Description

Vocera Communications develops device and software that improve communications in the hectic hospital environment. The company is essentially a one-product company with the Vocera Communication suite accounting for 90% of the company’s total revenue. The product is installed in more than 1,200 healthcare organizations, and customer base is diversified with the largest customer accounting for 1.1% of total revenue. The Vocera Communication suite is comprised of badges featuring voice recognition, and more recently, smartphone apps, that allow hospital staff to communicate with each in a hands-free manner.

We think the stock is interesting because (1) VP of Sales, who is crucial to the company’s turnaround, recently bought shares, (2) it trades at low multiples of sales and gross profit, and offers adequate downside protection, and (3) there are identifiable catalysts for the stock to be re-rated.

VCRA is a disappointing IPO.

- The company became public in March 2012 at $16 per share and did a follow-on at $28.75 per share six month later.

- In May 2013, the stock dropped from $20 to $12 after the company reported disappointing Q1 2013 revenue and revised down full-year revenue guidance from $120 mm ~ $130 mm to $100 mm to $110 mm. Management attributed the weakness to cost cutting initiatives at hospitals due to the healthcare reform.

- In July 2014, the stock dropped from $12 to $8 after missing Wall Street revenue consensus/prior guidance and revised full-year revenue guidance from $105 mm to $115 mm to $90 mm to $95 mm. Management said company continued to experience softness in hospital spending.

Two insiders bought shares on the open market, and CEO exercised options early.

- From August to November 2014, the CFO and VP of Sales bought meaningful amount of stock in the open market.

- Paul Johnson, VP of Sales, bought 10,000 shares at $8.49 in August 2014 and 10,000 shares at $10.08 in November 2014.

- Justin Spencer, CFO, bought 10,000 shares in November 2014 at $10.

- Brent Lang, CEO, exercised options on 29,167 shares in September 2014, 1 year and 9 months before expiration.

The Vocera Communication suite is sticky, inexpensive, and offers good ROI.

- Typical initial purchase of the product is $250,000 to $300,000.

- Support and maintenance renewal rate is above 98%. Hospitals may not be buying new badges, but if they give up the badges altogether for a competitor’s offering, they wouldn’t be renewing the support contract.

- An Evans Army Hospital study (http://www.slideshare.net/iHT2/powerpoint-integrating-hands-free-communication-technology-to-improve-quality-efficiency-safety-and-satisfaction-of-patients-and-staff) found that after implementation of Vocera, in-patient satisfaction improved by 20% which resulted in $150,000 quarterly benefit as a result of pay-per-performance model. Fall-related injuries decreased by 88%. Nurse response time decreased by 75%. Nurses saved 1.5 hrs/day. Physicians saved 40 minutes/day.

- A study (http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2656106/) says staff found Vocera to be a crucial communication system that eliminates the trouble of finding a phone, facilitates finding a person and streamlines workflow.

- Another study (http://www.medscape.com/viewarticle/780608) found that Vocera Communication meaningfully reduces interruptions in emergency departments.  

- Management says the company rarely, if ever, lost a customer.

Competition

- Vocera is in about 13% of the acute care hospitals in the US (800 out of 6,000), and 200 acute care hospitals internationally. Within these hospitals, Vocera is about 30% to 35% penetrated. Emergency departments, intensive care units and operating rooms find Vocera most useful.

- VCRA primarily competes with Spectralink, Ascom and Cisco. Management describes competitors’ product offerings as legacy hardware products and essentially cordless phones. Competitors don’t offer the communication workflow management that Vocera provides through on-premise servers. Competitive offerings also do not have voice recognition, and require users to dial numbers physically – an inconvenience for the busy hospital staff.

- There is now a trend among hospital employees to text each other. Some hospitals are considering using secure messaging apps due to privacy concerns. Messaging is a hot area and there are a lot of start-ups. If texting is widely adopted in hospitals, Vocera would face significant competition from well-funded competitors in the texting space.

- Vocera says hospitals found that staff still want hands-free voice communication in addition to secure texting. Vocera is now offering its HIPAA-compliant secure texting solution to existing users for free.

- In late 2014, CEO said “there's really no one out there who's got something with the same sort of capability and functionality as Vocera in terms of the wearable badge, the speech recognition, the workflow capability on the server side. It's really amazing how unique it stayed over the years.”

- As communication is transitioning to smartphones, investors wonder why Vocera would be competitive in developing smartphone apps. Management claims that the competitive advantage of Vocera lies in the intelligence and IP of the workflow on the server side, and that the company is device agnostic. We would closely watch whether development within the company validates this claim.

Selling strategy

- The company switched from a Value-Added Reseller (VAR) model to direct selling in 2009 to boost margins. However its sales team (50 to 60 salespeople) had not executed well. There was confusion about how the team divides between new and old businesses, the appropriate selling tools, the right coverage models etc. Paul Johnson was brought in to improve sales execution. Given this context, we think his open-market purchases are a meaningful indicator of the potential of the company

-Johnson came from Intuit, where he was responsible for leading sales and client relationship management for the company’s $500 mm financial services SaaS business. He replaced Robert Flury who previously worked as a chief operating officer at LifeNexus (a medical record company) and was a CPA.

- To complement direct selling, in 2014 the company started partnering with bigger healthcare IT vendors such as IBM, Epic and Cerner. The company is not going back to a distributor model – these vendors would recommend complementary VCRA products when they sell their own products to hospitals.

- Sometimes hospital IT departments are too busy with the Cerner/Epic work and Vocera does not get prioritized. In order to get more prioritized, Vocera is deepening integration with other hospital IT vendors. For example, inside the Epic Haiku app, there is now a Vocera button that allows hospital staff to launch Vocera functionalities directly from Haiku.

Half of the company’s market cap is in cash.

- The company has $116 mm of cash and short-term investments compared to $258 mm of market cap.

- CEO says he is very sensitive about the cash, and is unlikely to make a “transformative” acquisition. Instead, he prefers tuck-in deals to acquire innovative technologies. For example, Alert Management, a new product, was developed from a $3.5 mm acquisition done in 2014.

The company has a recurring supplies and service revenue stream.

- Product revenue comes from (1) devices and (2) software. Devices revenue are made up of (a) new badge sales (b) badge upgrades and (c) supplies such as batteries, chargers etc.  The third category, supplies, is about 20% to 25% of the business, or 40% ~ 50% of product revenue. The supplies revenue stream is like a consumables business, and should be recurring as long as hospitals continue to use the badges.

- About 80% of the service revenue relates to software maintenance and support, and the rest comes from professional services and training. Renewal rate for maintenance and support stands at 98%.

- Badge upgrades are more troublesome in our opinion. The company rolled out its newest generation of badges called B3000 in 2012. The previous generation, B2000, was introduced around 2008. However, in July 2014 CEO said 30% to 40% of the installed base was still on B2000. We think this is not a good sign because apparently some hospitals find it acceptable to use technology from 7 years ago.

There are identifiable areas where management can create value.

- International. Currently only 10% of revenue comes from outside the US. Management targets 25% in the next couple of years. Management is pursuing opportunities to expand to Malaysia, Singapore and the Middle East. International hospital new builds outside the US provide a tailwind for the company because new hospitals generally want the most advanced communications systems.

- New products:

                - Integration with Electronic Health Records (EHR) software so that orders entered on EHR can be immediately transmitted to relevant staff carrying Vocera badges or smartphone running Vocera apps.

                - Vocera Care Experience is a suite of solutions that improve communications with patients. The suite started with Good To Go, a product that enables hospital staff to record advice/instructions to the patient before discharge so that the patient can listen to the recording later. Now the suite includes solutions to streamline and improve pre-arrival communication and during-stay communication. Pre-arrival communication results in better patient readiness and fewer no-shows. Discharge communication reduces re-admission by 15%, which is important because CMS is no longer reimbursing unplanned readmissions within the first 30 days.

                - Alert Management, launched in July 2014, aims to improve patient safety by transmitting vital sign waveforms to hospital staff’s mobile devices. Alert Management also allows hospitals to analyze historical data in order to set optimal alert thresholds that minimize “alert fatigue” while also making sure patient needs are being attended to.

                - In Q4 2014, new products became 9% of total bookings.

- Other verticals: the company sold products to the Four Seasons in Orlando in 2014. It also sold to half a dozen nuclear facilities in 2014. In nuclear facilities, workers wear protective and clumsy clothing so hands-free communication is useful.

Upside

- The stock trades at 1.5x LTM sales and 2.4x LTM gross profit.

- If Vocera can show signs of successfully transitioning from physical badge to software, we think the stock would trade at a much higher revenue multiple. Healthcare technology companies trade at an average EV/Sales multiple of 4x. Cerner trades at 7x sales.  

- In addition, we think the low sales and gross profit multiples of VCRA, coupled with its simple yet sticky business model, make it an attractive M&A target. We suspect that much of the current R&D spending is geared towards new product development, and can be easily absorbed by a strategic buyer.

Risks

- Cash burn:

The company is not profitable, but management expects to achieve breakeven on adjusted EBITDA basis in 2015.

- Acquisitions:

VCRA hired Rob Born to head corporate development in July 2014. Born came from Thomas Weisel Venture Partners. He was hired to enlarge the deal pipeline and accelerate close rate on acquisitions. Sizable acquisitions would create uncertainties for the cash pile.

- Failure to change investors’ perception: 

The company could continue to be viewed as a manufacturer of outdated hardware. 

Catalyst

International growth

New products

Successful adoption of smartphones into product ecosystem