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Cerner (NASDAQ:CERN)

Q1 2012 Earnings Call

April 26, 2012 4:30 pm ET

Executives

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

Zane M. Burke - Executive Vice President of Client Organization

Michael R. Nill - Chief Operating Officer and Executive Vice President

Jeffrey A. Townsend - Chief of Staff and Executive Vice President

Analysts

David Larsen - Leerink Swann LLC, Research Division

Sebastian Paquette - Goldman Sachs Group Inc., Research Division

George Hill - Citigroup Inc, Research Division

Kipp R.F. Davis - Barclays Capital, Research Division

Steven Halper

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

Donald Hooker - Morgan Stanley, Research Division

Atif A Rahim - JP Morgan Chase & Co, Research Division

Sean W. Wieland - Piper Jaffray Companies, Research Division

Operator

Good day, ladies and gentlemen, and welcome to Cerner Corporation's First Quarter 2012 Conference Call. Today's date is April 26, 2012, and this call is being recorded. The company has asked me to remind you that various remarks made here today by Cerner's management about future expectations, plans, prospectives and prospects constitute forward-looking statements for the purpose of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading risk factors under Item 1A in Cerner's Form 10-K, together with other reports that are on file with the SEC. A reconciliation of non-GAAP financial measures discussed in this earnings call can be found in the company's earnings release that was furnished to the SEC today and posted on the investors section of cerner.com. At this time, I'd like to turn the call over to Mr. Marc Naughton, Chief Financial Officer of Cerner Corporation. Please proceed, sir.

Marc G. Naughton

Thank you, Anne. Good afternoon, everyone, and welcome to the call. I'll lead off today with a review of the numbers. Zane Burke, Executive Vice President of our Client Organization will follow me with sales highlights and marketplace trends. Mike Neal, Executive Vice President and Chief Operating Officer will discuss operations. Mike will be followed by Jeff Townsend, Executive Vice President and Chief of Staff, who will discuss strategic initiatives. Neal Patterson, our Chairman, CEO and President will be available during Q&A.

Now I'll return to the results. We delivered strong results in the first quarter with all key metrics above our expected levels. Bookings exceeded the high end of our guidance range. Our income statement performance was excellent, with revenue and adjusted EPS well above expected levels and continued margin expansion and strong earnings growth. We also had very strong cash flow performance.

Moving to the details. Our total bookings revenue in Q1 was $652 million, which is a record for a first quarter. Bookings exceeded the high-end of our guidance range by more than $50 million and were up 24% from Q1 of 2011. Bookings margin in Q1 was $529 million or 81% of total bookings. As Zane will discuss, the strength of bookings in Q1 spanned across all business models and included a new ITWorks contract. Our bookings performance drove a 22% increase in total backlog to $6.27 billion. Contract revenue backlog of $5.57 billion is 25% higher than a year ago. Support revenue backlog totaled $704 million, up 6% year-over-year. Revenue in the quarter was $641.2 million, which is up 30% over Q1 of '11. The revenue composition for Q1 was $226 million in system sales, $146 million in support and maintenance, and $258 million in services, and $11 million in reimbursed travel. The upside relative to our guidance was largely driven by higher system sales, but service revenues was also very strong.

System sales revenue reflects 61% growth from Q1 of '11. This was driven by strong growth in software and subscriptions and especially strong growth in device resale and traditional hardware resale. Services revenue was up 23% compared to Q1 '11, with strong growth in both managed services and professional services. Support and maintenance revenue increased 11% over Q1 of '11.

Looking at revenue by geographic segment. Domestic revenue increased 32% year-over-year to $554 million, and global revenue was $87 million and grew 23% compared to the year-ago period.

Moving to gross margin. Our gross margin for Q1 was 75.4%, which is down from 78.6% in Q4 and 81.6% in Q1 of '11. The decline in our gross margin percentage was driven by the very strong levels of device and hardware resale that I discussed, which impacted the mix of system sales. While the gross margin percentage for the quarter was lower, total dollars of gross margin grew 21% from the year ago period and total margin from system sales grew 32%, driven by the strong growth in software and subscriptions.

As we've noted in the past, while revenue mix can impact our gross margin percentage in any given period, we continue to drive operating margin expansion and strong earnings growth, as I'll discuss in a minute.

Looking at operating spending, our first quarter operating expenses were $346.8 million before share-based compensation expense of $8.9 million. This is an increase of 16% compared to Q1 of '11. Sales and client service expenses increased 22% compared to Q1 of '11, driven by an increase in revenue generating associates in our services business. Our investment in software development was flat compared to the year ago period. We've been hiring in our R&D organization this year and expect our R&D investments to grow throughout the rest of 2012, but the growth will still be moderate compared to expected revenue growth.

G&A expense increased 12% compared to Q1 of '11, driven by personnel and other expenses related to an increase in hiring and training.

Moving to operating margins. Our operating margin in Q1 was 21.3% before share-based compensation expense and was up 70 basis points compared to Q1 of '11. Given the much higher mix of lower margin technical -- technology resale for this quarter, I am pleased with this level of margin expansion. Going forward, we expect the mix to normalize somewhat, which will allow us to deliver margin expansion in our 100- to 200-basis point target range for the year.

Moving to earnings and EPS. Our GAAP net earnings in Q1 were $88.7 million or $0.51 per diluted share. GAAP net earnings include share-based compensation expense, which had a net impact on earnings of $5.5 million or $0.03 per share. Adjusted net earnings were $94.2 million, and adjusted EPS was $0.54, which is up 35% compared to Q1 of '11. The tax rate for adjusted net earnings was 32.2%, which is lower than normal due primarily to a favorable tax settlement we previewed last quarter. Note that normalizing to a 35% tax rate, which in the range we would've expected for Q1 without the settlement, would reduce adjusted earnings per share by $0.02. For the balance of the year, we expect our effective tax rate to be between 35% and 36%.

Now move to our balance sheet. We ended Q1 with $1.27 billion of total cash and investments, up from $1.13 billion in Q4. Total cash and investments include $894 million of cash and short-term investments and $375 million of highly rated corporate and government bonds with maturities over one year. Our total debt, including capital lease obligations, is $153 million. Total receivables ended the quarter at $536 million, which is down $27 million from Q4. Contracts receivable or the unbooked billed portion of receivables were $85 million and represents 16% of total receivables. Cash collections were a record at $683 million. Our DSO in Q1 was 76 days, which is down from 83 days in Q4 and 87 days in Q1 of '11. Operating cash flow for the quarter was $162.7 million. Q1 capital expenditures were $26.4 million and capitalized software was $23.1 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was $113.3 million. We expect an increase in capital expenditures for the rest of the year. Some of this will be driven by the construction of additional space at our new Kansas City campus as needed for our growing associate base. Those costs will span multiple years and we'll also be receiving incentives that will offset a portion of the construction cost.

Moving to capitalized software, the $23.1 million of capitalized software in Q1 represents 31% of the $74.8 million of total investment in development activity. Software amortization for the quarter was $19.4 million, resulting in net capitalization of $3.7 million or 5% of our total R&D investment. For the rest of the year, we expect quarterly capitalized software of $23 million to $26 million and amortization of $20 million to $23 million per quarter.

Now I'll go through Q2 and full year guidance. For Q2, we expect revenue between $620 million and $640 million, with the midpoint reflecting growth of 20% over Q2 of '11. For the full year, we expect revenue between $2.525 billion and $2.6 billion, with the midpoint reflecting 16% growth. This is up from our previous range of $2.425 billion to $2.5 billion. We expect Q2 adjusted EPS before share-based compensation expense to be $0.52 to $0.54 per share, with the midpoint reflecting 20% growth over Q2 of '11. For the full year, we expect adjusted EPS between $2.25 and $2.32, with the midpoint reflecting 22% growth. This is up from our previous range of $2.20 to $2.30. Q2 guidance is based on total spending before share-based competition expense of approximately $350 million to $355 million. Our estimate for the impact of share-based compensation expense is $0.03 in Q2 and $0.12 to $0.14 for the full year.

Moving to bookings guidance. We expect bookings revenue in Q2 of $675 million to $715 million, with the high end of this range reflecting double-digit growth over our strong results in Q2 of '11 when bookings grew 39%.

In closing, we are pleased with our strong results in Q1, with all key metrics above our expected ranges, including strong bookings, revenue, earnings and cash flow and strong margin expansion. With that, let me turn the call over to Zane.

Zane M. Burke

Thanks, Marc. Good afternoon, everyone. Today I'm going to provide sales highlights and discuss marketplace trends, starting with our results. Our bookings revenue in Q1 of $652 million reflects 24% growth over last year, as all-time high for our first quarter. We had strong contributions from both inside our installed base and from key competitive wins outside of our base. While our ITWorks contracts and record levels of technology resale clearly contributed to our booking strength, there was also strength across all other business models. This broad strength is reflected in our large deal account, with 23 contracts over $5 million, including 13 over $10 million, both of which are record levels for our first quarter.

Regarding the record technology results. These were driven by yet another record level of device resale and an unusually strong quarter in traditional hardware resell. The hardware resell strength was primarily driven by 2 large deals, so we would expect hardware to return to normal levels, but we do expect ongoing strength in device resale. The demand to use Cerner as a single source for connected devices remains robust, and we continue to expand our relationships with existing device manufacturers and add new ones as they recognize the value of our device connectivity platform and the strategic relationships we have with our clients. A recently announced example of the value we provide in this space is the use of our iBus device connectivity platform to integrate infusion pumps and Cerner's EMR at Oklahoma Heart Hospital. This new offering helps hospitals improve patient safety and reduce medication and administration errors while also reducing the number of manual steps required to program an infusion order in as many as 16 down to 2 or 3.

Another recent announcement that highlights this strategic value of the relationships we have with our clients is our partnership with Advocate Health Care, a long-standing Cerner client that is widely recognized as a leader in population health management. As Jeff will discuss, this partnership will allow us to significantly advance our population health initiative. It will also increase our competitive differentiation and allow us to help our clients have a meaningful positive impact on the health of the communities they serve.

Now I’ll move to the position market, where we continue to strong results in Q1. We had an all-time high level of ambulatory bookings in Q1 that included 2 large IDN selecting Cerner to replace their existing ambulatory supplier. The enhancements we have made to our solutions and the marketplaces' desire to have an integrated solution across inpatient and outpatient venues is starting to be reflected in our results. We believe this trend will continue as we have several more large clients that chose best-of-breed ambulatory providers in the last 3 to 5 years that are now coming back to the market for an integrated solution.

Additionally, significant greenfield still exists in a smaller end of the physician practice market, and we are well-positioned for this opportunity. Our competitive position in both replacement and greenfield opportunities will only get stronger as we roll out Millennium+ and PowerChart plus Touch which Mike will discuss. The strength of our ambulatory solutions is also translating into even stronger competitive position in the inpatient market. In Q1, we had several competitive wins including several end processes that included our primary competitor. In total, 25% of our bookings came from outside of our core install base and we believe we will continue to gain share in the coming years. We see a growing number of hospitals reconsidering their supplier as they face the rising bar for a Stage 2 and Stage 3 of Meaningful Use and additional requirements for Value-Based Purchasing, ACOs and data analytics capabilities. Several of our competitors continue to be vulnerable due to challenges with transitioning to new platforms and uncertainty around their ability to keep up with future requirements. As a result, we believe we are still in the early stages of a multiyear market share shift. Cerner's ability to help future proved healthcare providers in this environment have increasing complexity positions us very well to be the beneficiary of this shift.

As I have indicated, there is really only one competitor that presents a consistent challenge in these replacement opportunities and our competitiveness against them continues to improve. By significantly improving the physician experience, we are neutralizing the primary area they have used to compete. This allows us to change the conversation to the importance of a modern platform and our investments in interoperability, data analytics, and our Millennium+ and Healthe Intent platforms. These investments provide a meaningful differentiator against a company that has a platform that makes interoperability and data analytics challenging, if not impossible. We also believe that ultimately we'll need to do major upgrades in coming years to catch up in these areas and these upgrades are likely to be very difficult and expensive for clients. We see evidence of this by looking at challenges faced by another vendor that is currently trying to upgrade from a similar mumps based platform. My belief that we are incredibly well-positioned in this marketplace was reinforced at HIMMS. our launch of Millennium+ and PowerChart plus Touch was extremely well perceived, and I was very pleased with the level of excitement in our existing clients and the high volume of interest expressed by perspective clients.

Moving to our global result. As Marc mentioned, we had strong results outside the U.S. as well with 23% revenue growth. We continue to see some improvement in many global markets and had strong results in Canada, Australia, England and the Middle East. In Australia, we have had strong results the past 3 quarters, including bookings related to our long-standing presence in New South Wales and Victoria in Q1, as well as an initial booking from a significant relationship with Queensland Health in the past 2 quarters of 2011. We are also seeing more interest in our hosting capabilities outside of the U.S. and this quarter include hosting agreements in Australia and England. We believe the opportunity for remote hosting outside of the U.S. remains very strong.

Operationally, our success outside the U.S. is reflected in Cerner being the first hospital in France awarded HIMMS Level 6 status. We also expect announcements soon regarding a Cerner client being the first HIMMS Level 7 hospital in Spain and another being the first HIMMS Level 6 hospital in the Middle East.

In summary, I'm very pleased with our record results in Q1, and I think we are well-positioned for a strong 2012 and beyond. With that, I'll turn the call over to Mike.

Michael R. Nill

Thanks, Zane. Good afternoon, everyone. Today, I'm going to discuss ITWorks, revenue cycle and provide an update on imperatives I discussed last quarter. I'll start with ITWorks, where we got off to a good start this year by adding a new client in the first quarter. This brings our total to 10 ITWorks clients. This 750-bed hospital has been a Cerner client for more than a decade and has already implemented a broad suite of service solutions and attested for Stage 1 Meaningful Use. Debut ITWorks is the best way to continue their Meaningful Use journey and as a way to align with Cerner and further advance their organization strategically. The pipeline for ITWorks remains very strong, and I expect us to have a very strong year in 2012. I believe the recent tipping point with ITWorks were the success of our initial client, hopefully at a clear value proposition for prospective clients and makes future sales much easier.

Moving to revenue cycle. While we didn't sign a new acute-care RevWorks deal in Q1, we did add additional ambulatory business process outsourcing clients. We also had a strong quarter in our overall revenue cycle business with 6 new footprints and strong levels of bookings for patient accounting, access management and care management. We are building a good foundation in our install base and increasing penetration of these core revenue cycle solutions. Overall, the interest in our revenue cycle offerings continues to increase. I believe this is the result of hard work that we have done in recent years to improve our solutions and services. In addition, I think the desire to have an integrated solution is increasing as the industry begins to shift from a -- shift to a value and quality based model that will require tighter integration between clinical and revenue cycle systems, which is a trend that clearly will benefit Cerner.

Before handing the call over to Jeff, I want to provide a brief update on the 2012 imperatives I shared with you on the last call and at our Investor Day. These imperatives are: Drive Meaningful Use adoption; dramatically improve physician experience; empowering population health management. Regarding Meaningful Use, we're clearly on a good path and continue to expect about 85% of our clients to have attested for Stage 1 by the end of the year. This weight of activity will lead to our entire client base being on the current version of our software, which is a big undertaking, but also has a big positive from an ongoing support standpoint. As I mentioned last quarter, Meaningful Use is driving physician adoption at unprecedented levels. This process of change can be difficult for physicians who have little time to experiment with and to adapt to new methods of doing work. As a result, we are putting physician productivity and the overall physician experience front and center. The key element of this effort, which many of you saw at HIMMS, was PowerChart Touch, a native iPad app that is the first of a new-generation of physician applications. Our fast, easy, smart mantra reflects our focus on providing an extremely fast solutions that are easy to use and intuitively smart and contextually aware of the physician's specialty, venue and patient's condition. PowerChart Touch is enabled by the next generation of our Millennium architecture called Millennium+, which we also announced at HIMMS. Millennium+, combined with the enterprise platform with a secure Cerner cloud makes it possible to merge our relevant and available clinical, financial and operational information, which enables the physician to be much more productive.

As Jeff will discuss, Millennium+ is also an important component of our population health strategy as it enables broader interoperability across all EHRs and allows connectivity to our Healthe Intent population health management platform.

In closing, I believe we are off to a good start in 2012 and well on our way to delivering our imperatives and further strengthening our leadership position in the marketplace. With that, I'll turn the call over to Jeff.

Jeffrey A. Townsend

Thanks, Mike. Today I'm going to provide some more background and context on how Millennium+ fits in the evolution of our platform. As the industry has accelerated the adoption of EMRs, the concept of a paperless system is becoming a milestone on the journey versus an endgame. As we have discussed on past calls, there are second-order of facts that are just starting to surface that will challenge how we think about clinical computing. As the healthcare industry plays catch-up to other digital industries, it is also evolving as a system in search of solutions to coordinate care across venues and organizations and to managed populations for both health and care. Today, the EMR is optimized for the enterprise, and the new target is now evolving beyond the boundaries of a single provider organization. For those of you familiar with the original Ran study around digitizing the healthcare industry, 50% of the benefits were associated with coordination of care. The pivot point for this transformation is pointed at the physician, who is expected to consume more clinical information, merging evidence, dynamic reimbursement policies and increased efficiency all at the same time. Over the last few years, Cerner has continued to innovate around the EMR solutions such as CareAware that facilitates medical device interoperability. At the same time, we've been actively deploying solutions through Cerner's cloud services. Our next generation of this progression comes with Millennium+, which leverages the knowledge that exists in Cerner Millennium and combines it with the agility of cloud computing. While Cerner has been deploying cloud solutions for more than a decade, the significance of Millennium+ is that the solutions are now designed with those services in mind from the beginning. This isn't just the change in end user experience or devices. This is also a shift in the distribution channel for innovation all the way to the end user. Nearly everyone these days carries a device that allows you to download apps, whether it be for tracking weather, playing games, checking e-mail or viewing your friend's photos with a quick swipe of a finger. Now Cerner is extending the same experience to healthcare with a quick and easy access on the iPad. We understand this is a pretty dramatic change from the approach of today, and this is a more complicated computing environment than Angry Birds. But we're also betting that more recent cycles of mandates, measures and regulatory requirements is only going to continue to accelerate as the industry is digitized and the platform, to stay current, has to accelerate along with it. In addition to providing the next generation of user experiences, connectivity beyond the enterprise creates the potential to accelerate our population health and data analytics initiatives. As Mike indicated, Millennium+ enables broader interoperability across all EHRs and connectivity to Cerner's Healthe Intent platform. Last quarter, I discussed how we are building the foundational data for the Healthe Intent platform largely through our chart search offering. We now have over 125 clients engaged and are adding billions of results each week. As Millennium+ becomes broadly deployed, and we have the majority of our clients connected to the cloud, the volume of data on the Healthe Intent platform will accelerate.

As we outlined in our presentation at HIMMS, the difference between 400 attribute claim data sets versus a 20,000 attribute clinical data set is significant. The challenge the industry faces in aggregation of data into contextual meaning is variability in data collection methods and nomenclatures. We are using supervised machine learning algorithms to map and tag these attributes without significant clinical labor investment. As a byproduct of these metadata mapping techniques, it allows our Millennium+ solutions to become operational out-of-the-box, applying our big data efforts to identify relationship patterns across clinical data sets, it not only supports the creation of predictive algorithms, but also produces more productive workflows to understand the intent of the user. Using new Millennium+ mantra of fast, easy, smart, this is the source of the "it just knows" design. As Zane referred earlier, we announced a partnership with Advocate Health Care last week. Advocate is the largest health system in the Midwest and is already viewed as a national leader in clinical integration and population risk expertise. We believe that by combining our capabilities, we can increase the rate at which predictive models and advanced analytic tools are developed. We are initially focused on predicting and reducing incidents such as readmissions and hospital acquired conditions, and we'll expand our efforts to develop models that convert -- predict patient complications from chronic diseases. This alignment with such a strong client positions us very well to advance our population health platform, which can ultimately be deployed across our client base and have a substantial positive impact on the health of communities they serve. Now I'd like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of David Larsen with Leerink Swann.

David Larsen - Leerink Swann LLC, Research Division

Anything in the proposed Stage 2 rule that looks particularly promising from a vendor's perspective?

Zane M. Burke

This is Zane. There's a number of things which we think are very positive in the Stage 2 elements, which is the physician documentation pieces, some of the meds pieces we think there a number of elements that will, as well as the quality and outcomes based metrics which frankly, we're one of the few EMR providers that actually have those solutions in our capability set, and so that gives us some unique opportunities as we look forward. So we do continue to see some good opportunities in that space, both from a new business perspective as well as our install base.

David Larsen - Leerink Swann LLC, Research Division

Okay. Great. And then I don't know if you saw, but Allscripts just preannounced and it showed a pretty significant decline in bookings year-over-year. Any thoughts on Allscripts in the space right now or anything you're seeing in the market for eclipses as relative to eclipses?

Zane M. Burke

Dave, this is Zane again. I think as we've mentioned previously, we see a number of installed bases that are literally up for grabs, and we would put that particular organization in that situation and we've seen that playing out in the marketplace as we've talked about and highlighted in both the calls as well as some of the analyst events that we've had. And so, yes, we do think that presents opportunity for us.

Marc G. Naughton

Yes, Dave, this is Marc. We've continued to say that we think there are basically kind of a duopoly that we're seeing in the marketplace with 2 very strong companies that are going to be successful. These results are consistent with our view of the marketplace. It's consistent with our view of our pipeline of who we are seeing relative to their client base showing up as being in the market for new systems. So the timing is unfortunate for us, because we have a lot of good news to talk about today. We know you guys will be having to split your attention, but it is not something that's surprising to us.

Operator

And our next question comes from the line of Sebastian Paquette with Goldman Sachs.

Sebastian Paquette - Goldman Sachs Group Inc., Research Division

First is on implementations, can you just talk to us about after a strong ramping year in 2011 how you continue to hire there? And then for the implementations that or the bake-offs that are becoming a bit more competitive with some of your key competitors, are you seeing any implementation capacity issues with your competitors?

Marc G. Naughton

I think from an implementation standpoint for Cerner, we continue to be ready to start any project as soon as we sign the contract with the client. We've done a good job as you seen from our headcount numbers of on-boarding new people in that area who are very quickly trained, put into our solution center and being basically effectively working on implementations from, very soon after they are hired in. So I think that continues to work well. The good news is that the amount of work we have to do gives them experience very quickly in 12 months, those people are getting to work on 2 or 3 different projects, which would be normally take a much longer period of time. So I think all of that is working well for us. We are using our people, and not relying on third parties for the most part for doing implementations. I can't speak for what other people are doing. There are certainly a lot of consultants in the world that are always willing to kind of come in as a third-party to help do implementations. But, we don't see that as an issue, we certainly see it as a benefit when we are talking about relative to new client is that we will guarantee the implementation and the timing and the cost, and that doesn't seem to be something that is capability for some of the competitor, well basically all of our competitors.

Sebastian Paquette - Goldman Sachs Group Inc., Research Division

All right. And then maybe could you spend a little bit more time talking about your gross margin profile. And maybe first off, just highlighting some of the mix that is going on, any details you can give us around the actual proportion of tech resale and on the margins around tech resale or device works or some of the larger services contracts and maybe just talk about kind of when you think about the stage of where some of these services contracts are if they're starting out at lower gross margins or the potential ramp-up over time, just because it seems like it's one of the bigger disconnects in the model, even though overall profit margins are increasing, just try to get a better handle on the trajectory for gross margins would be really helpful.

Marc G. Naughton

Sure. It's actually, you threw out a lot of things there, but it's actually a fairly simple explanation. Just to provide a little -- just a context, relative to gross margin, for the most part, all of our services come through as 100% gross margin unless it's provided by a third-party, which is a very, very small amount. So from a gross margin perspective, the services business really doesn't have a significant impact on that from a relative to bringing it down below 100%, because all of that kind of revenue basically almost all of it drops to the gross margin line. The real key that you've seen in Q3, Q4 and now Q1, is us doing much stronger than we would have projected in both the device resale and even on our traditional hardware sale. So those are single-digit margin businesses, but the group of people that is responsible for doing that is basically a relatively small group that doesn't grow a lot, and they are driving more and more revenue, really, for us the key is they're driving more and more margin. So what you saw in Q3, Q4 and especially in this Q1, was significant strength on the device and the hardware sales. So we're $50 million over the top end of our range of guidance, probably $40 million of that is relating to technology resale in some form or fashion. Now that over Tayman [ph]only drove about $3 million to the bottom line because of the low margins that we get on that business. So from a management of the business, we've always talked about "I'm going to manage to the gross margin line," because that's really what I'm looking at. So I love it, I love all that extra hardware we're selling for really not a lot of extra effort, we're leveraging our client base and our relationships to be able to sell into that base, but I think if you look at the math, and at the results, you'll see that, that technology resale is what's kind of brought us down from 81% range down to kind of the mid- to upper-70s. Given that, we're kind of at 75-point something this quarter, I'm thinking that we'll probably get into 77% range at the end of Q3. With Q2 we think there's still likelihood it'd be a little bit higher tech resale, not significantly, but a little higher, nothing like we had in Q1. But at that point you're going to have kind of a normalized history with each of the preceding year ago quarters having a pretty good impact relative to the tech resale and then you'll be able to kind of see us doing more of our normal margin level gross growth at the operating margin level of the 100 to 200 basis points. Does that help clarify?

Operator

And our next question comes from the line of George Hill with Citigroup.

George Hill - Citigroup Inc, Research Division

Marc, maybe I missed this in the prepared comments, did you detail what the contribution was to bookings in the quarter from Queensland in the new ITWorks contract?

Marc G. Naughton

The -- relative to Queensland, there was nothing from Queensland in Q1. The Queensland initial bookings came through Q3 and Q4, and they were not part of any of the Q1 bookings. We had some other bookings in that territory, which were beneficial to overall bookings. But Queensland, actually, was a Q -- initial bookings were Q3 and 4, with obviously significant expansion opportunities and we roll forward with that contract.

George Hill - Citigroup Inc, Research Division

Okay. And then I guess just a follow-up and maybe this is a question for Zane or a question for Mike. As you see competitors kind of stumble in the competitive landscape, how should we think about your ability to effectively market around that and take share? And I guess how much of an opportunity does it really create versus how much of it, I'd say is public perception that we worry more about, than customers worry about, and should we see whether it's I'd say whether it's somebody stumbling in the revenue cycle management segment where you guys have the RevWorks business, which is more comprehensive in technology or whether somebody stumbling in the EMR business or whether somebody is stumbling in the patient accounting business? I guess, help us as investors bridge the gap between what is the perception that we see and what is the perception you guys are effectively able to market clients?

Marc G. Naughton

This is Marc, and I'll let Zane follow-up because he's the guys that's actually out on the marketplace. But clearly, if you referenced to put names to some of the suggestions you talked about, it's clearly fairly easy for us to differentiate ourselves from some of those companies that you reflected as, certainly in recent times having stumbled on revenue cycle in our sector. I think the concept of selling around their failures, we expect to create their failures, and we are absolutely doing everything we can to do that. So the fact that we start to see that occurring is very much in line with what we're doing. When you start seeing it from an outside perspective, you're seeing what we've been seeing in our pipeline for the last 6 months. So this is just better opportunity for us. Zane, I'll turn it over to you if you've got some additional comments.

Zane M. Burke

Marc hit it exactly on. I think the key here -- the other point to think about is primarily in the EMR market space, there is a bright line with the Meaningful Use element, and there's a bright line around things like 30-day readmission rate. And your -- the -- our clients' capabilities to get there and their confidence or lack of confidence in our competitors' capabilities to get them to that level. And so that bright line creates a very definitive opportunity by which you can market around pretty effectively and given what we have in our client base to date.

George Hill - Citigroup Inc, Research Division

All right, then just quickly, Zane, I just to boil it down to a simple, what you're telling me is can take these stumbles of these other competitors and turn them into business ones for yourself?

Zane M. Burke

Absolutely, and we're doing it.

George Hill - Citigroup Inc, Research Division

And just I know that you guys are getting a lot of questions. I just want to sneak one more in for Marc. Marc, according to my model, this is the first time that you guys, since 2001 that you guys have had bookings up sequentially. I'm sorry, system sales revenue up sequentially in Q1 from Q4. I guess can you talk a little bit more about what drove that? And then I guess whether or not we should think that this is sustainable trend?

Marc G. Naughton

Yes, George. This is Marc. Relative to the Q1, it's clearly very strong hardware and tech resale and device resale. So way beyond what you would've expected. A lot of that seems kind of get closed in last month of the quarter. So it's harder for us to provide visibility on that, because we are tracking margin, which isn't going to make a big difference to a quarter. But that's the main reason. We wouldn't necessarily expect to see a change in the seasonality too much, but when you're an active market like we're seeing right now, you're going to see it on occasion that a sequential quarter, which normally would be impacted by the seasonality kind of come through with more strength than you expected. So it's really related to hardware which goes completely as you know into system sales.

Operator

And our next question comes from the line of Kipp Davis with Barclays.

Kipp R.F. Davis - Barclays Capital, Research Division

One quick one, I know Mike, you had mentioned at ITWorks you felt like you've reached the tipping point and just kind of wanted to dig in there. How do we think about that, you obviously signed one deal this quarter, I know you guys have sort of said around the deal a quarter, are we at the point where we might start to see that accelerating maybe not in the next quarter but as we look at into late in '12 and '13 where we might see, say a couple a quarter?

Michael R. Nill

Yes. First to comment on the acceleration of business. ITWorks is it's really it's a bundling of many of the services and solutions that we've created over time. So we're starting with, not a brand-new foundation, but some very established businesses like CernerWorks, our AMS upgrade center, et cetera. So when we entered into the market with our first client, it was not a case where we need to go through a maturity cycle, we were able to deliver exceptional performance from day one. And those clients that we've engaged with, they have proven out that they can move forward with their clinical transformation projects 2 to 3x faster at the same or lower cost. We said that initially, and now we have multiple clients that have demonstrated data, proving that we said could happen is actually happening. In terms of the pipeline of business moving forward, it's very similar to our CernerWorks business. As our clients now see those proof points, there's more and more that are coming to the table saying they're interested in this type of partnership with Cerner. It's hard -- the pipeline looks very good. We have many prospects in the pipeline right now in terms of how many per quarter, I think you're going to look at really the same rate, it will be a gradual acceleration, but you could probably expect a client a quarter I think is reasonable.

Kipp R.F. Davis - Barclays Capital, Research Division

Got you. Okay. And then another question on sort of the revenue cycle side, just curious is the delay of ICD-10 impacting business there? Are people sort of saying might want to hold off on making decisions? And again I recognize you guys have a pretty broad offering across different areas of revenue cycle, but just curious if that's making some potential customers kind of pause? And then sort of a related question to that, obviously some folks have had some hiccups in the revenue cycle space, I know your model is a little bit different, I'm just curious if you're seeing that create opportunities as well?

Zane M. Burke

This is Zane, Kipp. I would tell you on the revenue cycle side we actually see the delay of ICD-10 creating opportunity for us. So it's allowing clients you may have wanted to wait 'till after the implementation of ICD-10 to upgrade their patient accounting systems in particular. So in the core system space, it's giving them opportunities to come back and may rethink some of that strategy, and we are actually seeing some opportunities in that space. It'll also elongate the services opportunity time for the preparation for ICD-10 as we move forward. As it relates to your second comment around the revenue cycle business outsourcing, obviously we are different than the one organization I believe you're referencing. And our focus is in our core installed base today, and that's where we have the best opportunity to succeed, and we think we'll continue to do well in that space. And so, while at this point, I would not, in fact, think that will have a lot of impact on our revenue cycle business at this point.

Operator

And our next question comes from the line of Steve Halper with Lazard Capital Markets.

Steven Halper

Just 2 questions. Given the slightly higher CapEx expenditures for the year, do you still expect free cash flow to grow year-over-year?

Marc G. Naughton

Yes, Steve. Relative at this point, we would expect to do that. The key will be kind of when the cash starts flowing down the second half relative to the building. But given our strong cash flow performance, I feel pretty confident we'll -- you'll see us growing free cash flow year-over-year.

Steven Halper

How much are you going to be spending in the second half of the year for the building?

Marc G. Naughton

It can vary. I mean, it can be anywhere between $30 million to $45 million, and some of that's going to be based on timing. We're trying to go faster, because we need the space. We're growing like crazy, and we need the space so that we can put our people that are involved in those what we would call continuous 24 by 7 businesses in a single campus, which we name the Continuous Campus, get them all in one place. Right now, they're split between couple or 3 different places and we want to get them all in one place to be effective.

Steven Halper

So that will be more sort of service-oriented folks, correct?

Marc G. Naughton

Yes, doing the 24 by 7 job.

Steven Halper

Right. So the other question is, when you look at device resale, specifically to this quarter, what pieces were strong in the quarter? Was it pumps? Was it dispensing cabinets from CareFusion? What goes into -- what went into that device resale this quarter?

Marc G. Naughton

It was strong across the board. We had interest in pumps, we had interest in our own cabinets. We had interest in the cabinets that we are reselling. So it's a -- the exciting part about that is we are continually -- continuing to actively add to that portfolio at a fairly high clip. People are seeing the success we're having. They understand that we can impact our clients' decisions on what they're going to buy by connecting them to the Millennium infrastructure. They trust us. So I think that's -- it's a great business for us to be in, but it was pretty broad across most categories relative to that resale. So that's good news for us, because that makes it easier to grow each element of that.

Steven Halper

Great. So if you, when you look at the upside on the device and hardware sale, was it more of the your traditional hardware resale? Or was it more of a device resale?

Marc G. Naughton

Yes. It was actually kind of both. So we had a couple of larger deals where clients purchased a bunch of hardware from us. And then we also had strength in the hardware side. Just as an aside, most of the focus will be on the hardware and the device resale and how that impacted the top line. I don't mean to minimize the fact that we also had a very strong software quarter, and that was certainly a component of driving higher system sales and driving part of the overtame on the earnings side. So it just wasn't exceptional like we saw in the hardware and the device resale.

Operator

And our next question comes from the line of Greg Bolan with Sterne Agee.

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

Can you just talk a little bit about Europe? It appears that there's some momentum it seems on the decision-making side for some of the trust underneath the NHS umbrella. Just kind of wanted to get an update on your thoughts on where that market's going, if it's, if you see it accelerating here in the coming 12 months?

Zane M. Burke

This is Zane. I think what we do see is there is buying happening at the trust level, and so the trusts are now reaching into their own pockets and making decisions. And that we view that as a very positive overall in the U.K. marketplace, that they are now entering into decision-making processes and actually going out procuring systems and we think that's a positive.

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

And would you characterize, it seems like there are really just 3 players, including yourselves, that are kind of at the helm. I mean, given the longevity of Cerner's presence within Europe, I mean how would you kind of characterize your -- what you think your batting average might be as these decisions are made at the trust level?

Zane M. Burke

Well, each one of them is unique. So every, and as are almost every single competitive situation that you have, we refer to them as they're all knife fights. And so each one of them has their own nuances to them. And so I would say that those 3 -- the 3 competitors are the ones that you would think of in this space.

Marc G. Naughton

This is Marc. I think one of the things that we're focusing on now that we start seeing the trust maybe coming to market, and you spending their own money. We're certainly focused on getting one of our clients to be an absolute showplace relative to our hosting it, relative to the solutions they have and relative to getting PowerChart Touch into the environment, so that the physicians can see the new iPad apps that we are rolling out now in the U.S. So I think -- keep in mind that we have been operating under a government program that told us what we should build and offer and being hosted by a partner. So for us to be able to go and show our complete portfolio, if you will, in country, we think is going to advantage us. Obviously we're leveraging the fact that we've successfully implemented a large number of sites in the last decade. But as Zane said, this is a business where it's not what did you do for me 2 years ago, it's what you're doing for me lately. And in many cases, as you've implemented things, the company coming in that has no history can make a lot of promises, and that's sometimes people will react to that. But we feel very good about our implemented client base and our ability to go create that show side that we think will be differentiating going forward.

Operator

And our next question comes from the line of Donald Hooker with Morgan Stanley.

Donald Hooker - Morgan Stanley, Research Division

So in the past I think you've, when you talk about bookings, you talked about sort of long-term bookings, as you refer to it as a percent of the overall. Can you share a percent for long-term bookings this quarter?

Marc G. Naughton

Yes, I think that was 25%.

Donald Hooker - Morgan Stanley, Research Division

Did I miss that?

Marc G. Naughton

Yes, 26%. It was a little lower than our average, it was kind of around 29%. I'd also point out that the ITWorks deal that we did do, which tends to be the kind of -- one of the longer term bookings only has a 6-year initial term. So it's not the normal 10 years that we see. So that was a lower relative bookings, than what you might see, there's a built-in extension to the contract, but the only thing that's included in bookings is that first 6 years.

Donald Hooker - Morgan Stanley, Research Division

Got you. And then the, with regards to the deal with Advocate, the predictive modeling and population management analytics deal that you had, can you talk about the economics of that? Just curious how you guys, how we should think about those types of deals because I suspect that's going to be more common going forward. I mean, is there a sort of a deal size or some sort of revenue number you can put around that, roughly?

Marc G. Naughton

This is Marc, for the most part those are leveraging a lot of the things that they have already bought from us. So and this ultimately that business is a per member per month type of management of a defined population in assisting them. Jeff, any other comments?

Jeffrey A. Townsend

So specific to this one what's significant for us there is that, as Marc mentioned, there is a portfolio, some of which they already own, some of which they'll grow into over time. But the significance there is really this joint development effort or joint innovation effort to combine what they've done, combine our portfolio and go create net new. So what you'll see in the coming months coming out of that relationship will be new IP or new solutions and services that we'll take to the market across the rest of our client base.

Donald Hooker - Morgan Stanley, Research Division

Okay and one last quick one and I'll jump off line. You -- I think you commented about strength in the ambulatory market. I was curious if you would be willing to put a percentage around that? Because I think you've got a pretty nice percentage growth in calendar '11. I was curious if that was continuing to grow at the same rate in going here into calendar '12.

Marc G. Naughton

Yes. This is Marc. I don't think in the comments we had anything relative to our growth in ambulatory. Continues to be a good portion of our business. But I don't think we have in the past we're talking about 50% year-over-year increases. I don't think we achieved that level, but we had good growth overall and that once again not only deals that leverage some of our clients as they go to affiliated physicians but also going directly to physician offices.

Operator

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

Atif A Rahim - JP Morgan Chase & Co, Research Division

So a question on the revenue cycle side. You said you didn't sign any acute business but added ambulatory business. How was your model there? Are you charging some of the 2 other structures in the industry that we're familiar with, like fixed percentage of collections, or do you have something other than that?

Zane M. Burke

This is Zane. Yes, we do charge a percentage of collections at typical revenue cycle outsourcing model in that space.

Atif A Rahim - JP Morgan Chase & Co, Research Division

Okay. And then competitively relative to other players, I don't know if you can discuss what you're advantages versus disadvantages are, maybe starting with price and running down to service?

Zane M. Burke

I would start -- the biggest key element is we have technology that supports the process of the collections, that supports the business processes of driving revenues for the organizations, where most all of our competitors do not have that type of technology, and that is a, that is absolutely the key differentiator in our offering and how we approach the marketplace in that areas. The marriage of the technology and the processes and understanding of how to use those in our client base is very, very unique, and it's really, truly only as Cerner can.

Marc G. Naughton

Yes, I'd just like to add to that point, it's much like the pattern of CernerWorks. Our ability to post at a world-class level has a lot to do with we own the IP and develop the IP that's being hosted. And so that closed loop model as Zane said a lot of the competitors in the space come in and kind of live with whatever's already been purchased, where ours is tightly bundled. But the other differentiator is that revenue cycle is becoming more than 50% about the clinical processes, the coding and the data that's being captured and it's becoming less and less about dropping the claim and trying to collect. So that's our, kind of our differentiator is that ability to go upstream into the clinical processes to ensure that the data's correct and accurate and codified well before it hits the back office.

Atif A Rahim - JP Morgan Chase & Co, Research Division

Got it. That's helpful. Could you mention [ph] that business for us in terms of maybe revenues and number of customers and also what the target market is for you, who you are targeting first?

Marc G. Naughton

This is Marc. I mean, it seems today that that's a pretty small number still. I mean, we're -- once again it's an area where the -- we're breaking into getting into kind of the, at the dock practice level. So the amount of dollars at this point is small enough that I don’t have it actually in front of me, and it wouldn't be a material item to know. But we continue obviously to push into that market because we think it's a natural extension, as Jeff was saying relative to our technology and our ability to drive, do that more efficiently, which is kind of the whole key on the revenue cycle. Keep in mind, revenue cycle today is not outcomes based as much for the most part. When it is becomes totally outcomes based pay-for-performance, you're going to have to have a clinical record driving the revenue cycle, and that we expect that to differentiate us. Fortunately, we have a little bit of time to get to that market because people are not necessarily making decisions currently because the deferral in ICD-10.

Operator

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

Sean W. Wieland - Piper Jaffray Companies, Research Division

So in follow-up to a couple of other questions that have danced around it. Accretive Health yesterday, could you just take the opportunity to differentiate your RevWorks platform from the way that we've learned Accretive Health goes about doing collections and hospitals?

Marc G. Naughton

This is Marc. A key differentiator that I can see is we are not a collection agency. We're not going to go try to use the data in the approach they were to go wring every dime out on that side. We're going to make sure that the claims are in the appropriate format and that we're getting bills out. And then we're certainly helping people with managing their collection relative to the system. But we're not going to be on the front-line berating the widows and orphans to get paid. So that's not our business model.

Sean W. Wieland - Piper Jaffray Companies, Research Division

Okay. That's helpful. And then one quick one. You've talked a lot on your prepared remarks about analytics. When do you think this becomes a meaningful contributor to your revenue?

Marc G. Naughton

I'd say there's pieces of it that show up today around just basic reporting around the EMR. So a fair number of our clients will have kind of a what I call it basic warehouse to be able to do operational reporting and improvement. In the past, we've also talked about our Lighthouse practices, where we are out pushing quality initiatives or process improvement type of initiatives, all of which drive off of those analytics. I think as Zane mentioned, the movement towards more of the quality type scores being tied more directly to how I get paid, or whether it get penalized is what we think will kind of drive the next wave for us.

Sean W. Wieland - Piper Jaffray Companies, Research Division

Okay. But in terms of helping doctors make decisions, better decisions at the point of care, and things like that, yes it's a differentiator in how you saw your software, but is there a longer-term plan there in terms of monetizing that?

Zane M. Burke

Yes. So as far as monetizing, in our, we talked about in the past deployment of our sepsis solution. That's an algorithm that is out there really become a condition our client base for lots of those yet to come. But in that process, you navigate through things like data rights, timeliness of the data, mapping of their information. So that's very significant to us to get both Search and Sepsis out in the market, which will allow us to not only monetize but roll those other things out much quicker without a long delay.

Marc G. Naughton

Sean, this is Marc right now, it's early, we're kind of creating the framework for significant number of analytical tools that we can roll out over time. But today, it's really not driving any revenue. As you are aware, sepsis and search we're making available free to get that infrastructure built.

And this is Marc. I think we've kind of gone our time. I know these guys are going to -- probably have a busy afternoon. So at this point, I'd like to thank everyone for attending the call. We're very pleased with our results, the strength overall of the business, and we certainly thank you for joining us. We look forward to talking to you soon. Bye-bye.

Operator

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

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