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Cerner Corp. (NASDAQ:CERN)

Q4 2009 Earnings Call

February 09, 2010 04:30 am ET

Executives

Marc Naughton - CFO

Mike Valentine - EVP & COO

Trace Devanny - President

Jeff Townsend - EVP & Chief of Staff

Analysts

Michael Cherny - Deutsche Bank

Glenn Garmont - Think Equity

Richard Close - Jefferies

Jamie Stockton - Morgan Keegan

Corey Tobin - William & Blair Co.

George Hill - Leerink Swann

Atif Rahim - JPMorgan

Steve Hopper - Thomas Weisel Partners

Sean Wieland - Piper Jaffray

Presentation

Operator

Welcome to the Cerner Corporation's fourth quarter 2009 conference call. Today's date is February 9, 2010 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 the forward-looking statements maybe found under the heading Risk Factors under Item 1A in Cerner's Form 10-K together with other reports that are on file with the SEC. At this time, I'll like to turn the call over to Mr. Marc Naughton, Chief Financial Officer of Cerner Corporation. Please proceed.

Marc Naughton

Thank you. Good afternoon, everyone and welcome to the call. I will lead off today with a review of the numbers, Mike Valentine, Executive Vice President and Chief Operating Officer will follow me with sales and operational highlights and marketplace trends. Then Trace Devanny, our President will discuss our global business. Trace will be followed by Jeff Townsend, Executive Vice President and Chief of Staff who will discuss innovation and our long-term strategic direction. Neal Patterson, our Chairman and CEO will join us for Q&A.

Now let me turn to the results. By many measures Q4 represents the strongest results in our history and positions us well for a solid 2010. Our bookings were all-time high levels and more than $200 million over the high-end of our guidance. Our income statement performance was compelling with revenue exceeding our guidance, operating margins reaching a long established goal and adjusted EPS above our guidance and the $0.04 over consensus even with the higher tax rate that impacted EPS by $0.02. Our cash flow performance was also at record levels of free cash flow for both Q4 and the full year.

Moving to the details our total bookings revenue in Q4 was $680 million which is 68% higher than Q4 '08 bookings and an all time high including record levels of software, professional services and managed services. Bookings in the quarter benefited from the previously announced tenant and numerous so called service contracts which were factored into our guidance at risked down levels.

In addition we had a booking related to our second IT works contract which was not factored into our guidance. In total, these three bookings were about a $250 million compared to about a $150 million that have been factored into our guidance. So the upside of booking is beyond these contracts were still about a $100 million over the high end of our guidance. Note that without these three large contracts, our bookings would have been within our guidance range which is reflective of the broad strength in the quarter.

The strong Q4 bookings helped bring full year 2009 bookings to record levels of $1.8 billion which is 19% over 2008 bookings. Our total backlog increased 21% year-over-year and ended the year at $4.21 billion. Contract revenue backlog ended the year at $3.59 billion which is 23% higher than a year-ago. Support revenue backlog was $621 million up 7% year-over-year. Our revenue in the quarter was $466.3 million which is up 14% sequentially. Total revenue was flat compared to Q4 '08 levels which 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. Adjusting for these items, results in 12% growth year-over-year.

Full year 2009 revenue was $1.67 billion which is flat compared to unadjusted 2008 revenue and up 3% compared to 2008 revenue adjusted for the UK catch up and extra week.

The revenue composition for Q4 was a $172 million in system sales, 123 million in support and maintenance, $164 million in services and $7 million in reimbursed travel. System sales revenue was up 45% compared to Q3 and have 60% year-over-year with record levels of software offsetting the decline in hardware sales. Services revenue which includes managed services and professional services was down 4% compared to an unadjusted Q4 '08 and up 9% after adjusting for the UK catch up and the extra week.

This growth was driven by strong growth in managed services with professional services down slightly year-over-year.

As we have discussed, the lower professional services revenue during 2009 has been driven by lower available headcount in the US, lower services revenue in the UK and the weak economy. However, we expect professional services revenue to rebound in 2010 to a strong bookings in the second half of 2009 and a strong outlook related to stimulus activity.

Our support and maintenance revenue was down 10% compared to an unadjusted Q4 '08 and up 2% after adjusting for the UK catch up and the extra week. As assessed last quarter, support and maintenance revenue growth has been impacted by the shifting of services 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. Maintenance revenue has been impacted by lower levels of technology resale with many existing clients on hardware support switching to our hosting options. Additionally support revenue has been impacted by the limited amount of software growth in the first three quarters of 2009 and limited annual CPI increases. We expect support revenue growth to improve as we move through 2010 and beyond due to a record quarter for software bookings and strong stimulus outlook.

Looking at revenue by geographic segment, our domestic revenue increased by 18% to $401 million. Global revenue of $65 million which is down 48% compared to an unadjusted Q4, '08 and down 31% after adjusting for the UK catch up. In addition to the UK catch up, we also had some very large global hardware sales in Q4, '08 which is normalized with lean to the global revenue decline being about 10%.

Regardless, it's still disappointing but not entirely unexpected level of global performance. As we've indicated throughout 2009, our global revenue has been impacted by a very difficult global economy. As Trace will discuss, we will remain optimistic that our global business will rebound and resume being a contributor to our growth. As a preview to the annual update of our detailed business model that will provided our March 11 Investor Day, I would like to provide you with a total revenue on growth by business model for the full-year of 2009.

Licensed software was flat compared to last year at $254 million, the strong Q4 growth offsetting declines in two of the first three quarters. Technology resale was down 12% to $152 million reflecting a [tempered] environment for capital purchases most of the year, and thus comparable due to some unique large 2008 hardware sales and it continued by as to our selection of our housing services instead of hardware purchases.

Subscriptions and transaction processing increased 5% to $99 million. Professional services revenue was $397 million, which is down 11% compared to unadjusted 2008 revenue and down 6% after adjusting for the UK catch up and the extra week with the decline driven primarily by the previously discussed slowdown.

Managed services was up 24% to $247 million driven by continued strong demand for our hosting services. Support and maintenance was $493 million which is up 4% compared to unadjusted 2008 revenue and up 8% after adjusting for the UK catch up and the extra week in 2008. And reimbursed travel was down 19% to $30 million reflecting a lower level of professional services travel. We'll go in to more business model detail at our Investor Day.

Moving in gross margin, our gross margin for Q4 was 83% which is up a 180 basis points year-over-year and flat sequentially. Our system sales margin was up over 1000 basis points year-over-year nearly 900 basis points sequentially with the [strains] driven by record levels of software and declines in hardware. Our gross margin for the year was 83.2% up 100 basis points.

Looking at operating spending, our Q4 operating expenses were $289.2 million before stock compensation expense of $4.6 million. This is up 6% compared to a year ago and 9% sequentially. Full year operating expenses were $1.1 billion, which is flat compared to 2008. Sales and clients service expenses were up 1% compared to Q4 '08 and up 8% compared to Q3 '09.

The increase from Q3 to Q4 was driven by Cerner health conference expenses, depreciation and incentive compensation. For the full year sales and climate service expenses were down 1%.

Software development expense was up 7% compared to Q4 '08 and 12% sequentially. The increase from Q3 to Q4 was driven by higher amortization expense, lower capitalization of software and higher incentive compensation.

For the full year software development expense was down 1%. G&A expense was up $10 million or 45% year-over-year and $4 million or 14% sequentially. Almost all of the $10 million year-over-year increase in G&A is due to reduced gains related to foreign currency. The sequential increase was primarily driven by property taxes and profit sharing expenses.

Moving to operating margins, our operating margin in Q4 was 21.0% before stock compensation expense. This is up 340 basis points compared to last year and 260 basis points compared to Q3 '09. Our full year operating margin was 18.5% and we continue to expect a 20% operating margin for the full year of 2010.

Those of you that have followed us over the last few years will recall that we have been working towards goal of 20% operating margins since 2003 when operating margins were 9%. So we are proud to be exceeding our 20% in Q4 and being on target to deliver 20% for the full year 2010. Beyond 2010 we believe we'll continue to have (inaudible) in that business that can drive margin expansion.

Moving to earnings and EPS, our GAAP net earnings in Q4 were $60.5 million or $0.71 per diluted share. GAAP net earnings include stock compensation expense which had a net impact on earnings of $2.9 million or $0.04 per share.

Adjusted net earnings were $63.4 million and adjusted EPS was $0.75 which is up 15% compared to Q4 '08. For the year adjusted net earnings were $204 million and EPS was $2.43 up 11%. Our tax rate was 35.5% which is about 1.5% above our projected level to primarily the lower international earnings. The higher tax rate reduced our net earnings by about $1.5 million or $0.02. We are projecting a tax rate of 35% for 2010.

Now, move to our balance sheet, Q4 was $559 million of cash and short term investments. Our short term investments now include $95 million of auction rate securities that were reclassified to short term that can be liquidated at par 2010. Our total debt is $121 million, total accounts receivable at the end of the year at $461 million which is down $9 million from Q3. Contracts receivable or the unbilled portion receivables were $135 million, which is down $30 million from Q3 now represents 29% of total receivables compared to 35% in Q3.

During Q4 the receivable related to the Fujitsu contract was reclassified to other long-term assets because we now believe that a resolution between Fujitsu and the NHS is unlikely to occur in the next 12 months. Despite the uncertainty about the timing of our Fujitsu and government we're on line with their contract so that we can finalize items with Fujitsu we still expect to fully collect those receivables. Cash collections in Q4 were record $478 million the third-party financings have only $7 million

DSO in Q4 was 90 days which is down from a 105 days in Q3. About 12 days of this improvement is related to the re-class of the Fujitsu receivable with the rest driven by strong cash collections. Operating cash flow for the quarter was a record of $108 million. Q4 capital expenditures were $41 million and capitalized software was $19 million. Free cash flow defined as operating cash flow less capital expenditures and capitalize software is also a record $48 million.

Full year operating cash flow was $347 million up 23% over 2008. Capital expenditures and capitalized software for the year were $131 million and $78 million respectively. Full year free cash flow was $138 million which is 33% higher than 2008. Our free cash flow as a percent of net earnings has increased from 22% in 2007 to 55% in 2008 and then to 72% in 2009 reflecting the strength in the earnings quality. We expect to continue growing free cash flow going forward to growth and operating cash flow combined with keeping capital spending in the $130 million to $150 million range.

Moving to capitalized software, the $19 million capitalized software in Q4 represents 25% of the $75.7 million of total spending on development activities. Software amortization for the quarter was $17.8 million resulting in the net capitalization of $1.2 million or 2% of the total.

As I previewed last quarter, amortization increased $0.9 million compared to Q3 as the full three months of the amortization related to 2007.19 release was reflected. In Q1, amortization should decrease about $2 million to approximately $16 million primarily driven by the amortization what was capitalized in 2004 been completed, partially offset by an increase in amortization of other non-core releases. Amortization will ramp back up in the Q2 timeframe on our next release become generally available.

Now I'll go through the guidance. Looking at Q1 revenue, we expect revenue in the $420 to $435 million range, but the mid-point of this range representing 9% growth over Q1, '09. For the year, we expect revenue between $1.8 billion and $1.875 billion reflecting 10% growth at the mid-point. We expect Q1 adjusted EPS before stock compensation expense to be $0.57 to $0.62 per share with the mid-point reflecting about 15% growth.

For the year, we expected adjusted EPS of $2.80 to $2.90 with the mid-point reflecting 17% growth over 2009.

Q1 guidance is based on total spending before stock option expense of approximately $280 million to $285 million. Our estimate for stock compensation expense is approximately $0.04 for Q1 and $0.16 to $0.18 for the year.

Moving to bookings guidance we expect booking revenue in Q1 of $380 to $410 million was a mid point of this range reflecting 19% growth over the last year. In closing we are pleased with our results in Q4 on 2009, including record bookings in revenue delivering over 20% operating margins and strong earnings growth and record free cash flow generation.

Finally I'd like to remind you that we are having our investment community meeting on March 11 here in Kansas City. If you are interested in attending and didn't receive the email invite please refer to the investor section of cerner.com and 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 U.S. market place and operational and top line highlights for the quarter end for the year. Starting with the market place, 2009 started on a difficult note with the level of activity through the first three quarters of the year impacted by the economic downturn and a pause as the market digested the stimulus act. The environment was much different in Q4 with improving access to capital and enough clarity around stimulus to drive big decisions and a return to Q4 seasonality where providers were looking complete agreements before year-end.

While uncertainty of our healthcare reform remains the fact that the hi-tech act is separate from reform and has moved forward on schedule reduces the risk to the HIT sector that might be associated with healthcare reform. We believe that in all scenarios our reform healthcare IT will continue to be viewed as an important element that is required to facilitate any meaningful transformation of healthcare.

Regarding the stimulus act I'd like to provide our current thoughts on how we expect it to impact us. Relative to meaningful use, the interim final rules that were released as expected at the end of 2009 had no surprises and continue to keep the bar at level that will drive tangible benefits from the invested stimulus dollars. In terms of certification Cerner millennium solutions went through CCHIT preliminary ARRA certification testing on January 15th 2010.

Our generally available solutions pass certification on almost all eligible provider and hospital components. We will have incremental testing to complete in the late spring or early summer as the final rule is completed.

As our Q4 results illustrate the stimulus opportunity is becoming real and has increased the level of activity both inside our base and with new footprint opportunities. We believe the next two years will be a major opportunity to expand market share and we really like our position because of the readiness of our solutions relative to most of our competitors and our unmatched ability to deliver value in a predictable timeframe and at a predictable cost.

Moving to our Q4 results as Mark mentioned, our bookings revenues in Q4 of $680 million was a record. These bookings included an all time high number of large contracts with 20 contracts over $5 million, 15 of these were over $10 million which is 6 more $10 million plus transactions than any quarter in our history. We also had a very strong level of new footprints with 36% of our bookings coming from outside of our core millennium install base. This is a great indicator of our competitiveness which I believe is very strong right now. Investments we made over the past several years that are improving the usability of our solutions hardening quality and creating efficiencies in our delivery capabilities are proving to be big differentiators in the market place.

Good examples of these capabilities waiting to success in the market place are Tenet Healthcare and Universal Health Services Contracts that were signed in Q4. Our broad and integrated suite of solutions combined with our proving ability to deliver value at a predictable cost were important factors in the selection by these very well respected core profit health systems.

Beyond our very strong market presence with large health systems, we're continuing to make strides in the community hospital market. Q4 was another good quarter of results in this market as we continue to see demand for our scalable ASP offerings. We see meaningful opportunities for growth in this market and have steadily gain attraction through to the last two years. The recent announcement by Fisher-Titus Medical Center and Magruder Hospital is a good example of small hospitals looking to Cerner solutions for achieving meaningful use and beyond.

Fisher-Titus and Magruder are independent community hospitals that collaborated on the automation of their hospitals to develop best practices for technology deployment and begin to coordinate care in that region. After their upcoming [go lives] they will both become completely digital smart hospitals just ten months after starting their projects. This will launch them into the top 5% of automated hospitals, and provide yet another proved point for Cerner's capabilities.

In the physician office market we had a good 2009 with 20% bookings growth, a strong increase in our pipeline, increase competitiveness including several wins against top competitors and increased traction with this distributing our solutions through our health system clients. We expect to build on this in 2010, with stimulus driven demand picking up and with the added capacity we've gained through our CDW channel relationship.

When looking at the growth opportunities over the next several years, capitalizing on the stimulus driven demand for core clinical solutions inside and outside of our installed base will be a major component.

However, I think Cerner will have many other contributors to growth, but during and beyond the stimulus era. Cerner is known as an innovator in the market place. A goal we're setting for ourselves is to remain a leader to the demonstration of continued innovations that set the bar for what meaningful new standard should look like beyond 2015. Having the ability to provide solutions beyond meaningful use not only make us a more attractive options as providers' asses their long-term strategy; it also provides us with another meaningful growth driver beyond the core EMR.

One example of this organic growth opportunity is in the device space. In the past few years we have expanded our traditional technology resell business into a business that creates connected medical device architectures. This approach has positioned Cerner at the forefront of extend the EMR to include medical device data capture. Today there are 75 sides across 36 clients that are live with the MD device connectivity architecture including clients outside of our millennium install base. Also in 2009 our RX station medication expense in cabinets reached a new stage of maturity and had successfully administered well in excess of 1 million medication orders, and we had a strong year with medical device resell helping offset some of the decline in traditional hardware resell.

We now have 8 value added reseller agreements in place for medical devices and we expect to continue growing this business which allows our clients to go through one supplier for both their devices and device connectivity solutions.

In 2009 we successfully launched more than 10 agile business units and which we are allowing sales services and development recourses across certain vertical markets to make us a stronger more agile competitor within markets that represent meaningful wide space opportunities with existing and future clients. A good example of where this focus has paid out for us is our women's health business unit which signed 22 clients in 2009 displacing the top best agreed competitors in many of these clients.

Additionally we have substantial growth opportunities and new service offerings that capture a larger percent of our clients existing IT spending, there services leverage our proven operational capabilities and the success of our Cerner works managed services business where we have demonstrated the ability to improve our client's service levels at a cost that is at or below levels that they are previously spending.

One of these new services is Cerner IT Works which is a suite of services that improve the ability of a hospital IT department to meet the organizations needs while also creating a closer alignment between Cerner and our clients. As we announced last quarter the first Cerner IT Works client was assigned in Q3 and in Q4 we signed our second client, University of Missouri, following the memorandum of understanding announced in Q3. Cerner IT works allows for Cerner's role to expand beyond millennium solutions and accelerates the time frame for stimulus meaningful use requirements.

A second new services, Cerner Web Works which includes solutions and services to help healthcare organizations with the revenue cycle functions. In 2009 we made great progress with our patient accounting solution including improving the features and functionalities signing 14 new clients and ending the year with 61 life size. With Cerner web works we are building on this progress to go beyond patients accounting. We are creating a clinically driven revenue cycle process that increases reimbursement accelerates cash, low risk cost, insurance compliance and eliminates waste, friction and delay.

And in summary Cerner IT works and web works represent a major contextual change for Cerner. They represent vehicles to significantly enhance our alignment with our clients. There strategies, goals and objectives become ours and ours become theirs and we become linked in a common identity. These new businesses require much more than just running the client's IT organization or revenue cycle operation. They require becoming fully aligned and motivated to improve the performance of the client's organizations.

So in addition to representing substantial revenue opportunities for Cerner, these initiatives make us much more strategic to our clients, and allow us to innovate at the edges of healthcare, and help, move the meter in healthcare quality, safety and efficiency.

In closing, I'm pleased with our Q4 results, and I believe we're entering the stimulus era as the best positioned company to not only gain share and grow as the EMR is adopted, but also as the best positioned company to create growth beyond meaningful use. With that I'll turn the call over to Trace.

Trace Devanny

Thanks Mike. Good afternoon everyone. Today, I would like to provide an update on a significant shift in my area of focus going forward, and then discuss our international business. As most of you know, I spend a lot of my time traveling to many of more than 25 countries where we currently do business. While that is very important that we see the opportunity created by the stimulus in the United States, we must also continue to advance our position as the HIT leader in the rest of the world.

It goes without saying that there is great interest around the globe in the extensive healthcare reform and stimulus funding activities in the U.S. This global climate will offer significant strategic opportunity for Cerner in the next three to five years. As such I'm excited to say that I'll be relocating to London to spearhead an increased focus on global markets and opportunities, which show the long-term promise of even surpassing the current United States market potential.

By having served as President on the ground Europe, we're sending a strong message about the importance of and our commitment to being a true multinational company, as we pursue the many large countrywide opportunities presented by healthcare across the globe. This announcement has already been recognized in many of our international markets as a positive sign of our commitment to our global business. Note that well I'll be spending most of my time overseas, I'll still be in the U.S. a fair amount as I would be maintaining many important relationships with U.S. clients as well as other duties.

Moving to our results, as Mark mentioned our global business had a difficult fourth quarter and year. This was in part due to a tough comparable with global revenue having grown at a 47% five year compound annual rates through 2008. Make no mistake the weakened global economic climate had a big impact on our 2009 results.

However despite these recent soft results, I'm very bullish about the many opportunities that we are currently working to grow our business. Again international growth is strategic to our company's long-term success by relocations in London sends a strong message of about our belief and healthcare transformation around the world. This increased focus will pay dividends in the future and I'm most please for the opportunity to continue to lead this effort from our London office.

On our last call I highlighted the importance of operational execution as the Lynch pin for market leadership. Specifically in England I noted that we had important conversions that would further differentiate Cerner as the one provider that is truly delivering results on a scalable current technology platform. I'm pleased to report that both Kingston Hospital NHS trust in London which is inside the national program and the New Castle upon Tyne foundation trust which purchased outside the program were successfully converted in the fourth quarter.

While there continues to be speculation about the direction of NHS program the need for technology to play a central role in NHS modernization continues to accelerate. And Cerner's delivery capabilities and commitment to the market place have not gone our notice. So I believe that our work with the NHS trust will continue to expand as we deliver demonstrable benefit to the trust.

Similar execution was evident in the Middle East where we had another successful go live as part of the SEHA system wide HIT upgrade. We have now deployed systems across all SEHA hospitals and clinics in the Emirate of Abu Dhabi making SEHA the only fully electronic healthcare system in the Middle East, a very important milestone in the region.

Also in 2009 we continue to expand the presence of Cerner Millennium solution in other parts of the world. With conversions in Egypt and Chile Millennium is now live on 6 continents. In addition solid progress was made in other countries including new clients and additional go lives in France and Spain, additional conversions in Australia and our first ever hosting agreement in Canada.

In summary while there were some disappointing aspects to our 2009 global results I still believe we advanced our physician as a leading global HIT company and to position ourselves for a return to solid growth in 2010 and beyond. I look forward to keep you updated on our progress.

With that I will turn the call over to Jeff.

Jeff Townsend

Looking back on 2009 I am pleased to report we accomplish from an innovation standpoint. As Mike discussed we are well positioned to deliver against meaningful use for requirements while as take our clients beyond the EMR. This along with additional services such as IT works and web works presents strong growth opportunities while creating strategic alignments with our clients over the next several years. And also believe we made good progress at advancing initiatives so would be the foundation for another leg of growth this decade.

Beginning this year I will take on responsibility for several of these initiatives which we collectively refer to as the acronym CERN which stands for Consumer Employer Research and Networks. It is across these combined markets that we must leverage our progress on existing initiatives to build towards the new middle which was the topic of Neal's key note as our last healthcare conference and included in my comments last quarter.

Last year we published the business case for the middle and the white paper called the ABC systemic health care reformed. In this paper we described how up to $500 billion per year could be saved in the US health care system by fully digitalizing and optimizing healthcare delivery so that care can be delivered in a coordinated and frictionless manner. Over the course of 2009 we showed the launch of several new initiatives that give us a good start to create in a new middle and changing the way, providers, employers, governments and consumers interact with healthcare.

I'll briefly describe some of these initiatives today; will go into more detail on our Investor Day on March 11. Over the years, we've leveraged our connectivity to our clients to create a network that helps manage and monitor client technical environments, as well as creating the common platform for learning and improvement. We've referred to these as the lights on network.

Learning from this platform lead to the creation in 2009 of uCern, a contextual collaboration platform to which we quickly connected almost all of our core clients by allowing end-users to engage both inside and outside the organizations. This platform has extended our knowledge ecosystem to the edges where our solutions and services meet healthcare delivery.

In 2010, we expect to extend this platform to the consumer or patient in the context of their healthcare experiences. uDevelop and uCern store additional initiatives that helped us connect with our client base and move our research in development efforts to the edges of healthcare where physicians and nurses interact with patients in context of the health conditions. We call the uDevelop as a collaborative ecosystem to support the unique audience of engineers, both Cerner associates and external developers. And the 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.

The ability to connect clients across our base and in inoperability capabilities through our Cerner hub are important differentiators as clients look at the inoperability requirements for stimulus funding. It also enables the creation of regional networks to facilitate broader inoperability allowing for things like personal health records, population health management and chronic disease management programs. In 2009, we also expanded our footprint and capabilities in the employer space, which is an important element of our long-term strategy given the amount of healthcare cost paid by employers.

Our acquisition of IMC health care expands our clinic offering to include occupational help will also establish in relationship with 15 employers some of which are very large. This gives us a great opportunity to grow these employer relationships to include other healthy employer services such as onsite pharmacy condition and wellness management programs and benefit plan design.

These services are designed to help employers control expenses associated with the help of their employees. We have proven the ability to do this at Cerner where we have held cost flat over the past several years while improving the health of our associate base as well as measured by cholesterol levels BMI blood pressure and glucose levels. In future these fruit points in employer relationships will be important as we look to change the current inefficient model for transacting healthcare.

In summary my focus over the next several years we'll be leveraging the accomplishments of all these initiatives as building blocks for new middle to healthcare. Through these connections and networks across employers', consumers and providers we believe we can help create an entirely new healthcare system that will introduce much needy competition for our current insurance based infrastructure.

In this new system the new middle will facilitate the sharing of relevant clinical and financial information between payers, consumers, and providers resulting an enhance care and reduced friction. Consumers will have a personal health record giving them ready access to information on both the price and quality of the care they receive. This record will have the consumers complete medical history be capable including in a predictive model of future needs based on his or her genetic code. On with this information consumers would have financial incentives to focus on controlling product conditions and reducing future melodies.

With more complete patient information providers can focus on preventive rather than reactive medicine. They were also be able to communicate instantly with the rest of the patient's care team and receive immediate point of payments for the delivery of appropriate care rather than waiting weeks or months or our plans work through the reimbursement process.

Finally, the segments of our society that pay for care and employers and governments would receive a rational health system on that eliminates variance cost and waste while maximizing the quality of healthcare for all of us.

With that I will turn the call over to the operator for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Michael Cherny of Deutsche Bank

Michael Cherny - Deutsche Bank

Somewhat dig in a little bit for this bookings number, Mike you already talked about number of large contract wins talk about some new competitive situations, specially large contract wins, were these more green field opportunities or replacements of legacy systems or kind of gives a little more characteristics of what that some of these contract wins.

Mike Valentine

Well I think Michael at a high level it's a result of an ongoing investment it's the investment that we have made in the specifically the two transaction that I think you are referring to UHS and Tenet a longer-term investment in the four profits base and developing a business on that front. Both of them had levels of HIT automation in place both had some other suppliers in the mix with different strategies. So I think that but there is a large tool it's a result of some longer-term investments that paid off.

The just a sheer volume of larger transactions I think is reflective of combination of new footprints coming to the marketplace. Existing clients finishing their journey and our catering percent of spend strategies coming to provision. So the average transaction is larger obviously, what we can define more of the roadmap and to get more of the stand at that transaction point. So, I think this quarter represented a great example of all that coming together at once.

Michael Cherny - Deutsche Bank

Absolutely, and then just question on the margin. It kind of relates to the first question as well. Obviously, I think once you're excited to see that guys broke through that 20% operating margin, but then going forward obviously a lot of new business to put in place. Could you tell us a little bit about the dynamics of the trade-off between some of the significant new business wins you have and what that means for the margin profile of the overall business?

Marc Naughton

Yeah, this is Marc. The deals that we signed this quarter were very consistent from a pricing perspective. We're not seeing a lot of pricing pressure out there. We kind of winning on our capabilities, and this will feed not only the software but feed to the services. And a lot of these are having elective services yet are future candidates for that. So, we don't expect any degradation to our margins and in the fact as we full utilize what we talked about as a bench in the services space, we actually think that will could be positive relative to our margin and help us get to a 20% margin for the full-year of 2010.

Operator

You have a question from the line of Glenn Garmont of Think Equity. Please proceed.

Glenn Garmont - Think Equity

Marc, just trying to understand the relationship here between that very impressive bookings number and your revenue growth guidance for this year and I'm just wondering obviously significant upside on the booking side, 10% revenue growth outlook sort of consistent with where its been. What's preventing sort of greater flow through there are you sort of constrained on the implementation side or is it the mix of bookings, are there more services in the booking, just trying to understand sort of a linkage there.

Marc Naughton

Yeah, good question. Clearly some of the mix relative to some of the longer-term deals from a hosting and IT works perspective, those being the income statement over longer period of time normally 5 to 7 years. So that's one impact. Some of these larger transactions particularly in the forward profits base probably have projects will go on over period of years and the professional services from those will flow into the income statement over that three plus year period of time.

So, obviously the big chunk of bookings very excited puts in their backlog as we roll forward it certainly helps support the view we have had for 2010 but keep in mind we try to be somewhat conservative on doing our plans relative to expecting more business then we kind of see in the past and I think this year we have been even more careful just to make sure that our numbers are solid and deliverable. So, in this economy we would be pleased with 10% growth of the top line 17% growth on the earnings line and we haven't factored in a whole lot of upside from stimulus and the numbers been provided that could happen. But, relative to the big booking of Q4 is going to have a multi year impact and that's why you are not seeing a huge amount of flow through in 2010.

Operator

Your next question comes from the line of Richard Close of Jefferies.

Richard Close - Jefferies

Just quick clarification, Mark on that last statement, did you say you have not factored in a lot of stimulus?

Marc Naughton

We built our plan based on kind of our 2009 activity levels adjusted slightly for pipeline so there is likely stimulus that's kind of in the middle of the year, end of the year we expect that there is potential for upside, we think Q1 as our guidance indicates relatively Q4 is going to reflect some of the seasonality that we normally encounter and obviously after a monster Q4 down slightly for Q1 numbers would make sense from our booking standpoint but our plan and that's what we base our guidance on going into the year doesn't expect anything heroic from a stimulus prospective.

Richard Close - Jefferies

When we look at the $15-$10 plus million deals how many of those would you characterize were from new footprints and stop there.

Mike Valentine

This is Mike, I would say about a third and we are not in our calculation we may do the 30 plus percent from new business we are not including Tenet and not even though all those technically represent new foot print facilities where those that's excluded from our calculations

Richard Close - Jefferies

Final, on the pipeline when you look out can you characterize at all stimulus related deals and have you seemed to pick up yet I mean based on your initial comments Marc, I guess you are really not factoring much in until later in the year, but are there active, increase in active RFPs because of the stimulus?

Mike Valentine

Yeah, this is Mike again. There are absolutely as an increase in RFP traffic, and the increase in activities in the market place. So we're like we've said in the last three calls now, we're seeing different behavior in the market place, that's driven by a desire to get the meaningful use for the clients here in the U.S. and the market in U.S. and we expect that to continue through the year.

Operator

You have a question from the line of Jamie Stockton of Morgan Keegan. Please proceed.

Jamie Stockton - Morgan Keegan

Thanks for taking my questions and good quarter. Mike, really I would say both of you kind of pertain to where the demand is coming from in the hospital space and then your opportunity in the community hospital space, and the first one is would you say its accurate that the larger the organization the more likely it is that they are moving now relative to the stimulus?

Mike Valentine

What I have said in the last couple of calls is the market is been broken down in about third to third to third. The third are waiting to see what meaningful use gets to find us, and if it sums real, a third are staying in course on the journey, they are already started and the third are either starting or accelerating. What I would say that we're seeing now is unless you have some special extenuating circumstances financial or other wise that bottom third that is what was waiting is at a minimum getting a plan to get towards meaningful use. So that I think every, its fair to say unless you get some extenuating circumstances, this is on your radar and you got a plan, and you're building a plan to action it.

Where you are in that decision process is a different point but I think it's a very active around getting journey started around meaningful use.

Jamie Stockton - Morgan Keegan

Okay and then with the opportunity in the community hospital space, what sort of a time frame do you think is out there as far as those potential customers making a decision as to whether or not they are going to go with their existing vendor or if they are going to switch?

Mike Valentine

I would say that we expect the activity around the stimulus to play out over the course of the next three to five years. So, the acceleration to get there will happen then. For a community hospital I would say, they tend to make decisions in entire time frame as little as 60 to 90 days and as we saw in Q4 we actually see some of either our clients or some folks in the market place really making a gut check around or the solutions or the technologies that they selected, are they going to get them to meaningful use and when they make a decision and it is no we need a new strategy they tend to act very quickly.

So, I think we'll see activity on that front in 2010 spike. So, people will make the gut check, make a decision and if the decision is a one that finds some self back in the market place, they tend to go very quickly. So I view it as, this is our one of opportunity from a replacement or displacement standpoint a best window of opportunity as driven by stimulus is going to happen in 2010.

Jamie Stockton - Morgan Keegan

Okay. And then my last question is on the physician side. You guys have hired a few more people from a sales standpoint I think in your physician business you have the partnership CDW, how are the conversations gone with the regional extension centers. Do you think that that is going to be another area where you can increase your distribution among physicians' especially smaller practices?

Mike Valentine

Absolutely our best means to reach high volume physicians' practices is through our client base. In our client base although the active participants in these are regional extension centers so I think when they announce the 60 or 70 where we will absolutely go, we are part of those functions just as we have sold through our base and allow them to essentially already serve as regional extension centers themselves without having a formal designation.

Operator

Next question comes from the line of Corey Tobin of William & Blair Co.

Corey Tobin - William & Blair Co.

Three quick ones here first what would you estimate replacement deals either departmental systems or core impatient systems, represents as a percentage of your total opportunities today?

Mike Valentine

You are asking a Q4 composition question?

Corey Tobin - William & Blair Co.

More asking about you look at the pipeline.

Mike Valentine

It's a tough question to answer because almost every situation represents a displacement for one and multiple supplier so an easy answer is 90% of the transactions that we do are replacing someone. But a pier a wholesale replacement has been fairly rare to-date. Q4 was obviously a big spike for us relative to single large transaction and a couple of others that are tagged along with it. So we haven't seen that as a huge opportunity for us, but as I mentioned in my comments earlier I think our best window opportunity to go, accelerate and perform on that front is probably 2010.

Corey Tobin - William & Blair Co.

Switching to the margin side for a second, now that you have a very nice quarter and congratulations in making the 20% goal and assuming that comes through in 2010 internally as you look out over the next three to five years, what sort of the next step with respect to margins and the next target with respect to margins that you would point us towards?

Marc Naughton

I'm kind of giving out of the setting the margin target business for at least one quarter if I can. No. We think 20% is a great target since it was 9% in '03, when we first establish it, but we don't think that's the total reflective of all the leverage that's in the business. So, we're on a very unique situation here, so we're going to do a good job. We think of balancing margin growth was investing as appropriate in the business. We've already made a lot of the investments, so those investments won't have a big impact on margins, but we would like to a steady state environment continue to try to grow margins between 50 to 100 basis points annually, but before at this point kind of say we're focusing on getting the 2010s to a full-year 20% and then we will kind of go from there. We aren't done growing margins.

Corey Tobin - William & Blair Co.

Final one if I could. Marc you said during your comments earlier with respect to top line guidance would you say at that this point, you're more comfortable with the guidance that was set out there for 2010 revenue, than perhaps you were coming into 2009 and getting the 2009 revenue target?

Marc Naughton

Every time we provide guidance, we're very comfortable with what we provide based on the facts that we know at the time. So I have to kind of save it at least my comfort level, I have to be very comfortable every time we talk. I think clearly the environment of January 2010 and February 2010 versus the same time a year ago feels much better from our standpoint relative to what we think we accomplished. I think I indicated that our plan doesn't assume more going to increase bookings over the prior year number. Stimulus will help us meet that target so its not completely exclusive but if we get some upside on to do this stimulus which is more likely in 2010, certainly then it was in 2009, then I think realistically the guidance is our best view of the year at the time we provide it. So I have to say that every time I provide you guidance, I'm comfortable with it.

Operator

You have a question from the line of George Hill of Leerink Swann. Please proceed.

George Hill - Leerink Swann

I have a couple of questions Marc, a real quick house keeping questions, you think tax rate is 35% for next year?

Marc Naughton

Correct.

George Hill - Leerink Swann

Okay, Mike I want to talk for a second about the UHF and tenant (inaudible) but I want to ask how we should think about these ones vis-à-vis. I think about all big contracts like Ascension Health and I remember when you guys first signed Ascension you guys had put a number around it, that looked about a $100 million and if I think about Ascension today, if I am doing my math right, they expect almost the quarter of $1 billion of you guys. Should we think about the large contracts that you guys sign not as terminal value contracts but these are really what it costs to bring the customers kind of up the initial curve and that there will be future spending after that?

Trace Devanny

Yes, that's absolutely the way we look at it. We talk about in my comments earlier about the dollars that go back into R&D to create new innovations at the edge and so we were talking a little bit about it and advance the call around the white space and how it's a little bit of a moving target because if you look back a year from today, we really didn't have an IT works client, right. It was something that we were launching and now it represents a sizeable chunk of what happened in Q4.

You look back two years from today and we were talking to you about the device connectivity and how meaningful that business is today. So you fast forward two years from today and I think there will be more good things going on in our install base that will go back into those large client transactions and we were doing for a large transaction in the US. We skipped 2008 and so having the two happen in 2009 was a good catch up and we expect that, we look for the larger opportunities or larger transactions and we fully expect to continue to leverage our solutions into beyond that initial point of sale and each one of those opportunities. So the short answer is absolutely yes.

George Hill - Leerink Swann

Second of all, not everybody in the healthcare technology sector has reported results as good as your guys are, even an outlook as optimistic as your guys in the most recent quarter. Do you think it's fair to say that they were starting to see the bifurcation of some of the winners and losers in the market?

Marc Naughton

I think clearly so competitive environment out there. Right now everybody can say that they are going to meet meaningful used targets and I think those that can prove it early are going to have an advantage and we forcefully have to be in that camp so, we'll see. Clearly our results do set us apart from the rest of the industry at this point.

George Hill - Leerink Swann

And also last question, Marc could you indulge me for just a few seconds, if I remember, when you guys first started on the data center projects four or five years ago, you invested about $100 million in the data center capacity that you have right now. Can you talk about what the managed services attached rate looks like? Maybe give us some color on where the hosted services, revenue line ended the year and what the profitability level there looks like?

Marc Naughton

Well, the top line of answer is about $250 million for the year. It clearly is one of our fastest growing elements of the business and the way we have set up our facilities is that we can incrementally add data center space in kind of digestible CapEx chunks. So when we talk about kind of spending the $130 million to $150 million in year in CapEx that covers kind of building out that additional capacity as well as putting computers in and adding people. So it is a business, we would continue to expect to grow. Our ultimate goal is every client is every client we have is managed service clients and then that client steps up and becomes an IT works client a little bit down the road.

Mike Valentine

So your attachment rate, so 100% of the people who made of the new clients that came to Cerner in Q4 that also made a technology decision went with our hosted managed services offering.

George Hill - Leerink Swann

And I guess some roughly I'm thinking about is if you guys, let's say you put a $150 million of worth of capital under this business, it's now a $250 million plus run rate business. It's generating maybe EBIT margins approaching 20%, some of the returns on capital perspective that probably looks pretty good.

Mike Valentine

Absolutely, we're excited when that business basically turned to where at cash flows it by itself covers itself capital investment on an annual basis so.

Operator

Your next question comes from the line of Atif Rahim of JPMorgan. Please proceed.

Atif Rahim - JPMorgan

Thanks and Mike congrats on a great quarter too. Quick question related to prior comments you made. What's the margin profile of the IT Works business? Is it something that's highly intensive in terms of cost upfront and then becomes profit leader or show you things a bit somewhat differently?

Mike Valentine

Yes, the IT Works business is primarily designed for us to kind of take over operating the client's IT which includes running their data center using their equipment. So, we don't have very much CapEx upfront and the (inaudible) we did are very illustrative of that. We didn't have a big CapEx yet in the front. We're not buying their assets. We are not doing the outsourcing view of the world but we do that. We are taking over their people, but that's an expense that we need to go run their things and we're getting paid for that.

So, relative to a margin view, we look at these kind of as it overall transactions so there is a providing operating their systems internally, there is a software component, there is often a managed service component for the Cerner elements of the deal because most of them already have a managed services component.

So, all in a (inaudible) that gets us to a margin rate that's pretty close to kind of a hurdle rate which historically has been 20%. Clearly the software component that helps get there but that's part of the overall design of others approach, and as we continue to be able to move them to Cerner solutions off their existing solutions all those support maintenance, they are paying on those other solutions flowing into the Cerner office. So those are higher margin businesses as well. So those will actually start out pretty profitable and they will get more profitable normally overtime.

Atif Rahim - JPMorgan

Okay and then on the 4Q bookings, Marc you said that even without the visible (inaudible) this quarter, you would have been about $100 million over plan. Could you give us any idea of where that strength is coming from? Is it mainly the community hospital market, or is it just existing customers? Any clarity on that?

Marc Naughton

Its all over, I mean from the very biggest deals we signed to the relatively small places that are less than a 100 beds and are signed up for $10 million worth of hosting and software and services. So it's really fairly broad across our spectrum of potential clients.

Mike Valentine

And this is Mike and it's also balanced across our business model. So services, software so it didn't land in one area.

Atif Rahim - JPMorgan

And then final question on the professional services side that's lagged somewhat and you are indicating that's going to be up in 2010. Any plans to increase your billable headcount there, and how is that going to that affect the numbers?

Mike Valentine

Yes, I think relative to that we've discussed previously that we had a (inaudible) bench in anticipation of some activity. That activity hit Q4 pretty well. So I think we are able to handle that business with existing headcount. We have a approach to that where we can hire kind of well seasoned from an education standpoint, kids off campus, run through a six week course where we basically make them capable of installing our systems in our solution center. So we will look at adding headcount as we go forward, but because of a short timeframe to get them up and billable, we won't have to do that significantly in front of seeming the demand. So we've worked very hard to establish this solution center approach and now it will help us meet the demand on a relatively real-time basis.

Operator

Your next question comes from the line of Steve Hopper of Thomas Weisel Partners. Please proceed.

Steve Hopper - Thomas Weisel Partners

Two questions; one on the contracts that you're signing today, are you doing 60 projects for implementation services?

Mike Valentine

Yes we are. 100% of the new business that took place in the US is going through the solution center and that is from an implementation perspective and that's a 60 model. There are some P4 services, things that tend to get hung up at that core arrangement that by and large the implementation is a fixed engagement.

Steve Hopper - Thomas Weisel Partners

And how do you price those out to ensure that you're not going to get burned on your cost?

Marc Naughton

See, we've been kind of installing systems for a long time. The advantage of having a very solid platform of Millennium is, we pretty much know what it takes to implement, and especially when they come to the solution center, we're doing a bigger percentage of the bill relative to the client. We have more control over it, and we've actually have a very good history of being [asked to table] to estimate our cost on those implementation, certainly as compared with the field. So all-in-all we much rather run things to solution center and the reality is, that because of the efficiencies of [our field] not traveling even with lower billable rates, we actually can drive a higher margin with those people that we wouldn't [field] people.

Steve Hopper - Thomas Weisel Partners

And so is the fixed fee, is that turning out to be a competitive advantage for you?

Marc Naughton

Yes.

Mike Valentine

Yes, I think the predictability in general is a competitive advantage for Cerner and the solution center and managed services and the fact that the software, the solutions are up and running in a lot of places, those three are what set us apart.

Steve Hopper - Thomas Weisel Partners

And one quick house keeping, the number of financing deals or the value of the financing deals were pretty small this quarter. Any color on that?

Mike Valentine

We ran out of room in our bank accounts for cash so, not it kind of indicates it's a little bit reflective of the health care entities that we are dealing with this quarter, that more of them were looking to push cash forward and did not need to access the financing capability we offer. So, little bit of a stating the health of those clients…

Steve Hopper - Thomas Weisel Partners

And your financing partners are still in place, improving, willing to lend more?

Mike Valentine

Yes, given the increasing financial health, they are begging for more business and so obviously if there is interest on the client side, we have people who ready to take that. We'll take one more question.

Operator

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

Sean Wieland - Piper Jaffray

So, given the comments around the stimulus and the guidance, you're saying that there is no impact in the stimulus baked into the guidance?

Marc Naughton

Sean, let me just clarify that there is, clearly we are doing our normal, we're not assuming any increase in bookings from '09 to 2010. There are probably with some of those bookings would have some stimulus element to them, just in normal course. What I'm really saying is there is nothing extraordinary. We are not including any of these deals that Mike talked about, hoping we were going to come up on the radar and do a transaction in a fairly short period of time. We have looked at our pipelines, there are elements in our pipeline that have some stimulus impact, but we aren't betting ahead of seeing that business coming to our platform. So I just want clarify that to make sure I am not saying we assume no stimulus, the normal amount of activity that doesn't exceed '09 bookings may have a stimulus component, but we think there is opportunity to increase that in 2010.

Sean Wieland - Piper Jaffray

So with that color, what do you need to see in terms of the macro landscape to start baking in an inflection point if one is out there?

Mike Valentine

We have always indicated Sean that kind of mid 2010, is when we start thinking the stimulus impact we're really going to see it. We had a little preview of it in Q4. Our Q1 guidance is a little bit normal seasonality, so I think as we come out of Q1 and have the 90 better view from our foresting process for the rest of the year, you'll be able to see it as in our bookings statements, it is our best view.

Marc Naughton

Sean just from a market perspective, the normal decision process historical has taken between 12 and 18 months for a HIT selection and so given if just back that up the stimulus basically became really at February, a lot of new buyers came to market or at least were thinking about coming to market and in the mid part of last year and so they are getting much more mature process are emerging from that. So, little bit of our reluctance to put a joint pipeline baked into our numbers is seeing that come to fruition. So that's kind of point number one, point number two is I think once our install base, our client base gets the final edict of what meaningful use is and the timing. So at stage one, stage two, stage three, I think that will have an impact on how rigid or how secure their timelines are to move forward. So until those things happen and we get further down the past year, we've been hesitant to put any big markers out there.

Mike Valentine

This time, I'll turn the call over to Neal for closing comments.

Neal Patterson

Great. It's always a good call when I only talk at the very end. So, I think just to recap frankly what we've offset here. First of all the intersection of IT and healthcare is a very good place to be. I think everybody on the call, both sides of the call cannot learn pretty much referring that and it is a very good place to be. I think Marc said we had a very good quarter which made a fair year out of it, but he remains cautious and he knows Q1 is going to be a seasonally as always a little bit harder, and then on the margin question, he wouldn't change his position, but he's very pleased to hit the 20% for the fourth quarter, and we expect to be out of persist that and he things there is more leverage in our model.

Mike basically said that US shipped, that fourth quarter was a very good quarter and he saw real improvements in the US. Trace said that even though it was not component, comparable basis and there were some tough things in that. There were some tough things on the overall global marketplace. He is very optimistic there, to the point he is moving. You heard from Jeff, we rarely see healthcare as a broad system, a very big system. The provision of healthcare, it comes together, its kind of the nexus of healthcare delivery, but health really you have to get beyond just the delivery side. So, we see the system in a much broader sense and we believe our size, our scale and frankly our fundamental skills we believe we're going to innovate significantly there over this next decade.

And so that's basically what you heard from the team here, I appreciate the call, I don't know where if you look out your window, but I only got this one is snowing. So I hope you are in some sunny and warm place. So, have a good afternoon. Thanks for your time and attention.

Operator

Thank you for your participation in today's conference. This concludes the presentation, you may now disconnect. Good day.

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Source: Cerner Corp. Q4 2009 Earnings Call Transcript
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