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Cerner (NASDAQ:CERN)

Q2 2012 Earnings Call

July 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

Analysts

Charles Rhyee - Cowen and Company, LLC, Research Division

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

George Hill - Citigroup Inc, Research Division

Zachary William Sopcak - Morgan Stanley, Research Division

Andrew O'Hara

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Michael Cherny - ISI Group Inc., Research Division

Sean W. Wieland - Piper Jaffray Companies, Research Division

Alexander Y. Draper - Raymond James & Associates, Inc., Research Division

Nicholas Juhle - Robert W. Baird & Co. Incorporated, Research Division

Operator

Good day, ladies and gentlemen. Welcome to Cerner Corporation's Second Quarter 2012 Conference Call. Today's date is July 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, perspectives and prospects constitute forward-looking statements within the meaning of the Federal Securities Laws. Information concerning words intended to identify such forward-looking statements and factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading Risk Factors in Cerner's Form 10-K, together with other reports that are furnished to or filed with the SEC.

Please see the company's earnings release that was furnished to the SEC today and posted on the Investors section of cerner.com for a discussion of the risks associated with forward-looking statements, as well as a reconciliation of non-GAAP financial measures discussed in this earnings call.

The company undertakes no obligation to update publicly any forward-looking statement, whether as a result of new information, future events or otherwise.

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

Marc G. Naughton

Thank you, Melanie. Good afternoon, everyone. 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 Nill, Executive Vice President and Chief Operating Officer, will discuss operations and provide an update on our corporate imperatives. Jeff Townsend, Executive Vice President and Chief of Staff; and Neil Paterson, our Chairman, CEO and President are traveling today. Now I will turn to our results.

We delivered strong results in the second quarter. Bookings were above the midpoint of our guidance range. Our income statement performance was good, with revenue at the top end of our guidance range and continued margin expansion, driving strong earnings growth. We also delivered very strong cash flow performance.

Moving to the details. Our total bookings revenue in Q2 was $701 million, which is a record for our second quarter. Bookings were above the midpoint of our guidance range and were up 8% from a very strong result in Q2 '11 when bookings grew 39%. Bookings margin in Q2 was $577 million, or 82% of total bookings. As Zane will discuss, the strength of bookings in Q2 span across several business models and included a new ITWorks contract.

Our bookings performance drove a 20% increase in total backlog to $6.51 billion. Contract revenue backlog of $5.8 billion is 22% higher than a year ago. Support revenue backlog totaled $714 million, up 5% year-over-year. Revenue in the quarter was $637.4 million, which is up 22% over Q2 of '11. The revenue composition for Q2 was $195 million in system sales, $150 million in support and maintenance, $276 million in services and $16 million in reimbursed travel.

System sales revenue reflects 24% growth from Q2 '11. This was driven by continued strong growth in device resale, traditional hardware resale and subscriptions. Software revenue was down slightly, in part related to a lower percent of current quarter software bookings being recognized as revenue in the quarter because of contract terms that result in revenue being spread over a longer period. This is obviously a positive long-term, and the impact on this quarter was more than offset by strong services, which demonstrates the strength and diversity of our overall business model. As Zane will discuss, our pipeline and outlook for the second half of the year is very strong.

Moving to services, total services revenue was up 27% compared to Q2 of '11, with strong growth in both managed services and professional services. Support and maintenance revenue increased 9% over Q2 of '11.

Looking at revenue by geographic segment, domestic revenue increased 25% year-over-year to $562 million. Global revenue was $76 million and grew 2% compared to the year-ago period.

Moving to gross margin. Our gross margin for Q2 was 76.9%, which is up from 75.4% in Q1 and down from 81.2% in Q2 of '11. Similar to the last quarter, the year-over-year decline in our gross margin percent was driven primarily by very strong levels of device and hardware resale. While the gross margin percent for the quarter was lower, total dollars of gross profit grew 15% from the year-ago period, and total margin dollars from system sales is up 15% year-to-date.

As we have 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 moment.

Looking at operating spending, our second quarter operating expenses were $345.2 million before share-based compensation expense of $8.6 million. This is an increase of 11% compared to Q2 of '11. Sales and client service expenses increased 15% compared to Q2 '11, driven by an increase in revenue-generating associates in our services business. Sales and client service expenses were down slightly sequentially, with salary expense growing less than expected due to timing of new hires, and this growth being offset by a sequentially lower other personnel and non-personnel expense.

Our investment software development was up 5% compared to the year-ago period. As we discussed last quarter, we have 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 decreased 1% compared to Q2 of '11.

Moving to operating margins. Our operating margin in Q2 was 22.7% before share-based compensation expense and was up 90 basis points compared to Q2 '11. This margin expansion contributed to operating earnings growth of 26%.

Given the much higher mix of lower margin technology resale this quarter compared to the year-ago quarter, I am very pleased with this level of margin expansion and earnings growth. Going forward, we expect the mix to normalize, which should allow us to deliver margin expansion in our 100- to 200-basis point target range.

Moving to earnings and EPS, our GAAP net earnings in Q2 were $97.8 million, or $0.56 per diluted share. GAAP net earnings include share-based compensation expense, which had a net impact on earnings of $5.3 million or $0.03 per diluted share. Adjusted net earnings were $103.1 million and adjusted EPS was $0.59, which is up 34% compared to Q2 '11. The tax rate for adjusted net earnings was 30.1%, which is lower than normal, due primarily to an increase in an estimated tax deduction available for 2011 that was recorded as a favorable discrete item. Note that normalizing to a 35% tax rate, which is in the range of what we expected for Q2 without this benefit, would reduce adjusted earnings per share by $0.04. For the balance of the year, we expect our effective tax rate to be between 34% and 35%.

Now I'll move to our balance sheet. We ended Q2 with $1.39 billion of total cash and investments, up from $1.27 billion in Q1. Total cash and investments include $980 million of cash and short-term investments and $412 million of highly rated corporate and government bonds with maturities over 1 year. Our total debt, including capital lease obligations, is $176 million.

Total receivables ended the quarter at $493 million, which is down $43 million from Q1. Contracts receivable or the unbilled portion of receivables were $45 million and represent 9% of total receivables.

Cash collections were $680 million, and our DSO in Q2 was 71 days, which is down from 76 days in Q1 and 88 days in Q2 of '11. Operating cash flow for the quarter was an all-time record at $182.8 million.

Q2 capital expenditures were $51.8 million, and capitalized software was $23.8 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was $107.3 million. Note that we expect the operating free cash flow to be lower sequentially in Q3 due to the timing of tax payments and an increase in capital expenditures.

As we have noted, the increase in CapEx is being driven by construction of our new Kansas City, Kansas campus. The construction cost will span multiple years and will also be receiving incentives that will offset a portion of those costs.

Moving to capitalize software, the $23.8 million of capitalized software in Q2 represents 31% of the $77.2 million of total investment in development activities. Software amortization for the quarter was $20.1 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 $21 million to $23 million per quarter.

Now I'll go through Q3 and full year guidance. For Q3, we expect revenue between $635 million and $655 million, with the midpoint reflecting growth of 13% over Q3 '11. For the full year, we expect revenue between $2.575 billion and $2.625 billion, with the midpoint reflecting 18% growth. This is up from our previous range of $2.525 billion and $2.6 billion.

We expect Q3 adjusted EPS before share-based compensation expense to be $0.57 to $0.59 per share, with the midpoint reflecting 21% growth over Q3 '11. For the full year, we expect adjusted EPS between $2.32 and $2.36, with the midpoint reflecting 25% growth. This is up from our previous range of $2.25 to $2.32.

Q2 guidance is based on total spending before share-based compensation expense of approximately $355 million to $360 million. Our estimate for the impact of share-based compensation expense is approximately $0.04 in Q3 and $0.13 to $0.14 for the full year.

Moving to bookings guidance. We expect bookings revenue in Q3 of $710 million to $750 million, with the midpoint of this range reflecting 12% growth over our strong results in Q3 '11 when bookings grew 31%.

In closing, we are pleased with our strong results in Q2, with all key metrics at or above our expected ranges, including strong bookings, revenue earnings and cash flow and strong margin expansion.

With that, I'll 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 Q2 of $701 million reflects 8% growth over last year's record bookings and is an all-time high for second quarter. We also continue to have a high level of large contracts, with 21 contracts over $5 million, including 9 over $10 million.

Our results included strength in several areas, with particularly strong results in services, device resale, revenue cycle, physician practices and community hospitals. In the hospital market, we continue to see strong levels of purchasing in our install base, and our competitiveness was very good with 28% of our bookings coming from outside our core Millennium install base.

Our pipeline for additional new footprint is very strong as we see a growing number of hospitals reconsidering their supplier as they face the rising bar for Stage 2 and Stage 3 of Meaningful Use and additional requirements for value-based purchasing, ACOs and data analytics capabilities. Cerner is well ahead of our competitors in investing in these areas, as most of our competitors are struggling with transitions to new platforms, integration challenges and other issues that have reduced the confidence in their install base. As a result, we believe there will be a robust replacement market for several years.

These significant opportunity is reflected in our leading indicators, with very strong RFP volumes, particularly for large IDNs and a record increase in our pipeline. While there is one competitor that remains a challenge, our competitive position against them continues to strengthen. At the same time, their weaknesses are becoming more known in the marketplace. As we've discussed, our significant improvements to our physician solutions and the workflow is neutralizing one of the primary areas they used to compete. And we believe the capabilities we are rolling out in Millenium+ and PowerChart+Touch surpass their capabilities. In addition, our investments in our operability, data analytics and population health management are becoming an increasingly important differentiator against them as their platforms make interoperability and data analytics very challenging. We also believe they will face an inevitable upgrade from their MUMPS-based platform that is needed to catch up in these areas, and this will be very disruptive and expensive.

Moving to the physician market. We had another strong quarter that included multiple competitor displacements. Our success in this market continues to be primarily driven by the marketplace's desire to have an integrated solution across inpatient and outpatient venues. As a result of this trend and strengthened physician solutions, I think we are in the early stages of a period during which many of our clients will be replacing best-of-breed ambulatory providers with our integrated solution. This desire to have a common platform across venues is also present in replacement and greenfield opportunities as part of the reason we are having success in these procurements.

I think it's important to note that this desire for integration is not limited to physician and hospital office integration. As reimbursement becomes increasingly tied to quality and outcomes and more care shifts to different settings, the ability to coordinate care across multiple venues is becoming critical. While this trend has already led to an increase in hospitals purchasing physician practices, other venues of care are also being consolidated. A good example of this is Dignity Health's purchase of the occupational medicine and urgent care centers of U.S. HealthWorks.

Cerner is well-positioned to benefit from this trend, given our broad platform that covers more venues of care than any other supplier. Cerner's ability to provide solutions for physician offices, ambulatory surgery centers, behavioral health, urgent care, home health, occupational health, rehabilitation hospitals, skilled nursing and long-term care facilities, as well as many other venues, becomes a competitive advantage in an environment where hospitals are looking to align more closely with these venues.

Moving to our global results. As Marc mentioned, our global revenue growth was low at 2%. This follows 23% growth in Q1, reflecting a lumpier nature of our global business and the challenging economic conditions in most global markets. With our year-to-date global growth of 12% and a good outlook for the rest of the year, we expect a solid year overall for our global business. This is driven primarily by a good outlook in Canada, Australia, the U.K. and the Middle East.

A highlight in Q2 was signing our first client in Mexico. The client, Médica Sur, is a multi-facility organization with 220 beds in their primary inpatient care center. They are the only publicly-traded hospital in Mexico and are applying for Joint Commission International certification this year. Its certification will put them among the most prestigious hospitals in Latin America.

Médica Sur is focused on quality care, growth and innovation and plans to demonstrate this in coming years through the creation of a medical city consisting of several new venues and an expansion of their main facility to over 500 beds. We have several other promising leads in Latin America and are already working to make sure this relationship is the beginning of a successful new market for Cerner.

In closing, I'm very pleased with our Q2 results and feel very good about how well positioned we are 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 and revenue cycle and provide an update on Meaningful Use, PowerChart Touch and our analytics and population health initiatives.

I'll start with ITWorks, where we signed our second client of the year during Q2. We have 11 signed clients since launching ITWorks in late 2009. The client we signed has 2 hospitals: one is a community hospital that's been using Cerner's solution and services since 2005 and has already attested for Stage 1 of Meaningful Use. As part of their growth strategy, they recently acquired another community hospital that is using a competitor's HCIT system. The client reviewed ITWorks as the best way to support their growth and continued on their IT road map, which now includes replacing that competitor's system with Cerner at the hospital they recently acquired. The pipeline for ITWorks remains very strong, and I expect us to have a strong year in 2012.

Moving to revenue cycle. We had another strong quarter in our revenue cycle business, adding 9 new clients. We've also been making good progress on implementations and have brought 14 hospitals and 41 clinics live on patient accounting this year. We now have 90 hospitals and over 400 clinics live.

In addition, by working closely with some our large clients, we have significantly advanced our solutions and are establishing more meaningful revenue cycle proof points. This progress has led to increased interest from other large clients in both our core revenue cycle solutions and our RevWorks services offering.

Discussions with our clients increasingly validate that our integrated approach is needed to succeed in the industry and begins to shift to a value -- as the industry begins to shift to a value- and quality-based model that will require tighter integration between clinical and revenue cycle systems.

I believe we will increase our differentiation through ongoing investments in technology that can automate more of the workflow, which is something that will be in high demand as healthcare deals with the increased complexity created by ICD-10 and other regulatory requirements.

Turning to Meaningful Use. Our clients continue to attest at a good rate. Currently, approximately 45% of our core hospital clients have attested for Stage 1 Meaningful Use, and we expect approximately 85% of them to have attested for Stage 1 by the end of the year. Looking ahead to Stage 2, we are well positioned to begin deploying Stage 2 functionality when the rules have finalized and the certification process opens. We believe the increased complexity and higher adoption levels required in the Stages 2 and 3 create challenges for many of our competitors.

Now I'd like to provide a quick update on PowerChart Touch, our native iPad app that is part of a new generation of physician applications. PowerChart Touch is enabled by Millenium+, which combines the enterprise platform with a secure Cerner cloud. And this connectivity makes it possible to merge our relevant and available clinical, financial and operational information, which enables the physician to be much more productive.

Since announcing Millenium+ and PowerChart Touch at HIMMS earlier this year, the level of interest by our current and prospective clients has been great. Given this high demand, we've been working very hard to meet our delivery goals, and I'm very pleased with our progress. We had a lot of success with our early adopters and remain on track for broader deployment later this year.

In addition to driving Meaningful Use and dramatically improving the physician experience in Millenium+ and PowerChart Touch, another imperative of ours is to power population health management. It's becoming increasingly clear that providers are going to become more accountable for the health of population through ACOs or similar models. As a result, many providers are beginning to focus on analytics and population health management capabilities. We believe Cerner is uniquely positioned to help our clients in this environment.

As background, our experience with data and analytics dates back to 1996 when we started Health Facts, which is a research database that now has over 150 million patient encounters and nearly 2 billion lab results. While in the past this data has largely been used to support pharma and biotech research, our server map organization is now using it along with published evidence to accelerate the development of predictive clinical agents.

Another example of where we have proven the value of data is our Lighthouse solutions and services. Lighthouse is a data-driven clinical process optimization that allows clients to leverage investments they have already made to digitize their environment. Lighthouse has a proven record of

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optimizing outcomes, reducing unreimbursed care and

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regulatory reporting and quality requirements.

As a result, it is becoming a meaningful business for Cerner, with over $130 million in revenue last year. Lighthouse is now becoming part of our broader Healthe Intent platform, which significantly expands the breadth of this offering.

As Jeff discussed on prior calls, our Healthe Intent platform is a cloud-based data layer that is agnostic to the source EMR and is able to capture research, evidence and claims data. Healthe Intent supports a new generation of real-time predictive analytics that we believe are critical to healthcare's ability to improve quality and control costs.

I'm sure that many of you read the recent sad story in The New York Times about the 12-year-old who died from sepsis. The first agent being deployed on our Healthe Intent platform is a sepsis agent, which can assist in detecting the conditions that indicate a patient may be developing sepsis and recommend action before it's too late. Clients that have deployed this agent have seen significant reductions in death from septic shock.

Another key capability enabled by Healthe Intent is population health management. As we have discussed, in an accountable care environment, providers need the ability to predict and prevent incidents such as readmissions and proactively monitor patients with chronic conditions so complications can be prevented. The partnership we announced in April with Advocate Health Care, a leader in health -- in population health management, will advance our population health capabilities and position us for significant opportunities as we deploy these capabilities across our client base.

Another initiative we believe will demonstrate the power of consolidated population health management is the partnership with Nevada, Missouri, which was announced earlier this week. We are collaborating with this city to build a new model of health and care, with the goal of significantly improving health status and the outcomes in Nevada.

In addition to deploying Cerner's solutions at Nevada Regional Medical Center, the project will focus on creating a culture of health and a community through education, incentives, infrastructure and partnership with stakeholders such as the Nevada School District, local employers and community organizations. In addition, all residents will have access to their health information, regardless where they are or what provider they see.

We believe a project of this scope has never been done before. Our goal is to see how quickly we can impact the cost, accessibility and quality of health and care and to create a replicable model and sustainable model for other communities.

With that, I'll turn the call back over to the operator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Charles Rhyee with Cowen.

Charles Rhyee - Cowen and Company, LLC, Research Division

Marc, you guys talked about really strong RFP activity here, and it looks like the third quarter bookings guidance, you're at the midpoint, guiding up sequentially. Obviously, over the last couple of years, you've been really good at exceeding sort of your guidance and today we're kind of coming in the upper end of the range. Anything in terms of deals that you might have saw in the second quarter that you're now expecting more in the third quarter? And then in terms of the RFP activity, is there a point when hospitals need to just say, hey, we might not be happy with our current vendor, but we just need to stick with them for now because we want to get through Meaningful Use and give them some of the things coming down the road. We don't want to be juggling lots of stuff. Is there a point -- at some point, do you think hospitals need to make that decision or not?

Marc G. Naughton

Charles, this is Marc. I'll let Zane talk about the market in RFPs and whether there's a time when they decide to just stay with what they have. But just relative to our guidance, our guidance always has planned to try to give you the best idea we can of what our business activity is going to be. So we have -- in a year, coming off a year where we -- kind of on a quarter-by-quarter basis, exceeded the prior year by over 30%. In this case, 39%. We entered this year talking about being able to grow bookings over an incredibly strong 2011. And through the first 2 quarters, we have achieved that. So we're actually very pleased with that. That being said, the last half of the year looks very strong for us. And Zane, I'll let you go ahead and chime in relative to that.

Zane M. Burke

So as Marc indicated, the back half of the year does look very strong. And to your other question around the -- if there's a date in which people will not cut over, I actually believe that it's a sinking ship scenario where you're going to find vendors over time are going to -- they're going to sink at different points over the next several years, based on the increasing bar of Stage 2, the increasing bar of Stage 3 and the value-based purchasing. And you really won't have an opportunity to not get off of that platform. It'll be a -- basically be a requirement if a solid EMR at the core is critical to managing through the changes in healthcare. And so we continue to see this evolving. I think that's one of the reasons why we saw our -- we continue to see our pipeline growth, which is a very long-term leading indicator out there. And it was the -- as I mentioned, it was a record high.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. That's very helpful. And then maybe, Marc, just one follow-up on the guidance here, when you talk about the revenue guidance for the third quarter, when we think about the mix between like system sales and service, should we look at the second quarter as sort of the relative weightings when we think about that? Or is there anything sort of you think unique about -- in system sales that we could see? Maybe that bumps up next quarter?

Marc G. Naughton

Yes, I would think, based on the relative -- Q1, we saw very strong incidents of DeviceWorks and the resale technology. I think, this quarter, certainly, that decrease have kind of got to a more normalized mix. Starting in Q3 is when we will actually get the year-over-year comparables that will have a pretty good mix of hardware and technology resale in those numbers. So I think as we roll forward, this is probably -- the mix should be in a similar range. We probably would assume that technology resale will be fairly strong. We would expect to probably see a little bit more software coming in as part of system sales. But I think, overall, gross margins that are kind of in the -- kind of the current quarter's range, which is pretty reflective of mix, would seem appropriate.

Operator

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

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

Marc, I want to dig a little bit deeper into that gross margin comment that you made. So in the current quarter, it's in the, call it, high 48% or mid-48% range for system sales. Is that what you're referring to? Or is it overall margins for the company? And then secondly, if you're looking at just system sales, that was, I would say, weaker, and you made some comments around some of the software contracted revenue being spread out over a longer period. So could you go over the specifics of what that is and how it's different versus prior quarters?

Marc G. Naughton

Well, it's not necessarily significantly different, Atif. Every contract has a different revenue recognition view. As we do more and more of our service contracts, more ITWorks contracts, the software that's attached to those deals is going to have a longer-term revenue recognition. So it wasn't a huge impact, but it was one of the things that, from a revenue standpoint, was slightly lower than we were looking for relative to licensed software. So I think that's the best way to describe that. It's nothing that's unusual, it's just going to be part -- kind of part of our business model, and it may vary a little bit from what we are expecting, depending on where those get included in the contracts. I think from a system sales margin standpoint, I mean, you've seen this kind of being in the 48% range. Currently -- a year ago, we were in the 60% range. I think you're going to -- certainly, that's a pretty wide range to say we're going to be some place in between those. But I think, with -- I mean, if you go back and kind of look at the Q3 '11 range and to follow that forward, I think it'll be -- well, it should be in a range that's somewhat consistent with those from a system sales perspective. We do continue to expect to have relatively strong tech resale results in our numbers. That's part of our strategy, it's part of what we've been delivering for the last 3 quarters, and we will expect that to continue going forward.

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

Okay, understood. And then when you talk about the pipeline being at record levels, is it more services-, ITWorks-, RevWorks-driven? Or is it just the rest of the business? And is there any way you can break out what you think the ITWorks or services mix is going to be for the back half of the year versus the rest of the business?

Zane M. Burke

This is Zane, Atif. The pipeline itself feels very consistent with what we've seen over the past, in terms of its very robust -- with software, with services, with ITWorks, with revenue cycle, et cetera. So it's very robust across all areas. As it relates to the mixture of ITWorks, I think we've previously said about 1 ITWorks deal per quarter is in that process, and that's about the trend we are on.

Marc G. Naughton

Yes, Atif, this is Marc. I think it'll be -- our long-term bookings that we've consistently looked at as kind of really been in the upper 20%, low 30% range for a while. And I think that we'd expect that to kind of continue.

Operator

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

George Hill - Citigroup Inc, Research Division

Marc, I might have missed this data point. Did you say whether or not the bookings mix has the typical 30, 35-ish percent of bookings that are recognized over a longer period of time? Or did that mix change at all this quarter?

Marc G. Naughton

Yes. No, it was typical. It was 32%, I think, for the quarter. So right in that range.

George Hill - Citigroup Inc, Research Division

Yes. And then a quick one for Zane. While the pipeline looks strong and you guys have guided to good bookings growth for Q3, I don't know whether or not you have commented yet, is it unrealistic to expect that bookings could possibly be up in Q4?

Zane M. Burke

We're looking at the back half of the year as being very strong.

Marc G. Naughton

And we think its -- George, I think it's -- we're looking at it. Certainly, we said we are looking to grow bookings for the year. We've done it so far. Obviously, we've got a good start on that, but we tend to be conservative Midwesterners here. But the last half of the year, given the level of pipeline, which is beyond anything we've seen before, the low RFP volume, which is beyond what we've ever seen before, the fact that some of these processes are now actually short-cycling to a 12-month period that we've historically seen, we expect to have a very good second half of the year.

George Hill - Citigroup Inc, Research Division

Okay. That's great to hear. And then maybe just one quick one for Mike and then I'll hop off. Mike, you guys were -- as publicized this week about some of the network difficulties that the company had on the West Coast. Can you talk about the conversations that evolved with customers following that and kind of maybe the source of the difficulty and how you guys plan to address that in the future?

Michael R. Nill

Okay. Sure, George. Yes, we did have an outage within our CernerWorks environment. And the source of that outage, after investigation, was human error. And we've obviously -- I mean, we take our hosting business very seriously. We have significant responsibility to our clients, and we delivered very high levels of performance and reliability for years. We had many -- well, with all of our clients, we had personal conversations to understand, so they understood exactly what happened and why. And we're in the process of reviewing our operational procedures to implement additional safeguards that would prevent an incident like this in the future. But I -- we understand fully what occurred, and we're taking the appropriate measures to deliver the same level of service that we have in the past.

Operator

Our next question comes from the line of Ricky Goldwasser with Morgan Stanley.

Zachary William Sopcak - Morgan Stanley, Research Division

This is Zach Sopcak in for Ricky, and we had a question about what happens when you reach the 85% attested, Marc, that you talked about in terms of the backlog? Would you see a reduction in potential backlog beyond that point?

Marc G. Naughton

This is Marc. Most of the work that's going to get to the 85% attestation is certainly ongoing, a lot of that, given the 90-day period to attest. We had a very busy services quarter in Q2 working on those projects. The work to get to Stage 1 attestation has been ongoing and is a -- the remaining amount of that work is a very small part of our backlog. Most of our backlog is in other -- it's the follow-on projects and other projects that are not specifically related to Stage 1. So there's not really a significant backlog impact for the 85%. It's not going to trigger a mountain of revenue that's going to be coming through. Most of that is services, and the services come through on a, as an hour worked, an hour revenued-type basis. So it will continue to come in strong as our services revenue has, but it won't be a significant change to backlog. In fact, given the prospects we have in the last half of the year, we would certainly expect to see backlog grow over the next half of the year.

Zachary William Sopcak - Morgan Stanley, Research Division

And just a quick question on acquisitions. With a lot of hostility out there with your competition and a lot of cash in your balance sheet, are there any interesting opportunities you see out there?

Marc G. Naughton

Well, obviously we can't speak specifically about any acquisitions, targets that we might be thinking or not thinking about. But we clearly have a significant amount of cash on the balance sheet. We think we are in a situation in kind of part of the market that there could be some interesting opportunities for us to deploy that cash in a way that could be -- either supportive of Millennium, get us more quickly into some of the new businesses that we're looking at. I think, relative to the existing traditional HIT market, the window is getting very close to being closed for that being interesting to us. So I think the status of many of those competitors are a little bit on the downhill side of the hill, and there's no sense in doing a market share acquisition for someone who's on the downhill side. We'd rather go out in the marketplace and win that business rather than try to acquire perhaps a sinking ship, as Zane put it. So right now, we're going to look for opportunities that help us grow probably into some of the new businesses we have and are less interested in something that would just be market share on our current market.

Operator

Our next question comes from the line of Ryan Daniels with William Blair.

Andrew O'Hara

It's Andy O'Hara in for Ryan this afternoon. A couple of quick questions here. On the ambulatory business, aside from your clients' desire to move to an integrated platform, can you talk about what you guys are doing specifically to move more of your existing inpatient clients to your ambulatory offering?

Zane M. Burke

This is Zane. As we have indicated, we have seen a lot of growth in the -- in our current inpatient clients moving to an integrated model. And we've seen a number of clients that made some decision in the mid-2000s, mid to late 2000, come back into the marketplace and choose Millennium as part of that. And much of that is because of the amount of progress we've made with the application itself and the user interface and workflow that we have. And in fact, we've got a leading physician solution today, which today competes by itself. So not just in the inpatient marketplace do we win, we compete head-to-head against all the niche providers when you look at our application on a stand-alone basis as well. So the solution itself is very strong. Our sales and marketing team is very good, and we've had very good proof points from the implementations to date.

Andrew O'Hara

Great. That's helpful. And then just curious, roughly what percentage of your new client wins include an integrated ambulatory offering?

Marc G. Naughton

I think, today, we would say that a smaller percentage do. I think most of the new wins are focused on the inpatient setting today. It's likely -- in some cases, that's included ambulatory. In many cases, ambulatory will be a second step following the inpatient. They've already got something working for the docs. So an existing supplier who might only be in the physician space. That's okay. Let's not disrupt the docs. Let's keep that going, establish the beachhead inside, get to Meaningful Use. And then as a future project, look to roll that out to their ambulatory. So really, what you're seeing from us is getting the inpatient footprint with the, basically, our opinion, whitespace opportunity for the physician side to be done in the future.

Operator

Our next question comes from the line of Jamie Stockton with Wells Fargo.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Maybe first, Marc, it sounds like, from a hiring standpoint during the quarter, you guys saw a benefit, you said, on the sales and client service line. You came in the quarter with a pretty good headcount. Could you give us a little color about how you're thinking on that front for the rest of the year?

Marc G. Naughton

Yes. I mean, Jim, if we're -- relative to this quarter, the primary impact on the personnel cost was the timing of the hires. Some of those hires were coming in more toward the end of the quarter and therefore, there was not as much expense. We still hired a fair number of people. They just really didn't hit Q2 as much on the expense. And the flip side of that is people that we hired in Q4 and Q1, we are now getting our people up to speed in 90 days, getting them out on billable projects. So as you look through kind of the services businesses, it was interesting, the ability to drive a good chunk of additional revenue without a lot of additional people cost. Our CernerWorks business had a nice growth in revenue, basically leveraging the infrastructure that they'd already created. Not a lot of -- the resource growth there is not linear. Our solution center and our upgrade center -- in the upgrade center, we were able to assign non-billable resources that had been working on internal projects, get them down with those internal projects and put them on to billable jobs. So basically, turn those into revenue-producing assets that we were already paying for but haven't been producing revenue before. And then in Solution Center, the Q4 and Q1 hires were all fully working on projects during the quarter. So you add all of that together, a high level of conversion. So a lot of hours getting worked. And even our, what we call, ACE, where we have Cerner associates who aren't billable, go help the clients on the hospital floor for the conversion period to answer questions, even that had a significant increase in revenue during the quarter. So just to give a little color around how, from the P&L side, how we can drive -- in Q2, we had kind of a little bit of a perfect storm around some of those things that drove revenue without a whole lot of people cost. Relative to continuing forward, we're going to continue, as we did in Q2, just from a timing perspective later in the quarter, hired a significant number of people. We're going to keep doing that as we see the business. And as I've said, the last half of this year looks really strong, and we would expect to continue hiring resources. We would much rather implement systems with our people than have to go to third parties. And we've been pretty effective at doing that. We'll continue to do that.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay. And then maybe one follow-up for Zane, and it touches on the strong second half. As you're having conversations with hospitals that maybe are attesting for Stage 1 with a different vendor and then they're looking to make the switch before they attest for Stage 2, when we talked about this a little at the Analyst Day, they've got to hit a higher usage threshold for Stage 2. Can you give us some sense for the conversations that you're having of how they're going to hit that higher usage threshold and also switch vendors at the same time?

Zane M. Burke

Sure. There's obviously a lot of planning that goes into the process of going from the Stage 1 to Stage 2. And the bigger bar, as you mentioned, is the physician usage, as well as the quality reporting metrics that are coming up. So I think many people focus on physician usage alone, and I think a lot of this is around some of the quality reporting elements that are also there. So our conversations are around how the process by which our clients will be able to attest on Stage 1 and then also be able to attest on Stage 2. And they may even be attesting for a portion of Stage 2 on the legacy element. So each one of those conversations is a little unique, based on the timing of that project and how -- and based on the lack of capabilities with their current provider today. And so the good news for us is we have a lot of experience with high levels of physician usage and with the quality-reporting metrics as such that we're not -- it's not a concern around. If we can do that, it's about how that legacy provider can do it enough such that the client can attest on Stage 2 in that framework, if that makes sense.

Operator

Our next question comes from the line of Michael Cherny with ISI group.

Michael Cherny - ISI Group Inc., Research Division

So just quickly, I want to dive into the international revenue a bit. I know you mentioned that there's some lumpy deals. Obviously, given the side of the revenue base and the deals in that market, are there any in particular that came in below expectations that led to the international growth being a little slower than 1Q?

Marc G. Naughton

Mike, this is Marc. There was not any specific thing that didn't happen in Q2. Our expectation was that there wasn't a lot of stuff that was going to happen. Those deals are lumpy, there's going to be quarters where they don't have something occur, in Q2 as the -- to be one of those quarters. I think we look at the marketplace and we see certainly pockets of countries we talked about that are doing okay economically, the Middle East, Canada, Australia. Those are places where we're going to see opportunities, and they're going to likely come in, in chunks. And they'll be part of our bookings forecast and part of our normal forecasting process as we provide guidance to everyone. I think probably the one country that's got a lot of demand is going to really be -- just a funding issue -- is the U.K. As more and more of those trusts are becoming foundation trusts, which means they control their capital outlet -- outlay as opposed to the government putting the dollars out there, we think that's going to turn into a more normalized U.S.- type market where each trust is going to go out to the market and look to acquire technology. In 2015, the current NHS contracts expire. So almost all of those trusts are going to be looking in the market in some form or fashion, probably depending on their access to capital. So we think that market is one that could heat up in 12 to 18 months from now, assuming that they can get access to capital. But it is going to be a little bit lumpy. And once again, we're not -- we don't guide specifically for internationals. So to the extend those deals are expected, they'll be in our guidance.

Michael Cherny - ISI Group Inc., Research Division

That's very helpful. And then just another way, I guess, to ask the M&A question, obviously, the cash flow profile has become very impressive. As you think about your portfolio mix right now and the experience you get from growing the ITWorks and the RevWorks solutions amongst others, do you view any other kind of areas where you're really trying strongly to beef up your capabilities or to make sure you're delivering even a more robust solution to your customers? I know you talked a lot about Meaningful Use Stage 2 and analytics work. Is there anything in that area that, from a broad technology perspective, may be of particular use?

Marc G. Naughton

This is Marc. Relative to acquisitions, we really don't see us having any gaps within our solution set. We can do everything from revenue cycle, home health, physician office. We have behavioral -- I mean, we can cover all of the venues of care with our current solutions. We believe that we are cutting edge relative to analytics. We've been, as we've discussed earlier, in the analytics business for a long time. And I think we're, as we've talked with investors, about focusing a group we call Cerner Math on driving algorithms and driving the warning out of all of these data that we've collected to date and that we expect to collect going forward. So what we'll likely look for would be some more targeted elements where it's not necessarily getting us into a new area, but they've got some interesting technology, or maybe there's an interest skill set and a set of proof points and clients that would be a good fit for us. Maybe it could be a little bit like -- even a small acquisition like our Clairvia acquisition, which basically -- I think, this quarter, we sold 2 footprints into our #1 competitor's hospitals. So things that give us the ability to go more broadly into the market and get into places that we don't have a footprint in today. I think that's a general view of those. I don't know what that's going to add up to. I like having cash on the balance sheet. I don't -- I've got $1.4 billion. I don't know that that's excessive for a company our size. Certainly, if we get to a point where we don't think there's opportunities for us to invest and get a good return on those, we'll look for an opportunity to return some of that cash to shareholders because I think that's the appropriate action. But right now, in this environment, with all this going on and the differences between successful companies and those being unsuccessful, well, we think it's good to keep plenty of powder dry for opportunities that could come up.

Michael Cherny - ISI Group Inc., Research Division

No, I've never heard of a CFO that doesn't like having too much cash.

Marc G. Naughton

I would not be among those that don't.

Operator

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

Sean W. Wieland - Piper Jaffray Companies, Research Division

Just a couple of follow-ups on the strength

[Audio Gap]

business. I think you said that it was due to customers getting ready for Meaningful Use attestations. So my question is, what happens after the Stage 1 deadline?

Marc G. Naughton

Why, I don't think we said that it was just from the strength of people getting ready for Meaningful Use attestation. I think I basically talked -- as I talked about CernerWorks having strength, which is obviously just not targeted specifically at any one goal, the other projects that we're working on, a fair number of those were focused on Stage 1. But a lot of those weren't focused on Stage 1.

Zane M. Burke

This is Zane. I think what I would say is our clients have been working past Stage 1 for years. And so for us, Stage 1 is really about when they determine they want to attest based on some of the dynamics of how reimbursement works. We've been working on things -- our clients are working on things that are well past Stage 1, and we continue to see a huge demand for services going forward over the next several years as you continue to see additional programs coming through from the government and from other payers to require more and more quality reporting, to require more and more access to real-time data, to integrate the data, to interoperate with other systems. That's going to drive significant services revenues into these several years. And the vast majority of our backlog is related to non-Stage 1 Meaningful Use.

Sean W. Wieland - Piper Jaffray Companies, Research Division

Okay. That's helpful. And what do you think are some of the other areas in a hospital that would be right for a works-type solution?

Marc G. Naughton

This is Marc. We're certainly not looking to launch 47 different works initiatives. But I think the -- for us, the ITWorks, the RevWorks are 2 very large areas that we can go be successful in, just leveraging our existing strength. I think probably the other initiative that maybe people don't think about much is QualityWorks, kind of leveraging what Zane talked about, about driving quality, getting those measurements out of our systems.

Zane M. Burke

Yes, and we're seeing really great market uptake for that, because people are recognizing that the quality reporting is only going to become more of a challenge for them. And in fact, our first QualityWorks site was named the Consumer Choice hospital, the #1 hospital on America, and yet they chose us to do their quality reporting for them. And that's an indicator of how they see the bar going to continue to raise. And so they're the #1 hospital in the country, and yet they're turning to us because they know that the game is changing and that we're the best suited to help them meet the changing landscape and environment. And so I think that will also be a huge growth area for us over the next several years.

Marc G. Naughton

And that's -- and my comment isn't meant to say we're not going to come up with more works businesses. But I think, from an investor standpoint, ITWorks and RevWorks are probably the largest contributors in the next -- by the end of the decade, and QualityWorks certainly is a strategic initiative for us that we think can drive a significant business as well.

Operator

Our next question comes from the line of Sandy Draper with Raymond James.

Alexander Y. Draper - Raymond James & Associates, Inc., Research Division

Most of my questions have been asked, but just maybe a quick follow-up, Marc, on the services side. Sean pointed out the strong growth there. Less about sort of demand drivers. How much of that is truly recurring? Or is there a point at which you would actually potentially see a decrease? Or you could envision a decrease sequentially, albeit up year-over-year? Or should we pretty much continue for the foreseeable future to see that as a sequential growth line?

Marc G. Naughton

Yes. Relative to services, we don't see an end to the demand. It's just -- as Zane was saying, most of the stuff we're working on isn't to get to a near-term goal. It is the continuation of a journey, and people that are even already have the technology that's going to get them pretty much close to -- even a Stage 3-level of facility are looking to go do the next thing, are looking at how they prepare to be an ACO or how they prepare their region to be an ACO. So right now, our backlog is -- we've got services businesses in there that's out significant amount of years for the roadmap or projects that clients are looking to go do. So we would expect it to continue to grow, and we'd certainly -- it's one of the things that we would let you know, relative to what's going to happen -- have been going on in the future. Because if that trajectory changes, we'll let you know. But we're hiring people. We are -- have our plans and expect it to continue to grow. So I think that's where we stand.

Operator

Our final question comes from the line of Nick Juhle with Baird.

Nicholas Juhle - Robert W. Baird & Co. Incorporated, Research Division

Just want to drill down just a little bit more on the RFP lines that you guys are seeing out there. It sounds like, the way you've characterized it multiple times on the call, that it's almost coming as a surprise. It's sort of -- not a surprise, but sort of a departure from what you have seen over the last couple of quarters to the positive side. Can you just kind of -- I guess, what's driving that strength? And if you had to put it into a couple of key buckets, is it broad based? Are there certain key drivers there? And then as a follow-up question, I'm interested to know if there's anything unique about the surge in RFPs and the market activity that you're seeing that would -- that might impact your hit rate within that?

Zane M. Burke

Well, this is Zane, Nick. The RFP volume, I'd attribute a lot to the failures of many of our competitors to be ready for the changing landscape. And so they're in the midst of either -- they've done acquisitions and they're trying to put things together, they're trying to move to new platforms, they're sunsetting existing platforms, they are on old technology. And those types of things, as people look to what the future is, they know that they have to have data liquidity, their systems have to be interoperable, and they're going to need that data no matter where the person is in the entire care cycle, inclusive of the home. And so what we are seeing is the -- I would say the additional bolus that we're seeing is one, the recognition that Cerner can do that work, that their current providers can't do that work. And in many cases, some of the current providers are actually telling our clients, we can't get there and you need to make a change of some sort. And that forces people back into the marketplace. So that has a dramatic impact. We do track our win rates versus -- out of those different competitor basis. So as you look at where those are coming from and we -- I feel very good about our win rate. Our win rate was the highest it's been over the last several years in the second quarter, and we've seen that trend up over the last 2 years. And I think we will continue to see our win rate increase as we move forward. So we're feeling very, very good about where things head.

Marc G. Naughton

And this is Marc. I don't think there's anything unique in those RFPs. As Zane kind of indicated, it's people that are out looking for a solution, having chosen a supplier in some cases that they thought was their end game and now having to reload. I guess the only unique thing is you've already eliminated one supplier, because they're not going to meet up with the people that aren't being successful. But other than that, it's just in our wheelhouse, and they're looking for a safe choice that they can count on. And that plays right into what we do.

Nicholas Juhle - Robert W. Baird & Co. Incorporated, Research Division

Got it. So fair to say that the surge that you're seeing really is just the realization of the theme you've been alluding to over the last year or 2, that as you move from Stage 1 to Stage 2, there's going to be a big opportunity for share capture?

Zane M. Burke

Exactly. And I would -- as we see it, we believe that continues for several years to come. Because as the bar gets taller, then the -- we actually believe we are the only ones capable of delivering as the bar gets taller.

Marc G. Naughton

Thank you. This is Marc. I want to appreciate -- thank everyone for being on the call. I know it's a busy time. We are, I would reiterate, very pleased with our results this quarter, and I think it was a very strong quarter. And as we've indicated several times, the back half of the year has a lot of opportunity, and we think we have the right team to go deliver that. So with that, I wish you a good day. Thanks for being on the call.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may now disconnect. Have a wonderful day.

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Source: Cerner Management Discusses Q2 2012 Results - Earnings Call Transcript
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