Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Cerner (NASDAQ:CERN)

Q4 2013 Earnings Call

February 04, 2014 4:30 pm ET

Executives

Marc G. Naughton - Chief Financial Officer, Executive Vice President and Treasurer

Zane M. Burke - President

Neal L. Patterson - Co-Founder, Chairman and Chief Executive Officer

Analysts

David H. Windley - Jefferies LLC, Research Division

David Larsen - Leerink Swann LLC, Research Division

Michael Cherny - ISI Group Inc., Research Division

George Hill - Deutsche Bank AG, Research Division

Steven P. Halper - FBR Capital Markets & Co., Research Division

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

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

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

Sean W. Wieland - Piper Jaffray Companies, Research Division

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

Donald Hooker - KeyBanc Capital Markets Inc., Research Division

Operator

Welcome to the Cerner Corporation's Fourth Quarter 2013 Conference Call. Today's date is February 4, 2014, 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 statement for the purpose of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading Risk Factors under Item 1A in Cerner's Form 10-K, together with other reports that are furnished to or filed with the SEC.

A reconciliation of non-GAAP financial measures discussed in this earnings call can be found in the company's earnings release that was furnished to the SEC today and posted on the Investor section of cerner.com.

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

Marc G. Naughton

Thank you, Breanna. Good afternoon, everyone, and welcome to the call. I'll lead off today with a review of the numbers. Zane Burke, our President, will follow me with the results highlights and marketplace trends. Neal Patterson, our Chairman and CEO, will be available during Q&A. Mike Nill, Executive Vice President and Chief Operating Officer, and Jeff Townsend, Executive Vice President and Chief of Staff, are at client events, but look forward to catching up with you at our Investment Community Meeting on February 25.

Now I will turn to our results. We delivered very good results in the fourth quarter and for the full year 2013. Our total bookings revenue in Q4 was $1.11 billion, which is an all-time high and reflects 9% growth over our previous record results in Q4 of '12. Bookings margin in Q4 was $975 million or 88% of total bookings. For the full year, bookings revenue was $3.77 billion, up 20% over 2012. Our bookings performance drove a 23% increase in total backlog to $8.91 billion. Contract revenue backlog of $8.13 billion is 24% higher than a year ago. Support revenue backlog of $786 million is up 6% year-over-year.

Revenue in the quarter was $795 million, which was up 12% over Q4 of '12. The revenue composition for Q4 was $246 million in system sales, $170 million in support and maintenance, $361 million in services and $18 million in reimbursed travel.

For the full year, revenue grew 9% to $2.91 billion over a tough comparable in 2012 when revenue grew 21%.

System sales revenue reflects a 2% drop from Q4 of '12, which had grown 14% over the prior year, and a 6% decrease for the full year of 2013 due to continued declines in technology resale revenue.

Q4 system sales margin dollars, however, still grew 13% over the year-ago period and full-year system sales margin dollars grew 15%, reflecting continued strong levels of high-margin system sales components like software and subscriptions. We are now through our toughest comparable periods for technology resale and we expect it to return to growth in 2014.

Moving to services. Total services revenue was up 24%, compared to Q4 of '12, and 21% for the full year, with strong growth in managed services and professional services and continued increasing contributions from ITWorks and RevWorks. Support and maintenance revenue increased 11% over Q4 of '12 and 10% for the full year.

Looking at revenue by geographic segment, domestic revenue increased 12% for the quarter and 9% for the full year. Global revenue was up 8% for the quarter and 11% for the full year.

As a preview to the annual update of our detailed business model that we'll provide at our Investment Community Meeting on February 25, I'd like to provide you with the total revenue and growth by business model for the full year 2013.

Licensed software grew 12% to $388 million; technology resale was down 33% to $263 million, but as previously discussed, this decline had a little impact on our gross margin dollars; subscriptions and transactions increased 19% to $197 million; professional services revenue grew 24% to $851 million; managed services increased 15% to $479 million; support and maintenance was up 10% to $662 million; and reimbursed travel was $70 million, which is up 27%.

Moving to gross margin. Our gross margin for Q4 was 82.1%, which is up from 78.4% in Q4 of '12, reflecting record software levels and a lower mix of technology resale. For the full year, gross margin was 82.3%, which is up 510 basis points compared to 77.2% in 2012, also reflecting record software and lower technology resale. Gross margin dollar growth for the year was 16%, which compares to revenue growth of 9%, with the difference in growth rates reflecting the decline in low margin technology resale. With the toughest comparable periods for technology resale behind us, we expect the gross margin fluctuation to moderate as the technology resale resumes contributing to revenue growth. This should also result in our revenue gross margin dollar growth rates being more aligned.

Looking at operating spending. Our fourth quarter operating expenses were $450 million before share-based compensation expense and the settlement charge. This is a year-over-year increase of 16%, which is below the 17% growth of our gross margin dollars, reflecting ongoing leverage. For the full year, operating expenses before share-based compensation expense and the settlement charge were up 15% to $1.66 billion. This compares to gross margin dollar growth for the year of 16%.

Sales and client service expenses increased 16%, compared to Q4 of '12, and 15% for the full year, driven by an increase in revenue-generating associates in our services businesses.

Our investment in software development was up 17%, compared to Q4 of '12, and 12% for the full year. As previously discussed, the growth in software development is due to increased focus on investing in growth initiatives, and we expect this growth to moderate later this year.

G&A expense increased 17%, compared to Q4 of '12, and 24% for the full year, driven by increased personnel expense related to our strong growth and a higher amortization expense related to recent acquisitions and acquired intangibles. We expect growth in G&A expense to be more in line with overall growth in 2014.

Moving to operating margins. Our operating margin in Q4 was 25.6% before share-based compensation expense and the settlement charge, and was up 160 basis points compared to Q4 of '12. For the full year, operating margins increased 220 basis points to 25.1%. This was driven by a combination of ongoing operating efficiencies, the decline in lower margin technology revenue and strength in software. Going forward, our plan reflects continued margin expansion, albeit at lower levels than 2013, since we expect technology resale to resume growing. We expect approximately 100 basis points of margin expansion, with higher or lower levels possible depending on mix. As in the past, we will focus on delivering predictable levels of gross margin and earnings growth, which has not materially impacted if we have fluctuations in technology resale.

Moving to net earnings and EPS. Our GAAP net earnings in Q4 were $60 million or $0.17 per diluted share. GAAP net earnings include share-based compensation expense, which had an impact on earnings of $9 million or $0.03 per diluted share and the settlement charge, which had a net impact of $68 million or $0.19.

Adjusted net earnings were $137 million and adjusted EPS was $0.39, which is up 16% compared to Q4 of '12. For the year, adjusted net earnings were $497 million and adjusted EPS was $1.41, which is up 18% from 2012.

The Q4 tax rate for adjusted net earnings was 34%, which is in line with our expected effective tax rate. For 2014, we expect our effective tax rate to remain within 50 to 100 basis points of 34%.

Now I'll move to our balance sheet. We ended Q4 with $1.43 billion of total cash and investments, compared to $1.5 billion in Q3. Total cash and investments include $879 million of cash and short-term investments and $555 million of highly rated corporate and government bonds with maturities less than 2 years. Our total debt, including capital lease obligations, is $166 million. Total receivables ended the quarter at $583 million, which is up $54 million from Q3 and driven by strong sales in the quarter. Our DSO in Q4 was 67 days, which is similar to Q3 DSO of 66 days and down from 74 days in Q4 of '12. Operating cash flow for the quarter was $141 million. Q4 capital expenditures were $134 million and capitalized software was $49 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was negative $42 million for the quarter due to the settlement charge, as well as continued higher capital expenditures, which included a $43 million land purchase that was announced during Q4.

For the full year, operating cash flow decreased 2% to $696 million, primarily due to the settlement charge. Free cash flow for the year was $168 million, with capital expenditures of $353 million and capitalized software of $175 million. Free cash flow is lower than 2012 due to higher capital investments tied to our cloud infrastructure, higher spending on land and facilities to support our growth, higher capitalized software related to investment in our growth initiatives and the settlement charge.

Looking at capitalized software, the $49 million of capitalized software in Q4 represents 42% of $116 million of total investment in development activities. Software amortization for the quarter was $25 million, resulting in a net capitalization of $23 million or 20% of our total R&D investment.

For 2014, we expect stronger free cash flow, driven by growth in operating cash flow, a decline in capital expenditures and flat-to-slightly-higher capitalized software. For capital expenditures, we expect them to average $65 million to $70 million per quarter, versus nearly $90 million in 2013.

For capitalized software, we expect it to be in the mid-$40 million range throughout the year, which will lead to being flat or slightly higher than 2013. This reflects a reduction in the use of third-party developers, which we slightly offset by an increase in our own developers.

I'd also like to note that we announced in December that our Board of Directors approved another stock repurchase program, authorizing the repurchase of up to 217 million of common stock. Like our last repurchase program, this one is targeted at offsetting dilution from options.

Now I'll go through Q1 and full-year 2014 guidance. For Q1, we expect revenue between $770 million and $810 million, with the midpoint reflecting growth of 16% over Q1 of '13. For the full year, we expect revenue between $3.2 billion and $3.4 billion, reflecting 13% growth at the midpoint. We expect Q1 adjusted EPS before share-based compensation expense to be $0.36 to $0.37 per share, with the midpoint reflecting 11% growth over Q1 '13 reported adjusted EPS and 14% growth when you consider the $0.01 benefit we have from lower taxes in Q1 of '13. This range is slightly lower than the Q1 consensus, which may have factored in growth off the Q1 '13 EPS that included the tax benefit. Consensus for the remaining quarters and the full year is within our full year guidance.

Q1 guidance is based on total spending before share-based compensation expense of approximately $455 million to $465 million. For the full year, we expect adjusted EPS between $1.62 and $1.67, with the midpoint reflecting 17% growth. Our estimate for the impact of share-based compensation expense is approximately $0.03 in Q1 and $0.11 to $0.12 for the full year.

Moving to bookings guidance. We expect bookings revenue in Q1 of $860 million to $930 million, with the midpoint reflecting a 12% growth over our strong Q1 '13 bookings.

In summary, we are pleased with our results in 2013, which was the year in which we were able to deliver good results, while also investing heavily in our future growth. With that, I'll turn the call over to Zane.

Zane M. Burke

Thanks, Marc. Good afternoon, everyone. Today, I'll provide Q4 and full year result highlights and discuss marketplace trends.

Starting with our results. Our bookings revenue in Q4 of $1.11 billion is an all-time high and reflects 9% growth over Q4 2012, which is our previous all-time high. Our full year bookings of $3.77 billion reflect 20% growth over 2012. This is particularly impressive when you consider we achieved this growth despite the large decline in technology resale.

For the quarter, we had 25 contracts over $5 million, including 16 over $10 million, driven by strength both inside and outside our install base. For the year, we had record level of contracts in both categories, with 101 contracts over $5 million and 57 over $10 million.

The mix of long-term bookings was 29% in the quarter. For the year, 32% of our contracts were long term compared to 31% last year.

Looking at our pipeline. We had a double-digit increase in 2013, even with nearly $4 billion of bookings coming out of it during the year. This positions us well for continued bookings growth.

A major highlight of our quarter and year was our continued success at gaining market share. This is reflected in the 39% of bookings in the quarter and 31% for the whole year, coming from outside our core Millennium install base. For the year, our total bookings outside of our base grew 24% and exceeded $1 billion for the first time.

We continue to have significant opportunities to gain share, as I believe that at least half of the market will evaluate if they are going with the right supplier over the next several years. These decisions are disproportionately going to Cerner and our primary competitor, and we believe our position against them continues to improve. This is apparent with our win rate, which has doubled over the past 3 years.

A major highlight of our competitiveness in 2013 was Intermountain Healthcare selection of Cerner. This selection and several other signature domestic and global wins over our primary competitor in 2013 have been noticed across the industry and are having a positive impact on our positioning. It is clear that investments in physician experience and Revenue Cycle are paying off and allowing our leading capabilities and vision for population health to carry more weight in the selection process. Our modern architecture and commitment to being open is also contributing to our positive momentum.

Now I'll cover some specific areas that contributed to our strong Q4 and full-year results. I'll start with ITWorks, which had a great year, including a new contract in the fourth quarter. Our new ITWorks client is a regional medical center with 2 hospitals that had gone live with over 50 solutions in 2012. The ITWorks alignment will focus on optimizing user experience and shifting routine, predictable work to Cerner Centers in Kansas City to free the client to focus on providing care.

Financial results for ITWorks were excellent in 2013, with both bookings and revenue growing over 40%. With ongoing pressures on our client spending, our offering is very compelling because we help them control spending, while getting more done and achieving a higher level of quality. This is evident in the fact that 100% of our ITWorks clients are reference-able, 100% have attested for Meaningful Use and 80% are HIMSS EMR adoption level 6 or 7. As a result of our value proposition and ongoing pressures on our clients, our pipeline is very strong, and I expect 2014 to be another great year.

Revenue Cycle also had a great year, with revenue growth of almost 50% driven by Revenue Cycle solutions and services and full RevWorks services for both inpatient and outpatient venues. Our execution in Revenue Cycle is evident in progress made at our largest RevWorks client, Adventist Health, who recently reported initial improvements as a result of the implementation, including cash collections at 103% of target, a 5.5% decrease in accounts receivable and a decline in accounts receivable aged over 90 days. These are encouraging signs and further validation of the focus we have put into our Revenue Cycle solutions and services is paying off.

The outlook for our Revenue Cycle business remains positive, as revenue and costs are top of mind for all providers, and the importance of Revenue Cycle being integrated with clinical solutions continued to increase as the industry shifts to at-risk models.

Another factor is health care is the only major sector in our economy that doesn't have a true costing system, and we believe that our work with Intermountain Healthcare to build an activity-based costing system will further our differentiation.

Our Population Health Organization also delivered strong results, with revenue growth of more than 20%, driven by demand for HIE, Enterprise Data Warehouse and Clinical Process Optimization. These solutions are foundational to our broader population health strategy, which we're advancing through the build-out of our cloud-based Healthe Intent platform. Our progress on this front was excellent. We achieved a major milestone last year by releasing our Healthe Intent Smart Registry solution just 7 months from contract signing. Healthe Intent Smart Registry is a cloud-based EMR agnostic solution that provides the capability to stratify patient populations based on risk, conditions and attributed physicians. In addition, the registries enable care managers to quickly determine what key quality measures specific to the designated condition of the patient have been met. Advocate Health went live with this solution in January, and everything is going well. We look forward to providing more details on this in our Investment Community Meeting at HIMSS in Orlando.

Moving to the ambulatory space where we had an outstanding Q4 and record year that included the following highlights: we had over 40% growth in bookings; 18 signature displacements of our key competitors; the signing of our largest ambulatory business office services contract; 5 new global footprints; and a total of more than 16,000 providers signed during the year. Clearly, it was a great year for our ambulatory business and I attribute this to the investments we made in our solutions and the ongoing trend of our clients wanting an integrated inpatient and outpatient solution.

We also had a record year of success with smaller hospitals, adding 20 CommunityWorks clients during the year, bringing our total to 66 clients. We are competing very effectively against the traditional suppliers in the small hospital space, and our recent recognition as best-in-class community HIS validates the strength of our offering and positions us for ongoing success.

Another highlight this year was the success at providing non-Cerner EMR clients solutions and services to help them with future stages of Meaningful Use in their population health strategies. In Q3, we were selected by a mid-sized health system with no existing Cerner Solutions to provide them with Health Information Exchange, Community Patient Index, Patient Portal and Enterprise Master Patient Index solutions to wrap multiple existing non-Cerner inpatient and outpatient solutions. In Q4, the client added our Enterprise Data Warehouse and we expect them to add our new Healthe Intent Smart Registry solution soon.

We also sold HIE to a 600-bed hospital that uses our primary competitor's EMR, as they found that our primary competitor was unable to effectively connect to other systems.

In addition, we sold our iBus connectivity platform to a client that uses our primary competitor's EMR.

These examples are evidence that our strategy of building EMR agnostic solution and device platforms is working and making our addressable market much bigger.

Outside of the U.S., we had a solid quarter and year, with 8% growth in Q4 and 11% growth for the full year. This growth was driven by contributions from the Middle East, Canada, Australia, France and Latin America. Looking at 2014, we have a good outlook for all of these regions, in addition to a strong pipeline in the U.K.

In the Middle East, we have made good progress on our work for the Saudi Ministry of Health and we are in pace for a 500-bed pilot site to be our fastest-ever global go-live. We believe a successful go-live in record time will serve as a major proof point that will help position us for more business in Saudi and the entire region.

Now I'll cover a few more marketplace observations. In the provider space, the focus remains on cost and quality in anticipation of an expected industry shift to an at-risk model that incents keeping people healthy. The financial pressures are coupled with a long list of priorities around Meaningful Use, ICD-10, health care reform and Value-Based Purchasing. Specific areas of focus on our clients' radar in 2014 will be Revenue Cycle, HIE, analytics and patient engagement. Our solution and services are very well-aligned with helping our clients address these immediate needs and their long-term challenges.

Another observation is that industry consolidation is continuing as providers look to attain scale. This is a trend that favors Cerner, as our clients are the most active and, in my opinion, the best-positioned to be successful over the long term. Cerner clients accounted for 61% of the buying activity in 2013, and these acquisitions create more than 100 sites into which we can potentially extend our Cerner footprint. This is more than 4x the number of sites acquired by clients of our primary competitor. Our Q4 bookings included an earlier turn on this trend as one of our large clients purchased solutions and services for hospitals they acquired earlier in the year.

In summary, 2013 was a great year that included strong growth and many records, and we are well-positioned to continue delivering good results in 2014.

With that, I'll turn the call over for questions. Breanna?

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Dave Windley with Jefferies.

David H. Windley - Jefferies LLC, Research Division

So I guess I wanted to focus on the Advocate population health platform that you've been working on diligently this year and what parts of that or to what extent do you believe you'll be able to commercialize that to your broader client base as you move into 2014?

Zane M. Burke

Dave, this is Zane, thanks for the question. We feel very good that this solution is ready for the marketplace. And, in fact, we have quite a pipeline built for that as we look into 2014.

David H. Windley - Jefferies LLC, Research Division

Care to put a number on that?

Marc G. Naughton

This is Marc. We wouldn't quantify what that is. But clearly, we've already, in '13, sold some of the Smart Registries to, not only Cerner clients, but non-Cerner clients. So the strategy of having an agnostic platform that can go outside of our base is paying off. And I think as Advocate starts generating results from their go-live in January, that the momentum for that solution is going to pick up. Keep in mind, this is just the first of our platform on which we will build a multitude of different solutions, Smart Registry is being one of the first.

David H. Windley - Jefferies LLC, Research Division

Sure. Marc, if I could follow-up. On the CapEx, you talked last quarter and again in your prepared remarks today that investments are expected to go down. Can you help us, from a free cash flow standpoint, understand how long that lower level of investment can be sustained? In other words, the investment that you've made in 2013 can support growth for how long, i.e. beyond 2014?

Marc G. Naughton

Well, I think, certainly, the -- we've doubled down in '13 relative to capitalized software and relative to building CapEx and capital expenditures on our cloud platform and other initiatives. I think the building CapEx, obviously, gives us a little bit of time to move forward. So you can look at '14, that's an area that you'll see a much lower number. Keep in mind, in Q4 of '13, we actually acquired a 230-acre track that we will be able to grow as we need to grow additional buildings for -- at a campus that is near our Innovation Campus, but that will be based on the need and timing. Kansas campus comes fully online the end of this month. So that should hold us for a little while. So you won't see us having to put a bunch of money into land or CapEx for buildings. Our capital expenditures for the business will stay relatively flat year-over-year. And, actually, our software, we expect to be relatively flat. So the big benefit will be a significant reduction in the building CapEx to the point where the free cash flow for '14 should be significantly higher. I don't know that I'd go so far to say that it's going to double, but it will be a significant increase over this year just because of the increase in operating cash flow we expect and the decrease in building CapEx. We can expect to continue to be able to ramp-up in '15, with a goal that, as you look at free cash flow as a percent of net income that we can go from this year, which will certainly kind of in the mid-30s to getting between 50% and 60% next year and then 70% in '15, ideally continuing to ramp up to where we bring free cash flow up to the level of net income on an equal basis. And, I think, we'd do that without having to disrupt our growth and continue to invest in things we want to invest in.

Operator

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

David Larsen - Leerink Swann LLC, Research Division

Zane, I think you mentioned at one point in your prepared comments that maybe up to 50% of hospitals could be seeking a new solution or, potentially, a new vendor. Can you just maybe give a little more color around that? And then also, congratulations in the community market. I mean, is there a certain pricing mechanism you guys are using? How can these hospitals, these smaller hospitals, afford Cerner?

Zane M. Burke

Sure. I'm going to do the second one first -- second question first around the CommunityWorks model. We've been able to create a model, which scaled down to critical access in small hospitals by essentially delivering in a combined Tenet domain. And it's a prepackaged offering, full-services offering that is off the shelf and gets great robust functionality to a market that typically does not get the kind of robustness that we have. And so our offering is much richer and deeper than those can typically expect in that marketplace and we're able to do that in a manner that's cost-efficient for them and is profitable for us. So that's -- it's been very effective and worked out very well for all of us. As it relates to the market comments, we see that there are a number of clients that continue to look at the marketplace. They may have made decisions in the past that they're looking at in the future having to undo. And that really relates to all the measures and mandates that are coming at them and making sure that they have a platform that will scale to the future changes as they evolve. And I've discussed this on calls for the last several quarters that we see that trend and we see that continuing. As we look forward, we see a number of large opportunities in the pipeline that reflect that type of scenario.

Operator

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

Michael Cherny - ISI Group Inc., Research Division

So I wanted to go back to the comment you guys made. Seems like the last, I don't know, a couple years, the competitive win rate you guys have had versus the other large competitor that you've called out, seems to be going up, seems to be doing better, specifically versus them on a head-to-head basis versus maybe the period before that. As you talk about how the competitive win rate has gone up, what's -- I guess, versus them head-to-head, what have been the key differentiating factors have been? Robustness of population health management tools? Has it been some of the investments you've made in the software development feature functionality? I guess, maybe just to get a bigger sense of why you are beating them more than you did in the past.

Zane M. Burke

Sure. This is Zane. Our investments in physician usability, our focus on fast, easy, smart, as it relates to our physician -- to the physician community, in particular; our focus on Revenue Cycle solutions and having clinically driven Revenue Cycle and having those proof points in the marketplace, are coming together well for us. And then it allows you to get to the dialogue of the future vision pieces around, first off, around the performance improvement that we can drive and deliver value today and we'll work with our clients to drive and deliver that value and then look at their future around managing their -- the population health. And our vision around population health and, frankly, our delivery in a short range of what we've been able to do in that space, as well as the continuum of care and having solutions across all the continuum of care. And there's also a desire for a company that has an open standards-based and transparent approach. And Cerner has clearly differentiated itself as the open, transparent and interoperable company, where our principal competitor is exactly the opposite of that. And there's a definite need for that in the marketplace and a desire for that.

Michael Cherny - ISI Group Inc., Research Division

Just one last quicker question. When you talked about the 61% of the M&A that was done over last year involving Cerner customers, is there any way you could frame what the potential opportunity could be from those acquired hospitals if you were to assume that they were all, over time, going to convert? Just give a sense of the magnitude of how big that could potentially be?

Zane M. Burke

I don't have a number detail at this point and I may be providing some additional color at the upcoming conference at HIMSS, but what I can tell you is, given that we're in 17 of the top 30 largest organizations as the principal EMR provider, we have significant opportunity in the white space in a number of acquired spaces, as well as our solutions in white space around, in particular, ambulatory, Revenue Cycle and population health, and so having those footprints are critically important. We may provide some additional color around that at HIMSS.

Marc G. Naughton

Yes. This is Marc. I would just add that even a these acquisitions get made, it will vary as to whether they acquirer decides to quickly replace all of their hospital technology or takes a tack of I want to do the larger hospitals but I'm going to wait for some of the smaller hospitals and do them at a later date. So it doesn't necessarily bring with it a large 12-month activity of new business. But clearly, over time, our expectation is that those clients will eventually move a significant portion of those acquired hospitals over to Cerner, which kind of gives us a nice annuity, if you will, of potential future business.

Operator

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

George Hill - Deutsche Bank AG, Research Division

I guess, Zane, I'll start with you. If we think about the population health management opportunity, 2 quick questions. Recognizing it is early in the sales cycle, I'll ask, is it -- are population health bookings and is population health business tracking to Cerner's expectations kind of above or below? And Part B of that question is, from a functionality perspective, what hasn't Cerner developed or what don't you have in your bag yet that you'd like to have in the bag?

Zane M. Burke

Well, I'll start, George, with the first part. I would say it's tracking at our expectations. And we've, actually, in addition to Advocate, kicked off 3 other client projects in that area. And so we have to anticipate the uptick to go well as we see more and more proof points in that space. There's a number of areas that you'll see additional features and functions and major modules past the Smart Registry's conversations. So whether it's additional scorecards for payers, whether it's some of the additional Web services that we'll add in that space, some of the quality measurements that we'll be doing, there's a number of things that you'll see us rolling out even -- and then those I mentioned would be in 2014. And there's much -- many, many things to go do in this space. So this is a multiyear rollout for population health.

George Hill - Deutsche Bank AG, Research Division

Okay. And then maybe a quick follow-up for Marc. Just with respect to 2014, we talked about tech resale. Should we expect tech resale to reaccelerate or just be flat in '14? And I guess any chance you would give us the contribution from Intermountain, the bookings in the quarter?

Marc G. Naughton

The -- addressing your technology resale question, our expectation is now that we've kind of level set and gotten rid of the 2012 bolus, if you will, that we would -- we'd continue to introduce new devices and new connectivity and continue to get uptake on those devices and, especially, the connectivity even in shops that are automated with our biggest competitor. They are buying our iBus and our connectivity engines because they clearly see us as the way to go pull their device infrastructure together, and that capability doesn't exist on the other side. So I think that we would expect it to grow, for tech resale to grow, to kind of grow at a rate that our overall revenue is growing. And based on that overall revenue growth, I think that it shouldn't, therefore, be skewing gross margins, operating margins, either way, because as long as it is growing at the same level, I think that's pretty -- that would be pretty effective. I think on Intermountain, we haven't talked about the bookings level. Obviously, our client contracts are confidential, but I think I've seen the analyst estimates that put it kind of in the 100, 125, 135 range. I think those are reasonable estimates for the base deal. We certainly look forward to doing more things with Intermountain in the future, but I think that's a reasonable -- those are not unreasonable projections.

Operator

Your next question comes from the line of Steve Halper with FBR.

Steven P. Halper - FBR Capital Markets & Co., Research Division

Just one housekeeping question. Marc, what's the implied or assumed tax rate for 2014 in the guidance?

Marc G. Naughton

Range is around 34%.

Operator

And your next question comes from the line of Eric Coldwell with Robert W. Baird.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

I guess the main thing I'm looking at is with that -- with those comments, are you seeing client purchasing orders picking up or getting client commentary that lends you confidence or is it more just macro what you're seeing with the connectivity engines and iBus and things of that sort of that you mentioned? And then perhaps as a follow-up to that, targeting operating margin expansion around 100% -- 100 basis points, I'm curious what influenced, if any, the RCM HIE analytics and patient engagement focus you talked about for 2014 has on that margin profile, i.e. is that still an investment phase, so it's somewhat margin-dilutive? Or are those lines, in aggregate, similar to the firm averages?

Zane M. Burke

Eric, this is Zane. I will comment on the technology resale, in particular, that you're speaking about around the iBus connectivity and the CareAware. I think what we're saying is that continues -- we think we'll have continued uptick, the pure tech resale, the resale of low-margin devices and hardware we think would be flat to slightly up in that space. So we're seeing continued good activity. We have not seen any issues around any kind of negative elements around that. On the business model side of that, the HIE, the patient engagement and the device -- and, I'm sorry, the Enterprise Data Warehouse, those are fairly high-margin business for us. So that's bundled, typically, in an ASP model, Software-as-a-Service model, all of those types of offerings. And those carry a bundled high-margin rate that includes services, software and hosting as one basic element.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Got it. So is there -- perhaps as a follow-on, that's very helpful. With those solutions you just referenced having a high-margin rate, for a margin being up 100 bps, which is still admirable, are there other areas, legacy areas, that perhaps you're seeing less margin expansion than perhaps in the past?

Marc G. Naughton

Eric, this is Marc. I don't know that there's anything, I think, across our business -- we'll certainly, at the HIMSS meeting, investor meeting on February 25, kind of go through and disclose all of the business model that we've briefly touched today and give you a sense of what those margins look like. But we see good trends across all of those, even with the services business, which, obviously, is now a very big business, but is able to, to the extent there is a low-component element of some of the Works businesses, still be able cover that and continue to see growth the overall margins of those businesses. So I think that there's nothing that we're seeing -- the basic, for us is -- the 100 bps is more a target. It certainly, if you look at our guidance, is kind of the answer you would get looking at our guidance. We think there's still opportunity to get synergies and to get efficiencies in the business, but we are going to continue investing in R&D and other things that we're not going to get as much leverage as you might have seen us get in the past. So that's probably the area that in the past you would have seen us getting more leverage. In this time period, we're not getting the leverage from that, we're really getting leverage from growing the business, and that's about 100 bps.

Operator

Your next question comes from the line of Robert Jones with Goldman Sachs.

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

Actually, Marc, just a follow-on. You just mentioned the R&D investments. Obviously, I think we are operating in the assumption that some of the R&D investments moderate in the back half of this year. And, I guess, how should we be thinking about capital allocation if I think about -- you mentioned that the authorization being up again. Just wondering, as we get into the back half of '14, any comment you have around capital allocation will be helpful.

Marc G. Naughton

I mean, relative to '14 and our expectations for the year, we'll look to continue to kind of spend about the same amount on R&D, from a capitalized perspective, as we did in 2013. It will be -- certainly, our plan right now is very close to that. We're going to see a tailing off of some of the third-party components of that as we go through the year and they complete their tasks. But we will also add some associates into that pool to -- for continued long-term development. So that will stay pretty flat. I think, as we look out to '15, you might see a slight reduction in there, but pretty nominal. I mean R&D is our lifeblood. There are a lot of opportunities ahead of us in health care and population health. And given the environment, given the lack of attractive targets from an acquisition standpoint, given that, that's not really our strategy, we're going to invest in the business and the way you're going to see us invest in the business, it's primarily going to be through that line. But it should be remain a fairly constant number, certainly, through '14 with a slight reduction in '15 on the R&D side.

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

Okay. Got it. And then I guess just this might be something we'll have to wait for HIMSS for. But just of your core EMR clients, could you give us any sense on the penetration within that base as it relates to RevWorks and maybe ITWorks? And then on the back of that, any kind of run rate you'd be willing to give us as far as what RevWorks and what ITWorks, separately, are generating at this point?

Marc G. Naughton

Well, I think -- this is Marc. The -- given that we have barely double digits in ITWorks and less than double digits in RevWorks, and we certainly have probably 350 places that we could go talk to and, certainly, at least over 200 conversations with people who probably would be interested in these services, not to mention going into the ambulatory business office side, which is a great business that we have made great inroads into. I think there's a lot of white space for us. I think we've talked about getting to a point where we can get a rhythm of certainly doing an ITWorks every quarter, doing a RevWorks every other quarter and then, over time, perhaps getting to a point where we can do 6 to 8 ITWorks a year, with RevWorks coming one a quarter. And I think we certainly see the opportunity out there, the need is out there, there's a -- health care is focused on reducing operating expenses. These Works businesses, over time, will certainly contain those expenses and they all have efficiency targets on how we can -- that we can drive down over -- their operating costs as they move forward. So everything we see would indicate that those -- that our clients are going to want to take up those offerings and we're very happy with where we're at. We would argue that we're ahead of where we thought we would be on ITWorks on launching these types of businesses. And we think that it's just a matter of time before they become somewhat like our hosting business where you have a vast majority of your client base taking it up.

Operator

Your next question comes from the line of Ryan Daniels with William Blair.

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

Zane, a quick one for you. One of the numbers that stood out in your commentary was the 39% of bookings in Q4 coming from outside of the core Millennium base. I think that's a record, both percentage and absolute dollars. So hoping you can shine a little more color on what's driving that, if it's truly just competitive replacements, rip and replace, or if it's really more of these EHR overlays that you're talking about with data warehousing and some of the other initiatives like HIEs?

Zane M. Burke

It is absolutely the EHR rip and replace platform.

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

Okay. That's helpful. And then...

Zane M. Burke

The HIE and some of the other pieces are, on a percentage basis, are fairly nominal at this particular point.

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

Okay. And then a lot of discussion on population health, and I am curious if when you look at that market and the opportunities you're seeing today, is it really true greenfield opportunities where they haven't made investments or is it going out there and seeing entities that have invested a lot in these point solutions that have been on the market for a number of years and wanting to do a more integrated or comprehensive solution with you?

Zane M. Burke

Well, I think, Ryan, you've gone to where we'll go to and is going to, which is people are looking at and are beginning to say there were piece parts, much like the old days of the niche markets when people would buy best-of-breed. And so I think there has been a historic best-of-breed for certain functions within organizations but clients are beginning to think or just beginning to think more holistically about what the future looks like in that space. So it's still, I would say, it's still a niche buyer from a buyer perspective. It's still a niche market, but the more progressive clients are beginning to think about what this will evolve to. And so, in some cases, it's a greenfield. And in some cases it's a replacement of some of those niche providers. So it just kind of depends on the maturity level and how far along the organization's journey is on the population health.

Operator

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

Sean W. Wieland - Piper Jaffray Companies, Research Division

I'd like to know how the ICD-10 go-live October 1 is factored into your outlook for the year? Do you think it's a headwind or a tailwind? And specifically, when you're in your Revenue Cycle business, when are we so close to that date that hospitals go into lockdown mode and don't want to touch anything?

Zane M. Burke

Well, Sean, I think I would tell you it's probably a no wind at this point, it's neither a headwind or a tailwind at this point. It's really -- while I think it's going to be a significant event from an execution perspective from our clients, which we've been preparing our clients for, for the last year plus to get ready, and I do think there will be a lot of execution work. It does not appear to be having any impact on our clients' buying cycles and is not reflecting itself in any of our forecast or pipelines at this point. We do see a fair amount of activity in the Revenue Cycle space as clients begin to look past the ICD-10 cutover and begin to think about their futures and what they need to go do in that space. So I would say it's beginning to be almost be back -- it will be back to normal, if you will. So whatever -- if there was a headwind, it was buried in the last time period and we wouldn't really see that as a result -- in our results. I would look at it and say, "That has -- really, is beginning to remove itself as clients begin to think past that in their strategic planning and begin to plan for the future."

Marc G. Naughton

This is Marc. It's not unusual for our clients to have projects in front of them, and especially on the Rev Cycle side, after ICD-10 is highlighting their current state of solutions in that space. And for them to start on the next track of, okay, what's -- when I get through ICD-10 cutover, I need to go in and do something on my Rev Cycle solutions. So I'm actually going to get into a buying mode, currently, as opposed to waiting until my projects are done. Most of the people we are dealing within the C suiters, that's just work to go do for them. Sure, it's work, it's very hard work and our clients are going to be very focused on it. We don't underestimate the impact. But from a purchasing side, we've been querying our teams and our sales executives, do they see anything that where ICD-10 is interfering in any of their ongoing pipeline discussions, and the answer was, no. Because we have the same question, is that going to impact 2014? And at this point, we don't see any impact.

Sean W. Wieland - Piper Jaffray Companies, Research Division

An unrelated follow-up. Last quarter you talked about mobile and an agreement you had -- you put in place with Apple. Any update there on how you're leveraging mobile to enhance physician experience?

Zane M. Burke

We've continued to roll out to some of our early adopters some of the technology. And we continue to see good progress on that side. But no other substantive rollouts. So continued progress. We should be able to update you some in that area as well at the HIMSS.

Marc G. Naughton

Yes. Sean, it's clearly -- it gives us an advantage to be able to sell the device direct without the cost of connecting to a network. But once again, it follows our strategy of we're going to connect to the device that is most often used by the health care provider, and this just gives us one more avenue to that. We're very pleased with our position. We're having active discussions. But obviously, still a fairly new agreement for us.

Operator

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

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

Zane, I think I heard you say that there is strong growth in the ambulatory bookings in the fourth quarter, with 18 signature accounts that were displacements. Can you help us to understand if these were driven more by docs wanting to choose a new EMR or was this more of the hospital client driving affiliated physician decisions?

Zane M. Burke

Lisa, it's a mixture of both. So it is both of those scenarios. But, in many cases, it's the -- the organizations wanting an integrated solution. And then our solution is very appealing and is second to none in the ambulatory marketplace. And so it's a driver of the business. And so you're seeing a combination of both.

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

Is there a way to quantify how big that opportunity is? I mean, clearly, you have a lot of very large hospital systems that are buying physician practices and driving what their decision is going to be around EMR. Is there any number we can put around that from an opportunity perspective?

Zane M. Burke

Well, it's tricky because I can tell you that about 70% of our clients have some sort of Cerner ambulatory footprint, but the number of physician in each -- physicians in each one of those organizations, there's a lot of white space as it relates to those organizations that we have a singular footprint, because they'll have many other connections with, perhaps, existing EMRs today. And so I don't have a ready number for that type of model. What's positive is the progress we've made in terms of the number of clients that have created a Cerner ambulatory footprint has grown dramatically. And so that gives us a good foothold and our success in there in that space will give us lots of opportunity to continue to grow.

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

Okay. Great. And then my second question just would be around -- would be for Marc, and the bookings in the first quarter. Just looking at 7% to 16% growth. Can you maybe just talk about the variables on each end, what would cause it to be on the lower end versus on the upper end? Is it single deals that you see in the marketplace and how much comfort you have, especially at the upper end of that range?

Marc G. Naughton

Lisa, I mean, normally, we go, as we always have, we go through our forecasting process where we review all the deals and we just get our best view of what the opportunities look like. And that's what we certainly base our forecast on. Whether being at one end of range or the other likely means did deal grow larger as we were moving forward, did we risk down a couple of deals and then both of them come through in that same quarter, do we have a Works deal that comes into that quarter that we might not have expected that we had a different time? So there's a variety of things. I mean we're signing thousands of contracts in a quarter anymore. So there's nothing -- our range that we provide is our best estimate based on the information we have. And it's a range because it's as much art as it is a science. So I think that's the best answer I'd give. I can't tell you that which end of the range is more likely at this time. We're working through the quarter as we always work. And we -- our goal is to provide you a range and that we think the bookings are going to be in. And when we exceed that top of that range, that means some things came into the quarter that either got bigger, or in this environment, there's things that come in very quickly and the business gets done with a very short cycle, especially with existing clients. So unfortunately, that's the best I can do to -- on comfort there.

Operator

And your last question comes from the line of Donald Hooker with KeyBanc.

Donald Hooker - KeyBanc Capital Markets Inc., Research Division

So I wanted to ask you about the managed services line, which is something that has been a big driver for you guys for many years, and it looks like it's continuing to kind of be a double-digit driver. What keeps that growing? Is there -- and what percentage of that is international at this point? I think you said it looks like it's about 15% growth year-over-year in managed services.

Marc G. Naughton

Yes. This is Marc. The international component today is fairly small. It's kind of just getting to get some traction. We do -- we co-locate data centers in-country for those -- for hosting into various countries, because a lot of them don't let their data go across their boundaries. But there's a much lower level of infrastructure investment than there is in the U.S. A lot of the uptake is that many of the new clients that get signed opt to do managed services with their initial contract. So there's that component. As our existing clients that are hosted do have acquisitions and expand their scope, that scope expansion not only applies to software and implementation services and all those other elements, it applies to their hosting infrastructure as well. So very few of our clients are just staying static and not growing. So that business naturally grows and then, obviously, the new clients that opt to do managed services immediately add to that number as well. So that's why we're able to see growth, both in the base and with new clients there.

Neal L. Patterson

Okay. So this is Neal, why don't I just wrap up here. So 2013, we just basically wrapped that. It was a good year. So as an entrepreneur and we're at the start of the kitchen table, the -- having $1 billion in bookings in 1 quarter certainly impresses me. You all know what we do is very hard, complex and at times can be very ambiguous, your questions kind of support that. I think we all know that we have -- Cerner has plenty of things to improve. And while we are doing very good, we could have -- we could be doing better. And I assure you, as a team, we are focused very much on being better. We're also very focused on being better whereas we focus on being better in the present, we also instinctively want to basically skate to where the puck is going. The population health investments that we are making, we do certainly believe that they -- that is -- that will be, by the end of the decade, a lot of health care organizations being responsible for the health of their population and their business models will have changed. I don't think we are quite at that trigger point. When the U.S. figures out an alternative to fee-for-service, that will be -- the market will move in a fairly significant way, it will be a major market at that point. So we expect to help facilitate that move and be there when it happens. So broadly, we think health care will change significantly over the rest of this decade. We think information technology is the biggest lever to implement change in health care. And we think we can -- we will be involved in significantly redefining how health care works. So we're going to continue to be bold. We'll see you at HIMSS in the very near future. Thank you very much. Have a good evening.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Cerner Management Discusses Q4 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts