Cerner Q1 2010 Earnings Call Transcript

| About: Cerner Corporation (CERN)
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Cerner (NASDAQ:CERN) Q1 2010 Earnings Call April 28, 2010 4:30 PM ET


Jeffrey Townsend - Chief of Staff and Executive Vice President

Marc Naughton - Chief Financial Officer, Senior Vice President and Treasurer

Michael Valentine - Chief Operating Officer and Executive Vice President

Neal Patterson - Co-Founder, Chairman and Chief Executive Officer

Earl Devanny - President


Corey Tobin - William Blair & Company L.L.C.

Michael Cherny - Deutsche Bank AG

Atif Rahim - JP Morgan Chase & Co

Richard Close - Jefferies & Company, Inc.

Charles Rhyee - Oppenheimer & Co. Inc.

George Hill - Leerink Swann LLC

Greg Bolan - Wells Fargo Securities, LLC

Sean Wieland - Piper Jaffray Companies


Welcome to the Cerner Corp.'s First Quarter 2010 Conference Call. [Operator Instructions] 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 for the purpose of the Safe Harbor provisions of the Security and Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements. Additional information concerning the factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading Risk Factors, under item 1A in Cerner's Form 10-K, together with other reports that are filed with the SEC.

At this time, I would like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corp. You may proceed.

Marc Naughton

Thanks, Teanna. Good afternoon, everyone. Welcome to the call. I will lead off today with a review of the numbers. Mike Valentine, Executive Vice President and Chief Operating Officer, will follow me with sales and operational highlights and marketplace trends. Then Trace Devanny, our President, will discuss our global business. Trace will be followed by Jeff Townsend, Executive Vice President and Chief of Staff, who will discuss innovation and our long-term strategic direction. Neal Patterson, our chairman and CEO, will join us for Q&A.

Now I will turn to our results. Q1 represented a solid start to the year with all key measures at or above expected levels. Our bookings were the high end of our guidance range and an all-time high for the quarter. Our income statement performance was good with revenue at the high end of our guidance range and strong margin expansion driving earnings upside. Our cash flow performance was also strong, with record levels of free cash flow.

Moving to the details, our total bookings revenue in Q1 was $405 million, which is 22% higher than Q1 '09 bookings, and an all-time high for a first quarter. Bookings margin was $340 million or 84% of total bookings revenue. The bookings margin percentage is lower than the 89% bookings margin percent in Q1 of '09 despite very strong year-over-year growth in Software bookings. This is due to lower margins on Technology Resale bookings, and a lower percentage of total bookings coming from Managed Services, which have 100% bookings margin.

Our total backlog increased 21% year-over-year to $4.32 billion. Contract revenue backlog of $3.7 billion is 24% higher than a year ago. Support revenue backlog totaled $626 million, up 7% year-over-year.

Our revenue in the quarter was $431.3 million, which is up 10% year-over-year and was at the high-end of expected levels. The revenue composition for Q1 was $117 million in System sales, $127 million in Support and Maintenance, $180 million in Services and $7 million in Reimbursed Travel.

Systems sales revenue reflects growth of 17% compared to Q1 '09, with strong software growth offsetting a decline in Hardware revenue. Note that within the Hardware revenue, we had our best quarter to date of device resale. The declines in Traditional Hardware more than offset this.

Traditional Hardware revenue continues to be impacted by the success of our Managed Services offering and lower prices of Data Center Hardware. We are encouraged by the trend of device resale and believe it will continue to grow as a contributor to top line, particularly given the CareFusion agreement Mike will discuss.

Services revenue, which includes Managed Services and Professional Services, was up 13% compared to Q1 '09. This growth reflects continued strong growth in Managed Services and return to growth of Professional Services, which was driven by increased implementation activity coming out of our strong Q4 bookings.

Our Support and Maintenance revenue increased 2% over Q1 '09. As we discussed last year, Support and Maintenance revenue growth has been impacted by the shifting of Services revenue that's previously treated as support to Professional Services, as part of our transition to working with BT [British Telecom] instead of Fujitsu in the southern region of England.

Maintenance revenues has been impacted by lower levels of technology resale, with many existing clients on Hardware Support switching to our hosting option. Additionally, Support revenue has been impacted by a limited amount of software growth in the first three quarters of 2009, and the limited annual CPI [Consumer Price Index] increases. We expect Support growth to improve by the second half of 2010 based on the improved Software bookings in the past two quarters and the good outlook for Software sales.

Looking at revenue by geographic segment, our Domestic revenue increased by 10% to $355 million. Global revenue was $76 million, which also reflects a 10% increase and is a good start to the year after a tough 2009.

Moving to gross margin. Our gross margin for Q1 was 84.2%, which is up 90 basis points year-over-year and 120 basis points sequentially. Our system sales margin was up 320 basis points year-over-year due to the improved Software levels. System Sales margins were down sequentially, largely due to lower Technology Resale margins and an expected decline in software from Q4 record levels to Q1.

Looking at operating spending. Our Q1 operating expenses were $282.1 million before share-based compensation expense of $5.5 million. This is up 8% compared to a year ago.

Sales and client services expenses were up 8% compared to Q1 '09, driven primarily by growth in Managed Services and a higher level of bad debt expense. Software development expense was up 3% compared to Q1 '09, reflecting continued control of this expense volume.

G&A expense was up $6 million or 23% year-over-year. The increase is primarily related to the year-over-year difference in the impact of foreign currency, as we had an FX gain in the year-ago quarter compared to a small FX loss this quarter.

Moving to operating margins. Our operating margin in Q1 was 18.8% before share-based compensation expense. This is up 200 basis points compared to last year, and keeps us on track for our full year 2010 target of 20% operating margins.

Moving to earnings and EPS. Our GAAP net earnings in Q1 were $50.2 million or $0.59 per diluted share. GAAP net earnings included share-based compensation expense, which had a net impact on earnings of $3.5 million or $0.04 per share.

Adjusted net earnings were $53.7 million and adjusted EPS was $0.63. This is up 21% compared to Q1 '09 and above the high end of our guidance. Our tax rate was 35.1%, which is in line with our projected level.

Now I'll move to the balance sheet. We ended Q1 with $609 million of cash and short-term investments, up $50 million from Q4 '09. Our total debt is $118 million.

Total accounts receivable ended the quarter at $423 million, which is down $38 million from Q4 '09, driven by record cash collections of $484 million. Contracts receivable or the unbilled portion of receivables were $125 million, which is down $10 million from Q4 and represents 30% of total receivables compared to 29% in Q4 '09. Third-party financings were $19 million representing 4% of the total cash collected.

Our DSO in Q1 was 89 days, which is down from 90 days in Q4 and 102 days in Q1 '09. The year-over-year decline was primarily related to the reclass [reclassification] of the Fujitsu receivable to other assets, which we discussed last quarter.

Operating cash flow for the quarter was $106 million. Q1 capital expenditures were $32 million, and capitalized software was $21 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was also a record for a first quarter at $53 million. It's worth noting that free cash flow for the quarter represents more than 100% of net earnings and reflects continued strengthening of our earnings quality.

Moving to capitalized software. The $20.5 million of capitalized software in Q1 represents 29% of the $71.5 million of total spending on development activities. Software amortization for the quarter was $15.8 million resulting in net capitalization of $4.7 million or 7% of the total.

The preview last quarter, amortization declined $2 million sequentially as the amortization of what was capitalized in 2004 completed. Amortization will ramp back up as we move through the year. Based on our current release schedule, we expect amortization to go up by about $1 million in Q2, and another $1 million in Q3 and Q4. That puts Q2 amortization in the $16.5 million to $17 million ramping up to about $18.5 million to $19 million by Q4.

Now I'll go through the guidance. Looking at Q2 revenue, we expect revenue in the $440 million to $455 million range, with the midpoint of this range representing 11% growth over Q2 '09. For the year, we continue to expect revenue between $1.8 billion and $1.875 billion, reflecting 10% growth at the midpoint.

We expect Q2 adjusted EPS before share-based compensation expense to be $0.64 to $0.69 per share with the midpoint reflecting over 20% growth. For the year, we expect adjusted EPS of $2.80 to $2.90, with the midpoint reflecting 17% growth over 2009.

The Q2 guidance is based on total spending before stock compensation expense of approximately $280 million to $285 million. Our estimate for stock based compensation expense is approximately $0.04 for Q2 and $0.16 to $0.18 for the year.

Moving to bookings guidance. We expect the bookings revenue in Q2 of $430 million to $460 million, with the midpoint of this range reflecting 13% growth over last year.

In closing, we are pleased with our results in Q1, with all key metrics at or above our expected ranges. Specifically, we are pleased with our strong bookings growth and outlook; return to double-digit revenue growth; continued strong margin expansion and earnings growth; and continued strong free cash flow generation.

With that, I'll turn the call over to Mike.

Michael Valentine

Thanks, Marc. Hello, everyone. Today, I'm going to provide observations on the marketplace, some operational updates and results highlights.

Starting with the marketplace, as reflected in our results, the marketplace has improved from the conditions we saw from most of 2009. The impact of the economic downturn continues to become less severe with access to capital suddenly improving. While some providers are still hesitating on stimulus purchases as they await final Meaningful Use definitions, most view the interim final definitions as enough to begin moving forward and are comfortable Cerner is a safe choice to deliver any version of the final Meaningful Use requirements. Based on our strong pipeline and forecast, we expect the volume of activity to build as we move through the year and the requirements become finalized.

Relative to Meaningful Use, there has been a lot of discussions and input by various groups suggesting the requirements should be softened or delayed. At this point, we don't foresee anything that changes the ultimate opportunity for Cerner, as we believe the end goal of driving tangible benefits through widespread and meaningful adoption of HIT [healthcare information technology] will remain intact, even if there are some tweaks to how the legislation is rolled out.

One item worth noting is that legislation passed earlier this month changed the definition of hospital-based eligible professionals to now include physicians that work in hospital-owned practices. This provides an important benefit to our client base as it increases the amount of incentive dollars available to them.

Looking at Cerner's overall stimulus opportunity, we continue to see a substantial opportunity in our installed base and for gaining market share. The billions of stimulus dollars, our installed base, is eligible to receive, create a large opportunity for us to help clients to get to Meaningful Use. For clients that are already at or near Meaningful Use, the stimulus dollars could provide capital to purchase solutions and services that will allow them to continue their journey beyond Meaningful Use.

In addition, we estimate there is an $8 billion to $10 billion addressable market for new footprints in hospitals that either don't have an EMR [Electronic Medical Record] today or those that will switch suppliers for a safer path towards Meaningful Use.

In summary, we continue to believe the next few years will be a major opportunity to grow revenue from existing clients and to expand market share. And we really like our position based on the readiness of our solutions relative to most of our competitors and our unmatched ability to deliver value in predictable timeframe and at a predictable cost.

Health reform has also been a major topic in our marketplace. While the ARRA [American Recovery and Reinvestment Act] legislation, which passed over a year ago now, will have a larger near-term impact on Cerner's core business, I'd like to comment on the recently passed health reform legislation and its potential impact on Cerner and our clients.

A key element of the health reform legislation is that it addresses what is probably the biggest operating and financial risk that our clients face, which is uncompensated care by driving insurance coverage for an estimated 32 million additional consumers. While on the surface, this is a major positive, there will be many second-order effects, including the potential for increased volumes that will create capacity constraints and challenges to profitably providing care at the rates reimbursed under the expanded coverage models. These are strong incentives for providers to maximize efficiency and represent another long-term positive for HIT. The legislation also creates more compliance and reporting challenges for our clients in the area of pay-for-quality and waste, fraud and abuse measures that we believe create the needs to further leverage HIT investments.

Another element of the reform legislation is an attempt to evolve new reimbursement models and care delivery models to create better aligned incentives between the government payer and providers as well as create economic alignment between the physicians in the community and major acute care hospitals.

One suggested model is Accountable Care Organizations, or ACOs, which will be contracting entities representing the physician, hospital and possibly other entities across the continuum of care for major high-cost or high-prevalence medical conditions.

We believe that the concept of the medical home will also evolve over this decade where individuals will have a defined relationship with an organization in a further attempt to coordinate care and improve health outcomes. While these concepts are still evolving, they will likely create both challenges and opportunities for our clients, and we believe they could play an important role in driving efficiencies and improving quality in health care.

These new models will also require technology systems to enable the clinical and financial changes necessary to efficiently deliver care. As Jeff will discuss in a minute, this direction is consistent with our vision of creating a "new middle" for healthcare, and we feel we have working examples of the necessary building blocks towards this vision in production at client sites today.

Moving to our results. As Marc mentioned, our bookings revenue in Q1 of $405 million represents 22% year-over-year growth in a Q1 record. These bookings include 17 contracts over $5 million, including eight over $10 million, which is also a record for Q1. Our bookings from new footprints was solid with 20% of bookings coming from outside of our core Millennium installed base, and our outlook for new footprints is also strong.

As I indicated, we are seeing clients move forward with the stimulus purchases, and this is reflected in good contributions from core EMR sales this quarter. In addition, we continued to drive results from our agile business unit, or ABU structure, we created last year to align sales, services and development resources across vertical markets, and make us a stronger, more agile competitor in those markets. This approach contributed to a good Q1 bookings in areas like device connectivity, device resell, RxStation dispensing units, Critical Care, Women's Health, lab and imaging. All of these areas represent meaningful white space opportunities with existing and future clients.

Our ABU structure allows us to leverage the depth and breath of our solutions and ongoing innovation to create a more sustainable growth. And we expect to remain the leader through demonstration of continued innovations that set the bar for what Meaningful Use standards should look like beyond 2015.

Our innovation is not limited to software solutions. We have substantial growth opportunities and new service offerings that capture a larger percent of our client's existing IT spending.

Cerner ITWorks is a good example of the new service offering with great growth potential. Recall that ITWorks is a suite of services where Cerner takes on a bigger role in a client's IT department to help them drive efficiency, performance and quality, while also creating a closer alignment between Cerner and our clients. We signed our first two clients in 2009 and have created good proof points very quickly. In fact, we signed another ITWorks client in Q1. It is worth noting that this hospital, based in Wisconsin, did not have an existing relationship with Cerner, and they were not initially considering ITWorks. After witnessing firsthand what we have already established at one of our existing ITWorks clients, they were convinced that this approach represented the kind of alignment they needed to accelerate their path to achieving meaningful use and ultimately to achieve their quality objectives.

Another new service with strong potential is Cerner RevWorks, which includes solutions and services to help healthcare organizations with the revenue cycle functions. We continue to make great progress with our patient accounting solution including improving the features and functionality. With Cerner RevWorks, we are building on this progress to go beyond patient accounting. We are creating a clinically driven revenue cycle process that increases reimbursement, accelerates cash, lowers cost, ensures compliance and eliminates waste, delay and friction. Our approach to revenue cycle is also very well aligned with supporting the clinical reporting required in the pay-for-quality elements of healthcare reform, as well as the new payment models that will be required to support the formation of HCOs [Health Care Organization].

In summary, Cerner ITWorks and RevWorks represent vehicles to significantly enhance our alignment with our clients. These new businesses require much more than just running the client's IT organization or revenue cycle operation, they require becoming fully aligned and motivated to improve the performance of the clients' organization. So in addition to representing substantial revenue opportunities for Cerner, these initiatives make us much more strategic to our clients, and allow us to innovate at the edges of health care.

Another highlight of the quarter was strong performance in the Physician Practice market, where we added nearly as many new providers as we did in all of 2009. This success was driven primarily through our large healthcare system client-based relationships as they pushed our physician office solutions to affiliated physicians. Well, we also had good early results from our CDW channel relationship, which has contributed to a large increase in our pipeline. Our competitiveness continues to improve, and the quarter included wins against all major physician practice suppliers.

Before turning the call over to Trace, I wanted to discuss an announcement that we made earlier today with CareFusion. As indicated in the release, Cerner and CareFusion will be offering enhanced medication management capabilities to existing and new clients of both companies. As part of the agreement, we will serve as a value-added reseller of CareFusion Pyxis dispensing technologies into our strategic Cerner Millennium client base.

We will also work together to develop an adaptor that supports integration at EHR systems and clinical information into the medication management, pharmacy and perioperative processes. This agreement is the first step in a broader intent to integrate CareFusion devices. Note that we will continue to develop and market our own RxStations solutions as part of our broad device work strategy.

This agreement is strategically significant to Cerner and CareFusion, as well as being a big positive for the healthcare delivery market. For Cerner, it is significant because it extends our DeviceWorks strategy to a leading global supplier of medical devices and validate Cerner's clinical workflow vision where the EHR serves as a single source of truth. It also creates an opportunity to significantly increase adoption of our iBus device connectivity solutions, which we formerly referred to as MDBus, both inside and outside of our installed base -- with Cerner software becoming the end-user interface for CareFusion's industry-leading devices.

For CareFusion, it means they can now offer a complete closed-loop medication system with fluent EHR integration. In addition, our iBus platform can be leveraged for integration of other CareFusion devices, such as Alaris and VIASYS. CareFusion also gains a strong distribution channel for their suite of solutions.

For the broader healthcare delivery market, this partnership brings providers what they want, a solution for integrated and automated workflows that is prebuilt and simple to purchase and implement. More importantly, together, we establish a single source of truth, which helps optimize patient safety and caregiver workflow.

From a financial standpoint, the impact will be immaterial this year as there will be some transition period to set up the operational processes. We expect the impact to begin ramping up in 2011 to more than $50 million of revenue annually. Margins are expected to be similar to technology resell margins with the potential to be supplemented with higher iBus margins when an expanded offering is included.

In summary, we're very excited to be joining with CareFusion to positively impact patient safety and clinician workflow. And I look forward to providing you more information as we move forward with this strategic relationship.

With that, I'll turn the call over to Trace.

Earl Devanny

Thanks, Mike. Good afternoon, everyone. Today, I would like to provide some comments on my transition to running our Global business in London and then discuss some highlights from our Q1 global results.

As I announced on our last call, I'm in a process of relocating to London to spearhead an increased focus on global opportunities, which show the long-term promise of even surpassing the current United States' market potential. The visibility of Healthcare Reform in the U.S. is not going unnoticed in countries around the world. And as I had indicated previously, having Cerner's President on the ground in Europe sends a strong message about the importance of, and our commitment to, being a true multi-national company.

I've been pleased with how well the move has been received by the many global clients and prospects I have met since announcing this transition a couple months ago. I am hopeful that this reception is an indication that this move will pay dividends as the need for healthcare information technology continues to grow around the world.

Moving to our results. As Marc mentioned, our Global business had a nice rebound in Q1, with a return to double-digit topline growth. Coming off of what was a very difficult 2009, and frankly, an enduring global economic crisis, this is a good start to the year. While we still face challenges in 2010, I believe our broad market footprint and our solid Q1 position us for continued momentum and a good year.

One example of this execution is in England, where we, along with our prime contractor, British Telecom, had another very important go live as part of the NHS [National Health Service] program in London. St. George's Healthcare NHS Trust, a 1,000-bed Trust with over 6,000 staff, converted several Millennium solutions across both inpatient and outpatient facilities in March. This is our third Trust conversion in November and brings the total live Millennium sites in the U.K. to over 60 with more than 30,000 daily users.

This past activity, along with nine other concurrent system implementations, demonstrates our unparalleled depth of clinical solutions in the U.K.

Most importantly, there is no other supplier working in England with this level of success and market penetration running on a current, scalable architecture, positively impacting clinical process in patient care.

These delivery successes and our longevity in the U.K. market have served us well as the national program continues its HIT journey. As many of you may know, BT and the NHS recently restructured their contract for the London region, which resulted in an updated contract between BT and Cerner. This creates much-needed clarity going forward, and allows for a greater emphasis on Cerner's more flexible implementation approach that has contributed to the improved satisfaction with our recent go lives.

Cerner will now assume a more strategic role for both implementations and training and will have a more direct relationship with the Trust. This is important because it will allow for a more localized configuration, and will enable us to leverage our proven implementation methodologies.

In the Southern region, we also formalized our role as a subcontractor to BT for an additional three Trusts, which brings our total in the region to 11. This is a very important step forward in our efforts in the South of England with three prestigious health authorities moving ahead with Cerner deployment.

Overall, we are pleased with our continued progress in England. While speculation about the direction of the NHS program has picked up pace in anticipation of the election on May 6, we strongly believe that the need for information technology will continue to play a central role in modernizing the NHS. And Cerner has proven delivery capabilities and commitment to the marketplace should position us to continue to expand our work across the National Health Service.

Moving to the Middle East, where we also had noteworthy results, recall that last quarter, I highlighted another successful go live as part of the SEHA HIT initiative in the emirate of Abu Dhabi. This success led to SEHA signing with Cerner in Q1 to significantly expand the scope of their project, which puts them on a path of becoming one the most advanced users of Healthcare IT in the world.

As a reminder, SEHA is a company that oversees operations of all public hospitals in Abu Dhabi. SEHA owns and operates 12 hospital facilities, 2,644 licensed beds and more than 40 ambulatory and primary health care clinics. SEHA is one of the largest employers in the Middle East with more than and 15,500 doctors, nurses and other clinical staff and administration. This continued execution and success should positively impact our efforts in the Middle East, as other countries in the region face significant healthcare reform challenges.

In summary, I am pleased with our solid start to the year and look forward to building momentum as we move through the year. I look forward to keeping you updated on our progress.

With that, I'll turn the call over to Jeff.

Jeffrey Townsend

Thanks, Trace. Today, I'm going to expand on comments I made last quarter when I introduced my focus on what we referred to as CERN, which stands for Consumer, Employer, Research and Network. These initiatives represent our efforts to capitalize on the second-order effects that will result as medical records become digitized and care delivery organizations get connected in the coming years. We believe this will create major new opportunities for Cerner.

Part of Cerner's vision for healthcare in this decade is placed in the consumer at the center of the health system. Each person in control of his or her own smart, secure, contextually relevant and interactive personal health record. This record, should be the private property of the person and should hold their complete medical history, quickly becoming the holistic platform for the current health status.

Also we believe that this record should give people ready access to information on both the price and quality of the care they receive, and that it will be capable of personalizing medicine using the predictive model of future needs based on the person's family history, medical history, current problems and unique genetic code.

Equipped with this information, consumers and their providers would have financial, emotional and pragmatic incentives to work together to achieve health objectives, strategically manage chronic conditions and intervene early in emerging future health issues. A new era of alignment in transparency will evolve, creating new delivery models and transforming the concept of the patient's care team as well as disrupting the current arcane, inefficient reimbursement system with point-of-service payment.

We also continue to believe that the employer will be a much more active participant in healthcare solutions in the next decade, due to the large percentage of healthcare costs funded by employers. The new U.S. legislation further expands employers' responsibilities in many cases, mandating their participation. In 2009, we expanded our footprint and capabilities in the employer space with our acquisition of IMC Health Care, which expands our employer clinic offering to include occupational health while increasing our list of employer clients, including some that are very large organizations. We have quickly integrated IMC into Cerner and already added two new employer clinic clients in Q1. Our growing base of employer clients represent a great opportunities and other employer services such as on-site pharmacies, condition and wellness management programs and new-age benefit plan design services. Cerner has designed these to help large, self-insured employers better control the costs associated with managing and improving the health of their employees, while bringing new levels of service and quality to their employees and their families.

As I have mentioned, we have proven our ability to do this inside Cerner where we have saved money on healthcare costs over the past several years, while improving the health of our associate base as measured by meaningful clinical indicators, such as cholesterol levels, body mass index, blood pressure and glucose levels.

Moving to the R, or research, in the CERN acronym, we also believe the managed transparency created by the EHR will transform how medical research is conducted in the U.S. and abroad by academic institutions, pharmaceutical companies and others. Our EHR capability should enable new and completely different methods, processes and platforms for clinical trials and regulatory compliance, shortening the timeframe needed for research to enter practice and giving researchers broad new data sources for prospective and retrospective study. Additionally, our research platforms involve identifying new and effective ways to incorporate the most recent clinical research contextually into care delivery.

Finally, requirements related to stimulus and reform will require new networks to facilitate the interchange of secure medical information. The ARRA-defined requirements and funding enable the creation of regional networks that will facilitate broader interoperability allowing for personal health records, population health management and chronic disease management programs to exist. With our Cerner Network offering, we facilitate ARRA interoperability and patient communication requirements by providing a clinical data exchange that is interoperable with all major EHRs and a portal for both providers and consumers.

We are also well positioned to participate in the numerous state networks and health information exchange, or HIEs, which are being driven by stimulus requirements. We have already proven strong capabilities and scale with our national influenza initiative and other state and regional networks we have created. Further, we believe our Tiger Institute initiative with University of Missouri will prove to be a model for how to work with a state to create a model that facilitates broad interoperability and improves efficiency and quality of care across the state. I believe our work with MU will play a role in the direction of new delivery and payment models such as ACOs. Every state is struggling with the reality of balancing their budgets and adapting to the new reform legislation. The need to innovate the care delivery models has never been greater.

In summary, we see the automation occurring in healthcare leading to a series of disruptive structural changes to healthcare ultimately creating new models for delivering care and radically altering the current middle layer that separates care organizations from the source of funds. And all of the CERN initiatives are tied to a bigger vision of creating what we call a New Middle for healthcare.

The New Middle is something we conceive as a radically different transactional layer for healthcare, one that will work synergistically with the broader EHR adoption and interoperability capabilities that will unfold in this decade. Our vision for a New Middle aligns well with the directions being driven by stimulus and reform and evolving payment and delivery models like ACOs. Over the next year, we will invest in further defining the characteristics of the New Middle. Our early discussions of this platform have already begun to influence our internal development activities. It is becoming the vision to guide a new era of long-term growth for Cerner.

With that, I would like to open up the call for questions.

Question-and-Answer Session


[Operator Instructions] Our first question comes from the line of Charles Rhyee of Oppenheimer.

Charles Rhyee - Oppenheimer & Co. Inc.

Maybe generally just talk about the stimulus and sort of what you expect here as we move into the back half of the year. Clearly, it seems with the intermodal out, a lot of people are weighing in. As we find the final rule, you mentioned briefly that it looks like people are starting to move ahead with their decision making. Do you think that once the final rule is published, the activity will then really accelerate? Or it's just that people are kind of moving along with the process and that when people sign the bottom line on the contract, that will still kind of take a little bit of time? Or do you think there is sort of this relative amount that will move people to just kind of sign and get going?

Michael Valentine

Charles, this is Mike. I'll take that question. Our sense is that the folks that have made decisions and on a trajectory will continue forward. So independent of the final definition of meaningful use, I don't think it's going to have a major -- we're not planning towards to have a major positive impact, and we're not planning for it to have a major negative impact. Our sense is that folks that are on the decision-making trajectory at this point are committed to the journey, and they view that independent of this next decision. They need to make the decision. They're committing their organizations to it, and they're heading down that path. So I actually don't view the final ruling to be substantial in terms of how we're projecting the remaining of the year, financially.

Charles Rhyee - Oppenheimer & Co. Inc.

I mean others -- is that just as you look at your customer base? Or is that your just sense of the overall market itself?

Michael Valentine

I think that's our sense of the market in total inclusive of our client base. So I think they're going to continue on the path. As we've said before, there are a lot of new decisions that will be made over the next 18 to 24 months for what represents net new footprints to Cerner. And at the same time, there are many clients in our base that are planning for journeys that take them to stage-one meaningful use and beyond. So I think that they are taking the information that's out there today, and they're making decisions. And I really don't see the final ruling independent of how it gets tweaked of having a major impact towards our financial view of the industry over the next three or four quarters.

Charles Rhyee - Oppenheimer & Co. Inc.

And maybe just a follow-up right there. In terms of the tweaking of the rules, I know some of the policy committee meetings have discussed allowing providers to drop some of the meaningful use criterias and still qualify. When you look at the 25 sort of measures that are out there, obviously, you can't drop CPOE. But looking at some of the other ones that people could drop, do you have a sense on -- in your discussion with clients, which hospitals are looking to see if they can just avoid at least for now and maybe come back to it later?

Michael Valentine

I think what you said in your last sentence is exactly where their heads are, which is they're not necessarily debating the definition of meaningful use. They're actually debating the timing for when it gets enacted and the measurement of being a meaningful user and, very specifically for them, the current binary state of it kind of a pass/fail nature. And so really, I think that what their argument is, is not the level, it's win. And do I get partial credit for being almost a complete meaningful user. So all of which, I think, supports their decision to start and to finish some of these journeys that they're taking upon.


Our next question comes from the line of Michael Cherny of Deutsche Bank.

Michael Cherny - Deutsche Bank AG

So I just wanted to -- thinking a little more on the CareFusion announcement today. Obviously, the MDBus now, iBus platform has been a big kind of talking point for you guys over the last few years. If you think over the next kind of, I guess, three to five years, how big an opportunity do you see this being kind of -- are you planning on focusing on some of these more kind of larger-scale partnerships similar to CareFusion partnership? Or I'm just going to say, kind of big-picture thoughts on where you see this going?

Michael Valentine

Yes, this is Mike. I'll answer that. We've been on this journey for three or four years. And there was a meeting probably two and a half years ago where we had almost 60 medical device suppliers, manufacturers at our headquarters in Kansas City. And we view that as kind of day one of changing the game for how devices would be, how their relevancy in clinical care processes in connection to electronic health records. So that was day one. Since then, we literally have around 50 partnerships that are -- different degrees of partnerships that include certification and includes -- some of them are reseller relationships. But all of them advanced the connectivity of clinical devices to the medical record and the clinical processes. So we've been on this journey. CareFusion is very noteworthy because they represent a substantial percentage in the marketplace for three or four different verticals within the medical device supply and/or medical device manufacturing space. So I think it's a major partnership. We're very excited about it. At a technical level, we will advance the cost relative to medication management, and they'll help us advance our solutions relative to connectivity to the supply chain. So I think it's very meaningful as it relates to the economic impact. We'd spoke to the kind of the near-term view of just a pure reseller arrangement, but we believe the real upside for both of us is in the new markets that it enables outside of just a core basic reseller arrangement. So we have very high expectations for what it could be to. We just need to go do the work now to enable those new markets.

Michael Cherny - Deutsche Bank AG

And I guess just one question kind of the cash flow. Marc, obviously, very strong cash flow during this quarter. You guys have really started to see some nice trajectory there. Obviously, you're getting a bit of a cash build of the balance sheet. And as we kind of -- especially, as we're moving to the meaningful use final definition, are there any thoughts on cash deployment in terms of as you look at the meaningful use definition, potentially in the areas you could firm up in order to make sure that you're hitting that by potentially making a couple of tuck-in acquisitions?

Marc Naughton

Yes, this is Marc. I think from our standpoint, we are very comfortable with our current ability to deliver 100% of meaningful use. That's not a question. And our strategy, clearly, is to build it within the Millennium markets actually, so. I don't see us needing or necessarily wanting to do an acquisition that would be related to meeting some requirement. We'll deliver those through our internal capabilities. I think though, as we've spoken before, that this time in the markets is going to be interesting 18 to 24 months that will result in a bifurcation between companies that are delivering and companies that are having difficulties doing so. And we think that's going to bring about some opportunities to do some acquisitions in this space, where the valuation differentials are pretty significant. So we're actually quite happy with having significant amount of cash on our balance sheet at this point, continuing to add to that cash. And we think that'll well position us should any of those opportunities come up in the next 18 to 24 months.


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

Sean Wieland - Piper Jaffray Companies

Can you give us some sense, I know you're not going to give me the exact number, but on the direction of the software sales component of your bookings, you've highlighted that in the past quarters as particularly strong.

Marc Naughton

Yes, this is Marc. I think relative to -- Q4 of last year was clearly a rebound, very strong quarter. Q1 of '09 was a very weak quarter. And I think what kind of we saw this quarter was more return to good solid software performance, stronger, certainly, relative to the year-ago quarter, but nothing overly unusual. So on a kind of element-by-element, everything is pretty much in consistent percentages. Most of the time, we kind of have really only referenced managed services of being somewhere around 20% of our bookings, and that was pretty much in line with that this quarter. So I think overall, a solid quarter, good continuation of software, but nothing huge or out of the ordinary, but just back to good solid performance across the board.

Sean Wieland - Piper Jaffray Companies

And then a follow-up question on CareFusion. It sounds like the initial effort will be around the Pyxis workstation, but then you did mention possibly integration with Alaris pumps. What's the timeline of that indignation? When do you expect to have a deliverable in the market? And then what does this do for the competitive advantage of your own medication dispensing system?

Michael Valentine

The timing on the integration of the rest of the CareFusion devices is TBD. The intent of the relationship is to set up a joint development capacity, probably shared between our headquarters here in Kansas City and their's in San Diego. So we'll be announcing more around that. But we obviously support the connectivity of a multitude of pumps and other devices today, and we're looking forward to wiring the full CareFusion suite into future. The second part of your question around RxStation. We're going to continue down the RxStation path. It's something that we were -- it was talked about a lot in the CareFusion agreement discussions. Our focus has been improving out the connectivity between the med-management process and the dispensing devices themselves. We think there are lots of opportunities to continue to innovate on that front. We view our relationship with CareFusion as probably an enabler towards that, and we look forward to giving you more details on what those roadmaps may look like going forward. But we're going to stay in the course with RxStation and we, in fact, plan to continue innovations in places that are largely complementary to what CareFusion provides today, and net new things for what centered [ph] us today.

Sean Wieland - Piper Jaffray Companies

In the agreement with CareFusion, are there terms that say that you can't go after CareFusion business with your RxStation?

Marc Naughton

This is Marc. We can't obviously discuss the terms of that agreement since it's not a public document. But suffice it to say that we're very pleased with the agreement and really look forward to our strategic partnership, working with them. This basically means that the EMR won. I mean this is a key statement for device connectivity and some system running those off of the system that controls the patient record and improved patient safety.

Michael Valentine

A single source of trigger [ph].

Marc Naughton

So I think as we go forward, more and more of the details would come out as we talk with you. But I think at this point, probably we won't tell you the details of the agreement other than to say we're very pleased with it.


Our next question comes from the line of George Hill of Leerink Swann.

George Hill - Leerink Swann LLC

Marc, did I hear you right that the capitalized software in the quarter was $25 million and change and the amortized portion was about $15.8 million?

Marc Naughton

Tell you what, once we go to your next part of your question, I'll go look that up.

George Hill - Leerink Swann LLC

Okay, well, my next part of the question was going to be was there anything that you guys have started developing or working on that you can talk about that lead to the jump up in the capitalization rate? Or the actually dollar level with respect to capitalized software?

Marc Naughton

For the number that was capitalized is $20.5 million and then amortization was $15.8 million.

George Hill - Leerink Swann LLC

And then I guess the second question I wanted to talk a little bit, one, about Charles' question with respect to the bookings mix. I guess could you give us any more color with respect to the composition of how much is coming from the managed services and the hosted services and the degree of which we're seeing a lengthening of the revenue recognition period with a lot of the bookings that you guys are adding to the backlog these days? And how should we think about the average backlog for end period?

Marc Naughton

Let me see if I can cover most of that in one answer. I think at managed services I made a comment that it was in line with kind of the historical view of it being 20% of our bookings. So I think that's pretty consistent. As you know, those are longer-term agreements, so they will extend the life of our backlog. As we do ITWorks, that will also extend the life of our backlog as well. So I think those are the two items that will make up a lot of backlog, that extend the days needed to fully get backlog into the revenue, but nothing out of the ordinary relative to that. I think really if you look across the board, almost everything had a good uptick relative to the prior quarter. Software had a little higher uptick relative to the prior quarter, but we also had good services bookings. And as I indicated, managed services on the higher number was near normal 20%. And so the mix of bookings wasn't anything too surprising and therefore, shouldn't have flexed the backlog rollout in any significant way. Clearly, some of the deals we did relative to Q4, some of those large deals that had a hosting element, that had a longer-term project element will also extend the time that those things remain in backlog until they roll out. But when you get to a backlog as big ours, it takes a lot to really change the days it takes to roll out very much.

George Hill - Leerink Swann LLC

And a quick on for Mike. Mike, as you look across the thousand plus volume footprints that you guys have out there. If you were to estimate the average, I guess, kind of the average Cerner customer penetration -- or how close those thousand sites are to achieving meaningful use, whether they wanted to use the HIMSS MRM model? Or what percentage of the proposed meaningful use stage one they've achieved? How close would you say a lot of those customers are?

Michael Valentine

That's a good question. Let me break it down a little bit. I'll talk about what I would describe as our top 275 clients. And that it doesn't back into your facility count very well, but you can think of it as decision-making bodies. And for each one of those, we have literally built out a roadmap and mapped out what needs to happen between now and the strike points of both carrots and sticks associated with meaningful use. And so we know where they stand and I would say that 3/4 of them now have a defined roadmap towards getting some level of stimulus payment. And defined roadmap means they know what it takes to get there, and they've organized around it. It doesn't necessarily mean that they've contracted for it, both services, software and the piece parts that would make up their journey. That number is up quite a bit from where we started, obviously, a year and a half ago. So I think 3/4 of that population is known and on a track. And the other quarter, I expect that we'll have that showed up by the middle of this year.

George Hill - Leerink Swann LLC

I guess then if I ask about the 2/3, it looks like I'm in Boston and you're in Kansas City. Are they in Connecticut? Or are they in Topeka?

Michael Valentine

I think that we have a high level of confidence that they will achieve seamless funds from meaningful use. So what I would say is that, that 2/3 is in good position to go get the fees, the benefits that carrot has associated with meaningful use. Now the rest of the base is really made up of our vertical marketplace and folks that don't have full EMR today from Cerner. So it's a much more difficult question to answer, but we have a lot of activities largely driven by the ABUs, agile business units, we talked about earlier in playing a part in that roadmapping as well.


Our next question comes from the line of Richard Close of Jefferies & Company.

Richard Close - Jefferies & Company, Inc.

You said something about the physician growth being, I guess, in the first quarter larger than all of last year. Can you guys quantify that a little bit more. I think you said you had 20% growth in the fourth quarter?

Michael Valentine

Yes, we haven't given specific numbers around physician practice counts. But we did say in the earlier text was we had nearly as much growth in Q1 -- nearly as much volume in Q1 as we had in all of 2009. And that was largely driven by around 10 major decisions and contracts for our larger IDN clients connecting their affiliated physicians.

Richard Close - Jefferies & Company, Inc.

And then with respect to, I guess, the opportunity on a go-forward basis there, how many of your hospital clients would you say that you've penetrated from the physician-EMR standpoint?

Marc Naughton

This is Marc. I think we're still fairly early in that. We've had a lot of discussions. But I think as far as agreements with those existing clients, it's still pretty early. Many of them are still looking at what they want to do for their physician strategy, especially in the context of HIEs and the variety of other things that are in place. So I think people are taking a lot of time to think about it before they go and initiate a strategy. So that's a little bit why it was significant that we had that much growth in the physician space because we've been kind of seeing people sitting on the sidelines waiting to, as they try to come up with their strategies, to go forward.

Michael Valentine

The other part of the answer is we have about 30 or 40 large health systems that have endorsed our PowerWorks model as their vehicle for connecting both owned and affiliated physicians. So just out of that 275 entities that I talked about previously, you can do the math on who have -- declared as that. Now it doesn't necessarily mean Cerner is the only option, but it's endorsed as an option for and a vehicle for their owned and affiliated physicians.

Richard Close - Jefferies & Company, Inc.

For your first quarter, pretty solid on the bookings and the size of the contracts. When you look at the pipeline, do you see these, call it, $5 million contracts steadily expanding as we progress through the year? Any sort of feedback on maybe the size or the average size of the potential contracts in the pipeline?

Michael Valentine

I think we'll see more productivity in the new business, net new footprints to Cerner in Q2 and in the back half of the year. So I think that, that will drive the volume of transactions above $5 million as they make their first initial big purchase with Cerner, and generally contracting for a path towards meaningful use.


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

Atif Rahim - JP Morgan Chase & Co

Just tagging along to the prior question. Is there any way you guys could break out the percentage of bookings coming from the Solution business? And has the model changed around that? Is it still kind of the subscription model charging about $600 a month?

Marc Naughton

This is Marc. As we've indicated previously, we do not provide a lot of detail on the bookings at that range or a level. So unfortunately, we can't provide that information. But the majority of the business, we are looking at it right now is the ASP business relative to new opportunities. The one we've talked about is being $600 per provider per month.

Atif Rahim - JP Morgan Chase & Co

And then can you just elaborate a little bit on the RevWorks business. You talked about -- I think Mike mentioned it. How is this different from your corporate [ph] solution? Are you building a capability where you have people actively going back and checking claims and eventually outsourcing the whole thing? Or is it the software that you [indiscernible]?

Michael Valentine

The strategy behind RevWorks is to essentially own the back office processing. So it's more of an outsourced-like arrangement around the revenue cycle functions inclusive of the many aspects of our software that make up those functions. So it's comparable to the strategy that we have around the broader ITWorks strategy.

Atif Rahim - JP Morgan Chase & Co

And how many clients do you have on that today?

Michael Valentine

We have no clients that are official RevWorks outsourcing clients, but we expect to deliver some in 2010.


Our next question comes from the line of Greg Bolan of Wells Fargo.

Greg Bolan - Wells Fargo Securities, LLC

Now that you've been in the community hospital market for the past several quarters, can you talk about the pricing environment? And also could you remind me if you are reaching deep enough in the stream to touch critical access hospitals with your ASP offering?

Michael Valentine

As far as pricing in the community hospital market space, we feel comfortable that our community works offering is price competitive all the way down to critical access hospitals. So I think what we're seeing relative to pricing is if we can get a bundled solution, and we can get support for the kind of solution that we offer, we're getting a lot of traction. From a clinical perspective, we differentiate ourselves substantially. We're also nearly the only one that offers up a hosted solution. So it's kind of an all-in ASP-hosted solution. And the other aspect that we've seen traction on is allowing our larger clients to offer up their solution into smaller community hospitals and/or critical access hospitals in kind of a franchise model. So those three approaches are working well for us. We feel good about our price competitiveness. We did add a few more clients to our mix in Q1. It wasn't as many as we hoped for. Our pipeline looks very good. We were unable to get some contracts over the line for a variety of reasons, but we feel like that Q2 will be a good quarter for us on this front. And we have high expectations, relatively speaking, for that business model in 2010. So it feels good as a business to us, and we feel good about our ability to deliver a solution that resonates with that target audience.


Our next question comes from the line of Corey Tobin of William Blair.

Corey Tobin - William Blair & Company L.L.C.

Just with respect to new footprint bookings, the percentage of bookings from new footprints came down and kind of reversed the trend that we were seeing over the last couple of quarters. Any color on why the reversal there? And what would you expect that to be as you sort of round up a full year?

Michael Valentine

I would say that we had a solid quarter of bookings all the way around to get to the number that we attained. We did not get the volume of new footprints across the line in time for the quarter. The good news in that is we're off to a good start in Q2 thus far already in the month of April. So I expect it to continue to be in the 20% to 35% range through the rest of the year. The pipeline certainly supports that. And that's where our expectations are.

Corey Tobin - William Blair & Company L.L.C.

So no change with respect to the mix of deals from existing versus new clients in the pipeline?

Marc Naughton

This is Marc. Corey, obviously, there are new clients. They are just a little less predictable as to when they're going to land relative to a signing because there are two integrated contracts. So there wasn't anything other than just kind of the deal, the series of people you're working with and the timing they ultimately do to land. The rest of the year looks pretty solid from a new footprint perspective.

Corey Tobin - William Blair & Company L.L.C.

Marc, I think previously, you've said that the budget or the guidance for this year based on less than flat bookings, if memory serves, is the terminology that was used. So I guess just based on what we saw here in Q1 and the strength projected in Q2, what sort of expectations do you have baked in the guidance right now with respect to bookings?

Marc Naughton

Well, I think the concept of what we start the year, what we do our full year plan initially at, it kind of just where the concept of less than flat bookings depending on what we see. But when we give you guidance for a quarter, which is kind of the mode we're in now that we're starting the year, that guidance is not based on some assumption. That guidance is based on a detailed forecast process that we go into and look at every deal, look at timings, and we go out four quarters. So really the guidance that you're being provided right now is a very timely up-to-date version of what we expect the business to do. So our current guidance as we're kind of in the year is definitely based on that, and really is much less related to any assumption that we would have had in our initial plan.

Neal Patterson

With that, I think I'll close. This is Neal. I appreciate you all for your time on the call here. As I was sitting here and kind of listening through the part of the presentation or the script here, there's several things of noteworthiness. One is that you can see the landscape of healthcare changing, and it changed a lot this last decade, but we're entering this decade with really at a high rate of velocity here. So most of the questions you're asking this quarter, you didn't know about a year ago because a lot of them are stimulus driven. I found it strange that there was no reform, another piece of legislation that is going to change landscape, too, and that is around reform. And I think this time next year, you will be -- there'll be a lot of discussion about the impact of that legislation on the behavior and the landscape of healthcare and the role of IT in that. So healthcare is being digitized around the world from the inside out. And we are, for the most part, the infrastructure that's doing that for our clients. Another significant thing that happened here is the relationship with CareFusion. Two leading companies coming together around the fact that healthcare is digitizing, and everything about healthcare needs to get smarter. And you can't get smarter if you're disconnected, no matter how fancy you make at the end of it. So that connection, that will be a theme throughout this next decade as fundamental platforms are formed to delivery care. And then none of you asked question to Jeff or Trace over there, but the stuff that -- Trace has made a very clear statement this is a worldwide, most major countries are doing major work here and building this infrastructure and digitizing healthcare. And then Jeff took you through some of the kind of the second quarter impacts of that, and we think they are material. So everything -- I mean we're getting better at what we're doing, and we started off being reasonably good. So things are -- this is kind of a very fun place to be. It's going to be a very exciting decade. The topics are going to change quite a bit through that. Part of that is going to come, as I said earlier, legislatively. But there's a whole lot of second quarter impacts around digitizing healthcare. So it's a fun place to be. We like where we're at. We're impatient to get to where we're going though. So thank you for your time, and have a good day.


Thank you for your participation in today's conference. This concludes the presentation, and have a great day.

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