Cerner Corporation F1Q09 Earnings Call Transcript

Apr.29.09 | About: Cerner Corporation (CERN)

Cerner Corporation (NASDAQ:CERN)

F1Q09 Earnings Call Transcript

April 28, 2009 at 4:30 pm ET

Executives

Marc G. Naughton - Senior Vice President & Chief Financial Officer

Michael G. Valentine – Executive Vice President, General Manager & U.S. Client Organization

Earl “Trace” Devanny, III - President

Jeffrey Townsend - Executive Vice President

Neal Patterson - Chairman & Chief Executive Officer

Analysts

Charles Rhyee - Oppenheimer

Michael Cherny - Deutsche Bank

Steve Halper - Thomas Weisel Partners

Sean Wieland - Piper Jaffray

Anthony Vendetti - Maxim Group

Atif Rahim - JP Morgan

Frank Sparacino - First Analysis

Gene Mannheimer - Auriga USA

Sandy Draper - Raymond James

Operator

Welcome to the Cerner Corporation’s first quarter 2009 conference call. Today's date is April 28, 2009 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 for the purpose of the Safe Harbor Provisions of the Security and Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading of Risk Factors under Item 1A in Cerner’s Form 10-K, together with other reports that are on file with the SEC.

At this time, I would like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corporation. Sir, you may proceed.

Marc Naughton

Thank you, Tanya. Good afternoon everyone and welcome to the call. I will lead off today with a review of the numbers, Mike Valentine, Executive Vice President and General Manager will follow me with sales and operational highlights and market place trends and Trace Devanny, our President, will discuss our global business and thoughts on the opportunities associated with the HIT Incentives in the Stimulus Bill. Trace will be followed by Jeff Townsend, Executive Vice President and Chief of Staff, who will provide some additional thoughts on the stimulus and Neal Patterson, our Chairman and CEO will participate in the Q&A.

Now I will turn it to our results, although there will continue to be a very challenging environment, we delivered mostly solid results in the first quarter. Bookings were at the low end of our targeted range for the quarter. Earnings were inline with our expectations and cash flow performance was very strong. Our revenue, particularly system sales where nonrecurring revenue is reported, was below our expectations reflecting the impact of the challenging economy and what we believe is a bit of a pause as healthcare providers track the HIT provisions in the American Recovery and Reinvestment Act which became a law on February 17.

Despite the lower top line, we are pleased with our otherwise solid results and encouraged by an improved forecast that reflects increased activity for the rest of the year. We are also increasingly encouraged by the opportunities created by the HIT incentives and the Stimulus Bill which we believe will help offset the impact of the economy particularly as we move to the second half of the year.

Moving to bookings, our total bookings revenue is Q1 is $33 million. Good bookings for many services helped toss that lower level of software bookings allowing us to achieve our bookings guidance range but not our revenue guidance range. Moving to backlog, our total backlog increased 7% year-over-year and ended the quarter at $3.6 billion. Contract revenue backlog ended the quarter at $3 billion, which is 7% higher than a year ago. Note that the contract backlog growth would have been 13% excluding the Q2 '08 backlog adjustment related to Fujitsu. Support revenue backlog was $584 million, up 5% year-over-year.

Our revenue in the quarter increased 2% over Q108 to $392.3 million. It is about $18 million below our guidance range.

The revenue composition for Q1 was $100 million in system sales, $125 million in support and maintenance, $159 million in services, and $8 million in reimbursed travel. As I have mentioned, most of the shortfall in our revenue was in system sales which was down $16 million of 14% compared to, compared to Q1 ’08. This decline was primarily driven by lower software sales. As you would expect, sales of nonrecurring items such as software are most vulnerable in the challenging economic environment. However, as I have mentioned, we are seeing signs of the demand picking up and expecting system sales to improve as we move through the year. In fact, at this time, we believe our total revenues for the year will be within our prior guidance range for the year although potentially, it is the lower end of the game range.

One thing to know relative to license revenue is at the high level of recurring invisible revenue in our business model as compared to the prior years allowed us to absorb the license short fall and still deliver earnings within our guidance range. Services revenue which included managed services and professional services grew 5% compared to the year ago quarter with a slight decline in professional services more than offset by a continued strong managed services growth. The decline in professional services continued to be the result of lower global headcount in the United States and lower services revenue in the United Kingdom. We did have a strong quarter of application management services bookings which will help to drive services' revenue as we move through the year. In addition, activity in the United Kingdom is ramping back up. The demand related to the HIT stimulus incentives contribute to improve services revenue later in the year.

As we have discussed previously, our efficiency initiative such as Bedrock, MethodM and our solutions center, allows us to deliver high levels of value to our clients without having to increase our services headcount. Well, this has had a negative impact on services' revenue growth. The success of these initiatives are the fact in continued strong growth and support revenue was increased 15% over Q1 '08.

Our gross margin for Q1 was 83.3%, which is flat compared to Q1 ’08 at 330 basis points compared to Q4 '08. Our systems sales margins did decline year over year from 65% to 59% driven by the lower software and lower margins on hardware.

Moving to operating expenses and earnings, our operating expenses in Q1 were $260.9 million before options expense of $3.9 million. This is flat compared to a year ago. Sales and client service expenses were up $2 million or 1%. Software development was down to $5 million or 7% compared to Q1 '08 but basically flat compared to Q4 '08 if you adjust Q4 for the extra week.

The year-over-year decline reflects the movement of some associates from R&D to support roles and continued efforts to control R&D expenses such as our India location. G&A expense was up about $3 million or 13%. G&A expense included benefits from the foreign currency of $5.5 million similar to the $5.6 million benefit in Q1 of '08.

Moving to operating margins, our operating margin in Q1 was 16.8% before options expense which is up 120 basis points compared to last year. We maintain the goal of exiting 2009 with operating margins at 20%. Looking at the non-operating lines, net interest was down about $1.5 million sequentially and year-over-year reflecting lower investment returns. This partially offset the FX benefit in the quarter.

Moving to earnings and EPS. Our GAAP net earnings in Q1 were $40.8 million or $0.49 per diluted share. GAAP net earnings including stock options expense, which had a net impact on earnings of $2.5 million or $0.03 per share. Adjusted net earnings were $43.3 million and adjusted EPS was $0.52. Our tax rate was 34% which is in line with what we expected. Overall, we are pleased that we delivered solid earnings despite the lower than expected revenue.

The increase in contributions over the last several years from more visible and recurring sources such as managed services, support, and professional services have been a big help in weathering the challenging environment. Resources will continue to provide a solid base of profitability and we expect our earnings to accelerate as demand from the stimulus begins to drive higher software sales.

Now, I will move to our balance sheet. We ended Q1 with $347 million of cash and short-term investments and $100 million of auction rate securities. The auction rate securities balance is $5 million less than last quarter due to some redemption. The ARS balance also reflects that the net impact of marketing the securities to market and value in the option provided by UBS to buy the securities at par. Our total debt is $145 million.

Total accounts receivable in Q1 at $437 million which is down $32 million from Q4. Contracts receivable or the unbilled portion of receivables were $161 million or 37% of total receivables, which is similar to the 36% that represented the year ago and up from 30% in Q4. Third party finances were $10 million which is about half of normal levels. Despite the lower third party financings, cash collections were a record in Q1 at $458 million. The lower third-party financings did contribute to the increase in our contracts receivable as the cash received from third-party financing usually is for balances that would be in contracts receivable.

Note that our balance sheet still reflects billed and unbilled receivables related to the Fujitsu contract that represents over 10% of total receivables. While we still do not know the timing when Fujitsu and the government will unwind their contract allowing us to finalize that with Fujitsu, we currently expect to fully recover these receivables. However, they will have a negative impact on DSOs in the meantime.

Despite the record cash collections and decline in our receivables, our DSOs still increased from 92 days in the last quarter to 102 days this quarter. This increase was driven by the large sequential decline in revenue which is annualized in the DSO calculation and in the lower level of third-party financings. For the expected revenue levels, our DSOs would have been basically flat compared to last quarter. We believe, this quarter, DSO is normally expected to decline going forward.

Operating cash flow at the quarter was very strong at $98millinon. Q1 capital expenditures were $43 million and capitalized software was $18 million. Free cash flow defined as operating cash flow, less capital expenditures and capitalized software was also strong at $37 million up $34 million over Q1 of 2008.

While cash flow will likely be lower in Q2 given the lower level of receivables, this quarter's cash flow was a strong start for the year and positions us to meet our target of more than $100 million of free cash flow in 2009.

Moving to capitalized software, the $18.3 million of capitalized software in Q1 represents 26% of the $70 million of total spending on development activities. Software amortization for the quarter was $13.1 million resulting in net capitalization of $5.2 million or 7% of the total.

Consistent with what we said last quarter, the increase in the amortization related for the release of the Millennium 2007.18 release going live during the quarter was basically offset by the completion of amortization of amounts capitalized in 2003. Q2 amortization expense should increase by about $2 million compared to Q2 since we will have a full quarter of amortization related to the new release. This will bring amortization of between $15 million and $15.5 million beginning in Q2.

Now we will go to the guidance. While the economy did have some impact on the results in Q1 particularly in revenue, our overall outlook for the year remains intact. We continue to provide a wider range given that the uncertainty remains but we believe that the most challenging quarters maybe behind us. Looking at Q2 revenue, we expect revenue in the $415 million to $435 million range. We expect Q2 EPS before options expense to be $0.52 to $0.58 per share.

The Q2 guidance is based on total spending before options expense of around $270 million. Also our guidance assumes we have no material negative impact from foreign currency exchange. Our estimate for option expense for Q2 '09 and 2009 is approximately $0.03 and $0.12 to $0.13 per share respectively.

Moving to bookings guidance, we expect bookings revenues in Q2 of $370 million to $410 million with a midpoint of that range reflecting basically flat bookings compared to Q2 of last year. Looking at full year 2009, we maintain our guidance range for adjusting EPS before stock options expense of $2 or $0.40 to $2.50. We also maintain our 2009 revenue guidance of $1.75 billion to $1.8 billion with a bias towards the lower end given the lower Q1 revenue.

In closing, we are pleased with our results in Q1 including solid bookings in a tough environment, continued progress on our margin expansion initiatives, delivering earnings in our guidance range despite lower revenue and strong free cash flows reflecting the continued over all health of our business.

With that, I will turn the call over to Mike.

Michael G. Valentine

Thank you, Marc. Good afternoon all. Today, I am going to cover sales and some operational highlights and also some marketplace trends. From a sales perspective we had a solid quarter particularly given the tough macro environment. As I will discuss more in a minute, the economy continued to impact hospital spending this quarter. We also saw some clients paused as they monitored and awaited clarity on the HIT incentives in the American Recovery and Reinvestment Act. Our bookings revenue for Q1 was $332.8 million which is at the low-end of our guidance range. Our deal mix included ten contracts over $5 million, seven of which were over $10 million. The 14% of bookings came from outside of our millennium install base, this is lower than historical levels but this is more of a function of less deals getting done in the quarter than a major change in the marketplace. In fact we continue to feel very good about our competitiveness particularly with some of the change in uncertainty as some of our competitors and we have a good pipeline of new footprint opportunities so going forward I would expect our mix to return similar levels as we delivered in 2008.

As Marc mentioned, we had a strong levels of managed services bookings with much of it coming from our existing clients choosing to have Cerner take over the management of their Cerner Systems. We also had good levels of Application Management Services or AMS bookings. Recall that AMS goes beyond what we do with traditional managed services as we are helping clients manage not only their technology but also their applications. We are also engaged in discussions with clients about further extending our services through our IT Works Organization which leverages our operational capabilities in infrastructure to take on additional IT functions for our clients. We are targeting clients who are committed to Cerner as their strategic HIT provider and looking to complete their journey in the most efficient manner. IT Works represents a substantial revenue opportunity as we convert more of our client's current IT expand into Cerner revenue.

This is also a significant opportunity to tighten our alignment with key clients accelerating expansion of our solution footprint and replace competitor solutions. Our success was on our works in AMS combined with the substantial opportunities associated with our IT Works offering or to finding the next generation of our client relationship model.

In general, our business models are becoming more directly aligned with the success of our clients. For example, our lighthouse clinical process authorization service facilitates clients leveraging investments, they have already made in digitizing their environments to drive more efficiency and optimized outcomes. Create quick, measurable ROI. Based on our improve points, we are going to align our payments with the client's results. There are significant number of opportunities for us to create this deeper client alignment and sharing the efficiency games created by lighthouse in a way that it creates a strong return for both CERNER and for our client. Additional opportunities exists for us to work with our clients in creating regional networks to facilitate rather inoperability allowing for things like health record banks.

This differentiates our client in the region as well as providing a new business opportunity for CERNER. The collective power of our alignment across our client base is currently reflected in our lights on network which monitors more than 2 million Millennium users and billions of clinical transactions and creates a near real-time evidence-based technical network.

Moving down to our highlights for the quarter, we continue to our momentum with our CareAware Swedish Solutions including a noteworthy sale of MDBus device connectivity solutions outside of our install base which further proves that these solutions can be an entry point in the competitor basis. We also continued our fast start in the device resell initiative with another good quarter of contribution from reselling devices and we have more clients sign up to pilot our Rx Station Medication Dispensing Unit. The success of our CareAware Initiativesz reflects our ability to successfully in our vertical market. We have found that being able to align sales, services and development resources across certain vertical market makes us stronger, more agile competitor within those markets and can also accelerate our ability to fill line space within our existing base and more effectively pursue opportunities outside of our base. Other verticals were these agile business units are targeted including women's health, critical care, surgery and anesthesiology, emergency, revenue cycle, workforce management and lighthouse clinical process optimization.

Operationally, we had a strong quarter delivering value to our clients. I’d like to highlight the recent accomplishments of one of our clients that I think is a great example of our differentiated ability to deliver value and cost to our clients. Mercy Hospital and Medical Center in Chicago has recently designated a stage six hospital on the HIMSS EMR adoption model. This puts them in the top .05% of all hospitals in the United States. Most impressive is the fact that they accomplished this by implementing 21 Cerner Millennium Solutions in just 14 months when according to HIMSS, this level of automation takes most hospitals 7 years to realize.

This one is accomplished by leveraging our solution center which allows clients to envision, design, build, and deploy certain solutions by utilizing a standardized scope and project tools, provided structure, discipline, predictable implementation, and experience. They also leverage our method and implementation methodology which draws upon premium practices from literally thousands of past implementations to deliver projects with discipline predictability and efficiency. Mercy's speed devalue was isolated by the choice of Cerner Works Manage services which provides unparalleled system performance and allowed them to avoid upfront hardware cost and ongoing technology risk by using Cerner State of the Art Data Centers.

Mercy is clearly a shining example of our strategies coming together to set a new bar on delivery for the industry and for Cerner, the timing couldn’t be better with many of the house systems that will now enter the market looking to get to meaningful years in a timely and cost-effective manner. With HIMSS in Chicago this year, we were able to arrange a full schedule of tours for prospective clients at Mercy. Well, we also have our Smart Semi to demonstrate our device connectivity and other capabilities of our Smart Hospital and room in the future. This, combined with our highly successful CIO9 and 26 clients participating in education session, allowed us to get a great deal of value and interaction with clients during the week of HIMSS without the traditional presence on the trade show for which is we have discussed before was no longer providing meaningful value to us.

In summary, we believe the progress our clients have made using Information Technology to advance quality safety and efficiency of care is creating a gap in the industry. Mercy is a perfect example of this. As I mentioned earlier, now is a good time to be providing the market with many proof points for delivering these kinds of capabilities in a predictable manner.

Now, I’ll make some comments on the US market place. As reflected at, in our top line the lower top line group this quarter, the economy did have an impact on our results. We continue to see healthcare delivery organizations that are doing fairly well operationally but many of them have reduced their budgets as they deal with the reduction and their foundation investment portfolios caused by the general financial market decline. They are also very focused on maintaining strong cash balances to enhance the debt rating and control their cost of capital while this pull back in extending impacted our top line results this quarter. I believe, we had served better and are better positions in most other companies.

Health care organization remain focused on strategic spending that generates a return on investment and as we have indicated in the past, our HIT initiatives are [20:35] being highly strategic due to the role they play in improving safety and efficiency, reducing cost and meeting regulatory requirements and as you all know the value of HIT investments does not gone unnoticed by the Obama administration and with the passing of the American Recovery and Reinvestment Act in February, the US Congress made it clear that they view HIT as strategic. As Trace will discuss in just a minute, we believe this act represents the largest offered opportunity in the history in the industry and we are very well position to benefit from it.

So, in summary. We really view Q1 to be the intersection of what amounts to be somewhat of a bipolar business environment. By that I mean coming end of the year, we are seeing several thing in general group towards reductions and the operating cost and capital spend. However, post stimulus announcement in February we saw the market start to move in a positive direction. Many of the same core strengths that have allowed us to weather the tough economy including our large and diverse client base proven abilities to deliver value to our clients and the strategic value of our solutions will also help us to flourish as the stimulus standing against the [21:48]. With that, I’ll turn the call over to Trace.

Earl “Trace” Devanny, III

Thanks Mike. Good afternoon everyone. Today, we’ll discuss our international business and provide comments on the American Recovery and Reinvestment Act (ARRA). Beginning with our global business, we have a very solid start to 2009. Starting with England, we continue to make steady progress in our participation with the national health services countrywide HIT initiative. In the London region, with our prime contractor, BT. We received good news in February that we could re-initiate implementation work that have been previously been put on hold.

The key to our success has been a greater emphasis on a more flexible implementation approach with a specific local configuration. In approach in which we will continue to focus with high expectations for continued success. In the southern region, BT has taken over as the prime contractor for the 8 trusted and previously gone live with Fujitsu.

We are now working directly with BT on those 8 trusts. In addition to those aid, BT has signed an agreement for 4 additional trusts providing us the opportunity to significantly expand our presence across the southern region. In Australia, we had another important goal [22:58] in New South Wales and we continue to rev up our efforts in Victoria. Other noteworthy global success in Q1 includes strong bookings in Canada or we booked our first manage services agreement and again in the Middle East where we continue to extend out market share lead. Over-all we continue to be very please with our global progress and despite of the tough economic climate believed we are position to have a good year abroad.

I would now like to discuss the American Recovery and Reinvestment Acts and provide some color on the potential impact that may have on our business. First, I want to provide some background on the stimulus package as we believe that this opportunity maybe under appreciated with some elements that are not completely understood. Some of the key provisions of the acts support an investment of approximately $35 billion to advance the adoption of health information technology. The investment is predominantly directed toward Medicare and Medicaid providing incentive payments for hospitals and physicians to adopt qualified electronic health record technology. It is estimated that approximately half of the incentive dollars will go to hospitals and half to eligible professionals which will primarily be physician practices.

To qualify for incentive payment, health care providers, physician practices and hospitals must meet eligibility requirements and demonstrate meaningful use of a certified electronic health record system. Current legislation provides flexibility for the secretary of HHF to further define meaningful use of any HR. To date, it has initially been defined to include the use of e-prescribing, to report in of clinical quality measures and the use of EHR technology which is properly implemented as designed to improve the quality of care to an improve care coordination process. Additionally, the legislation clarifies that a qualifying EHR system must have the capacity to capture patient demographic information, record a medical history, provide clinical decision support, allow for physician order entry, facilitate quality reporting and be inoperable.

We think these definitions are important and Jeff will provide some additional comments and I believe that, that it doesn’t needs to be a high bar for qualified EHRs and meaningful use. Assuming a high bar is maintained and we sincerely hope there will be. We think the incentive structure make is very likely that we will have a nearly digitized US health system by the middle of the next decade. Hospitals and physicians can qualify for incentive payments beginning in 2011. Physicians must qualify by 2012 and hospitals by 2013, to receive the maximum incentive payments over a 4 year period. The incentive payments are designed to fund a meaningful portion of the upfront investment by hospitals and physician practices.

Our care of associate with qualifying percentage is attractive. The stick comes into play in 2015. At that time, hospitals and eligible professionals will be penalize with lower Medicare reimbursements if they are not yet meaningful users of a certified EHR system. We believe a few health care organizations can afford to ignore these powerful incentives. This creates a substantial opportunity for Cerner and our industry. Well, it’s difficult to estimate the exact timing and amount of the impact on our business. We believe it could be a significant contributor to our core business going forward. In addition, working in this environment where providers we look in to qualify for incentives, I believe are installed base of clients will be a tremendous affect.

To provide some perspective, let me share some numbers pertaining to our footprint in health care and then quantify what the incentives could mean to that base. Cerner Solutions are license by nearly 1700 hospitals in the US representing 29% of the total US hospitals. More than 3300 physician practices representing more than 30,000 physicians in the US. More than 500 ambulatory facilities such as laboratories, ambulatory centers, cardiac facilities, radiology clinics and surgery centers. Nearly 600 home health facilities and nearly 1500 retail pharmacies.

We believe our footprint is the broadest and most strategic in health care. Most of our clients will have an opportunity to qualify for incentives of some type, after conducting a detailed analysis of our larger health system clients and their employed physicians. We estimate there is approximately 6 billion of Medicare – Medicaid centers available to them ranging from approximately 10 million to over 200 million per health system. In addition to this, we estimate at least 2 billion incentives will be available to our power works physicians, ambulatory facilities and hospitals with the smaller millennium footprint. Clearly, not all incentive dollars from our clients will be spend on service solutions and services but I think it is important to understand the magnitude of the opportunity. Up to this point, we have had many detailed reviews with our clients about this specific incentive opportunity. The solutions needed to qualify for the incentives and about the exposure to penalties if they are not proactive and qualify in time. These discussions have been very encouraging and invalidated our belief that the stimulus opportunity is substantial. We also believe that the opportunity outside of our client base is significant. There are a large number of health care providers review the not bought systems or continue to use legacy systems from suppliers who been promising to deliver a more modern platform. This opportunity for incentives as well those the risk of facing families has the attention of these providers and we think the next years will present a big opportunity to expand our presence in the US.

Clearly, we feel we are well positioned in the hospital and health systems markets with our large and diverse client base and proven track record of value and creation for our client as it pertains to the decision market, we really like our physician with our low-cost, speed-to-value ASP model which you are now are seen other suppliers try to replicate. As we have all ready proven with our ambulatory surgical centers, our power works model can also be leverage from more than just position practices. This capability significantly expands our range of opportunity related to the stimulus bill which includes percentage for such areas as federally qualified health centers, public health departments and critical access hospitals. Further, we see the stimulus as an event that will provide an opportunity to work with other stakeholders to develop innovative approach as to the delivering health care to populations with traditionally been underserved in rural and urban America.

The ARRA provisions for community health centers, condition management, education, broadband and telemedicine provide new opportunities for Cerner to continue to help transform the delivery of care in the United States.

In summary, we’re on the front end of the biggest HIT opportunity in our 30 years as a company. More importantly, the stimulus funds are use wisely. This investment could create the level of systemic change in US health care system needed to address a number of serious issues thus creating a more efficient, safe and higher quality system for our families, communities and the nation for generations to come. With that, I will turn the call over to Jeff.

Jeffrey Townsend

Thanks, Trace. I wanted to add to Trace’s comment on the HIT incentives in the American Recovery and Reinvestment Act rapping in some of our prior discussions around the strategic nature of HCIT. They are clients and how all this type together some of our course strategic investments. Although stimulus is a substantial incentive, our clients are on a journey. Over the last few quarters, we discussed the EMR investments by our clients in this economic climate and how many of them have continued to fund this as one of their top strategic initiatives. For those, the stimulus is confirmation of their strategic journey. For those that were stretching their journey during this economic window, the stimulus has triggered to rethink of their timing assumptions. For all of our clients, the reason for investment and the impact of a digitized health system has not changed.

Starting with the IOM on patient's safety followed by the increasing demands and paper performance measures to name a few, the case to proceed faster continues. Now it is both a significant incentive and a trailing penalty. At this point in time, there is a lot of focus on the term meaningful use within the stimulus package which is yet to be defined but has a due date no later than the end of this year. The danger is that many see this as a definition of an endpoint rather than a preliminary minimum requirement on the journey. While the end criteria maybe very technical in definition and will include requirements for inter-operability, there are some simpler, visible experiences that demonstrate meaningful use such as no pen is being used to place orders and no clipboard in the waiting room for your medical history.

In the HCIT talk, this would be CPOE, medication reconciliation and inter-operability to support health record banks. There needs to be two axes to the measurement. The first being the functional capability and the second being adoption measured as use of the system. While pilots are a valid approach to state's deployment and learning, they are not a proxy for meaningful use. The target should be closer linked to the objectives of the broader healthcare reform agenda to ensure that longer range strategies around chronic disease management and new care are built in. They should not require another round to accomplish this.

If the country proceeds on this journey, Cerner believe the increased transparency of learning an adoption is a key. Using our lights-on network, we have been expanding our measurement and shared benchmarking capabilities from technical performance and configuration measurements to measure the functional use. The collective learning of over 2 million Cerner millennium users can have a significant impact on the speed to adoption with over 19.5 billion application transactions measured in 2008, 2 billion of which were clinician orders. Over the summer in preparation for our healthcare conference, we are expanding this platform to measure workloads and end-user experiences to more rapidly expand this experience sharing platform.

Overall, we believe that the bar set appropriately high for meaningful use and qualify the EHRs. The return on the HIT stimulus investment could be substantial. To understand the potential return, meeting a vision what type of change will be created with a completely digitized healthcare system and how society should benefit. We have published our view of the direction of reform and the future status such as healthcare system in a short paper called the ABC to Systemic Healthcare Reform which for those of you who are interested is available at Cerner.com/ABC. In this paper, we described how up to 500 billion per year could be saved in the US healthcare system by fully digitizing and optimizing healthcare delivery. Most healthcare executives we have spoken to agree with our views of properly directed HIT investments could produce powerful positive systemic benefits for healthcare delivery. If we do this right, we can have a modern, affordable, friction-less and high quality healthcare system in the next decade.

The opportunities created by digitizing our healthcare system position us for acceleration of many of the initiatives we have started in this decade. We have always said that the core EMR is only the beginning. It is the infrastructure that will enable our host to sophisticated future solutions and services. While we have clients at some of the highest levels of automation including paperless and filmless, they have list for the next wave of innovation creating a smarter system as we have outlined in what we call the four box, our pharma initiatives will benefit from a digital healthcare system that will fundamentally change discovery of new knowledge impacting clinical trials and surveillance systems for medicines in active use. Our CareAware platform of devices and device connectivity initiatives will benefit as the medical device industry becomes more part of the HIT industry and our employee and our government initiative extend to accelerate with the opportunity to completely redesign the fundamental commerce of healthcare eliminating the friction that consumes more than 30% of precious resources connecting government, employers and consumers directly with their healthcare professionals facilitating the whole process based on personalized needs of the individual.

In summary, we are on the front end of an unprecedented opportunity. If HIT investments are made wisely, Cerner, our industry and our society will realize substantial benefits. Now, I will turn the call over to the operator for the Q&A.

Question-and-Answer Session

Operator

(Operator's instruction) Your first question comes from the line of Charles Rhyee - Oppenheimer.

Charles Rhyee - Oppenheimer

I wanted to really talk about the managed services business here. Obviously, it hinges a lot of talk from a lot of the vendors on providing sort of hosting options, subscription pricing and things like that and as I look at the managed services business here for you guys, can you give the sense on the strength of the, you talked about the strength in bookings in the quarter. Can you give a sense on the share of the bookings in the quarter coming from managed services?

Marc Naughton

Yes, this is Marc. That is a kind of statement between the 15% and 20% to 25%. That is quite a little bit towards the higher end of that range during the quarter, pretty consistent with what we have been seeing though.

Charles Rhyee - Oppenheimer

Okay, so then when we look at the shortfall in system sales line, I mean, have you seen any sort of a shift in clients really looking for the managed service option in which case we are going to see stretching of the revenue recognition? In other words, how much maybe the shortfall in system sales would you might attribute to maybe greater managed services?

Marc Naughton

Really the key, Charles, for our managed services is it does not replace software with some type of the subscription approach or any different type of revenue. We do a normal revenue deal, normal license deal which basically they buy the license. They own the license. There are services to implement and the only difference is rather than selling equipment for them to run it, we enter into a hosting agreement where we provide the services and the location and do the hosting. So, the reality is managed services booking actually normally will draw with some level of license software as well. In this quarter, that was not necessarily as much the case as normal. A lot of the sales this quarter were back into the base which a lot of those people have already laid in some level of software. So, the enhancement and managed services did not drive a lot of license software. Going forward, our pipeline is showing us an up tick in license software as well as managed service opportunities.

Michael G. Valentine

Charles, this is Mike. Just to add a few comments to it, what you also see is about 90% of our net new footprint clients will go with a managed services hosted option. It is actually our lead with preferred option has become the same for our prospects. Within that contract, we generally give them a high degree of predictability of what it will cost, what their future would cost them if they expand the software so that would be the direct linkage back in the software. They understand what the hosting fees would look like for their future software roadmap.

Charles Rhyee - Oppenheimer

Just so I can be clear here, so if you sold a managed services deal and there has been, there is buying a license of course and let us say license was $5 and the managed service fees over time was $10, that $5 though we recognized that as a traditional up from license revenues, so that might be sort of a larger portion but that is not stretched over the life of the hosting component?

Michael G. Valentine

Yes, that is correct. Our clients actually want to own the license. They want the freedom that for some reason, they want to take it back and run it in their own datacenter, they have that capability and for the most part to maintain that, they buy a perpetual license just like our standalone clients.

Charles Rhyee - Oppenheimer

And just one last question here in terms with the guidance, can you give us a sense on the activities you have seen in April because clearly, your second quarter guidance suggest we should see an up tick both the bookings sequentially and in the revenue and maybe you can just give us a sense on what you are seeing so far in April?

Michael G. Valentine

Yes, well this is Mike again. We have had a great start to April. So, it is probably the best start we have had in the long time relative to contracts and the doors so we are feeling good both about what transpired and what is built up in Q1 and what we see in the pipeline drawing downstream in the back half of the year. So, that feels very good and then in terms of our connectedness to our clients, we really put pretty exhausted campaign to make sure that our clients fully understood our interpretation of the stimulus and the potential opportunities for them and where we did perceive gaps where we are proposing on projects that will fill those gaps.

So, from a market perspective, the bipolar nature we talked about as we came in to the year, seeing some downward trend and we about midterm in the quarter started going other direction and in April and beyond, it looks that we headed the other direction. So that feels good.

Operator

Your next question comes from the line of Michael Cherny - Deutsche Bank.

Michael Cherny - Deutsche Bank

So, actually I have one quick question regarding the numbers, Marc. I may have missed this. I apologized if I did. Did you guys do anything on the share buyback during the quarter?

Marc Naughton

We did not.

Michael Cherny - Deutsche Bank

Okay, that was easy and then I like to kind of follow up on Charles' question regarding stimulus and the way you are seeing in terms of trends in the end markets given some of the pressures were under the capital environment. Do you have your clients coming to you now and saying, "We cannot buy everything now. We cannot buy the whole system but we need product X, Y and Z to allow us to make it through the next six months"? Everyone I think on the call sees kind of all the [AJ] service and everything that is out there. It seems that there are certain products that people need just to kind of bridge the gap and have you seen a change in trend in terms of customer in terms of some of those products?

Michael G. Valentine

This is Mike again. I think Jeff said it pretty well. About a third of our base was a justification to stay the course so there was just further incentive to keep going and the uncertain times for another third if it is may viewed as reason to go accelerate and some of those as Jeff mentioned in his comments had even stalled out. So, I was on the call just a week and a half ago where the CFO from a community hospital in Pennsylvania and he is absolutely using this as something to go back to his board in a May Board meeting and map it out and we are going to help him by mapping our payment flows to what he would expect seeing of the meaningful use incentive payments going forward under the stimulus.

Operator

Your next question comes from the line of Steve Halper - Thomas Weisel Partners.

Steve Halper - Thomas Weisel Partners

On the efforts for the PowerWorks applications which are targeted in services which are targeted towards the physician area?

Michael G. Valentine

Steve, can you give the first part of the question? You were cutoff before the…

Steve Halper - Thomas Weisel Partners

Yes, I was looking for an update on how the PowerWorks solutions performed in the quarter and what the outlook there and what you are doing on stimulus related activities there.

Earl “Trace” Devanny, III

Steve, this is Trace. We continue to be very pleased with our ASP model. I think the model is now greater than ever in the market place and I think we continue to see increased levels of activity around how these positions connect with the providers. So, as you heard from my comments, there is well over 2 billion identified in our installed base of physicians where we can go directly at them with stimulus opportunity. So, that has equal level of interest has had our provider clients.

Marc Naughton

Yes, Steve this is Marc. I think Q1 was not a big change relative to actual business that we got signed but once again there is, we are having a good conversation with not only listing provider clients but looking at physician groups that we think will be attractive ways to get even including ambulatory centers that do not get any money directly but are in aggregation of physicians who are all in each point to get their own dollar. So, our client base is going to connect us we think even beyond just what the stark opportunity was to a subset of physicians that could grow our market and we are offering the type of application, ASPs, small upfront investment that those guys are looking for.

Steve Halper - Thomas Weisel Partners

Just to follow up, how much investment are you doing in that area from a product standpoint or is the product done and you just got to tweak it here and there?

Marc Naughton

It is pretty much done. We have got our certification. We are fully certified both ambulatory and on the inpatient basis, sort of finishing up the finalization of that in May. So, the solution is ready to get the market and fully certified.

Operator

Your next question comes from the line of John Wheeling - Piper Jaffray.

Sean Wieland - Piper Jaffray

It is actually Sean. So, a couple of questions on the stimulus; you mentioned that customers are pausing, waiting clarity. Exactly what are they looking for clarity on? Is it the definition on meaningful use and certification and what are they worried about?

Michael G. Valentine

This is Mike. I would not say that people had paused because of the stimulus. I would say that the folks that have already paused because of the economic climate and the environment are now looking, there is a third of the base that is looking to kind of weight it out and see what the meaningful use bar is to continue on their journey. But I would categorize those as the most conservative audience of the thirds that I talked about.

Sean Wieland - Piper Jaffray

Okay. So, could you just go over that again and I may have missed that, so a third of the base is waiting to see what meaningful use and what are the other..?

Michael G. Valentine

Yes, so in sending order, the first third is, they are staying the course. They are the ones that have always stayed in the course. Many of them may have started their journey recently and so they feel that they are going to use the funds to further reinforce the decisions they had made upstream. The second third are the ones that are using this as a reason to accelerate through some of their timelines. So, the examples that I spoke out of the Pennsylvania, they view this as their funding source to go hop and finish their journeys in an accelerated fashion and then there is another third that is just the conservative audience that they were probably stalled out to begin with for whatever reason and may have been sold out for multiple years and they are talking a wait-and-see attitude which is essentially they are not prospectively taking action. They are going to wait to see what the meaningful use as far as to see if they are really qualified and then once they receive those bonds, they may take action.

Sean Wieland - Piper Jaffray

So, what is your best estimate for when we should see an acceleration of bookings because of the stimulus?

Michael G. Valentine

I think you will start to see it, I think we are seeing it now. So, I think the action that we saw in the month of April, many of those, you can map directly back to a confidence level that has been generated by the stimulus. So, I think it was starting out and it will continue to ramp into full force in the second half of the year and again, as Jeff mentioned, I think we are hopeful that this just inspires confidence that the decisions I have made were the right ones and they are going to continue on with their journeys and this will continue to be a moving bar in terms of what definition of meaningful use will be.

Sean Wieland - Piper Jaffray

Okay and what kind of upfront investment is required by you guys to execute on something?

Marc Naughton

From our side relative to, we currently have a very good structure relative to the solution center. Methodology is in place that allows us to meet a lot of this demand with existing in place associates. So, we do not expect a lot of expense impact relative to gearing up to these projects. We are used to doing this. We are doing them very quickly as the Mercy example that Mike talked about indicate. So, initially you will not see our expenses going up in anticipation.

Michael G. Valentine

And Sean, the other thing that we are doing in the new footprints based is we are very clearly mapping out the slots that we have available and if you are looking to get to a certain level, if you are hanging your head on a certain level of being meaningful use, here is when you need to get start. So, we are giving clients the least time so that they can on prospect the lee time so they can secure a lot into a spot in a solution center to go and get going.

Sean Wieland - Piper Jaffray

Okay, so last question, how many slots do you have still available so that customers can get the full benefit?

Marc Naughton

If you need one, we will work on it.

Earl “Trace” Devanny, III

That is a great question, Sean. We are ready for the next question.

Operator

Your next question comes from the line of Anthony Vendetti - Maxim Group.

Anthony Vendetti - Maxim Group

To continue along the stimulus package, on the hospitals, I think you mentioned the opportunity to the hospital that your customer is anywhere from $10 million all the way up to $200 million. I would assume that is the larger integrated delivery network but can you quantify that a little bit more? Had you come up with those figures and exactly when do you have to qualify from the hospitals these are the standalone EMRs with the individual with PowerWorks?

Earl “Trace” Devanny, III

Why do not I take a shot Mike then you add color to that? We launched immediately upon the February 17th stimulus date, of the legal date of launch with very specific per client studies about what it could mean to an individual client and as I said in my comments, anywhere from a low end $10 million all the way up to $200 million for a large health system. So, those are very, very real numbers. We have delivered probably half of those, maybe more than half of those presentations have been delivered up to this point with really great reception and that comes from across the management team, Neal, all of us had been delivering these messages and as I said, they are very, very well received. What was the second part of the question?

The count off of their activity levels from Medicare and Medicaid patient volumes so it is pretty transparent how they do the math per site.

Anthony Vendetti - Maxim Group

Okay, so you came out with a $10 million to $200 million, and the opportunity for them to start qualifying for the stimulus? Did that vary because they are hospitals versus being an individual doc?

Marc Naughton

No, it is all fiscal year 2011 so October 1st, 2010.

Earl “Trace” Devanny, III

To be completed by 2015 or the panel has become the stick.

Operator

Your next question comes from the line of Atif Rahim - JP Morgan.

Atif Rahim - JP Morgan

I guess just talking about the prior question, how much of the opportunity do you think would be realizable? I think Trace, you had mentioned with the hospitals and physicians, it would get about $6 billion, $2 billion respectively but clearly, some of the clients will get the most cash probably they have the best installed systems out there so they would not necessarily be buying more from you. So, what do you think would be, what you realized from these proceeds?

Earl “Trace” Devanny, III

If I could predict that, I would probably be in a different line of work. It is very difficult to say. As I said, the Medicare and Medicaid levels of activity have dictated what we believe is the opportunity on a per client basis. Some of course are much further along and others, I might describe a 1/3 to 1/3 to 1/3. There are some that are going to be qualified today. There are some that are along the journey and there are some that is still trying to figure out what to do next. So, I do not know that I could put up an actual number. We think it is a billion dollars is the number we have identified between the hospitals and the physicians to name a few. Those are the employed positions and an additional $2 billion for the non-employed position.

Marc Naughton

Yes, Atif this is Marc. If you are going to do a kind of testing to the wind, half of that should be something that we can go address relative based on where our clients are relative to the booking. That is just our existing client base. We have a fairly strong pipeline of new clients and we particularly see certain participants, contenders in this environment that if the bar is set high enough are not going to be able to deliver solutions that meet that bar. So, we think we are well positioned to go after more of the market. So, let us assume half of that $8 billion comes to Cerner over that time period, we think there is still upside to that. We think there will be more potential based on that and that will be over three to four year period.

Atif Rahim - JP Morgan

Okay, I understood and then something to your question on the UK, could you mention what the contribution was that you get this quarter and then with the BT contract coming I guess, the relationship they are getting better. Do that change with the contribution that is going to be for 2009?

Marc Naughton

From a financial side, the revenue is going to be kind of $15 million range and the contribution margin of that is going to be $2.5 million to $3 million and that will be consistent over the life of the contract based on the long term contract percent of completion rules so that will not change. Clearly the excitement for us is the fact that we went into, it has been a year with that kind of lag jam and now, the things that were standing in our way, London being able to proceed with their implementations. The South being at least settled us out. It is going to go forward. Those are now done and completed and we can go work on those, be successful and go for more opportunities within the program. So, we actually think with a lot of progress got made. It is not going to show up in the P&L in the near term other than just the continued contribution that we have seen over the last few quarters.

Operator

Your next question comes from the line of Frank Sparacino - First Analysis.

Frank Sparacino - First Analysis

Trace, I just wanted to ask you about NHS in terms of what is changed now in terms of the local specific delivery model which, can you suggest a higher level of customization of that and maybe less repeatability as you start to work your way through NHS but I just want to get some further clarification on that if I am thinking about that in the right sense?

Earl “Trace” Devanny, III

Yes, I will have quick comment and then ask Jeff to add some technical color. The challenge we face has been the layers in which we must work in order to get to the client. We as a company have always done really well and we work directly with our clients and I think what we have began to be able to do is custom and locally, customize the solution to a much greater detail, to much greater level and that is I think at the end of the day what the clients are most interested in. So, we are working hard with individual trust. I think you have seen some of the success from that work and I think that will be the model we will live off up going forward.

Jeffrey Townsend

Yes, I had described it in and it has been published but you have to piece lots of articles to the other to get it but it is, the original procurement was somewhat of what I call a top-down one size fits all and it is a standardized approach. There are still elements of that in place but when you see the term locally configured, that really means local trust is going to have a lot more flexibility to take the standardized model and make some adjustments to it and what we think as Marc said, we are getting the increasing momentum as our ability to then go faster in some of those deployments versus the prior model of everything being improved centrally before can go out is a fundamental shift.

Operator

Your next question comes from the line of Gene Mannheimer - Auriga USA.

Gene Mannheimer - Auriga USA

Just continuing along those lines with respect to the Southern cluster of England, is that to say that there would be more than one prime contractor in the south or you are still expecting a single vendor to be chosen?

Earl “Trace” Devanny, III

The south of course has moved from Fujitsu to BT. That is well documented so we clearly are the partners with BT and although I think there is flexibility to buy outside the program, that is the direction and that is what we hope we will see going forward but the trust do have the ability to step outside the program in the Southern cluster.

Gene Mannheimer - Auriga USA

Okay and then also along the international bend with respect to Australia, it sounds like you had some progress there during the quarter. Is this driven by any regulatory changes in the country or just continue elaborate on that?

Earl “Trace” Devanny, III

No, no fundamental regulatory changes in Australia. I mean they like the rest of the world had been stung by the economic climate but I think what we are doing is we are turning on systems in new South Wales where we have had a contract for many years successfully. Victoria has had a change in leadership which we think has been, has worked to our advantage and that has jumpstarted the line of business that we won there a couple of years ago as well. So, I think it is a little bit of the line of the stars if the time and place for the types of solutions that Cerner brings, our successes are well known and we are the, I would consider us to be the team to be in Australia. But other than elections and some change in leadership which happens frequently in that country. We are just executing turning on systems and being recognized for it.

Marc Naughton

Why do not we get ahead and take one more call or one more question.

Operator

Your final question comes from the line of Sandy Draper - Raymond James.

Sandy Draper - Raymond James

Most of my bigger picture questions have been answered. I just have a question, Marc in terms of the guidance for the revenue. Obviously you are expecting a pretty good recovery away from the back half of the year. When I look sort of what you are looking after EPS and where it is sort of growth margins would be, are you expecting more hardware to comeback in the back half of the year because it looks like you need to get to your numbers and not go too high, your gross margins have to come down that you are going to get to the lower end of your revenue range. I am just wondering if the reason you expect a revenue ramp is higher hardware which would sort of depress the margin.

Marc Naughton

Not significantly, I mean we are at 83% for Q1. I think if our gross margins are in the 81% range, you are going to find it pretty close to our guidance. Obviously, we looked at some, there are some opportunities here and if the life of software comes back, that is going to help those gross margins as well but I think without any major changes because we certainly do not really look for hardware to be a larger contributing factor than it has been the last couple of quarter. So, I think you will see some changes; maybe some sublicense software impact that would get us to somewhere around the 81% gross margin range which would put us in range of our revenue guidance.

Sandy Draper - Raymond James

Okay so the 81% is for the quarter and for the year or is that just for the…

Marc Naughton

Probably around 81 for the year, some place in that vicinity would be my rough estimate. It will vary a little bit by quarter and how we get there.

Sandy Draper - Raymond James

Okay and then I missed out; I got on the call late. Did you make any commentary about where the margins came in? Obviously, your system sales were light but your margins held up pretty well. I am just trying to understand, was there any mix in there or what drove that pretty good margins relative to that lighter revenue?

Marc Naughton

Yes, I mean basically if you are talking about the margins on system sales that was lower, the gross margin from that was lower relative to what was in the year ago quarter but a lot of that is the mix between hardware and software, obviously lower software mix and then also just the margins on the sublicense software and hardware that were lower. So, for all that, that was the impact. It was mixed and then the contribution from each of those elements.

With that, let me turn the call over to Neal for closing comments.

Neal Patterson

Thanks Marc. Thanks, guys. So, I think you are hearing from us that it was a good quarter based on all the fundamentals that we were facing with coming into the quarter. There were a lot of fundamental gains, almost the gain changing aspects of what happened during the quarter with the legislation that basically funded and pretty much mandated full adoption of HIT in US healthcare system and if that all plays through which is the law of the land and we believe it will play through, it is going to be a very, the nature of this next decade will change here during these last 90 days but I do not think we should lose site to the fact that from a policy point of view, I do not think policy in this country in the US is finished with regards to healthcare. There is going to be another major set of policy that is going to come so I do not think the only change we are going to have the US healthcare system is embracing of HIT.

Then also, so there is another big shift that is going to come and you all should be contemplating kind of understanding what that is going to do to healthcare delivery and all the other companies you follow because it is pretty significant too. But I think if we play through that, it will basically be a world that is focused on set of principles around transparency, quality, safety and efficiency because if we do not drive efficiency and healthcare delivery around the world, there is going to be a lot of countries in trouble including the United States.

So, the next decades are pretty exciting decade for us. I really think clearly make mistakes and could have found shorter paths from A to B but we are very well positioned to enter this next decade. So, what we look out to do if you will, we look out to the year 2020 or our vision for 2020, we just think this think the next thing in the year is going to be pretty dynamic and we really believe we have set it up pretty well from things we have done and we invested in, not that we have done it perfectly and not that there will be a straight run in itself. We like where we are at. We like what happened in the last 90 days. We will be silly not to say that and the fundamental has changed and we actually did not call it the change because whether what we are doing inside but it did certainly changed our environment so there are lots to do this year.

The absorption of what has happened is just beginning and we, I think as Mike said it will be last half of the year reports all kind of completely in but there is not a lot of negative to it. Now there will be, I got the Business Week article here in front of me with, they made sure they did not get a picture I was smiling, I have gotten a little bit ribbing from here but I look pretty upset. But there is going to be a lot of people should at this level of investment but every one of those and every one of those stories end it there. There is another big; there is not all the facts that will get into the papers. This is all happening. Every client I talked to, we really kind of fun thing here. This kind of where we create the program to go basically do the math, somebody asked us how we did the calculation. We used a computer and we read the legislation and we built the models and everyone of the CEO, what fun is I talked to more CEOs this last 45 days than I have talked to in any 45 days and I talked to a lot of CEOs in any given 45 days and I have talked a lot now.

Everybody basically, because these are very large clients, I got the privilege to talk with some of our, most of our largest clients. They all felt they were on this path. They put their reputations in many cases of their careers at risk but they are bored on this past and this is fundamentally validation that they are on the right path, and in many cases, they are going to get checking the mail they paid for, all of it or a big chunk of it.

So, they are all feeling very good. It will generate a lot of business. We do not know exactly what percent but there is not a lot of bad news in this. But we still got to get fully absorbed because the bipolar nature with the hard environment, we were doing okay in it but it was the most, I think I ended last call basically with saying, hey, if we could change it, we would like to have better environment but it is an environment where we are still winning. Most people are staying in the course with us. But it was affecting everything. So with that, thanks for your time and we will talk to you in 90 days.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.

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