Cerner Corporation Q3 2009 Earnings Conference Call

| About: Cerner Corporation (CERN)

Cerner Corporation (NASDAQ:CERN)

Q3 2009 Earnings Call

October 28, 2009 4:30 p.m. ET


Marc Naughton - CFO

Neal Patterson - Chairman and CEO

Mike Valentine - EVP

Trace Devanny - President

Jeff Townsend - EVP and Chief of Staff


Sean Wieland - Piper

Atif Rahim - J. P. Morgan

Richard Close - Jefferies & Company

Charles Rhyee - Oppenheimer

Steve Hopper - Thomas Weisel Partners

Anthony Vendetti - Maxim Group

Corey Tobin - William Blair

Sandy Draper - Raymond James


Welcome to the Cerner Corporation's Third Quarter 2009 Conference Call. Today's date is October 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 provision 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 forward-looking statements maybe found under the heading 'Risk Factors' under Item 01 A and 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's Corporation. You may proceed, sir.

Marc Naughton

Thank you, Josh. Good afternoon, everyone and welcome to the call. I will lead off, Mike Valentine, Executive Vice President of our worldwide Client Organization will follow me with sales and operational highlights and marketplace trends and then Trace Devanny, our President will discuss our global business and provide stimulus opportunity and our position to practice strategy. Trace will be followed by Jeff Townsend, Executive Vice President and Chief of Staff who will provide an update on our initiative and discuss our vision for a new Millenium healthcare. Neal Patterson, our Chairman and CEO will join us for Q&A.

Now I will turn to our results, overall we delivered solid results we remained in a challenging environment. Our bookings were strong and above our targeted range with upside driven by some initial benefit from the stimulus as our new Cerner IT works initiative. The strength of our bookings didn't translate directly to our Income Statement as the bookings upside was related to services that don't have large up front revenue recognition. As a result our revenue was at below end of our guidance range reflecting some continued impact of the challenging economy particularly on items that require an up front capital outlay. Earnings were again our expected range largely driven by continued cost control. Our cash flow performances were strong, putting us on pace to exceed our full year free cash flow target.

Looking ahead we are encouraged by the significant opportunity associated with the stimulus that is showing up in our leading indicators including a very strong Q4 forecast that includes record booking levels and strong sequential Income Statement performance.

Moving to the details, our total bookings revenue in Q3 was $424 million which was above the high end of our guidance range and up 11% over last year. Our total backlog increased 13% year-over-year and ended the quarter at $3.85 billion. Contract revenue backlog ended the quarter at $3.25 billion, which is 15% higher than a year ago. Support revenue backlog was 604 million, up 6% year-over-year. Our revenue in the quarter was 409.4 million, which is up 1% sequentially and down 3% compared to Q3 '08 levels due to the challenging environment and a tough comparable. The revenue composition for Q3 was $118 million insist system sales, $122 million in support and maintenance, $162 million in services and $7 million in reimbursed travel.

System sales revenue was up 4% compared to Q2, but down 14% compared to Q3 08 driven by decline in technology resale and software. Note that Q3 '08 was our strongest software quarter of 2008 due to strong global sales, so it presented our toughest comparable on a year-over-year basis.

Looking at sequential trends our software is basically flat from Q2 and we had sequential increase in technology resale leaving total system sales increasing by 4 million as compared to Q2. While the market remained challenging in Q3, our forecast for Q4 suggests a significant sequential improvement.

Services revenue which includes managed services and professional services was up 3% compared to the year ago quarter but the decline in professional services being offset by continued strong managed services growth. The decline in professional services is the result of lower billable headcount in the U.S, lower services revenue in the UK, and the overall challenge in the economic environment. However, our outlook for professional services has improved for next year with stimulus driven services demand showing up in our bookings and forecast. Our support and maintenance revenue increased 3% over Q3 '08 and was down $1.5 million or 1% sequentially. I would note the support and maintenance revenue is up 10% year-to-date. The sequential decline was primarily driven by shifting some revenue that was previously treated as support to professional services as part of our transition to working with BT instead of Fujitsu in the Southern region of England. This shift does not impact the overall economics of the contract. Support and maintenance revenue growth has been impacted by lower levels of hardware maintenance, revenue related to lower levels of technology resale with many existing clients on hardware support switching to our whole [seed] option. Additionally most of our support contracts tie annual increases to inflation so there have not been increases this year.

Looking at revenue by geographic segment our domestic revenue increased by 2% to $339 million and global revenue declined by 23% to $71 million. As we previewed last quarter our global revenue was a very tough comparable this quarter due primarily with the large Middle East contract signed in Q3, ‘08. Q4, ‘09 will also face a tough comparable due to the $29 million UK catch up in Q4, of ‘08. While these comparables in a challenging global economy have impacted our global growth this year we maintain a very positive long-term global outlook and expect to return to solid growth next year.

Moving to gross margin, our gross margin for Q3 was 83.0% which is basically flat year-over-year and sequentially. Our system sales margin was 540 basis points year-over-year and 320 basis points sequentially to 59.5%. The year-over-year decline is due to lower [software] compared to Q3, ‘08. The sequential decline is due to the increased mix of technology resale as compared to Q2 09.

Looking at operating expenses and earnings, we have continued to prudently control expenses in this challenging environment. In Q3, our operating expenses were $264.5 million before options expense of $4.7 million. This is down 5% compared to the year ago period and 1% sequentially. Looking at the expense categories, sales and client services expenses were down $8 million or 4% compared to Q3, ‘08 and basically flat compared to Q2, ‘09.

The year-over-year decline is primarily due to lower professional services expense. Software development expense was down $2 million or 2% year-over-year reflecting our ongoing focus on controlling R&D expenses. Software development expenses up slightly sequentially due to an increase in amortization expense which I'll discuss in a moment. G&A expense was down $5 million or 14% compared to a year ago and down $3 million or 9% compared to Q2,’ 09. However, note that both comparable periods had foreign currency losses that increased expenses with Q3, ‘08 including a $5.6 million loss and Q2, ‘09 a $1.6 million loss.

This compares to a minimal impact of the $30,000 gain in this quarter. Therefore, G&A expense is basically flat year-over-year and sequentially after adjusting out the FX losses.

Moving to operating margins, our operating margin in Q3 was 18.4% before options expense, which is up by 150 basis points compared to last year and 110 basis points compared to Q2, ‘09. We maintain the goal of exiting 2009 with operating margins around 20% and achieving 20% operating margins for the full 2010. Moving to our earnings and EPS, our GAAP net earnings in Q3 were $48.4 million or $0.57 per share diluted. GAAP net earnings included stock option expense, which had a net impact on earnings of $2.9 million or $0.04 per share.

Adjusted net earnings were $51.3 million and adjusted EPS was $0.61. Our tax rate was 32.1%, which is about a 1.5% below our projected level due primarily to the release of an unrecognized tax benefit. The lower tax rate benefited our earnings by about $1.2 million or a penny.

Now move to our balance sheet. We ended Q3 with $436 million of cash and short-term investments. We also have $95 million of auction rate securities, which is down from $99 million last quarter due to $4 million in redemptions. Our total debt is $144 million. Total accounts receivable-ended Q3 at $470 million, which is up $25 million from Q1. Contracts receivable or the unbilled portion receivables was a $165 million, which represents 35% of total receivables compared to 32% in Q2.

Cash collections in Q3 were $410 million with third party financings of $21 million. Our DSO in Q3 was 105 days, which is up from 100 days in Q2. Note that our balance sheet still reflects bills and unbilled receivables related to the Fujitsu contract that represents over 10% of total receivables. While we still do not know the exact timing of the Fujitsu or the government allowing their contract to [allowance] to finalize with Fujitsu, we currently expect to fully collect those receivables.

However they have a negative impact on DSOs in the meantime. In addition to the impact of Fujitsu receivables our DSO this year has been impacted by the economy. We are not having issues with collect ability of receivables but are seeing some slower payments in more interest in deferred payment terms which we often accommodate by facilitating third party financing.

Operating cash flow for the quarter was solid at $73 million. Q3 capital expenditures were $24 million and capitalized software was $20 million. Free cash flow defined its operating flow less capital expenditures and capitalized software was $29 million. This brings year-to-date free cash flow to $91 million, which is strong growth compared to $58 million in the first three quarters of 2008, which positions us to exceed our target of $100 million on free cash flow in 2009.

Moving to capitalized software, the $20.1 million of capitalized software in Q3 represents 29% of the $69.9 million of total spend on development activities. Software amortization for the quarter was $16.9 million resulting in net capitalization of $3.2 million or 4% of the total. Compared to last quarter, amortization increased $1.1 million as our 2007.19 release became generally available in August. Next quarter amortization should increase from $16.9 million to about $17.5 million as a full three months of the amortization related to this release will be reflected. This release approach is consistent with our prior statements that we were moving towards faster development cycles, with this GA occurring about six months after the 2007.18 release. The financial impact of this approach is the amortization of capitalized software get started faster and the increases to amortization occur more frequently but are smaller.

Now I'll go to the guidance. Looking at Q4 revenue, we expect revenue in the $435 to $465 million range which is strong sequential increase from Q3 and reflects our expectation that we will see a seasonally strong Q4 and increasing stimulus driven demand. Looking at the year-over-year growth rate for Q4, you need to consider the Q4 08 reported revenue of $465 included $29 million of UK catch up revenue and had an extra week that resulted in about $20 million of additional support and services revenue.

Therefore the comparable Q4 08 revenue would be about $415 million. Our Q4 09 guidance range reflects 5% to 12% growth over this amount, which is a strong improvement, compared to our top line performance in the first three quarters.

Moving to EPS, we expect Q4 EPS before options expense to be $0.68 to $0.74 per share, also reflecting a strong sequential increase compared to Q3. The Q4 guidance is based on total spending before options expense of $275 to $280 million. Our estimate for options expense for Q4 09 is approximately $0.03 to $0.04.

Moving to bookings guidance we expect bookings revenue in Q4 of $425 to $475 million with the mid point of this range reflecting double digit growth over last year and representing an all-time high level of bookings for a quarter that doesn't include a large UK booking.

Now I'd like to provide our initial thoughts on 2010. Based on the initial version of our 2010 plan, the 2010 consensus estimates for revenue and earnings both appear reasonable with top line growth of approximately 10% and bottom line growth of approximately 17%.

We believe the improving macro environment combined with the beginning of stimulus driven demand supports this level of growth and perhaps some upside as stimulus demand accelerates. As always we will continue to update our outlook on future earnings call.

In closing we are pleased with our results in Q3, including strong bookings at a tough environment, continued progress in our margin expansion initiatives, delivering earnings growth at a challenging environment and strong free cash flow generation that keeps us on track for more than 100 million of free cash flow for the year. With that I'll turn the call over to Mike.

Mike Valentine

Thanks, Marc. Hello, everyone. Today I'm going to provide some observations on the marketplace, operational and top line highlights and an overview of our health conference. Starting with the marketplace, we are seeing signs of improvement but some challenges remained during Q3 with many clients still focused on maintaining strong cash balances to enhance their debt ratings and control their cost of capital. To some extent the market continued to watch developments around the High-Tech Act and the discussions around the definition of meaningful use, but we are clearly starting to see many of our clients and prospects embrace the current definition of meaningful use realizing that the primary requirements are unlikely to change materially.

We did have some transactions driven by the stimulus in Q3 and we fully expect this trend to continue in Q4 and beyond.

Another dynamic in the marketplace is healthcare reform and the uncertainty about how it will impact our clients. This uncertainty has contributed to more conservative near term spending by our clients; however, we believe healthcare IT continues to be viewed as a transformational agent that is essential in all scenarios of reform.

In summary, we are beginning to see the market turn with the stimulus funding tied to meaningful use being the primary driver. This position is supported by our leading indicators including a record level of RFPs again in Q3, a solid Q4 forecast and a strong pipeline into 2010.

Moving to our Q3 results. Our bookings revenue in Q3 of $424 million exceeded our guidance range and is a record for Q3 bookings representing 11% growth over Q3 08 which was also a Q3 record. Our deal mix included several large contracts with 12 contracts over $5 million, eight of which were over $10 million.

This quarter included a very strong level of new footprints with 29% of bookings coming from outside of our core Millennium installed base. This is a large increase from the first half of the year and is consistent with the messaging I provided in our Q2 update. Going forward, our pipeline continues to reflect a strong level of new footprint opportunities.

Looking at the mix of bookings, we had software at levels similar to Q2 but it was down year-over-year. Our Q4 software forecast is very strong, which is driving this large sequential increase in our earnings guidance that Marc provided. Q3 bookings also included strong contributions from managed services and professional services.

As I previewed last quarter, we signed our first Cerner IT Works client in Q3. Recall that Cerner IT Works services built upon our industry leading hosting and professional services capabilities to take on additional IT functions for our clients including running their non-Cerner systems as well. Our first signed client is a health system that has been a Cerner client for more than 10 years and a remote hosted client since 2003.

This deeper relationship will expand Cerner's responsibilities to include their Cerner non-Cerner IT functions such as managing their help desk, desktop support, non-Cerner applications, and their local and wide area networks. In addition we will expand Cerner Solutions into more areas such as critical care, pretty operative and leverage new solutions from Cerner such as CareAware and M-pages.

Many of you have also seen our announcement last month about a Memorandum of Understanding being signed with the University of Missouri to create the Tiger Institute for health innovation. Cerner IT Works is at the core of this relationship as MU also sees the value of expanding their existing relationship to include Cerner taking on their non-Cerner IT functions. The Tiger Institute will allow for an accelerated path to meeting stimulus meaningful use requirements as well as build on our history of R&D collaboration that has already lead to our successful medical home project. Note that the MoU signing was not included in our bookings. The Definitive Agreement is expected to sign in Q4 or Q1 and will be included in bookings at that time.

In summary, Cerner IT Works has the potential to become a significant growth driver as we convert more of our clients current IT spent into Cerner revenue. Our clients view these types of relationships as more of an opportunity to create greater solution and strategy alignment with Cerner as compared to the typical and more traditional approach of outsourcers that focus heavily on cost reduction and cost containment. We believe that almost all indicators are pointing towards IT becoming even more strategic to our clients.

Another observation on this quarter's results is that our focus on aligning with vertical markets is continuing to pay off. We entered this year with a focus on aligning sales services and development resources across certain vertical markets to make us a stronger more agile competitor within those markets. This focus is helping accelerate our ability to fill white space in our existing base and effectively pursue opportunities outside of our core base. A great example of this is our CareAware suite of solutions which had a record quarter in Q3 including strong sales of MDBus, device connectivity, three new RxStation footprints and another good quarter of reselling clinical devices packaged with our connectivity solutions. Other examples of vertical alignment working well include strong Q3 results in women's health, imaging, critical care and Perry operative. We also expanded our solution suite in two of these areas with FDA 510(NYSE:K) clearance for solutions in our women's health and imaging business units. This includes approval for our fetal link solution which integrates fetal and maternal monitoring wave form data into the EHRs of mother and child. This solution along with our power chart maternity solution makes us the only provider with a solution that seamlessly integrates the maternal record across inpatient and outpatient venues. FDA approval was also received for our provision workstation mammography solution. This solution eliminates the need for separate general imaging and mammography viewers reducing inefficiency and delays created by using different viewing systems. With our solutions, radiologists can now view all imaging modalities and the patients EMR from a single workstation.

Q3 also included good results in the community hospital space. As I discussed last quarter there are about 2000 small community hospitals and 1300 critical access hospitals. While we have substantial white space opportunity in our install base of mostly larger hospitals and health systems, the smaller hospital market will also be an important element of our growth going forward. Our Q3 results in this area build on a strong Q2 and our pipeline in this market is rapidly expanding.

Before I turn the call over to Trace I'd like to provide a recap of our recent healthcare conference, which was held here in Kansas City earlier this month. Despite the challenging economic environment we had over 6,000 clients, partners & associates from 20 countries in five continents attend this year. The feedback from our clients was very positive with approximately 80% of the clients responding to our feedback survey indicating that it's the single most important industry event that they attend. We had particularly strong attendance at our leadership forum and physician forum which provides an opportunity for C level leaders from our clients around the world to attend and participate in the conference. The leadership forum attendance was up 10% over last year to 243 attendees and the physician forum attendance was up 75% to 183 attendees. The highlight of the conference this year was the solutions gallery. Our interactive exhibit for clients to network, collaborate and see new Cerner solutions in action. With seven smart rooms and over 100 partners and sponsors, attendees were able to dive deep into many solutions and services, talk with experts on stimulus reform, and health information exchange and even track their movements through the solutions gallery with our new enterprise positioning solution. The experience our clients had at the solution gallery and other conference sessions helped us accomplish one of our key goals for the conference. This goal was to energize our client base, not just about the stimulus and getting to meaningful use but also about embracing our general innovation direction and thinking about what can be accomplished with adoption beyond the definition of meaningful use. This message resonated well with our clients and we believe the timing was right. Some described this as the biggest CHC yet in terms of unleashing new innovations ready for market.

Overall the Cerner health conference was a big success and I feel our alignment with our clients has never been greater. In closing, I'm pleased with our Q3 results particularly given the challenging environment. Our health conference created a lot of energy and alignment with our client base and we expect to build on this as we finish 2009 and look to next year. With that I'll turn the call over to Trace.

Earl “Trace” Devanny, III

Today I will discuss our international business, provide an update on our U.S. stimulus opportunity, and reiterate our strategy in the position practice market. Beginning with our global business, as Marc mentioned global revenues declined year-over-year due to tough comparables following a very strong performance in 2008. This coupled with tough economic conditions overseas has made it a challenging year.

While global results will continue to be pressured by the global economy and face tough comparables in the near term, we remain positive around the longer-term outlook for global HIT and expect growth to resume next year. A highlight for the quarter was winning an important new client in Spain, which builds on our earlier success at Marina Salud, our first Spanish client. Our new client, Hospital Universitari Son Dureta is the largest health facility in Spain's Balearic Islands with five facilities and 1041 beds.

This win is a testament to our global competitiveness as we were selected from six bids ranked on a rigorous 100 point scale. We scored 95 out of a 100 but the second place competitors scoring 74. Moving to England, we continue to focus on operational delivery as the Lynch (inaudible) for marketplace leadership. As noted on our last call, we have a series of important conversions scheduled before the end of the year including the Kingston Hospital NHS Trust in London, which is inside the national program, and the Newcastle [upon] Tyne Foundation Trust in the North of England, which purchased outside the program.

The need for information technologies will play a central role in NHS modernization continues to grow and to that end our work with NHS Trust continues to expand. As we continue to deliver demonstrable benefit to those organizations, we believe it will create positive momentum for existing and perspective clients going forward. I've recently returned from two weeks of travel across Europe meeting with clients and potential prospects. I came away convinced that we remain the strongest and best positioned HIT supplier outside the U.S. as evidence by our competitive win in Spain, Millennium is the one platform that is truly scalable globally. As we continue to execute internationally I believe we will position ourselves for a return to good top line growth in 2010.

I would now like to provide a brief update on the stimulus and how we expect it to impact our business. Relative to meaningful use, we believe the current recommendations are appropriate. We believe they maintain proper focus on outcomes and continue to contain important elements such as CPOE, which are a fundamental building block for patient safety. The current proposed requirements also factor in required adoption metrics to ensure that important benefits are being realized from this historic investment, and the proposed staging of future requirements to include more robust capabilities such as clinical documentation and evidence based order sets is clearly on target as well.

This effort embeds HIT into the dialogue of policy, quality and efficiency and positions Information Technology to play a vital and ongoing role in the systemic reform of the U.S. healthcare system.

In other comment on current stimulus activity, as we've discussed in previous quarters the American Recovery and Reinvestment Act, ARRA provides a significant opportunity from both inside our install base as well as from new client footprint opportunities. From my numerous interactions with clients at our recent health conference it is clear our client base is both energized and focused on meeting the requirements to access the stimulus dollars.

These activities continue to reflect this unprecedented opportunity to change the direction of the US healthcare system. In addition, we are well positioned to gain new market share in this reinvigorated IT environment. As mentioned earlier, our success outside our client base in Q3 included purchases of providers driven back into the market by stimulus dollar opportunities. These providers either didn't have an existing supplier or didn't believe their current supplier offered a viable path to meaningful use.

As Mike discussed, we expect these stimulus driven opportunities both inside and outside of our base to continue to ramp, as evidenced by record RFP levels, increased pipeline and our strong Q4 outlook.

Moving to the physician practice market, as mentioned previously there is also a significant stimulus opportunity for Cerner in this sector. We continue to be well positioned with our low cost speed to value ASP model. We also benefit from our install base of align health systems that sponsor power works as their preferred electronic medical record. In addition, we recently announced an agreement with CDW healthcare to be a national partner for outpatient offerings. CDW healthcare is an industry leader in technology, hardware solutions and services and they will now market Cerner's full suite of physician practice solutions.

This agreement will increase our ability to scale our physician practice business as CDW created a dedicated sales force for Cerner solutions and will leverage its large healthcare sales organization for lead generation. We believe that the Cerner CDW relationship will create a one stop shop for physician practice automation with CDWs rich technology portfolio and unparalleled service CDWs complementing Cerner’s strong clinical and business applications and remote hosting capabilities. This relationship will also simplify the experience of purchasing, deploying and supporting the technology necessary to automate a practice and make the process affordable.

In other emerging area focus within the stimulus package is the need to support to the interoperability and requirement for regional or health information exchanges or HIEs. Cerner has a history of proven innovation with interoperability capabilities like the Cerner hub, which connects healthcare providers within a community. This capability is an important differentiator given the emerging interoperability requirements to qualify for stimulus funding.

We are also having discussions with many of our clients and state governments about creating regional networks to facilitate broader interoperability allowing for capabilities such as health record banks, population health management, employer based wellness programs and chronic disease management programs. These capabilities offer clear differentiation for our clients and their respective markets as well as provide a significant new business opportunity for Cerner.

A great example of our capabilities around interoperability is our current collaboration with the department of HHS and Centers for Disease Control to create the flu pandemic initiative. This is a secure, HEPA compliant rapid detection network for the influenza virus including H1N1. The initiative supply State and Public Health Departments, Cerner clients and the CDC with situational awareness information to help communities triage resources.

With this system in place, this information is now available in near real time compared to taking up to four days to assemble previously, a critical time improvement allowing the public health system to react more quickly and isolate areas of outbreak. As part of this initiative Cerner’s clients who represent nearly 1/3 of the U.S. healthcare system have agreed to fees summarized non-patient specific HEPA compliant data into specially designed software that aggregates and organizations it for use nationally as well as locally regionally.

Currently more than 1000 facilities in 46 states have agreed to participate and more than 450 are already contributing data. This national initiative is evidence of differentiation created by our unmatched combination of a broad footprint in healthcare and our inneroperability and reporting capabilities.

Truly, a national healthcare network. As a result of this differentiation we believe we are well positioned to help healthcare providers and states execute their growing need to share critical patient record data. These examples of expanded innovation continue to position Cerner as a broad based healthcare company, not merely an HIT supplier.

In Summary we continue to view the stimulus as a substantial opportunity for Cerner and expect to play a major role in the transformation of our healthcare system that will occur within the coming years. With that I'll turn the call over to Jeff.

Jeff Townsend

Thanks Trace. Over the last three quarters we've shared the launch of several new innovations. Both Mike and Trace highlighted for our clients several of these came together at the conference creating a new level of energy and focus as we innovate beyond the EMR and beyond meaningful use. As I highlight a few of these I wanted to share the broader context of the emerging network effect that is pointing out across our client base.

As we introduce the lights on network a few years ago to monitor and manage the technical environments of our clients, which provides a level of transparency and measurement across the client base this, became the early signs of our ability to create a network. This created a common platform of learning and improvement to all Cerner clients could benefit from. We've continued to innovate this offering, this year moving the measurements all the way to a single user experience providing comparative measurements for physician order entry and clicks. Allowing our clients to apply science to the adoption of CPOE.

Using the learning from this platform we announced our Blue Sky initiatives moving more offerings to the cloud. Starting with uCern, which is a contextual collaboration social networking platform that we've been using internally since last fall.

As I mentioned last quarter we began to roll out uCern to our client organizations over the summer in the interest and adoption accelerated going into the Cerner health conference. With the objective of having everyone connected prior to the conference. The ability to extend the learning from an annual conference to a continuous collaboration medium was a major theme, with 95% of our core Millennium clients actively engaged in the platform today.

In a very short time we've extended the reach of our knowledge ecosystem to the edges where solutions and services meet healthcare delivery allowing end-users to engage both inside and outside their organizations. It is quickly become the place for clients to go when they want to collaborate with peers or Cerner associates about topics ranging from healthcare reform to solution enhancements to project status updates.

It has shifted the traditional concept of customer service going way beyond simple point-to-point interactions. In 2010 this is the platform that extends to the patient consumer in context of their healthcare experiences. As we've outlined a few times to reach the full potential of the digital health system, more of our R&D will move to the edge where physicians and nurses interact with patients in context of the health condition.

To support this initiative we launched both you develop and the uDevelop and uCern store. uDevelop is a collaborative ecosystem to support a unique audience of engineers both Cerner associates and external developers.

uCern store is a place for providing quick contextual access to innovations developed by Cerner and others allowing for innovation to be accessible beyond the boundaries of IT reaching the end-user community. Architecturally this approach continues to take advantage of the separation of the end user visual experience from the EMR platform.

To date, the uCern store has already had over 300 client organizations engaged in activities including wish list prioritizations for future purchases.

As Trace outlined the influenza monitoring initiative is just another example of creating value out of the collectiveness of our client base. Engaging the majority of our Millennium clients within two months of starting the program. Collectively we're very pleased with how rapidly our clients are grabbing and extending these concepts as we now turn our focus towards the consumer and the context of a patient experience.

Before turning the call over to Q & A, I wanted to touch briefly on the topic of Neall's keynote during our health conference as it will play a major role in shaping Cerner's direction in the coming years. We've been talking for several years about friction in the healthcare system that creates unnecessary waste, variance, air, and delay. Much of that was outlined in our ABCs of systemic healthcare reform. What Neal recently outlined was healthcares need for a new middle. Regardless of the outcome of current healthcare reform policies, the momentum around broad adoption of EMRs and interoperability of health information will provide the initial infrastructure to change our delivery and payment system as we know it today. As Mike shared the announcement of the Tiger Institute represents a new alignment model with our clients but also creates a regional or statewide collaboration platform to make the middle smart, creating the opportunity to coordinate care, apply new clinical evidence and ultimately change the health status of a region. As we'll share over the next year, we believe we are very well positioned to play a role in creating an operating system for health. With that I'll turn the call over to the Operator now Q&A.

Question-And-Answer Session


(Operator Instructions). And our first question comes from the line of Sean Wieland from Piper. Sean, you may proceed.

Sean Wieland - Piper

Hi, thanks. On this stimulus demand that you're seeing and forecasting for the fourth quarter in 2010, how do you go about quantifying what is stimulus, and what would be kind of bookings that would come through the normal channel, and then on specifically around your pipeline in software sales, exactly where are you seeing this demand? What areas of the products?

Unidentified Company Representative

I'll take a stab at it and I'll then let Marc give his commentary as well. The point of your question I'm thinking is dead on. It's difficult to determine whether when meaningful use is a definition at least of a subset of who you are and what you do it's difficult to describe what's being driven by stimulus or not. What we have looked at is the effect of stimulus as it relates to acceleration of decisions, so we can't show you that new entries into the marketplace, so people building out HITs for the first time are making decisions in a tighter time frame, so whereas before the selection process has took on average around 15 months, now we're seeing it in less than a year so they're condensing and accelerating their time frames to make decisions on average across-the-board. There are also, when I look at the competition of software, you were seeing a larger mix to new footprints and I think we spelled that out in terms of percentage of our total bookings but I think you start to see it going forward in the software category as well and then you see more software from a composition standpoint broken out in the core of what we do so by solutions, things that map directly to meaningful use. It's hard to again categorize as that $2 billion more than we would have otherwise and I think that's the label that we're putting on it right now in terms of total pipeline and activity but in any given quarter it's really difficult to break it out and say this one was absolutely stimulus driven but it by every measure is on everyone's radar, everyone is paying attention to the definition of meaningful use, mapping projects to win stimulus funds become available for meaningful use, so it's hard to quantify but it's absolutely there.

Sean Wieland - Piper

Okay, thanks and a quick follow-up if I could. What do you think about this Grassley letter?

Marc Naughton

This is Marc. The government is making a large investment in healthcare information technology so it kind of makes sense for them to fully understand what that investment is going to be related to. We view the committees interest and HIT is becoming embedded kind of in the dialogue around healthcare policy and reform so we look forward to working with the committee and providing requested information and working with them as needed, so we don't see it impacting our near term business and I think that it's something that the government is doing their job and we fully look forward to complying with any requests.

Sean Wieland - Piper

Okay, thank you very much.


Our next question comes from the line of Atif Rahim from J. P. Morgan. You may proceed.

Atif Rahim - J. P. Morgan

Hi just a follow-up on the stimulus. I think Mike you said I don’t know if you mentioned $2 billion per year in your prepared comments or just in the last question but that's kind of the incremental opportunity. Have you had a chance to review that both the meaningful use recommendations coming up and is there any change to that outlook. That's the first question and then I have a follow-up.

Mike Valentine

The first answer to your question is we absolutely track the definition of meaningful use and as per my comments earlier, what we see in terms of the broad definition, the content of it we don't see that fundamentally changing a whole lot between now and the end of the year, beginning in next year so and I think I got the majority of our clients actually see it that way as well. Their [actioning] along the lines of the current draft definition of meaningful use, at least for the standards that come into play in 2011. Some of the people have not made a decision yet so the net new buyers they are holding out and looking at the definition and those are the ones that would impact the numbers that you speak of.

Atif Rahim - J. P. Morgan

And then in the terms of the buyers that were out there, how are the smaller hospitals fairing? You mentioned you've built on some momentum from 2Q. Are those guys turning out to be a decent portion of the buyers and I don't know if it's possible to provide what percentage of bookings there starting to constitute or what the sequential growth might have been in bookings from those guys?

Unidentified Company Speaker

I won't comment on the specifics but I'll tell you if you're referring to essentially 100 beds or lesser, 75 beds or less which has been our most recent focus with our community work solution, there's a lot of activity in that space, we're a relative newcomer to that marketplace and a new option for those folks as buyers, so there's I would say there is a fair bit of education that we've been doing to familiarize them with the Cerner story and Cerner as an option and they absolutely view it as a very appealing option and we've got some early proof points that serve as goodwins for us and good demonstration points from the industry that there's a Cerner path in a hosted model that's a subset of our application so it's kind of you think of it as a Cerner light or some of these smaller health systems with more restrictions on them.

It's a very active marketplace. We signed a few more this last quarter, I mentioned we signed some last – the quarter prior in Q2 and the pipeline moving forward looks very good. It's not the same margin business for us, it's not the same dollar business for us, a dollar [provided] its probably about the same, but it's a nice market to be in, I think our solutions have come to fruition at the right time.

Atif Rahim - J. P. Morgan

Could you quantify the bookings from them those guys or not?

Marc Naughton

This is Marc, we can't quantify those separately. We don't break out the detail on the bookings, sorry.

Atif Rahim - J. P. Morgan

Okay. Got it, thanks.


And our next question comes from the line of Richard Close from Jefferies. Richard, you may proceed.

Richard Close - Jefferies & Company

Yes, thank you. Follow-up on the community hospitals if you could tell us who you've competed against and you've beat on succeeded against on those contracts and then also Marc, I think you talked a little bit about extended payments or extended terms, if you could talk a little bit more about that, what's driving that, is it just the economy or is it people trying to just get great deals with respect to the stimulus and then talk about the pricing environment you guys see currently?

Michael Valentine

Okay, Richard this is Mike. I'll take your first question. It's the typical that I think you would expect in the smaller end of the market. Meditech is in there, CPSI is in there, Healthland I believe is the new name they go by, they're there, so I think all of the normal and actually some few new ones that we've actually never ever competed with, our sales cycle is fundamentally different than our traditional model so a lot of it is delivered virtually demonstrations are delivered virtually and we're tapping into a sales force that already exists but also assigning a specialty force and then we're also leveraging our client book prints to extend into their regional.

So, Jeff mentioned a regional play. Several of our installed clients are offering a EMR solution off of their existing infrastructure, so they essentially become a channel for us to sell into a region or to market into a region whether that (inaudible) would be affiliated or have some level of affiliation or interest in sharing in that capability, so that's how we see it. I think it's fairly competitive. It looks to be regionally competitive as well, but those are the folks that we would see.

Marc Naughton

This is Marc. The comment I made about extended payment terms was more related to when we see that. That's when we try to introduce the client to the financing options that we have available, as we in normal course don't have significant levels of extended payments, I think to some extent you're seeing that because of the economy because of the access to capital if they can access another source of funding, that's attractive to them.

Relative to the pricing environment, I look at it basically discounts off those price and those are fairly consistent with where they've been in the last three or four quarters. So, I think the competition that's going on out there is not from a pricing standpoint for the most part among the competition, at least we're not seeing it in our deals.

Richard Close - Jefferies & Company

Okay, thank you.


And our next question comes from the line of Charles Rhyee from Oppenheimer. Charles, you may proceed.

Charles Rhyee - Oppenheimer

Yeah, thanks for taking the questions. Maybe first I can just jump back to that Grassley letter. Can you give a sense on a lot of the questions we're asking were in terms of contract language related to pushing some of the liability, but pushing on some of the responsibilities of things that happened with the use of the solutions on to the responsibility of the providers and particularly around like harm homeless provisions. Can you discuss how those sort of arrangements were again to the extent that your contracts work that way?

Unidentified Company Representative

Yeah Joe pardon me but what probably respond to the committee with the information, that information obviously will be made public, so that's probably the time that we think it's appropriate for giving all of that information out.

There's no question on that letter that we're not looking forward to answering that we have any issues with and that we think is different from any other companies normal business practices at least with respect to us, but I think at this point we would like to defer answering those specific questions until we get our information before the committee.

Charles Rhyee - Oppenheimer

Okay thanks and then Trace you talked about bringing on some key trusts online in the fourth quarter and particularly talked about one in London and one in the North. Can you talk about what's going on in the South with the open bidding process there and sort of how your progress is going there and working under PT?

Unidentified Company Representative

Yeah we continue to thank you. We continue to have good activity across the in tire NHS program. As you probably know there's an election coming up next year so to some degree there's a little bit of paralysis within the actual structure of the NHS around extending the program, but our challenge and our goal has been and we stated clearly is to continue to execute on the go lives that are in place.

We're working very well with BT across the program to do that and we expect to be successful in Q4 around that point, so I think the best thing we can do to make our business continue to grow is to execute and that's our plan and that's what we intend to do.

Charles Rhyee - Oppenheimer

Is there a lot of revenue expectations in the guidance currently coming out of the South?

Marc Naughton

This is Marc. There isn't. I mean, overall, UK, we kind of expect it to be somewhere around $14, $15 million a quarter type of revenue stream current State. We expect that to change as we kind of roll into 2010, the government election occurs in May and other things get kind of settled out but currently that gives you a sense and it's fairly consistent with what the 09 revenue levels were.

Charles Rhyee - Oppenheimer

That's largely London, right?

Marc Naughton

Primarily London, but it does, it spreads between both because there are revenues coming through the South as well.

Charles Rhyee - Oppenheimer

One last question for Marc. Can you talk about the sequential uptick in the revenues here? You talked about your confidence that to see this. Can you give us a sense of where you're getting this confidence and how do you think that splits between system sales versus support and maintenance and services and second to that is when we look at the bookings this past quarter, the 424, how much of that is something that can be recognized let's say over the next 12-24 months versus something that might be stretched out a little bit further?

Marc Naughton

Okay, well relative to kind of the bookings, it was probably the element that was stronger than perhaps normal was the services, professional services side and those bookings will tend to be over the next 12-24 months coming into revenue, managed services was kind of at its normal historical levels, so I think that's clearly a positive.

As you know we could do a rigorous forecasting process recorder and that's where our information comes from relative to our next quarter guidance. When we look at this quarter coming up, we see a significant increase in license software in the pipeline that looks like it's going to be a Q4 item and I think in essence looking at that pipeline, looking at where we stand quarter to date right now relative to closing deals, that kind of gives us our number that we can get the revenues to increase the level that we've guided to.

Charles Rhyee - Oppenheimer

Great. Thanks a lot for the comments.


Our next question comes from the line of Steve Hopper from Thomas Weisel Partners.

Steve, you may proceed.

Steve Hopper - Thomas Weisel Partners

Sure. The first question is on the MU deal is that included in your fourth quarter bookings guidance?

Marc Naughton

Steve, this is Marc. The NOU that was signed in Q3 that we expect to sign to be completed either in Q4 or in Q1 so our guidance does not include that.

Steve Hopper - Thomas Weisel Partners

Okay, and then while you were discussing your professional services and assuming we're going to see an acceleration in software because of stimulus, does Cerner have enough headcount to satisfy the potential implementation challenges that a lot of your customers are going to be facing or given that they want to accelerate implementation?

Mike Valentine

Steve, this is Mike. We talked about this a little bit on the last call as well. It's something that's been, we're paying very close attention to as a timing of the resourcing. What we're seeing is historical run rates have been about a 70% of our implementation work in total takes place in the field and 30% takes place in a centers vehicle so centralized implementation model and what we're wiring towards as the demand ramps up and as Marc said we saw a strong Q3, we expect a strong Q4 on the services front, we're wiring towards a richer composition of central implementation. We think we're able to ramp up that center in a quicker fashion and we're I think we had visibility enough to allow for that to happen. So right now we don't see it as being a risk. As you'll recall we went through with everyone of our top installed clients mapped out their road map to meaningful use with kind of the fundamental definition, built out the timing for that and are building, staffing and consulting arrangements accordingly in addition to what software needs to be acquired and hardware to support the journey, so we think we have a pretty good sense for what all that looks like and how it comes together. There's still wildcards on timing as you would expect but right now, we feel pretty good about our position in maintaining implementations mostly in house as we have historically.

Steve Hopper - Thomas Weisel Partners

And how do you feel about your competitors on that same subject?

Unidentified Company Representative

You know, I think everyone gets the opportunity to talk about it. I think those that have just moved to own more of their implementations. I think it's going to be a real wildcard for them. It's not something they've proven in the past whereas we've owned our implementations historically; we've had minimal third party involvement. Others have come from a place and have recently kind of informally announced themselves getting out of the implementation business. I think there's some wildcards on those fronts so I would say where there's uncertainty on their side, there's a pretty solid track record on our side so I feel pretty good about it.

Steve Hopper - Thomas Weisel Partners

Great. Thanks.


And our next question comes from the line of Anthony Vendetti from Maxim Group. Anthony you may proceed.

Anthony Vendetti - Maxim Group

Okay thanks just two quick questions on the Fujitsu you said ARs for that particular deal we are contributing to the DSOs rising along with the economy. What's the size of the AR?

Unidentified Company Representative

We have indicated it's over 10% of receivables and it really hits the gross number it would not be within the numbers in Q2 as well as some more level so that the 5 day increase in DSOs would be primarily related to just a little bit slower collections once again we indicated its not the people are paying some of them are just a little slower paying. We actually expect as we hit (inaudible) in the complete Q4 then that number will be back under a 100 days.

Anthony Vendetti - Maxim Group

Okay and just one quick one -- okay just one quick follow up Marc on the guidance for Q4 on the revenue side to 435 to 465 was the guidance for the year prior rto this quarter 1.7 to 1.75 billion so that implies 60 million to 80 million less or (inaudible) is that correct?

Marc Naughton

I think basically as result of Q3 coming at the bottom of our guidance range you know and once you get down to the last quarter of the year, I am not sure it kind of spend a lot time thinking about what my full year guidance was clearly the incremental increase in revenue from Q3 to Q4 (inaudible) 10% is a pretty good indicator of what we think that the demand that we seeing in that our ability to convert it into revenue so you know I wouldn’t say your numbers are wrong, I still don’t actually even have those in front of me because I am not seeing focusing on those is being relative I am looking at Q4 and with our guidance kind of what you will see (inaudible) for the year. But we think clearly top line is been challenged at the first three quarters and we if we are able to finally break and through to get back to some good double digit (inaudible) gross on the top line in Q4.

Anthony Vendetti - Maxim Group

Okay and then you comfortable with the consensus for 2010. you said in both top line and bottom line.

Unidentified Company Speaker

Yes. In traditional --- in keen with our traditional practice at that level we have basically flat bookings assumed. We do not have that number building and any significant contribution from stimulus. So, that’s why today we are fairly comfortable giving that as our guidance agreement with consensus. We think there could possibly be upside of that but once we get through Q4 we will be able to address more clearly our year end call.

Anthony Vendetti - Maxim Group

Okay. Great. Thanks, Marc.

Marc Naughton



Our next question comes from the line of Corey Tobin with William Blair. Corey you may proceed.

Corey Tobin - William Blair

Hi, it’s (inaudible) for Corey. A couple of questions on your commentary regarding the stimulus one is related to --- I wonder if there is anything distinctive related to the type of discussions or the type of hospitals that are kind of leading you out you are leading the charge I guess in stimulus activity either from like a profit versus non profit standpoint or from a regional perspective. Is there anything distinct that you are seeing in terms of the type of customer that’s kind of first to (inaudible)?

Unidentified Company Speaker

I would --- Jeremy. This is Mike. I would say that it’s a return to very broad mix of the segmentation. So, when I look at our Q4 forecast in particular all major segments are represented including core profit and including the newer lower end markets, smaller markets that we talked about earlier. So, I would say it’s a return to broader diversity than we had historically.

Corey Tobin - William Blair

And then one follow-up on the international side in terms of the growth you expect next year, where would you say you with respect to the pipeline you are seeing the strongest potential for growth and may be where you are also seeing things a little bit wider than you otherwise would have from a regional prospective?

Trace Devanny

Yeah Jeremy this is Trace having just returned from Europe its imagine that the US economy with no stimulus relative to the health care activity so its while its very robust for us here but having said that there is not the cycles in single pair systems and other parts of the world so you are not seeing sort of the dramatic ups and downs of the health care spend. My experience in the last few weeks has been while it is slow down and government are waiting to see what's going to happen to the economy, there is still a lot of variant and health care activity going on around the world.

Relative to those specific markets I think they are all active some will be better than others. We have some very large transactions in the Asia Pacific we have some good transactions in the middle east and there is some very important transactions in Europe so broadly I think you'll see as the economies improve around the world you'll see health care activity return and I think that particularly in the last half of 2010 things will return to a much more positive note as the economic situation works itself out.

Corey Tobin - William Blair

From hearing what you say there is no region that sort of particularly stands out from the upside or downside they are all….

Trace Devanny

Every region has highlights and significant opportunities so I wouldn’t say that one region has been immune from the difficult economy so the answer to your question is no.

Unidentified Company Speaker

I will take one more call or one more question.


And our last question comes from the line Sandy Draper from Raymond James, Sandy you may proceed.

Sandy Draper - Raymond James

Thank you very much I have got just may be two quick questions. One Mike if can comment when I think you said 29% of new footprints. Is there a way to split that out between new footprint wear, these are clients that don’t have maybe any other clinical system and it’s a totally new buy versus replacement. Is there a way you can segment that up?

Unidentified Company Representative

I could. I don’t have it with me. I would tell you that almost all of them have, I would say, 80% have a core EMR, core automation capability that is with a single supplier. The rest of them would be left overs from the best of breed era. So, (inaudible) break down, that’s probably non scientific, that’s just my gut feel on that mix.

Sandy Draper - Raymond James

And then final question. Just in terms of thinking about when you commented about the stimulus activity and buying incremental. Do you look at that as incremental in terms of just accelerating growth and eventually you would have expected these customers to buy this over some very much longer period and its incrementally compressed or are there actual products that you think may be would never have been purchased by the customers that are now actually being worked at.

Unidentified Company Representative

There is nothing as meaningfully as today that is an ah-ah for us that says or finally we can go sell one of those. So the good news is, there is GAAP, no major solution GAAPs for us in the current definition of meaningful use. In fact, it actually shed some lights on device connectivity, interoperability, personal health record. There is scenarios that we’ve been preaching for quite some time that now they are getting full attention. So, from that I think that gives you a little bit of the incremental.

There is another phenomenon that we touched on in the text. We had a great (Inaudible). We unveiled 100 plus new banks that we’re going to market with and part of our belief is that our advanced install base will go set the bar for the next round of definition for meaningful use. So, if we can move the (Inaudible) through new innovations, the fact that it’s a stair step definition in meaningful use, the innovations that we’re doing today, the funding that’s coming into clients that are already near meaningful use but they are going to continue to expand around the (Inaudible). We think that actually creates new markets for us, so meaningful use definition and 20-20 which is a lot ways from being defined. We hope that innovations that we’re creating today become that incremental in the future.

Neal Patterson

Very good so. This is Neil, I have been quite silent here, but I have been word clouding the both the questions and our comments. And let me just close here with a brief thought. So, I think we are (Inaudible) is a very good place in many respects. I think the environment we’re in even though its we all speak to (Inaudible) about the economic impact of the environments in any country, but if you dissect that, the environment around the intersection of relevancy of healthcare to our societies and the role of IT in that the relevancy is getting great, greater and greater.

And I think that (Inaudible) itself in a number of ways including people trying to educate them on what is IT, mean and healthcare. But there is no question about the fundamental direction and the increased importance of IT in that. I think we lead and we’re going to continue to lead, we’re going to have a great decade, the next decade. Because our relevance could not have – we couldn’t start the decade with a better trend on our relevancy to very important subjects in health are in society. And we are going to lead through innovation in both IT, we’re going to lead in (Inaudible) around services. So, the work you saw us do and starting to deliver in the IT works, that’s s a huge contextual change to (Inaudible) and to our end around our relationships with our clients. So, and it puts us really at the edge of using the technology directly while supporting we’re now face-to-face with doctors and nurses and pharmacists. And that’s really a big-big deal, and it changes the context in a major way.

And as we end this decade and we start the next decade, I think from the performance side most anything you can find at (Inaudible) is on a very good trend. Financially we’re going to go, we intersect with the broad environment out there, but I thin that’s still a really healthy place in the long-term for us. But internally, we just get better and better every year and its kind of fun to watch and fun to be part of. So, I think we set it pretty well to finish this decade and start the next one, and I think it will be really big one.

So, hey thanks, I know it’s a tough day out there and we’re all the finance but thanks for the time and the attention and good questions. So, have a good day.


Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect, have a great day.

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