Vocera Communications (VCRA) Q1 2019 Earnings Call Transcript

Vocera Communications (NYSE: VCRA) Q1 2019 Earnings CallApril 25, 2019 5:00 p.m. ET

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 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.

Sue Dooley -- Director of Investor Relations

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'd like to take this opportunity to remind you that during the course of this call, we will make forward-looking statements regarding projected operating results and anticipated market opportunities. This forward-looking information is subject to risks and uncertainties described in our filings with the SEC, and actual results or events may differ materially.

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Except as required by law, we undertake no obligation to update or revise these forward-looking statements. On this call, we will refer to both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings release. And with that, let me turn the call over to Brent.

Brent Lang -- Chief Executive Officer

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 want to highlight on 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'm proud of our team. Our professional services expertise remains a meaningful differentiator in helping our customers achieve real improvements 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're 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 and 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're 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 badge refresh from Banner Health and an expansion deal at NYU Langone for Winthrop University Hospital, where they are rolling out Engage. In another significant development for the quarter, we received an authority to operate known as an ATO from the U.S. Department of Defense. This DoD certification based on compliance with strict security requirements and risk assessments is a required part of authorizing, securing and managing healthcare technology systems across the DoD.

You may recall, we already had 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 to 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 AR 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 smart badge. 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've 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've built to date. I'm particularly pleased that early feedback on the Smartbadge has been positive in terms of its pricing, size and weight. And we're seeing a lot of excitement around putting some of our software to work in the hands -- to work in a hands-free environment.

As an aside, April is Workforce Violence Awareness Month. You'll 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 Sutter's CPMC awareness in San Francisco. You'll 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're using several integrated clinical workflows and the power of Vocera Analytics to transform their organization. We also went housewide 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 the 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'd like to 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 pipelines for our sales team. We were pleased to see many of you at our investor event 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. 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 to 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 communications 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've 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 toward our profitability goals. I'm 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 business is building with strategic customer bookings, successful large scale deployments and high customer loyalty. Now I'd like to give our CFO, Justin a chance to cover the financial details around our Q1 results and our guidance for Q2.

Justin?

Justin Spencer -- Chief Financial Officer

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 improved profitability in Q2. Total revenue in Q1 with $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'll 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 or banned 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 at the Smartbadge and associated software revenue over the next several quarters. As further context on our software revenue, it is worth noting that we faced 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've 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 continues to be in excess of 95%, well above industry standard and reflects the benefits our customers experience from using our solutions. Professional services was down slightly when compared to last year as the 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 had 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'd 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 their 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 in 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 softer 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 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 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 and help set us up for stronger growth in the second half of 2019.

I'll now turn it back to Brent.

Brent Lang -- Chief Executive Officer

Thanks, Justin. In summary, I'm 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 introduced two new board members, who we announced a couple of weeks ago in a press release.

As of our Annual Stockholder Meeting on May 31st 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'm 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'm really proud that Vocera is the quadruple aim company.

We look forward to making a difference to the hospital's bottom line, as well as to quality of care and staff resilience as we drive toward enabling the real-time health system. With that we're 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.

Questions and Answers:

Operator

[Operator instructions] Ryan Daniels, William Blair.

Ryan Daniels -- William Blair -- Analyst

Hi, guys. Thanks for taking the questions and I appreciate the commentary that you're getting positive feedback thus far in the new badge. I guess my question is given that that is still in process and most of the badge shows are in pipeline, I'm curious if there's 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?

Brent Lang -- Chief Executive Officer

Ryan, thanks for the question. There are a couple of things that we're 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-house and get them qualified.

We've also been doing what we think of as kind of a white glove install treatment where we're really bear hugging these initial customers as they're doing the deployment and installation to make sure that we're getting immediate feedback on what they like or anything that needs to be fixed or improved. As they go forward, we're helping them with the software upgrade that has to be done in order to be able to use the new badge. So we're definitely putting effort and focus on this. I'm really encouraged by the size of the pipeline.

It's growing faster than I expected and I think we are going to start to see 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're 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're definitely providing both financial incentives, as well as support and services incentives to help them with that transition and evaluation.

Ryan Daniels -- William Blair -- Analyst

Very helpful. And then my follow-up, maybe a little bit more detail if you could on the Nordstrom's win. I am curious, just a little bit more background there, is that something you've 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 in Puerto Rico.

But I'm curious how many badges that might be given this is U.S. full line only. Thanks.

Brent Lang -- Chief Executive Officer

Yeah, we're really excited about it. This is a deal that we've been working on for about 18 months. We actually first 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 our IT group and was looking at various communication solutions that might be able to be used in the retail environment, they heard about our solution and reached out to us. They've actually done a fair amount of work with us already. They did a pilot in two different stores in the back half of last year. They've also done some work in one of their warehouses to evaluate the use of the product.

So they're 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 of 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 the number of stores is right on. I think it's right in the mid hundred 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're 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 get the name out there and very appreciative of that. But we're somewhat limited in terms of what we can say about the size of the deal in terms of number badges or dollars.

Ryan Daniels -- William Blair -- Analyst

Fair enough. That's great color.

Operator

Sean Wieland, Piper Jaffray.

Sean Wieland -- Piper Jaffray -- Analyst

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 would that come from? Was it from better sale of Smartbadges or what?

Justin Spencer -- Chief Financial Officer

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 OK as well. The badge business continues 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 more of those decisions to be made. And so we'll likely see our device revenue increase sequentially in both of the original badge, as well as the beginnings of the ramp up on revenue from the Smartbadge. And just scientifically, as it relates to Smartbadge revenue in Q1, it was pretty minimal. Most of the shipments of the Smartbadge were just small quantities of valuation units.

So it didn't represent a significant amount of revenue in Q1.

Sean Wieland -- Piper Jaffray -- Analyst

OK. And now the 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?

Brent Lang -- Chief Executive Officer

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're still working a lot of cross-sell opportunities and even a couple of years into this.

Well, that portion of our business is growing really nicely. We're still at very low penetration rates across the installed base. I think the Smartbadge will help accelerate that. But there's 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 any 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.

Sean Wieland -- Piper Jaffray -- Analyst

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

Brent Lang -- Chief Executive Officer

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

Sean Wieland -- Piper Jaffray -- Analyst

Thanks so much.

Operator

Sean Dodge, Jefferies.

Sean Dodge -- Jefferies -- Analyst

Good afternoon. Thanks. Maybe going back to Ryan's question on the kind of the evaluation process of the new badge. I think you'd initially said we'd get some test size order quantities, people would take maybe a month, two months to evaluate that and that should be followed by some order.

So kind of evaluation process to order time taking maybe a quarter or two. Is that right and is there anything I guess as we've kind of got into the first couple of months of this that have caused you to think that maybe that time line could shorten or conversely lengthen?

Brent Lang -- Chief Executive Officer

I think it's right on track. As I mentioned in the prepared remarks, the pipeline has grown faster than I originally anticipated. The time frame 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 tonne of time for them to be in the evaluation mode but we've 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 Smartphone -- Smartbadge evaluations has both a hardware component to it for the badge -- the Smartbadge plus batteries and chargers. But it also has a software component and services component to because in many cases there will be drag along revenue associated with that. So we're tracking pipeline both from pure hardware perspective, as well as from a total dollar value and I'm very encouraged by what we've seen so far.

Again, just to mention our expectations in the 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.

Sean Dodge -- Jefferies -- Analyst

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

Brent Lang -- Chief Executive Officer

Yes. So revenue from international in the first quarter was right on par with where it's been over the last couple of years just right around 10%. We continue to be encouraged by the activities that's going on there and building out the teams in the local markets. From a marketing perspective, we're starting to do more localized collateral or more localized marketing campaigns, some field marketing activity to drive pipeline.

So it's in process. I don't think there's been any dramatic shift yet but we're hopeful that that will continue to drive growth of the businesses as we move forward. International, because that's a small piece of our business, can be a little lumpier than the business overall. And so we monitor that on a sort of extended time frame.

But I'm pleased with the activity that we've had and I'm pleased with the investment that we've made there both on the sales side and services, as well as on the marketing side to drive demand there.

Operator

David Larsen, Leerink.

David Larsen -- SVB Leerink -- Analyst

Can you talk about the competitive environment? I think Cerner has care aware solution and Huron recently acquired I think, OK. What is your win rate look like and I mean are you seeing any sort of change in that given these two other sort of competitors? Thanks.

Brent Lang -- Chief Executive Officer

Hi, David. Thanks for the question. We really have not seen much of a change in our competitive win rate. It remains up in the 70% to 80% of the deals that we're involved in.

We end up winning. Obviously the Cerner Care products has been in the market for some time. It hasn't been a big impact on the market dynamics and the whole Huron 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've essentially created. And I think it's a validation that it's a large market, but 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 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 markets and continue to be the clear market leader.

David Larsen -- SVB Leerink -- Analyst

OK. And then just any color on the sales force? I mean is it -- has there been any changes there or not, any changes in the commission sort of rates? Any color around like the activities of the sales force will be very helpful, restructure of the sales force also be helpful. Thanks.

Justin Spencer -- Chief Financial Officer

Yeah. Hi Dave. Yeah, 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've 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 as we've added folks to complement the sales person.

So clinical specialists, sales engineers even support personnel in market in our international regions really bolster our ability to close deals and grow market share in those regions.

Operator

Matthew Gillmor, Robert Baird.

Matthew Gillmor -- Baird -- Analyst

Hey, thanks for the question. I want to follow up on the Hill-Rom acquisition and I guess -- I 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 that does not make sense for anyone. Just wanted to sort of understand that as a risk factor.

Brent Lang -- Chief Executive Officer

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 of 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. It's something that their customers and our customers rely upon. We've 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're leveraging pretty standard open APIs that unless they try to design them out in a future version of the product would continue to be accessible to us.

And I'm fairly confident that we'll be able to maintain that relationship. So we'll 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 to block that integration.

Matthew Gillmor -- Baird -- Analyst

Got it. And then following up on the Nordstrom deal. I appreciate you're 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.

Brent Lang -- Chief Executive Officer

On a store basis or a personnel basis or what --

Matthew Gillmor -- Baird -- Analyst

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

Brent Lang -- Chief Executive Officer

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 will -- we're going to be deploying this across the majority of their stores. So we'll begin with the shipment of the badges, one tranche of the badges and the software here in Q2.

And then some of the professionals -- 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 the economic model is very similar to what we have on the healthcare side.

Operator

Mohan Naidu, Oppenheimer.

Mohan Naidu -- Oppenheimer and Company -- Analyst

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

Brent Lang -- Chief Executive Officer

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've 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're really encouraged by the ongoing conversation that we're 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're 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'll 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'll continue to win that business increases every day.

Mohan Naidu -- Oppenheimer and Company -- Analyst

And maybe a quick one on general federal deals that got pushed out of Q4. Given 2019, I guess so far how many have closed and do you think that you'll have an year-over-year growth in those deals?

Brent Lang -- Chief Executive Officer

Yes. So the federal bookings in Q1 were a combination of some of the deals that had moved out Q4 and then some deals that were new that had been forecasted for Q1 from a prior forecasting. I think we're 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.

Operator

Vikram Kesavabhotla, Guggenheim Securities.

Vikram Kesavabhotla -- Guggenheim Securities -- Analyst

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've talked about achieving a faster conversion of the backlog in 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've won?

Brent Lang -- Chief Executive Officer

Vikram, 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's really nice to see that 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've 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 standards 606, our software revenue recognition has been able to convert a bit more quickly, meaning we've 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're 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. And so nothing has changed in the last quarter, that over the last year or so since we have been operating under ASC 606, that's the new paradigm for not just us but all companies that are perpetual, have a large component of their software that is perpetual.

Operator

Matt Hewitt, Craig-Hallum Capital.

Lucas Baranowski -- Craig-Hallum Capital -- Analyst

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?

Justin Spencer -- Chief Financial Officer

Yes, there will be a little bit of a -- first of all, Q1 is usually a -- we did have some big expense -- bigger expenditures in Q1 particularly around HIMSS and the 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 be -- 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.

Lucas Baranowski -- Craig-Hallum Capital -- Analyst

OK. And then just one last question here. Non-GAAP gross margin, it sounds like that'll 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 is smaller uptick maybe 50 basis points.

I mean, should we expect maybe a little more of an increase than that this year?

Justin Spencer -- Chief Financial Officer

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're 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.

Operator

[Operator instructions] Stephanie Demko, Citi.

Stephanie Demko -- Citi -- Analyst

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've got the moving pieces with the Smartbadge. As you say, we've been 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?

Brent Lang -- Chief Executive Officer

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 is 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'll 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.

Stephanie Demko -- Citi -- Analyst

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

Brent Lang -- Chief Executive Officer

This level of -- I am sorry, software lumpiness?

Stephanie Demko -- Citi -- Analyst

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

Justin Spencer -- Chief Financial Officer

Stephanie, no, right as expected, we knew we had the difficult to 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 out 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.

Stephanie Demko -- Citi -- Analyst

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?

Brent Lang -- Chief Executive Officer

It's primarily timing. Yes. They had been evaluating the previous version of the badge, the B3000 and they ran their pilots and trials using that and they budgeted for based on the B3000. And 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're not doing a lot of text messaging or messaging alerts to the badge. They're doing some but not as extensive as some of the healthcare customers.

And 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 run.

Operator

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

Brent Lang -- Chief Executive Officer

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

Operator

[Operator signoff]

Duration: 54 minutes

Call Participants:

Sue Dooley -- Director of Investor Relations

Brent Lang -- Chief Executive Officer

Justin Spencer -- Chief Financial Officer

Ryan Daniels -- William Blair -- Analyst

Sean Wieland -- Piper Jaffray -- Analyst

Sean Dodge -- Jefferies -- Analyst

David Larsen -- SVB Leerink -- Analyst

Matthew Gillmor -- Baird -- Analyst

Mohan Naidu -- Oppenheimer and Company -- Analyst

Vikram Kesavabhotla -- Guggenheim Securities -- Analyst

Lucas Baranowski -- Craig-Hallum Capital -- Analyst

Stephanie Demko -- Citi -- Analyst

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