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Cerner Corporation (NASDAQ:CERN)

Q2 2014 Earnings Conference Call

July 24, 2014 04:30 PM ET

Executives

Marc Naughton – Executive Vice President, Chief Financial Officer

Zane Burke – President

Michael Nill – Executive Vice President, Chief Operating Officer

Neal Patterson – Chairman and Chief Executive Officer

Analysts

Jamie Stockton – Wells Fargo Securities, LLC

Michael Cherny – ISI Group

Stephen Harper – FBR Capital Markets

Gavin Weiss – JPMorgan

David Larsen – Leerink Swann & Company

Robert P. Jones – Goldman Sachs Group Inc.

George Robert Hill – Deutsche Bank Securities Inc.

Steven Valiquette – UBS

David H. Windley – Jefferies & Company, Inc.

Ricky Goldwasser – Morgan Stanley

Sean Wieland – Piper Jaffray & Co.

Operator

Good day ladies and gentlemen and welcome to the Cerner Corporation’s Second Quarter 2014 Conference Call. Today’s date is July 24, 2014, and this call is being recorded.

The company has asked me to remind you that various remarks made here today constitute forward-looking statements, including without limitation, those regarding projections of future revenues or earnings, operating margins, operating expenses, product development and new markets or prospects for the company’s solutions. 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 Item 1A in Cerner’s Form 10-K together with the company’s other filings.

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

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

Marc Naughton

Thank you Glen. 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 observations. Mike Nill, Executive Vice President and Chief Operating Officer, will discuss operations. Jeff Townsend, Executive Vice President and Chief of Staff, is with the client today and Neal Patterson, our Chairman and CEO will be available during Q&A.

Now I will turn to our results. Our total bookings revenue in Q2 was $1.08 billion, which is an all-time high for a second quarter and reflects 15% growth over our previous Q2 record results in Q2 of 2013.

Bookings margin in Q2 was $980 million or 91% of total bookings. Our bookings performance drove 21% increase in total backlog to $9.69 billion. Contract revenue backlog of $8.88 billion is 23% higher than a year ago. Support revenue backlog of $807 million is up 7%.

Revenue in the quarter was $852 million, which is up 20% over Q2 of 2013. The revenue composition for Q2 was $235 million in system sales, $175 million in support and maintenance, $413 million in services and $29 million in reimbursed travel.

System sales revenue reflects a 17% increase over Q2 of 2013, driven by a strong growth in software and technology resale. Q2 system sales margin dollars grew 19% over the year-ago period, driven by continued strong levels of software.

Moving to services, total services revenue was up 28% compared to Q2 of 2013, with strong growth in managed services and professional services. Support and maintenance revenue increased 7% over Q2 of 2013.

Looking at revenue by geographic segments, domestic revenue increased 24% for the quarter. Global revenue was down 4% from Q2 of 2013, due mainly to the timing of couple of global contracts. Zane will discuss our global outlook for the rest of the year, which looks solid.

Moving to gross margin, our gross margin for Q2 was 80.9%, which is down from 82.2% in Q2 of 2013. The slightly lower gross margin is mainly due to an elevated level of third party services, being used in this quarter to support a significant number of systems go live.

The highest level of go lives also led to a large increase in reimbursed travel revenue, which is zero margin and also impacts our margin percent, but not the absolute dollars of margin.

Looking at operating spending, our second quarter operating expenses before share based compensation expense were up 19% to $483 million. Sales in client service expenses increased 22%, compared to Q2 of 2013 driven primarily by continued increase in revenue, generating associates in our services businesses. Our investment in software development was up 18%, compared to Q2 of 2013, continues to be driven by investments and our growth initiatives.

G&A expense increased 8%, compared to Q2 of 2013, driven mostly by growth in personnel.

Moving to operating margins, our operating margin, before share-based compensation expense was 24.3% in Q2. This is down 80 basis points, compared to Q2 of 2013, due to the higher level of third party services and reimbursed travel revenue.

Our forecast for the second half of the year reflects between 50 basis points and 100 plus basis points of margin expansion, depending on mix. While this will put us below our original target for margin expansion this year, our earnings guidance is still higher than we began the year. As always our focus is on delivering predictable levels of growth in gross margin and earnings dollars, which we have done this year, even with that expected levels of margin expansion.

Moving to net earnings and EPS our GAAP net earnings in Q2 were $129 million or $0.37 per diluted share. GAAP net earnings included share-based compensation expense which had a net impact on earnings of $10 million or $0.03 per diluted share.

Adjusted net earnings were $139 million and adjusted EPS was $0.40, which is up 18%, compared to Q2 of 2013. The Q2 tax rate or adjusted net earnings was 33.7%, which is in line with our effective tax rate. For the second half of 2014, we expect our effective tax rate to remain within 50 basis point to 100 basis points of 34%.

Now I will move to our balance sheet, we ended Q2 with $1.47 billion of total cash and investments, which is flat compared to Q1 as we used our free cash flow for share repurchases. Our total debt, including capital lease obligations, is $155 million.

Total receivables ended the quarter at $615 million, which is up $51 million from Q1. Our DSO in Q2 was 66 days, which is flat compared to the Q1 DSO and down from 68 days in year-ago quarter.

Operating cash flow for the quarter was $248 million. Q2 capital expenditures were $62 million, and capitalized software was $42 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was $144 million for the quarter.

Moving to capitalized software, the $42 million of capitalized software in Q2 represents 37% of the $115 million of total investment in development activities. Software amortization for the quarter was $25 million, resulting in net capitalization of $17 million or 15% of our total R&D investment.

Our outlook for capital expenditures and capitalized software remains the same as what we provided last quarter. We expect capital expenditures to be $260 million to $280 million for the year, which is down from $353 million in 2013. We expect capitalized software to remain in the mid-$40 million range per quarter throughout the year, which will lead to it being flat or slightly higher than the $175 million capitalized in 2013.

Regarding our share buyback, we purchased 2.8 million shares for approximately $142 million during the quarter, bringing our year-to-date total to 4.1 million shares repurchased for a total of $217 million. This completed the original amount that was approved in December of 2013, but we still have the additional $100 million of authorization that was approved in May.

Now I’ll go through Q3 and full year 2014 guidance. For Q3, we expect revenue between $840 million and $870 million, with the midpoint reflecting growth of 17% over Q3 of 2013. For the full year, we expect revenue between $3.3 billion and $3.4 billion, reflecting 15% growth at the midpoint. This is up from our prior range of $3.25 billion to $3.4 billion.

We expect Q3 adjusted EPS before share-based compensation expense to be $0.41 to $0.42 per share, with the midpoint reflecting 19% growth over Q3 of 2013 adjusted EPS.

Q3 guidance is based on total spending before share-based compensation expense of approximately $485 million to $495 million. For the full year, we expect adjusted EPS between $1.64 and $1.67, with the midpoint reflecting 17% growth. This is up slightly from our prior range of $1.63 to $1.67. Our estimate for the impact of share-based compensation expense is approximately $0.03 in Q3 and $0.11 to $0.12 for the full year.

Moving to bookings guidance, we expect bookings revenue in Q3 of $1 billion to $1.1 billion, with the mid-point reflecting 13% growth over Q3 of 2013.

With that, I’ll turn the call over to Zane.

Zane Burke

Thanks, Marc. Good afternoon, everyone. Today, I’ll provide Q2 highlights and discuss marketplace trends. Starting with our results, our bookings revenue in Q2 of $1.08 billion reflects 15% growth over Q2 2013 as a record for a second quarter. For the quarter, we had 31 contracts over $5 million, including 19 over $10 million. The mix of long-term bookings was 33% in the quarter, which includes an ITWorks contracts and strong managed services bookings.

Our competitors in the quarter was strong with 32% of our bookings coming from outside of our core Millennium installed base. This reflects the continuation moment and has been building in recent years, including our record level of new over 200 bed hospitals with that hospitals in 2013. We believe we have a multi-year window to continue expanding our footprint, as other suppliers continue to struggle to help their client navigate the increasing regulatory requirements and changing healthcare economy.

This opportunity reflected in our pipeline, which is all time high across all segments. We are also gaining shares the ongoing consolidation industry that has been led by health systems that are Cerner clients. In fact each of the last three quarters has included booking contributions from client by Cerner solutions for hospital they acquired.

Now discuss a few areas of our business that contributed to our strongest results. I’ll start the population health. Our population health organization delivered strong results again in Q2 driven by sales with HIE, Patient Portal, Enterprise Data Warehouse, clinical process optimization and our new Healthy Registry solution.

Coming out of this significant number of meetings on population health they both Cerner and non-Cerner clients in Q2 and even more confident that are EMR-agnostic approach, which spans the continuum care is the right one. Continue to compete against many best of re-suppliers. But none are following our comprehensive platform approach, so they are only effective in certain areas.

In addition, most of them have not taken on the significant challenge of aggregating and standardizing clinical claims and financial data across multiple systems. As a result, competing offering are using incomplete and latent data sets, which limits the value in our opinion.

Most importantly, we are achieving value with existing clients, with capturing major value statements across multiple areas of our population health portfolio. And these are strengthening our competitiveness with our prospects.

I’ll move to revenue cycle, where we had another strong quarter driven by sales of our broad suite of Revenue Cycle solutions and services. Our Revenue Cycle business has grown more than 40% year-to-date, which is impressive when you considering we’re coming off at 51% growth in 2013. This success is evidence that the significant investments we have made in our revenue cycle capabilities in recent years are paying off. We have now gone from simply trying to meet minimum expectations to having major differentiators in areas such as contract management and care management.

Operationally we are establishing scale and now have over 1,200 clients live on patient accounting, including approximately 200 hospitals and over 1,000 clinics. Importantly, we have been establishing through points at much larger clients and this success is leading to significant demand from other large whole systems. The momentum we are building through selling our solution portfolio is also helping build our pipeline for our full-service offerings.

Today I’d like to highlight a subset of our RevWorks offering that have been growing in recent quarters. That offering is an extended business office or EBO, which is a service where we augment the client staff with our resources. EBO services offer greater flexibility and can be deployed to target a specific client need such as helping with legacy AR or coding backlog or a long-term staff augmentation strategy. As a result of this flexibility and a faster sales cycle then for RevWorks deals this business has scaled quickly. We currently have 250 associates in our EBO supporting over 100 acute and ambulatory clients.

In summary, our investments and execution of Revenue Cycle states have led to much stronger competitiveness, contributing meaningfully to our growth and created substantial pipeline of opportunities going forward.

Moving to ambulatory space, we had a strong Q2. We added over 2,000 providers in the quarter, bringing our total to over 65,000, which is approximately double the number of providers we had just four years ago. We continue to continually displace our key competitors as our large acute care clients favor a common platform for their affiliated and employed physicians. This competitiveness is a result of the significant investments we have made in our physician solutions and we expect our success to continue.

We also had a very good quarter in the small hospital market, adding eight new CommunityWorks clients and bringing 70 clients live. We have signed 13 new clients year-to-date and expect to easily exceed the 19 we signed in 2013. Outside of the U.S. we had another strong quarter from a booking standpoint, driven by contributions from Middle East, Canada and the UK.

As Mark mentioned, revenue was down slightly due to the timing of a couple of contracts. In addition, some of those booking strength came from hosting contracts, which don’t have material upfront revenue, but they contributed to a more visible revenue stream going forward. In fact, we already have more global hosting bookings in the first half of the year than we did in all of 2013 and we expect this trend to continue.

Looking at the rest of the year, we expect improved revenue growth outside of the U.S. We expect this growth to be driven by the strong bookings in Q1 and Q2 and a good booking’s forecast for the remainder of the year.

Now I’ll cover a couple more marketplace observations. Overall, we believe marketplace dynamics continue to favor CERN. There are pressures on healthcare providers to control cost and increase quality and they continue to view IT as a key lever and helping them do this. While the meaningful use continues which we for the first adjustments of stage two meaningful use. Really don’t change much. In the end bar remains high, which is an advantage for Cerner. In addition meaningful use is just one area of focus as providers are dealing with the impact of other major and mandate such as healthcare reform (indiscernible) and ICD-10.

The final observation I’d like to make is the importance of interoperability is increasing. As you know, Cerner is committed to interoperability and having the most open EMR. It is becoming clear this is the right strategy. Our healthcare system has been done in times and the opportunity improvement with this data will not be fully realized unless all stake holders commit to interoperability. If not return on billions of dollars invested in systems to be limited and the opportunity to have major positive impact on the quality of healthcare systems will be wasted.

We believe that operating as it close systems more align and more. Yet, there are still major players that continue to operate this way. We are pleased the members of Congress have recently then demanding the tax per dollar not line the pockets of vendors that have develop business models around interoperability. We also acquired should be focused on delivering the value of true interoperability. We believe it is wrong for tax payer dollars to subsidize closer platforms consumers have a right to their data one of the primary reasons, Neal joined the our NC policy is insured that they will have it.

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

Michael Nill

Thanks, Zane. Good afternoon, everyone. Today, I’m going to discuss ITWorks and provide some operational highlights. I’ll start with ITworks. This quarter we signed an ITWorks contract with the full service community hospital. It has 120 active staff positions practicing in 37 different specialties. They are on long-term Cerner client and are currently pursuing Global six recognition. Similar to most of our ITWorks clients, this quite concluded that ITWorks was a good fit after completing an evaluation of the resources needed to continue meeting regulatory mandate such as future phases or meaningful use in ICD-10.

These pressure are common across our client-based and the reason our ITWorks pipeline remain strong. As a media update on ITWorks financial contribution and outlook our ITWorks revenue is up over 50% year-today, that we expected to also have a full year growth of over 50%. This growth is driven by strong booking last year, bookings and scope expansions this year and a strong pipeline for the second half of this year.

Now, I’d like to provide a couple of operational highlights and discuss some client achievements. I’d like to start by giving you a sense for the volume and diversity of work we are doing with our services business. Professional services organization is the largest healthcare focused consulting business in the world. It has over 5,500 associates and will contribute over $1 billion of revenue in 2014.

In Q2 alone we implemented 2,507 solutions at 197 sites adding 174,000 new users. Our services capabilities create a competitive advantage over competitors that rely almost solely on third-party services. Through our Solutions Center implementation approach and best practice methodologies, we provide predictable results at a predictable cost to our clients.

In recent projects we’ve incorporated what we refer to as our model systems approach. That approach jump-starts the project by starting with a fully built best practices system, which is then fine-tuned as users get hands-on experience and training. This approach has the potential to significantly reduce implementation duration and effort and can materially benefit new clients transitioning to Cerner platform, as well as reducing the cost of transition.

Of course we offer much more than just implementation and training services. In total, we offer more than 20 different lines of service including operational management, performance improvement, healthcare intelligence and analytics, strategy consulting and regulatory to name a few. This growing diversity of services and consulting offerings positions our services business for ongoing growth.

Finally, I’d like to highlight a recent client accomplishment at HealthSouth. During the second quarter HealthSouth brought five additional rehabilitation hospitals live with their suite of millennium solutions, bringing their Cerner footprint to a total of 46 of their 103 hospitals. Since December of 2012, HealthSouth has launched Cerner solutions into roughly five facilities per quarter, with each facility taking on a full suite of more than 15 solutions. HealthSouth has 31 facilities in HIMSS level VI and anticipates that each newly added Millennium site will also qualify for the same recognition.

Going forward, there are 10 additional hospitals scheduled for conversion later this year and 25 facilities scheduled for conversion in 2015.

In summary, we are making significant accomplishments with our clients as we help them maximize their business in the present, while also preparing them for the future.

With that, I’ll turn the call over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Jamie Stockton with Wells Fargo. Please proceed.

Jamie Stockton – Wells Fargo Securities, LLC

Yes, good evening. Thanks for taking my questions. I guess maybe the first one, Zane. The Stage 2 numbers have continued to be pretty weak for everybody and just big picture. It seems like hospitals as they stayed in the meaningful use program, it kind of felt there on a tread mill. They have to keep qualifying with their current vendor. If we see a lot of hospitals, shake out first stage to is that the big catalyst that you guys are looking for that is going to drive market share your way or do you think that they will ultimately be a lot of hospitals that ultimately qualify for stage two.

Neal Patterson

Thanks Jamie. I will start with our clients. We have the most stage two hospitals that have tested today to many other spire out there. So while not the large size numbers the most that are out there. And we had expect our clients to incredibly well on stage two at the station as things move forward here. And I think it’s a little early to determine what the market impact is going to be, given those low numbers for everybody.

But I can look forward to our own numbers and know that our clients are in very good shape to a test moving forward. And I do think there are some plus and with winners that will struggle get through that hurdle. But I think it’s still early to determine what that means in terms of the pipeline for us.

Jamie Stockton – Wells Fargo Securities, LLC

Have you seen an acceleration of hospitals coming to you say oh and we thought we are going to be able to handle stage II with whoever but now it’s apparent that we can’t. And therefore, we are getting off the treadmill and open to moving to other solutions.

Neal Patterson

Does it really occurred prior to this time period. So the buying today has been driven primarily by people that are looking to create platforms that are beyond meaningful use. So we are entering really the era of what’s the foundational plumbing that I need to be more nimble and contemplate the future of healthcare decisions beyond just meaningful; use. So I would say to date not a lot of that in the current part of it something worth watching.

Jamie Stockton – Wells Fargo Securities, LLC

Okay, and then my question is on the population health that you highlighted that you were talking to both core clients and non-core clients. Can you give us some sense for the deals that you’ve signed so far, some rough portion of that has been noncore clients enjoy everything you throw into the population health bucket?

Neal Patterson

There is a handful of clients to date, that we are seeing a lot of activity picking up in the pipeline and frankly quite a bit of activity in our own base which probably exceeding our early expectations for the year. And so that the trends are very good in terms of both what we delivered and then the pipeline activity in our current client base as well as some of those other clients. So I’d anticipate you will see signings in the upcoming quarters and both our core client base as well as non-Cerner core EHR organization?

Jamie Stockton – Wells Fargo Securities, LLC

Okay, that’s great. Thank you.

Operator

And your next question comes from the line of Michael Cherny with ISI Group. Please proceed.

Michael Cherny – ISI Group

Good afternoon guys. Congrats on nice quarter.

Marc Naughton

Thanks.

Zane Burke

Thanks.

Michael Cherny – ISI Group

So I just want to dig into a little bit color on the trend file which Alan obviously nice enough percentage out as he always does. Looking at the deals for the quarter, looks like they were fewer deals so the average deal size, but my calc is pretty big. I know you’ve mentioned by 19 deals larger than 10 million. As you think about that, think about the large deals you’re going after. I guess how many opportunities are you seeing that are more near term and very urgent replacement in nature versus how many of those where you’re actually might some greenfield for some of the particularly larger deals that you potentially go after.

Zane Burke

Mike this is Zane, I would say that if you looked at the total deals which I do pretty closely that activity was actually quite for all transactions. There was sort of I’ll call that midsized transaction anomaly where we didn’t have as many mid-sized transactions in the quarter.

And I think that’s reflective of a lot of activity it’s going on where people are – some of the large buyers are making decisions either through acquisition, some of the acquisition activity, so you see some things in some of the large side to that – our IT works, our hosting opportunity, people that are filling out the rest of their portfolios and the rest of the EMAR and some of the larger size, I would tell you that community hospital marketplace we highlighted, the community works which was one of our strongest quarters ever and I see a whole lot of strength in the small community hospitals and in fact, I see that as a big growth marketplace for us as we move forward.

So I’m not sure there is a trend there in that mid range piece, but I didn’t note that myself is – point through the numbers as well. I think it’s more just reflection of the deal mix for the quarter.

Michael Cherny – ISI Group

Thanks, that’s helpful. And then Marc a question for you and when I’ve some previous calls I apologize from repeating myself as the cash balance continues to build the ability to generate strong cash flow.

Have you rethought the strategic priorities will relative to capital employment, now you did a lot of buyback in the quarter, but as you think also about the new normal what your product offerings is going to be over the next five to 10 years. How much does M&A which has never been something that Cerner has been particularly play factor is that.

Marc Naughton

Mile this is Marc. I think the uses of cash that we’ve always talked are pretty much the same as we’ve been talking out we are going to invest in our business, you’ve seen us do that, through the R&D, through CapEx relative to our growth infrastructure. So that’s the same, we are committing more funds to stock buybacks. You saw we did $217 million this year-to-date basically spend all of our free cash flow for this quarter on our stock buyback and has some more to go to do. I think we’ve always talked about if there is some element of strategic acquisition potential in our approach to use of cash. The key for us as we don’t really have any gaps that we need to go fill.

So, we’ll be continue to look at things that are interesting to complement Millennium that have good price the value ratio, but there is really pretty consistent. I think in our approach to cash as we talk about before.

Michael Cherny – ISI Group

Perfect. Thanks, guys.

Operator

Your next question comes from the line of Steve Harper with FBR. Please proceed.

Stephen Harper – FBR Capital Markets

Hi, just a quick – we would like to have quick update on Intermountain activities as well as Advocate as you approach the end of that development cycle.

Zane Burke

Hi Steve, it’s Zane. I have just a quick update on Intermountain. We continue to there engage in the build process on the project process is going incredibly well. They are great client has been a very collaborative. They engage with us in a number of ways and we are really excited for them to continue to move forward with the projects, which remains on track and going well. Around Advocate we went live with the healthy registries and there are seeing significant benefit from that and we continue we’ve actually had our second go live in Healthy Registry in our client base today as well.

So it’s not just an Advocate story any longer, which is good and they but Advocate continues to be a leader in the space and that has a great proof point of what we can do.

Stephen Harper – FBR Capital Markets

Are you seeing increased activity in the pipeline regarding healthy registries.

Zane Burke

Absolutely. In fact, it’s as I have mentioned earlier its exceeding some of our early expectations around what that pipeline looks like both in our core plant base as well as our external client base and I would also say beyond the registry themselves as we rollout other capability the demand for some of the upcoming capabilities as very much in process of our prospects and existing clients today. So I feel very bullish about the past that we’re on and is going to have a meaningful impact to Cerner as we move forward over the years.

Stephen Harper – FBR Capital Markets

Great, thanks.

Operator

Your next question comes from the line of Lisa Gill, JPMorgan. Please proceed.

Gavin Weiss – JPMorgan

Yes, it’s actually Gavin Weiss in for Lisa. I might have missed this in the prepared comments, but at Investor Day you showed a slide that outlined the potential wins for Cerner based on hospital M&A activity in 2013. So can you talk about where you are in terms of converting those potential wins and how is 2014 M&A activity looking for you?

Neal Patterson

Good question. I did have some very brief prepared comments, but the M&A activity has picked up in 2014 pretty significantly. 2013 was a little bit lighter than some of the previous years. In first half of the year there has been about 70 hospitals that have changed hence. Cerner hospitals continue to acquire at a greater rate than any of our competitors and it was very consistent with kind of the previous three-year trend of Cerner clients buying at around 45% to 50% rate of all acquisitions.

Again last quarter, we converted some of those acquired basis into Cerner clients. So we’ve had that happen each of the last three quarters where we’re converting that element, but we have not yet disclosed some of that conversion rate. We’re still kind of evaluating how fast those convert and how that works through the pipe. It continues to be a huge opportunity for us as we move forward.

Gavin Weiss – JPMorgan

Okay. And then just in terms of the competitive environment it’s been publicly reported that one of the hospital IT players has put their business up for sale. How does that affect those customers? Have you seen them come to market maybe with new RFPs or is it still too early?

Neal Patterson

It’s early, but obviously that can cause some folks that are on those basis to consider what their long-term strategies are. And so, I think that could provide some impetus for us and a little bit of tailwind for us. So we have seen some early conversations in that dialogue.

Gavin Weiss – JPMorgan

Okay. Thank you very much.

Operator

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

David Larsen – Leerink Swann & Company

Hey, guys. Congratulations on a good quarter. There’s been some recent news articles about interoperability between vendors such as like Athena and Cerner and quality systems in Cerner. Can you just talk about that and mention how to have sort of any interoperability engagements going on with Athena? Thanks.

Zane Burke

This is Zane. So, as it relates to Cerner and Athena, specifically there is not a program there. What we’ve done is have our industry group, which is called Commonwealth, which Athena is one of those partners. That group has grown from the original five partners, which if you may remember, is McKesson, Cerner, Greenway, Athena and Allscripts and has grown to almost 12-member, I think about 12 members to date including CVS and other HIT suppliers. And, so we’ve got four proof points today in the marketplace on putting together that patient identifier, managing the consent and that’s gone incredibly well upfront.

We are absolutely 100% committed to seeing that through and think it’s a super strategic and a valuable thing and an important thing in our industry for us to do and for us all to collaborate on. And when I mean all of us, it means all suppliers in our industry, need to get on board and be part of solving interoperability challenges. Athena is obviously part of that Commonwealth initiative. So we have had success with them and they’re part of those pilot projects.

David Larsen – Leerink Swann & Company

Okay, great. And then, just when you say part of those pilot projects, does that mean field to field bidirectional data interchange?

Zane Burke

This is solving a piece of interoperability. So this piece of interoperability is actually the lack of the national patient identifier in this country, which will not happen for mainly political purposes and really could and should be solved by industry at this point. And so, what we’re doing is actually where are making it where we can share data based on that national patient identifier and that patient identification. And, so that’s how the data sharing is occurring and the consumer themselves will have the right to determine who gets that information, where that information – whether they want to consent to that. So that could level interoperability that we’re at.

David Larsen – Leerink Swann & Company

Great. Sounds like you guys have taken a great leadership role. Thanks a lot.

Operator

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

Robert P. Jones – Goldman Sachs Group Inc.

Thanks for taking the questions. Marc, it sounds like the bolus of the go-live implementations and the related expenses what you’re pointing to for the short fall in operating margins were the original goal for the year. I’m just curious was there anything specific about these go-lives or the associated cost that was outside of your initial annual plan? And then, just on the back of that, anything we should be thinking about as we look forward as far as risks associated with additional go-lives?

Marc Naughton

This is Marc. The Q2 was expected to be a very big quarter for doing go-live. So it wasn’t anything that was really outside our expectation. I think the upside in revenue over our guidance range was probably kind of driven half by additional third-party consultants. And half by the increased travel that we saw quarter-over-quarter. So nothing that was beyond our expectations or that makes us concerned about our expense model. I think clearly the height revenue impacts operating margin percent it certainly didn’t impact our operating margin dollars which is our key focus. We really want to drive out the operating margin dollars. We’re actually fine that the revenue grows a little faster than we would have projected, because we do have a pretty good history of being able to bring our and expand our operating margin percentages, as we go forward.

So nothing that I found this quarter that would concern me. It was pretty much a volume related item and a project specific relative to the use on certain projects a s in third parties. The clients would have requested, given as we talked about our the size of our consulting organization 5,500 people. We for the most part due to our, all of our own implementation work. So it’s kind of a little bit at the edge element, but doesn’t significantly my view.

Robert P. Jones – Goldman Sachs Group Inc.

So no reason to think differently about the margin opportunity expansion going beyond this year?

Marc Naughton

Correct.

Robert P. Jones – Goldman Sachs Group Inc.

And I guess just to change gears a follow-up question on outside the U.S, you’re thinking about the UK dynamics. Any sense you can us on the competitive dynamics there, anything updates as far as opportunities or market developments?

Zane Burke

Sure this is Zane we had a great Q2 as we mentioned in my prepared comments. And we have seen a lot of activity with those coming out of the trust which is principally complete at this point. So those coming out of the trust program are principally complete. But there is a ton of activity in new business and within those clients that have come out and have gone Cerner’s direction and joined with Cerner directly. We see the UK as the fantastic growth opportunity and very bullish on our growth in the UK.

Robert P. Jones – Goldman Sachs Group Inc.

Great thanks so much.

Operator

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

George Robert Hill – Deutsche Bank Securities Inc.

Hi, good afternoon guys and thanks for taking the questions. I think Zane or Mike this is either one for either you guys to feel. As you’re talking to your clients about population health and kind of as they build the functionality stack, like what components of the functionality do they feel like they need to start with or by first, and kind of how do they move down the line? And like, so are they starting with data warehousing or they started with Dana analytics and moving down the end towards patient engagement or risk stratification? And so I’m trying to figure out kind of where are we in the build of the functionality stack, where do you guys index against where we are in the build from a product offering? And kind of how far up the adoption curve do you think we are?

Zane Burke

This is Zane. I would say there’s some core foundational elements which many folks have and they just the HIE and Portal Space which has broadly put in that. But as you refer to its George, it’s really the next phase of that. So registries and data warehouse and analytics are the pieces that where clients are in their lifecycle buying thoughts, bigger contract management and the patient engagement side to that actually a full CRM for healthcare. Are really the future, and so there is the demand and the needs are there for this roadmap to layout over the next several years. And we’re developing work on that today.

And so we’re early in the delivery side of this and we’re very, very pleased with this. But the thing that we have done different than anybody else, is create a platform by which of all of this is on one single platform and is not isolated in the single niche supplier. So we’re coming out of from a broad platform perspective which we’ve now built that broad platform and then we can build on the pieces of functionality for each one of the areas to satisfy the needs going forward. And so we are incredibly well positioned on a broad platform perspective whereas the competitors in the space have come from a niche perspective and know how to try to cut, figure out how to make that into a boarder platform and that’s a lot harder way to run the railroad.

George Robert Hill – Deutsche Bank Securities Inc.

Okay that kind of leads me to my follow-up. And if I think about Cerner’s evolution on the clinical side and the financial side, I guess, I would ask from a Pop, if you look at your clients Pop Health wallet how much leakage do you guys think you have right now, or how much share of wallet are these niche competitors taking that you guys might have to go recapture in the future the way you went later in the adoption cycle and captured things like ED, and surgical, and cardiology and radiology impacts. I’m trying to think about how much of the wallet is being committed now that you’re not capturing, that you kind of comeback and catch in round two, and round three, or inning two, inning three and inning four?

Neal Patterson

Think it’s a interesting element and I think it’s an astute observation in what’s occurred, because those that were early and had something that sounded like population health one kind of the first round of that in many cases. And so oftentimes we are back and in those niches you’re already in inning two, if you will. And what I sound profound about this phase is the competitor of the day, it really is a competitor of the day dynamic who was the big competitor 12 months ago is not the competitor of the day. And so I’ve never seen some of this move so quickly, and I think it depends on a lot where the client is in their evolution as well. So where you are in innings one or inning two depends on the client’s evolution. So they were a Medicare advantage part of the Medicare Advantage programs or been one of the pioneer grants.

They have likely made some sort of purchase along the way and are much further along in their thinking of operationalizing population health. Those that haven’t done that probably actually haven’t made many of any purchases in the space. So you sort of have to bifurcate the marketplace and say where are – where is that organization in their life cycle of going at risk. And I thinking of at risk element, so it’s a bit bifurcated in that space. Is that kind of make sense.

George Robert Hill – Deutsche Bank Securities Inc.

Yes, so if I think about that analogy right and I’m sorry that I am kind of go into (indiscernible) if we think about kind of later part to the top health technology structure like what I would call like provider network management and provider kind of provider evaluation managements. We might be in the first inning there but if I look at HIE, I feel like we mattered to be in the fourth innings because I’ve already seen an handful HIE companies coming well. Is that…

Neal Patterson

I think you have it exactly right, George so maybe HIE is obviously that most of sure if you will in that side and there has been there evolution in that side. I don’t know that’s where the buying is going. So the buying is really moving towards some of those other areas that we talked about. So the patient registry, the data warehouse elements and some of the analytics capabilities, analytics and reporting capabilities that’s where the principle buying as referral management. That’s where things are going.

George Robert Hill – Deutsche Bank Securities Inc.

All right. I’ll hop off, I appreciate the color. Thanks.

Neal Patterson

Thanks.

Operator

And your next question comes from the line of Steven Valiquette with UBS. Please proceed.

Steven Valiquette – UBS

Hi, thanks, good afternoon. So I guess if we think big picture about some of your biggest potential drivers of bookings and contract wins over the next two years or so, which you may include age or replacement and also RCM sales into the installed base, but maybe not PHM in big size just yet. I guess I’m just curious is there general expectation from your random percent of contract dollars from new clients with that potentially move higher over the next few years and versus the current 30% trends or could that move lower, given you certain mix or just too hard to predict that metric at this time, thanks.

Zane Burke

I think our expectations for just remains some alone. And but again those given that the numbers continued to grow, the dollars on new business continues to grow significantly. So I think that’s one of the elements, but I think we’re anticipating it will be fairly similar at this point.

Steven Valiquette – UBS

Okay. And just quickly, last quarter it may have been a little bit too soon to get read on implications from market demand trends following the ICD-10 delay, but I guess now that another three months have passed, just curious if there’s new or additional observations you may have regarding any market’s shift just following that delay?

Marc Naughton

We saw very good performance in our Revenue Cycle solutions. So as I mentioned in our comments, we’re at 41% growth over 2013, which is coming off of 51% growth over 2012. So I think we’re feeling very good about where we are on revenue cycle and where our clients or how the clients are feeling about our solutions and they’re able to navigate the ICD-10 element. And so they can plan on either side of that deadline today and we’re able to accommodate that, but I don’t see that as a driver of additional elements. I would say some of the [EBoP] (ph) that I highlighted earlier, some of those types of stock augmentation, some of that type of work I think does have some planar ICD-10 elements to it that we’re hoping augment some staff and do some things like that.

Steven Valiquette – UBS

Okay. All right, got it. Thanks.

Operator

Your next question comes from the line of Dave Windley with Jefferies. Please proceed.

David H. Windley – Jefferies & Company, Inc.

Hi, thanks for taking the question. So, Zane, your chief competitor seems relatively uninterested or unmotivated in pursuing pop health based on some of the chatter in the marketplace. And given the size of their client base and the size of the client in that client base it would seem like they would be logical earlier buyers of some of those capabilities and that would make them a very opportune and rich target base for you to go after. I guess I’m wondering in that context if there are kind of particular initiatives that you might call out to drive your pop health platform into the belly of the beast for a lack of their phrase.

Zane Burke

I think you make a very good assessment of the marketplace. So I think that’s probably as much as I want to comment on that dialogue, which is we have solutions that the industry needs and our solution is EHR agnostic. And so we’ll work regardless of who the competitor is and it makes sense that we are talking with some of those clients that may have made another selection on the EHR side. And I think you’ll definitely see some fruit that as we look forward here, moving forward. So, we absolutely see at the same way you see it.

David H. Windley – Jefferies & Company, Inc.

Okay. Totally separate topic. On the EBO type opportunities mentioned in the prepared remarks, always understand that little better not sure exactly how far long you are on those, but have you seen any instances where a client starts with a – which sounds like a kind of a fraction of a RevWorks deal and moves into a full RevWorks deal. And if not can you talk to us about how you might see that evolves.

Zane Burke

We haven’t seen that happen today, but we also – we do see that as an opportunity and a very likely outcome of get started, do good work and then, get hired to do more work. And that’s a pretty much a fundamental that we try to operate center as proved the value and move forward. So, today as I mentioned about a 100 clients are utilizing our services today doing a number of different things. And we continue to grow our portfolio of services that we’ll do on kind of standalone basis and I do believe that we’ll drive additional growth on the full Revenue Cycle out sourcing.

David H. Windley – Jefferies & Company, Inc.

Great, thanks. And last question, conceptually with a number of cross selling opportunities that Cerner has, be it pop health or the works deals things like that beyond basic Millennium solutions I guess on interested in the context of capital deployment and M&A and so forth how the company looks at the long-term value of adding a member to your footprint be at buy organically and or acquisition and how you weigh the balance between getting that a substantial addition to your footprint quickly versus winning them by the once.

Marc Naughton

This is Marc. I think the value of a member of client in our footprint I don’t know to the source of that value where they client came is from is critical. The key for us and our strategy is how can we continue to add more value to that clients by more solutions, more services, more opportunities to help them improve. And to reduce their cost because that’s what the two key things are looking to do so. For us it really doesn’t matter where they come from it’s really us going to the next key in our strategy. Zane (indiscernible) comment.

Zane Burke

And we do track the value of the new footprint. So I always say that new footprints are life blood of the company, because we are a growth organization. And we do a lot of things across the entire healthcare spectrum, conserve this in a number of way. And so tracking that value of the footprint is something that on an internal basis, is we do. And so adding new foot princes incredibly important and that is why we have big focus on it and served us very well.

David H. Windley – Jefferies & Company, Inc.

Very good, thank you, I appreciate it.

Operator

And your next question comes from the line of Ricky Goldwalker with Morgan Stanley. Please proceed.

Ricky Goldwasser – Morgan Stanley

Yes, hi, good afternoon. A couple of follow-up questions here. I mean obviously interoperability is made for clients and the big current going forward. So from the conversations you’re having with those hospitals that are not currents on our clients. And when you think about the pipeline, do you think that replacement opportunity around kind of like, from potential customers it is currently are with players who don’t necessarily have that ability. Do you think that something that you could see in kind of like the next in the near term and the next 12 months do you think that these potential customers will first relate to a test for meaningful use to before they make the potential transition.

Mike Nill

I view that as a very long cycle of things. I think it past that 12 months cycle on it and as we said previously I think this is a five to seven year trend of replacement EHRs, and so I think we are early in that five to seven years in that cycle. I do think that ultimately that will be important is durability to be interoperable. And to play a role I don’t think that meaningful use to having a significant impact on a lot of the buying right now.

Ricky Goldwasser – Morgan Stanley

Okay and then can you just show us with your thoughts on just the Apple’s announcement that it will collaborate with kind of like the player in the space that is not part of the Commonwealth?

Mike Nill

I know that we have been real comments on what other players do. We see commonwealth as the key structure through which we will keep some identification information in the future. And I think that people are certainly welcome to join that organization regardless what other organization that they are members of. So it’s not exclusive, it’s all welcoming of all players. So you are going to see a lot of different announcements.

I think the key for us we are going to spend the effort in welcome the technology to make it happen. We are going to make it available to our clients and we are hoping that as we increase membership it will become the de facto standard. We’ll take one last question.

Operator

And our last question comes from the line of Sean Wieland with Piper. Please proceed.

Sean Wieland – Piper Jaffray & Co.

Hey, thanks a lot. So I want to go back to Intermountain. Can you talk about how the work you’re doing with Intermountain is going to translate into your competitive advantage in the marketplace? And when do you think the market or has the market started to realize what you’re doing with Intermountain?

Neal Patterson

Well, I think there is a couple of things there. Intermountain is one of the leaders in being the lowest cost provider, highest quality and the work that they have done around creating the care process modeling and their level of diligence around becoming the best provider at the lowest cost are things that – and the innovation that they have done on a number of different areas. We’re incorporating some of those things as we go. So we have an agile cycle that we’re able to actually bring some of those things to bear early in our process.

Our clients are becoming aware of what we’re doing there, but I think it will be more to come and certainly much of our client base and perspective client base are very interested in the outcomes that we bring at Intermountain and bring to bear. And the objective is to bring that to our client base and to the entire healthcare industry, some of the successes that they’ve had and make that part of the solutions that we deliver.

So I would say there is a high awareness, obviously, of the project overall from our client base and from our prospects. They’re already beginning to see some of the benefits of that. They’ll see much more of that as you get to the end of the year and into the next couple of years. And our ability to go, harvest some of that information together with Intermountain.

Marc Naughton

Yes, Sean. This is Marc. Obviously Jeff is kind of on some of the calls, got on some of the calls. Our expectation is from the next quarter we’ll have him be able to speak and present and I will obviously use that opportunity to go deeper in the Intermountain and what’s going on there, how the benefits we expect to derive from that relationship. So more information, stay tune to just to give a preview.

Sean Wieland – Piper Jaffray & Co.

Super. Thanks a lot.

Marc Naughton

I want to thank everybody for being on the call today. We’re very pleased with our results for Q2 and we look forward to talking to you all soon. Thanks very much. Bye-bye.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.

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Source: Cerner Corporation's (CERN) CEO Neal Patterson on Q2 2014 Results - Earnings Call Transcript
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