Clifford Meltzer - Executive Vice President of Solutions Development
William Davis - Chief Financial Officer and Principal Accounting Officer
Glen Tullman - Chief Executive Officer, Executive Vice President and Director
Seth Frank - Vice President of Investor Relations
Allscripts Healthcare Solutions (MDRX) Q2 2011 Earnings Call August 2, 2011 4:30 PM ET
Good afternoon. My name is Alicia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Allscripts Second Quarter 2011 Earnings Conference Call. [Operator Instructions] Mr. Seth Frank, Vice President, Investor Relations, you may begin your conference.
Thank you, Alicia. This is Seth Frank, Allscripts Vice President, Investor Relations. On the call today are Glen Tullman, our Chief Executive Officer; Bill Davis, our Chief Financial Officer; and Lee Shapiro, our President.
Before we begin, let me read the brief Safe Harbor statement. This presentation will contain forward-looking statements within the meaning of the Federal Securities laws. Statements regarding future events and developments or companies future performance as well as management's expectations, beliefs, intentions, plans, estimates or projections relating to the future are forward-looking statements within the meaning of these laws. These forward-looking statements are subject to a number of risks and uncertainties, including our ability to achieve the strategic benefits of the merger with Eclipsys and other factors outlined from time to time in our most recent transition report on Form 10-KT, our earnings announcements and other reports we file with the Securities and Exchange Commission. These are available at www.SEC.gov. The company undertakes no obligation to update publicly any forward-looking statements whether they are results of new information, future events or otherwise.
And with that, I'd like to turn the call over to Glen Tullman, CEO of Allscripts.
Thanks very much, Seth. I want to welcome all of you to the Allscripts 2011 Second Quarter Earnings Call. I'm pleased to welcome Cliff Meltzer, our new Executive Vice President of Solutions Development who I'll ask to say a few words later in the call.
Let's begin the call today with a high-level view of the market, and then we'll walk through the details of the quarter. I really see 2 stages playing out in this market. The first stage is Meaningful Use, which will continue to be a significant driver in accelerating adoption in this market. We are perfectly positioned with the largest footprint in the market, with clinical and financial solutions for all points of care and the largest sales force in the industry. We believe we have leading share in the market today and that it will continue to grow.
The second stage will be the emergence of new payment models, such as accountable or value-based care where providers will be paid for quality versus quantity. This market will be driven by companies that can connect care and provide insights that drive clinical and financial outcomes. Relative to the second stage, our open platform will connect patient information into a single view and help to coordinate care, both inside an organization and throughout the community. Our analytics capabilities, which include our partnership with and strategic investment in Humedica, signed in the second quarter, will provide insights that will drive both clinical and financial outcomes. That is what will be rewarded in the future model where Allscripts has already proven that we can deliver. As the advisory board cited in the their leasing report, Allscripts is the "market leader in improving clinical outcomes" through the delivery of actionable insights.
The key point here is that Meaningful Use, the Meaningful Use threshold of the Federal HITECH Act that we have all heard so much about, is increasingly being seen as minimum use. In other words, it's the first stage in building the infrastructure that will enable the delivery of insights leading to better outcomes. There will be significant growth in this market for years to come, and we believe that there is no company better positioned to capture the opportunity in the market today and in the future.
Having made these points, let's turn to the quarter. Allscripts' performance in the second quarter was strong across-the-board, reflecting the demand in the market and the strength of our solutions. We delivered bookings of $244.6 million, up 15% from the first quarter of 2011, reflecting strong sales across our entire portfolio. The overall volume of bookings for the transactions over $1 million was up by over 50%, which indicates a very solid mix of business across a large number of clients. To give you an example of how our market penetration is growing compared to another publicly-traded peer we're often compared to, in the June quarter, Quality Systems reported 97 new client agreements. By comparison, Allscripts signed a total of 359 net new clients during the quarter. It's clear that we're winning in the most important area of all: market share. Every quarter, more and more healthcare organizations are using Allscripts as their operating system.
Last quarter, I mentioned third-party validation of that fact from MGMA. In June, yet another major industry survey confirmed our leadership and mind share among physician practices planning to purchase an Electronic Health Record. The survey of 1,300 physician groups from CapSite, a respected research and advisory firm, reported that Allscripts leads all other Electronic Health Record providers in mind share, spanning the full spectrum of physician groups.
Returning to the numbers, in the second quarter, we also delivered non-GAAP revenue of $363.5 million, non-GAAP net income of $42.5 million and non-GAAP earnings per share of $0.22, which together reflects solid execution against our operational and financial plan during the quarter. Our financial results were driven not only by new clients, but by significant cost sales into our base as well. In fact, our current client base expanded their investments with Allscripts across all of the segments we served.
In the acute care market, we expanded relationships with a number of our existing Sunrise clients, plus new Sunrise Clinical Manager sales. On our last call, we discussed the sale of our Sunrise Enterprise suite of clinical and financial solutions to Hannibal Regional Healthcare, which closed early in the second quarter. Yesterday, we announced another net new Sunrise Enterprise agreement with Heritage Valley Health System in Western Pennsylvania. Heritage Valley is an Allscripts client who currently uses our Enterprise Electronic Health Record for their 200 employed physicians. They will deploy the Sunrise Enterprise suite across their 2 hospitals, with a combined 550 beds and more than 70 community-based patient care locations. This new Sunrise sale represents a significant cross sale of Sunrise to an enterprise EHR client, one of the important revenue synergy opportunities we identified premerger. Notably, at Heritage Valley, we won an head-to-head competition against Cerner.
Along with Heritage Valley, several large existing clients expanded their long-term relationships with Allscripts during the quarter. As you know, we recently signed a significant expansion and extension of our relationship through 2018 with West Penn Allegheny Health System in Pittsburgh. The multimillion dollar agreement expands West Penn's Sunrise Enterprise 5.5 suite of clinical and financial solutions and adds our MyWay Electronic Health Record and Practice Management solution for their affiliated physicians. Allscripts also announced a meaningful addition to our international client base through a second quarter agreement with SA Health, the public health system of South Australia. The agreement, valued at $5 million, commences the first stage of a systemwide Electronic Health Record implementation for 80 hospitals. As you may recall, following their process, SA Health announced publicly in November of 2010 that Allscripts was their vendor of choice for this major initiative. As noted, this is the funding for much of the advanced work with SA Health to define their scope of work for their hospitals and other facilities. We expect the remainder of the agreement to be signed prior to year end.
On the ambulatory front, our industry-leading footprint continues to be a competitive differentiator during the second quarter, especially when it comes to selling hospitals. For example, Louisville, Kentucky based Baptist Healthcare System added our Practice Management solution to their deployment of Enterprise for 300 employed physicians. Baptist Healthcare System, which owns 5 hospitals and manages 2 others, also agreed to underwrite the cost of our Electronic Health Record for their hundreds of affiliated physicians. Jackie Lucas, who is Vice President and Chief Information Officer of Baptist Healthcare System commented on the agreement in a July 27 podcast on healthsystemCIO.com. When she was asked why Baptist Healthcare System selected Allscripts for their affiliated physicians, instead of their in-patient provider McKesson, Jackie said, and I quote, "We looked at the State of Kentucky, and we looked at our independent physicians and what products they already have implemented. And there were a large number of practices already on Allscripts. It was probably the dominant product, certainly in Kentucky and certainly in our physician practices." That same consideration played a role in another important second quarter win that we announced this morning,
St. Luke's Hospital and Healthcare Network in Bethlehem, Pennsylvania. St. Luke's is a very satisfied user of our Care Management Solution in its 4 hospitals. They selected Allscripts on our Electronic Health Record for their 400 employed physicians. St. Luke's will also offer to underwrite a portion of the cost of the EHR for their 1,200 affiliated physicians. A combination of satisfaction with our existing Care Management products, paired with our ambulatory market penetration, are key reasons why we beat Epic in a head-to-head competition with St. Luke's.
By the way, St. Luke's may not be known to some of you, but it should be. It's one of Pennsylvania's largest healthcare networks, serving 8 counties and over 1 million people, with 4 hospital locations and a fifth to open in the fall of 2011. It's not only a great organization with excellent leadership, but it is growing in influence and size. It's an ideal fit for Allscripts.
Recent wins like St. Luke's, Heritage, West Penn and Baptist Healthcare System confirm that our cross-selling effort continues to pay dividends. On that note, I'm excited to announce that later this month, at the Allscripts Client Experience or ACE, our user group meeting which takes place in Nashville, approximately 5,000 attendees will see the full integration of our ambulatory enterprise Electronic Health Record with our Acute Sunrise Clinical Manager running live in production at one of our sites. This fulfills the timetable we set out when we announced the merger.
While there is more work to be done, we're making solid progress towards achieving our vision of a connected community of health. And on that subject, I'd like to introduce Cliff Meltzer. Cliff held senior development leadership post at Apple, Cisco and IBM, including extensive experience integrating technology platforms. We recruited Cliff away from his most recent assignment at CA Technologies, where he led a 1,400-member development team as Chief Development Officer. I couldn't be happier that we were able to attract someone with Cliff's world-class leadership skills and experience at some of the world's top technology companies. Cliff, why don't you say a few words?
Thanks, Glen. I'm extremely enthusiastic about contributing to the team. I joined Allscripts because the intersection of healthcare and technology represents one of the most socially relevant challenges and business opportunities in the market today. And my past experiences have all prepared me for this opportunity. My time in Apple provided insight as to better navigate how we enhance our product's design efforts and user interfaces, including our new iPad applications. My time at Cisco positioned me well to assist as we connect all key constituents in healthcare, most importantly the patient. And my time at IBM, gives me a strong systems view into how to use information to informate the decision process all 3 companies, by the way, our strong partners with Allscripts today.
So bottom line, I'm thrilled to be part of a company that's making such an important impact on healthcare, and I can tell you that I'm already deep into the issues and enjoying the challenge.
Thanks, Cliff. As most of you know, we announced Cliff's hiring, at the same time we announce the hiring of 3 other key executives. Steve Shute joined Allscripts as Executive Vice President of Sales, and will lead our sales organization. Steve is a veteran sales leader who was most recently Vice President of Worldwide Sales for Enterprise Content Management at IBM. Jackie Studer, our new General Counsel comes to us from GE Healthcare IT, where she spent 8 years most recently as General Counsel. Jackie has hit the ground running and brings broad experience in everything we do. And John Guevara, a seasoned leader with extensive success leading mission-critical operations for Microsoft and other top technology companies, joined Allscripts as Chief Information Officer. John already has a few months under his belt and will play an increasingly important role as we expand our hosting options.
Overall, I'm very confident that the team we now have in place will build on our success and take us to the next level of execution, while allowing us to accelerate into what we believe is a very vibrant market.
And with that, I'll turn the call over to Bill Davis to take us through the detailed financials. Bill?
Thanks, Glen, and good afternoon, everyone. Before I begin, I encourage you to review the GAAP and the non-GAAP financial tables in the press release issued earlier today, and accompanying explanations to assist you in evaluating and reconciling our GAAP and non-GAAP financial metrics that we will discuss on today's call. As a reminder, please note that Allscripts' 2011 second quarter financial statements include consolidated results for both Allscripts and Eclipsys for the 3-months ended June 30, 2011.
Given our change to a December fiscal year last August, historical consolidated results of Allscripts on both a GAAP and non-GAAP basis as well as bookings will recast to provide comparative results for the 3 months ended June 30, 2010. This information is available in the non-GAAP statement included in our press release, as well as the supplemental booking schedule we published at the time of our first quarter 2011 release. This data is also posted on our website at investors.allscripts.com\webcast and the presentations as well.
I'm excited to discuss our second quarter results and would like to start out by highlighting the following: As Glen indicated, our second quarter bookings of $244.6 million represent 15% sequential growth versus the $212.4 million we reported in the first quarter of this year. The quality and breadth of product mix within new sales was very strong, and I will elaborate on those details in a few moments.
Non-GAAP revenue growth was 11% year-over-year in the quarter, driven by a 14% increase in Systems revenue and 19% top line growth in our Professional Services. Non-GAAP operating margin expansion year-over-year of 280 basis points was driven by sustained realization of cost synergies, even while our total R&D spending actually increased approximately 5% year-over-year.
Our non-GAAP net income growth was 20%. Non-GAAP EPS was $0.22 per share, up 22% over the year-ago quarter and cash flow from operations was $52.3 million. We were able to repay an additional $25.5 million of our outstanding debt, and we also repurchased $50 million in Allscripts common stock in the quarter.
Taken altogether, we think this is a great quarter. We continue to grow our industry-leading footprint by expanding market as well as market share. We are exceeding our financial objectives even while increasing our investment in future growth. We delivered sustained cost synergies and continue to generate strong predictable cash flow.
Turning to bookings, there are 2 main takeaways from my perspective. First, the underlying year-over-year growth in new system sales is very strong; and secondly, the quality of our bookings is exceptional and reflects an improving competitive win rate for new clients, plus meaningful growth within our existing base. The latter point is illustrated as a lesser of the long-term value we are creating and the strong alignment of our clients with the Allscripts' vision for transforming healthcare.
With regard to bookings growth, as you can see, the $244.6 million we posted in the second quarter constitutes 15% growth sequentially over the first quarter bookings of $212.4 million. In terms of total bookings growth, consistent with what I indicated on our first quarter call, the $234.6 million in bookings one year ago includes 2 non-reocurring items. First approximately $17.5 million from a large IT outsourcing agreement that was not repeated this year, and second, as you'll recall, Allscripts was on a May fiscal year last year, thus we estimate they were somewhere between $15 million to $20 million of year-end seasonality in the comparable period a year ago. Adjusting for these items reveals that we believe to be a more realistic and more normalized year-over-year growth rate of approximately 22%, comfortably ahead of the 15% to 20% growth we've discussed as new system sales booking growth rate for Allscripts.
Turning to our booking mix. We saw a continuation of 3 trends we discussed on our first quarter call. First, new Sunrise Enterprise footprint sales continues to expand. Second, a terrific quarter of add-on sales across our entire base. And then third, incremental gains in the ambulatory market, particularly in the small and mid-sized, physician practices. In the Hospital segment, as Glen indicated, we added 2 new Sunrise clients, Heritage Valley Health System and Hannibal Regional Healthcare System, which again, closed earlier in the second quarter. We also are very excited about our preproduction agreement facilitating the first stage of South Australia. As Glen indicated, we anticipate the second and larger contracts with SA Health to sign in the second half of the year, most likely in our fourth quarter.
Our ambulatory sales were also very strong in the quarter. We had solid growth in Enterprise EHR, particularly with add-on sales to our existing clients. Our Professional EHR sales continued to show consistent growth, up year-over-year in the 20% plus range. Finally, sales of our MyWay EHR to the Allscripts distribution network and is part of our community EHR solution, continues to demonstrate very significant growth, both sequentially and year-over-year. To put a final point on the market dynamics within the least penetrated market segment for Electronic Health Records, the subside physician segment, we saw nearly a threefold increase in dollar sales with MyWay products over the last year and very healthy growth over the first quarter.
The dollars in our Channel segment remain relatively small as a percentage of our total bookings, reflecting the still low penetration of EHR into the subsite physician market. Nevertheless, we expect substantial growth and market share gain as the federal incentive program continues to gain momentum and publicity among community physicians continued. In addition, physician consolidation and affiliation trends with hospitals and healthcare delivery networks will continue to drive significant growth in this market segment.
Now I know many of you were also interested in our international growth outside North America and its relative contribution to this quarter. As Glen indicated, there was less than $5 million of booking related to the South Australia contract we announced this afternoon. The year-ago period included approximately $8 million in international bookings, largely from Pantai Holdings in Malaysia. So as you can see, the growth, quality and breadth of our new bookings are in our view among the best in the industry.
In terms of license versus subscription, or bookings mix, SaaS or software as a service transactions totaled approximately $48 million or 20% of our second quarter bookings. This result is consistent with our first quarter performance. Please remember that most of this quarter's SaaS bookings will be recognized as revenues over the next 48 months.
Regarding backlog, Allscripts ended the second quarter with approximately $2.73 billion in total backlog, up approximately $16 million compared to the end of the first quarter. Approximately 83% of our backlog is derived from multi-year reoccurring revenue sources, including maintenance, subscription contracts, outsourcing engagement, remote hosting contracts and transaction processing fees. This figure is consistent with our first quarter.
Backlog at quarter-end is allocated as follows: Software and related professional services represents approximately $467 million of our reported backlog. Subscriptions and fast backlog totaled approximately $635 million. Maintenance fees represented approximately $779 million of our reported backlog. This backlog category primarily consist of annual maintenance fees for our ambulatory clients and multi-year maintenance fees among our acute care clients, generally averaging approximately 4 years in duration. A significant number of our acute care renewals, particularly existing clients, accounted for the majority of increase in maintenance backlog this quarter. Please remember, we do not include maintenance in our quarterly bookings metric.
Finally we ended the quarter with approximately $851 million of transaction and other backlog revenue, which principally consists of Allscripts outsourcing, acute remote hosting and transaction fees from our Payerpath business.
I want to turn now to highlights of our income statement and a few notable items. Non-GAAP revenues were $363.5 million or 11% growth when compared to the second quarter a year ago. Q2 2011 non-GAAP revenue includes approximately $6.7 million of acquisition-related deferred revenue adjustments in connection with the Eclipsys merger. Non-GAAP revenue and gross profit by line item is derived by allocating the deferred revenue adjustment as follows: Approximately $1 million pertains to Professional Services, $2.9 million related to maintenance and another $2.9 million related to transaction processing and other. It's important to note that approximately 2/3 or 65% of revenue was reoccurring in the quarter and is consistent with prior quarters.
Looking at top line growth profile this quarter, non-GAAP system sales grew approximately 14% and Professional Services grew approximately 19%, both our year-over-year comparisons. System sales revenue growth of 14% accelerated meaningfully during the quarter versus Q1. This reflects the add-on client sales we discussed earlier, again particularly in our Acute Care segment. Professional Services revenue growth reflects our continued focus on Meaningful Use upgrades among our client base, especially within our Sunrise base. This upgrade activity is at a peak level now, and we expect it to continue through the summer and begin to taper off somewhat as we proceed to the balance of 2011.
Transaction processing and other revenue grew approximately 14% year-over-year on a non-GAAP basis. We saw strong double-digit growth in ePrescribing, our SaaS service offering, as well as outsourcing revenue. Finally, non-GAAP maintenance revenue was up 3% year-over-year. A couple of items impacted this figure that I would like to highlight. First, year-over-year comparisons are challenging, as we did not pass through price increases at the same rate this year as we did in 2010. And this was motivated by the anticipated incremental costs our clients are incurring this year to facilitate Meaningful Use version upgrades. Second, there are a number of clients rolling off our legacy Misys maintenance contracts and are moving on to our professional platform or our SaaS offerings, thereby, moving same client revenue to our transaction processing revenue line.
Finally, as we have discussed, and you saw on our first quarter results, new enterprise ambulatory clients are coming online at a slightly slower pace now as we focus our resources towards a balance of Meaningful Use upgrades and new client installs, which has always been our plan in 2011.
Attrition has not changed, and our client retention rate remains in excess of approximately 97%. Over time, we continue to expect maintenance growth will be in the low to mid-single digits overall, given the size of our installed base and the fact that much of that base will continue to be subject to CPI growth.
Turning to gross margins. Our non-GAAP gross margins were down 130 basis points over last year and quarter-over-quarter. While new system gross margins were up meaningfully in the quarter, this was offset by approximately $1.5 million in incremental merit bonus in the quarter. In addition, acquisition-related amortization, which we do not exclude from our gross margin calculation, drove a $4 million or 110 basis point negative swing in gross profit when you compare to a year ago.
On a sequential basis, the 130 basis point decline in gross profit was driven by the previously mentioned merit bonus increase, as well as a $1.8 million increase in amortization of capitalized software, as well as higher use of third-party contractors within our service organization in the quarter. Overall, pricing trends remain stable for our new business, with firm pricing across solutions that we offer. Gross margins should increase slightly as we progress through the second half of 2011.
Non-GAAP operating profit margins were 20.5% and improved 280 basis points year-over-year and were flat sequentially. We continue to be on track for at least $25 million in cost synergies attained this year and $35 million in 2012 and $40 million in 2013 and beyond.
Research and development expense totaled approximately $37.8 million, again a 5% increase year-over-year and also represents a slight increase over the first quarter. We think this is a notable achievement as we continue to invest in our business to drive future growth and innovation into our solutions. Capitalized software attributable to R&D totaled approximately $13 million or approximately 34% of gross R&D spend, which is down from 40% in Q1. This marks the second quarter of declining capitalized software on a percentage basis, which is consistent with the previous guidance that we've provided.
Software amortization totaled $5.4 million, up from $3.6 million in Q1, yielding a net capitalization rate of approximately 20% in the second quarter, which is down from 31% in Q1.
Turning to net income and earnings per share, after adjusting for stock-based compensation, acquisition-related adjustments and tax rate alignment to reflect the 39% effective tax rate, non-GAAP net income totaled $42.5 million or 20% growth over the second quarter of 2010. And non-GAAP diluted earnings per share totaled $0.22 per share versus $0.18 per share, which represents 22% growth in 2011, again on a non-GAAP basis.
Turning to our balance sheet and liquidity, Allscripts ended the quarter with approximately $117 million in cash and marketable securities, a decrease of approximately $30 million versus March quarter end, reflecting our share repurchase program, which I'll discuss in more detail in a moment. Cash flow from operating activities were very solid, totaling approximately $52.3 million, while free cash flow, after capital expenditures and capitalized software, totaled approximately $29 million in the quarter.
Allscripts continues to build an enviable record of generating stable, predictable and sustainable free cash flow, thereby allowing us to continue to reduce our debt at a rapid pace, invest in future growth and buy back common stock, all moves that we believe will create sustainable growth for our shareholders.
Allscripts accounts receivable ended the quarter at $356.9 million, which equates to days sales outstanding or DSOs of approximately 89 days, up 5 days from March 31. The uptick in DSO this quarter was due to the timing of certain large billings at the end of the quarter, which explains the increase that you'll see in our deferred revenue balance as well. We anticipate DSOs will decline back to the mid 80-day range in the second half of 2011.
Turning to debt, Allscripts reduced its outstanding debt by approximately $25.5 million in the second quarter, resulting in outstanding borrowings of approximately $423 million as of June 30. We have reduced our borrowings by $147 million since inception of these facilities in August of 2010. Regarding our share repurchase program that we announced in May, Allscripts has repurchased $50 million of common stock during the quarter, totaling approximately 2.6 million shares at an average share price of $19.51 per share. Thus, we have approximately $150 million remaining under the 3-year $200 million share repurchase program authorized by our board.
Finally, we ended the quarter with approximately 5,900 employees, which is up from 5,800 at the end of our first quarter.
Before I turn the call back over to Glen, I did want to make a few comments regarding our 2011 guidance. In terms of guidance, we are updating to the high-end of our existing guidance range. Specifically, non-GAAP revenue is now anticipated to be in the range of $1.44 billion to $1.45 billion versus a range of approximately $1.425 billion to $1.45 billion previously. We anticipate non-GAAP operating income of approximately $305 million to $308 million, non-GAAP operating margin of approximately 21% and non-GAAP net income of approximately $172 million to $176 million, equating to non-GAAP EPS range of between $0.88 to $0.90 per share, which is up from the previously communicated range of $0.86 to $0.90 per share.
We have adjusted down our anticipated interest expense, given the rate at which we've been reducing debt and the impact of our debt refinancing in the first quarter. In addition, we have assumed slightly higher stock-based compensation expense, $44 million, for 2011 versus $40 million previously communicated in light of additional stock grants to our new senior-level executives.
Finally, I want to provide some color on the line down of transaction-related expenses. We anticipate that all remaining acquisition-related expenses are known, and as such, our third quarter transaction-related expenses will be approximately $8 million. Starting in the fourth quarter, we anticipate the remaining retention bonus payment and stock compensation expense related to the 2-year retention agreements provided to certain executives at the time of the merger will be approximately $3 million per quarter through the third quarter of 2012.
In terms of thinking about our bookings expectations in the third quarter, I would note that we typically experienced a summer lull that can result in third quarter contributing the least on a percentage basis to the year's total booking, resulting in a sequentially flat or slightly down comparison as is typical in the industry. At the same time, we expect reported year-over-year bookings growth to accelerate markedly relative to this quarter, and be more in line with the underlying growth of 18% to 20% we discussed earlier for new system sales booking, as we approach the anniversary of the merger and largely eliminate the comparison issues that existed in the first half of 2011.
As I hope Glen and I have clearly relayed to you on this call, we are very pleased with the company's performance this quarter and year-to-date.
Thanks for your attention, and we look forward to taking your questions after Glen makes a few closing remarks.
Thanks, Bill. So to sum up, we are delivering both strategically and operationally. We have a broad and growing portfolio of solutions that is increasingly attractive to all segments of the market, and we're confident that our growth will continue. The industry is changing, and Allscripts will continue to respond to its needs and continue to innovate. We do that in part through a great group of clients, who give us the opportunity to make a difference, and with an extraordinary team of our employees who, along with our shareholders, are committed to delivering on our mission and vision.
And with that, we will now be happy to take your questions. Alicia, if you'd open up the lines, that would be great.
[Operator Instructions] Our first question comes from the line of Michael Cherny with Deutsche Bank.
So just -- I want to dig into the Heritage deal a bit, in terms of using that as a microcosm for the rest of your client experiences. You, obviously, that was a legacy Allscripts customers that you were able to cross sell with the Sunrise portfolio. Can you talk about just as you were selling those products, what was the key selling points for them, that they decide they want to go with the legacy Sunrise products and kind of, was it the connectivity was it experience with Allscripts from a service perspective? Just walk us through a little bit of the sales cycle there, just to give a sense in terms of how that relates to some of the other conversations.
I think it always begins with client satisfaction. If the client is not happy, they're not going to buy from you. So that's the first step, which is they were happy with the offerings they had. They have received grants on their ePrescribing program and they were happy with their Electronic Health Record rollout. And from there, it just made sense as they looked at what's the next step. In addition, we keep coming back to this idea of market penetration. And in the Pittsburgh market, it's a great market for us, we have a lot of connectivity and penetration. Heritage is one of the ring hospitals, if you understand how that market is set up and connectivity is important to them as well. But this is a very innovative group, a very innovative organization, a very innovative group of leaders there. And so it was a big win for us. And I think it's consistent with what we said. What we said was, we got to take Allscripts products, sell them into the legacy Eclipsys space and we got to take legacy Eclipsys products primarily SCM and sell them to former Allscripts clients, and we've done that. So one other note I make is that we have more than 20,000 physicians in the State of Pennsylvania. So again, that kind of penetration, when you talk about connectivity, when you talk about hospitals, who want to get their lifeblood referrals, that becomes a very important part of selling proposition. So it's an agreement that we're very proud of. And again, that's a big part of our future, making those kind of sales.
Great. And then just in terms of Australia, it's nice to see the first tranche of that deal. Are we at a point now where you can give us updated expectations in terms of what the full scope of that deal could end up contributing from a bookings perspective, or is it still too early to figure that out?
Well, I think -- let me just comment on the deal. We're excited about it because the first step was the development lab, the implementation, the planning, that's now underway in a big way. We're starting to exchange tremendous amount of information and the like, and we continue to say that that's something that we expect to deliver in total by the end of the year and that's 80 hospitals. So it's a very substantial bookings for us in that respect. I'll let Bill comment on how that's going to drop to the extent we want to make any comments.
Well, I would just reiterate what I've said in the past, and we have indicated that this deal will likely represent one of the largest deals that the company has done on a combined basis. And we have sized that in terms of historically what margin deals we've ever done in the kind of $45 million to $50 million range. So I would encourage you to think about it, potentially a little bit north of that but not substantially north of that.
[Operator Instructions] Our next question comes from the line of George Hill from Citigroup.
Bill and Glen, first of all thanks for all the financial color. I don't know if it's just me but these seems like a lot more color than you guys previously given. I'm sure we all appreciate it. Let me bring up a topic we haven't talked about in a while, which is the transition from the Misys customer base to the Allscripts customer base. You guys brought it up in this call. I guess, can you talk about the contribution of that segment of the business to the bookings growth this quarter? And how should we think about where that legacy customer base is from a technology perspective on the upgrade cycle and how much room is left around with those guys?
Yes, we don't break it out separately to the market. I appreciate your acknowledgment, Bill has worked very hard with his team, with Seth and the group to make sure that we're giving you a really strong view into the analytics, because we think the quality of our earnings is substantially better than some of our competitors who are reporting. So number 1, I just wanted to thank you for recognizing that. That said, relative to the Misys space, we've spent a lot of time we have in upgrade program underway that allows them to easily and painlessly convert to the existing supported products that we have and we've made good traction there, we continue to make good traction there. And I think there's still a significant amount of room to run. One thing I'll say about a lot of the Misys Practice Management products, they were solid kind of working products and they continue to work. So really, what's going to start to happen now is that, that second half of the base, if you will, the ones that haven't converted are going to start to convert as they start to upgrade to Electronic Health Records and go for Meaningful Use, and we'll start to see that in the next 6 to 12 months. But we've seen a constant steady stream of that, we made real good progress.
What I would add to that, George, while we're recognizing that, that base is largely in the medium- to smaller-sized segment of the market. We've seen adoption of Electronic Health Records in that base, keep pace if not slightly better than the broader market adoption in those subsegments. So we've been very pleased. I'd also would underscore the retention comment that I made earlier. So we are very optimistic that as they make Electronic Health Records decisions, we are revered in the market as being the safe and logical choice for them in that context. So again, it serves to be a great opportunity for us as we look forward.
Good to hear that you guys are holding on to those. Maybe I can sneak one more and then -- Bill, you talked about not taking the price increases on service and maintenance as customers are going through the upgrade cycle. I imagine that is benefiting the systems sales line and kind of holding back the maintenance line a little bit. Can you give us anything directionally around the degree to which that's impacting those lines?
Yes. Again, it's actually the -- it's showing up more and that -- it showing up on the service, professional service line as opposed to the system line because in lieu of a maintenance increase, if you will, they are paying us upgrade fees, which again is largely service or professional service based. And as I've indicated, recognizing a substantial portion of our maintenance is effectively subject to CPI, we typically define it being as kind of 2% to 3%. That's effectively what has been potentially foregone. But again, that -- it wasn't across-the-board. We were very specific just in terms of where that was pulled in terms of a trade-off in recognizing what the clients were taking on this year.
Okay. So that -- this is being done client by client then?
Our next question comes from the line of Jamie Stockton with Morgan Keegan.
Bill, on the transaction process and other line. A couple of questions there. One, the costs look like they ramped a fair amount sequentially. I know you talked about some merit and I'm going through that, I know that it would be hitting that segment. I was curious if maybe there was anything related to the ACS deal that would be going on there?
No, actually it's -- we did see a nice uptick in outsourcing revenue in the quarter. And so the incremental cost is a complement of the bonus that pertains to that segment but more notably on the outsourcing revenue.
Okay. and then, I guess, on the same line, just looking at the backlog. It looks like, if my numbers are right, it was down a little sequentially. Is that, that duration is coming in a little bit for the contracts that you have in place or can you give us any...
Yes, a great question. It really pertains to just the timing of bookings, again, specifically to the outsourcing arrangement. These are long-term arrangements and they will ebb and flow from quarter-to-quarter. So the timing of booking is one. Second is the revenue uptick. It was up sequentially about $5 million, and this was related to increased activation support in one of our large outsourcing arrangements there in the second quarter. And so it's really those 2 dynamics that drove the backlog, the slight decline. Again, that will change from quarter-to-quarter, just recognizing the long-term nature of those relationships.
Great. Last question, SCM outsourcing, you guys have started to talk about it a little more lately. What kind of a contribution does that make today? I know it's very small and where do you think that business can go? And that's it for me.
I'll comment, in terms of its contribution today, I mean, we have a whole host of products that we sell and have been selling that are a meaningful part of our overall performance. I think what you're speaking to in terms of the broader service offering, that is representing virtually no contribution to our financial performance today. We are taking the migration in terms of that offering very slow, in terms of making certain we have our Ts crossed and our Is dotted, just in terms of the requisite infrastructure and operations to ensure that we do it on the right way. So that will take some time to manifest itself in our financial results.
Our next question comes from the line of Atif Rahim with JPMorgan.
Question for Bill. On the 3Q bookings, are there any one-time items that were present in the year-ago quarter similar to what you've called out, call it, the first and second quarters?
No. I mean, I think as I've intimated before, I think the comparability of our booking results, most notably in Q3 and Q4 of last year become a lot cleaner than certainly what we were dealing with in Q1 and Q2. So there are no notable callouts in terms of the year-ago comparison. And again, why I feel comfortable in terms of the reasonable growth rates that I described. We should be able to deliver on those.
Got it, okay. Glen, you talked about the physician market. You're definitely gaining share there. On the hospital market, the data that's coming out seems to imply that you're net down in 2010, and perhaps that was a legacy Eclipsys issue. But as you look to 2011, and which you've done so far in terms of wins versus losses, should we expect '11 to be a year where you're up in terms of the number of hospitals you have?
Yes, absolutely. I think you can expect that we will be up over the course of the full year. And I think you'll see solid growth there. That said, we should understand that putting together the offering, making the case, which we are increasingly getting by into why people want to go with us, whether it's architecture. We have a modern architecture based on Microsoft.NET and the new Microsoft technologies versus some of the other architectures that make it hard to connect, hard to exchange information. If you look at what the advisory board has said, it said we're best positioned relative to what's coming on ACOs and the like, which is the ability to use our system to drive insights and better outcomes. As those kinds of messages get out along with the sense of what do hospitals want to do? They want to connect with those people who refer to them, which are small to mid-sized physician practices. And we have 50,000 of them, who they can connect to. No one else is close. I mean, everybody on the call understands that traditionally, the large hospital vendors have not had competitive ambulatory products. And today, we are the only one who competes against -- competes across ambulatory, acute and post-acute. And as you start to look at where the market's going, that's very important. Let me make one other point, and that is, Oliver Wyman did a study that said that 93% of the market can't afford to rip and replace, and can't be dependent on one set of architectures. What they need to do is use what they have, build upon that, fill in the gap. Only 7% have enough money, enough time and essentially kind of the monopolies in the area to do that. So we compete in 100% of that market. Some of that is at the very high end, where we're competing and winning. You heard me talk about 2 of our substantial wins that we're head-to-head against our 2 primary competitors at the high end. But moreover, when you look at the community hospitals, when you look at that mid-market, we're going to make substantial traction there. And that story is coming together, we're going to have it at the end of the month at ACE as I mentioned. There are more than, close to 5,000 of our clients who are going to see that story come together. We're going to deliver on the integration that we talked about. So we are very bullish on what's happening in the high-end SCM market.
Okay, that's very helpful. And then just in terms of the latest contracts you've announced, looks like there's 3 big ones in Pennsylvania. Anything going on there that gives you somewhat of a larger presence than in other regions, or is it just a coincidence?
Well, I think it's coincidental, although I would say, we've got great penetration, we've had great results in Pennsylvania. So that word spreads pretty quickly. But the northeast was traditionally strong for legacy Eclipsys. That's helpful. So those markets are strong, but we see it happening. I mean, you're going to see those kinds of agreements happen across the country as SCM really begins to take off. We know this is the best software in the market today. And there have been a number of reasons that it wasn't promoted that way. But I think that has come off and if you talk to anyone, even some of our competitors, their clients, they'll tell you that the best market used by the best customers or the best software, I should say, used by the best customers is our Sunrise software. And we have to get out there and make that case to the market. And we're going to do that. The big effort that Steve Schute is going to lead is making sure that we deliver that message and that's going to result in sales. Now the high-end is an incredibly vibrant growth market opportunity. People talked about between 300 and 400 large acute deals happening in the next 18 to 24 months. And we expect to get more than our fair share of that and we think we're well positioned to do it.
Our next question comes from the line of Eric Coldwell with Robert W. Baird.
Just following up on Atif's question and your answer to that. You talked about making sure you get out in the market with your message. Is this kind of a trial balloon or a signal that perhaps we could see some SG&A increase as we go into 2012? Or longer term, are you still thinking that margin expansion is clearly on the table, net of all other adjustments? How do we think about that?
I think, there's 2 answers. I'll answer that and then Bill can comment as well. But what I'll tell you is, we have everything we need from a sales perspective, now it's about telling the story. The first thing was as we look at the merger, people said, "Well, can they work together, continuing to deliver?" Then, "Can they cross-sell?" Then, "Can they sell in both directions?" And then the final question was, "Does the software work together well?" Each one of those, we've knocked off quarter-by-quarter as we continue to educate the sales force, as we continue to educate our clients and they see what we can deliver. Now what you've already started to see is, we're actually starting to run the first ad that, I'm not sure if Eclipsys ever ran ads, but they sure haven't run ads recently, nor had Allscripts to tell the story not of us, not of our software but of the successful outcomes of our clients and we're delivering. We're #1 in CPOE, we have been for a long time. We're #1 in utilization, we're #1 in electronic prescribing. And in the world of Meaningful Use, where it all gets measured, that kind of stuff becomes very important. And in terms of physicians wanting to use the system, again, those metrics are important. So I don't think that we need anything more than we have today. We just have to get out there and tell the new story. Bill?
I just would underscore that we absolutely believe that margin expansion is very much of our financial model. And we remain committed to delivering that. So there was no intended message in Glen's early remarks.
That's great. And I'll treat that as my follow-up to Atif's question. And my main question is actually on the affiliated physician group selling activity that you're seeing. I believe in the past, you've talked about UPMC and maybe Long Island Jewish, some others, St. Lukes, now that are actually supporting the community physicians and helping them to write the product. Is there any way you could quantify what kind of market activity you're seeing there? What may be the total affiliated physicians that hospital CFOs are supporting now in these affiliate programs? Any sense we could get on the size of that opportunity and how much you expect that to grow?
Let me say, again, as you look at the market, there's a few things happening. One, you have hospitals who are trying to buy practices. We benefit from that to the extent they own these practices, they need software. We have other practices, multi-specialty groups, they are growing larger. And then you have a hospitals that are providing endorsements and those endorsements, as you heard me talk about today come in the form of funding. So we had talked about too. What I can tell you is that we have a more than 20,000 slots that are essentially pre-endorsed or funded at some level ready to be sold by hospital partners. And those vary across a variety of markets, stretching from California markets to the Northeast, to almost every area of the country. And that's, again, a key selling item because those hospital endorsements, if you wanted to endorse some of our competitors who have hospital products, it's very difficult to deploy those products both from an architecture standpoint, try putting MUMPS into a small office and from just a usability standpoint. So when we're out there, these hospitals are using our Sunrise systems at the hospital level, and then as they roll out, they might be using Enterprise, they might be using professional, they might be using MyWay or a combination thereof. And that's what makes the offer so powerful, as they understand that, we see the attraction.
Our next question comes from the line of Charles Rhyee with Cowen.
I don't know if Cliff is still on the call here, but I was curious maybe to get his early impressions here. I think in your comments, Cliff -- is he still on?
He is still on.
Okay. Yes, you said you're already sort of getting your arms deep into sort of the issues. Maybe if you could just give us a sense on what you're seeing so far, and obviously you talked about the experiences you bring. Maybe as you take a first look, where do you see sort of the biggest opportunities to move forward perhaps from a product development stance? Maybe I'll start there.
I'll just add that we've been dragging Cliff all around the country. I think he's been at every one of our development sites, and he's headed over to India next week or the week after. But in addition, he's been at a substantial number of our client sites and of course, ACE will give him the opportunity here directly. This is very -- this is stuff that Cliff has done before in a number of different companies, and so that's what made him so appealing for us to get on board here.
Great. And then maybe a follow-up for Bill. Maybe I missed it here, what sort of the expectation and the guidance for the tax rate? And in terms of the share count guidance, clearly with the stock where it is, can you give us any thoughts here on sort of how aggressive the company can be in terms of buying back stock? Because if I look at the guidance, it's for still 194 million shares for the full year, and we're already sitting here at a 193 million. Maybe some thoughts there.
So we have not built into the guidance any additional buyback. As I've intimated in the past, we will obviously look for opportunity to exercise our commitment in terms of the 3-year program. We've not made any specific commitments in any particular quarter, and I'd be hesitant to do that at this juncture. So to the extent we do that, that will represent incremental upside to our share count assumptions and results and EPS for the year. In terms of tax rate, here again, we are doing a lot of work in terms of bringing organizations together from a tax profile perspective and planning perspective. And I do see opportunity there. I think that candidly, I'm being conservative in my assumptions in terms of what's being conveyed but I do at the same time expect that much of what we're focused on will start to present itself most likely end of Q3, beginning of Q4. So it's contribution to this full year will be less than what I expect in 2012. So I do expect that we're going to come back to the market and share some positive direction on tax rate. But again, I would expect that that's going to start to show up more in 2012 than 2011 .
And then just to clarify, on the share repurchase program, the 3-year program, is there anything in terms of timing requirements that limit you or is it just that the programs 3 years in length and it's up to the company and the board to decide when to exercise it?
Yes, it's really the latter in terms of the discretion and our commitment to fulfill the program over that 3-year period. And our commitment in turn to the market is that we would provide updates, formal updates each quarter, which we fully intend to do on these calls.
There's no limits.
Yes, there's no limitation.
The board and management will determine how to spend that based on what we perceive the valuation of the stock to be.
Our final question comes from the line of Larry Marsh with Barclays Capital.
Just a big picture question for Glen, you're defining, you said the $300 million to $400 million enterprise decisions over the next 12 to 18 months. As you think about in your mind, how many of those decisions in the market have been made? And you said you'd be disappointed if you didn't get your fair share. Is that 50 to 60 or a lot more than that, or how do you quantify that?
Let me say a few things. One, I believe what we're seeing, we're just at the beginning of this transformation. So what we're starting to see is not only those people who don't have existing systems but even people with systems are talking about upgrades. And you know I talked about the difference between Meaningful Use and minimum use. And the idea is that people are starting to say, "Hey, we understand there's a sea change going on, this is now about information, we need better information systems and we need software that's going to give us that extra kick." So we don't see this as a one-time upgrade. We've got a lot going on. Now that said, Larry, I think that if you look at the market, we said there's going to be hundreds of decisions and you look at a really a 2-year window, and you look at us being under any set of circumstances in the top 3, I would argue in the top 2 right now and eventually #1 in the market in terms of the assets that we have. You have to do some planning. But I'd be hesitant before we come out with guidance, official guidance. When we do that, I think we'll have -- we'll give you some visibility into what we expect that to be. But most people believe that after we did the merger, it would be a year where no one would buy anything from us. And I think you're seeing substantial decisions already getting made, and I can assure you that the pipeline has grown in terms of the high-end SCM decisions. So we see a vibrant market opportunity.
Okay, very good. And just a quick follow-up to Bill. You're communicating the 18% to 20% rough growth in bookings from Q3 last year, it was down sequentially, I guess that would compare to the 198 in Q3 of 2010. And then as we -- I know you're not talking about Q4, but I know that's a tougher comparison with Q4 being strong last year. Should we still think of the same kind of growth rate off of that number for the end of the year?
Yes. So the 198 comparison for Q3 is what I was absolutely contemplating when I made the 18% to 20% growth. So that's correct. I really candidly would like the benefit of working through the third quarter before I comment specifically on the fourth quarter. The one specific callout I would make is, again, anticipation of the South Australia deal, and that would obviously be helpful in the context of relative growth off of that period. But going beyond that at this point, I prefer not to do it.
Again, I just want to thank everybody for joining us on the call. We continue to believe that we are extremely well positioned in a very vibrant growth market. It's a market that's growing now, that's being stimulated by the government. But frankly, the real stimulus here is that we got to improve healthcare from a cost standpoint, a quality standpoint. And we think we're making the right decisions to do that both for today's market and for the future market in terms of information and services and the like. So thanks for joining us. We look forward to talking with you next quarter.
And this concludes today's conference call. You may now disconnect.
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