Eclipsys Corp. Q4 2007 Earnings Call Transcript

Eclipsys Corp. (ECLP)

Q4 2007 Earnings Call

February 14, 2008 8:30 am ET

Executives

Andy Eckert - President and CEO

Bob Colletti - CFO

Jay Deady - EVP of Client Solutions

Analysts

Richard Close - Jefferies & Co

Corey Tobin - William Blair & Company

Sandy Draper - Raymond James

Atif Rahim - JPMorgan

Sean Wieland - Piper Jaffray

Presentation

Operator

Welcome to the Q4 2007 earnings results. (Operator Instructions).

At this time, I'd like to turn the conference over to your host, Andy Eckert. Please go ahead.

Andy Eckert

Thank you very much and good morning. Joining me today are Bob Colletti, our CFO and Jay Deady, our Executive Vice President of Client Solutions.

Please note that we issued a press release on our fourth quarter and year end 2007 results earlier this morning. A copy of that release is also available on our website at eclipsys.com.

Before we get started, I would like to remind our listeners that our prepared remarks and answers to questions will include forward-looking statements. These include statements about the company's capital position, backlog, and anticipated financial performance including revenue margin, cash flow and profit expectations, our business plans including plans related to software development and capitalization, sales and marketing, business development and cost control initiatives, client relationships and contracts, scheduled implementations of the company's software, benefits to the clients of the company's solution and marketing competitive information.

Actual results may differ due to a number of risks and uncertainties. Financial performance targets might not be achieved due to various risks including slower than expected sales or implementation or higher than expected costs to meet client commitments and achieve our development objectives.

Cash consumption may exceed expected levels at the timing of collections and expenses is not in-line with out forecast or strategic opportunities require cash investments, software development may take longer and cost more than expected, and incorporation of anticipated features and functionality may be delayed due to various factors including programming, integration challenges and resource constraints. We may change our software development strategy in response to client requirements, market factors, resource availability and other considerations. Competition is vigorous and competitors may develop more compelling offerings or offer more aggressive pricing.

Eclipsys is required to meet specified performance, standards and clients can terminate contracts, assess penalties or reduce contract scope under certain circumstances. We undertake no obligation to update forward-looking statements or relevant risk. These are the risks that described under the heading "Risk Factor" in the company's Form 10-K, 10-Q and other filings made from time to time with the Securities and Exchange Commission.

So with that said, I would like to thank you all for joining us on the call today.

First I'll provide some very brief comments and turn it over to Bob Colletti, who will review our financial results for the fourth quarter and the year ended December 2007, and Jay will comment on progress in our sales and marketing efforts, and after a few more formal remarks we'll open the call up for your questions.

In 2007, Eclipsys made significant progress across several key areas, including upgrading the management team, refining our business model, improving sales execution and establishing international presence.

We had a very strong finished in 2007 with significant improvements in our revenue, earnings and cash flow. Our revenues for the fourth quarter were $124.4 million, an increase of 8.7% million from the fourth quarter of 2006. And for the year, revenues totaled $477.5 million, an increase of $50 million or almost 12% over 2006.

On that note, I'll pass the call over to Bob.

Bob Colletti

Thanks, Andy. Our 2007 results reflect major improvements in all areas of our company which show significant improvement in our revenues, earnings and cash flows and are benefitting from initiatives we implemented during the past two years.

We are particularly pleased that we generated $22.1 million in free cash flows in Q4 and $32.9 million for the year. It represents an improvement of $37.9 million over the prior year. We ended the year with $191.4 million of cash and investments on our balance sheet.

I will now review our results in more detail followed by discussion of our outlook for 2008. Reviewing our results on a GAAP basis, fourth quarter 2007 net income was $24.2 million or $0.44 per diluted common share, compared to $4.7 million or $0.09 per diluted common share in the fourth quarter of 2006.

Non-GAAP net income for the quarter was $15.8 million or $0.29 per diluted share. Q4 2007 GAAP results included the following items that we've excluded from non-GAAP earnings.

Stock-based compensation of $0.06, corporate restructuring relocation costs associated with moving our headquarters to Atlanta, plus costs incurred to exit the network service business of approximately $0.04, derivative litigation $0.05, and net gain on the sale of CPMRC after deducting $0.06 contribution to our corporate bonus full funded by proceeds in this transaction, which net of $0.17 in the transaction, a partial reverse of our Canadian tax valuation allowance of $0.09.

Attached to our press release this morning is a detail reconciliation of these non-GAAP items.

As a result of a very strong Q4 2007, we significantly exceeded our 2007 EPS target and accordingly funded an incremental $0.06 of bonus which was funded on the gain on sales of CPMC. This is consistent with a prior year as our Q4 2006 results benefited from reduction in bonus accrual of $0.04.

This quarter also reflects the reduction in a portion of our valuation allowance for our deferred tax assets related to our Canadian operations of approximately $0.09

Later on in this call, I would discuss our income tax accounting in more detail.

For the year ended December 31, 2007 revenues were $477.5 million. On a GAAP basis, net income for the year was $41.1 million or $0.76 per diluted share. On an annual basis, excluding items previously described, non-GAAP net income was $43.3 million or $0.80 per diluted common share.

Turning to our Q4 2007 operating results, revenues for the quarter were increased by $8.7 million to $124.4 million compared to revenues of a $115.7 million for the quarter ended December 31, 2006, an increase of 7.5%. For the year, revenues total $477.5, an increase of $50 million or 11.7% over 2006.

Our growth in Q4 was primarily driven by increases in recurring revenues, software license fees and profession services. Revenues in Q4 consisted of the following: Recurring revenues were $77.2 million, an increase of $4.8 million or 6.7% over the prior year. Software license fees totaled $9.1 million, an improvement of $3.6 million or 66.6% over the prior year.

For the year, software related fees totaled $21.5 million compared to $13 million in 2006 which is an increase of $8.5 million or 65.7%. In 2007, software license fees were approximately 2.5% of total revenues. These license fees include one-time license fees associated with new contracts signed in the period, including add-on license fees to existing clients as well as revenue generated from contract backlog that had not previously been recognized pending contract performance that occurred or was completed during the period and certain other activities during the period associated with existing client relationships.

Professional services were $29 million compared to $26.8 million in the prior year, an increase of $2.2 million or 8.4%. Third-party software license fees were $3.4 million which was relatively flat compared to the prior year and hardware revenues were $4.5 million which is a flat compared to last year.

Networking services $1.1 million compared to $3 million in 2006. As discussed in last quarter's conference call, we completed our exit from this business during the fourth quarter.

Reviewing gross margins, any discussions regarding margins or expenses are based upon non-GAAP results and excludes stock-based compensation and the other items which I had previously discussed. Gross margin in the quarter was 47.6% compared to 43.9% in Q4, 2006, an increase of 3.7 percentage points. The growth in the margins was a result of improvement in our revenue mix.

Reviewing capitalized software development costs, the amortization of such costs which is included in cost of systems and services revenues totaled $3.2 million in Q4 which is down approximately $1.1 million compared to the Q4, 2006.

Capitalized software development cost were $5.7 million in Q4 or 29.7% of gross research and development expenditures compared to $4.7 million or 26.3% in Q4 of last year.

2007 software capitalization was primarily related to development of Sunrise Clinical Manager 5.0, which was made generally available in December of this year.

Turning to expenses for the quarter, sales and marketing expenses were $20.3 million, an increase of approximately $4.8 million over the prior year. The increase was due to significant increase in commission expense related to strong sales bookings in the quarter.

Gross research and development expenses were approximately $19.1 million compared to $17.8 million in Q4 2006. Net research and development expenses were $13.4 million, an increase of approximately $300,000 over the prior year.

Q4 general and administrative expenses were $6.8 million which is an increase of $1.1 million compared to last year. The increase was primarily related to higher incentive compensation costs.

During Q4 2007, we recorded an income tax benefit of approximately $4.5 million or $0.08 per diluted share. The benefit reflects a reversal of the valuation allowance of deferred tax assets related to our Canadian operations of approximately $5.1 million which is offset by an AMT provision.

For purposes of our non-GAAP results, we've excluded the benefit of the reduction in the valuation allowance. We continued to have a strong balance sheet. We ended the quarter with a $191.4 million of cash and marketable securities and no debt compared to $138 million as of December 31, 2006. This represents an increase of $60.6 million or 46.3%.

Briefly I'll discuss our auction rate securities. As of December 31, 2007 we had approximately $170 million of auction rate securities on our balance sheet. These auction rate securities are highly rated, government-backed securities in which the interest rates reprice every 28 days under a Dutch auction process. The majority of these assets are related to government insured student loans.

During Q1 2008, in the normal course of business, we converted approximately 30 million of these securities into cash equivalents. During the past several days, several of these auctions were not successfully completed by the brokerage firms that manage these auctions. We will continue to monitor a balance sheet and asses the market value of these securities as we progress through 2008.

Given our strong balance sheet and cash flow generation capabilities, our intention is to hold these securities until market conditions improved. These securities are regularly reinvested are not part of our normal working capital requirements. We remain comfortable with our liquidity.

In reviewing deferred revenue in the quarter, deferred revenue was approximately $150 million which is essentially flat compared to last year. On a sequential basis, deferred revenue increased $5.9 million. Day sales outstanding were 72 days which is down 2 day sequentially and is at the same level as Q4 of last year.

Briefly highlighting our cash flows for the quarter, for Q4 operating cash flows are $31.2 million which is an improvement of $13.4 million over the same quarter of last year. Free cash flows in the quarter were $22.1 million. As mentioned earlier, we had an improvement of $37.9 million in our annual free cash flows in 2007 compared to last year.

I'd now like to review our backlog as of December 31, 2007. In order to provide better transparency as to the components of our backlog and the changes in our backlog, we are providing incremental disclosure on this call.

On this call, we will disclose both the outsourcing component of our backlog and the backlog associated with our software operations. Additionally, in prior years we only included one-year software maintenance in our backlog. From this point forward, we will close the contracted software maintenance for the term of the contract. Typically, our software maintenance contracts extend significantly longer than one year. As far as this disclosure, I'll be providing additional information regarding 2005 and 2006 for consistency purposes.

As of December 31, 2007 outsourcing backlog was $299 million compared to $350 million as of December 31, 2006 which is a decrease of 14%. As of December 31, 2007 our software related backlog was $1.072 billion which is compared to $875 million as of December 31, 2006. This represents an increase of 23%.

As of December 31, 2006 our outsourcing backlog was approximately $350 million compared to $357 million as of December 31, 2005, a decrease of 2%.

As of December 31, 2006 our software related backlog was approximately $875 million compared to $793 million as of December 31, 2005 which is an increase of 10%.

Overall backlog increased 12% in 2007 compared to a 6% increase in 2006. We are pleased with the level of bookings we made and the major progress we made in our existing clients in 2007.

I'd now like to review our guidance for 2008. Our non-GAAP guidance excludes stock-based compensation which we currently expect to be about $0.30 for the year and costs associated with our corporate relocation which will be completed in Q1 which we currently expected to be approximately $0.04 and costs associated with our derivative litigation which is difficult to predict at this point.

In comparing 2007, please note that we exited the networking services business and sold CPMRC in Q4 of 2007. These decisions resulted in reduction of approximately $20 million from our base business which resulted in adjusted base business of approximately $457 million for 2007. We expect 2008 revenues to range from $506 million to $518 million which reflects the year-over-year increase in revenues from the 11% to 13% after adjusted 2007 revenues. We expect non-GAAP EPS to range from $0.98 to $1.02.

As noted in our prior calls our policies only provide annual guidance. However, I'm going to provide additional information respect to a progression for 2008. Consistent with the last four years, we expect to have a sequential decrease in revenues and EPS for Q1. The sequential decrease is a result of several factors, including lower software license fees, costs associated with the HIMSS trade show, higher payroll related taxes, lower software capitalization and higher amortization of capitalized software development costs. As a result of these items, we expect non-GAAP EPS in Q1 to range from $0.12 to $0.14.

Several items to note about our 2008 expectations.

We expect software license fees to approximate 2007 levels as a percentage of revenue. We anticipate that there will be an increase in the volume of software transactions as we progress through the year. However, this revenue is subject to significant fluctuation in any given period.

Capitalized software development costs are expected to be at significantly lower levels during the early part of the year and are expected to increase as we progress through the year.

Amortization of capitalized software development cost is expected to increase in Q1 and then decrease in Q2 and remain consistent for the remainder of the year at the Q2 level.

We expect to have positive free cash flows in 2008 with the slight improvement over 2007. Based on our strong results from 2007, we had both taxable and book income and utilized a portion of tax NOLs to offset current taxes payable.

Based on our current expectations in 2008, it is expected that we will recognize our fully reserved deferred tax assets in the second half of 2008. The asset is expected approximate $60 million to $80 million and will result in a one-time benefit in the P&L in the quarter in which it's recognized.

Excluding this one-time benefit, our income tax provision for 2008 is expected to approximate $0.03 primarily related to AMT. For 2009, we will record a statutory tax provision at a rate slightly higher than 39%. This provision will be a deferred provision as we do not expect to pay significant cash income taxes for several more years. We made major progress in 2007 and we believe we are positioned for success in 2008.

Major factors that will impact our ability to achieve our forecast include: We need to continue to have successful software bookings including one-time and recurring license fees, as well as increase our hosting revenue and margins. We need to have continued execution in professional services, including further expanding our margin in this area as well as delivering projects on time and on budget. And we need to leverage our operations in India to help expand the capabilities in all areas of Eclipsys including R&D, client support, professional services as well as G&A.

I'd also like to mention that we are hosting investor meeting at HIMSS trade show coming up in February and I recommend you please contact Jason Cigarran, our Director of Investor Relations if you would like to attend.

In summary, we closed 2007 on a very positive note and look forward to building on our progress in 2008.

At this point, I'll turn the call over to Jay. Thank you very much.

Jay Deady

Thanks, Bob. On today's call I'm going to provide an update on our new solutions as well as our progress in our primary markets over the past year. First, from a product life cycle perspective on our enterprise solutions with the GA release of Sunrise Clinical Manager 5.0 in December, we rebranded our solutions as Sunrise Enterprise. We did this so the market could better understand the breadth of our solution capability, particularly in the areas of access management and revenue cycle.

Some of the key components of Sunrise Enterprise include Sunrise Access Manager is now delivered on the Eclipsys XA architecture, integrating clinical and financial operations. By starting the process at the earliest point, Eclipsys revenue cycle solutions help to deliver cleaner claims, reduce days and accounts receivable, increase cash flow and enhance patient services.

Many advanced functions that improved communication between members of the interdisciplinary care teams enhance usability and facilitate more rapid physician adoption of our solutions. For example, the new Sunrise clinician portal allows anytime, anywhere web access to the patient record in a very easy-to-use user interface.

A physician can review the patient chart and write orders using the same personal preferences available within the hospital. With the joint commission focus on medication reconciliation now as a national patient safety goal to reduce preventable medication errors, Sunrise Enterprise enables healthcare providers to go beyond medication reconciliation to improve patient safety throughout the care process.

The new orders reconciliation capability within Sunrise Enterprise allows caregivers to reconcile all orders related to patient care at all handoffs between caregivers and units as well as at admission and discharge. Of all the new functionality within Sunrise Enterprise, order reconciliation is a major competitive differentiator for Eclipsys.

Sunrise Analytics is Eclipsys solution or healthcare business intelligence that enables organization to easily extract data from Sunrise Clinical Manager in order to understand trends and how patient care is delivered. The solution enables real-time analysis and if necessary real-time intervention to better manage paper performance, quality reporting and a positive outcome.

Sunrise Clinical Manager 4.5 significantly improved Eclipsys competitive position including game changing functionality particularly in the areas of medication management and ambulatory.

Sunrise Clinical Manager 5.0 includes a similar level of uplift and the new capabilities including ones I previously outlined are helping to separate Eclipsys from the competition, win significant new deals such as Sing Health win we announced back in October. All of the new solutions I just mentioned will be showcased in our booth at our major industry trade show coming up in two weeks HIMSS in Orlando Florida.

We now have approximately two-thirds of the Sunrise Clinical Manager base live on version 4.5 and we hope to achieve similar results with 5.0 in the same timeframe. We've already engaged in a number of sites for the first activations in 5.0, have shift code and are making solid progress.

Let me update you on Sunrise Clinical Essentials, this quarter we also announced in a release Sunrise Clinical Essentials Eclipsys' new cost effective clinical information solution, consisting of pre-bundled professional services and software to support care delivery including medication management in acute and emergency care environment.

This solution will help make Eclipsys more competitive in international and North American community hospital markets where there is greater demand for pre-configured and easy-to-implement solutions. Sunrise Clinical Essentials delivers faster time to value and provides a base for more advanced applications to be added later.

We believe that Sunrise Clinical Essentials clients can expect to go live within 10 to 12 months of contract signing with a reduced demand on their staff.

I'd like now to comment on market opportunity, we continue to see positive pipeline expansion in all of our four key markets, the U.S. new enterprise clinical sales market, the add-on sales to our existing clients, revenue cycle management and the international marketplace.

I'll provide some detail on recent progress on the first three and then Andy will cover our international efforts.

First, U.S. enterprise clinical sales, we recently announced two new client wins including the Robert Wood Johnson Hospital University at Rahway and Clark Memorial Hospital which we announced just this morning.

Robert Wood Johnson Hospital at Rahway was a great win for Eclipsys because we beat the competition by demonstrating how our solutions can help achieve outcome improvements in areas related to core measures. There is obviously a lot of focus on core measure improvement in the market and it's great for us to get a win where this was the key deciding factor.

Our improved demonstration capabilities that is significantly improved over the last half of the year reflect the recent investments we've made in this area including hiring a number of new clinical executives to help improve our ability to fully demonstrate the prospective client how our solutions are enabling our current client to achieve industry leading outcomes.

Clark Memorial Hospital was the significant contract win against our primary competitors and has agreed to implement all of the entire Eclipsys Sunrise enterprise solution portfolio.

Clark Memorial Hospital represents the growing number of healthcare organizations that see the benefit of having integrated clinical and revenue cycle workflows. Our strong client references and experience across clinical, access and revenue cycle solutions position us well for continued success in the community market.

Now some comments on add-on sales, clearly the Q4 and FY '07 license software revenue result that Bob reviewed earlier is a strong indication of improving client satisfaction as well as strong sales execution.

I expect to continue to see significant growth in our sales to existing clients. An example of this success is our contract renewals where over the past year we achieved an attachment rate of more than 80% of the time not only with a renewing but we are adding more solutions to the contract with Eclipsys.

Our clients are increasingly seeing the value of having all key workflows on the integrated platform at Sunrise Enterprise. This should help us continue to expand add-on sales into existing clients especially access, revenue cycle and decision import opportunities within our Sunrise Clinical Manager base.

Next, I'll make some comments on revenue cycle management. One of the strong highlights of 2007 was Eclipsys revenues cycle management sales which were significantly stronger than 2006. We saw in a number of new clients including North Mississippi Health system which is the highly competitive win for us. We had a successful activation across five facilities, the Kalida Health, the largest healthcare provider in Western New York State where we replaced five systems from two of our primary competitors.

Our ability to execute on the growing replacement market for revenue cycle solutions is very important to a successful 2008. With this in mind, we spent a lot of time training our sales force in this solution and helping them to better understand how to successfully position our revenue cycle solutions.

We have aligned our marketing efforts and sales programs to enhance our focus on this segment. Our pipeline continues to grow and we expect to add a number of new clients in 2008 as well as execute in the previously mentioned cross selling opportunity in our clinical base for revenue cycle solutions.

I'm really proud of the progress we've made within the client solutions group in 2007 and I want to thank my team for their hard work and the very strong results that they produced.

At this point, I would like to turn the call back over to Andy Eckert.

Andy Eckert

Thanks, Jay. As I said earlier 2007 was a year of significant progress. We added management depth in every part of this company in product development, professional services, sales, marketing, outsourcing, finance, human resources, India and now Asia. I'm very proud of the team we've assembled. It represents a lot of industry experience combined with functional depth in important areas such as product development.

Since our last call in November, we have a completed a build out of our new Atlanta based finance team. Most of the key leadership has done on board for six to eight weeks. They have been deeply involved in the 2007 audit process and are already well integrated into our company.

Admittedly moving a company's headquarters is a challenging undertaking. I feel manage this process exceptionally well and I'm personally quite excited about a talent we've attracted to the company. In my eyes, the risk around this move really has been eliminated.

In the last few months, we've made a number of important moves to rationalize our product line. We exited the networking business as well as divested our CPMRC content business Elsevier. These decisions reflect our strategy to focus on solutions to deliver outcomes value to our clients and higher margins to Eclipsys.

We will continue to be disciplined in terms of what we put in our sales people's bags. We really have no interest in what healthcare IT companies like Eclipsys traditionally marketed our job is to continually assess and adjust our mix based upon where we see opportunity in this dynamic market.

It's been busy year for our delivery teams with well over 200 activations of major new functionality across our client base. We kicked off the year with one of largest activations in our history at Calgary Health region where we had more than 12,000 users trained on Sunrise Clinical Manager. And as we discussed a few months ago, just a few weeks after that activation 90% of the orders were being directly answered by resident physicians into our system.

We feel providing this rapid time to value is a critical success factor for our activations and we experienced similar success with activations at several other places including NYU Medical Center.

Just a couple of weeks back, we turned on another major activation at our largest client, North Shore-Long Island Jewish. We will continue to publicize these types of events because despite what you might hear from other vendors, I don't think names like these are activating with nearly the tremendous early user adoption that has become the norm at our company.

We continue to make progress with our nation international business. We expanded our contract with SingHealth in the fourth quarter to include our medication management solutions. And as you may have seen yesterday, we announced the addition of David van Eck who will manage our operations in the Asia-Pacific region.

Prior to joining Eclipsys, David was running Asia for Elekta and before that helped to build Oracle's healthcare vertical in that part of the world. One of our primary goals in 2008 is to Eclipsys into a global brand, and we took a big first step towards accomplishing this with our recent participation at Arab Health which is held just a few weeks back in Dubai.

As you all know, the Middle East is in the midst of an unprecedented economic boom which is driving dramatic investment in healthcare. Hundreds of new hospitals are being built and this state-of-the art technology and our participation at this important trade event, we think will help us get our foot in the door for these new deals.

We will also participate for the first time at the HIMSS Asia Pac meeting in May. I don't expect these new initiatives to move the needle dramatically financially for us in 2008, but we certainly see a great future as a number of the institutions that we have met in our global travels want to learn more about Eclipsys given our reputation here in North America.

Our progress in India is perhaps the most important long-term advantage we have driven in the couple years. In 2006, we established a footprint in India with the acquisition of Sysware and now we have more than 350 employees in India supporting a broadly range of functions within our company including G&A, client support, professional services and R&D.

While 2007 was spent primarily building out presence in India, we anticipate the 2008 will mark the beginning when we will see a real impact on our business.

I expect we will have upwards of 600 hardworking Eclipsys associates by year end helping us to drive our global growth.

So 2007 was a pivotal year for our company. We are excited about the progress we made on many of these key initiatives our strong finish to the year financially, I believe was testimony that we are on the right track while the market certainly remain highly competitive and there is still much work to do. I feel we're headed in the right direction. Our business is getting stronger. Our competitive positive continues to improve and our sales team executes at a higher level each and every quarter.

As is my custom at this time of the year, I'd like to thank all of the employees of Eclipsys for their incredibly hard work, sense of urgency, client focus and drive to succeed.

At this point, I would like to ask the moderator to open this call up for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Richard Close of Jefferies & Co. Please go ahead, Mr. Close.

Richard Close - Jefferies & Co

Great, thank you very much, congratulations. I had a couple of questions here. Jay, you mentioned renewals about an 80% attachment rate, I guess including add-on sales. Can you say how that 80% compares to maybe a year ago and what the exact number of renewals were this year versus last?

Jay Deady

Richard, thanks for the question. We haven't disclosed volumes or renewals but since we did give you the attachment rate, I can tell you that on a year-over-year basis that came close to being doubled in terms of the attachment rate where they were buying add-on solutions as they renewed multi-year contract with us.

Richard Close - Jefferies & Co

Okay. That's helpful. And then just I guess a discussion on the 5.0 going live or beginning to get rolled out. We've heard, I guess, with heard, they had some decline in software sales year-over-year. Part of the reason there was the millennium '07 upgrade, maybe people focusing on the upgrade and not buying additional software. Can you talk a little bit about how you see 5.0 rolling out? Do you anticipate any higher cost from implementations at those existing sites? And maybe your comfort that you're not going to see a fall off in maybe add-on software sales because of the roll out?

Jay Deady

Well, Richard, I won't comment on Cerner's performance. But as it relates to ours, we learned a lot during the success we had at going up to an upgrading today two-thirds of our client base to version 4.5. And, so as we start to roll 5.0 out, we expect to have the same types of very positive results.

We have a lot opportunity, additional clinical add-ons, constant add-ons, decision support, revenue cycle, access management into the clinical client base and then there is some new stuff that I went though which we are getting very strong reaction to.

We started by launching it at our EUN this past October and we've been able to go out and follow-up on client interest since that time related to orders reconciliation which includes medication reconciliation. That's an externally hot topic for the entire industry and certainly our client as well and then analytics.

The analytics tools allows them to stop having the manually track chart pulls for quality initiatives, paper performance, core measure reports and submission and automates that entire process. And then we take it to the next step where in a dashboard format, it allows them to real-time intervene while the patients still on the bed and not just to reporting.

We've got an extremely strong early response from our client base there. So obviously the proof will be in the putting over the course of the year, but we think we have a good number of new offerings combined with other add-on modules and other solutions that we don't expect any type of drop off.

Richard Close - Jefferies & Co

Okay. And everything is fully tested, you don't anticipate any bugs or anything like that necessarily?

Jay Deady

Well, this is software, Richard, so to say that we do not expect any bugs, would not be accurate because you do in every software program. But we certainly don't believe that based on the testing that we do before releasing it, doing beta testing and then even releasing it internally into an integrated solution, because that's what we use to demonstrate and we kind of thoroughly tested out ourselves and use it out in the field.

So we don't expect any type of major performance issues, that's where you are going but I'm sure there is going to be a couple of things along the way we are going to have to fix.

Richard Close - Jefferies & Co

Okay, thank you. That was very helpful, congratulations again guys.

Jay Deady

Thank you.

Operator

Thank you for your question. And next we go to the line of Corey Tobin from William Blair & Company. Please go ahead.

Corey Tobin - William Blair & Company

Hi, good morning guys. Congrats on nice quarter.

Jay Deady

Thank you.

Corey Tobin - William Blair & Company

A couple of quick things here. Can you give us feeling Jay that the statistics you're going to attach are quite interesting. I'm sure your track attrition is well. Can you give us a feeling for how that's trending with respect to clients that are up to renew their maintenance agreements once the initial term end? Or what percentage of them have opted not to and how's that trended?

Andy Eckert

This is Andy, Corey. We have several products that we sell. And as you know, several legacy businesses that are part of this company. And so in core business, I mean kind of the core patient financials and clinical suite attrition is negligible on that front.

Now there are also legacy businesses where 10 and 15-year-old products where the attrition is higher to be honest with you. And one other things we've done particularly now with our extra resources offshore, we are able to address some of these legacy products with lot more resources, so we could begin. And we are starting this now to begin to kind of reenergize that install base and give them a bit of a future with Eclipsys.

These are all relatively small pieces of our company. So in terms of kind of the current core products that we market heavily and talk to you folks about attrition is incredibly modest.

Corey Tobin - William Blair & Company

Great. And then on the switching gears a bit to the backlog, the decrease that we saw in the outsourcing backlog, I know some of this is by design as you're focusing greater on the software side I think. Where do you expect that the trend here going forward, I mean we've seen a pretty significant decrease? Are you expecting that to continue to trickle down or should stabilize at this point and start to move back upwards?

Andy Eckert

Well, the outsourcing business is an interesting business for us. We have a very strong set of clients in that business. I will tell you that the market seems to have changed a bit in that.

I think it's generally slowed down a bit. I think customers by and large are, if they are looking at that, where we see most of our opportunities, Corey, are in what we call staff augmentation work with existing clients, folks that just don't have enough bodies to manage their business, not necessarily interested in turning over all but all of the entire operation to a third party.

And in terms of how we're trying to run our business, we're trying to be very strategic. We want to work with clients with our outsourcing business that are current software clients or in the near or medium term will be software clients of ours.

I inherited when I got here a number of sites that were third-party software, running third-party software that didn't really kind of make sense to us strategically. But over time as we have focused on this business, we're driving it very hard for profitability and focusing our marketing efforts on frankly our current client base.

So this is not, the engine is going to drive our company going forward for sure. We've really allocated our resources around being a software organizations and using this as a supporting set of services to help us sell more software.

Corey Tobin - William Blair & Company

So if you look at the $300 million or so, it's in there today, how much of that is what you'd consider to be sort of the legacy type outsourcing engagements verus how much is the newer type that has either already has software engagements tied to it or the potential to become a software?

Andy Eckert

The overwhelm majority, I mean our folks like El Camino Hospital or North Shore-Long Island Jewish where we have huge amounts of software activity. And so, there is a few legacy accounts that they don't run Eclipsys solutions and we don't have an opportunity to get in there. But for the most part, these are active Eclipsys users both in the software and service front.

Corey Tobin - William Blair & Company

Okay. So not to put a number in your mouth but we shall see it probably stabilize at this point?

Andy Eckert

I would think so, although we've broke it out of you. So if it grows, you can see it grow, if it falls back, it's in area of our company that we don't consider incredibly strategic but yet another set of services for us to be able to sell software. I mean as this stuff we sell gets more and more complicated. We find existing at clients and prospects. They struggle with finding the talent to operate as complex enterprise systems.

And so in that sense, this is a strategic, this is a good business to support us but it's certainly not an area we are investing heavily and hiring sales people to scour the earth. This is not really our focus. Our focus is to follow into current and hopeful software client. So it's tough to say whether it will go up, I don't think it will go up dramatically and I don't think it will go down dramatically. I think we are going to continue to expand our relationships with our current accounts and pick off new accounts where it make sense.

Corey Tobin - William Blair & Company

Got it, great. And then final question on the financing front, anything that you are hearing from customers with respective to been able to finance system purchases given the current credit environment or anything along those lines? Thanks.

Jay Deady

Thanks for the question. This is Jay. Yes, clearly our subscription model continues to be an effective weapon in the hands of our sales folks out in the field and that in many areas of the company, country rather, given reimbursement levels and their payer mix etcetera that the ability to not have to put up such an upfront capital commitment with us and take advantage of the subscription model versus the competition has been very advantageous. And in fact a healthy percentage of our net new business wins definitely utilize the subscription model. And then we did win loss analysis clearly indicated that that was an attractive feature of doing business with Eclipsys, so that continues to be very strong for us.

Corey Tobin - William Blair & Company

Okay, thanks.

Operator

Thank you for your question. And next we go to the line of Sandy Draper from Raymond James. Please go ahead.

Sandy Draper - Raymond James

Thanks and good morning. Congrats on a nice quarter and year.

Andy Eckert

Thank you.

Jay Deady

Thanks Sandy.

Sandy Draper - Raymond James

First question, Bob, you made some comments about on R&D line, just to get a sense, would you expect your growth R&D expenses I guess primarily because of your folks in India have been pretty moderate in terms of the growth. Would you expect that trend to continue? Or is there any major step up in growth R&D expenses you would need to be doing in '08 or '09?

Andy Eckert

Yes. Hi, Sandy. This is Andy. As we said here today, we have 50% more software engineers in this company than we did two years ago. That's a good number. Now I think we've done it in the right way which is to have a mix of folks here and offshore. And so we are going to continue to invest heavily in our development team and have.

But doing in way, so we can keep this number relatively flat, it will probably grow a bit over time. But don't take a flat level investment as meaning we are not investing more and more every single quarter of this company we are heavily. So I'd expect that kind of stay flat and grow a little bit over the years.

Sandy Draper - Raymond James

Okay. So you're still in the mode of, if someone here in the U.S. leaves or you let them go, you are still looking at first choice is can we replace them in India so or grow. So in the net, you may be able to have two or three new people in India for the same cost as one person over here?

Andy Eckert

Yes, or four or five.

Sandy Draper - Raymond James

Or four or five.

Andy Eckert

But it's all about mix. Listen, we continue to hire here pretty aggressively as well. But we're aiming our hiring here at the high end, the designers, the architects, the real heavy development engineers. Those are the folks that we want here. And then in India, we will hire a broader spectrum of talents to support our activities.

Sandy Draper - Raymond James

Okay, great. And Bob, could you just reiterate your comments you said about what you expect in terms of amortization and R&D at the beginning? And then you said some of that either gone flat or down in the first quarter and then changing, I just want to make sure I've got that right?

Bob Colletti

Yeah, probably, so on cap software side, you'd expect capitalize software development cost to be down significantly in Q1 and then go up gradually as we go through the years as we work on the next release. So you don't like kind of normal trends Sandy, drop down in cap when you go to a new release and then build as you start the capital will go up as you go through the year.

On the amortization side, you have an increase in Q1 related 5.0 being released in December. So amortization goes up in Q1 and then goes down again because we have the full amortization on 4.0 which was released about three years ago, in March three years ago. So up amortization in Q1 and then down in Q2.

Sandy Draper - Raymond James

And so that's why one of the major factors in first quarter lower EPS that you got cap software going down but amortization going up?

Bob Colletti

Yeah, both factors going up exactly negative on the P&L in Q1, that's exactly right.

Sandy Draper - Raymond James

Okay. Two more quick questions, I'll jump back in the queue. One Bob obviously strong gross margins in the quarter after adjusting out a lot with one-time software. How should we be thinking about gross margins, maybe both, and I would imagine down sequentially but long-term any changes to your targets?

Bob Colletti

Our targets have not changed, but I would expect is expect the same type of seasonality you saw in '07, drop in Q1 and then build through the year. So you really start to see in the business consistent level of seasonality last three to four years, so our model was going down in Q1 and then going as we go through the year and exiting the year a little bit higher than we were this year as we continue to go on target to those margins we talked about in the past.

Sandy Draper - Raymond James

Okay, great. And then the final question. Do you have a specific share count you factored into your guidance?

Bob Colletti

I just have it modestly I put about a 2% increase as we go through the year in the share count.

Sandy Draper - Raymond James

Okay, great, thanks.

Bob Colletti

Thank you Sandy.

Operator

Thank you. And next we go to JPMorgan from the line of Atif Rahim. Please go ahead.

Atif Rahim - JPMorgan

Well I think it's the other way around, but Bob a quick question on the backlog, just to clarify your definition in terms of what used to be there in the past. The outsourcing always, was that always just one year out that you included in your backlog?

Bob Colletti

Outsourcing was always the full contract term.

Atif Rahim - JPMorgan

So it's just a software that you had while you were in.

Bob Colletti

Yeah.

Atif Rahim - JPMorgan

Okay. So it looks like the net increase in the '06 looks like it's a $113 million versus what you had given last year. So is that a realistic expectation or has in terms of the mix or the percentage of software that extends beyond a year or has that increased I guess because of some of the larger deals for example SingHealth that you signed, is the software portion that's more than one year out a bigger component?

Bob Colletti

We had a very good 2007 expanding the existing client relationships, so we were able to expand contracts, to expand them. So you look at the software piece, the book is up like 20%, 22%, 23% for the year in the software business. So a definite trend has been a significant improvement in the existing clients as well as adding new clients into that.

Atif Rahim - JPMorgan

So the percentage that's out more than a year is definitely higher then?

Bob Colletti

We really start to make a lot of progress with our clients, yes.

Atif Rahim - JPMorgan

Okay. And then question for Jay. What's the early lead on the Clinical Essentials product? What is the feedback you’re getting from customers? How do you stack up versus competitors? And if possible, what's your ticker price versus the competition out there?

Jay Deady

Well, from a early read, when we had release this, we actually have, we didn't announce this publicly until actually we've already taken a client live on it which was Holy Spirit. And so we got very positive results. We've recently signed a couple of more clients and we have quite few in the funnel.

So we are getting a lot of traction with a few data points that are indicating some pretty good results as we embark with multiple more clients on the deployment side. In terms of competitively when we look at a couple of our major competitors and you combined the software and the services pricing in this type of model, we are competitive in the marketplace.

So this was intended to really allow us to be more competitive in the 200 to 400 bed marketplace. We’re still a little premium priced to be honest compared to a couple, but it now brings us into a range where we can still hold a premium. But the deployment model is now vastly accelerated and that's what these clients and prospects are looking for.

So, we're all in the neighborhood. Everybody in this industry has a pretty good sense of everybody else prices. We're holding a premium over most of them by 15% to 20% actually, but early indications are this is going to be something that will be really strong for us in 2008.

Atif Rahim - JPMorgan

Okay. And is this also being sold in a subscription basis or is it upfront licensed software?

Jay Deady

So far, all of them have been subscription.

Atif Rahim - JPMorgan

Okay. All right. Thank you.

Jay Deady

Yeah. Okay, operator we have time for one more question.

Operator

Okay. Thank you. And that question will come from the line of Sean Wieland from Piper Jaffray. Please go ahead.

Sean Wieland - Piper Jaffray

Hi, thanks for taking the question. Can you comment at all on what you are seeing in the ambulatory market and the uptake of your systems and the affiliated medical groups with your hospitals?

Andy Eckert

Sure. So we continue to had success in the net new clients with an attachment rate that's been approximately 80% of ambulatory going with the acute care clinicals and that's both for the owned practices and clinics and employed physicians as well as we've had some successes last year with affiliated entities.

So, we've had a good uptick there. The majority of our prospects or funnel base if you will is still associated with owned clinics and employed physicians. We're seeing some modest growth with affiliates.

And right now what we're looking at strategically is we're getting more request on how can we help our clients, meet the needs of kind of really loosely affiliated practices that are small in nature, that are out there where the dollars in that market are fairly constrained but the unit volume is high.

So we are looking at that strategically in terms of different options that we might have that is an increasing request coming from our client base and something that we hope to better address over the course of 2008.

Sean Wieland - Piper Jaffray

Okay, thanks. And then can you talk specifically as you can on SingHealth and how you expect to recognize that revenue and how that's going to come in and where it's going to hit the model?

Bob Colletti

Yeah, Sean, it's Bob, good morning. It's really not what I tell you on the base Sing contract, it's just the normal type of contract. It will be recognized the implementation over about 12 to 18 months if they roll it out. So, and the model, it's not anything, it's not an up front license fees, taken in over time. Little bit of it was in Q4 on the services side and will continue. I would comment the project is going very well. They are great user technology. We've made a lot of progress early, but I just call it's normal baseline contract not going to move the needle in the short term.

Sean Wieland - Piper Jaffray

Well, the licensed fees hit the recurring revenue line or the non-recurring revenue line?

Bob Colletti

It's percentage of completion, so it will be a based on about 18 months, so it's kind of better both really, it's just went a little bit over time.

Sean Wieland - Piper Jaffray

Okay. So is it going to come in to the license revenue line?

Bob Colletti

Yeah, within the license revenue, but it's the modest license fee in the first part of it.

Sean Wieland - Piper Jaffray

Okay. So none of that was in the fourth quarter?

Bob Colletti

Very minimal, yeah.

Sean Wieland - Piper Jaffray

Okay. And then so going forward, I think you said that the one-time license revenue will come in at about the same percentage as it was in 2007. So it looks in '07 that number beat your original expectations a little bit. Can you just comment on why the upside you think you came in about 4.4% of total revenue as license revenue versus 3% to 4% guidance? Anything specific there that you want to comment on?

Bob Colletti

We had a real strong Q4 just across the board of the sales side. So I think it was just, we implemented a lot of initiatives in the last couple of years and we start to get some tractions towards the back of half year really. So I'll make just point to balance on the sales side across the entire sales force, so I think it just combination of those things. So it did come up a little bit higher than we originally anticipated. I think it was just combination of better execution as we went through the year.

Sean Wieland - Piper Jaffray

Okay, great. Thank you very much.

Bob Colletti

Thank you very much. Thank you everybody for the time this morning. We appreciate the support. Thanks for listening and thanks for the questions. And look forward to working with everyone in 2008 and love to see at HIMSS, if you can make it down there, that would be great. We've got a very big booth down there and we'd love to see you come down and come to our investor meeting as well. So, thanks everybody and have a great day.

Operator

Ladies and gentlemen, this does conclude our conference for today. Thank you for your participation and thank you for using AT&T Executive Teleconference. You may now disconnect from the call.

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