Allscripts Healthcare Solutions Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 8.13 | About: Allscripts Healthcare (MDRX)

Allscripts Healthcare Solutions (NASDAQ:MDRX)

Q2 2013 Earnings Call

August 08, 2013 4:30 pm ET


Seth Frank - Vice President of Investor Relations

Paul M. Black - Chief Executive Officer, President, Director and Member of Compensation Committee

Richard J. Poulton - Chief Financial Officer, Principal Accounting Officer and Secretary


Charles Rhyee - Cowen and Company, LLC, Research Division

Michael Cherny - ISI Group Inc., Research Division

Diego Hernandez

Zachary William Sopcak - Morgan Stanley, Research Division

Richard C. Close - Avondale Partners, LLC, Research Division

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Sean W. Wieland - Piper Jaffray Companies, Research Division


Good afternoon. My name is Wanda, and I will be your conference operator today. At this time, I would like to welcome everyone to the Allscripts Q2 2013 Earnings Conference Call. [Operator Instructions]

I would now like to turn the call over to Mr. Seth Frank, Vice President of Investor Relations. Please go ahead, sir.

Seth Frank

Thank you, Wanda. Thank you for joining us on the call today. Today with us are Paul Black, Allscripts President and Chief Executive Officer; and our Chief Financial Officer, Rick Poulton.

During today's call, we will reference supplemental financial tables available on the Investor Relations homepage of the Allscripts website at In addition, we will reference both GAAP and non-GAAP financial measures on today's call. Reconciliations of non-GAAP financial measures are available in the news release, which accompany explanations -- with accompanying explanations to assist you in evaluating the financial metrics we will discuss today.

Before we will begin, I will read our Safe Harbor statement. This presentation will contain forward-looking statements within the meaning of the federal securities laws. Statements regarding future events and developments, the company's future performance, as well as management's expectations, beliefs, intentions, plans, estimates or projections related to the future are forward-looking statements within the meaning of these laws.

These forward-looking statements are subject to a number of risks and uncertainties, including factors outlined from time to time in our most recent report on Form 10-K, our earnings announcements and other reports we file with the Securities and Exchange Commission. These are available at The company undertakes no obligation to update publicly any forward-looking statement, whether as a result of new information, future events or otherwise.

And now I'd like to introduce Paul Black, President and Chief Executive Officer of Allscripts.

Paul M. Black

Thank you, Seth, and thank you, all, for joining us to discuss Allscripts' 2013 second quarter earnings results. Allscripts previously disclosed its preliminary results for this quarter, specifically bookings as well as non-GAAP revenue and non-GAAP operating income. With that in mind, I will focus on 3 topics: one, review Allscripts' significant accomplishments this quarter; two, discuss the key growth drivers and their impact on Q2 results; and three, provide an update on the actions we are implementing to improve Allscripts' operational and financial performance for the long term. Finally, Rick will provide you additional color on the financials.

During the second quarter, we had meaningful achievements along several business dimensions that will strengthen the company's long-term position. First, we achieved the highest level of bookings or new sales since December of 2011. Second, we extended an outsourcing agreement with North Shore Long Island Jewish, Allscripts' largest client, through 2020. We signed additional significant renewals of long-term managed services agreements. These renewals contributed to 16% quarter-over-quarter growth in contract backlog. While contract extensions are not treated as new bookings, they clearly validate the significant value we provide to our clients.

Third, we continue to execute successful new client activations in both acute and ambulatory EHR platforms, domestically and in the United Kingdom. Fourth, we announced certification of all core EHR systems, including Sunrise 6.1 for both acute and ambulatory systems, Enterprise EHR 11.4.1 and Professional EHR 13.0. This a critical step to ensure client readiness to support Meaningful Use Stage 2 attestation. Fifth, we closed approximately $1 billion in refinancing activities that immediately enhanced Allscripts' capital structure and provide us with greater flexibility to achieve the company's strategic imperatives. Rick will discuss these activities later.

Finally, we continue to strengthen the internal team and our Board of Directors. For example, Brian Farley joined us as Allscripts' new General Counsel and Corporate Secretary. Brian joins us from Motorola, where he served as General Counsel for Motorola Mobilities home business.

Total bookings for the quarter were $214.1 million, which equals 10% growth year-over-year and 21% growth over the first quarter of 2013. This is an important accomplishment that demonstrates increased confidence by clients in prospects in Allscripts.

This quarter also marks the first time since December 2011 that Allscripts grew bookings over the prior year. Sequential bookings growth is also the highest it has been since the end of 2011. We enjoyed a balanced mix of sales within and outside the core install base and across multiple solutions within the corporate portfolio. Most importantly, we achieved these results without relying on any one specific transaction.

To give you a sense of new business success year-to-date, in 2013 we have added over 400 new client relationships to Allscripts across the care continuum thus far in 2013. Allscripts sales results illustrate the depth and breadth of the solutions portfolio and our clients' collective efforts to transform the practice of medicine, in part through successful utilization of these solutions. Solutions that clearly align with the major challenges facing the health care services industry for the foreseeable future. The most significant of these challenges is the shift to value-based care with a goal of optimizing outcomes in a cost-effective manner, moving away from volume-based fee-for-service reimbursement.

The second challenge is rapidly accelerating vertical and horizontal integration among health care providers, where many organizations will be going at financial risk for the populations they serve. And the third is what I think of as sort of the new frontier, active consumer engagement in the medical and related economic decision-making process. These challenges require retail pharmacies, pharmacy benefit managers, employers, insurers, hospitals, physician practices, health systems and post-acute providers to analyze complex massive sets of data across populations and communities. Through the first half of 2013, we have secured new business in each of these venues.

Movement to the value-based care requires refining workflows to standardizing care guidelines, to minimize unexplained variances in care delivery. It also requires seamless care coordination and transitions of care inside and outside of any individual health care organization. With provider consolidation, rip and replace strategies for core IT systems increasingly make neither economic nor practical sense. Alternative technologies are necessary to enhance existing investments while extending clinical functionality and fluidity of data across care settings.

The regulatory requirements of Meaningful Use 2 attestation requires physicians to ensure that consumers have access to their electronic medical information and meet minimum levels of online patient interaction. Opportunities abound to engage individuals in their care, be it chronic, acute or preventative, by providing practical access to mobile devices that will enable transactions, transmit data and ultimately, fill this missing link in health care today. This is especially important as health plans and employers provide more choice and financial incentives for preventative health maintenance.

These are all drivers of Allscripts' corporate vision for an open Connected Community of Health. And because we can deliver the solutions that caregivers need to address these challenges, we have a unique opportunity to deepen relationships with existing clients, gain market share and expand the company's client base outside of the core EHR install base.

As some of you saw at the Allscripts Population Health Management Investor Summit in Pittsburgh in June, we hosted senior executives from the University of Pittsburgh Medical Center and Unity Health in Rochester, New York. These institutions discuss the challenges in how they are deploying Allscripts community architecture even though the majority of their core IT infrastructure comes from other non-Allscripts solution providers.

The benefit of this positioning in the market is paying off for us, and you see it in this quarter's bookings results. We saw significant double-digit growth in sales of population health management solutions year-over-year and sequentially quarter-to-quarter. Population Health Management solutions refers to Allscripts' Care Management, dbMotion, the FollowMyHealth patient portal, Care Director, PatientFlow as well as post-acute decision support and clinic -- clinical analytics solutions. We expect that Population Health Management will be a significant growth globally for us over the next several years.

Allscripts' presence in the post-acute market is a significant differentiator for us. In addition to the macro trend of care moving out of the highest acuity into more appropriate and less costly care settings, such as a home, rehabilitation and hospice, these organizations are seeking solutions to connect, transition and coordinate care between hospitals and post-acute care givers. For example, we signed a new agreement this quarter with Kindred Healthcare. This represents an exciting long-term new business opportunity in the post-acute provider market.

Utilizing dbMotion, Kindred will drive improved care ordination, link referring providers to Kindred facilities and ultimately, enable an open Connected Community of Health. Kindred is an existing client for Allscripts' post-acute solutions. The initial plan is to launch this initiative with a subset of their organization. We look forward to expanding this strategic relationship over time. We will continue to aggressively strengthen Allscripts' Population Health position, leveraging investments and innovation, as well as Allscripts' existing footprint across multiple solution sets, including care management, connectivity and analytics.

In addition to Kindred, we had multiple agreements for dbMotion with multiple providers, as well as a large national chain of retail pharmacies. With the patient engagement requirements of Meaningful Use 2, we see growing demand for patient portal solutions, specifically the FollowMyHealth offering. In Q2, we saw strong demand from hospitals and increasing demand from physician practices for patient portal, which is sold on a subscription basis. This provides us with an additional recurring revenue stream. Allscripts patient engagement strategy includes direct sales to existing clients and open technology to connect to other EHR systems. Allscripts' Care Management suite also had a strong quarter, with double-digit growth in Q2 versus Q1, as care coordination referral management and other discharge-related activities transitioned from paper, phone and fax to a fully integrated and connected digital platform.

We had a significant number of 7-figure agreements both inside and outside the company's core Sunrise install base for Care Management. This is a best-of-class solution that clients appreciate given its superior reporting capabilities and proven ability to integrate Allscripts Care Management platform with other EHR systems. We had a strong quarter of EPSi sales, both in and outside of the install base with triple-digit year-on-year growth.

Health care financial decision-makers continue to face an increasingly complex and dynamic reimbursement environment, impending transition to ICD-10, as well as a shift to value, increasing the need for an actual financial decision port solution.

Finally, we saw triple-digit growth over 2012 in the emerging, but rapidly growing clinical analytics business, Allscripts Analytics. In Q2, Managed Services, which includes IT outsourcing and remote hosting services, grew double digits over 2012 and the first quarter. We've indicated that one opportunity for growth is to increase our capture of the percentage of spend with our clients' IT operating services that take incremental operating and capital expenditure pressure off their budgets. By choosing Allscripts to provide hosting services, we eliminate significant upfront capital outlays by clients who can redeploy expensive physical plant space reserved for IT to other functions and have the benefit of robust data backup and disaster recovery services.

Hosted clients can also benefit from an accelerated deployment times for new software and for upgrades. While we have work to do to improve the profitability of this business, we are seeing increased interest in migrating to hosted solutions with multiyear agreements across the acute and large ambulatory clients.

Within outsourcing, we are pleased to announce extension of the outsourcing agreement with North Shore Long Island Jewish Medical Center, Allscripts' largest client. This agreement, valued at more than $400 million over 5 years, is important for several reasons. First, it ensures an important and large component of the company's recurring stream of revenue will continue for sometime, not a small achievement. In addition, Allscripts' partnership with North Shore is mutually important to both organizations, and the renewal of their commitment to us is of tremendous value in the HCIT marketplace.

This quarter, bolstering the growth in managed services bookings, was a new outsourcing agreement with Liberty Hospital in Missouri. Liberty Hospital currently has a staff of over 30 people managing their IT solutions. This is a great example of how Allscripts can extend relationships with existing Sunrise clients in allowing them to focus on patient care, while Allscripts provides the expertise within the information technology to improve overall organizational and financial performance.

We find the clients who outsource their IT staff to Allscripts report among the highest satisfaction scores within the company's client base. We view the extension with LIJ, the new agreement with Liberty, as well as other agreements signed this quarter, as significant endorsements of our strong long-term relationships, as well as endorsements of Allscripts' future solution development and overall technology strategy.

Turning to Electronic Health Record and Revenue Cycle Management, Allscripts' core business within the ambulatory and acute care segments, overall business trends remain stable from a bookings perspective in Q2. We had success with add-on solutions sold into the installed Sunrise Clinical Manager base. Examples of new sales in Q2 include multiple Sunrise Financial Manager agreements and add-on Sunrise modules, including departmental, ancillary and administrative systems. In terms of new market share opportunities in the ambulatory and acute, corporate results and pipeline over the last 6 months suggest opportunities for displacing competitors during the next 6 months and into 2014, as prospects first demonstrate and attest for Meaningful Use on their current platforms.

We anticipate a combination of dissatisfaction with incumbent relationships, combined with a significantly raised bar for Meaningful Use 3, will likely result in additional market share opportunities for Allscripts. We see this across acute, ambulatory and integrated delivery segments, and we expect to be successful in winning share driven by an open technology, robust systems and strong value proposition. Within the ambulatory client base, we continue to see a growth trend where large practices get bigger. Ambulatory bookings were up over the prior year in the first quarter of 2013, driven by Enterprise EHR sales within the existing client base. We also had several new Enterprise EHR sales in the quarter one to a university medical center in the mid-Atlantic.

In addition, we had double-digit sequential growth in Professional EHR, as we add new physicians through communities agreements, whereby hospitals endorse and often subsidize Allscripts ambulatory EHR solutions. We also had strong Professional EHR sales through our direct sales to these practices.

Allscripts' position in the EHR market remains strong, and overall client satisfaction is improving, while we still have more work to be done there. Before Rick discusses the numbers, I want to update you on several operational initiatives of importance to meeting the strategic imperatives we discussed earlier this year. There is nothing more important for Allscripts right now than precise execution around Meaningful Use 2 and ICD-10 obligations. Successfully protecting and defending the install base, Allscripts' #1 strategic imperative, depends on us being successful with this next upgrade cycle. With ICD-10, there have been some comments about EHR projects being put on hold or implementation slowing due to the approaching ICD-10 deadline in October of 2014. To date, we have not seen ICD-10-related slowdowns. All clients will need to upgrade for ICD-10, and we are working with them to make sure they are successful. In order to assist now, we are offering the solutions to assist clients to prepare for ICD-10 today.

Turning to Meaningful Use. Allscripts Meaningful Use releases of all core EHRs are now certified, including Sunrise 6.1 Acute, Sunrise 6.1 Ambulatory Enterprise EHR 11.4.1 and Professional EHR 13.0. In addition, all solutions are generally available for implementation, except Professional EHR, which we anticipate will be generally available later this month.

In addition, FollowMyHealth, a module for meeting Meaningful Use to patient portal requirements, met certification criteria in June. We have a significant queue of clients across the base slotted for upgrades. We will ensure all current and future clients who want to demonstrate and attest for Meaningful Use 2 in 2014 will be able to do so before the deadlines in May of 2014 and August 2014 for the acute and ambulatory eligible providers, respectively.

We also delivered several new client activations that are now highly referenceable. During Q2, we brought 7 new hospital clients live on Sunrise Clinical Manager, adding functionality, new modules and departmental systems at dozens of additional sites. Robust activations and upgrades also continue within and across Enterprise and Professional EHR install base.

I also want to mention a highly successful big bang implementation at Flagler Hospital in Saint Augustine, Florida. This was a complete replacement of a privately held competitor that we won in 2011. The go-live marks a major success for Flagler and Allscripts, as they went live on over a dozen new applications, including revenue cycle, ambulatory, inpatient, multiple ancillaries, including Allscripts' laboratory information system, all in 1 integrated architecture. Additionally, Sunrise activations this quarter included Salford Royal NHS Foundation Trust and Liverpool Heart and Chest Hospital, both in the United Kingdom. These institutions are truly leaders in their respective communities.

Salford Royal is nationally recognized in the National Health System as a quality and patient safety leader. They went live with over 1 million patient records converted by Allscripts from their legacy system, 145 million order sets and results and 14 million clinical documentations -- documents. In their first day, Salford Royal had a peak of 675 concurrent users, leveraging Sunrise's clinical functionality.

In addition, Liverpool Heart and Chest Hospital is another highly regarded institution, based in part on their high ratings for quality care and patient satisfaction. Liverpool Heart and Chest was recognized by Health Services Journal as the Provider of the Year in 2012. The activation at this site was also highly successful.

Having just returned from these locations, I was thrilled to hear directly from the executives and caregivers regarding the exceptional level of satisfaction. I believe the United Kingdom and other international markets are exciting opportunities for Allscripts.

Finally, Allscripts investment in research and development, which is up 20% year-to-date, is paying off. The company was just notified that Allscripts Wand version 2.0, the Apple iPad companion application for Enterprise EHR, is now for sale through the Apple App store earlier than we had anticipated. Wand is a mobile streamlined version of EHR that can be carried anywhere. It provides physicians with the vast majority of functions that they use daily in a new, highly intuitive and improved user interface. This new user experience accelerates proficiency in the mobile environment. The availability of Wand via the App Store will allow us to further extend our leadership in the mobile healthcare arena.

Turning to the company's efforts to be more efficient, we continue to advance operational efficiency and site consolidation. Cost-efficiency plans which were laid out earlier this year remain on track. We have implemented new travel policies and discipline policies around discretionary spending that will result in meaningful cost savings over time.

And with those comments, I will hand the call over to Rick, who will review the financial highlights for the quarter. Rick?

Richard J. Poulton

Thanks, Paul, and good afternoon, everyone. As I comment on the numbers, please utilize the GAAP and non-GAAP financial statements in our earnings news release, as well as the supplemental data sheet available on our Investor Relations website that Seth referred to earlier.

I'm going to start by making some general comments on the quarter and amplify a couple of the themes that Paul discussed, and then I'll review the numbers in detail. After what was a very challenging 2012, our team has been focused on stabilizing our client base and workforce, building confidence in Allscripts in the marketplace and creating positive momentum in executing our sales and delivery plans. We believe our second quarter results reflect encouraging signs across each of these goals.

As Paul has discussed, we are pleased to generate bookings growth year-over-year, driven by a well-balanced mix across our solution set. You may recall that during the first quarter call, we stated that our goal was to generate bookings growth in 2013. We certainly still have a lot of work ahead of us, but at the midway point, bookings are up slightly year-to-date compared with the prior year, and this was the toughest comps that we thought we would face all year. So we remain comfortable with that outlook that we announced earlier. Also as Paul had mentioned, client renewals, which are important indicators of stability and confidence in Allscripts, were largely responsible for a 16% sequential increase in our contract backlog to what is a record $3.2 billion.

In addition, we executed a highly successful convertible notes offering and refinancing of our bank credit facilities in June. Both of these offerings were highly oversubscribed, and we took that as a strong sign of confidence in our team and our future prospects. While these accomplishments are encouraging, we recognize we still have important work to accelerate top line growth, improve profitability and generate sustainable, predictable growth in the future.

We continue to invest in our technologies and our client partnerships. As Paul indicated, year-to-date, we are spending 20% more on R&D than we did a year ago, and we're taking definitive actions to increase our operational effectiveness. And as we've shared previously, the validation points in the financials will lag the actions that we are taking today.

In addition, a shift to higher subscription-based revenue, as well as deferrals that are required on some of our upgrades, has muted some of our top line growth in the near term, but we believe in the model and that this will help create long-term value for our shareholders.

Non-GAAP revenue and operating income for the second quarter were materially consistent with Q1 of 2013. This is in line with the view that we provided to the market in our 8-K filing on June 12, which was the day we launched the sale of our convertible notes offering. In addition, on July 10, in conjunction with providing our earnings release date, we announced that bookings were expected to exceed $200 million for the quarter. As you see in the results today, we comfortably exceeded that initial view and the year-over-year, as well as sequential growth of 10% and 20%, respectively, is certainly a step in the right direction for Allscripts.

Our bookings this quarter did not translate into significant additional revenue due to the longer-term nature of the agreements and in the form of subscriptions and other multiyear agreements. As you'll see in the supplemental data sheets, subscription-based sales represent 30% of bookings during the quarter, which is an increase compared to last year, as well as the first quarter of this year. Paul already provided a comprehensive discussion of the booking drivers for the quarter, I would just like to emphasize that the sales mix was strong this quarter, representing many types of clients, as well as many types of solutions that we offer.

Also we were not reliant nor were results skewed by any one agreement or any particular contract. We had one meaningful new outsourcing agreement, which was with Liberty Hospital, but it did not skew our bookings results for the quarter. In fact, we are posting our strongest growth rates in businesses outside of our core EHR market within the Population Health Management solutions suite that we offer. 1/3 of our bookings this quarter were derived from these solutions, and growth rates are very strong both year-over-year, as well as compared to our first quarter. It's important to understand our opportunity in the is emerging and will increasingly come from outside of the Allscripts core installed EHR base.

Please be aware that the dbMotion acquisition did not contribute significant incremental bookings in the quarter, due to the fact that Allscripts' pre-existing relationship with the company where we sold this product, all of this was reflected in our bookings during those transactions previously. So there's not a large incremental change there.

So with that backdrop, I'd like to move to the P&L. Total non-GAAP revenue was $347 million. This represented a 6% year-over-year decline, but was flat sequentially. While revenue was flat with the first quarter, the mix was much improved. System sales revenue increased 20% sequentially to approximately $33 million, which reflected a strong quarter from our ambulatory segment sales and a nice mix between new client, as well as add-on client sales. I would also add that acquisitions had no material impact on our system sales revenue performance during the quarter.

Looking at maintenance. Revenue, as well as backlog, stabilized this quarter. Maintenance revenue was relatively flat over the prior year and down just slightly versus our first quarter. Going forward, we anticipate maintenance revenue will trend generally flat on a quarter-over-quarter basis. This is due to the shift from perpetual license agreements to subscription-based arrangements and thus, the recharacterization of these maintenance dollars into transaction processing and other revenue. You will note from the supplemental data sheet that SaaS-based revenue, which is obviously another term for these maintenance agreement -- or excuse me, these subscription agreements. Our SaaS-based revenue continues to be at all-time high levels, and we expect this to continue to tick up in the future.

Maintenance revenue backlog was very stable compared with the first quarter, as you'll see from the supplemental data sheet, and overall attrition rates within our core client base are very consistent with prior quarters. Professional services revenue was essentially flat versus Q1, but down over last year to $61 million, primarily attributable to a lull in upgrades ahead of Meaningful Use 2.

As we indicated last quarter, we expect services revenue will increase during the back half of the year, as we prepare and start to execute on the Meaningful Use 2 upgrade cycle. Our transaction processing and other revenue decreased 4% and 3% versus the prior year and last quarter, respectively. The primary driver of the decline was the roll-off of one outsourcing client who has moved their staffing back to an in-house model. They remain a strategic Sunrise Clinical Manager client for us. And as we've seen in the past, outsourcing can be lumpy with both new client adds, as well as subtracts, which can cause temporary volatility in both bookings and revenue.

The remaining revenue components of transaction processing, including subscription, remote hosting and our transaction businesses were stable or grew slightly in the quarter relative to our prior periods.

Switching to margins. On a GAAP basis, system sales gross margins increased substantially relative to Q1 based on a higher software mix. Our GAAP system sales gross margins were just slightly under 60%, and this compared with just slightly over 50% in the first quarter and 56% last year. We have continued to break out noncash amortization, and you will see that amortization expense increased due to higher capitalized software development expense, as well as amortization of acquired intangible assets.

Non-GAAP services margins improved just slightly versus Q1 and continue to be impacted by lower utilization and continued investment in ongoing client commitments. Again, we would expect that utilization to improve during the back half of the year. Maintenance margins improved slightly this quarter as did those in our transaction processing and other line item, owing in large part to the lower mix of outsourcing revenue we discussed a moment ago. Remember, outsourcing revenue is among our lowest gross margin revenues in our portfolio. So the improved mix between system sales and our transaction processing revenue lead to an improvement in Enterprise non-GAAP gross margins by 150 basis points on a sequential basis to almost 44%.

Moving down to operating expenses. SG&A expenses, as reported, increased approximately $12 million or 13% over the prior year and were essentially flat on a sequential basis. Our reported SG&A was impacted by the following onetime items this quarter. We had approximately $4.2 million of severance and other nonrecurring costs. We had approximately $3.1 million associated with the MyWay platform, a migration to a pro product; and $5.6 million of transaction-related costs associated with the acquisitions we completed earlier in the quarter -- or excuse me, earlier this year, which is a total of $12.9 million in total. Please note that $2 million of this transaction-related cost this quarter are associated with the terms of our dbMotion acquisition, which provided for what we call deferred consideration payouts, and this is effectively payments to the old management team that has to be recognized as compensation expense in our P&L. We'll continue to incur this through the third quarter of this year, and then that will go away.

Taking this total amount of $12.9 million of nonrecurring cost into account, SG&A would have been approximately $91 million on a steady-state basis, which is up about $5 million compared with the prior quarter and a year ago. The majority of this increase is due to the additional expense structure that is associated with the acquisitions of dbMotion and Jardogs, which is again, is our FollowMyHealth portal product, which occurred, remember, in March of this year. So this quarter marks the first full quarter of expenses associated with these acquisitions.

Our corporate overhead actually reduced during the quarter by $1 million relative to the first quarter. Becoming more operationally efficient remains a top strategic comparative as Paul mentioned. And as we have consistently said, we are working hard to enhance long-term strategic value for our clients, employees and our shareholders by investing in our client base, aggressively growing our R&D initiatives and continuing to focus on innovation that will provide product solutions in growth markets like population health management.

Part of the move to be more efficient is portfolio consolidation. We expect some additional expenses related to MyWay product consolidation, severance and other operational initiatives relative to our facility footprint initiative and all of these expected costs are in line with our guidance that we laid out for you in the beginning of the year.

We remain on track to drive in excess of $50 million in annualized savings from our cost structure on a full year run-rate basis, beginning in 2014. We also remain on target with our stated goal to invest in double-digit growth in our R&D investment through 2013. In the second quarter, Allscripts gross R&D expenditures totaled almost $63 million, which represent a 21% growth over last year's second quarter. We capitalized $11 million of this R&D investment or approximately 18% of the total, which was up from 13% in the first quarter. You may recall, in our first quarter call, we indicated we expected this number to rise up to closer to 20%. On a reported basis, R&D increased 35%, which versus one year ago, due to our innovation initiatives as well as much lower software capitalization rates earlier in the year. These details could be found on the supplemental data sheet on the website.

Our non-GAAP operating margins came in at 5.4% for the quarter, which is a 30 basis point improvement versus the first quarter, thanks to the higher gross margin percentage we discussed earlier.

Moving down to nonoperating items. Please note that we recorded $4.2 million in charges to interest expense that related to our financing activities this quarter. The majority of this was related to the write-off of deferred debt acquisition costs associated with our bank facilities. But we also have a recurring noncash interest charge that stems from convertible bond accounting rules. And what this, in essence, represents, is the difference between our cash cost of this bond, which is 1 1/4%, and a theoretical debt cost of approximately 5 1/2%. So this will be with us for the foreseeable future and we will continue to add this back as an expense for non-GAAP purposes.

Moving down to tax rate. Our non-GAAP effective tax rate for the quarter was 34%, which was consistent with the guidance we provided at the end of our first quarter, and it's more indicative of what we would expect to see for the remainder of this year.

After excluding the noncash and other adjustments we discussed, non-GAAP net income totaled $9 million or $0.05 a share. Adjusted EBITDA totaled $42.1 million. You can see the details of this calculation in Table 5 to the news release. Our EBITDA declined on lower income -- basically due to lower income for the quarter. Please note that Q1 EBITDA included a onetime gain, which did not obviously recur in the second quarter.

After completing our debt refinancing, the company has total liquidity of approximately $437 million. This is comprised of cash, marketable securities and undrawn amounts under our revolving credit facility. This $437 (sic) [$437 million] represents the largest available liquidity in the company history and is obviously a substantial improvement from where we were at the end of our first quarter. The refinancing also provided a lower cash interest expense for the company and significantly reduced near-term debt service requirements. As you can see from the balance sheet. You'll note that current maturities of debt are quite a bit below where they were previously.

Finally, please note that our weighted average share count increased to approximately 178 million shares outstanding, up from 174 million last quarter. This is primarily due to the issuance of shares in our dbMotion acquisition earlier this year, and this is again a first full quarter where you see that effect. So you should expect this as close to the run rate going forward.

So with that, thanks for your time and attention, and now I'll turn the call back over to Wanda to take any of your questions.

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Charles Rhyee with Cowen and Company.

Charles Rhyee - Cowen and Company, LLC, Research Division

Paul, I wanted to talk about the bookings here. Obviously, you kind of signaled where we're going to be earlier and we came in here in 2014 and gave a lot of good description on the strength and the variety in it. Maybe I could talk about outsourcing and services and talk a little bit more about opportunity you clearly extended with the North Shore and the Liberty deal. Can you talk about other -- what percentage of the current installed base is a good target for outsourcing, as well as other hosting services that you might be able to provide? Can you give us a character on some of the pipeline opportunity there and how close we might be seeing some of that?

Paul M. Black

Sure. Thanks, Charles. The activity level in the install base for having somebody else run their computers, for having somebody else manage their teams has increased pretty dramatically from my perspective given what's going on inside of health care in the United States with the CMS cuts that they all received in the last 30 to 60 days. So every client that I'm out talking to is looking for ways to cut their operational costs, and we make a pretty compelling case to them with regard to being able to outsource their teams and to be able to outsource their computers. So we have a pretty high percentage of clients who are talking to us about that and we have a pretty low percentage right now of clients who -- that we already have under contract. So I think that's going to be, as I said in the call today and as I've said in the past, I think that's going to be a nice growth driver for us. There's a lot of synergies that come out of that with faster activations, with faster upgrades, with more control over the end user experience from a response time, from an uptime standpoint, it's a great business model.

Charles Rhyee - Cowen and Company, LLC, Research Division

Your hosting, in particular, I know you guys talked about putting a lot of resources into last year to really improve the service level. Can you talk about where you're at in terms of uptime and sort of the ability to keep customers satisfied with the service level at this point. Are you happy with where you're at, or is there still room to improve?

Paul M. Black

There's always room to improve on something like that, but I'm a lot happier today than I was when I sat on the board this time last year and also, I think where we were at the beginning of the year. We've had a lot of focus on it. We've got some executives that are in charge of that, that are quite good at it, that have been here for a while and brought in some new talent to help them. And I'm pleased with where we are today.

Richard J. Poulton

Charles, I would just pile on. But I mean, priority one was the operational side and I think we have made nice strides there. Our next focus will be improving the profitability of that business for us. So we have a ways to go on that as well.


Your next question comes from the line of Michael Cherny with ISI Group.

Michael Cherny - ISI Group Inc., Research Division

So you talked a lot about dbMotion. Obviously, it was a nice follow-up on the Population Health that you did back in Pittsburgh. And maybe digging a little bit more and also fill-in people, I guess, who weren't able to attend that day. In terms of after you acquired dbMotion and as you went back out to market, more to push most -- Population Health, did the conversations change at all with customers, as you were going through that pipeline, had the customers that you'd already sold it, what was their reaction towards you now owning dbMotion? What was their excitement going forward, particularly as you build out the broad product suite that you're pursuing?

Paul M. Black

I think the clients are pleased with the fact that we have a little bit more breadth and depth to offer them in addition to just the dbMotion suite of solutions. So that was an important interoperability layer for us, but it also then provides the capability for us to add analytics, care coordination, care management and also the FollowMyHealth patient portal to it as a platform all of which sits on, and is plugged into, the dbMotion community architecture. And I think the other thing that they like about it is a bit of the stability behind the R&D that we're able to put into it and to accelerate some of the timeframes of product and solution delivery that they've been hoping for and had been expecting. Broadly, it's been very well received from clients and some of our other Sunrise and Enterprise clients, they were pretty intrigued by that acquisition and it increased their interest in us on the core products as well.

Michael Cherny - ISI Group Inc., Research Division

Great. And then, I know you guys aren't giving guidance at this point, but just in terms of thinking about the targets, Rick, that you outlined, reiterating the fact you are targeting $50-plus million of [indiscernible] savings in 2014. As you think about, particularly as we head into the fourth quarter, how much of that do you think is going to start to show up in the P&L at this point? Just big picture, not necessarily specific numbers, but in terms of the magnitude, from a step-function perspective, when do you expect to start to see some of those chunks of savings kind of hitting the P&L?

Richard J. Poulton

I think -- I mean, there are moving pieces, obviously, Michael, and we'll have to isolate on some of this stuff. But I think we'll start to see the benefits in Q3 a little more in some of the SG&A area us. We've got some initiatives that I think will begin to kick in, in a meaningful way, won't be a full quarter effect, but we'll start to see some of it. And so I think, it may be a long-winded way of saying Q4 should be a quarter where we start to see more impact. And then even some of that will be a partial quarter's worth. So you may not really get a full dose of it until you get into Q1.


Your next question comes from the line of Glen Santangelo with Credit Suisse.

Diego Hernandez

It's actually Diego, filling in for Glen. I just have -- I was wondering if you could give us a little bit more color. I mean there's a lot of talk about Population Health out in the market and I was wondering if we could get some color as to what the economics look like on a typical contract and for that matter, what a contract design typically looks like?

Paul M. Black

This is Paul. That's a pretty broad question. It depends what they're looking for, and some of the people are stepping into it in a -- I want to connect the differentiated electronic medical records that are out there and make some semblance of all this data. So there are some people that are just looking at that and they want to, if you will, get connected. There's other people that are saying I've got a partial connectivity strategy already in place and I'd like to understand how I can put together an analytics layer, so that I can segment my populations and really get a better feel for what the different populations are inside of my coverage area, like a diabetes population of over 65 population, pediatric population, et cetera, so that I can plan my care paths and I can plan my care coordination around those different populations. So there's an analytics play in that regard. And there's others folks that are saying, I kind of got -- I know what I need to go do here, I need to have some sort of vehicle to execute my care coordination strategy and I need to have something that I can plug in my care paths into and give that to a care coordinator that's sitting in a phone bank room perhaps somewhere, or that's sitting in a physician office practice who is making telephone calls outbound everyday to get people to come in and make a -- to attend -- to come to a visit. Or to -- have you gone to the smoking cessation class or whatever that might be. So there's many different permutations of this. An all-in, large contract with a large client can be multimillion dollar deal. And in some cases, on a small physician practice that we also do not ignore, that can be a couple of hundred thousand bucks. So it's a pretty wide range of outcomes, and it's typically a contract that's multi-year and it's typically a SaaS-based contract.

Diego Hernandez

Great. Very helpful. And then if I could just follow-up on a slightly different topic. I know there's been a number of industry groups out there kind of commenting or asking for a delay in Stage 2 and I was wondering if you can give us your expectations around that?

Paul M. Black

I'm not planning for that myself. I have read some of the same stuff that you've read, but most of our clients that we're working with are not planning on it from what I can tell, given the staging of the high percentage of our client base that's going through upgrades right now to put our now certified Meaningful Use 2 code in place and get it operational.


Your next question comes from Ricky Goldwasser with Morgan Stanley.

Zachary William Sopcak - Morgan Stanley, Research Division

This is Zach in for Ricky. First, I just wanted to ask, sticking to Population Health, 33% of the bookings this quarter from Population Health Solutions. I was wondering if you can give any color on how that compared to the first quarter.

Paul M. Black

Well, as we said, I mean our growth rates are up substantially from first quarter. So rough order of magnitude, think of it as probably between 20% and 25%, first quarter. A little higher, maybe a little slightly higher than that.

Zachary William Sopcak - Morgan Stanley, Research Division

Okay, great, that's helpful -- okay. And then on the gross margin mix, I know you talked about the lumpiness of outsourcing. Should we think of the 44% this quarter as kind of normalized, barring an additional lump, or is it just going to be hard to predict for the next few quarters?

Paul M. Black

Well, look, I mean I think our goal is to get back to gross margins at an enterprise level that are certainly even higher than what we came in this quarter. And we see areas of opportunity to make that happen. We were pleased to see the level of system sales come back to a more -- a level that we're more accustomed to this quarter, and so that certainly helps with some of the lift. And as I talked about a couple of questions ago, we do see an opportunity to improve our gross margins around our hosting business. That's not going to play out in 1 or 2 quarters, but that will -- should have a lot of opportunity as we look out over the longer horizon. So we see ways where it can certainly can go up. Every new deal around Managed Services, to the extent we continue to grow that, as Paul indicated earlier, those don't tend to carry the same margin profile as software does. So it kind of -- you get into a mix question at that point. So I think that's probably a long-winded way of saying it's difficult to have a lot of precision on that and it'll have a lot to do with what the mix of business looks like. But I think, we don't see any imminent fall-off in this level right now either. I'd also note that our services margins are especially nonexistent right now and that's reflective of some of the utilization challenges we talked about, as well as some of the -- we still continue to invest in some of our customers, and making good on previous commitments that had not been honored. So all-in, services and hosting have upside potential on the book of business they have today. If we grow Managed Services, that will put a little downward pressure, and we hope to grow out the software even more. So those are the variables at play, where it plays out, we'll have to just kind of keep watching.


Your next question comes from the line of Richard Close with Avondale Partners.

Richard C. Close - Avondale Partners, LLC, Research Division

Just really quick. Population Health Management, you talked about those tools being sold within and outside the existing base. Can you give us any additional detail or look into that in terms of how much of the bookings is coming outside the traditional base?

Paul M. Black

It's the minority of it today, but it's above 0. And so the point is that addressable base of -- outside our base is huge. And so, when we look at it all together, we see a lot of upside in the future for that.


Your next question comes from Robert Jones with Goldman Sachs.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Just looking at system sales, solid growth obviously in the quarter, probably a little better than the preannouncement, yet the backlog in that category continues to decline. I was just wondering how we should be thinking about new wins in system sales? Is this a trend that's more indicative of where we are in the market today? Or are you guys maybe not winning at the rate that you had hoped?

Richard J. Poulton

Well, there's a couple of things embedded in that, right, Bob? I mean some of it is -- and again, as we sell in a subscription or SaaS-basis, you're not going to see it go into system sales backlog, right? You're going to see it go into transaction processing backlog. We've also had a little bit of -- we used to sell a lot more hardware along with our deals than we do today. We don't see a lot of value add there. We only do it where we absolutely have to do it. So some of that is normalizing, where you're getting a much more pure look of software as opposed to a little heavier mix between software and hardware. But having said all that, we would like to bring that number back up.

Paul M. Black

We like to have more brand-new footprints while we had 400 so far this year. We'd like to have that number be higher and that's something that the entire sales organization's working on every day.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

I guess, Paul, just to follow-up on that then. You did mention the replacement opportunity that you're starting to see out there. I mean, I would imagine this would be one of the areas that could help spark growth in that within systems backlog. Is this coming more widespread? Is there anything worth calling out? Are you hearing a few isolated competitors that folks are looking to go away from? Any additional color around how the replacement opportunity is sizing up will be really helpful.

Paul M. Black

Yes. It's a little bit of all the above. There are some competitors that are out there that are stumbling a bit that we expect to have some success with. And I've directed the teams to make sure that they are putting proposals in front of them, spending time with them to make sure that they understand what Allscripts can do. Especially given some of the brand new footprints that we had that just went live, and talk about what it's like to do business with Allscripts in 2013 and beyond. As far as predictability around getting broad-based deployments of, especially on the acute-care side, multiple applications deployed in a decent number of months versus multi-years. Secondly, there are some ambulatory folks that are out there that, because of our footprint, we're going to get a lot more replacement opportunities as our organizations get bigger, and we saw some of that again this quarter and we'll continue to see that since we're in a lot -- a very large ambulatory and multigroup physician practices throughout United States. Those folks are all acquiring physician practices, which will give us additional opportunity for growth there. And then, there's kind of a traditional 6% to 8% or whatever the number might be, depending upon who you talk to, just natural ebb and flow of people getting -- making new decisions based on potentially a new management team that comes in to an organization that has had some experience with us in the past. And those are other reasons why people make solution or platform decisions to switch.


Your next question comes from the line of Dave Francis [ph] with JAG Research [ph].

Unknown Analyst

I wanted to take a look at the bookings number a little bit differently if possible. If you could characterize bookings a little differently, how much of the new bookings book represents pent-up demand from customers who might have been waiting to see how the new team was doing relative to what you might characterize as a simple organic demand from the marketplace?

Paul M. Black

That one's hard to gauge. I would, of course, like to take full credit for that, but I think that is not appropriate. That's really tough to say. There were some people though that were sitting on the sidelines given the pause button that they -- we gave them reason to depress last year. And those people have come back. And so I would say, a lot of that or some of that latent demand, if you want to categorize it as that, I think we've probably burnt through that in Q1 and at the end of last year. We've got other people that are -- because of deployments that we have with them, they're waiting to get the stuff deployed that we have in process today before they take the next step, as an example, to go initiate Population Health Management strategies with us. Then we have some people that, because they're full-bore out implementing Meaningful Use 2 releases, they're not adding a lot of brand-new functionality during this time frame either. So there's a little bit of all the above. That, to me, increases our chances, if you will, to go outside of our installed base, especially with the Population Health Management component, to other folks that either don't have that as part of their strategy or don't have it available outside of their own base, or are not finished with what they have, if you will, in the stove.

Unknown Analyst

That's helpful. A quick follow-up, to switch gears a little bit, on CommonWell. Can you just tell us from your perspective kind of, again, from your perspective, who's driving the train there and what are some of the short-term benchmarks or events that we should be looking for here over the next quarter or 2, in terms of moving that ball forward?

Paul M. Black

I think it's been a pretty collaborative involvement between Allscripts, athena, Cerner, Greenway, McKesson. And with the new guys coming on board, Sunquest and CPSI, we expect that to -- for that train to keep moving in the appropriate direction. The goals of it have been to have interoperability for, if you will, the common good, to identify patients across settings and make use of a commonly available unique identifier, that's not been ever supplied by any governmental agency or any sort of standards board. So I think that the group of suppliers got together and said, "It should be us that demonstrates that and be us that get together and comes up with the standards." I think as others have talked about, we expect to have something demonstrable in 2014. So I wouldn't expect anything major as far as a proof statement yet this year. We'll announce where the pilots are going to be and we expect to be able to demonstrate and show the marketplace results in the 2014 time frame.

Unknown Analyst

Is there any single individual in charge of that effort at this point?

Paul M. Black

No, it's been a collaboration, and it's been in a very -- again, in talking to our guys, they've been very pleased with the level of dialogue and the level of collaboration that goes on in that.


And your last question comes from the line of Sean Wieland with Piper Jaffray.

Sean W. Wieland - Piper Jaffray Companies, Research Division

I want to ask about the maintenance revenue line and the transaction revenue line. I hear what you're saying that the shift to SaaS would pressure any upside to the maintenance revenue, but why would it be down and why would transaction revenue be down?

Paul M. Black

Why is recognized transaction revenue down in the quarter?

Sean W. Wieland - Piper Jaffray Companies, Research Division


Paul M. Black

So we, I thought, covered that. I mean, we mentioned we had one outsource client who decided to take their work back in, and that switch happened very early in the quarter. So you had basically a full quarter's worth there, and that's the biggest driver. That's more than offsetting what is a growth in our SaaS-based revenue, which goes into that same line item. But that's the explanation for why that line item is down quarter-to-quarter.

Sean W. Wieland - Piper Jaffray Companies, Research Division

Okay. And then you mentioned that portfolio consolidation remains a focus. So I guess there on MyWay, where do you stand with regard to the migration of these customers to professional? What's the retention rate there? And then, what other products do you think are next up for consolidation?

Paul M. Black

I'd say on the MyWay stuff that we're proceeding on plan. It's never as fast as you want it to go, and it's never as bad as what it could be. So we're proceeding according to our plan there and the people that are migrating over are migrating over to a hosted platform, and that feels pretty good. And they're also, in some cases, adding the capabilities with our patient portal, so we're making some progress there. And there's not any other major platform discussion that I would talk about today.

Thank you very much for your questions today. As we've all talked about, we have a great deal of work to do to return Allscripts to sustainable, predictable growth and to assist our clients in achieving their goals. This quarter's achievements are certainly encouraging. I believe we are moving forward on multiple fronts and in a positive way.

Finally, I want to mention the company's annual users group meeting, the Allscripts Client Experience, or ACE, on August 21. Thousands of clients will gather in Chicago for the user group meeting. We're excited to share the company's vision and other global updates at that event. Thank you very much for your time today.


This does conclude today's conference call. You may now disconnect.

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