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Cerner (NASDAQ:CERN)

Q3 2010 Earnings Call

October 28, 2010 4:30 pm ET

Executives

Jeffrey Townsend - Chief of Staff and Executive Vice President

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

Michael Valentine - Chief Operating Officer and Executive Vice President

Neal Patterson - Co-Founder, Chairman, Chief Executive Officer and President

Analysts

Michael Cherny - Deutsche Bank AG

Atif Rahim - JP Morgan Chase & Co

Bret Jones - Brean Murray, Carret & Co., LLC

Steven Halper - Stifel, Nicolaus & Co., Inc.

Greg Bolan - Wachovia Capital

Anthony Vendetti

Eric Coldwell - Robert W. Baird & Co. Incorporated

Jamie Stockton - Morgan Keegan & Company, Inc.

Richard Close - Jefferies & Company, Inc.

Sean Wieland - Piper Jaffray Companies

Operator

Welcome to Cerner Corp.'s Third Quarter 2010 Conference Call. [Operator Instructions] The company has asked me to remind you that various remarks made here today by Cerner's management about future expectations, plans, perspectives and prospects constitute forward-looking statements for the purpose of the Safe Harbor provisions of the Security and Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading Risk Factors under Item 1A in Cerner's Form 10-K together with other reports that are on file with the SEC.

At this time, I would like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corp.

Marc Naughton

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

Now I will turn to the results. All key measures in Q3 were at or above our expected levels. Bookings were strong and exceeded the high-end of our guidance range. Our income statement performance was very good with revenue slightly above the mid-point of our guidance range and continued strong margin expansion and earnings growth. We again had great cash flow performance, with record levels of free cash flow reflective of high earnings quality.

Moving to the details. Our total bookings revenue in Q3 was $496 million, which is 17% higher than Q3 '09 bookings and above the top end of our guidance range. Bookings margin was $398 million, or 80% of total bookings. Even though we had a strong year-over-year and sequential growth in software bookings, the bookings margin percent is down sequentially and year-over-year due to lower margins on technology resale. Given the strength in software, the lower margin percent does not concern us.

Our total backlog increased 21% year-over-year to $4.66 billion. Contract revenue backlog of $4.02 billion is 24% higher than a year ago. Software revenue backlog totaled $642 million, up 6% year-over-year.

Our revenue in the quarter was $462.7 million, which is up 13% year-over-year. The revenue composition for Q3 was $133 million in System Sales, $130 million in Support and Maintenance, $191 million in Services and $8 million in Reimbursed Travel. System Sales revenue reflects growth of 13% compared to Q3 '09, with strong growth across software, sub-licensed software and hardware revenue. Services revenue was up 18% compared to Q3 '09, with strong growth in both managed services and professional services. Support and Maintenance revenue increased 7% over Q3 '09.

Looking at revenue by geographic segment. Our domestic revenue increased 16% to $394 million. Global revenue was down $2 million or 3% to $69 million. While the weak global economy is still impacting our global business, global revenue is still up 6% year-to-date, and expect improved growth in Q4 and in 2011.

Moving to gross margin. Our gross margin for Q3 was 82.9%, which is down 10 basis points year-over-year and up 10 basis points sequentially. System Sales margin decreased 250 basis points year-over-year due to lower margins on technology resale, which were driven by a combination of lower margins on hardware and device resale and lower margins of sublicensed software. Similar to our bookings margin, the lower system sales margin is not a concern given the strong levels of software bookings and revenue. Further, as I'll discuss in a moment, we are still driving stronger operating margin expansion even with lower system sales margins.

Looking at operating spending, our second quarter operating expenses were $283 million before share-based compensation expense of $6.6 million. Total operating expense is up 7% compared to the year ago quarter. Sales in client service expenses were up 10% compared to Q3 '09, driven primarily by growth in managed services. Our investment in Software Development was flat compared to Q3 '09, reflecting continued leverage of our R&D spend, and G&A expense increased 5% year-over-year.

Moving to operating margins. Our operating margin in Q3 was 21.7% before share-based compensation expense. This is up 330 basis points compared to last year and keeps us on track to exceed our full year 2010 target of 20% operating margins. The margin expansion was driven by a combination of increased profitability in our professional services, managed services and support business models, along with ongoing leverage of investments in R&D and SG&A expense.

Moving to earnings and EPS. Our GAAP net earnings in Q3 were $60.9 million, or $0.71 per diluted share. GAAP net earnings include share-based compensation expense, which had a net impact on earnings of $4.1 million or $0.05 per share. Adjusted net earnings were $65 million and adjusted EPS was $0.76, which is up 25% compared to Q3 '09. Our tax rate was 35.4%, which is in line with the level we expected.

Now I'll move to our balance sheet. We ended Q3 with $770 million of total cash and investments, which is up from $678 million in Q2. Total cash and investments include $565 million of cash and short-term investments and $205 million of highly-rated corporate and government bonds with maturities of over one year. Our total debt is $119 million.

Total accounts receivable ended the quarter at $463 million, which is up $22 million from Q2. Contracts receivable, or the unbilled portion of receivables, were $137 million and represent 30% of total receivables compared to 29% in Q2.

Cash collections were $472 million, which is a record for a third quarter. Third-party financings were $21 million, representing 4% of total cash collected. Our DSO in Q3 was 91 days, which is up from 88 days in Q2 and down from 105 days in Q3 '09. The year-over-year decline was primarily related to Q4 '09 re-class of Fujitsu receivable to other assets, which we discussed on prior calls.

Operating cash flow for the quarter was an all-time high at $119 million. Q3 capital expenditures were $19.3 million and capitalized software was $20.5 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was also an all-time high at $79.1 million. Free cash flow for the quarter again represents well over 100% net earnings and reflects continued strong earnings quality. Also note that our year-to-date capital spending of $75 million remains below our planned level for this point in the year. We do expect capital spending to be higher in Q4, but we will be below our initial guidance of $130 million to $150 million.

Moving to capitalized software. The $20.5 million in capitalized software in Q3 represents 29% of the $70 million of total spending on development activities. Software amortization for the quarter was $17.8 million, resulting in net capitalization of $2.8 million or 4% of the total. Based on our current release schedule, we expect amortization to increase approximately $18.5 million in Q4.

Now I'll go through the guidance. For Q4 revenue, we expect revenue in the $490 million to $510 million range, reflecting growth of up to 9% over Q4 '09, which you will recall was a very strong quarter that reflected a $57 million sequential increase over Q3 '09. We expect Q4 adjusted EPS before share-based compensation expense to be $0.80 to $0.85 per share with the midpoint reflecting double-digit growth over the very tough Q4 '09 comparable. Q4 guidance is based on total spending before stock compensation expense of approximately $290 million to $295 million. Our estimate for stock compensation expense is approximately $0.05 for Q4.

Moving to bookings guidance. We expect bookings revenue in Q4 of $490 million to $530 million, with the midpoint of this range reflecting strong sequential growth. As expected, the guidance range did not surpass the all-time record bookings in Q4 '09, which included the two largest contracts in our history as well as our second ITWorks contract.

However, our year-to-date bookings, combined with our Q4 guidance, positions us to exceed our full year 2009 bookings by over $50 million, which is strong considering we entered the year indicating full-year bookings could be down due to the challenging comparable.

Now I would like to provide our initial thoughts on 2011. Based on the initial version of our 2011 plan, the 2011 consensus estimates for revenue and earnings both appear reasonable, with top line growth of approximately 13% and bottom line growth of more than 20%. We believe the improving macro environment combined with the continued ramp up of stimulus-driven demand supports this level of growth and perhaps some upside if stimulus demand accelerates. As always, we will continue to update our outlook on future earnings calls.

In closing, we are pleased with our results in Q3, with all key metrics at or above our expected ranges. Specifically, we are pleased with our strong bookings and revenue growth, continued strong margin expansion and earnings growth, and record levels of free cash flow generation.

With that, I'll turn the call over to Mike.

Michael Valentine

Thank you, Mark. Good afternoon, everyone. Today I'm going to cover sales and operational results, marketplace trends and highlights from our health conference.

Starting with the results highlights. Our bookings revenue in Q3 of $496 million included 22 contracts over $5 million, which is an all-time record. 12 of these contracts were over $10 million, which is a level only surpassed in Q4 '09 when we had 15 contracts over $10 million. Looking at competitive wins, our bookings from new footprints were strong again, with 30% of bookings coming from outside of our core Millennium installed base. As I discussed last quarter, we feel very good about Cerner's competitive position due to the depth and breadth of our solutions, readiness to meet meaningful use and proven services capabilities.

With many competitors having solution gaps, multiple versions of solutions with unclear migration paths scare services resources, or the uncertainty related to going through a merger, this is a prime opportunity for us to gain additional share. The gaps of some of our competitors gets even larger when considering potential requirements beyond Stage 1 of Meaningful Use, and we are getting a lot of tractions when we discuss our capabilities beyond Stage 1 with prospective clients.

This quarter included strong levels of bookings in the licensed software, professional services, managed services, and technology resale business models. And almost all of our business units had strong bookings, with particularly strong performance in women's health, critical care, perioperative, revenue cycle, medical devices, imaging, a clinical process optimization and community hospitals.

Another area I would like to highlight is our physician practice business. Based on the extremely positive reaction from clients who saw our improved user interface and workflow while at our recent health conference, it is clear that the investments in our physician practice solutions are paying off. This progress is also reflected in another solid quarter of physician practice sales, including establishing seven new alignment relationships in our health system client base that allow for rollout of our physician practice solutions to their affiliated physicians. We expect this trend to continue as our ability to offer fully integrated EMR across inpatient and outpatient venues aligns well with the trend of more hospitals and health systems influencing physician practice decisions and/or employing a larger number of physicians.

Having an integrated platform across all venues will only increase in importance in coming years with the evolution of new care delivery and reimbursement models such as ACOs, which will blur the boundaries between different venues of care. I'd also like to provide an update on the substantial progress we've made in DeviceWorks, one of our newer business units.

In addition to illustrating at our health conference the progress our clients have made in redesigning the care environment with our Smart Room, we also demonstrated the next generation of Smart Room with specific solution advancements such as nurse call integration and mobility. We expect these advancements to lead to significant changes in client strategies for the procurement of devices the technology that operate in the care environment. We continue to have success with our medical device resell business, with the third quarter including strong sales of pumps, beds and vital sign monitors. We now have over 30 medical device manufacturers participating in the certification program for integrating medical devices.

The alignment we announced with CareFusion is beginning to yield results, with a growing pipeline and expanded solution development. We expect to share more exciting news on this front by the end of this year. We are also gaining increased traction with medical device integration into the EHR, as it is becoming a top priority for our clients. Building on the success of our initial iBus capabilities, we are seeing more adoption of solutions like point of care vitals collection and supplementary device alarm routing that extend connectivity to enhance workflow and increase patient safety.

In addition to the DeviceWorks success, a highlight for the quarter was signing our fourth ITWorks client. This contract is smaller than our previous contracts because they are not initially doing the full scale of what we have done with our other ITWorks clients. I'm excited to announce that we started off Q4 on a good note by signing our fifth ITWorks client, who is also doing RevWorks, which I'll discuss a little bit later in the commentary.

The momentum with our ITWorks offering is building and the pipeline of prospects has increased significantly in the past quarter, largely because our clients are viewing ITWorks as a way to align strategically with Cerner during a very critical period of execution. Also, word is getting out about the success at our initial clients.

Operationally, we had a great quarter of execution in our professional services business. As Marc indicated, the top line performance of our professional services business has picked up this year and increased utilization has allowed this business model to contribute nicely to our margin expansion. This is evidence that the investments we have made in the implementation tools and methodologies continue to pay off. And the predictability we create the automating much of the implementation process is a big differentiator in the marketplace.

Our clients are very focused on locking in their services team for their Meaningful Use journey, and we are seeing them add solutions and services beyond Meaningful Use to their roadmaps as well. We have also seen a pick-up in demand for our Lighthouse services as many clients create their Stage 2 plans. This activity helps with the visibility of our services revenue. And looking ahead, we still feel good about our ability to work through our existing backlog and meet expected demand through a combination of increasing utilization of existing resources and ongoing hiring.

Looking at contributions by region, the U.S. was the primary driver of our bookings growth in Q3 as the weak global economy impacted our results in some non-U.S. regions. However, we continued our steady progress in our larger global regions, including the U.K., and we established new footprints at an academic hospital in Spain and a children's hospital in Australia during the third quarter. Looking ahead, our overall global outlook in coming quarters is strong.

Turning back to the U.S. marketplace, we continue to see steady increases in stimulus-driven activity both the inside and outside our installed base as providers engage in a path to Meaningful Use and beyond. As reflected in our strong outlook for the rest of the year and our initial 2011 guidance, we expect this momentum to continue building. Looking beyond 2011, we believe this will be a multi-year opportunity with each stage of the stimulus requirements building on the prior stage and the additional demand for solutions and services being driven by second order effects of stimulus and health reform.

As we have discussed, health reform will change many things in the healthcare landscape and create new opportunities for Cerner. Creating coverage for the uninsured will create second order effects such as increased volumes that will create capacity constraints and changes to reimbursement models that may make it challenging to provide care profitably. The legislation also creates more compliance and reporting challenges for our clients in the areas of pay-per-quality and waste, fraud and abuse measures. These challenges create strong incentives for providers to maximize efficiency and present another long-term positive for HIT.

Another part of the changing landscape will be the evolution of reimbursement and care delivery models such as the Accountable Care Organizations, or ACOs, that are designed to align incentives between the payer and providers and between the physicians in the community and major acute-care hospitals. These new models will likely create both challenges and opportunities for our clients while also creating opportunities for Cerner to play an expanded role in driving higher quality, better coordinated and more efficient care.

For those of you who attended the Cerner Health Conference earlier this month, you saw firsthand how focused our client base is on preparing for the challenges driven by reform. While discussions around stimulus were prevalent, it is clear that our clients are also thinking beyond Meaningful Use, and there were multiple client-led sessions on the impact of reform and how providers are positioning themselves to take the lead in establishing new delivery models such as the ACOs. Even though the definition of an ACO remains vague, all signs point to a linkage between quality outcomes and reimbursement which aligns very well what Cerner has been investing in for quite some time now. Leading provider organizations are planning ahead to make sure they are ready to react quickly as details around reform become available.

We believe ACOs, whatever form they may take, along with other changing regulatory requirements like bundled payments, value based purchasing and even the move to ICD-10 create a significant opportunity for Cerner to become more strategic to our clients as they look to navigate these fundamental changes.

For example, the major impact these requirements will have on providers' revenue cycle creates a major opportunity for our improved and expanded revenue cycle solutions and services. Our conviction that this opportunity is significant was further strengthened at our health conference, where there was an unprecedented amount of interest in our revenue cycle offerings. Our health conference gave us the opportunity to highlight the progress we have made on our revenue cycle solutions, including substantial improvements in our patient accounting solutions. This progress was also evidenced by the presence of several rest of reference clients our conference willing to share their revenue cycle success stories.

Just to give you a numerical perspective on our progress on the patient accounting front, we entered the year with 61 sites live with our patient accounting solution. We now have 80 sites live and counting only the clients we have currently contracted projects underway for, we will end next year with 115 live client sites, effectively doubling the size of our base in two years.

The broader awareness around our capabilities in revenue cycle has allowed us to advance conversations with clients about our Cerner RevWorks offering, which goes beyond solutions and transactions, and provides operational services to help healthcare organizations improved their end-to-end revenue cycle functions. As I mentioned, we signed our second RevWorks client in early Q4, and we look forward to sharing more information about that client on our next call.

As part of our increased emphasis on revenue cycle solutions, we also announced three partnerships during our health conference that extend our revenue cycle platform by allowing us to embed industry-leading content and solutions from Ingenix, MedAssets and Search America. While we are continuing our aggressive expansion of Cerner-developed revenue cycle capabilities, these partnerships quickly enhance our revenue cycle offering and extend the value to our clients by embedding content from the industry leaders into our platform.

Before turning the call over to Jeff, I want to highlight another announcement we made at our health conference. Doing Neal's keynote, he indicated we will be offering our new semantic search solution for free. As Jeff will discuss, semantic search uses natural language processing to provide a contextual searching of a structured and unstructured information across the medical record. We are providing the subscription to semantic search for free because we think it is important to drive rapid adoption and quickly prove the benefits of the solution, which we believe will change the way clinicians interact with the EMR while also helping to solve many of the interoperability challenges the industry faces today.

The early feedback I'm getting from our clients is that docs love this capability, which in turn, I believe, will lead to a much faster adoption rate than we originally expected. At the end of the day, I see these capabilities further differentiating Cerner and strengthening our competitiveness, while at the same time, setting the stage for additional solutions we will be offering in the cloud.

With that, I'll turn the call over to Jeff.

Jeffrey Townsend

Thanks, Mike. Today I'm going to talk about a couple of the themes coming out of our health conference and some launch announcements we made that will shape the next wave of innovation beyond the enterprise EMR stage.

As Mike discussed, many of the discussions at our health conference revolved around actions our clients are taking to address challenges that will come with health reform, the changing reimbursement requirements and proactively staying ahead of the Meaningful Use of the phases. It is clear that information technology is emerging as the centerpiece of strategic investment to deal with the changing landscape.

As our clients are becoming more digital, it's also clear it has increased the appetite for innovation and accelerated the demand for the next new. For Cerner and our clients, the Health Conference has become an annual milestone event where our clients shape their strategies and create their roadmaps for the future. Our collaborative uCern platform, which was introduced at a conference a year ago, has created a medium for year round innovation and sharing, which moved the bar of the quality, depth and breadth of the interactions this year allowing groups to more effectively self organize in a purpose driven ecosystem.

In total, there were over 250 client led presentations, 72% of which had continuing education credits sharing their successes, lessons learned and what we call, innovation at the edge, where they are showcasing their own development gadgets.

As Mike mentioned, the first big launch to the client base was around our semantic search capabilities, which I discussed last quarter and is the first major solution within our cloud base, Healthe intent platform.

To speed adoption and create a platform for the next wave of solution offerings, we announced this cloud based service would be offered as a free subscription service: No license, no operating fees. The importance of solving the challenges of unstructured data and varying nomenclature across an ever-increasing store of clinical information were stalling the momentum of the industry. Standards and interoperability, while progressing, will span this decade. We strongly believe there is an opportunity to leap frog this cycle to more rapidly impact the continuity and coordination of care and intend to improve it over the next year across nearly or 1/3 of the U.S. market.

Our challenge to the client base is to adopt this capability as quickly as we deployed Lights On, with the goal being that the majority of our clients are in production one year from today. This value will be significant to both our clients and the potential innovations. As you may recall, we utilize a sophisticated natural language processing engine to parse through clinical information and map to ontology's and nomenclatures. The semantic engine then creates indexes which map the source data to multiple clinical concepts and categories.

During Neal's keynote, a physician from the University of Missouri demonstrated the abilities of this solution using a real patient attempting to understand their prior medical history and what medications have been tried in the past. In this case, searching Ace inhibitor not only retrieves the documents for this phrase, but also all medications within to drug class bringing to the surface a document that was several years old explaining the patient side effects from one of these medications, which the patient didn't remember until reminded. Not only saving time and clicks, it impacted the quality of care changing the course of treatment in seconds.

As the name of the Healthe intent suggests, we believe this platform continues to evolve in sophistication to the point that it can anticipate and determine the clinical intent based on the behavior of the specific user, the history of the patient and the context of the prior actions. Rapidly deploying the base infrastructure across the scale of our client base will expedite the learning and discovery of used cases significantly.

Moving to the second part of the launch. We demonstrated a health agent operating system earlier in the year that applied sophisticated, statistical algorithms up against contextual clinical activity to recommend clinical action. Some of you may remember the demo from our Investor Day in March where we took a patient with multiple conditions, each with multiple stages of progression and suggested medication orders which were derived from analysis of several thousand permutations. Using a similar approach to our efforts last year during the influenza concerns, we challenged our client base to sign up for our Sepsis surveillance algorithm as our first national health agent. Within the Healthe intent platform, this runs using an indexes created by search, removing the need to perform specific mapping or custom extracts from each enterprise.

In 2009, Sepsis affected nearly 750,000 Americans annually, resulting in a mortality rate of 28.6%, and is expected to top the $1 million mark in 2010. Annually, more Americans die from Sepsis than either heart attack or stroke. The algorithm has been in place at a few Cerner clients for some time, embedded within the enterprise, showing a remarkable results in mortality rates. By moving this capability to a health agent in the cloud, we want to prove the speed at which new capabilities in evidence can be deployed through interoperability.

To close, we also announced our new mission statement: "To contribute to the systemic improvement of healthcare delivery and health of communities." We think that the solutions I discussion show both our intent and capability both disrupted and systemically accelerate the move towards a New Middle, changing the paradigm for both interoperability and the adoption of new clinical evidence.

With that, I would like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question today comes from the line of Jamie Stockton with Morgan Keegan.

Jamie Stockton - Morgan Keegan & Company, Inc.

Mark, with your bookings guidance for the December quarter, last year, in the December quarter, we had a couple of big lumps in there, maybe three. This year, would you say it's going to be a much more normal quarter from a booking standpoint? Just no huge deals?

Marc Naughton

The expectation comes out of our forecast, Jamie, is much more of a normalized quarter without any big deals skewing the numbers. So that's why we think it's comparable if we're looking at the Q4 a year ago x those large deals.

Jamie Stockton - Morgan Keegan & Company, Inc.

Mike, you guys have been controlling your sales and client service expense fairly well. That makes me wonder heading into 2011 on the implementation front, implementation capacity, what your thoughts are? Are you guys go to be hiring as we go into 2011 to try to increase capacity there? Or do you feel like some of the steps that you've taken to try to automate, or the implementations are going to allow you to continue to leverage that line?

Michael Valentine

Yes, I would say both. We are hiring. We've increased capacity in the U.S. by around 100. The first half, first 3/4 of this year. And going forward, we expect to continue to hire through the middle of the next year as what our pipeline is showing us. At the same time, we're showing efficiencies in the implementation process, effectively driving down the total work effort on both side of the equation, ours and our client. systematically year-over-year. So we're going to continue initiatives on that front while at the same time ramp up our work force. We have actually transitioned some capacity out of non-US markets and into U.S. markets at the same time. So we're going to continue to manage the levers to address the growth in pipeline.

Jamie Stockton - Morgan Keegan & Company, Inc.

Last question on the same lines. New hospitals signed up up today, when can they start their implementation?

Michael Valentine

We try to start them right away. A lot of the time, we're dependent on their time frame as well. So we want to get them started. Most of them have their eyes set on some level of achievement in Meaningful Use Stage 1. And so we're trying not to delay. There are some things that we'll do back in Kansas City to engage in the project and start to build out their computing environment. Again, nine out of 10 clients tend to come into our data center and are hosted. So we'll start all of that work right away and get them going.

Operator

Your next question comes from the line of Greg Bolan with Wells Fargo.

Greg Bolan - Wachovia Capital

With regards to the Cerner network, can you quantify the number of clients that are now installed on the network? And then, thinking about the ultimate goal for interoperability among providers, does the network have the bandwidth to handle kind of an exponential increase in transactions? And how should we think about the financial meaningfulness of this network to us?

Marc Naughton

This is Mark, Greg. I think it is still an early effort for us. At this time, we are creating the infrastructure for that network that we will basically manage and own ourselves. So as far as people linked to that, it's very small number mainly just trials at this point. But the size of the network and the capabilities of the network from its initial size to exponentially grow you indicate, that's the design. It's designed to carry a lot of commerce and transactions and information across that network.

Michael Valentine

The only thing I'd add is, with high percentage of our own clients being inside of a data center, a lot of that traffic doesn't leave the building. So there isn't kind of the typical bandwidth concern you might be thinking about. Most of that data is house in the same floor space.

Operator

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

Michael Cherny - Deutsche Bank AG

So obviously, you're starting to see some nice traction with the ITWorks' clients. Can you give us a little sense about when you signed those up just the different margin profiles in terms of what takes to getting an ITWorks client up and running, and then kind of what that contract will look like versus the typical contract?

Marc Naughton

Yes, this is Marc. For an ITWorks deal, the initial deal normally has obviously Services components where we're taking over the operations of their systems, and there is a margin related to that, that's not 20%, it's less than 20%. But there's also usually part of that deal includes software and other elements that are a higher profit margin that brings the blended rate in for that deal over time to be accretive to our 20% goals. So those come in over time. But basically, that spreads, if you look at the map, it spreads over the life of that ITWorks client for the most part.

Michael Cherny - Deutsche Bank AG

And then, obviously with the announcements or the partnerships at the leadership meeting a couple of weeks ago, how quickly will it take to get those guys up and running and really having the full sales force engaged to being able to sell a comprehensive suite of solutions?

Michael Valentine

This is Mike I think we're ready now. We demonstrated the capabilities of the embedded technologies at the Cerner Health Conference. We actually had our sales meetings for the leadership and launch the capabilities and launch some programs to help accelerate the adoption of some of the capabilities. So we're ready now.

Operator

Your next question comes from the line of Steve Halper with Stifel, Nicolaus.

Steven Halper - Stifel, Nicolaus & Co., Inc.

Regarding CapEx, you indicated that you were going to come in below your expected range. Can you just give us some commentary about next year? And are there any major projects on the dock yet?

Marc Naughton

Yes, this is Mark. I think clearly, where we are today, we've had gain some efficiencies relative to data center purchases and be able to use Linux, things like that. So my guess is we end up this year at someplace 110, 120 range, maybe a little, that product is a little about right. We don't foresee any major projects. There's our normal data center build outs that we have to do. So I think relative to next year, for 2011, for the most part, we kind of go in looking at somewhere around $150 million as a target. This year, we had some efficiencies, no big projects, even if we roll in a couple of larger projects next year. We shouldn't be higher than that. But I wouldn't model less than kind of in the 130 to 150 range going forward.

Steven Halper - Stifel, Nicolaus & Co., Inc.

Any increased activity in small hospitals arena for the company?

Michael Valentine

Yes, this is Mike. I think we're seeing more activity on that front, Ano we had a good quarter in Q3 and we have aspirations for Q4. So we're getting better at executing on that front, and we're seeing more activity on that front.

Operator

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

Atif Rahim - JP Morgan Chase & Co

Question on the bookings. So last quarter, they signed up your revenue works client, you said you hadn't included any of the contribution from their inter-bookings did, did anything go into 3Q? And how should we think about that going forward, especially around bookings margin earlier this quarter, the bookings margin came in a little for other reasons. But as revenue works and ITWorks grow, should we just expect margins there -- the bookings margins to come a little bit?

Marc Naughton

This is Mark. The bookings margin for most of those deals, when we do book them will vary. But those are Services businesses. So normally, a services contract is 100% bookings margin. So relative to those, they've actually be accretive to your overall gross margin relative to bookings margin. So it's not going to drag it down. Relative to the first part of your question is on the RevWorks client, we still haven't taken any bookings on that client, it's an initial client. And so we're going to be very conservative as how we recognized any of that in either our bookings or once it gets in the bookings pulse through in an income statement. So at this point, most of the revenue bookings Mike talked about another revenue bookings, the revenue RevWorks client being booked to this quarter. And once again, that won't contribute to the bookings either.

Neal Patterson

And the one thing I would add is that both RevWorks an ITWorks represent further alignment with our clients, and they're generally longer-term arrangements. So longer-term contracts. When you're doing that, we tend to also do our traditional business contracts at the same time. So we're adding in software to the journey. We're adding in professional services. We're adding in third-party content, including some of the partnerships we did just announce. So they all have, depending on the composition and what the client decides to layer in to that aligned relationship, you'll get different margins as Mark described.

Atif Rahim - JP Morgan Chase & Co

On the Fujitsu issue, we're kind of coming up to a full year here with the receivables. Do you have any insight on that whether that you're going to move those receivables back to short-term or any indication on the collections procedure there? And then secondly, just an update on the U.K. in general, how are things progressing there?

Marc Naughton

This is Mark. Relative to the Fujitsu receivable, that process is ongoing and currently, there is no facts that we would based to move to a short-term characterization. So it will remain in long-term. We still remain very confident that we will collect that receivable. But the process has to go to be completed, and that process is ongoing. And so my expectation is the foreseeable future, no change in the characterization and classification of the asset until we see some substance of change in the process.

Michael Valentine

Regarding how we're doing over there, I think things are going well. As you know, we signed TCN3, which locked us into a contractual arrangement. We've been executing against that. We had some pretty important go lives and/or upgrades in the quarter that represent good execution progress. We've mentioned the Cerner health conference, we had nearly a hundred clients and/or prospects from the U.K. attend our health conference this year. So we literally had a breakout session to address some of their unique needs. So as we described in the last call, we're positioning to not only execute on the existing contracts that we have in place, but also address the independent trust buying behavior that we're going to experience going forward. We have momentum on that front. We have a lot of activity in our vision center that we have built out in the London office. And then finally, we mentioned Matthew Swindells as another leader that we're adding to the mix in Europe, and he's on board now. So we feel good about the trajectory that we're on.

Operator

Our next question comes from the line of Bret Jones with Brean Murray.

Bret Jones - Brean Murray, Carret & Co., LLC

Mark, I was just wondering if we could circle back on the sales and client services line for a second. I know it was asked a little earlier. But I think we all expect to see some leverage, but I was surprised to see the actual dollar amount decline. Were there any one-time items in that line?

Marc Naughton

There's nothing unique in that. If you look at it year-over-year, it's up 10%. So if you have seen growth of the year ago quarter, I think Mike laid out pretty well that what you seen from our standpoint is you've got U.K. and some of the global markets being us able to reduce our costs relative to the sales in client service. And those markets relative to job demand, to some extent we're moving some of those people over to the other jobs in the U.S., to some extent those people are leaving for other opportunities. But then, we're growing the U.S. The fact that it's relatively flattish make sense within that, and that adds a whole lot of people this year. And the 10% year-over-year increase kind of covers that headcount increase.

Bret Jones - Brean Murray, Carret & Co., LLC

Can you give us a sense for where the ambulatory HR footprint right now? You talked about seven new alignment deals and I was just wondering, are those where the hospitals actually purchasing alignments or are offering them for affiliated physicians?

Michael Valentine

I'll answer the latter part of your question, I'll let Mark answer the first, they're doing both. The agreements that we talked about were actual purchases. So our purchasing for both owned and affiliated physicians, and then sponsoring them in some former fashion. And the ones that I spoke of in this call, they're all posted at our environments, so the PowerWorks solution model. And we're seeing a mixed bag of, I would say, it's 70, 30 relative to whether we do the PowerWorks hosting solution, the software as a service model or a client attempts to host it themselves.

Neal Patterson

And we haven't disclosed any specific numbers relative to physicians on the power work solutions at this point. We probably will keep in doing that maybe in the future at some point. But don't have any numbers for you here.

Operator

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

Richard Close - Jefferies & Company, Inc.

With respect to operating margins, Mark, obviously, doing very well there and exceeding, I guess, your target of 20%. Any update on where you think that can go with all of these other automation and efficiency, I guess, things that you're driving? Were the operating margin could top out it over the next three years?

Marc Naughton

I think, well obviously that 21.7% we're very pleased with. As a diligent analyst, you want it to be higher than that. And we've indicated that there's not a 20% was not our ultimate goal. We think we can grow more than that, and obviously we're proving that this year. One of the keys is not only watching our expenses as we have on the R&D and SG&A side. But Services business, the more efficiencies is that business grows, as the stimulus projects come in, keep in mind that, that level of revenue per quarter, if we can get 3% improvement on the contribution margin from that business, that drops 100 basis points toward our total margins. So in that business has historically been in the upper-20s. I think as we get higher utilization rates and utilize more automation, then you'll see us be able to kind of grow that up into the low-30s and get the commensurate increase out on the operating margin line. So I wouldn't put out another marker. We've kind of get out of that business a little bit relative to where they think they can get to. But I think we're fairly comparable in that we can continue to increase operating margins. And so, we'll see where we end up this year. We'll be over 20%, and then we can give you an estimate as we kind of go forward.

Richard Close - Jefferies & Company, Inc.

And Mike, I was wondering if you could talk a bit about the pipeline and the potential clients that you're seeing in the pipeline. Are they -- is it skewed towards more people starting at ground zero? Or they have something and they're just looking for patches, you guys come to in and offer patches or just trying to get a feel of really what the opportunity is on a go-forward basis here?

Michael Valentine

The bulk of the opportunity in the U.S. is associated with people committing to a meaningful use journey, and we were hopeful that we're the primary EMR provider in that. But there are cases where we are plugging the gaps for other suppliers. I would say, the bulk of what we're up to is like our mix, 70% of our business comes from our base and finishing their journey. And this quarter, literally, 30% came from people starting a Meaningful Use journey. So I think that's what we expect to see. The health conference we announced many solutions that are really extensions that don't necessarily tied directly to Meaningful Use and maybe enable a new world once you have the core digitize. So I would expect that 30% will change a little bit over time to be not just net new EMR footprints but also at expansion and capabilities. The final thing I would add is just looking for a pipeline, we're seeing a higher or an increased percentage of that pipeline made up of what I would describe as rebounds. So people who have started the journey with someone else and have given up on it, and they're back in the marketplace. We didn't have that as a substantial percentage of our pipeline I would say a year ago. And looking a year forward, it's showing up substantially. So we're excited about that opportunity as well.

Richard Close - Jefferies & Company, Inc.

I know you guys have done pilots for certain customers in the past. I was wondering if you could just remind us in terms of how those have worked out in terms of pilots? have they expanded into substantial business with those particular clients in the past? Any type of track record along those lines?

Michael Valentine

Our normal business model doesn't have us doing a whole lot of what I would describe as pilots. But it's not uncommon for people that are making substantial decisions to get some proof points under their belt prior to moving forward. So we're accustomed to that model. We don't necessarily describe them as pilots because we view it as the beginning of the journey. But like any case, our job is to execute very well to deliver predictability and to make sure that the solutions that we're putting forth are the best solutions. And we have a track record that when we do that, good things happen downstream.

Operator

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

Sean Wieland - Piper Jaffray Companies

On your 2011 outlook, you said some upside of stimulus accelerates. So I'd like to know, what are your assumptions on acceleration or what are the leading indicators that we should be looking at? What are the leading indicators that you're looking at that gets you to your guidance?

Neal Patterson

Well, to our guidance, once again, the acceleration I talked about was driving results in excess of where the street is now, which is our guidance we're comparable with where the Street is. We have been pretty consistent, Sean, in our process. We based it on a forecast process that goes out four quarters. And we look at a preliminary view of the 2011 plan, that plan process and approach has been consistent for quite some time relative to being, we think, respectfully conservative. And based on all that data we pull together, we are comfortable with where the street is, relative to the potential to exceed that in the acceleration. You all will be able to see it in our bookings number, given -- we're one of the few company that provides bookings, data and guidance. You should be able to see when we start exceeding, having larger bookings numbers than we've guided or be at the top end of our range. But that's going to be a precursor to us being able to deliver above that amount.

Michael Valentine

Relative to a trigger, and I'll do the non-financial trigger. One of the things that, that may happen, and is that our client side that I saw a little bit of this starting to take shape is now that the infrastructure is being laid, Meaningful Use stage one for some folks is literally just finishing off the edges. So it's smoothening off the rough edges to get to a point where they can submit the appropriate measurements and literally achieve Meaningful Use. But at the same time, there is a pent-up demand to go do the higher order clinical work that's represented in some of our lighthouse initiatives. And really, that's start to bleed into what is Stage 2. And I think the clinicians are not going to -- they're not aligning their demands towards the Meaningful Use, they're aligning their demands towards what they need to effectively perform their roles. So there may be a trigger that the clinical need drives forward faster than the policy around Stage 2 Meaningful Use.

Sean Wieland - Piper Jaffray Companies

On the incremental operating margins. Obviously, your operating margins were at an all-time high. Your incremental operating margins were north of 40%. As I think about your growing your business into 2011, would there be anything that you're doing that would be dilutive to those incremental margins?

Marc Naughton

Well, I think the key driver of that was primarily the Services business and enhanced margins there. So as long as those continue to strengthen, there's nothing specifically that we have to invest relative to the delivery on stimulus that would be a negative to the margins. So I don't know if there's anything that I see on the horizon that would impact that negatively. But once again, it all still ties back to a great component of tied back to the services.

Operator

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

Eric Coldwell - Robert W. Baird & Co. Incorporated

Question gets back to the strength that you're seeing in the physician practice business, and it maybe a level details, but too granular for the call here. But I'm curious whether any of these were replacement sales where you are knocking out an incumbent or a series of incumbents? And if there's any common theme, any commonality in terms of what does affiliated physicians were using prior to Cerner getting the engagement.

Michael Valentine

This is Mike, Eric. Probably the common theme is the systematic approach by a sponsoring health system into a region of physicians. So the common thread is not people are leaving a specific ambulatory EMR or practice management solution platform and coming to Cerner, it's more of a systematic alignment to an affiliated health system that is driving the change.

Eric Coldwell - Robert W. Baird & Co. Incorporated

And then just a quick follow up. You talked about a number of areas of strengths during the prepared remarks, everything from device connectivity to even revenue cycle, which seems to be bucking the trend a little bit this quarter. Simple question here, laundry list of things that are working outside of a little bit of sluggishness on the global side, which you think will recover next year. Is there anything right now that you're surprised isn't working, and if so, why where there wouldn't be demand today, and if so, why?

Marc Naughton

Eric, as I actually look through the lines of the business and the data, they are all performing well. I don't self-serving comment it feels like, but there really isn't any single area where we're not doing as well we kind of thought. Probably the only thing I'd look at would be hardware margins are tend to always be under pressure. And therefore, you would saw that impact as some of our gross margins and bookings margins being lower because of the pressure we're seeing on hardware margins. But that's something that's just part of being in that business. So we saw a lot of hardwork, it's going to have -- their margins are just naturally lower. So actually wouldn't highlight anything that's not coming out to the expectations that we've laid out kind of plan and our forecast.

Operator

Your final question today comes from the line and Anthony Vendetti with Maxim Group.

Anthony Vendetti

Just a quick question clarification on the deals. Over $5 million, would you say 22? And how many were over $10 million?

Marc Naughton

But 22 over $5 million and 12 over $10 million.

Anthony Vendetti

And the 12 over $10 million, is that the most...

Marc Naughton

It was actually the second highest watermark, the first being Q4 '09.

Anthony Vendetti

On the ambulatory products and PowerWorks and so forth, can you just give us an update on how that's going?

Marc Naughton

Well, as I mentioned in the comments, the progress that we've made on the solution front is, we're very, very pleased with. It was one of the buzz items at our health conference. We've gotten a lot of external validation, both by our clients and by analysts that we're making a tremendous amount of progress just on the solutions front. So we're very pleased with that trajectory and reviewing where we're going. I think we're headed down a great path, and it's making a big difference in the marketplace. And then our ability to go provide that as either a solution that is offered by our clients in their domain. So in their technology framework or offered through our data center as a software-as-a-service model, I think this is a differentiator that helps our clients basically do more at the same time. So it just gives them the ability to have concurrent threads if they need to or leverage their platform if they need to. So that ability to go both directions into the marketplace is making a difference. And I like the trajectory that we are on. We're off to a good start in Q4 on that business and we're staying the course.

Anthony Vendetti

What's your install base there right now? Number of physicians?

Neal Patterson

Yes, I think Mark said earlier in the call that we're not providing that information.

Marc Naughton

We will let you know when we are. I'd like to turn over to Neil for closing comments now.

Neal Patterson

There is very little, you guys have done a great job kind of outlining us, and we're kind of taking it how do you summarize this call. I think from our side, the message we have been sending is we're definitely in a good place at a very good time. So healthcare IT worldwide is, I don't think you want to trade it with any other healthcare company. And our broad message to you is we're using our scale to increase our productivity. We are executing very well on most all of the cylinders. But we continue to innovate, frankly, fairly aggressively. I did get from the call here, I think possibly my favorite all-time question I've heard from these calls over several decades, and it was Eric's the call before last year and basically he ask us anything it's working. There are always things that we can find that we can make work better. But it does summarize that we are at a good place at a good time, and we're executing well. And then if you look forward, which most of you that have listen to me over time know that that's an important context that I will typically bringing to a conversation because that forward-looking always gets here. But frankly, looking forward in healthcare in mid-decade in the U.S., we have a completely digitized. We, collectively, in this country have completely digitized the content of a major industry, and it's healthcare. And the records of healthcare, of us as individuals in our society and in our communities will be digitized by the mid-part of the decade. And fundamentally, no industry that goes through a complete digitization of the content of an industry, no industry hasn't had fundamental major change to it, subsequent to that.

So what we are threading into the conversation, through the innovation, through our continued investment in IP is our version of what that's going to look like once at the end of the decade, and we think it's a big environment. It's a big opportunity for Cerner throughout this decade.

The other thing I would say, and one of the largest health systems in the country yesterday, and all of the industry's. Healthcare tends to do this every decade, it seems like there is kind of a major theme that everybody says will fundamentally change how healthcare works, and would change the cost curve. And every decade that theme comes and goes. So everybody's kind of a little tense as to will all of this happened on how, are we on a fundamentally different path or is this going to be at a lot of work and then we just nothing will change.

Fundamentally, and when you go -- and the conversation yesterday and recurs in most every conversation I have. The big difference now versus the 90s and the 80s and the last decade, the big difference is IT. These major health systems fundamentally since they have a different lever to make huge changes to it, and everybody knows there's huge changes that have to come to healthcare. So I think the environment, or else from my point of view, I've never seen a better environment to be in what we're doing in over the last 30 years.

So this should be a real big decade for Cerner. So with that all, I'll led you back to your day jobs. Thank you for your attention, and so look forward to seeing you in the future. Good night.

Operator

Ladies and gentlemen, thank you so much for your participation in today's conference. This concludes the presentation, and you may now disconnect. Have a wonderful day.

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