Cerner Management Discusses Q4 2012 Results - Earnings Call Transcript

 |  About: Cerner Corporation (CERN)
by: SA Transcripts


Welcome to Cerner Corporation's Fourth Quarter 2012 Conference Call. Today's date is February 5, 2013, and this call is being recorded.

The company has asked me to remind you that various remarks made here today by Cerner's management about future expectations, plans, perspectives and prospects constitute forward-looking statements within the meaning of the federal securities laws.

Information concerning words intended to identify such forward-looking statements and factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading Risk Factors in Cerner's Form 10-K, together with other reports that are furnished to or filed with the SEC.

Please see the company's earnings release that was furnished to the SEC today and posted on the Investors section of for a discussion of the risks associated with forward-looking statements, as well as a reconciliation of non-GAAP financial measures discussed in this earnings call.

The company undertakes no obligation to update publicly any forward-looking statement, whether as a result of new information, future events or otherwise.

At this time, I'd like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corporation. Please proceed.

Marc G. Naughton

Thank you, Cheverly. Good afternoon, everyone, and welcome to the call. I'll lead off today with a review of the numbers. Zane Burke, Executive Vice President of our Client Organization, will follow me with sales highlights and marketplace trends. Mike Nill, Executive Vice President and Chief Operating Officer, will discuss operations and our 2013 areas of focus. Jeff Townsend, Executive Vice President and Chief of Staff, will follow Mike and discuss strategic initiatives. Neal Patterson, our Chairman, CEO and President, will be available during Q&A.

Now I'll turn to our results. We delivered excellent results in the fourth quarter and for the full year 2012 with strong growth across all key metrics. Our total bookings revenue in Q4 was $1.02 billion, which is an all-time high. This reflects 13% growth over our previous record results in Q4 of '11 when bookings grew 44%. Bookings margin in Q4 was $888 million or 87% of total bookings for the full year. Bookings revenue was $3.14 billion, up 15% from 2011. Our bookings performance drove a 19% increase in total backlog to $7.27 billion. Contract revenue backlog of $6.53 billion is 21% higher than a year ago. Support revenue backlog totaled $738 million, up 5% year-over-year.

Revenue in the quarter was a record $710 million, which is up 15% over Q4 of '11. The revenue composition for Q4 was $252 million in system sales, $154 million in support and maintenance, $209 million in services and $13 million in reimbursed travel. For the full year, revenue grew 21% to $267 billion (sic) [$2.67 billion]. System sales revenue reflects 14% growth from Q4 of '11 and 28% growth for the full year. While this growth was largely driven by an acceleration of device resale during 2012, we also had strong contributions from software and subscriptions.

Moving to services. Total services revenue was up 20% compared to Q4 of '11 and 22% for the full year, with strong growth in managed services and professional services, with increased contributions from ITWorks and RevWorks. Support and maintenance revenue increased 8% over Q4 of '11 and 10% for the full year.

Looking at revenue by geographic segment, domestic revenue increased 21% for the quarter and 24% for the full year. Global revenue was down 17% for the quarter due to a tough comparable and up 5% for the full year.

As a preview to the annual update of our detailed business model that we'll provide at our Investment Community Meeting on March 5, I'd like to provide you with the total revenue and growth by business model for the full year 2012. Licensed software grew 6% to $345 million. This followed strong growth in 2011 and makes 2011 and 2012 the strongest 2 years of software growth in a decade. Technology resale was up 59% to $392 million, driven by growth in device resale. Subscriptions and transactions increased 22% to $166 million. Professional services revenue grew 25% to $686 million. Managed services increased 19% to $417 million. Support and maintenance was up 10% to $604 million. And reimbursed travel was $55 million, which is up 24%.

Moving to gross margin. Our gross margin for Q4 was 78.4%, which is up from 77.9% in Q3 and flat compared to Q4 of '11. The sequential increase in gross margin was driven by slightly higher system sales margins and strong services margins. For the full year, gross margin was 77.2%, which is within 100 to 200 basis points of where we expect gross margins going forward as we believe the mix shift tied to the increase in device resale has moderated.

Looking at operating spending, our fourth quarter operating expenses were $386 million before share-based compensation expense of $10 million. This is a year-over-year increase of 14%, which is below the growth of our revenue and gross margin. For the full year, operating expenses were $1.45 billion, up 14% from 2011. This compares to revenue growth for the year of 21%, reflecting ongoing operating efficiencies.

Sales and client service expenses increased 15% compared to Q4 of '11 and 17% for the full year, driven by an increase in revenue-generating associates in our services business.

Our investment in software development was up 7% compared to Q4 of '11 and 5% for the full year. As we have discussed, we have been hiring in our R&D organization and expect our R&D investments to continue growing. This will be reflected in increased gross spending and increased capitalized software in 2013.

G&A expense increased 27% compared to Q4 of '11 and 11% for the full year. The higher year-over-year growth in Q4 is driven by increased personnel expense related to our strong growth, higher amortization expense and a slight FX loss in Q4 of '12 compared to gain in Q4 of '11.

Moving to operating margins. Our operating margin in Q4 was 24.0% before share-based compensation expense and was up 30 basis points compared to Q4 of '11. For the full year, operating margin increased 70 basis points to 22.9%. This is slightly below our 100-plus-basis-point target, but we achieved this margin expansion on approximately $160 million more revenue in 2012 than we originally projected. So even with slightly lower margin expansion, we still drove approximately $0.14 more EPS than we guided to going into the year. While some of this upside was driven by lower taxes early in the year and a gain this quarter that I'll discuss in a minute, we still drove out good incremental earnings on very strong revenue growth.

Going forward, our plan reflects continued margin expansion even with the increased R&D investments I mentioned. We expect the margin expansion to come from leverage across many of our business units and moderation of the disproportionate growth of device resale that impacted our 2012 margin expansion.

Moving to net earnings and EPS. Our GAAP net earnings in Q4 were $112 million or $0.63 per diluted share. GAAP net earnings included share-based compensation expense, which had a net impact on earnings of $6 million or $0.04 per diluted share.

Adjusted net earnings were $118 million, and adjusted EPS was $0.67, which is up 22% compared to Q4 of '11. Note that our other income for Q4 included a $4.5 million gain resulting from the sale of a company in which Cerner had a venture capital investment. This gain contributed to approximately $0.015 of our EPS upside. For the year, adjusted net earnings were $421 million, and adjusted EPS was $2.39, which is up 28% from 2011.

The Q4 tax rate for adjusted net earnings was 34%, which is in line with our expected effective tax rate. We also expect our effective tax rate to be approximately 34% plus or minus 50 basis points in 2013. The tax rate will be lower in Q1 as there will be a catch-up for the 2012 portion of the R&D tax credit that was approved after our year-end, but we'll still base our guidance on an effective rate of approximately 34%.

Now I'll move to the balance sheet. We ended Q4 with $1.55 billion of total cash and investments, up from $1.5 billion in Q3. Total cash and investments include $1.04 billion of cash and short-term investments and $509 million of highly rated corporate and government bonds with maturities less than 2 years. Our total debt, including capital lease obligations, is $196 million.

Total receivables ended the quarter at $578 million, which is up $35 million from Q3 and driven by strong sales in the quarter. Contracts receivable or the unbilled portion of receivables were $48 million and represents 8% of total receivables.

Cash collections were a record $690 million. Our DSO in Q4 was 74 days, which is similar to Q3 DSO of 73 days and down from 83 days in Q4 of '11.

Operating cash flow for the quarter was $181 million, Q4 capital expenditures were $53 million and capitalized software was $28 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was $99 million. For the full year, operating cash flow grew 30% to $708 million, and free cash flow grew 18% to $425 million, with capital expenditures of $183 million and capitalized software of $100 million.

Looking at 2013, we expect quarterly capital expenditures to remain in the $50 million to $60 million range as construction of additional space at our new Kansas City campus continues. At these levels, we still expect to generate good levels of free cash flow.

Moving to capitalized software. The $28 million of capitalized software in Q4 represents 33% of the $85 million of total investment in development activities. Software amortization for the quarter was $21 million, resulting in net capitalization of $6 million or 7% of our total R&D investment.

As I indicated, we expect capitalized software to continue increasing in 2013 as we invest in areas Zane, Mike and Jeff will discuss that will position us for strong growth through the decade. Note that much of the growth in capitalized software will be related to third-party developers we are using to accelerate development in certain areas. As a result, we expect the growth in capitalization to be temporary as we plan to moderate the use of third parties after 1 to 2 years. We view this approach, combined with our share buyback and small acquisitions, to be a good use of our capital.

Now I'll go through Q1 and full year guidance. For Q1, we expect revenue between $690 million and $715 million, with the midpoint reflecting growth of 10% over Q1 of '12. For the full year, we expect revenue between $2.95 billion and $3.05 billion, reflecting 13% growth at the midpoint. We expect Q1 adjusted EPS before share-based compensation expense to be $0.61 to $0.63 per share, with the midpoint reflecting 15% growth over Q1 of '12 reported adjusted EPS and 19% growth when you consider the $0.02 benefit we had from lower taxes in Q1 of '12. For the full year, we expect adjusted EPS between $2.75 and $2.82, with the midpoint reflecting 17% growth to our reported adjusted EPS. This reflects 20% growth when you adjust 2012 for a lower tax rate in Q1 and 2 and the gain on the investment sale we had in Q4. These items collectively benefit EPS by $0.075 in 2012, which we indicated when we reported the results during the year. Q1 guidance is based on total spending before share-based compensation expense of approximately $385 million to $395 million. Our estimate for the impact of share-based compensation expense is approximately $0.04 in Q1 and $0.16 to $0.17 for the full year. Moving to bookings guidance, we expect bookings revenue in Q1 of $720 million to $760 million, with the midpoint reflecting 13% growth over our strong Q1 '12 bookings.

In closing, we are pleased with our strong results in 2012, with us again delivering a year with strength across all key metrics. As the rest of the team will discuss, we are positioned for a strong 2013 and beyond.

And with that, I'll turn the call over to Zane.

Zane M. Burke

Thanks, Marc. Good afternoon, everyone. Today, I'll provide sales highlights and discuss marketplace trends.

Starting with our results. Our bookings revenue in Q4 of $1.02 billion is an all-time high and reflects 13% growth over Q4 of '11, which is our previous all-time high. For the year, bookings revenue was up 15% to $3.1 billion. This growth is on top of our 37% growth in 2011, giving us a 2-year compound annual growth rate of 25%. It is worth noting that our record bookings in Q4 was achieved without an ITWorks or RevWorks contract in the quarter. We had 30 contracts over $5 million, including 17 over $10 million, driven by strength both inside and outside our installed base. The mix of long-term bookings was 33% in the quarter, which is in line with historical levels, primarily driven by very strong levels of managed services. For the year, long-term bookings represented 31% of total bookings, which is the same as last year.

A major highlight of our quarter and year was our continued success at gaining market share. This is reflected in the 35% of bookings in the quarter and 30% for the full year coming from outside our core Millennium installed base. Recall that in 2011, we had grown our bookings from outside our base by more than 50% over 2010. In 2012, we delivered double-digit growth over that tough comparable. And when you look at 2011 and 2012 combined, our bookings from new clients are approximately equal to new client bookings for the prior 4 years combined.

In Q4 alone, we had several signature wins against our primary competitor, including being selected by Los Angeles County Department of Health Services for a broad suite of solutions, services and hosting, making it one of the largest contracts in our history. In addition, the largest provider of health care services in Kansas, Via Christi Health chose Cerner to provide a broad suite of acute ambulatory and revenue cycle solutions and services to support their population health management initiatives.

We entered 2013 with a level of competitive momentum I have not seen since the early 2000s. This is driven by several factors, including our improvements and ongoing investment in key areas such as physician experience and revenue cycle; our proven and predictable services and operational capabilities; our ability to drive value, improve quality and performance, reduce costs and drive reimbursement; our leadership in population health capabilities and ongoing investments in our comprehensive operating system for population health, which is becoming more prominent in discussions with prospective clients; and we are also benefiting from the challenges faced by many of our competitors, including leadership turnover, integration challenges, platform limitations and issues with offering their clients a clear path to meet the rising bar for Stage 2 and Stage 3 of Meaningful Use and additional requirements for Value-Based Purchasing, ACO and population health.

The opportunity both in our base and for new footprints is very apparent in our pipeline, which increased substantially during 2012. The pipeline strength is well-balanced between new client opportunities and our installed base. In total, our pipeline has doubled over the past 2 years, which is particularly impressive when you consider the fact we have signed record levels of bookings out of the pipeline during that same time.

Now I'd like to provide some additional 2012 highlights. We continued to have strong success in 2012 at building our presence across the continuum of care. An important component of this is our traction in the physician market, where we had 29% growth and 30% revenue growth, which was driven by our improved solutions and our clients' increasing desire to expand their Cerner platform to employed and affiliated physicians. Beyond the physician office, we differentiate our ability to provide solutions for other venues such as ambulatory surgery centers, behavioral health, urgent care, home health, occupational health, rehabilitation hospitals and skilled nursing and long-term care facilities. As we have discussed, with reimbursement increasingly tied to quality and outcomes and more care shifting to different settings, the ability to coordinate care across multiple venues is becoming critical. These capabilities are also important to our population health efforts. Our current capabilities and comprehensive vision for population health are becoming a bigger part of the consideration process when we're competing for new business, and this is clearly a trend that favors Cerner.

Another area of noteworthy strength was in revenue cycle. Mike will provide an update on revenue cycle, but I wanted to note it, as the progress we've made in the past year and the ongoing investments we are making in revenue cycle are critical. Revenue cycle is part of almost every new business discussion, and our ability to deliver an integrated revenue cycle solution is a key competitive advantage. In addition, the amount of opportunity in our existing client base is significant, and we are starting to see that play out with some of our largest clients embracing our revenue cycle solutions and services.

Moving to DeviceWorks. As we have discussed throughout the year, our DeviceWorks organization made major contributions to Cerner's growth. Our clients' interest in using Cerner as a single source for connected devices continues to increase. In addition, more major device manufacturers are looking to Cerner to be resellers because they recognize the value of our device connectivity platform and the strategic relationships we have with our clients. I also remain impressed with the ongoing innovation within our DeviceWorks organization. As an example, we recently launched CareAware Connect, which is a nursing mobility solution that delivers communications such as voice, text and alarms, along with EHR workflow tools on a single smartphone device. I'd also like to point out that the growth in technology resale was not solely driven by devices. In fact, we had very strong growth in both hardware resale and sublicensed software. This balanced contribution to growth, particularly from sublicensed software, led to a strong growth in margin dollars from technology resale, so this business is contributing to more than just our top line.

Outside of the U.S., we continue to have good results in Australia, Canada and the Middle East. However, we did have lower revenue year-over-year in Q4 due to the ongoing soft global economy that impacts many of our markets. We also had a tough comparable, last year's Q4 having grown 35%. Full year growth outside the U.S. was 5%. While our results may continue to be lumpy, I remain optimistic about our global opportunities, and this outlook is supported by pipeline that is up more than 40% year-over-year.

Another highlight for us in 2012 was the success of our clients at demonstrating industry-leading levels of achievement with information technology. During the year, we had nearly double the number of client sites achieve Stage 6 or 7 status on HIMSS EMR Adoption Model than our closest competitor. We also have the most Stage 6 and 7 hospitals outside the U.S., with clients in 5 different countries achieving Stage 6 or 7 status in 2012.

Moving to some broader marketplace observations. Prior to 2012, there was clearly a major focus on Meaningful Use Stage 1. We have seen a shift to focus to Stage 2 and beyond. The focus over the past 3 years has been enough to create a clear distinction between the winners and losers in this industry. As providers look at the increasing complexity of compliance beyond Stage 1, more of them are reevaluating their supplier strategy. And many other suppliers, including our primary competitor, are showing signs that they will be challenged by the increasing requirements and have tried to push back on them. As a result, we enter 2013 with significant opportunities to displace other suppliers and in a stronger competitive position against our primary competitor.

In addition to Meaningful Use, the volume of measures and mandates our clients have to address is accelerating. With health care reform beginning to be implemented, along with countless other programs such as Value-Based Purchasing, quality reporting, ACOs, our clients are faced with an unprecedented decade of change. As they begin to experience the impact of these changes, they are looking to us for solutions and services that help them navigate these major shifts in the industry. One thing that became clear during 2012 is that our clients no longer need to be convinced they need a population health strategy. They now see it as the only way to address the inevitable shift to a model that incents quality and outcomes over volume.

The final industry trend I'd like to highlight is the ongoing consolidation among providers. Providers are looking for scale and to have more control over the complete continuum of care. As a result, hospitals are actively buying other hospitals, as well as buying physician practices and other outpatient facilities. This is the trend that benefits Cerner given our ability to offer integrated solutions across the continuum of care, and our strong market share, which includes a relationship with 7 of the 10 largest health systems in the U.S. and many more IDNs that are actively doing acquisitions.

With that, I'd like to turn the call over to Mike.

Michael R. Nill

Thanks, Zane. Good afternoon, everyone. Today, I'm going to discuss ITWorks, revenue cycle and our other areas of focus for 2013.

I'll start with ITWorks. While we did not sign an ITWorks client in Q4, 2012 was still a great year for ITWorks. We added 3 ITWorks clients during the year, which is the same as 2011, but ITWorks bookings still grew 30% based on larger contract sizes and scope expansions.

Overall, 2012 was a year during which the value of strategic alignment created by ITWorks relationships became increasingly clear. Most of our ITWorks clients expanded their relationship with Cerner in some way. Several of them expanded the scope of their ITWorks engagement, bought more solutions and adopted our employer wellness offerings. We also had 1 ITWorks client become a RevWorks client, and this client is now fully aligned with both solutions and operational support across the suite of clinical and revenue cycle solutions.

Overall, our clients are embracing the deep relationship created by ITWorks and view it as a part of their strategy to be successful in this period of rapid industry change that Zane discussed. Benefits of strong alignment is also evident in the accomplishment of our ITWorks clients, as all of them have attested or are in the process of attesting for Stage 1 Meaningful Use, and almost 3/4 of them have achieved HIMSS EMR Adoption Level 6 or 7.

This success and high client satisfaction is contributing to an increased pipeline for ITWorks, and I am confident, in 2013, we'll have another great year.

Moving to revenue cycle. 2012 was a very strong year for revenue cycle for both sales and operations. Revenue cycle bookings increased 26% in 2012, and this is following a strong 2011 during which bookings had more than doubled. The year included our fifth RevWorks client, which we announced in Q3, and it's our largest to date.

Operationally, we significantly advanced our revenue cycle portfolio of solutions and achieved a major milestone by surpassing 100 hospital sites in our patient accounting solution. As Jeff mentioned last quarter, we bought -- we brought 24 solutions within the revenue cycle suite to general availability over the last 18 months. Our expanded portfolio of solutions, coupled with our strong execution at delivering them, is creating momentum for us at a very critical time. Revenue cycle is part of every new business discussion, and it is essential to the success of our client base, because providers will be facing unprecedented changes in reimbursement structures in the coming years.

Further strengthening our position is that more of our large clients are beginning to fully embrace our revenue cycle solutions. For example, Adventist Health System, one of the largest and most respected health systems in the U.S., is deploying additional Cerner revenue cycle solutions to their 39 hospitals, with the first site going live last month. This builds on their existing Cerner access, scheduling, HIM and case management solutions and will result in them having a full suite of revenue cycle solutions in all of their hospitals.

Further validation of our progress in revenue cycle occurred in Q4 when another one of our large and prestigious clients, Adventist Health, a separate client from the Adventist Health System, signed a contract with us to implement a revenue cycle platform across acute, ambulatory and post-acute venues, with the first site scheduled to go live later this year. The scope of this project includes Cerner's end-to-end revenue cycle portfolio, remote hosting, application management and upgrade center. In addition to covering Adventist Health's 19 inpatient facilities, the scope of the project includes more than 150 clinics in 4 Western states. Note that in 2011, Cerner was chosen by Adventist Health to replace our primary competitor's clinical solution in their outpatient facilities. We are now their supplier for end-to-end clinical and revenue cycle solutions throughout all of their venues.

For both Adventist Health System and Adventist Health, their agreements represent a platform that will allow them to adapt to the changing reimbursement models while improving quality, patient safety and financial performance.

In summary, we are in a very strong strategic position in revenue cycle. Our comprehensive and integrated approach is unmatched in the industry, and I believe our revenue cycle business is entering a significant phase of growth that will last for several years.

Before handing the call over to Jeff, I'd like to share our areas of focus for 2013, which mostly build on the significant progress we made in 2012. First, we are going to increase our investment we are making in the physician experience. With Meaningful Use driving adoption at unprecedented level, we believe it is critical to provide physicians with solutions that are fast, easy and smart. In 2012, we brought PowerChart Touch, our native iPad app, from vision to reality by bringing the solution live at 13 early adopter sites. We are now working with 29 beta clients that have 1,800 ambulatory physicians and 3,500 inpatient physicians and are getting ready to roll out significantly expanded functionality.

In 2013, we are accelerating our investment in physician solutions, including continued expansion of functionality that will build out specialty workflows for PowerChart Touch. In addition, we're continuing to roll out improved workflows and a new look and feel across all of our solutions.

The second area of focus and increased investment in 2013 is revenue cycle. As I discussed, we had a great year in 2012 with rolling out additional functionality and getting our large clients to adopt our revenue cycle solutions. This progress has been well-received by our client base and is reflected in significantly improved KLAS scores, a large pipeline of revenue cycle opportunities in our installed base, and improved competitiveness for new business. In 2013, we continue to invest heavily in our core revenue cycle solutions and further differentiate and integrate clinical and financial platforms. Examples include advancements in computer-assisted coding and population analytics capabilities that enable aggregation of both clinical and financial data sets and support outcome-based reimbursement models.

Our third area of focus in 2013 is continued investment in population health. We have been investing in elements of population health for several years, and we increased that investment in 2012. Our clients are now committed to population health and are looking to us for solutions. We're going to increase our investment in population health and build a comprehensive platform that will clearly -- that will be clearly differentiated and superior to the current piecemeal approach that is evolving in the market today.

I believe these areas of focus and investment in 2013 will have a very positive impact on our competitiveness. By strengthening our physician and revenue cycle capabilities and advancing our population health platform, we will widen competitive advantage and expose the weaknesses of our primary competitor. We refer to these areas of focus as PPR: physician, population and revenue cycle. Jeff will detail additional initiatives that overlay PPR in his comments.

In summary, I am extremely pleased with our execution in 2012 and believe we will create significant differentiation in 2013 that will position us to continue our strong growth through this decade.

With that, I'll turn the call over to Jeff.

Jeffrey A. Townsend

Thanks, Mike. Today, I will build on comments Zane and Mike have shared, recapping our 2012 efforts around population health, as well as outline the next wave of strategic priorities being embedded into our focus for 2013.

In 2012, we made good progress at advancing elements I view as foundational to population health. These early accomplishments already differentiate Cerner. We advanced adoption of our Healthe Intent platform, with Chart Search adoption exceeding half of our client base and the adoption of our sepsis cloud-based algorithm accelerating and driving more widespread proof points where clients are significantly reducing sepsis mortality rates. Both of these initiatives have produced deep, rich understanding of the opportunities and innovations ahead as we innovate in a post-digitized EMR era.

A highlight of 2012 was the launch of our partnership with Advocate Health Care that has quickly led to joint development of a predictive agent for readmissions that has demonstrated a 20% to 30% improvement in predictive power as compared to the majority of existing models. We continue to see significant potential from working side-by-side with one of the most advanced population health organizations in the country.

The portfolio of solutions that support our population health initiatives had a very strong year in 2012. Our Cerner Network interoperability and HIE offerings, which support data liquidity, grew by more than 50%, and our Lighthouse Enterprise Data Warehousing and Quality solutions grew more than 20%. We also advanced our patient portal platform, PHR solutions and employer wellness offerings.

In addition to the PPR focus that Mike shared, we have added initiatives we refer to as CIM+1, representing the continuum of care, intelligence, the member and personalized medicine.

The C represents the continuum of care, focusing on a level or coordination and collaboration across all venues of clinical interaction. As part of this focus, we recently aligned additional groups under the population health umbrella, including home care, long-term care, retail pharmacy, research, workforce management and healthy athlete. By bringing these groups together, along with our existing quality, network, employer and consumer-focused innovations, we have created more focus on the entire continuum of care, allowing for new health and care delivery models to emerge beyond today's silo-based orientations. We think this is a very strategic direction that will leapfrog us ahead of traditional delivery models as we support emerging models of medical homes, chronic condition management and at risk for health business models.

Moving on to intelligence. We have continued to expand both our Millennium and Healthe Intent platforms to embed more sophisticated decision support within the workflow and data management layers of the architecture. Last quarter, we announced a clinical programming language called Synapse, which creates agents within the Healthe Intent operating system to trigger and coordinate health care programs across a population. In 2013, bringing the smart elements of population health inside the day-to-day workflows of both the physician and continuum of care efforts will emerge as a significant differentiation for those organizations focused on taking the variance out of care delivery. As more and more of the revenue cycle aligns with Value-Based Purchasing and outcome objectives, the ability to programmatically manage evidence-based care across a delivery system will be critical for those organizations taking on more risk.

The third of the layered initiatives is for member. Similar to the objectives around the continuum of care, the role of the individual and their family will be represented across the breadth of solutions. As new delivery models are emerging, the majority of them are designing beyond the boundaries of a patient to include a more lasting relationship before and after care is needed. The ability for the platform to know me is not only differentiating as organizations compete in their markets but is also fundamental to the ability to apply contextual intelligence to their individual needs.

Last is the +1, representing personalized medicine and the inclusion of the genome in the life cycle of individualized diagnosis and treatment. Cerner invested in this area early on with Millennium Helix and is now seeing an acceleration of bench to bedside activity as the procedure costs continue to drop. Much like the other initiatives, this too becomes a fundamental component of the broader platform to apply across the operating system for population health, well ahead of the marketplace.

Before closing, I'd like to discuss the importance of data liquidity as we've been increasingly vocal around our support for interoperability and the importance this will have on realizing the benefits of a digital health economy. As part of our commitment to universal data liquidity, Cerner has contributed tens of thousands of lines of open-source software, personnel and money towards the development of the Direct Project, which is a standards-based method for electronic sharing of encrypted health information. Going forward, we believe the industry needs to continue to step up to the challenges of interoperability, including the patient identification. We need to set aside the admittedly tough politics of this issue and do what is right for the health care consumer.

For the level of care coordination we envision in the future, comprehensive health data should be available in a secure and trusted manner to patients and providers regardless of where care occurs, and provider access to this data must be built into EHR technologies and available for use by a broad range of health care providers and the patients they serve.

In closing, this decade offers us the chance to put a true system in the health care. Some of our competitors argue we're moving too fast and that Meaningful Use is too complicated. We believe we cannot move fast enough, and the complexity is the nature of our industry. In our view, the pace of change is exposing vulnerabilities of our competitors' platforms and their inability to adapt to increasingly complex requirements. We believe this rising bar of industry requirements will play to our advantage, and our investments in 2013 are focused in areas that will ensure we continue to widen this differentiation.

With that, I'll turn the call over to the operator for Q&A.

Question-and-Answer Session


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

Ryan Daniels - William Blair & Company L.L.C., Research Division

A lot of conversation tonight about population health and kind of the changing end market environment and how that positions you competitively. Can you talk about, as you look at the pipeline, if that's manifesting solely in a higher win rate today on new accounts or if you're actually starting to see some competitive displacements enter that pipeline at this point?

Zane M. Burke

This is Zane, Ryan. What we are seeing is a bit of both of that, and what it is, is it's the vision for population health as we talk about a full operating system for our population health model. And we have a robust business today in the population health space but -- in terms of HIE and in terms of some of the analytics that we do today. But it's really the vision that we're taking them on, and we're seeing that in the win rates increasing, as well as we see that manifesting in the pipeline itself.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Given the investments that some of these larger systems have made with your primary competitor, is there anything you can do to make it more palatable to switch over? Or is it certain -- just going to be the urgency of the need for kind of better platforms and more data liquidity in the future that forces that move even if they sunk a lot of money into the system?

Zane M. Burke

The short answer is, there's never going to be a great time to switch, but there's not an opportunity to stand fast either because they are forced to make changes because of the -- the penalties are so great. I'm not really speaking about the Meaningful Use penalties as much as I think about the changes in their reimbursement environment. From a quality perspective and otherwise, the cost of these systems are insignificant in relation to the challenges they are faced from a reimbursement perspective overall around quality.


Your next question comes from the line of Lisa Gill with JPMorgan.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Marc, I was wondering if maybe you could just give us a little bit more color on some of the bookings in the fourth quarter. I think you talked about 10 deals being greater than $17 million, and I think you specifically called out the L.A. Department of Health. Can you give us maybe just a little more color around that relationship? And do you see other opportunities similar to that with other government-type relationships?

Zane M. Burke

This is Zane. So I'll answer, Lisa. Obviously, the L.A. Department of Health relationship is -- we've got a very strong client footprint in Southern California and a very active network there and have had a lot of success in that marketplace overall. And that's been an opportunity we've been working on for several years. There is -- the public health overall has the same challenges and needs that overall health care has. They've got to go and solve these broader problems around managing the population. In fact, they have the bigger impetus. And so I think there is a bigger marketplace both in the local marketplace, as well as the state and federal levels, for the types of technologies that we deliver and offer to provide value. And we see that as a market opportunity for us moving forward.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

And Zane, just a follow-up on that. Is there another technology that's in there today and so you're coming in and you're replacing it, and that's going to be the opportunity for Cerner? Or is it that when you think about these public health entities, they have no technology at all today and it's a matter of convincing them that they need to move in that direction as the world just evolve?

Zane M. Burke

It's a combination of both, Lisa. It's -- in the case of L.A. County, there has a lot of replacement technology engaged in that situation. At the state level, they are in need of technology. They're in need of thinking about this -- about solving the problems they're faced in -- they're facing in a different way. And so -- and I would say that also applies at the federal government level. So those are net new technology areas.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Okay. And I think it started out by saying this was clearly part of one of the larger deals that you signed. Can you give us any other incremental color on some of the larger deals that you signed and your bookings in the fourth quarter? And I'll stop there.

Marc G. Naughton

Lisa, it's Marc. Basically, we had good segmentation of larger deals. As we said, the numbers were similar to what you would have seen. In the year-ago quarter, probably had 4 of them that were over $40 million. And so we had some significant transactions. I think the interesting thing to me was we had very strong representation in our hosting business. So something that we've kind of taken for granted that makes up one of the components of our longer-term bookings. And a quarter where we didn't have any RevWorks or ITWorks, we still delivered strong longer-term bookings because of some of these new relationships also adopting hosting as part of the overall view of operating Cerner Solutions. So I think that's probably the color I would add.


Your next question comes from the line of Dave Windley with Jefferies & Company.

David H. Windley - Jefferies & Company, Inc., Research Division

So to follow up on the bookings, you said, I think, in the fourth quarter, your long term was 33%. It's run around 30%. Is your expectation that it will continue to run around 30%? Or would some Works contracts kind of catch up here in the absence -- and the fact that you didn't have one in the fourth quarter, will we see works get heavier and maybe drive the percentage up?

Marc G. Naughton

Yes, this is Marc. I think the last 2 years, you've seen our long-term bookings kind of be in the 30% to low 30%. I don't know that there's anything that we see in the pipeline that's going to materially change that. The ITWorks and the RevWorks bookings are good-sized deals, but there's -- they kind of are in our pipeline that roll out over a period of time. I don't know that we expect to see a flurry of them land in any single quarter. Certainly, if we did, we would give you some notice of that. But I think we're continuing to see that mix as we expect to continue growing bookings overall. I think the percent of those bookings in the long term will remain fairly consistent.

David H. Windley - Jefferies & Company, Inc., Research Division

Okay. And that segued nicely into my next question, which is, your views for bookings growth for 2013, your first quarter in which arguably is your toughest comp, your guidance suggests a mid-teens bookings growth. Is that directionally how we should be thinking for the full year in light of comps kind getting easier? Or do the law of large numbers start to catch up with you over $1 billion?

Marc G. Naughton

Yes, this is Marc. Yes, comps are getting easier when we just booked a billion-dollar quarter. I'm not sure that those are -- if that would be the way, I would phrase it. As we do any time, the more detailed bookings guidance we can provide is on a quarter-by-quarter basis. We certainly expect to grow bookings in 2013 over 2012. I think that's consistent with what we said on our last call. I can't quantify that, but certainly, our guidance in Q1 would support that statement we made a quarter ago.


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

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

I guess maybe, Marc, the first question, just to follow up on the composition of bookings. You mentioned that remote hosting or remote services had a good quarter. Was there maybe a good-sized deal in the U.K. as you're renewing those relationships that contributed during the quarter or something like that?

Marc G. Naughton

Jamie, there's nothing in the U.K. that was a contributor to our -- to the big deals that we talked about, certainly, the 4 over $40 million.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay. And then, I don't know, Zane or Mike, whoever wants to take this. I think for the last couple of years, you guys have signed a few Works deals in the third quarter, and I was just wondering if there was anything different that's developing today. I know that you spoke to the fact that the pipeline seems to be pretty robust. But to go from 3 last year to none in the fourth quarter this year, I was just curious if there was any change in the marketplace that would have been driving that or is it just purely a sense of timing?

Zane M. Burke

This is -- Jamie, this is Zane. It's purely a sense of timing. We see this as a great opportunity for us on both the RevWorks and the ITWorks side of the house, and we anticipate continued performance on both of those businesses. As you look at them on an annual basis, they tend to be a little bit lumpier because, again, it's a small number of transactions that get completed. As you might understand, they have quite a bit of process to them. And so we manage them very closely. We see a great amount of pipeline and feel very good about both those businesses. But we -- I anticipate continued -- a little bit of lumpiness just because of the nature of the types of contracts and transactions that they are.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Do you expect ICD-10 to drive a big acceleration for RevWorks in 2013? Or I guess maybe I should just say, do you think that there's a better chance of seeing a real inflection point in that business?

Zane M. Burke

I think the inflection points are really based on our performance. So more so than the ICD-10, which there will be additional work around that and whether that yields itself in full RevWorks out -- full outsourcing, there's additional services work that we certainly will see as a result of that. But I think what we believe will drive a bigger, higher percentage of growth is the sustained performance that we're having and experiencing with our existing clients today. And as that story becomes much more broadly understood, I think that will continue to drive bookings in a better way.


Your next question comes from the line of George Hill with Citigroup.

George Hill - Citigroup Inc, Research Division

I've got a question for Neal, if he's still on the line. Neal, business continues to chug along extremely strong. I'm just interested in the types of conversations that you're having with customers and having with counter-parties in this space. We read about your testimony down in D.C., Cerner moving from a position of vendor to thought leader in this space. I guess I would like your characterization of what you see is the opportunity both near term and medium term as based upon what you're working on.

Neal L. Patterson

George, I'm not sure that testimony I gave was actually going to change the perception of the marketplace with regard to Cerner, but I was very candid as always there. And broadly, I think the conversations I'm having in the marketplace are kind of reflective of how the marketplace is becoming basically -- there's a choice between 2 companies, and we certainly positioned ourselves and always have been as been one of the major innovators in this industry or the innovator in this industry, actually. So the number of those very broad conversations is increasing on my calendar, both as our current clients, as well as prospective clients. So it's a very good time.

George Hill - Citigroup Inc, Research Division

Okay. And I guess maybe just a quick follow-up then for Marc. I guess can you walk us through again given the L.A. deal that was signed and the strength of the bookings in the quarter? What are we seeing with respect to how new business is booked and goes into the backlog and goes into revenue recognition? And I guess I'm just trying to understand, are we seeing a slower pull-through of the software revenue recognition as we're waiting for some of these customers to get deployed and go live? And I guess I just -- I would have expected to see more revenue pull through in the quarter from such strong bookings, from such a large deal like L.A. Maybe just walk us through that again for our benefit.

Zane M. Burke

This is Zane. As it relates to L.A. County and without divulging any of the confidentiality pieces of that, oftentimes, in government situations, you have many more milestone-based type arrangements. And so I do think it's a bit unique in that regard in that you have a longer-term process. And so I think that's part of what you're seeing in that particular situation.

George Hill - Citigroup Inc, Research Division

Okay. And then maybe -- well, just one more. Was that milestone-based process, was that part of your competitive ability to win? Was that something that you offered that competitor did not?

Zane M. Burke

No, that's part of dealing with a governmental entity. You're going to have that.


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

Sean W. Wieland - Piper Jaffray Companies, Research Division

I want to squeeze in a couple of questions around your data and analytics initiatives, maybe what I'd call your Big Data initiatives. Can you quantify what level of R&D investment is going into these programs? Tell us what the technology platform is that you're using to deliver the new initiatives and what's the revenue model for the business?

Marc G. Naughton

This is Marc. Relative to the investment, I mean, it's kind of when you're certainly utilizing the Millennium platform for a lot of this and other platforms as well. The teams that are created to go pursue a lot of these innovation aren't large teams. It's more of a matter of the entire community of development that we work through. So I think from an economic standpoint, it's certainly part of our increased R&D investment that we talked about, that you saw us do in 2012 and you'll see us do again in 2013 as we push hard to get through some innovation projects that will position us well going to '14 and beyond. But Jeff, [indiscernible].

Jeffrey A. Townsend

Yes. So I'd probably put our Big Data efforts into 3 buckets. One, we've talked about for a very long time is our Health Facts data repository, which has 35-some-odd million patients covered over more than 10 years now. So you're accounting in a billions of rows type of metaphor there, which we use a fair amount in creating or validating published evidence. So as I mentioned, the readmission project with Advocate, we would have taken publicly available guidelines, validated those guidelines against that large database and then begin to develop new algorithms. So we have that as our backdrop. I think the other thing that's unique as we talk about population health is we don't look at Big Data as purely a repository to go run reports and do analysis off of. We look at that as a live, interactive environment that is capable of real-time decision support. So as we talk about things like sepsis, it is a very large database with lots of data sources hitting and, at the same time, constantly being monitored against health programs as we define it. And then the third area, as Marc kind of hit on, is purely the big -- is what we call Cerner Math. So that is discovering using mathematical techniques that other industries use heavily, especially in the financial area, to find patterns in the data that may not be current evidence to attempt to then convert that into executable knowledge.

Sean W. Wieland - Piper Jaffray Companies, Research Division

That all sounds great. Can you just comment on the revenue or the business model behind this?

Jeffrey A. Townsend

The business model will vary there from a -- some of these capabilities are your traditional licensed software. So a client is buying an enterprise data warehouse with platform on top of it, and they're driving things like quality measures. Other elements in there will include things like our Lighthouse quality reporting initiatives, which is more around standardized mandates. And then the third around things like readmissions and new algorithms would be things that we would push out on more of a subscription basis. From a roll-up, I think we have it in here the number kind of broadly across that umbrella of the population health. Marc probably has the number in front of him.

Marc G. Naughton

Yes, I mean, right now, that business is about $150 million business for us from a revenue perspective as we continue to evolve and to kind of consolidate things into that space. We kind of expect it to be quickly a $300 million business, with some of that being existing businesses that we roll in, some of it being growth. So it's -- the big business model is stuff that we're still working on. So the true population health management, logically, it feels like it's going to be a per member per month so it aligns with the entities that -- how the entities are getting paid that are going to utilize these solutions. But that actually -- that's still to be determined at this point.

Jeffrey A. Townsend

Yes, the triggering event for that is when our clients begin taking more risk, and that's how they're getting paid, then you'll see our business model shift that way. But in the early stages of the experimentation of ACOs and the startup-type risk initiatives, it's a little bit more of a traditional model.


Your next question comes from the line of Steven Valiquette with UBS.

Steven Valiquette - UBS Investment Bank, Research Division

So just a big picture question on competitive landscape. It seems like based on some recent channel checks, it's been growing feedback that some of your largest competitors are not succeeding in larger RFPs because of long lead times for implementation. So I guess just generally speaking, when we think about Cerner's implementation times on key product offerings, especially as it relates to Meaningful Use Stage 2, do you think this is accelerating as a variable for you to exploit as an advantage in RFPs over the next year or so?

Zane M. Burke

This is Zane. That's probably not the primary driver in the competitive side of this. I do think there are -- there certainly are -- there's a lot of work for people I refer to as a full employment act for health care IT professionals. So there is a ton of things to get accomplished, and our clients are faced with all sorts of mandates. And so staffing is certainly a consideration for many. We are well-prepared in that space to deliver, and we've proven over time that we know how to scale and grow in a different way. And that is one of the capabilities we provide. And so it's a level of confidence that our clients and prospects have in what we do that perhaps -- that others don't have some of those capabilities and operating efficiencies. But it's not the primary driver.


Your next question comes from the line of Steve Halper with Lazard Capital Markets.

Steven P. Halper - Lazard Capital Markets LLC, Research Division

Marc, specifically, regarding your commentary on margins, I know the goal had been to increase margins 100 to 200 basis points, and we understand the impact of lower margin device resale and the absolute operating profit being better than expected. But are you backing down from that goal for 2013?

Marc G. Naughton

Well, Steve, I think the way I would state the goal, which is pretty consistent, I think, with what it's been is that we're going -- we expect and our guidance would reflect that we're going to drive greater than 100 basis points growth in 2013. So the impact of the significant increase in the hardware, as you mentioned, the devices that hit us in 2012 certainly made growing the percent of operating margin more challenging. But now that, that's normalized into the income statement, I think you'll see us be able to continue growing overall businesses, especially those businesses that are higher margin such as software. Zane gave an example of some contracts where some of that software is going into backlog, probably more than you might have seen us in the past. So we have actually software coming out of the backlog, which is high margin, something we wouldn't have seen 3 or 4 years ago. So we still, based on our guidance, based on our plans, would indicate that we'd expect to exceed 100 basis points. We wouldn't necessarily cap it at 200 basis points. But I think exceeding the 100 basis points is a consistent message with what we've been saying and reflective of what our guidance is.

Steven P. Halper - Lazard Capital Markets LLC, Research Division

Good. And then, Zane, just quickly, could you talk to some of the success that you might have had in the small hospital market in the last quarter or so?

Zane M. Burke

Sure, Steve. We did actually have some good success in our community works offering and actually are nearing 50 clients in that space. We had a couple of significant competitive wins over both the EPIC extensions, as well as the other principal competitors in this space. And so we actually see this as a very robust market for us.

Steven P. Halper - Lazard Capital Markets LLC, Research Division

Great. And are these wins replacements or new opportunities?

Zane M. Burke

Most often, they have some sort of technology in place.


Your final question comes from the line of David Larsen with Leerink Swann.

David Larsen - Leerink Swann LLC, Research Division

As far as your base goes, is it fair to say that 85% are at Stage 1 as of now?

Marc G. Naughton

Yes, I think the -- if you look at -- based on the timing of attestations, when that comes up, by the end of Q1, 85% of our base will have completed the attestation process, the rest of them scheduled to occur in '13.

David Larsen - Leerink Swann LLC, Research Division

And then when we say 30% of bookings are from outside the Millennium base, are these typically hospitals that went with a competing vendor? They thought that vendor was going to bring them through Stage 1, and then they're now switching. Is that -- are those mainly Meaningful Use replacement wins, that 30% outside Millennium?

Zane M. Burke

They are typically a replacement of some sort of existing technology. And so as we think about it, it's really creating the platform for the future, which does include some of the Meaningful Use elements. But most clients are really looking at what they need to operate in a future environment around ACO initiatives, around bundled payments, et cetera. Meaningful Use is just another one of those elements that they have to factor into the mix.

David Larsen - Leerink Swann LLC, Research Division

Okay. And then just lastly, the licensed software number, $345 million, up 6% year-over-year. I mean, is that 6% growth rate in 2013, is that a reasonable estimate going forward as well?

Marc G. Naughton

Yes. We don't really guide to the components of the income statement, but we are expecting bookings to grow. So you would expect elements on the income statement to grow as well.

David Larsen - Leerink Swann LLC, Research Division

Okay. Great. And then if I can, just 1 more. As far as your rev cycle deals go, is there any way to size sort of what portion of the bookings those were in the quarter? It sounds like you've got the full solution set: acute care, ambulatory, post-acute. You've got the whole spectrum for population health management. Within that $1 billion of bookings, any way to size sort of what portion are tied to rev cycle? I'll stop there.

Marc G. Naughton

Well, clearly, we indicated that for RevWorks, which are bigger outsourcing-type deals, that there were none in Q4 for that. Relative to rev cycle and overall revenues, it would have been a normal component, along with our other solutions. Zane, do you have any other color on that?

Zane M. Burke

The other color I'd add is most new business includes revenue cycle as part of that. So you can pretty much look at the 35% of bookings. Of our new business bookings in the quarter, that revenue cycle was a key contributor as part of that process.

Marc G. Naughton

Appreciate -- this is Marc. Thanks, everyone, for being on the call with us. We expect to have a very solid 2013. We're very pleased with our 2012 results. We continue to enjoy being a company who's innovating and moving forward in a sector that seems to be very concerned about trying to deliver things that are in the rearview mirror for us. So with that, I bid you good afternoon. Thank you.


Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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