25-bed hospital illustrates how even a small customer can leverage our solution to meet their objectives for efficiency, and patient experience. Also during Q4, Ohio Health in Columbus, Ohio to completed expansion of our solution, but included integration with our new partner QGenda. Its seamless integration between Vocera and QGenda eliminates the need for most end users to manually access the on call scheduling system and pave the way for greater workflow efficiency, scalability and end user accessibility.

Now I'd like to talk for a moment about the market for our solution and share what we're hearing in our conversations with customers. As we begin 2019, cost savings and efficiency remain top priorities for IT spending. Customers are looking for a partner who can take a clinical approach to solving workflow bottlenecks by mobilizing data to speed decision making with improved context about patients and caregivers. Our unified solution combining real-time voice secure texting and deep clinical integration is succeeding because it delivers on these challenges.

While there are aspects of the markets that are outside of our control, we remain focused on our opportunity. Government budget uncertainty changes to healthcare policy and reimbursement and even the economy overall are all of concern to enterprises and to companies everywhere and they represent dynamics, we always pay careful attention to. There are also plenty of things we know for sure like our large market opportunity. Our unique competitive advantage and our own execution. Our focus continues to be on developing our pipeline of strategic accounts, engaging with customers about the powerful new Smartbadge, advancing our ROI based selling, and working to elevate our solutions as a spending priority for hospitals. Regardless of what the macro environment, maybe in a given year, I believe that we're just getting started. We are managing the business for the long term, and we believe we are in the early stages of a market that is underserved. There is a large opportunity for us to continue to drive substantial growth in the business for years to come, as we grow our footprint across the US and expand internationally.

Now I'd like to highlight a couple of our key priorities for the coming year. In 2019, the number one priority for us is to drive our bookings growth at a mid-teens rate, by winning new hospital systems and driving systemwide expansions in our existing customers. We'll also continue to focus on growth from our international markets, where we are building strength in our local team. We are making focused investments internationally, providing compelling ROI based key studies to our teams to help them build pipeline and we feel confident in our ability to succeed in these markets.

The introduction of the Smartbadge will also be a catalyst for growth. While maintaining the magic of our lightweight hands-free device, the Smartbadge is a game changer for our business, with its 2.4-inch touchscreen and enhancing features, designed to improve the workflow of the care teams. Not only do I believe the Smartbadge will drive a hardware refresh, it will also drive software sales, particularly for integration and messaging licenses as customers gain appreciation for the power of the device.

With more users utilize intelligent alerts and alarms through the Smartbadge, I believe it will drive demand for Engage software licenses over the long term. Four weeks into the launch, the striking new form factor of the wearable Smartbadge has received a lot of attention from the industry and in already catalyzing conversations with customers who may have previously decided against the use of the Badge. We believe the new Smartbadge will enable us to reengage with potential customers and displace legacy competitive solutions, where screen size has been an inhibitor to our success. On the software front, while we believe our current platform can be sold as a complete solution today. We are always looking for ways to expand our offering across the care continuum, by building, buying or partnering with solutions to further enable the real-time health system.

We are investing in product innovation to extend our clinical relevance both within and outside the four walls of the hospital. We are bringing to life our vision of consolidating clinical data and delivering actionable information and context to the right care team member at the right time. We had many milestones this year and are pleased with our progress. It's an exciting time for Vocera as we strive to grow the business and accelerate toward our profitability goals. I'm proud of the work we've done to move closer to our target model, and I'm excited about our future.

Now I'd like to give our CFO, Justin, a chance to cover the financial details around our Q4 results and our 2019 guidance. Justin.

Justin R. Spencer -- Chief Financial Officer

Thanks, Brent. Hello, everyone. Q4 kept us a positive year overall highlighted by continued revenue growth and significantly higher profitability in 2018. Total revenue in Q4, grew 11% to $48.9 million, driven largely by the continued expansion of our software platform. For the full year, total revenue was $179.6 million, also up from 2017. As we entered 2019, the ASC 606 transition is now behind us and we believe future results will have better year-over-year comparability. Product revenue in the quarter increased 11% to $27.2 million, with very strong performance in software. Device revenue was below our expectations as we believe rumors of our new Smartbadge delayed some purchases in Q4.

We believe this is a temporary issue and is tied to a natural enterprise product introduction cycle. We are really encouraged by the significant interest that customers have already shown in the new Smartbadge, since our launch in early January. We expect our device revenue to grow again in 2018.

Our software revenue was exceptional at $11.8 million in Q4, representing growth of 41%. Software revenue alone represented 24% of total revenue in the quarter and was 21% for the full year as we continue to make progress toward the revenue mix goal in our target model. As an additional reference, software and software maintenance revenue combined, which we view holistically as our software business grew 21% in 2018 exceeding 50% of total revenue. We expect another strong year of software growth in 2019, driven by a continued cross selling and now the wearable Smartbadge. We view this new device as a vehicle to effectively deliver the power and functionality of our software platform to a broader set of users. This Smartbadge is capable of delivering the full functionality of our software platform and will likely drive the sale of additional software licenses.

Services revenue in the fourth quarter was $21.7 million, also up 11% from last year. Our professional services revenue was down year-over-year as we have focused on streamlining our implementation processes and driving down this cost for our customers, which has enabled us to shift more of the deal value to software. Having said that, we expect professional services to grow again in 2019, as we have a strong backlog of projects, several of which are tied to the large deals we closed in 2018.

The other large portion of our services portfolio is software maintenance and support, which I touched on a bit earlier. With the sizable increase in our customer base this year, and our renewal rate well above 95%, our software maintenance and support revenue grew 21% in Q4 compared to last year. This revenue is all recurring and is tied directly to the enhanced value and functionality our customers have been able to receive from our software platform.

Now I'd like to comment briefly on our backlog and deferred revenue. Our combined backlog and deferred revenue at the end of the year was $120.4 million. While up only slightly from last year, I'd like to provide some context around this number. First, we had a softer than expected device bookings quarter in Q4 and we attribute this to rumors of the new Smartbadge introduction in January. We believe our device backlog will grow by the end of 2019, as we drive bookings and revenue growth again in this category. Second, we are delivering on our goals to convert our backlog to revenue more quickly. Something I talked about earlier last year. ASC 606 has shortened the revenue recognition on software and our streamlined implementation processes have reduced the time and cost that it takes to go live with our solution. So, as we look to the full year of 2019, we don't need as much backlog and deferred revenue to achieve our revenue goals as we need it going in prior years. Having said that, we always strive to build backlog and deferred revenue in conjunction with our revenue growth.

On the profitability side, in Q4 we adjust -- we achieved adjusted EBITDA of $7.5 million. For the full year, our adjusted EBITDA grew 29% to $21.2 million, exceeding our original expectations. We drove 35% operating leverage in 2018 and continued to make good progress toward our target profitability model.

Now let me get into some more detail on our non-GAAP gross margins and operating expenses. Non-GAAP gross margin in Q4 exceeded 67%, driven largely by a higher mix of software and the associated software maintenance revenue. We are pleased with our product gross margin of 75% moved largely by our software business. Our services gross margin increased compared to last year as we drove even more leverage in our software maintenance and technical support functions. For the year, our gross margin increased to a record of 66% again tracking well toward our target model. As we now look forward to 2019, we expect our overall non-GAAP gross margin to be similar to 2018.

The gross margin on our Badge is quite healthy, and we expect similar margins for the new Smartbadge. Given our expected revenue seasonality in 2019, we believe the gross margin percentage will be in the low 60s in the first half and then in the high 60s in the second half. Non-GAAP operating expenses increased to $25.7 million in Q4, reflecting in part the investment in R&D and marketing to support our Smartbadge launch in early January.

For the full year, operating expenses were $99.1 million or 55% of revenue, which was down from 56% last year. We have remained very focused on becoming more efficient throughout our entire business as we scale. In the last five years, our operating expense to revenue ratio has declined from 77% in 2014 to 55% in 2018. And we expect this positive trend to continue in 2019, as our revenue growth rate, allocates with our expense growth. In Q1, 2019, we expect our non-GAAP operating expenses to be around $27 million, and then should remain at that quarterly level through the rest of the year.

Now I'd like to make a few comments about our cash flow and balance sheet. We added $6.2 million of cash to our balance sheet in Q4 as a result of our profitability and working capital management. For the full year, our operating cash flow was $14.3 million, and we expect this to be even higher in 2019. Following our seasonal pattern, cash flow will likely be negative in the first half of 2019, and then positive in the second half of the year. Our CapEx is expected to be around $5 million in 2019 or roughly 3% of revenue. With our balance sheet, we believe we are well positioned to capitalize on new growth opportunities.

Turning to guidance, Brent spoke earlier about market dynamics related to the impact of government budget disputes and general uncertainty in the macro environment, which we are watching carefully. In setting our guidance, we've also taken into account the Smartbadge introduction. Our guidance assumes a short-term, temporary decline in device revenue including minimal revenue from the Smartbadge in the first half of the year. However, we expect our device revenue to grow again in the second half fueled in large part by traction with the new Smartbadge. As a result, we expect our revenue seasonality in 2019 to be more pronounced than usual with roughly 40% of our revenue in the first half, and 60% in the second half.

During the second half of the year, we expect our revenue growth rate to be at or even exceed mid teens. Our profitability is tied closely to our revenue, so we expect adjusted EBITDA to be negative in Q1 and then up significantly as we move into the second half of the year. For 2019, we expect revenue to be between $187 million and $197 million. With this annual revenue growth, we also expect to improve profitability and continue toward our target model. We expect adjusted EBITDA to be between $22 million and $26 million in 2019, improving each quarter as the year progresses. For the first quarter, we expect revenue to be between $32 million and $35 million, reflecting the impact of the lower device backlog and Smartbadge introduction, I discussed earlier. Adjusted EBITDA is expected to be between negative $6.8 million and $4.5 million. As we look back on 2018, we believe we have a lot to feel good about. We are now laser focused on a successful Smartbadge ramp along with continuing to drive our software business even higher levels. With success in these areas, we expect to exceed mid-teens growth during the second half of the year, while also delivering even higher levels of profitability, and cash flow in 2019.

I'll now turn it back to Brent.

Brent D. Lang -- Chairman and Chief Executive Officer

Thanks, Justin. Overall, I believe 2018 was a year of tremendous accomplishment for Vocera, demand for our products is on the rise and we have further extended our competitive advantage. With the introduction of the Vocera Smartbadge, we've redefined wearable mobile communication, and expanded the opportunity for new conversations with existing and prospective customers. The functionality and scalability of our differentiated software platform is unmatched in the marketplace and our solution provides a compelling value proposition for hospitals of all sizes.

We had a truly great year from large system wins and our continued success underscores the strategic importance customers are seeing in our products. The capability of our solutions and our ROI based sales approach are resonating with a large underserved market that is prime for growth. Our financials and balance sheet are strong and our operating model has tremendous leverage. As we transitioned to being increasingly software centered, our profitability is expanding. We are well positioned for long-term revenue growth and expanding margins and we are excited for the year ahead.

Before opening up the call for questions, I'd like to personally invite all of you to our Investor breakfast at HIMMS next Wednesday. Feel free to contact Sue if you have any questions about this, and please stop by our booth at HIMSS to check out the new Smartbadge and see how it showcases our expanded software capabilities.

Thank you for listening today. Operator, we're ready to open up the call for questions. Thank you.

Questions and Answers:

Operator

(Operator Instructions) Your first question is from Ryan Daniels with William Blair. Your line is open.

Ryan Daniels -- William Blair -- Analyst

Yes. Thanks for taking my question, given that you want us to stick to one. I'll ask a multi-part question. And it relates to the bookings in the fourth quarter, little bit more detail there, if you could in regards to -- I guess Internationalwide a few markets you thought were weak. If there's any sales force turnover, anything unique there? And then with the federal weakness in bookings. I know the shutdown started I think December 20th or 21st. So were those deals that you thought would close in the last week of the year that are kind of still in the queue?

And then lastly on the device sales, more broadly, is it just your assumption that (inaudible) did you actually hear that from your sales team or clients? I'll stop there. Sorry for the three-fold question.

Brent D. Lang -- Chairman and Chief Executive Officer

Thanks, Ryan. So I'll take them one at a time. First of all, on the international side, I think it was a combination of factors. As I mentioned in the prepared remarks, the international business is still in the early stages and some of these deals do come in a little bit lumpy. And so I think we're going to see some variability from quarter to quarter. If you look at internationals for the year, we are pretty happy with the results, but if you look at it on a quarterly basis, you're going to have more more lumpiness in the results. I do think that there was some weakness caused by sales reps performance execution internationally and we have made some changes there that we think will have improvement moving forward. And we're still in the early stages of the investment we're making into those regions, both in terms of the sales leadership in those regions as well as the marketing support that we're starting to drive into those regions.

And so while it's lumpy, I think we still remain very positive for the opportunity moving forward. The excitement that we saw from some of the larger deals we closed is an indication of the success that we can have there.

Secondly, with regard to the fed, you're absolutely right. What we observe happening was the deals that we had originally planned to close during that last week or so in the quarter, which is -- lot of our bookings come in, didn't come in. And so with the shutdown occurring on December 22nd, it couldn't really frankly happened at a worse time for us, And we had a hard time getting people to return phone calls and get things done. We are starting to see the Fed government business (inaudible) and things are returning back to normal. We're hopeful that that will continue, but it definitely lost some momentum at a critical time for us at the end of the year. And some of the VA and DoD bookings that we were anticipating happening right at the end of the quarter did not come through.

And then specifically on the device sales, it's a little hard to classify it. We do know that during the later part of the quarter, we were starting to have an increased number of beta sites that we're using in the new Smartbadge, we were doing sales training for our own sales force. We were -- obviously had a lot of activity that we're running up to the ramp. And we saw a precipitous drop off in device bookings that started to occur toward the end of the quarter. Clearly the salesforce knew about it at that point in time, and there's obviously a strong level of loyalty to their installed base. We anticipate some of that they have caused them not maybe push quite as hard with the previous version of Bade toward the end of the quarter. And I think that within the marketplace with the beta testing them going on that was going to naturally be downstream effect of that.

So I can't give you a lot of specifics, but we definitely saw the impact of that with the device bookings dropping off once we started doing those beta testing and sales training.

Ryan Daniels -- William Blair -- Analyst

Okay. Thank you for that detailed answer that. That's very helpful. Thanks.

Operator

Your next question is from Sean Dodge with Jefferies. Your line is open.

Sean Dodge -- Jefferies -- Analyst

Good afternoon and thank you. Thanks for taking the questions. On guidance and how you develop your revenue target. I guess, Justin, you mentioned continued improvement in the revenue conversion out of backlog and deferred revenue, and we also have now the accounting changes. Thinking about how you formulated guidance this year versus those in the past, are there any big changes there, are the proportions of revenue that you still have to win this year and the amount expected to come from backlog in deferred revenue, are those still similar to the kind of the proportions that we've seen in years past?

Justin Spencer -- Chief Financial Officer

Yes, hi Sean. The framework is very, very similar and we start by looking at the amount of deferred revenue and backlog that we have at the end of the year. And we estimate how much of that will convert to revenue in the year. And the good news, as I mentioned in my prepared remarks is that we are finding that largely in part due to 606, because of the software, the more favorable software recognition rules. And our our streamlined process for implementations, we've now, particularly with the larger deals, we've now been implementing these larger scale projects for a few years now and we have learned and we've gotten better each time. And so we're finding that we are -- we have significant opportunities for to streamline processes and we're just getting a lot better and smarter at how we go about those.

And so that's enabling us to shorten the time for implementation. A long way being of saying that the amount of revenue that we need from our backlog and deferred revenue is we don't need as much backlog in deferred revenue service, our revenue goals in 2019 as we may have in prior years. We expect a continued strong base of supplies business in the year the other part of our kind of visible revenue to us and we take those two pieces. That's our -- the deferred revenue, the backlog plus supplies, that's our visible revenue and that is right in line where it's been in prior years, as we think about our guidance range for 2019.

The amount that remains, is the amount of new revenue that needs to be sold in the year and converted to revenue in both in terms of dollars as well as in percentages. That is right in line with where our historical norms have been. So, we feel comfortable with the guidance range. We -- as I mentioned -- as we mentioned in our prepared remarks, we are going through a new product introduction cycle here. We expect our device revenue to decline a little bit here in the first part of the year and then reaccelerate and we expect growth in the device category overall for 2019. So as we turn and look forward into the second half of the year, we expect our growth rate to return to the mid-teens level that we've been more accustomed to.

Ryan Daniels -- William Blair -- Analyst

Okay, very helpful. Thank you.

Operator

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

Matt Gillmor -- Robert W. Baird -- Analyst

Hey, thanks. Sorry I had myself on unmute. Thanks. Thanks for the question. I've got a two-parter as well. So on the first quarter guidance, can you sort of give any indication as to whether you've assumed the federal government side, sort of freeze up? I know you made some comments there, but I was curious if there was any assumption that the deals that slipped come in at the first quarter or not. And then would you mind just giving us a little bit overview of the up-sell opportunity with Smartbadges? And sort of what's the most immediate addressable area for upsell. I would think it would be your clients are just on voice and then they could by a messaging license as well as the badge, but just how you're thinking about the cross-sell and what the priorities are?

Justin Spencer -- Chief Financial Officer

Hi, Matt. I'll address the first question, then I'll turn it over to Brent to address the Smartbadge question. So in terms of our Q1 guidance, we're coming off a period where toward the end of the quarter as Brent mentioned. We did see some impact in terms of slow decision-making around the federal government business. And we've seen a few of those orders actually come in, in the first part of this quarter, so that's really good. And we're starting to see things kind of return back to normal level. Obviously, if there is an extended shut down, I think then for not only Vocera but pretty much any company. I think there could be an impact there. So we haven't assumed in our Q1 guidance and extended type shutdown scenario. We know that, like all that -- there are discussions happening in Washington around that. But we've tried to be pretty conservative, both in terms of our view of the macro level environment, as well as our expectations for -- the new Smartbadge launch and ramp. We don't expect any significant revenue from Smartbadge in Q1. So I think if there is an extended shutdown that could impact Vocera as well as any other company to a large extent. But, other than that, we don't anticipate anything else.

Brent D. Lang -- Chairman and Chief Executive Officer

And in terms of the, the Badge upsell opportunity, there's really several different buckets here. The most obvious is the refresh bucket. One of the things that we've seen with the B3000 and the current version of the badge, is durability and robustness in the marketplace has meant that it lasted much longer than prior versions of the device. And so several of the badges -- many of the badges that are out there are quite old at this point. But have continued to work fine.

We believe that the added functionality of the Smartbadge will be a catalyst for many of those customers starting to look at refreshes of their installed base. And it will take some time, as I have mentioned before that will probably start with small orders in order to evaluate it in their environment. It used to the functionality tested in their wireless networks, but we do think that it could drive a substantial refresh opportunity. Now, it's important to note out -- note that refresh is always a part of our business. Roughly 50% of our device sales are recurring sales into installed base users replacing it, but it's not -- that this is a purely new incremental source of revenue, in many regards refresh is a core part of our business, but I do think that the existence of the Smartbadge will be a further catalyst to drive those refreshes.

I also think that this will be an opportunity for us to go back to customers who may have held onto a legacy device in-building wireless phone or pager or something, because of the screen that they wanted with that, and this will be a real reason for them to finally make the transition. We've already heard feedback from some customers, who have mixed environments where their intention is to start to use the Smartbadge as more of a bigger portion of their overall installed base.

We continue to support the idea of device of choice and I think our customers will likely have environments where they have both the old B3000n Badge, as well as the Smartbadge as well as smartphones. And depending on the user and their particular profile, you may see a mixture of those different devices. And I think the final piece, I'd point out here is that we do see a really interesting opportunity for this to drive software sales, because of the increased screen size, the messaging capabilities and the ability to drive clinical integrations and alerts and alarms to the Badge, we believe will drive more Engage software licenses.

You asked the question in the context of what's the relative timeframe of those. Obviously, I think the new software sales are going to probably take longer than the device sales, but each of those represent an interesting growth driver for the business over the long term.

Matt Gillmor -- Robert W. Baird -- Analyst

Got it. Thank you.

Operator

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

Sean Wieland -- Piper Jaffray -- Analyst

Hi, thanks. So maybe we could just take it up a level or two. I'm looking at these results, particularly the '19 guidance and the numbers seem to describe a business that's decelerating and deleveraging. I'm not really hearing in the commentary that matches the numbers. So I'm trying to get an understanding of why that disconnect, because your commentary sounds quite optimistic despite some nips and tucks . And maybe if you could quantify some, put some numbers behind some of these specifics around the -- how much revenue is going to come out of 2019 because of the badge transition. How much revenue, specifically from international or government. Just put some numbers behind this would be helpful.

Brent D. Lang -- Chairman and Chief Executive Officer

Yes. So I'll start first with the up level answer your question and then I'll let Justin speak to some of the numbers. I think the first point I would make is, we feel like this is a temporary transition period. Going to the new product introduction is something we've done in the past, and we've modeled the impact that it has on device bookings. And so largely the impact on the first half of the year, and particularly the Q1 guidance is a function of stuff that the badge transition.

But we're optimistic, because in the longer term, we believe the Company is much better positioned with the Smartbadge and without the Smartbadge. And so we're sort of looking at the longer-term growth trajectory of the business that actually puts us in a better situation with a more differentiated offering and we feel like we just have to sort of manage through this transition period, as opposed to having it be something that sort of systemic with the business. The exact time frame with which people are going to adopt the new Smartbadge is a little unknown, where this is sort of unknown territory for us. We've never launched a product this substantial since the original launch way back at the beginning of the founding of the Company.

And so, I think we are trying to figure a cautious stance in terms of that product transition. The government piece -- again, we think of a temporary transition based on the dynamics that we are going on the federal government toward the end of the year, but we remain really, really bullish about our position within the federal government and continue to get very, very positive feedback from them, not only about their plans for the future, but also there's specific plans for Vocera. And so I think the optimism you're hearing is really tied with the fact that we feel like there is a short-term impact which obviously affects the numbers for the year, but both of those could be easily managed through. And if you look at the growth rates this really translates to in the back half of the year, it is more in line with the expectations that we have for the business.

Justin Spencer -- Chief Financial Officer

And just to add to that, Sean. So as we think about our kind of the four main categories of our revenue model, hardware and software and the product segments and then support and professional services. In 2018 the software grew 25%. We were really pleased with that, and we expect another strong year of growth in 2019. And support revenue, maintenance -- software maintenance and support revenue was up nearly 20% as well. Our professional services revenue was down in 2018 largely as I mentioned because we have shifted some of the deal mix to software. But we have a large backlog, fairly large backlog in professional services projects, but we expect that category to grow.

The one thing that we're being a bit conservative on is our hardware business, given the Smartbadge introduction, as Brent alluded to. And so as we think about 2019 we are being -- we think we are being hopefully conservative and realistic about the timing and the ramp of the Smartbadge, but as we get to the second half, we think that will contribute more meaningfully to our revenue. And for the full year the hardware revenue should turn from a decrease that we saw in 2018 to a net positive growth contributor in 2019.

Sean Wieland -- Piper Jaffray -- Analyst

Okay, thank you.

Operator

Your next question is from David Larsen with Leerink. Your line is open.

Dave Larsen -- Leerink -- Analyst

Hi. If I look at your 1Q revenue guide, I think it's implying a decline of about 17% year-over-year, like in the guide for the year, the midpoint, I think, is up 7%. So can you just talk a little bit about sort of your expectations for the back half of the year, what percentage of revenue is covered now for the year and how does that compare to last year. Thanks.

Brent D. Lang -- Chairman and Chief Executive Officer

Hi, Dave. So as we look at our overall visibility as I mentioned earlier, the overall amount of revenue that we see visible to us is on a percentage basis -- as a percentage of our overall targeted, not too far off from where it's been in recent year. So our visibility is pretty well in line there. And so we said, as we think about our overall guidance range, we take into account the amount of deferred revenue and backlog that we have and because that was a little softer than we had expected as we exited 2018, we've adjusted that or factored that into our overall guidance for 2019. So what that does is, it has more of a near-term impact on our overall revenue expectations, which is why our Q1 revenue expectation is down. That is very directly related to the softness that we saw in ffed in Q4 as well as the overall kind of device booking softness that we saw as a result of the rumors of the Smartbadge.

We believe that that's going to correct. And so as we move through the year, our backlog and deferred revenue is going to increase. And as we get to the back half of the year, we believe that our bookings in our revenue growth is going to return to the mid-teens level. So what we see right now, our pipeline is very strong. The excitement within the Company is very strong, we're going through new product introduction cycle, which is largely the cause of the near-term revenue trajectory. But then as we get to the back half of the year, we expect backlog and deferred revenue to once again really start growing along with the bookings in the revenue and deliver mid-teens growth in the back half.

Dave Larsen -- Leerink -- Analyst

Okay, thank you. And then just in terms of like your EBITDA margin expectations, any sense for how much you would expect those to grow on a year-over-year basis, 50 basis points or 100 basis points, any color on that would be great.

Brent D. Lang -- Chairman and Chief Executive Officer

Yes. One of the things that we're really pleased with is the momentum that we have with our profitability. 2018 was a really solid year in that regard, we drove 35% incremental EBITDA margins. And at the high end of our guidance range, which is always what we targeting here internally, we're driving around 30% incremental margins in 2019, even with this new product transition. I will say just in the event that it's asked that the gross margin that we expect in our Smartbadge is very similar to our badge. And so it in itself should not dilute our gross margin, that should be kind of right in line with where our historical device margins have been. So we expect again as we continue to drive revenue growth in 2019 to drive higher levels of EBITDA as we continue to achieve that revenue growth that exceeds the level of investment in our operating expenses.

Dave Larsen -- Leerink -- Analyst

Thank you very much, Justin, appreciate it.

Operator

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

Mohan Naidu -- Oppenheimer -- Analyst

Thank you very much for taking my questions. Brent, Justin on the conversion from orders to revenue, how fast are you guys doing it now? I'm surprised to see such fast impact on revenues from delays in Q4 bookings, it just feels like Q1 should be drawing most of its revenue from bookings that happened far before Q4.

Brent D. Lang -- Chairman and Chief Executive Officer

Yes. So our vast conversion on our backlog and deferred revenue is -- it varies, but it's between 70% and as high as 80%. It's been trending up over the last couple of years as we have become more proficient in implementing, particularly the large deals. Because of the device softness that we saw in Q4 that tends to turn really quickly, so any backlog, our device backlog was a little bit lower than we had expected as a result of the device booking softness in Q4. And so that has a direct impact on Q1. But as the bookings of our Smartbadge and our devices overall pick up here in the first half of the year, we expect that to convert to revenue fairly quickly as it historically has.

Mohan Naidu -- Oppenheimer -- Analyst

So the device weakness that you guys -- we're talking about is mostly the add-on sales to existing customers?

Brent D. Lang -- Chairman and Chief Executive Officer

Yes, I think that's fair to say, I think that's -- typically the fastest part of conversion with the expansions within existing customers. So the near-term impact is orders that book and ship typically within a quarter or so. And a lot of the device replacement is obviously getting within existing customers. The new customer sales have a longer sales process and we typically have visibility into those orders, not only in the pipeline from when they become a booking, but also once they become a booking until they convert to revenue, it's further out in the future. And so I would say in the near-term impact is more in the category of exchange within existing customers.

Mohan Naidu -- Oppenheimer -- Analyst

Okay. Thanks for taking my questions.

Operator

Your next question is from Jamie Stockton with Wells Fargo. Your line is open.

Jamie Stockton -- Wells Fargo -- Analyst

Yes, thanks for taking my question. So I guess maybe just one more on kind of visibility. And setting aside the full year, if we just look at the step up in business that you guys are talking about from Q1 to Q2, can you talk about your level of confidence in that right now given that we're almost halfway through the first quarter?

Justin Spencer -- Chief Financial Officer

Yes. I think, we feel the energy and the excitement in the sales force is really strong. A lot of what we booked Jamie in the first quarter will translate to revenue in the second quarter, we're still early on in the first quarter here. But what we can say is that our pipeline is really strong, the excitement overall, and the sales force is really strong. We have some projects, some larger projects that Brent touched on a couple of large deals that we closed in Q4 that will start to convert to revenue in the second quarter. So at this stage, and it's early, our primary focus is on Q1, but we -- everything that we see at this point in terms of our (inaudible) suggest that Q2 will play out as we expect. Now we've just got to go execute. And as we achieve our bookings targets in Q1, and we build the backlog and the deferred revenue we expect, then Q2 will come into form at that point.

Jamie Stockton -- Wells Fargo -- Analyst

Okay, thanks.

Operator

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

Stephanie Demko -- Citi -- Analyst

Hey, guys. Thank you for taking my questions. I guess the -- I wanted to ask is, given your heightened mix of software, what is driving the return to negative profitability in 1Q, especially in such a dramatic fashion?

Brent D. Lang -- Chairman and Chief Executive Officer

Hi. Stephanie. Yes, so our business large works -- is it's largely a function of the revenue base. So our cost structure there is a fairly significant portion of our cost structure that is fixed. So we tend to see lower profitability in the first half and higher profitability in the second half, mostly driven by the level of revenue. So as our -- as we look back over the last several years, our profitability has pretty typically been much, much higher in the second half than the first half. And because our revenue seasonality is even more pronounced as a result of the new Smartbadge introduction in 2019, it causes a little bit larger swing in profitability from the first half to the second half. There is nothing unusual in terms of the underlying cost structure, we're actually going to be at about $27 million of operating expenses in Q1 and then we'll likely, say fairly flat through the rest of the year. So we're properly, we're trying to manage our expenses and be smart about where we invest.

We are investing for growth in areas like international and new product development, but those continue to be important themes for us. But it's largely just driven by the revenue base that we've got in the seasonality that we typically see in our business.

Stephanie Demko -- Citi -- Analyst

Alright. I understood. And one quick follow-up to that one. I'm just looking at the 1Q revenue guide. Is there a meaningful downtick in the recurring portion of your revenues that you're baking into the guidance, just given it now making up over half your revs?

Brent D. Lang -- Chairman and Chief Executive Officer

No, I think the recurring portion of the revenue is right on track with where it's been in the past. I mean typically the biggest portions of recurring revenue are the maintenance renewals and the supplies business and we continue to have very, very high maintenance renewals through the end of the year. And so the revenue recognition associated with that maintenance renewal continue in Q1 as it has in the past and the supplies business also will continue and we've seen continued strength in our supplies business so far this quarter that gives us reassurance that that portion of the business will continue.

So it's really the timing of the deployments of large deals that have been booked in prior quarters, obviously, which is reflected in the backlog and deferred revenue coming into the year. And then our expectations for win larger book ship deals will occur in Q1. And so if you look at the backlog of deals that are yet to ship that we would have booked last year and how many of those are our plan to ship in the first quarter of this year and then expectations for how quickly we think customers are going to evaluate in place book ship deals in Q1. Those two factors really grow the number for the Q1 guidance, but the recurring piece is really rock solid and we have not seen any impact on that at all.

Stephanie Demko -- Citi -- Analyst

Alright, understood. Thank you for clarifying.

Brent D. Lang -- Chairman and Chief Executive Officer

Yes.

Operator

(Operator Instructions) Your next question is from Matt Hewitt with Craig-Hallum Capital. Your line is open.

Matt Hewitt -- Craig-Hallum -- Analyst

Good afternoon. And I apologize if this was mentioned earlier I jumped on late, but could you provide an update or maybe some visibility into your pipeline in the mix in particular? How much of that pipeline is government versus commercial business and maybe where that compared to a year ago? Thank you.

Brent D. Lang -- Chairman and Chief Executive Officer

Yes. Hey, Matt. So in general, our government business, if you look at it on an annual basis is in the 15% to 20% of our business. It fluctuates a fair amount from quarter to quarter because the government business tends to be more concentrated in Q3 and Q4. But if you look at it on an annual basis, it is in the 15% to 20% range.

I would say that if you look at that trend over the last couple of years. It's definitely increased from probably low teens up into the high-teens range in general. So it's a growing piece of our business. And the pipeline also reflects that it would remain in that sort of high teens range of our business.

But the good news here is that we have still got a large opportunity with the Fed both on the VA side where we're only about 50% penetrated into those facilities and still have a larger remaining cross-sell opportunity. And then on the DoD side, again, there's a lot of facilities that are not yet customers, we're starting to see better progress with the air force and the navy, which was the portions of the DoD that previously has not had a lot of Vocera penetration. And so we can see the pipeline in that part of the DoD starting to come to fruition. And that's what gives us confidence that the fed business will continue to be in the high teens range of the overall business.

Matt Hewitt -- Craig-Hallum -- Analyst

Got it. Great, thank you.

Operator

This concludes the Q&A portion of today's call. I'll now turn things back over to Brent Lang for any closing remarks.

Brent D. Lang -- Chairman and Chief Executive Officer

Great, thank you. And thank you to everyone for dialing for the call today. We look forward to following up with you and seeing many of you at the end of the next week. Thanks for your time.

Operator

This concludes today's conference call. You may now disconnect.

Duration: 70 minutes

Call participants:

Sue Dooley -- Director, Investor Relations

Brent D. Lang -- Chairman and Chief Executive Officer

Justin R. Spencer -- Chief Financial Officer

Ryan Daniels -- William Blair -- Analyst

Sean Dodge -- Jefferies -- Analyst

Justin Spencer -- Chief Financial Officer

Matt Gillmor -- Robert W. Baird -- Analyst

Sean Wieland -- Piper Jaffray -- Analyst

Dave Larsen -- Leerink -- Analyst

Mohan Naidu -- Oppenheimer -- Analyst

Jamie Stockton -- Wells Fargo -- Analyst

Stephanie Demko -- Citi -- Analyst

Matt Hewitt -- Craig-Hallum -- Analyst

More VCRA analysis

Transcript powered by AlphaStreet

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.