Cerner Corporation Q1 2008 Earnings Call Transcript

| About: Cerner Corporation (CERN)

Cerner Corporation (NASDAQ:CERN)

Q1 2008 Earnings Call

April 22, 2008 4:30 pm ET


Marc G. Naughton - Senior Vice President and Chief Financial Officer

Michael G. Valentine - Executive Vice President and General Manager, US Client Organization

Earl H. “Trace” Devanny, III - President

Jeffrey A. Townsend - Executive Vice President

Neal L. Patterson – Chairman of the Board and Chief Executive Officer


Charles Rhyee – Oppenheimer

Bret Jones - Leerink Swann

Steve Halper - Thomas Weisel Partners

Atif Rahim – JP Morgan

Anthony Vendetti - Maxim Group

James Kumpel - FBR Capital Markets

Richard Close – Jefferies

Sean Wieland - Piper Jaffray

Frank Sparacino - First Analysis

Sandy Draper - Raymond James


Welcome to the Cerner Corporation’s first quarter 2008 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 Securities and Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in forward-looking statements may be found under the heading “Risk Factors” under Item 1A in Cerner’s Form 10-K, together with other reports that are on file with SEC.

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

Marc G. Naughton

I will lead off today with a review of the numbers followed by sales and operational highlights from Mike Valentine, Executive Vice President and General Manager of the U.S.; Trace Devanny, our President, will discuss our global efforts and our physician practice business. Trace will be followed by Jeff Townsend, Executive Vice President and Chief of Staff, who will discuss innovation. Neal Patterson, our Chairman and CEO, will be available for Q&A with us today.

Now I will turn to our results. Bookings, operating margin, earnings, and cash flow performance were all at or above expected levels and our outlook for 2008 remained strong. Like last quarter, we delivered expected levels of gross margins but our revenue was less than expected. An important difference this quarter that we did have good growth in software but this good growth in software was offset by year-over-year decline in technology resale. I will discuss this more in a moment.

Moving to bookings, our total bookings revenue was $347 million, which is the high-end of our guidance range. Bookings are basically flat compared to Q1 ‘07, which included $50 million of over-attainment related to our hosting business. Adjusting for this, bookings are up 14% year-over-year.

Moving to backlog, our total backlog increased 21% year-over-year and ended the quarter at $3.35 billion. Contract revenue backlog ended the quarter at $2.79 billion, which is 22% higher than a year ago. Support revenue backlog was $555.7 million.

Our revenue in the quarter increased 5% over Q1 ‘07 to $384.8 million, which is about $5 million below the low end of our guidance driven by year-over-year decline in systems sales, which was again driven by lower hardware sales that offset growth in software. The revenue composition for Q1 was $116.2 million in systems sales; $107.9 million in support and maintenance; $151.9 million in services and $8.7 million in reimbursed travel.

Systems sales revenue was down 5% compared to Q1 ‘07. As mentioned, this decline was driven by lower hardware sales, but it is important to note that we did have good growth in software, which is very positive after the decline last quarter and last year.

However, the growth in software was more than offset by the decline in hardware. Given lower hardware sales in the past two quarters, we took a conservative approach to hardware revenue in arriving at our guidance going into Q1, but still ended up below our expectations. Similar to past quarters, the lower hardware had little impact on our gross margin dollars.

Services revenue, which includes managed services and professional services, grew 9% compared to the year-ago quarter, driven primarily by strong managed services growth. Our professional services revenue was only up 1% year-over-year due to slightly lower billable headcount in the U.S. and less services revenue in the southern region of England relating to the contract resets which has slowed the pace of new implementation work.

We have hiring plans that should drive growth in U.S. services revenue as we move through the year and we expect work to ramp up in the southern region later this year. Note that we have continued to staff to demand in U.K., so the lower services revenue does not materially impact the overall profitability of the southern region. And we still expect to be recognizing margin on both regions by the end of the year. Support and maintenance revenue grew a strong 15% reflecting our delivery on system implementations.

Looking at a geographic view of revenue, our domestic revenue grew 7% year-over-year and our global revenue declined 1.6%. As I have mentioned, the strength in hardware sales during the first half of 2007 was driven by global hardware sales, which were down about $6 million year-over-year in Q1.

This coupled with lower services revenue in the southern region of England, led to a lower year-over-year global revenue despite strong growth in most of our other global business models and regions. The comparable for global revenue will be very tough in Q2 as well because the record hardware sales in Q2 ‘07 were concentrated outside of the U.S.

Moving to gross margins, our gross margin for Q1 was 83.3%, which is up 310 basis points from year-ago and up 80 basis points from Q4. The higher gross margin percent reflects the lower hardware sales and growth in software. This is also reflected in the systems sales margin percent which increased from 61.7% in Q1 ‘07 to 65.4% this quarter.

We also had improvements in our support, maintenance, and services gross margins which increased from 93.0% to 94.1% year-over-year driven by lower third party costs. The stronger gross margin percent again led to margin dollars growing faster than revenue with margin increasing 9% well above the 5% growth in revenue.

As we have indicated, we view the 9% growth rate in gross margin as more reflective of our performance than the 5% growth in revenue since our gross margin is very similar to net revenue which neutralizes the impact of fluctuating levels of third-party sales.

Last quarter, I discussed in some detail items impacting our systems sales with the primary item being the continuous slowdown in the resale of hardware. The slowdown is being driven by a fundamental shift in our business where clients are adopting our Cerner hosted model instead of buying hardware upfront from us.

As we’ve said, the financial impacts of this trend is very positive in the long run because the low-margin upfront hardware sales is being replaced by a higher margin recurring managed services revenue stream. So the decline in hardware is impacting our systems sales in the near term.

We are continuing to look for opportunities to grow our technology resale business including potentially reselling devices as a part of our CareAware strategy and expanding global channels. However we think it is prudent to assume that lower levels of hardware will continue for the foreseeable future.

The impact decline in hardware will have on our growth rate should peak in Q2 of this year because Q2 ‘07 revenue included an all-time high level of hardware due to a few large global hardware sales. Beginning in Q3 of this year, the hardware component of systems sales will have normalized and we expect to be able to show growth in systems sales in the second half of the year.

Shifting to software, I should note that we showed good progress in reversing the slowdown in software sales that occurred in 2007 with good growth in software in Q1. Recall that much of our client base was focused on adopting our latest version of Millennium last year, and since a perpetual license to Millennium means upgrades are free of any additional license fees, the activity did not add to license revenues. The focus on doing the upgrade also impacted our ability to sell what we call white space Millennium applications back into our base in 2007.

While we still have clients doing upgrades, we believe we are through most of this impact as current upgrades could be done faster with less disruption. Also since the next several releases will be based on the Millennium 2007 code set, we don’t expect an impact on white space activities when we roll them out.

Moving to operating expenses and earnings, our operating expenses before option expense in Q1 were $260.4 million, which is up 6% over year ago. Sales in client service expenses were up 9% with managed services growth being the primary driver.

Software development was up 5%, which is in line with expected levels. G&A expense was down $3 million or 12% year-over-year. The decline in G&A was driven by a higher-than-expected benefit from foreign currency exchange. These FX gains and losses have always run through our G&A as an increase or decrease to the expense, but have usually not been significant one way or another.

This quarter, we had expected about $2 to $3 million gain when we provided guidance on January 31, which would have led to flat year-over-year G&A expense. We ended up with a $5.6 million gain, which drove the decline in G&A. The $2.6 to $3.6 million difference between our planned levels and the actual gain benefited EPS by $0.02 to $0.03 in the quarter.

The higher amount of FX gains was primarily driven by the weaker dollar and we don’t expect large gains or losses in the future unless the dollar sees sizeable movements in exchange rates.

Our GAAP net earnings in Q1 were $36.8 million or $0.44 per diluted share. GAAP net earnings including stock options expense which had a net impact on earnings of $2.2 million or $0.03 per share. Excluding options expense, adjusted net earnings were $39.1 million, which is 30% higher than Q1 of last year.

Our adjusted EPS was $0.47, which is $0.03 higher than the consensus estimate and our guidance range. As I mentioned, the higher FX gain contributed $0.02 to $0.03, so we review our performance as in line to slightly better than our expectations.

Moving to operating margins, our operating margin before options expense in Q1 was 15.6%, up 250 basis points over the prior year. This quarter, our operating margin was impacted by about 80 basis points due to approximately $20 million of zero margin revenue from our projects in Southern England and London with Fujitsu and BT. The initial FX gain also benefited operating margins by 50 to 80 basis points.

Overall, we remain on track for our goal of achieving 20% operating margins in 2009. Note that our path to 20% continues to include the assumptions that we will be able to recognize margin on our U.K. contracts by the end of 2008, which remains our current expectation.

Now I will move to our balance sheet. We ended Q1 with $251 million of cash and $101 million of long-term investments or auction-rate securities. Total debt was $192 million. As you note on our balance sheet, we’ve moved our investment in auction-rate securities from short-term investments to long-term to reflect the current lack of liquidity in that market.

The $101 million on the balance sheet reflects approximately a $5 million reduction from par value. We review this impairment as temporary to the underlying credit rating of the securities and the intent and ability of the company to hold the securities until the market recovers.

I would stress that the vast majority of our auction-rate securities are AAA rated and backed by the U.S. government or state governments, unlike many of the ARS that represent collateral mortgages or corporate debt.

I would also note that $5 million temporary impairment does not impact the income statement, but is reflected in comprehensive income on the balance sheet. We believe our $251 million of cash, available $90 million line of credit and expected free cash flow for the year should more than meet the company’s cash needs. As an aside, it is worth noting that our ARS are currently yielding an average tax-free return of over 5%.

Total accounts receivable in the Q1 at $388 million, contracts receivable or the unbilled portions of receivables were $138 million or 36% of total receivables, which is down from 39% in the first quarter of last year.

Our DSO was 92 days in Q1, which is up two days compared to last quarter and three days from a year ago. Year-over-year increase is driven by an increase in billed receivables as opposed to unbilled items which are flat year-over-year.

Third-party financings were $20 million or 5% of the $427 million of total cash collections. Operating cash flow for the quarter was $51 million, which is up from $42 million a year ago.

Q1 capital expenses were $31 million, including $5 million of property expenditures. Capitalized software in Q1 was $17 million. Free cash flow defined as operating cash flow, less capital expenditures and capitalized software, was $3 million. This compares favorably to the negative $23 million of free cash flow in Q1 of last year. And we maintain our target of $80 to $100 million of free cash flow for 2008.

Moving to capitalized software, the $17 million of capitalized software in Q1 represents 23% of the $75.2 million of total spending on development activities. Software amortization for the quarter was $11.0 million, resulting in net capitalization of $6 million or 8% of the total.

On software amortization, as we communicated in last quarter, the $2.4 million decline compared to Q4 ‘07 reflects the completion of the amortization of amounts capitalized in 2002. We expect the amortization to increase in the second half of the year when we roll out our next release of Millennium 2007. The rollout of this next release will trigger an increase of approximately $4 million per quarter. We expect part of this increase to occur in Q3 with the exact amount depending on when the release occurs.

Now I’ll go through the guidance. Looking at Q2 revenue, we expect revenue in the $390 to $405 million range. This guidance reflects growth similar to the 5% level in Q1 and assumes a more conservative stance on hardware. Note that Q2 is by far our toughest comparable for the full-year as revenue grew 17% in Q2 ‘07 driven primarily by the unusually large hardware sales.

We expect our revenue growth to continue to strengthen in the second half of the year, but we will likely be on the low-end of our 10% to 12% revenue growth goal for 2008 due to lower hardware and lower professional services in the first half of the year.

We expect Q2 EPS before options expense to be $0.50 to $0.51 per share. This guidance is 1% less than consensus which is artificially high due to two outlier estimates for Q2 ‘08 that had assumed 34% and 37% EPS growth for Q2 and caused consensus to go up from $0.51 to $0.52. The Q2 guidance is based on total spending before options expense of around $265 million.

For the year, we continue to expect EPS before options expense to grow more than 20%. On our last call, we indicated comfort with consensus of $2.14 per share. With the $0.03 over attainment in Q1, we are now comfortable with $2.17 for the year. Note that this guidance assumes we have no materially negative impact from foreign currency exchange for the remainder of the year.

Our estimate for options expense for Q2 ‘08 and 2008 is approximately $0.03 and $0.12 to $0.13 per share respectively. For bookings, we expect bookings revenues in Q2 of $370 to $400 million. This guidance assumes about $20 million less hardware bookings in Q2 ‘07 which was an all-time high. Similar to our revenue guidance, our bookings face a tough comparable with bookings growing 25% in Q2 ‘07 even after adjusting out a $98 million U.K. booking.

Before turning the call over to Mike, I wanted to highlight the stock buyback we announced today. Our Board approved a stock repurchase program authorizing the repurchase of up to $45 million of common stock. We believe that some of the shifts we have discussed that are occurring in our business and impacting our top line in the near term appear to be contributing to a market value that doesn’t reflect the significant opportunities we have in the long-term.

Therefore, we believe the repurchase of our stock is a good use of fund. We plan to execute this program by repurchasing shares from time to time in the open market by block purchase or possibly through other transactions managed by broker dealers. Based on today’s closing price, approximately 1.1 million shares could be repurchased if we fully exercise the program.

With that I’ll turn the call over to Mike.

Michael G. Valentine

Today I am going to cover sales, operational highlights and marketplace trends. From a sales perspective, we had a good quarter with a return to good software sales. While the top line benefit of improved software was offset by continued lower levels of hardware sales, we obviously feel better about the mix of our revenue including stronger software.

In Q1, we did $346.6 million of bookings which is our second highest level of bookings for our first quarter with the highest being Q1 of last year. As Marc mentioned earlier, our results last year included $50 million of hosting over attainment. Our growth against Q1 of last year adjusted for this was 14%.

We had a good mix with 11 contracts over $5 million, seven of which were over $10 million. 25% of our contract bookings were for new Millennium footprints, which is higher than all but one quarter in 2007 and consistent with what we had been communicating about an increase in opportunities outside of our installed base.

From a leading indicator perspective, we continue to see strong levels of Vision Center visits, RFP activity and our pipeline is growing consistently with a continued strong level of new footprint opportunities over the next several quarters. Specifically worth highlighting is that our Vision Center activity was at an all-time high in Q1 with significant increases year-over-year and sequentially.

Historically, the level of Vision Center visits has proven to be a good leading indicator of sales activity in coming quarters, so we are encouraged to see this activity level to start the year.

Operationally, we had another solid quarter of execution with strong levels of conversions across the wide range of venues around the world. During the quarter, we did 394 conversions of Cerner Millennium solutions and now have done nearly 8,000 cumulative conversions at nearly 1,300 facilities. I’d like to note a change in how we talk about operations going forward.

While conversions were a useful measurement back in 1997 and several years after that as we were trying to show progress at rolling out the then new Millennium solution, they are less relevant as a metric today given that we’ve clearly established the scale and industrial strength of Millennium.

Additionally, changes in the packaging of our solutions have made counts less comparable to prior periods. Therefore, we don’t plan on reporting these conversions going forward, but we will continue to provide color on our operational performance that is more relevant to how we are running the business day-to-day.

On the competitive front, we had a good quarter in Q1 as reflected by us getting 25% of our bookings from new business development. In general, it remains very competitive, but no more competitive than in the past.

We continue to like our physician as the provider with the most depth and breadth of solutions, industrial strength architecture and established Cerner brand. And this competitive differentiation is augmented by our proven ability to deliver with implementation tools and methodologies that help our clients drive quality and predictability up, while at the same time driving total cost of ownership down.

Looking at the overall marketplace, we believe the market remains solid. As I mentioned, our leading indicators are very strong and reflect a good mix of opportunities across most segments and both inside and outside of our installed base. Demand continues to be driven by CPOE with an increased focus going beyond just basic CPOE to include more robust clinical documentation, decision support and closed-loop medication administration.

We are uniquely positioned to offer true closed-loop medication administration with all of our solutions on a common platform, including our RxStation medication dispensing units, which add an important additional level of safety and improved workflow. Other areas of emerging opportunity that represent what we called white space include revenue cycles, RIS/PACS, and device connectivity.

On the revenue cycle front, we have made progress with the ProFit solution, which is a clinically driven approach to revenue cycle and we are well positioned to participate in what we believe will be a replacement cycle over the next several years.

We’ve also improved our position in the RIS/PACS market with our new provision PACS workstation, which is a very attractive offering for clients who are looking to move their PACS system to a common platform and is also competitive outside of our installed base.

And on device connectivity front, there’s a substantial amount of opportunity both inside and outside of our installed base as we are still in the very early stages of adoption for solutions that connect medical devices to the EMR. And our early success in this space leads me to believe that we will benefit significantly as more hospitals look to improve safety and workflow by integrating the information from their medical devices with their clinical systems.

In addition to the white space solution opportunities, we are also seeing opportunities to grow our services business. One example of this is the Application Management Services or AMS, which goes beyond what we do with our traditional managed services as we are helping clients manage not only their technology, but also their applications.

Another example of services opportunity is transformation services, where we are helping our clients leverage their digital and Millennium platforms to optimize their performance. Both AMS and transformational services provided strong contributions to bookings in Q1 and the revenue impact ramps up as we move through the year.

I’d like to make one other comment on the broader market. Many of you have asked if the issues in the credit markets, specifically auction-rate securities, are having an impact on our clients’ ability to purchase IT. Many of our clients are dealing with auction-rate security issues, but we have not seen it have a significant impact on their purchases of clinical systems.

While some of the survey is done by sales side reflect mixed results, the two consistent take-aways from the surveys are first, healthcare IT spending is still expected to grow and second, HIT spending remains the top priority for most hospitals and other items would likely be cut before HIT if hospitals did have to cut budgets.

We believe this is especially true for solutions like Cerner’s that directly support pay-for-performance initiatives. I don’t want to leave the impression that we are dismissing the chance that the credit markets could impact our clients’ IT purchasing, but we are not seeing it having a significant impact at this time.

With that, I will turn the call over to Trace.

Earl H. “Trace” Devanny, III

Today I would like to discuss some good progress in our international business and physician practice solutions.

On the global front, we had a solid Q1. As Marc mentioned, our global revenue declined slightly year-over-year, primarily due to declining hardware sales. But that is not reflective of the continuing progress we have made or of our strong international position going forward.

Specifically, we had a strong bookings contribution from global including contracts from another large academic medical center in France as well as our first client in South America. We expect additional business to come from both France and Latin America in 2008. We also had a strong year-over-year increase in profitability despite the lower revenue, which is consistent with the revenue decline being driven by hardware.

We also made good operational progress. In England, despite the slowdown during the contract reset in the southern region, we continue to successfully bring solutions live in both that region and in London. Since last quarter, we have launched many more solutions in numerous acute care facilities. We now have a total of 61 sites and 313 solutions live, which is up from 55 sites and 255 solutions last quarter.

In addition, use of our Choose and Book national scheduling and referral system has been steadily increasing and is now being used for about 50% of referrals according to Connecting for Health. This marks a significant milestone in the use of Choose and Book, which has now have been used for more than 6 million referrals, considerably up from about 1 million a year ago, illustrating that this solution is becoming very mainstream to the National Health Service.

Moving to our PowerWorks physician practice business, we had a good start to the year with solid bookings growth, particularly bookings to new providers. We are also making progress on several of our pilots with large acute care clients for promoting PowerWorks as the preferred EMR in the physician provider communities.

As I have mentioned on previous calls, our clients believe that Cerner’s unified architecture supporting both the inpatient and outpatient environments is an important competitive advantage. This opportunity to leverage our large installed base is substantial with a potential to more than double the number of providers using PowerWorks over the next five years.

Last quarter, I mentioned that we had expanded our PowerWorks market by signing our first outpatient surgical center. I’m pleased to report that we’ve already successfully brought our PowerWorks solutions live at this site which specializes in spinal surgery. This represents a great start for Cerner’s ASP model and package of solutions geared specifically for ambulatory surgery centers.

A broad range of solutions were implemented including PowerWorks surgery center EMR suite, surgery, scheduling, registration, clinical supply chain, practice management and anesthesia. In addition, we implemented CareAware medical device bus, which is connecting 15 patient monitoring devices to the electronic medical record.

At Cerner, we continue to drive innovation into new markets by leveraging our broad range of solutions and our proven delivery and hosting capabilities.

We expect to build on this success and we have a strong pipeline of similar opportunities that will continue to fuel future growth in this critical position marketplace.

With that I will turn the call over to Jeff.

Jeffrey A. Townsend

Today I am going to provide a couple of quick updates on our CareAware platform and make some broad comments on Cerner’s long-term opportunities. Our CareAware platform is a new architecture that was started in 2005.

The core principle around this development was the premise that electronic medical records created a new digital medium for care delivery. From there, the entire care delivery experience could be redesigned to include a contextual awareness with the entire experience well beyond the workflow represented on the screen.

Our CareAware MDBus device connectivity solution allows medical devices to be connected to the EMR through a USB like plug-and-play connection. It is more than just connectivity, as today these devices require human interaction to adjust to the changing treatment or context with patient care.

Making the devices and the EMR aware of each other introduces a new paradigm in what’s possible. In Q1, we signed several more clients and completed 51 new drivers, which increased our library of device drivers by over 50%.

We also made good progress with RxStation, our medication dispensing units. We shipped our first production units of RxStation in the fourth quarter of last year and we are in the final stages of completing the implementation at our first site. Early feedback has been positive and we have a strong pipeline going forward.

Again, what was once an island of information in an isolated experience is now a comprehensive workflow with a single source of truth. Our marketing approach to the CareAware suite of solutions is experience oriented. You have to see it in context to understand it.

Beginning in May through a collaborative effort between Cerner and Steelcase Incorporated, we’re taking the Smart Room, MDBus and RxStation on a mobile tour. Between May and December, the Cerner Smart Semi will visit over 40 major cities showcasing our innovative technology and workflow solutions in three venues, a medical surgical Smart Room, a caregiver area featuring the RxStation and a waiting room.

Inside the semi, we will be demonstrating a complete redesign of the care experience with Cerner CareAware MDBus providing connectivity to numerous devices including a Hill-Rom bed. CareAware myStation, providing rich content for patients and families and RxStation towers showcasing nursing workflow through both the touch screen solution and care mobile handheld devices.

Now, I would like to make a few comments about our long-term growth opportunities. During this period when some shifts on our business have led to top-line growth that is not reflective of our fundamental strength, we believe it is easy for some to lose sight of the significant potential for Cerner.

We believe we offer a significant value proposition to the largest segment of our economy, as most of you know that healthcare spend in United States is expected to nearly double over the next ten years, moving from just over $2 trillion to more than $4 trillion.

Similar trends exist in almost all other major developed countries. This is an unsustainable rate of increase that must be addressed. We will not solve it alone but our mission to eliminate all inappropriate variance, avoidable medical error, unnecessary waste, needless delay and costly friction will make a significant contribution to addressing healthcare spending issues. And the growth opportunities involved in achieving our mission are substantial.

There is amazing amount of complexity in healthcare which is why there are no simple solutions or quick fix to issues that are causing spending to increase. Cerner has a long history of working through complexity to address the future needs of the healthcare industry.

Today the most consistent trend worldwide is to increase the measurement of quality than linking those to pay for performance initiatives. This plays to our clinical strengths. In addition, we see the strengths finding a wave of requirements well beyond workflow which requires innovation at the point of decision in context which will drive an expansion of our solution portfolios not just in software and content but also in services.

The substantial value of the large and strategic client base we’ve built over the past 29 years coupled with our strategic initiatives that are expanding our boundaries to address a much bigger portion of healthcare spend, positioning us for another wave of very strong growth.

As Marc mentioned, our clients are getting value from the 2007 Millennium release and we are positioned with the next set of solutions that lay on top of that release. The next layering of complexity is applying the context of condition to the traditional world venue.

For example, it is no longer just emergency medicine, but the added context of the patient’s condition, the continuum of care prior to the ED visit and the continued coordination of care beyond the visit. Adding women’s health in conditions specific offerings such as oncology and cardiology will create new opportunity on top of our existing network.

Many companies large and small sense the business opportunities inside healthcare, but few if any have the scale, the experience, the team, the technology and the vision to make a big difference. That is why for the past three decades the names of our competitors changed routinely while Cerner is consistently innovated to create strong organic growth. And we believe that what we have accomplished so far is only the beginning.

We understand the importance of focusing on short-term results. We have a great track record of doing that over time and we believe we are close to working through the shifts in our business that have impacted our top-line in the past few quarters. So, when we step back and look at our business, we also think it is important to see where the next billion dollars of revenue is coming from.

With that, I will turn it over to the operator to take questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Charles Rhyee - Oppenheimer.

Charles Rhyee - Oppenheimer

We’ve now had a couple of participants in the market refer to particularly the month of March as saying that it was a difficult where they’ve seen the pullback in spending. And the comments that I’m hearing from you is that you are not seeing this., Can you give us a description of maybe where your customer base might differ from some of these other competitors that we’ve heard negative comments out of?

Michael G. Valentine

We mentioned before the auction rate securities as being on the radar of our clients, and specifically most of our larger clients. But what we saw happen in the quarter is, this is just something they had to deal with, it was literally in their windshield, most of them took action in Q1, if not took action clearly early in Q2. But we didn’t see a change in the direction they were headed as an organization.

So, their decisions around utilizing Cerner and there are certain active Cerner initiatives weren’t impacted, the financing wasn’t impacted as we move forward. So, we saw it out there, it was definitely something that was in the windshields of our clients, but the kinds of initiatives that they funded with Cerner are long-term initiatives that actually helped better position them on their revenue generation side of the house, so they are staying the course relative to their investments in our types of solutions.

Charles Rhyee - Oppenheimer

Apart from the auction rate securities issue, if you think more broadly to the macro environment and the direction of perhaps the economy, can you give us a sense of your conversations with your clients in regards to how they are trying to position themselves in light of potentially a weakening economy and how that might affect their business?

Michael G. Valentine

What we see them very focused on is positioning themselves for the pay for performance initiatives, and continuing their journeys around efficiencies, leveraging our technologies. So, I think that the general point that I would make is that they view us as a longer-term solution for addressing their operational efficiencies and just very specifically how they get paid. So, they are viewing us as fundamental to whatever the economy looks like going forward.

Neal L. Patterson

I think the place where I think our client gets hit with a downturn is primarily in bad debt. And just my anecdotal sampling is, even though they are seeing a little bit of that, it is really not impacting the financial health of the firm, of the people we work with. So, we are just not seeing it quite the way I think other people have described it. So, I don’t know what that says, but we can’t speak for what they are seeing, we can speak for what we’re doing.


Your next question comes from Bret Jones - Leerink Swann.

Bret Jones - Leerink Swann

The new initiatives in aggregate, when we think of CareAware RxStation, the Application Management Services and transformation services that you spoke about earlier, if they are becoming a meaningful percentage of bookings in aggregate?

Michael G. Valentine

I would say they are, each of them has a maturity cycle of their own. But I think the traction that we’ve seen, I will speak to AMS, the Application Management Services, our clients have become very comfortable, our client base and the population of prospects that we talk to are very comfortable with the managed services model.

And historically for Cerner, managed services has meant the management of the technology and the hosting of the technical side of the equation and what we’re doing with the Application Management Services is essentially just broadening out that curtain of management to include more of the application.

And we think the growth opportunity there is not only in our base of our managed service clients, but also a whole new wave of growth as well. So, it was a meaningful to us in Q1, of the ones that you spoke of, I think they have the best near-term meaningful impact to both our top line and bottom line.

The CareAware, specifically the MDBus components, I think hold good potential and I would describe our launch over the last several quarters as we are very optimistic about what we’re seeing. So even though the vast majority of clients that are making the decision towards the MDBus component of CareAware are doing it in a pilot-like phase, there is a good upside once we get out of pilot phase and go across the enterprise.

And we have just tipped the tip of the iceberg in terms of the coverage that we have with the MDBus in terms of the number of devices that connect in, so we were very encouraged in that space as well.

Bret Jones - Leerink Swann

My concern is the health of the core clinical market where we are essentially from a saturation standpoint and where if you are getting contribution from these other pieces and it’s becoming meaningful, where that sits, especially looking at I know you’ve talked about the number of Vision Center visits being record number.

And I was wondering directionally, can you talk about the dollar opportunity? Is that a smaller opportunity, are these smaller hospitals coming through and the number is bigger, but the dollar opportunity may be smaller, or is that not the case?

Marc G. Naughton

We don’t talk a lot about our pipeline numbers. But I think as we look at that pipeline, we see a mix of deals that continue to span what we historically see. We see some strong community hospitals in the mix. We see some IDNs coming into the mix.

So, and I don’t think anything Mike says should be taken as these new initiatives are driving our bookings. I think in some targeted services areas we are pleased with the progress, but for example RxStation, we are just turning those on and really have negligible bookings to date in that space. Hence, are going on the road, if you will to go take these to the clients to drive more demand there.


And your next question comes from Steve Halper - Thomas Weisel Partners.

Steve Halper - Thomas Weisel Partners

On the tax rate, it looks like it was a little bit below what we were looking at. Was there anything there of notice?

Marc G. Naughton

I think it is 35.8% and we thought we were looking for 36%.


And your next question comes from Atif Rahim – JP Morgan.

Atif Rahim – JP Morgan

Marc, usually you comment on the deals that are north of $5 million or $10 million. I am not sure if you spoke about that this quarter. And then secondly on the revenue guidance, given your updated guidance, it looks like you are still looking for something like mid-teens top line growth in the back half of 2008. So, could you give us some color on where that growth is going to come from?

Marc G. Naughton

Yes. A lot of the comparable growth obviously comes from the fact that our comps are going to be lower relative to Q3 and Q4 from a hardware perspective. You’re going to go from significant record levels of hardware in Q1 and Q2 to Q3 which basically had the lowest level of hardware that we can recall.

So I think you are also going to see, we talked a little bit about the fact that we are adding more headcount in our services organization. We see some good opportunities there to grow that business, it has grown significantly in the past. But we brought that headcount in on Q1, they weren’t productive and driving revenue, but we will get them trained up and get them out in the field working as we hit the back half of the year.

So I think to comparables, stronger services, and continued strength in the software as we look at our forecast and our pipeline just shows an overall strength in almost all of the components of our top line except for revenue. And given that revenue should be a net neutral from a growth perspective in the last half, we feel pretty good about looking at double-digit growth for the year.

Atif Rahim – JP Morgan

In terms of the number of deals, north of $5 or $10 million?

Michael G. Valentine

Yes, there were 11 contracts of over $5 million and seven of which were over $10 million.

Atif Rahim – JP Morgan

You said you are going to start recognizing margin on the U.K. contract in the back half of ‘08. Any idea on the numbers there, what the EBIT contribution might be?

Marc G. Naughton

Yes, the statement we are making is that we expect, not that we will, but we expect to begin recognizing margins in the last part of ‘08. And at this point, we will have to do work to know exactly what that financial impact is. As soon as we have better visibility, we’ll obviously share that with investors, but currently there is nothing in our numbers or our guidance for ‘08 relative to that.


And your next question comes from Anthony Vendetti - Maxim Group.

Anthony Vendetti - Maxim Group

During the call there was a mention that there has been because of the transition to new leadership at NHS there has been a slowing in the implementation a little bit. Is that in your forecast and do you expect that to pick back up?

Marc G. Naughton

I think what we’ve indicated is that in the South there is an ongoing contract reset process, and it makes sense as that is ongoing, that you’re going to minimize the work you are doing there until you know how you’re going forward.

So we really can’t comment on the status of that process, but we continue working under our existing contract, and we would expect that to be settled out by the last half of the year and we would get back to more normalized levels of service revenue coming from the Southern Cluster.

Anthony Vendetti - Maxim Group

On the Southern Cluster, is it possible that an outcome could be you taking on a greater responsibility there?

Marc G. Naughton

Yes, we obviously can’t speak to any hypothetical things that might occur. We are really limited to indicating that we are continuing to work under the existing contract and we will continue to do that until reset occurs or if reset occurs. So we will continue to work as we are working now, and once again whether or not reset occurs does not impact our ability to look forward to get our ducks in a row and begin recognizing margin in those clusters.

Anthony Vendetti - Maxim Group

So then there is not a likelihood of a diminished responsibility, is the point?

Marc G. Naughton

Once again we can’t comment on any hypothetical situations. We are continuing to work on the contract and will provide an update as we are able.


And your next question comes from James Kumpel - FBR Capital Markets.

James Kumpel - FBR Capital Markets

Marc, can you just talk about your own auction rate securities and comment on the amount that you sold between year-end 2007 and the end of the first quarter and if you have been able to liquidate any more?

Marc G. Naughton

Yes, we got out of about $50 million of auction rate securities after the first of the year. So we’re in the $150 million range or so and we’re down to as I said to $106 million par with recording a temporary impairment of $5 and $101 million. We’re pretty comfortable with that investment, we have moved into the long-term because those auctions are not settling currently.

But those bonds are backed by either the U.S., they are all AAA-rated. They are either backed by the U.S. Government or a state government. So we’re very comfortable in our ability at some point to realize par from those obligations. And the good news is our strong cash performance and strong cash on the balance sheet means that we have the ability to hold those and earn some very nice tax-free rates of return for the foreseeable future.

James Kumpel - FBR Capital Markets

Is the $5 million temporary impairment is that related to the non-federally backed student loan portfolio and if so what percentage markdown was that?

Marc G. Naughton

It’s over the entire portfolio. Basically our broker is providing guidance relative to a model that they are providing which I think may be the only broker doing that which calculated that relatively low level and it’s indicative of the quality of the credits and the fact that it’s all been backed by either the U.S. or state governments.

James Kumpel - FBR Capital Markets

And the issuers, can you comment on who the issuers were?

Marc G. Naughton

Other than to say that they are AAA rated, U.S. and state backed, I probably won’t lay out our entire portfolio. But we feel very comfortable with where we are obviously from a lot of focus out in the marketplace.

And you can see some people taking some big write-offs that have the mortgage-backed and corporate-backed, but we were very careful in what we put our money in and feel very confident that there will be a resolution to those credits and to that marketplace. So they are going to look to refinance and given their credit they will be able to do that we would expect within the next 12 months.

James Kumpel - FBR Capital Markets

On the G&A line, it was significantly below what we’ve been modeling and your experience in 2007. Is your guidance for the reminder of 2008 essentially taking into account current rates as they exist today, so essentially extrapolating from the $22.7 million that you put up in the first quarter or does it assume a return to the more normalized levels of G&A that you have recorded in the income statement in 2007?

Marc G. Naughton

Yes, Jim, I think we clearly have an FX impact that was much higher than we expected this quarter that was positive and impacted that by probably somewhere in the neighborhood of $3 million. So as I was modeling forward, I would probably exclude that one-time benefit that you saw in Q1 as I model it forward to Q2 and beyond.

James Kumpel - FBR Capital Markets

So something like $25, $26 million would be more of a normalized level to start from?

Marc G. Naughton


James Kumpel - FBR Capital Markets

In terms of PowerWorks comments, can you comment as to whether or not you’re seeing in the marketplace any change in the dynamics or a change in the considerations by clients from the Misys-Allscripts link up, and if you’re seeing any benefits from the loosening of Stark rules last year?

Earl H. “Trace” Devanny, III

As we’ve mentioned on previous calls, we have seen some benefits from the loosening of Stark, which has I think benefited all of those of us in the business. Where I think Cerner is particularly strong is the platform that we represent, our Millennium platform supports both the ambulatory as well as the inpatient environment.

So unlike some of our competitors, they haven’t had the advantage of that platform and the solid footing that many of the large IDNs or large health systems are looking for today as they extend the reach from the provider, their provider environments, their hospitals that is out into the physician community. So we like our position vis-à-vis in both Misys and Allscripts.

James Kumpel - FBR Capital Markets

And has there been any change in dynamics as a result of that new link-up, because Allscripts has a pretty good reputation for its EMRs and Misys clearly has a pretty big footprint?

Michael G. Valentine

The traction we are seeing as Trace mentioned earlier in the marketplace is really around leveraging our client base and having some regional level of sponsorship to take advantage of the Stark allowances. And so, that’s been driving our marketplace.

When we look at the merger between Allscripts and Misys, we don’t see them getting lift from that. And we specifically we don’t see them better positioned because of that vis-à-vis the way the prospects and clients are purchasing today the PowerWorks model.


And your next question comes from Richard Close - Jefferies.

Richard Close - Jefferies

On the PowerWorks, did you actually say what the year-over-year growth in bookings was?

Marc G. Naughton

No, we didn’t.

Richard Close - Jefferies

On software you mentioned strong growth there. Did you give a percentage number on the software?

Marc G. Naughton

We did not, Richard. We don’t break out the detail relative to that, the detail on the business model usually is on a revenue basis. At the end of the year we do provide that, but not in the quarter.

Richard Close - Jefferies

But would you say they were within your expectations for the first quarter?

Marc G. Naughton

Yes, we do a very comprehensive forecasting activities at the beginning of each quarter to lay things out. And what we ended up with certainly we expected to be stronger in software, as our pipeline for 2008 rolls out, as we indicated on the call relative to the Millennium 2007 implementations we are accomplishing and so it was within our forecast and our expectation.

Richard Close - Jefferies

Trace had mentioned the Choose and Book and the positive things that were going on there. I guess came across an article on some technical problems. Do you have any commentary around those issues with Choose and Book in the U.K. or is that just an article reaching?

Jeffrey A. Townsend

As Marc said before, most of the communication goes through Connecting for Health. However, I think in this space the communications that is going on out there, there is a new release that’s schedule to go in. Prior to that new release going in there’s been a technology problem that’s been pinpointed to the technical stack.

And so it is accurate in that they took a pause to confirm that problem before dropping this next release in, but it hasn’t been anything material that would change that we think would change the adoption or the take-up and we’re pretty excited about the new capabilities in the next release that’s going to go in there.

Richard Close - Jefferies

Marc, is everything going as planned outside of the Southern Cluster?

Marc G. Naughton

By outside, you mean the rest of our business other than Southern Cluster?

Richard Close - Jefferies


Marc G. Naughton

Relative to the U.K. specifically, yes, as far as when we do our forecast and do our projections for the quarter, those projects are delivering as we are projecting them.


Your next question comes from Sean Wieland - Piper Jaffray.

Sean Wieland - Piper Jaffray

About the evaluation process that your customers are undergoing when they are making decisions, did you see or are you seeing any changes in how they are evaluating systems and contracts, particularly executive level sponsorship at the hospital or additional board level review processes?

Michael G. Valentine

I will comment on the U.S. We really haven’t seen a fundamental change in the selection processes. In a typical situation, a prospect hires a third party to help them navigate the process and there really has been very little innovation. I would say that, in general the market puts a high value on seeing and touching and client reference ability and really seeing the achievements that a solution provider has delivered.

So, we view that as playing into our strengths. We’ve always done well, connecting into the C suite. They continue to drive decisions. There are obviously clinical constituencies that are supporting the process. But we continue to monitor everyone. Every opportunity has a tendency to play out in some unique aspect. But, the fundamentals of the selection processes really haven’t changed.

Sean Wieland - Piper Jaffray

The percentage of deals that were signed in mid to late March, is that consistent with, what you’ve seen in past quarters in terms of the timing of the deal flow during the quarter?

Michael G. Valentine


Sean Wieland - Piper Jaffray

The new EPS guidance of $0.03, does that include the accretion from the potential share buyback?

Marc G. Naughton

We haven’t factored any of that in until we get a chance to get into the market at the level we’ve announced. It’s not going to significantly move that meter, but it does not include any impact on that.


And your next question comes from Frank Sparacino - First Analysis.

Frank Sparacino - First Analysis

This is on Robert Hughes at the NHS. Can you remind me the event that triggers the margin change and then between now and then what could happen that would push that out further given there has been a fair amount of negative news that doesn’t really seem to be impacting your confidence in the timing of that?

Marc G. Naughton

Yes, the key element of relative to recognition of margin on the U.K. cost for contracts, at this point we are under long-term contract accounting. To be able to start recognizing margin under long-term contract accounting you really have to be able to show history of being able to actively estimate your cost.

What we didn’t have going into those projects is the history of this type of projects and how accurate we are at being able to estimate those costs. We now have a fairly good history. Unfortunately, we have a fairly good history of accurately estimating the work effort that it is taking to go through these projects.

So, from our perspective and from the accounting perspective, those are all elements that given time and given our experience that we would expect by the end of the year to have a broad level of experience that would allow us to meet the requirements under 81-l on long-term contract accounting to go ahead and start recognizing revenues.

So, it is really more experience than it is any specific event and that’s is why we continue to indicate our expectation that as we look towards year-end of recognizing margin on these contracts irrespective of any specific event or status of the project.


And your final question comes from Sandy Draper - Raymond James.

Sandy Draper - Raymond James

There was an article about some similar to what we hear a lot out of the U.K., there was something on some noise down in Australia about some delays. I don’t know if you’ve seen the article or not and if you have, any commentary on how things are going down there or if that is something that we should be watching that would just be helpful.

Earl H. “Trace” Devanny, III

I have not seen the article you are referencing, but we have been selected for both New South Wales, the state of New South Wales and Victoria in Australia. Victoria has had some delays in their project roll out, I would say most of which have been political in nature, but we expect to see that regenerate itself here in the second and third quarters.

Neal L. Patterson

So let me say a few comments here in closing. Most times during my reflection of what we do, I will clearly get out what we do is very hard. We’re this strange layer of the new healthcare delivery systems whether it is hospitals, doctors’ offices, laboratories, retail pharmacy we touch everything. So that’s what makes what we do very, very hard. So there is going to be in Victoria and Australia and in the South and London or in the south in the U.K. there will be bumps to what we do.

Fundamentally though almost all trends that I look at that are significant at Cerner are positive and most of them are very positive. Those of you that know me know that I’m very, very critical and I’m fairly transparent too. So we are developing a real powerful company here and it continues to evolve and it continues to grow in frankly strength.

Plus our ability to innovate, we are funding that and then we are using that. And broadly, we’re creating another type of company, because our goal we are heads down here to finish this decade very, very strong, and our momentum is growing. We are going to end this decade very strong. And at the end, we are going to have a very significant strategic footprint in the United States without question.

We will have a very major part of acute care where we are, if you will, the motherboard of how those health systems, or hospitals operate. It’ll be a smaller percent, but we will have an important and a growing percent of physician offices in as part of our footprint, as well as things such as retail pharmacy.

So that strategic footprint plus our ability to innovate, I thought Jeff said it very well in his piece, it keeps the excitement here very high because healthcare is going to, in the next 10 years double in size, double in the expenditure and nobody knows how to even slow it down, let alone stop it and nobody can stop it.

But we feel like we are at the right place, right time and with the right scale and the experience and confidence on how to create large value. So there is a lot of hard work, but it is a good place to be and we feel like we are at the right time. So thank you for your time and I’m sure we’ll be in touch.

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