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Cerner (NASDAQ:CERN)

Q3 2012 Earnings Call

October 25, 2012 4:30 pm ET

Executives

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

Zane M. Burke - Executive Vice President of Client Organization

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

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

Neal L. Patterson - Co-Founder, Chairman, Chief Executive Officer and President

Analysts

Michael Cherny - ISI Group Inc., Research Division

George Hill - Citigroup Inc, Research Division

Steven P. Halper - Lazard Capital Markets LLC, Research Division

Ricky Goldwasser - Morgan Stanley, Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division

Glen J. Santangelo - Crédit Suisse AG, Research Division

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

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Richard C. Close - Avondale Partners, LLC, Research Division

Operator

Welcome to Cerner Corporation's Third Quarter 2012 Conference Call. Today's date is October 25, 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 security laws. Information containing 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 or filed with the SEC.

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

Marc G. Naughton

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

Now we'll turn to our results. We delivered excellent results in the quarter, and we continue to have a very positive outlook. Bookings, revenue and EPS exceeded our guidance range, and we again delivered very strong cash flow.

Moving to the details. Our total bookings revenue in Q3 was $770 million, which is a record for a third quarter. This reflects 18% growth over our very strong results in Q3 of '11, when bookings grew 31%. Bookings margin in Q3 was $671 million or 87% of total bookings. Our bookings performance drove a 20% increase in total backlog to $6.79 billion. Contract revenue backlog of $6.06 billion is 22% higher than a year ago. Support revenue backlog totaled $724 million, up 5% year-over-year.

Revenue in the quarter was a record $676 million, which is up 18% over Q3 of '11. The revenue composition for Q3 was $230 million system sales, $154 million support and maintenance, $278 million in services and $14 million in reimbursed travel.

System sales revenue reflects 22% growth from Q3 '11. This was driven by record Q3 license sales, as well as continued strong growth in device resale, traditional hardware resale and subscriptions.

Moving to services. Total services revenue was up 19% compared to Q3 '11, with strong growth in both managed services and professional services. Support and maintenance revenue increased 11% over Q3 of '11.

Looking at revenue by geographic segment. Both domestic and global revenue increased 18% year-over-year, with domestic growing to $591 million and global coming in at $85 million.

Moving to gross margin. Our gross margin for Q3 was 77.9%, which is up from 76.9% in Q2 and down slightly from 78.9% in Q3 of '11. The sequential increase in gross margin was driven by stronger software and the year-over-year decline was driven by slightly higher third-party maintenance costs.

Looking at operating spending. Our third-party operating expenses were -- our third quarter operating expenses, pardon me, were $369 million before share-based compensation expense of $10 million. This is a year-over-year increase of 14%, which is well below the growth of our revenue and gross margin, and reflects ongoing operating leverage.

Sales and client service expenses increased 17% compared to Q3 '11, driven by an increase in revenue-generating associates in our Services businesses. Our investment in software development was up 7% compared to the year-ago period. As we have discussed, we have been hiring in our R&D organization this year and expect our R&D investments to continue growing, but the growth will still be moderate compared to expected revenue growth.

G&A expense increased 8% compared to Q3 of '11.

Moving to operating margins. Our operating margin in Q3 was 23.3% before share-based compensation expense and was up 90 basis points compared to Q3 of '11, which is just below our targeted range due to continued high levels of tech resale revenue and slightly higher spending in the quarter. However, we still generated earnings upside as this level of margin expansion, combined with our higher than expected revenue, still drove operating earnings growth of 23%.

Moving to net earnings and EPS. Our GAAP net earnings in Q3 were $99 million, or $0.56 per diluted share. GAAP net earnings include share-based compensation expense, which had a net impact on earnings of $6 million or $0.04 per diluted share. Adjusted net earnings were $105 million, and EPS was $0.60, which is up 25% compared to Q3 of '11. The tax rate for adjusted net earnings was 34.8%, which is within our expected effective tax rate range of 34% to 35%.

Now moving to our balance sheet. We ended Q3 with $1.5 billion of total cash and investments, up from $1.39 billion in Q2. Total cash and investments include $1.04 billion of cash and short-term investments and $463 million of highly rated corporate and government bonds, with maturities over one year. Our total debt, including capital lease obligations, is $197 million.

Total receivables ended the quarter at 55 hundred and $42 million [ph], which is up $50 million from Q2. Contracts receivable for the unbilled portion of receivables were $86 million, and represent 16% of total receivables. Cash collections were $662 million. Our DSO in Q3 was 73 days, which is down from 87 days in Q3 of '11.

Operating cash flow for the quarter was $182 million. Q3 capital expenditures were $52 million, and capitalized software was $26 million. Free cash flow, defined as operating cash flow, less capital expenditures and capitalized software, was $105 million.

Going forward, we expect quarterly capital expenditures to remain in the $45 million to $60 million range, driven by the ongoing construction at our new Kansas City, Kansas, campus. As we demonstrated this quarter, we can still generate strong free cash flow even though -- during this period of elevated capital spending.

Moving to capitalized software. The $26 million of capitalized software in Q3 represents 31% of the $83 million of total investment in development activities. Software amortization for the quarter was $21 million, resulting in net capitalization of $5 million or 6% of our total R&D investment.

Now I'll go through Q4 and full year guidance. For Q4, we expect revenue between $670 million and $700 million, with the midpoint reflecting growth of 11% over Q4 of '11. This equates to full year revenue between $2.63 and $2 -- I'm sorry, $2.63 billion and $2.66 billion, with the midpoint reflecting 20% growth. This is up from our previous range of $2.575 billion and $2.625 billion.

We expect Q4 adjusted EPS before share-based compensation expense to be $0.62 to $0.64 per share, with the midpoint reflecting 15% growth over Q4 of '11. This equates to full year adjusted EPS between $2.34 and $2.36, with the midpoint reflecting 26% growth. This is up from our previous range of $2.32 and $2.36.

Q4 guidance is based on total spending before share-based compensation expense of approximately $375 million to $385 million. Our estimate for the impact of share-based compensation expense is approximately $0.04 in Q4, and $0.13 to $0.14 for the full year.

Moving to bookings guidance. We expect bookings revenue in Q4 of $925 million to $975 million, reflecting solid growth over our record Q4 '11 bookings of $899 million, which were up 44% over Q4 of 2010.

I would also like to provide our initial thoughts on 2013. The initial version of our 2013 plan supports current 2013 consensus estimates for revenue and adjusted earnings per share. As always, we will continue to update our outlook on future earnings calls.

In closing, we are pleased with our strong results in Q3 with all key metrics 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 Q3 of $770 million reflects 18% growth over last year's bookings and is all time high for a third quarter. Bookings included 21 contracts over $5 million, 9 of which were over $10 million. Noteworthy areas of strength included licensed software, professional services, Managed 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, as our clients purchase additional solutions for Stages 2 and 3 of Meaningful Use, and prepare for Value-Based Purchasing ACOs and other shifts in the industry that will require additional IT investments.

We also continue to sell strong levels of services to our installed base, which was very evident this quarter in the ITWorks and revenues RevWorks successes that Mike will discuss. Outside of our install base, we continue to operate in an environment with multiple install bases actively considering alternatives, and we're in -- in strong competitive position in these opportunities. Evidence of our competitiveness is that 31% of our record Q3 bookings came from outside our core Millennium installed base. A highlight this quarter was a new relationship with a major investor-owned health system that will be implementing Cerner Solutions in 19 of their hospitals, displacing 2 different competitors in the process. We are very excited about this new relationship, which we believe could grow significantly in the coming years.

We also had a major Catholic health system choose to expand their use of Cerner to 9 -- by 9 hospitals, for which they had previously chosen another supplier.

As I indicated last quarter, our pipeline for additional new footprints 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. We believe Cerner is the only company with the comprehensive and scalable platform that will position our clients for success, as the industry transitions from a fee-for-service model, revolving around treating people when they get sick, to a pro-active model that keeps people well. We believe our primary competitors' narrow focus on simply being an EHR product company will become a problem for both them and their clients, as they realize their antiquated platform will not be sufficient in the evolving health care landscape.

In addition to our investments in areas we believe will be necessary to support the future healthcare environment, we've also continued to invest heavily in the areas that still drive many of today's decisions. As an example, we believe we are leapfrogging our competition with Millenium+ and PowerChart Touch by providing a physician experience that is superior to any other system, and also fits into our broader analytics and population health strategy. These improvements are already contributing to an improved win rate in the hospital market. We also continue to have strong success in the ambulatory market, where we are benefiting from our improved solutions and the marketplace's desire to have an integrated inpatient and outpatient solution. As I indicated, this desire for integration is not limited to hospital and physician office integration. With reimbursement increasingly tied to quality and outcomes and more care shifting to different settings, the ability to coordinate care across multiple venues is becoming critical. Cerner's ability to provide solutions for physician offices, ambulatory surgery centers, behavioral health, urgent care, home health, occupational health, rehab hospitals, skilled nursing and long-term care facilities as well as many other venues is another competitive advantage in this environment.

One additional trend I'd like to discuss is that consolidation is occurring in the hospital market. Given our strong market share and strong relationship with IDNs that are frequently the acquirers, we believe this is a potential positive trend for Cerner. In the past 18 months, Cerner clients have acquired more than 75 hospitals, with the majority of these representing net new opportunities to extend our client base.

Outside of the U.S., we had a very good quarter with solid results in most regions and particularly strong results in Canada, Australia and the Middle East. In the Middle East, we signed a contract to provide solutions and services to a 1,200 bed private hospital in Saudi, which we believe contributes to our strong position in the region and helps our chances to participate in a large opportunity for the country's public hospitals. We were also selected for new business in Australia, England and Ireland during the quarter.

Before handing the call over to Mike, I'd like to make a couple of comments about the 2012 Cerner Health Conference, which was held in Kansas City earlier this month. This conference was a huge success, with more than 10,000 attendees, including global attendance that was up 34% from last year and included attendees from 21 countries. Our theme, because it's personal, struck a chord with attendees and included our clients and associates sharing stories of why healthcare is personal to them, not only in the job they do, but also as individuals who interact with the healthcare system. I came away from the conference with increased conviction that we are focused on the right things for the right reasons. The conference also reinforced my view that we still have significant room for growth, both with our existing clients and through an increasing number of new client opportunities. With that, I'll turn the call over to Mike.

Michael R. Nill

Thanks, Zane. Good afternoon, everyone. Today I'm going to do success ITWorks and revenue cycle and provide an update on our physician experience imperative. I'll start with ITWorks. In Q3 we signed our third quarter -- our third client of the year, bringing the number of clients signed since launching ITWorks in late 2009 to 12. Our new ITWorks client has worked with Cerner since 1997, and believe that an ITWorks alignment would further align its strategic goals of transforming health information in its region, enhancing clinical processes and positioning the health system for future growth and advancement. The broader point, which we have made before, is that ITWorks is much more than traditional outsourcing. Aligning IT resources and using our scale and expertise to improve and accelerate IT outcomes at our clients is important, but it is only part of how we align with them. The level at which we align is captured in the ways of transformation model we recently created with the leadership of our ITWorks clients. This model starts with technology as a foundation for greater levels of transformation in the areas including patient experience, physician experience, clinical and financial operations, quality, safety and, ultimately, population health management. These continue to represent major categories that impact the industry, and our clients are leveraging ITWorks as part of their strategy to be successful in this period of rapid industry change.

As I've discussed in the past, the tight alignment we have with our ITWorks clients often leads these clients to rapidly adopt additional Cerner Solutions and Services. A good example of this occurred in Q3 when one of our ITWorks clients also became a RevWorks client. The client established an ITWorks agreement in 2011, and their high satisfaction with that relationship contributed to the decision to align with Cerner to manage their day-to-day revenue cycle, operational and administrative functions. Another important consideration in their decision is that they believe we help position them to achieve their organizational mission of managing the health of their community. This marks the fifth RevWorks acute services client and our second combined ITWorks and RevWorks client.

In addition to another RevWorks client, we also had a strong revenue cycle sales quarter, adding several new clients. Operationally, we passed a milestone by bringing our 100th hospital live on patient accounting during the quarter. We also have more than 430 clinics live. As I mentioned last quarter, we've been working closely with some of our largest clients to advance our solutions. This has resulted in functionality, in clinical, financial integration that is unmatched in the industry.

With the rollout of our revenue cycle solutions progressing nicely in our larger clients, we believe we are establishing proof points that will lead to an acceleration of revenue cycle adoption in our client base and strong differentiation when competing for new business.

It is becoming increasingly clear that an integrated approach is needed to succeed as the industry begins to shift to a value-based -- to a value and quality-based model that will require tighter integration between clinical and revenue cycle systems.

Next I'd like to provide an update on our physician experience imperative. As most of you know, we had a big push this year toward enhancing the physician experience, and we've made significant progress. We brought PowerChart Touch, our native iPad app, live at a client site for the first time in August, and we now have 13 early adopter clients. The feedback has been great, and the solution's ease-of-use and the amazing speed at which it runs has been substantial. The speed is enabled by our design approach and by Millenium+, the cloud platform on which we are deploying PowerChart Touch. As we discussed, Millenium+ is also an important component of our population health strategy, as it enables broader interoperability across all EHRs and provides connectivity to our Healthe Intent population health management platform. I'm pleased that we've accomplished -- I'm pleased with what we have accomplished with PowerChart Touch. In less than one year, we went from a mere concept to a production application. While we view this as just the first milestone in a long journey for PowerChart Touch and other future mobile applications, it proves our ability to bring a concept to a reality that can radically alter and improve the user interactions within -- with Millennium. This project also demonstrates a new method for designing and building applications with the end in mind. All design development systems management and support teams were involved in the project at the outset to ensure that we not only created a great user interface, but one that performed well and delivered the levels of stability that our clients expect. In short, I believe we are demonstrating the agility of a small, entrepreneurial company we still are, at our core, while leveraging the scale and resources of the large organization that we have become.

I'd also like to point out that our focus on the physician experience goes well beyond the iPad. We continue to roll out improved workflows and a new look and feel across our solutions and the response has been extremely positive. We are also taking a comprehensive approach to maximizing physician productivity through optimal design, configuration content and training across all venues. We have rolled out best practice standards for our preferences and privileges that are derived from the accumulated experience of implementing our solutions and CPOE across our client base. In many cases, this approach allows us to reduce what took hundreds of configuration decisions now down to about 10. This, too, is having a very positive impact on our physician experience.

In summary, I'm very pleased with our progress we have made on improving the physician experience and I believe we are on a clear path to leapfrog our competition. With that, I'll turn the call over to Jeff.

Jeffrey A. Townsend

Thanks, Mike. Today I wanted to recap some innovations that were highlighted during the Cerner Health Conference, the evolution of our Healthe Intent platform, our population health initiatives, which both Zane and Mike highlighted. Our health conference creates an opportunity for us to sync with our clients on both future and current state activities at a significant scale. This year was highlighted by more than 500 client-lead interactions as they shared and showcased their progress over the last 12 months. The solution gallery was our largest to date, providing an opportunity for more than 250 solutions and services to be showcased. As many of our client organizations have either completed Stage 1 of Meaningful Use or are approaching that milestone, they are now positioned for a wave of next new capabilities that position them to improve safety, reduce cost and improve outcomes.

As an example, Care Connect was introduced during the conference. Initially introduced on the iPhone, this is a comprehensive communication and care delivery solution that integrates voice, messaging and care delivery capabilities, such as medical device association, clinical alerts and medication administration into a single application workflow. For the first time, clinical collaboration is possible through traditional communication technologies, with the EMR and medical devices all synchronized into a single, embedded on the go mobile experience. As Mike outlined, the revenue cycle suite is continuing to gain traction across our client base and was another heavy traffic area during the conference. Over the last 18 months, an additional 24 solutions have become GA within the revenue cycle suite. The continued progression of revenue cycle upstream into the clinical workflow and physician documentation areas is creating greater opportunities within the existing clinical experiences, as well as driving more and more innovations to begin the roadmap of replacement with their existing platforms as they approach the ICD-10 transition in 2014. As new models continue to emerge in both quality incentives and population management, the ability to navigate the continuum of revenue cycle demands is becoming increasingly important to our clients. Our client base will have at risk more than $5 billion of annual revenue in the coming years tied to Value-Based Purchasing, Medicare 30-day readmission rules, quality reporting requirements alone. As a result, Cerner's alignment with our clients to help them mitigate these risks and succeed in the evolving health care landscape will create a significant financial opportunity for Cerner.

Moving onto our Healthe Intent platform. Chart Search has now hit a tipping point across our client base, and we expect accelerated adoptions as clients complete their checklist of mandates. Over 50% of our U.S. client base is now utilizing this solution, as we are approaching 1 petabyte of index clinical information. Much like the speed of deployment around Millenium+ and PowerChart Touch that Mike shared, we are seeing a similar pattern emerge through our Healthe Intent cloud-centric solutions. While Cerner has offered a sepsis alerting package within our Lighthouse practice for several years, the adoption and use of our cloud-based algorithm is more than twice the adoption of the prior solution in half the time since general availability. In addition, the ability for the platform to support an agent-based learning environment has allowed for the algorithm to evolve on a 30-day lifecycle, followed by rapid adoption within days versus months. We are seeing the platform validation and distribution model change the paradigm for speed to value.

We shared our population health relationship with Advocate in the past. Early progress from these efforts was another highlight of our health conference. Joint development of more sophisticated predictive models has been an initial focus of this partnership. While we're only a few months into the partnership, the combination of Advocate and Cerner Math teams has created an initial predictive agent for readmissions, which was shared during the conference. It has demonstrated a 20% to 30% improvement in predictive powers compared to the majority of existing evidence-based models in use today, and we're confident it can be improved. We continue to see significant potential from working with one of the more advanced population health organizations in the country.

More specific to population health, there is a pattern from a couple of decades back that is now repeating. There is a growing number of niche, best-of-breed solutions emerging much as they did in the '80s and '90s around clinical solutions. In the end, architecture and integration won out. We believe we are similarly positioned for success in population health as the rest of this decade plays out, while others repeat history with the spare piece parts.

We have outlined the foundational elements of population health in the past in a more granular level, somewhat as clues to the larger strategy that is now playing out. From data liquidity through the Cerner Network interoperability in HIE offerings, to our Lighthouse enterprise data warehousing and quality solutions, as well as our patient portal platform and PHR Solutions which offers a range of device and provider connectivity offerings, as well as wellness options. While we expect the foundational portfolio to continue to evolve, these have become real businesses, with total revenue in excess of $150 million. Supporting these solutions is Healthe Intent, which is our cloud-based architectural platform for population health. At our Health Conference, Neal shared our vision for how we would continue to advance our capabilities in this area, providing a glimpse under the hood. Fundamental to the design of this platform is an evolving operating system, specifically designed to identify the person, predict where interventions will be effective, attribute the individual to accountable providers and guide them to take appropriate action. During the keynote address, we outlined the clinical programming language we called Synapse. This is a purpose built clinical programming language that creates agents within the Healthe Intent operating system to trigger and coordinate health care programs across the population. Very much like the clinical definition, the language supports the recognition and signaling of an event, then coordinates that action across the platform based on localized requirements. We think this is a fundamental differentiator as the level of sophistication to manage the health of a population ultimately requires both personalization to the individual, and localization to the provider network within the community. This must be much more than a set of workflow applications with independent data sets and configuration options. The ability to create these sophisticated commands in a natural language familiar to clinicians, will create an ecosystem of rapid discovery and innovation beyond the 4 walls of Cerner. While this description oversimplifies the complexity of healthcare as it plays out at a ZIP code level, we believe we are the only company positioned to comprehensively facilitate population health. Over the next year, we will bring more Synapse agents to life, leveraging the platform we have evolved over the last 3 years.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Michael Cherny from ISI.

Michael Cherny - ISI Group Inc., Research Division

So just thinking ahead a little bit on the outlook, and obviously with the 4Q bookings number, very impressive number, especially given the growth you'd put up last year. I want to get a sense if you can, about the expectations for any of the larger deals, particularly the works types deals in the fourth quarter. As you get more comfortable with these deals, as you get greater clarity about what it takes to get clients signed up for them, is it giving you a higher degree of visibility in terms of being able to guide to these deals? And is there any kind of clarity you can give around any potential contribution in the fourth quarter of any deals you can be expecting?

Marc G. Naughton

Mike, this is Marc. I think the -- we've been indicating that clearly for -- so far for this year, we've been consistent with having an ITWorks deal every quarter. I think we're able to predict those, at least relative to our normal forecast process where we review all the deals, lay out where we think they're going to happen. So it kind of varies between -- if there's one that we think is on track for Q4, we would -- it would be part of our guidance. If there isn't one that's on track for Q4, it wouldn't be part of our guidance. I think you've seen us be fairly consistent with those long-term bookings to be kind of around the 30% level, a little over, maybe a little bit under. So I think it's pretty fair to say that, that feels like that's going to be a fairly consistent number, that you are going to see us in the upper 20s to low 30s of that number, relative to the total bookings. And I think the -- we are getting a little bit of an ability to forecast those at a higher degree of certainty, and a little bit less risk in our forecast process. But -- so each quarter is going to be a little bit different, the types of deals, but I think, overall, with our mix of long-term opportunities in any one quarter, you can kind of still see us generating that type of percentage on a quarterly basis.

Michael Cherny - ISI Group Inc., Research Division

Great. And then just quickly on the large, for profit public company you guys referenced. Obviously, it seems like that customer had a fairly recent go-live with one of the solutions you're displacing. Can you talk a little bit about -- if you can, any clarity as to how you guys were able to wedge your way in there? What that means, going forward, and I know you talked about a few other systems that are looking now for replacement. How quickly you expect this replacement marks [ph] to develop with Stage 2 on the horizon, about 15 months from now?

Zane M. Burke

This is Zane. As it relates to this particular investor-owned organization, we've been working it for about the past 2 years, and having dialogue is -- and they had an awareness of, maybe some of the shortcomings that were in some of our competitors solutions. And then some of the success that we've had in the investor-owned segment. And so, really, the combination of our success in the investor-owned marketplace and in fact, delivering on predictable timelines on particular budgets and creating a framework by which you can use your scale in a different way, which is what the premise behind these large-scale organizations, really drove home what they needed to do there. So my expectation is, we'll continue to see opportunities, both in the investor-owned segments as well as other segments as people look at our competitors and where they are, relative to being able to meet the mandates that are coming up.

Operator

Your next question comes from the line of George Hill of Citigroup.

George Hill - Citigroup Inc, Research Division

Marc, I guess just a question on the bookings guidance, following up on Michael's question is, I guess, do we know what the composition of the Q4 bookings will look like? Or I guess, can you give us directionally, because I would've expected the revenue guidance to be a little higher, given the bookings strength in the quarter? So is there anything that's changing in the composition in the booking mix? Or is there anything you know now about the bookings mix that's putting the revenue guidance kind of where it is?

Marc G. Naughton

No. There's nothing in particular in the bookings guidance. I think the -- for this quarter, obviously, we had a strong software quarter. So it drove out a higher level of revenue, relative to the bookings performance. But I think Q4 feels pretty normal. Once again, still looking for a percent somewhere around 30% of the bookings to be from a -- long-term in nature. And there's still going to be a chunk of that, that's going to be hardware-related, but that's kind of now equalized on a quarter-over-quarter basis. So I don't think there's anything unique, George, that's -- that I point to relative to the -- to looking at the revenues coming out of that. Keep in mind, you're getting a lot of us -- revenue, a lot of our revenue is coming from the backlog, and a lot of the bookings is driving into some of the backlog, even the stuff that isn't the 30% long-term can still have a 3- or 4-year element of some of the service components. So I think it's -- there's not going to be necessarily a complete, direct correlation between the bookings number and the revenue number. But it's -- there's nothing unique about it.

George Hill - Citigroup Inc, Research Division

All right, I appreciate that color. And also a question for the Mikes. On the displacement opportunity, I guess just how quickly are we starting to see the market turn? I feel like, historically, whether it's been Meaningful Use or CPOE or care based drift cycle, whatever the industry trend was, market churn really never ticked up much above 5%. Do we feel like we're seeing an acceleration? And I guess, how do we expect that to play out into '12 through '13, and maybe first part of '14?

Zane M. Burke

George, this is Zane. I would say that we are seeing a bit of an acceleration in the displacement market, and I think that's evidenced by some of our -- the things that I discussed in my script. And I think that's indicative -- that, those comments are indicative what's going on, broadly. And I actually believe, again, that this is a long-term view, that this is a 5- to 7-year marketplace, as you look at it. I think that many organizations will look at who they're -- with the horse that they bet on, and make a decision to go a different direction. And I think it will occur over that 5 to 7 year time period. I don't think -- I think we'll actually -- you'll see some -- there's obviously a natural curve to some of those things, but I think we're on the very beginning of that curve.

Operator

Your next question comes from the line of Steven Halper of Lazard Capital Markets.

Steven P. Halper - Lazard Capital Markets LLC, Research Division

Just looking at the operating margin before stock comp, it was up 90 basis points. And a touch below that target understanding the high level of tech resale that's been happening in the quarter. But when you look at the consensus numbers for 2013, and you support those numbers, is it safe to assume that you'll -- you get back to that goal of 100 to 150 basis points? Or is the composition of the model changing such that, that goal might be too high now, even though the absolute operating profit might be where you want it to be?

Marc G. Naughton

Steve, I think when we've look at operating margin percentage, we've always, again it provided obviously all the way from down -- 9% on up, trying to provide a path to let people know what we're going to grow there. That's always been conditioned a little bit on what we saw this top line growth. And I think this year, certainly, we're seeing top line growing at a rate that is faster than we envisioned when we first -- when we started the year, which is a good thing, because we have a tendency to be able to capture that growth and then grow margins on that higher revenue number. So based on the current consensus estimates, clearly they're looking to have some place between 100 and 200 increase in operating margins. Unless there is a significant adjustment in what our current plan is, that would be our continued expectation. I think we're looking to continue to see opportunities to grow software sales, these deals that are longer-term, that have a negative or certainly a breakeven impact in the early part of those deals, are now getting some time on them that increases naturally, the profitability of those deals as we [indiscernible] more, so I think all I think those are all good points. We're also planning on investing heavily in R&D. And as we did that this year, we increased our R&D spend significantly. We're going to continue to do that in 2013, because the amount of things we have in front of us as opportunities, that we can deliver by developing and innovating, is as great as I think we've ever seen. And I think we're going to continue to make those investments as we appropriately can. But I think, today, there's -- I don't, would not say that there is anything that's going to be different from what you guys have in your models, which is going to be over 100 basis points to 200 basis points increase in margin. Obviously, we're going to land our '13 plan as we finish out the year, and get all of our initiatives lined up, and we'll provide true guidance on our Q4 call. But until that time, we're comfortable with what consensus is.

Steven P. Halper - Lazard Capital Markets LLC, Research Division

Right. And then, just one other quick question on 2013, if I may. In terms of free cash flow, on the margin, do you expect free cash flow to be -- to grow in '13 versus '12?

Marc G. Naughton

Our expectation would be to see it grow. Obviously, in '13, we'll have a full year of investing in our new Kansas campus. You're -- I think you're aware -- investors are aware, we're building one tower. We're going to start building the second tower immediately. So we're going to continue to have that capital outflow. But I think our cash flow performance, certainly to date would indicate that we'd be able to grow year-over-year free cash flow.

Operator

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

Ricky Goldwasser - Morgan Stanley, Research Division

I had a question on the value of the contracts. Just looking at some of the data points, it seems that, the total number of contracts year-to-date is about in line with last year, maybe even a tad lower, but the dollar value associated with it obviously is greater. So can you just give us a little more color on the scope of the contracts that you're seeing and your expectation for that trend to continue or not?

Marc G. Naughton

Ricky, this is Marc. I think every quarter, obviously, is a little bit of a unique microcosm of the deals that are available. If you look back in Q3 of '11, I think we probably had 25 contracts that were over $5 million and 16 that were over $10 million. This quarter we're $21 million -- or 21 contracts over $5 million, and $9 million over 10. So clearly, with the enhanced bookings, that would imply that the ones that were over $10 million were stronger over $10 million than the 16 in the other. I think you've got, certainly this quarter we had 3 large deals that were over $60 million. And that would include the RevWorks, the ITWorks and another large client deal. So I think the mix is going to change, relative to kind of forecasting forward. I think we're going to continue to see a mix of RevWorks and ITWorks deals coming in that we'll have the over $10 million number, be, at little bit higher, but it going to -- it will depend a lot on the quarter. We are selling a lot of things to a lot of people. And I think that broad support in the marketplace is allowing us, the growth of bookings, isn't just the bigger contracts kind of getting bigger. It's a broad support across a variety of contracts that's allowing us to deliver these enhanced bookings. So this just kind of quarter-over-quarter, I provide a little bit of view into that. But it'll vary each quarter, and we continue to look at our client base and new opportunities as providing the leverage on a quarterly basis.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And obviously, the trend of cross-selling opportunities between hospital and ambulatory is an important one, and I know we talked about strong growth on the ambulatory side. Can you quantify it for us, how fast is ambulatory growing in the quarter?

Marc G. Naughton

We have -- for us, ambulatory is still a fairly small part of our overall business. The percentage trends for a lot of that business is growing 50% year-over-year. I think it's continuing to grow. It's not quite growing at that level, but it continues to grow. And a lot of that growth is thriving because of the desire of clients and physicians to be on the same system. And so a lot of our clients are looking to standardize on a single platform. That's where we're getting -- our footprint inside the acute-care facility, acute-care health system is, what's driving a lot of our ambulatory business. And I think it's important to see that as a differentiation from others in the industry, who don't have that footprint inside the acute-care industry and who are trying to either get it in there or just trying to sell on the ambulatory side. We're continually seeing a standard, centralized platform for both ambulatory and inpatient being what's driving the market, and that's what's driving our success. Obviously, as we continue to get bigger, the growth rates don't continue to grow as much. But we're very happy with where that business is, keeping in mind it still is, today, a small part of our total revenue.

Operator

Your next question comes from Charles Rhyee of Cowen and Company.

Charles Rhyee - Cowen and Company, LLC, Research Division

Maybe a question for Jeff here. You're talking about the Healthe Intent platform and then obviously the big focus at the user meeting a few weeks back here. And you talked about what you're doing with Advocate. Can you talk about, sort of where we are in this segment of the market? You -- definitely a lot of small players coming up with sort of technology solutions, but it seems that the way you guys are approaching it is not only from technology, but really also engaging employers as well as, and patients as well the members. And can you talk about how that all needs to come together to really drive, I guess, true population health and where are we at in sort of this adoption curve, and how long do you think it takes for it to really sort of take off here? And then lastly, if there's a change in the administration, with the elections, and you start potentially seeing some type of rollback with the health reform, how do you think that kind of either stalls or maybe changes the pace of some of this?

Marc G. Naughton

Help me if I forget one of those, A, B, C, and Ds. But -- so at the macro level, and I think some of you have visited and seen it. We've been running our own health plan since the middle of the decade. And have not only ran our own plan, but put up clinics and used our population as something to experiment with. And that has been a big driver for us, as we've stepped back and said holistically what does the platform really have to do to manage the health of a population. What impact does it have on revenue cycle and new reimbursement models and then, more broadly, how great it is all that have to be. So that's been a big guide for us as we've designed the systems. At the adoption curve level, and we've mentioned that a few times, they are on the front end of the market as far as taking risk and seeing significant shifts in their business model of how they are being reimbursed. I think the rest of the market, still either has experimentation or is beginning to kind of stick their toe in the water in these spaces. So what you're seeing play out, and you kind of mentioned it, is a lot of niche players to do one very small piece for one very specific scenario, whether that's quality reporting or its maybe a pilot ACO with a small number of lives. So we think that trend is going to continue, but in pretty short order here, and I'd say somewhat as we lead into the 2014 window, with the uncertainty of whether the current health plan model proceeds or not, you're going to continue to see at a CMS level, kind of independent of Obama care and who's in place, there is a demand to drive cost down. And pretty much the consensus thinking is you have to move from a care model to a health model. And at the end of the day, you've got to drive demand down and drive down the cost per unit of what it takes to deliver those demands. So we don't see anything on the horizon that's going to slow the economic trends all the way from the pressure on deficits, to the total cost of healthcare. All of these things are kind of set up, independent of whatever the next thing is that gets passed, or who's elected here in 2 weeks. But I think on the short-term, if you're looking for kind of where is the fuse is going to get lit, I think you're going to continue to see a lot of niche experimentation out there. And we, frequently will hear from our clients, as "I just need is as a placeholder to get me this through this next short window in time. I know there's a bigger, broader strategy that I need to develop." So my long answer to that, I'd say in the next 12 to 24 months, you're going to see more and more movement from a small percent of the marketplace experimenting with population health to the majority of the marketplace having some level of risk inside their revenue mix.

Operator

Your next question comes from Glen Santangelo from Credit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

I just had 2 quick questions if I could. I wanted to sort of follow-up, Zane, on an earlier question regarding the shift in market share, I think in your prepared remarks, you talked about a number of potential customers are reconsidering their supplier, and it seems like the company has put a significant amount of focus on data analytics and population health and I'm kind of curious as what's sort of driving the market share shift? Do you think it's really some greater transparency around Stage 2 guidelines? Or you think it's clients are really starting to look down that 5- to 7-year road that you kind of discussed and we're at that tipping point where they're really going to have to decide to make a dramatic shift, if that's the case? I mean, what do you think is creating an acceleration potentially in that market share shift?

Zane M. Burke

Glen, I think it's actually both. So I mean some of that is the -- get to Stage 2 and looking at Stage 3. But ultimately, if you're going to make it that kind of selection, I think there are -- it's really about the additional mandates that are coming at or the client base over time. And so things like the value-based payments, the 30-day readmission elements. None of our competitors are ready to handle that, today. And so we are -- we're in uniquely in that situation, and there it just becomes more and more mandates that are coming at that our clients, and are going to continue to come at them over time. And so it's really a combination of those things. And I think we're going to see that continue, that I think we are very much on the front side of that trend.

Glen J. Santangelo - Crédit Suisse AG, Research Division

And just to think about the longer opportunity here for a second, we really didn't talk a lot about HIEs here. How do you think about the information exchange marketplace? And how do you view that opportunity for Cerner, like, particularly relative to some of your competitors that maybe could have issues, as far as that's concerned?

Zane M. Burke

Well we probably have 2 sets of bets playing out simultaneously here. On the HIE side, we are a big interoperability advocate. And around some of the things being driven out of DC, like the Direct Project, Cerner contributed the majority of the open-source code for that project. So inside kind of our core business offering, we are proponents of getting the -- what we call it, liquefying the data. So getting the data moving is key to kind of the next stage of improvement around population health. Our other bet in parallel, and we've signaled some of this with technologies like Search and then some of the things we've done around sepsis is, we've invested in technologies that we think can accelerate beyond the standards, so we don't have to wait. So being able to take things like textual documentation, parse that, find the clinical meaning and then put it into a structured form will get us past or through some of the delays you see, I'll call them, orphan systems out there that aren't going to be able to keep up with Meaningful Use Stage 2 and Stage 3. We don't think that data needs to stay as an island. But I think you will continue to see at the pure HIE level, you'll continue to see a fair amount of experimentation and probably multiple networks in some of the communities or states. As they -- as some will find that they didn't discover a business model to drive it, and others you'll find multiple private networks in a given community.

Operator

Your next question comes from the line of Greg Bolan from Sterne Agee.

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

Can you maybe talk about, actually progress with IDN clients that are consolidating solely with Cerner products and services across the organization?

Zane M. Burke

Sure, this is Zane. So what you're -- what we're seeing is it is -- obviously our clients are well-positioned to be the acquirers. In fact, our -- in the last 18 months, our clients have acquired more share than any other clients, any competitor have acquired in that space. So nearly half of the hospitals are up -- were acquired by Cerner clients. Now that being said, not all -- that doesn't -- guess we moved to a Cerner platform. It really just provides a good opportunity for us to come back in and use that as a selling opportunity that as they look to leverage their scale, to drive down costs within their organizations and create better efficiencies across the IDNs. And so we work with our clients in that way. And we have the proof in the large systems of how to run these very large programs in a way which you can predict the costs, get the outcomes that we're looking for, and really set them up to become systems of the future. And that's what we're doing with these large IDN clients.

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

And this last one, this -- if you could, maybe characterize the audition process for the investor-owned hospital that you had mentioned earlier and maybe your thoughts around the ability to penetrate more of these hospitals, because it looks like you're at around 15% penetration now for this system?

Zane M. Burke

Obviously, there's the opportunity to do -- if we do good work, it tends to get other work. And that's been our experience in the investor-owned, that the -- that -- those organizations tend to be a prove-it model, so that they don't go all in upfront, but they look for, kind of a pilot phase, and with success, it will get other success.

Operator

Your next question comes from Jamie Stockton of Wells Fargo.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

I guess maybe, Zane, just following up on one of Greg's questions. Is there a number you can put around the facilities that are maybe within existing client footprints that are not Cerner shops today, and I don't really mean like the Kaisers of the world, but more like Catholic Health West, where there are facilities that are maybe with another vendor and you have a decent shot at getting those?

Zane M. Burke

We do actually quantify that data...

Marc G. Naughton

We can put a number to that, Jamie, yes, is that your question?

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Yes, can you give it to us?

Marc G. Naughton

Can I share you that number? No. Sorry.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay. Well, all right. Well, maybe then, Mike, just touching on RevWorks. You had another deal there this quarter. I think maybe that's the second deal in the last 6 quarters. Could you give us some color on what the environment for deals in that space seems like today? Has it slowed down and that's why we saw kind of a window where there weren't a whole lot of RevWorks deals? And is it starting to reaccelerate now?

Zane M. Burke

This is Zane, I'll take that one. The, I think it's pretty -- it's natural that there's an ebb and flow in that side of the market. And that as we get more and more proof points, I think you'll see more predictability, it's very similar to where we were in the ITWorks' life cycle. So it's a little bit behind -- RevWorks is just, in terms of when we launched it, it's just a little behind that ITWorks life cycle. And I think it's quickly going to go down a similar path where it'll become a more predictable part of what our business, because our clients are seeing success from our RevWorks offerings. And that, again, that success begets other success, and that's what occurred on the ITWorks side, in that we had some early initial wins, had some variability in when those would come through the pipeline, but as we've gained success and the success becomes known within our client base, it becomes a much more repeatable thing. And I think that's what we're beginning to see on the RevWorks side as well. And in fact, this particular client was a Rev -- was an ITWorks client, where we've had success on the ITWorks side, and they've seen the success that we've had around ITWorks, and they extended it into their RevWorks case [ph] as well. So I think that's a natural extension, on top of what we do around ITWorks, and I think you can look at that as a great extension of our business.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay, and then, maybe just my last question. Along the lines of what's going on in revenue cycle, I think 2 or 3 years ago, at the Analyst Day, you guys threw up this chart where you kind of showed the map of revenue cycle solutions, and then you showed a future state of revenue cycle. Could you give us a feel for, like where are you in the progression of the portion of the revenue cycle platform that you want to fill out? I think Jeff said that you'd had 24 solutions go GA in the last 18 months. Are you where you want to be? Or is there incrementals development that needs to occur?

Jeffrey A. Townsend

This is Jeff. We -- I think we're within, I'd say 6 to 12 months of where we want to be from a kind of a completeness. At the same time, as I mentioned, that depth and breadth of solutions going out, there's been 2 trends inside our portfolio: One is bringing more of the capabilities inside of a native Cerner platform, versus using third parties. That's both at a solution level as well as at a connectivity level. So things like an EDI connectivity is an example. So we're seeing more being pulled back in. The other is somewhat as Zane pointed out, the mandates, the measures, how you get paid is a moving target that's going to require more and more investment by our client organizations in some of these areas to adapt to a modern platform, and as simple as take a charge and drop it on a claim. So if you were to look at our roadmap today, as compared to the one you saw several years ago, you'd see probably about 75% to 80% of that filled out in a GA form. And you would see that at the same time though we have a list of futures, not quite as large, but that we anticipate a need to be built out to deal with the future state.

Operator

Your final question comes from Richard Close of Avondale Partners.

Richard C. Close - Avondale Partners, LLC, Research Division

I was just curious, with respect to 2013, is there any reason we should not expect bookings at least flat to the 2012 levels?

Marc G. Naughton

There's no reason that you shouldn't expect us to grow bookings in 2013.

Zane M. Burke

You know what? I'll turn it over to you to close [ph].

Neal L. Patterson

Okay, great. So, I thought I'd make a few comments here. So I tell these guys is, you guys, if you all ask questions, they can't answer, I'll step in, but as you can tell, it's a very good, it's a very strong team, very good job. So we, basically, wake up every morning at the intersection of healthcare and IT, it's a very good place to be, it generates enormous opportunities for us. There are clearly challenges to being here, but I can't imagine a better place to start the day. So we've kind of basically, as a company, we kind of reinstated a boldness around here. The opportunities are just too significant not to be driving hard forward. We are clearly an innovator, probably we're the most significant innovators in healthcare, because we think this intersection of healthcare, IT -- healthcare and IT is really going to create the foundation of the future healthcare, how healthcare is delivered and managed, both at the delivery side and inside populations. So the environment of healthcare is always going to have a political aspect to it, but the fundamentals don't change based on the elections. The fundamentals are, the cost of healthcare have been rising for the last 60 years faster than the growth of our economies. And because of that, there is fundamental pressure to find a -- to drive improvements in the current healthcare systems that create and deliver greater value. We think Information Technology is going to be the core way of doing that. So we -- our goal is to be the trusted partner of our clients in this industry, and drive innovation with them and creating platforms for them to both deliver medicine and in the future, manage populations. So with that, I'll sign off. We're about ready to commence here in the room, a surprise party for Jeff Townsend, who is now celebrating his 25th anniversary. So I thought I'd share that with you guys, and let you be part of this small celebration here. So have a great day. Thanks for being on the call.

Operator

Thank you all for your participation in today's conference. This concludes the presentation. You may now disconnect. Take care.

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