塞納 (CERN) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to Cerner Corporation's Second Quarter 2005 Conference Call. Today's date is July 21, 2005, and this call is being recorded. The company has asked me to remind you that various remarks made here today by Cerner's management about future expectations, plans, perspectives and prospects constitute forward-looking statements 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 factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading "Factors That May Affect Future Results of Operations, Financial Condition or Business." In the management discussion and analysis section of Cerner's form 10-K, together with other reports that are on file with the SEC.

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

Thank you Michelle. Good afternoon everyone. Welcome to the call. I will lead off today with a review of the numbers followed by sales and operational details from Paul Black, Executive Vice President and Chief Operating Officer, and broad market observations from Trace Devanny, our president. Neal Patterson, our Chairman and CEO, is traveling today. Now I''ll turn to the results. Our results were strong across the board in Q2. Our new business bookings were in all-time record, and our income statement and balance sheet also reflects very strong performance.

Starting with bookings, we delivered an all-time high level of new business bookings that are well above the high end of our guidance. Bookings revenue was $284.4 million, which is up 18% over Q2 2004. Bookings margin was $242.2 million this quarter. Note that our bookings did not include any contribution from the memorandum of understanding announced by Fujitsu for the southern region of England. Recognition of bookings from that project will begin when a final contract is signed, which we except to have in Q3. Moving to back log, our total back log increased 23% year-over-year, and ended Q2 at $1.72 billion. Contract revenue back log ended the quarter at $1.34 billion which is 25% higher than a year ago, and support revenue back log was $380 million.

Moving to the income statement, we delivered strong revenue growth with a continuous increase in more visible and recurring components. Total evenue in Q2 was $277.8 million, up 22% compared to the year-ago period. Excluding about $18 million in revenue, related to the physician practice management business acquired from Vital Works in Q1, our revenue growth was still strong at 14%. The revenue composition was $105.2 million in system sales, $73.1 in support and maintenance. $91.1 million in services and $8.4 million in reimbursed travel.

System sales revenue grew 24% over the year-ago quarter with a higher hardware mix than a year ago, but still strong levels of software. Services revenue grew 23% compared to the year-ago quarter through the mostly by organic growth of professional and managed services.

Support and maintenance revenue grew 22% over the year-ago quarter, with about half of that growth from Vital Works support revenue. Our gross margin for the quarter was 78.5%, which is up 60 basis points over the March quarter, and down 40 basis points compared to the year-ago quarter. The lower year-over-year grows margin is driven by the higher levels of hardware this quarter when compared to a year ago. Moving to spending, our operating expenses for the quarter were $184 million, which is up 21% over a year ago and in line with our guidance. The increase in total spending was driven by the inclusion of Vital Works medical practice, growth in our services organization and increase in global spending related to our U.K. and France activities.

Total spending as a percent of revenue is down 30 basis points compared to Q2 of last year, driven largely by a decline in R&D as a percent of revenue. Moving to earnings, net earnings were $19.8 million in the second quarter, compared to $14.3 million a year ago. EPS was $0.51 per share compared to $0.38 a year ago, reflecting strong growth of 34%. Looking at the operating margins, we delivered solid improvements in operating margin. The operating margin in Q2 was 12.3%, which is 100 basis points higher than Q2 2004, and contributed to our strong earnings growth. We continue to expect to drive greater than 20% earnings growth over the next few years as we approach our management target of 20% operating margins.

While I'm discussing the income statements, it would be a good time to provide a preview as to how we expect our participation with Fujitsu and England's Connecting for Health Initiative to impact our financial results going forward. The overall treatment will be as a licensed software and services contract for a specific term with certain software elements that will be delivered in the future. The accounting treatment of such contracts provides for the recognition of revenue in an amount equal to costs incurred until all the software elements are delivered. Upon such delivery, the total profit margin on the contract will be recognized ratably over the remaining term of the agreement. Cerner currently expects delivery of the software elements between 2006 and 2008, and the contract to extend through 2013.

This conservative approach to recognizing margin will likely have some impact on our operating margins through 2007, because we'll be adding revenue with no margin. However, we are still targeting 20% operating margins by the end of 2007, excluding the U.K. revenue. And we should exit 2008 with 20%-plus margins for all revenue, as the U.K. revenue begins delivering additional margin for the duration of the project. Let me repeat that we still expect to drive 20% to 25% earnings growth between now and 2007, based on margin expansion and revenue growth of our core business.

The expected revenue on margin from the U.K. will help extend this level of earnings growth beyond 2007. Now I'll move on to our balance sheet which remains strong. We ended the quarter with $132.3 million in cash and total debt of $152.9 million. Accounts receivable end the quarter $299.7 million, up $15 million compared to last quarter. Contracts receivable, or the unbilled portion of receivables were $100.9million or 33.7% of total receivables. The unbilled receivables for flat compared to last quarter and the year-ago quarter. Our DSO's improved again to 98 days, which is down one day compared to last quarter and five days compared to a year ago.

We again delivered strong cash flow. We had near-record cash collections of $277.6 million in Q2, and operating cash flow was strong at $44.3 million. Third-party financings were $16.8 million, or 6% of total cash collections.

Moving down the cash flow statement, Q2 capital expenditures were $29.8 million and capitalized software was $15.6 million. As we mentioned on our last call, our CapEx this quarter included $10 million for exercising an option to purchase a 260,000 square foot office building that we were leasing for our managed services business. Our capital expenditures also included $10 million for equipment in our data center. Total cash used by investing activities was $50.7 which includes $5.3 million for our purchase of Axios, a French company. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software was negative $1.1 million if you include the purchase of the building and positive $8.9 million if you exclude it.

Net cash provided by financing activities during the quarter was $12.4 million, which is comprised primarily of proceeds from option exercises. With respect to capitalized software with $15.6 million capitalized software in Q2 represents 29.9% of the $52.3 million of cash spent on development activities. Software amortization for the quarter was $12.1 million, resulting in net capitalization of $3.5 million, or 7% of the total. Our net capitalization is at a multi-year low.

For the full year, we still expect operating cash flow of more than $180 million. We expect capital expenditures for 2005 to be in the $75 million range, including this quarter's purchase of the building for our managed services business.

Moving to revenue and earnings guidance, looking at Q3 we expect revenue in the $285 million to $290 million range. We expect Q3 EPS to be between $0.54 and $0.55 per share which is over 20% growth compared to Q3 of last year. This guidance is based on total Q3 spending in the low-to-mid 190 range. Our revenue and spending guidance include contributions from the Bridge Medical and Axios systems acquisitions, as well as the initial amount of revenue off setting expenses associated with our project with Fujitsu in England.

For bookings, we expect bookings revenue in Q3 of $245 to $260 million, which reflects growth of up to 20% over Q3 of last year, and would be an all time Q3 high. Our bookings guidance does not include any bookings from our subcontract with Fujitsu. For the full year 2005, we expect EPS to be between $2.13 and $2.16 per share, which is up from our prior range of $2.10 to $2.14. We expect full year 2005 revenue to be in the range of $1.2 billion and $1.4 billion, which up from the prior range of $1.09 billion and $1.11 billion. This increase in our full year guidance related in strong performances of our core business and revenue expected from our project with Fujitsu in England from our Bridge and Axios systems acquisitions.

I will note our guidance does not include any impact from the proposed requirement to expend stock option. We intend to wait until the final rules goes into effect, which now looks like it will be Q1 of 2006. As a point of reference, our FAS 123 estimated impact of stock options expense for Q2 2005 is approximately $0.07 per share, or about 14% of our pro forma EPS. This is a level we believe that compares favorably to other technology companies. With that, I'll turn the call over to Paul.

Thanks, Marc. I will start by covering our sales and operational results and make some comments on the competitive environment. Q2 was a great quarter from a sales perspective. As Marc mentioned we had an all time record levels of bookings and our outlook remains very strong. Q2 included success across the broad range of solutions with particular restraint in emergency home health, knowledge, and content, laboratory, surgery, radiology, and computerized physician order entry or CPOE. Our managed services business had an all time record level bookings and again represented about 20% of total bookings.

We signed 279 contracts in the second quarter, an increase of 22% compared to a year ago. We also had a good mix of larger contracts in Q2 with seven over $5 million, three of which were over $10 million. As Trace will discuss, we had record levels of global bookings with strength in several geographies. We continue to have strong bookings outside of our install base with 33% of our contract bookings coming from new clients. Our leading indicators remain strong.

We experienced a record level of new RP's in Q2 and the activity in our vision center was also at record levels for Q2, topping the record volume that we experienced in Q1. During Q2 we announced the acquisition of Bridge Medical, which adds a standalone medication administration solution to our portfolio, allowing have to sell outside of our Millennium installed base. Bridge's best-in-class medication administration solutions complements Cerner's point of care solutions.

This acquisition closed at the beginning of Q3 and we have already seen strong demand for the Bridge offering. Operationally, we also had an outstanding Q2. During the quarter we turned on 347 millennium applications. This represents a 37% increase over the year ago quarter and was our second highest ever level of conversions in a quarter. This brings our total count to over 4,300 live millennium applications at nearly 860 client facilities worldwide.

The goal lies during the quarter demonstrates millennium incredible depth and breadth, with 41 different types of solutions going live at facilities throughout the world, at variety of different types of health care organizations. Further evidence of our delivery capabilities and breadth of solutions is that we now have 18 different major solution categories that have been brought live more than 100 times and five more that have been brought live more than 200 times.

Our implementation success again includes good progress, bringing clients live on CPOE, or computerized position out of entry. Cerner now has over 415 live CPOE locations, including 85 acute care sites. A great example of Cerner CPOE in action is at Penn State-Hershey Medical Center, where more than 12,000 orders are being placed each day. Almost 1,000 faculty, residents and staff at the medical center are placing almost 100% of their orders online with enhanced medication checks in place. Cerner CPOE solution is unique in stability to unable Penn State-Hershey to unify with medication management process bringing the physician, pharmacist, and nurse together from order management through administration.

In addition, clinical knowledge is infused into the order process to provide timely accurate, situation specific, decision support, and guidance. Penn State Hershey is one example of how Cerner distinguishes itself in the market place. We have recently made other announcement that describe how Cerner solutions are transforming clients from cumbersome paper-based facilities to truly digital hospitals.

On July 18, Cerner and Baptist Health in Jacksonville, Florida announced a completely digital hospital, Baptist Medical Center South, which has 21 Cerner solutions throughout the recently opened community hospital. With information technology as the hospital's backbone, Baptist is the facility that office the most complete, most the activate information to improve health outcome. Physicians and nurses have applauded Cerner's technology, and the expectation to roll out the same solutions at their other area hospitals is extremely high.

Now I will comment on the Cerner's professional services business. We continue to make progress at improving our productivity and profitability of our consulting organization with strong sequential and year-over-year increases and services operating margins. As we have discussed, the key to our significant improvements in our services organization is the maturity and improving quality of our intellectual property. We now have much more predictability in our consulting business which makes a big difference in our ability to efficiently to get projects done and deliver value to our clients.

Our Accelerated Solutions Center, or ASC had record quarter tuning on nearly 100 applications for 11 client sites. ASC is a standard evidence based rapid delivery model that benefits both Cerner and the client by providing product ability around implementation timelines, functionality delivered and overall implementation costs.

We are also continuing to make good progress on our Bedrock initiative. Bedrock is a layer of technology that build in manages Cerner Millennium Information Platform. This approach has the potential to reduces implementation times to less than six months for a typical hospital, and to a much shorter timeframe for physician offices. We continue to have success improving our Bedrock approach at alpha clients' sites and we have begun to use our Bedrock approach for the initial stages of implementations in our Accelerated Solution Center. This initiative will further distinguish Cerner's capabilities from our competition.

In summary I would like to reiterate how pleased I am with the Q2 results. Our sales and operational execution this quarter was very strong. And we intend to build on this momentum throughout 2005 and beyond. We are the only company in this market that is consistently delivering strong levels of sales and consistently bringing our solutions live at a wide range of clients. This ability to consistently deliver value to our clients is reflected in our continued strong financial performance. With that, I'll turn the call over to Trace.

Thank you, Paul. Good afternoon, everyone. Today I would like to provide broad market observations and give an update on our global business and other strategic initiatives.

The second quarter of 2005 was again full of positive activity in the healthcare IT market place. We talked a lot in the past about the government's increasing commitment to healthcare information technology. Recent legislative activity illustrates the strength of this commitment.

There have now been at least 18 HIT bills introduced with broad bipartisan representation. These recently introduced bills propose facilitating HIT investment by offering incentives such as direct grants, favorable tax treatment, reduced Stark and anti-kickback rules, HIT loans and differential reimbursement.

Recently, the supporters of two of these bipartisan bills indicated that they would be combining their bills to consolidate support for common goals. While it's unclear exactly how these legislative measures will unfold it is clear there is a strong support for HIT initiatives, and we believe any of these measures have the potential to positively impact our industry. In addition to legislative activity on June 6, Health and Human Services Secretary Michael Leavitt announced the formation of a national collaboration in an effort to advance President Bush's goal for all Americans to have an electronic health record within 10 years.

This private/public collaboration, called the American Health Information Community, or AHIC, will focus on privacy, standards, certification and architecture. In our view, these are the right areas of focus. We strongly support this initiative and we will be engaged in this collaboration. In summary there is no question our government recognizes the fact that healthcare IT has the potential to save thousands of lives and billions of dollars in annual healthcare spend. We are pleased to see policy makers taking step to break down regulatory barriers, as well as investing in strategies that will elevate safety and decrease costs.

As the enactment of an HIT bill gains momentum we look forward to working with members of Congress to ensure the private sector is a core element of any contemplative legislative approach. Also worth noting is the fact that Moody's investor services has chimed in on HIT with a May 2005 report, in which they conclude that there are significant benefits to providers who invest in clinical technology. These benefits will allow them to increase safety and quality while becoming more efficient. Moody's also supports the view that HIT investments will be critical for providers to remain competitive. Clearly, having a major rating service support HIT investment is important to providers, so we view this as another positive for the HIT segment.

With such strong industry fundamentals, we feel good about Cerner's ability to continue to deliver strong results. As a whole, our competitive landscape has not changed much. With some competitors having some success and others struggling to work through technology or organizational challenges. We don't expect our competitors to lighten the pressure but we are confident in our ability to compete. We also believe the environment is conducive to several companies doing well. On the global front we have had several exciting developments.

As previously mentioned we are substantially increased our involvement in England's countrywide Connecting For Health Initiative by becoming a subcontractor to Fujitsu Corporation in the southern cluster. Cerner will now work with Fujitsu to provide the software necessary to automate the process and digitize the medical records for 13 million residents of the southern cluster, one of the five regions in England.

As we have mentioned previously, Cerner has been successfully delivering on the Choose and Book portion of the initiative and numerous other projects in the United Kingdom. We believe this successful execution is the primary reason we have been given the opportunity to increase our participation.

Our proven ability to deliver on these projects also gives us confidence that we will be successful in working with Fujitsu to deliver value in the south of England. Beyond the United Kingdom Cerner Global had a record quarter with a significant deal in the United Arab Emirates,, the city-state of Abu Dhabi, which we announced in June. We also had strong performances in Canada and Australia, resulting in a record quarter from a bookings and financial contribution perspective.

We also made a strategic move in France when we acquired Axios Systems, a Paris-based healthcare IT company, in April. Axios is an excellent fit for Cerner because we have complementary solutions and a similar view of the importance of a unified architecture. We are now better positioned to capitalize on the emerging opportunities in the French market.

Now I would like to comment on some noteworthy activities in the grids organization. As we mentioned in previous calls, our goal is to connect hospitals, physician offices, clinics, pharmacies, laboratories, consumers and the home to a common and secure architecture. In 2004, we made meaningful progress towards laying the foundation for this organization.

This year we are making significant progress in demonstrating the potential of these initiatives. On May 27, we announced that we are providing solutions to connect healthcare organizations throughout Tennessee to shared health, a new company formed by Blue Cross Blue shield of Tennessee. Through the use of a Community Health Record or CHR, different healthcare providers treating the same person can now viewing aggregated visit, medication, laboratory, and immunization claims information, from multiple sources through a secure Web site.

This CHR is expected to generate substantial savings through the elimination of redundant procedures, prevention of costly medical errors, detection of fraud and abuse and the reduction of emergency department admissions. We have already deployed the CHR for 750,000 TennCare members and expect to increase it to over 1 million by the end of the year. Later this year and throughout 2006, we will target the commercially insured and Medicare lives, which will bring our total targeted population to nearly 4 million. We will also add additional services such as e-prescribing later this year.

Our community health record and e-prescribing initiatives directly support President Bush's mandate to leverage healthcare technology to provide consumer-centric and informationrich care by centralizing an individual's healthcare information. We believe this initiative will not only stand as a national model but as a testament to the role that the private sector can play in helping solve the U.S. healthcare crisis.

One final note on this initiative is that both the CHR and other services are priced on a per member per month basis which fits nicely with our focus on increasing revenue visibility. This is also a scaleable business model and technology and we are targeting similar opportunities in other states, while also focusing on expanding our presence in Tennessee.

A final thought on our previously mentioned juvenile diabetes initiative. We announced this program in October of 2004, when we pledged to provide every child in the United States with Type 1 diabetes a personal health record and a secure connection to their care provider. Shortly after the announcement, the majority of pediatric endocrinologists in the United States expressed an interest in being a part of this first ever National PHR network. Today we already have 16 children's hospitals live and we expect to double this count by the end of Q3. This is a great start to this program, which we believe will represent a future model for managing chronic disease and improving health outcome.

Now, to close I, would like to iterate how pleased we are with Cerner's performance in the second quarter and we remain encouraged by the outlook for our company and the healthcare IT industry. With that I would like to turn the call over to the operator for Q&A.

[OPERATOR INSTRUCTIONS]. Our first question comes from the line of Lisa Gill of JP Morgan, Please proceed.

Thanks. It's actually Arthur Raheman(ph) for Lisa. Had a question regarding the government initiatives that are going on. I know HHS. put out a few contracts for bid sometime in June. Are you going to participate in this? What are the levels of revenues or anything else along those lines that you expect to see from government initiatives, say, in the next 12 months.

We see -- this is Trace Devanny . We see as I mentioned in my comments, a high level of activity at the governmental level regarding initiatives and programmatic approach to solving the health care crisis. We are very participatory in the initiatives that have been announced to date. We expect more and will be very heavily engaged in future activity. We think it will have a very positive impact on the broader healthcare debate and we look forward to being a part of the private sector participating in this very important movement at the national level.

Yes. This is Marc. We wouldn't expect to really see any reflection in our P&L. from those activities in the next 12 months.

Okay. How about the HHS initiatives? Anything you're doing there directly or individually?

Yes. We are at the table for all the HHS discussions. Are you speaking about the AHIC?

That's one of them -- they have six contracts out and one of them -- I think AHIC is four of them put together. Is that right. .

Yes. And we're are participating I believe in four of the six.

Okay. Thank you.

Our next question comes from the line of James Kumpel of Friedman, Billings and Ramsey, please proceed sir.

Hi. Good evening. Can you characterize the emerging opportunities that you're seeing in France and Canada, Australia, Wales, Scotland, etc.? And where do you see them in terms of developing kind of a nationwide initiative along the lines of the U.K.?

Jim. This is Trace again. We have been engaged in the global marketplace for probably 20 years in various countries. And like the United States, there is a huge amount of activity at the government level across Europe, specifically the U.K., which we've chronicled in previous calls. France, I think, has become a little -- has been a little bit under the radar, but has been a very, very active market. Germany is a little less so. Canada clearly has many initiatives. Australia is also there -- they are kind of heating up once again. So like the United States, there's a global healthcare crisis.

We have a very rapidly-aging population, in many of these countries, and as the Baby Boomers begin to affect the health care delivery system, health care's got to be ready. The difference I think as you would expect in these foreign countries, they have a single-payer system for the most part and therefore can make decisions at a government level that can affect the entire health care system. So having been invested there for some years, we're beginning to see some benefit from the leverage of our Millennium solution in those markets. We expect to see continued activity and we will be very much engaged wherever we can be.

This is Marc Naughton. One of the things I look at, Trace is very engaged there, travels to Europe constantly to really assess the markets. But when you look at the recent announcements of our Abu Dhabi deal and our U.K. opportunity in the south, we are coming up on the radar as -- as lot of these big opportunities, being invited to meetings that probably 12, 18 months ago we wouldn't have known about. So we are gaining a much bigger global presence just from the acceptance by other countries globally of our solution.

The U.K. initiative has had worldwide exposure, worldwide coverage, and our active participation there has served us well in other markets we have been active as well.

Did the U.A.E contract and the TennCare contract Are those two of the deals that are over $10million?

Say that again, I'm sorry.

Are the U.A.E. and the TennCare contracts, are they two of the ones that are over $10 million this quarter?

The U.A.E. is one of the ones over $10 million. But the other is not. We have not included anything for bookings on the southern cluster at this point. Just as a point of reference, the -- that was announced originally, is about a $1.6 billion contract. We would expect to be supplying about 25% to 30% of the value of that contract in our role as subcontractor, so that gives you a sense of the value that we expect to receive from that contract. Part of that will be as support services, which would not be included in our bookings going forward. But the remainder would be.

And then I guess the last question, it's kind of all along the same lines. With the Rio initiative that Dr. Braylor is trying to promote, can you talk about your involvement in certain of the projects and how you see this unfolding over the next year and maybe over the next five years?

Yes. Jim, it's very early. Dr. Braylor comes with a strong message but little funding at this point. We are participating in numerous Rios, and we will respond to those requests for proposals vigorously. There are many different types of Rios that are popping up all over the country. And many have a different slant, each and every one really has a different slant. So at the state level, at a local community level, as well as the national level, I think Dr. Braylor has achieved at least an escalation of the issue and a conversation, and that is fueling a lot of activity in our business model.

This is Paul Black. There are multiple discussions going on every week with our large IDN clients, with state governments, with payers like our friends in Tennessee, the Blue Cross Blue Shield. We are having multiple conversations with people that historically have not been in this game and are expressing a pretty interesting demand curve for a lot of the solutions in the architecture we're able to bring to the table.

Excellent. Thank you.

Our next question comes from the line of Anthony Vendetti of Maxim group. Please proceed. Mr. Vendetti, our line is open, sir. Our next question comes from the line of Sean Wieland of Piper Jaffray. Please proceed.

Hi. Thank you. Marc, a quick financial question on the U.K., on the southern region. Can you talk about the cash flow that you expect from this deal and potential penalties on the contract?

We can't really talk in detail on any of the elements of the contract. As you are probably aware the government and Fujitsu are fairly strict about what we can say about it. I know that some of the major players in those clusters have indicated significant working capital requirements in order for them to meet their contractual obligations. I would merely indicate that relative to our activities in that cluster, we do not expect any significant commitment of working capital. So it's from a cash flow perspective, it would be positive for us.

How about payment terms? Are they going to -- are you going to pay -- are they going to pay as revenue is recognized or do you collect cash up front?

Once again, I can't talk a lot about the payment terms. They will likely be milestone based.

All right. Then along those -- a different tack, what is it that you plan on doing differently over there that maybe others have not -- to not land yourself in the crosshairs of Richard Grainger?

We felt we might succeed and deliver the results that are expected. We have -- as we've talked on the last call, some of our activities, some of our clients in the U.K. are already really laid, if you will, the Phase I set of solutions that we are going to deliver into that cluster. So the good news is we've actually already done the work, nationalized the solutions in such a way that we can already start the project.

The additional software deliverables that I mentioned in my comments are ones that are relatively straightforward, and it will just be a matter of time getting those accomplished. When you look at delivery side of this contract, Fujitsu brings to the plate about 500 inplementation consultants.

Our expectation is we will hire in-country, supplement that at any one time with perhaps up to 50 U.S. associates out of our 6,300 associates we currently have. So we see a very clearing path to delivering on this contract to being successful on it, without having to take away from any of our growing U.S. business. I think a good example of that is our Choose and Book. We are familiar with how you have to act to deliver in this situation, and I think we are the only one with a track record of delivering.

And Sean, you may remember we were finalists in many of the final contracts, and for that reason, we had to perform as though we were going to win, all the scalability, all the performance, all the strict requirements necessary to get to the final consideration, we completed. And as I think Marc articulated very well, we've done a lot of the work and are well ahead of what they would expect because we have done the work.

Okay. Great. One other quick thing. Can you talk about lobbying efforts, particularly in the U.S.? What's your lobbying activity level? Has it changed with respect to all the government activities?

We have been more active, as you would expect, than ever before as a company, as the national conversation around the health care crisis continues to rise, we have been very active at the state level. Paul referenced the fact we have conversations going on in as many as 20 states anywhere from at the governor level down to the head of Medicaid level and various government -- local government officials as well.

So it's part of what we described when we launched our grid services solution set or program, if you will, and it really is a different set of conversations, a different opportunity, and it allows us to talk about the new healthcare transaction, which is what we think will emerge from this discussion.

Okay. Thank you very much.

Our next question comes from the line of Andrew Weinberger of Bear Stearns. Please proceed.

Yes. Hi. Two quick questions please. First with regard to the Bridge acquisition, I understand the rationale there. But how do you guys guard against cannibalizing the -- your original sort of POC offering? And then a quick follow-up to that.

This is Paul Black. The original POC offering is live and it's being well-accepted in the marketplace. And for Cerner Millennium clients we recommend and we will implement and continue to deploy the Cerner POC. The Bridge solution works quite nicely in a Meditech or an HBO or an FNS or some other client that doesn't have Cerner farm net Millennium installed. And we can go in immediately into that install base tomorrow there and that's that new market for us that we were historically not able to go after. So it works very nicely, dovetails quite nicely and as I mentioned earlier, they have a pretty good following and nice scores and closs and we are getting quite a bit of traction already post the acquisition herein the beginning of the quarter.

Keep in mind, Andy, we've got 1,000 clients that do not have Millennium solution. So the ability to take them cutting edge technology that they can install in their current environment quickly, given that the market is heating up in this space, just seemed like a good opportunity for us to step in at this time.

Okay, great. The follow-up question I guess I had was you know, just with regard to deferred revenue. Just seem to keep my eye on that number. It was just down sequentially. Not much, but just sortof want to get the explanation there.

The revenue is primarily driven by the level of financing we have in any one quarter. This quarter's financings were a little bit lower than you've seen in the last quarter. That's the primary driver of deferred revenue being down a little bit. I think -- and you've also seen a little bit -- we have a fairly big increase around the end of the year, plus some of the acquisitions. So that is added some, which is now kind of rolling into the income statement. So not unexpected that you see a $5, $6 million decrease in deferred revenue. If you look at a year over year you see it's up significantly.

Great. Thanks.

Our next question is a follow-up question from the line of Mr. Steve Halper of Thomas Weisel Partners. Please proceed.

Oh, hi. On average these days, what percentage of your revenues come from current quarter bookings and do any of these international deals that you've signed, are they materially different?

Steve, let me answer the first question, as far as current quarter bookings. Right now, it's probably in the range of 10% maybe.

Right. That's down from a couple years ago, right?

Absolutely. We used to see 15% to 20%. Once again, the impact, the improvement of the visibility of the business. Hit we with your second question, Steve.

So do the international contracts have a dramatically different profile in terms of how much revenues you might or could recognize up front?

Most of the global contracts will be our standard approach to contracts. So it will be based -- it's obviously the same revenue recognition. But normally the structures are fairly comparable.

One thing we do try in the global contracts is to get more upfront cash, just because -- just some of those environments could be a little bit more risky than the U.S. environment. The difference will be the southern U.K. cluster. But for the most part, they are going to be the same from Canada, to Abu Dbabi.

So it's not like you're doing -- selling it to a third party or anything like that and taking the full value of the software up front, if it's kind of a third-party software sale.

Our strategy has been we go into each of these countries with our own subsidiary, and basically do business on our own without third-party involvement --

Is that the case in Abu Dhabi too? That's a Cerner subsidiary?

It is basically -- yes. There is a Cerner Abu Dhabi company.

And Cerner people will be helping in the implementation of that contract?

Yes.

Great. Thanks.

Our next question comes from the line of Michael Baker of Raymond James. Please proceed.

Yes. I was wondering if you could update us on your success in pushing downstream to a smaller-sized hospitals in the domestic marketplace.

This is Paul Black. We've been working on that endeavor for a long period of time. Historically we sold standalone laboratory or stand alone radiology systems to these folks. Over the course of the last four, five years they have been increasingly interested in a one-stop shop if you will, being able to completely replace all the systems that they have with a new supplier.

And we have taken an approach there that's combined the breadth of the Cerner applications that we have. That, combined with the new methodology and implementation approach, which we talked about historically as an Accelerated Solutions Center. And we also combined a third approach, which is for Cerner to host those applications for that client. So we package that all together and we go out and offer pretty much a -- one place to buy all those applications from, to buy the deployment services from and to buy the operational services from. And we are enjoying pretty good margins out of that business, pretty good receptivity to that approach in the business. And that is something that has continued to serve us well.

The 200 to 400-bed hospital marketplace, stand-alone marketplace in the United States is a good marketplace for us. Those people didn't buy physician office practices, those people typically didn't buy a health plan or invest in an insurance company, and the margins that those people enjoy today and have enjoyed historically, given a -- I don't want to say noncompetitive. But they don't have as fierce a competition as they would if that 200, 300-bed hospital was in Manhattan. They are enjoying relatively decent margins and are investing in clinical information systems to improve the quality to the populations they serve.

So you're effectively able to get down to about 200-bed size then.

Yes. We've got examples where we have gone lower than that. Our strategy will be-- will continue to be to take that -- our ability to put something in front of them that's affordable, to take that to a much smaller operating expense organization and we're doing that again through our ability to host that application back here and share, if you will, the unit cost of that. One of the biggest pieces of expense is the hardware to share that unit cost across a number of clients.

Is that a similar approach that you plan to take on the physician side --

Exactly.

-- given some of the affordability issues they have as well?

Yes.

Thank you.

You bet.

Our next question comes from the line of Edward Hermagon of Seacon Weisels (ph), Please proceed.

I just had a question regarding your margins on maintenance and service. They have been trending down to levels that-- that are significantly lower than they were before. I know you've been trying to really improve that. But was this quarter a bit of an anomaly or do you really expect -- I think it was 10.74. Do you expect that to continue to trend lower?

Yes, I think on the -- on the support and maintenance and the services, at least year over year. My data would say that we're trending up in those gross margins. So that's a positive. The insistent sales, the focus of the sales team on hardware sales, as we talked about a year ago, we were not getting the level of hardware sales we had enjoyed. We thought we were cannibalizing those with our hosting services, which we were. But what we've done is then re-energized the sales force to -- we know our clients are buying a lot of hardware.

We enhanced those efforts significantly and we are now back at traditional levels of hardware sales relative to year over year comparisons that are higher. That's why we break them out. But that's the difference you'll see in the systems sales line, as far as the gross margin difference.

Edward Hermagon; The main thing my question wasn't real clear, I apologize. But your support and maintenance gross margins have really been moving up. I look at the cost of revenue, my calculation at a year ago was 15.13%, and this quarter it was10.74%. Is that a new level we should expect?

My numbers don't equate with yours. I probably show about a 200-basis-point increase. I think some of that has to do with some of the acquisitions we bought in, that we brought in to bear, with Vital Works, etc. I think we are also using a little less third-party help on some of our -- some of our support and maintenance work, and by doing that, that just takes the cost out of -- cost of sales and puts it down to operating expense. I don't think it is a material change in our business.

Okay. Great. Thanks.

Our next question comes from the line of Anthony Vendetti of Maxim Group,. Please proceed.

Sorry about that. I had echnical difficulties before. Marc or Trace, maybe you can talk a little bit more about the southern cluster. When do you expect to actually sign the contract with Fujitsu? Is there a timetable on that?

When you're dealing with a government the size of England it is difficult to predict. We have been guidance, could be the next 30 to 45 days. So we're -- we won't -- we will expect it when we see it signed.

We do expect today that it will be sometime in Q3.

Okay. Marc, I was wondering if you could just talk a little bit more about how the revenue recognition would work. I guess for the -- what you were saying, was for the first couple of years, it would be -- the revenue you would recognize would just offset the expenses associated with implementing the project. And did you say '07 is when that would end? Do you expect to see the revenues increase above expenses?

Yes. Our comments were basically that until we deliver all of the elements of software, that leaves an undelivered element under the accounting rules. And so you basically recognize revenue equal to what costs you're incurring. Now those cost are going to be U.K. costs. There will be costs in the U.S. that are related to that project. It will be all the costs of that project. But that's what the revenue's limited to. There is no additional margin.

We think that the final rule over software will be in 2008 as currently specked. But once again, he contract has to be finalized, that is our best estimate today. What that t means all of the margin, all of the profits on that contract, which is currently about eight years of duration, will be squeezed into five years and recognized ratably over those five years. That is why we were indicating that come 2008, when you look at our operating margins and our goal there to continue to go beyond our 20% goal, is that we're going to have an eight-year profit of a contract squeezed into five years.

So that will be very profitable business, relative to our others, given the squeeze that will happen, by not having any profit recognized in the first period of the contract.

When you're saying 2008, you're talking about the beginning or end or --

I would use midpoint.

Mid for now?

Once again, this is all -- right now we're estimating, subject to knowing all the details and all the rollout schedules.

You know, somebody else mentioned Richard Grainger's deadlines and penalties and so forth, and he doesn't really pull any punches when he talks about meeting the deadlines from what I've seen. You know, are the deadlines something that is a concern for you, is that something -- and what are the exact deadlines or do you not have that at this point? I mean, are the penalties something that you're reserving for part of what you consider normal business?

Yeah. The deliverable guidelines have been out there. I mean I think -- most of the delivery dates that are in some of the existing prime contractor contracts are very clear. I think the contracts probably over time, could be adjustment to those. So it's pretty hard for us to comment. One comment we would make is given our current position, relative to having the solutions available to deliver and begin installing, we like our chances of meeting the guidelines better than the competitors at this point.

I think it's very important point to make that the reason we were selected in the southern cluster is because of our success with Choose and Book and other client relationships in England. So we had to prove ourselves, not being selected as part of the original winning consortium. We had to prove ourselves in the market and have done so. That is why we have been successful in the southern cluster.

Okay, and 50 associates is what you think is sufficient to implement this and you'll just transfer them to the southern cluster?

My point was that any one time there will be, probably, we're estimating 50 U.S. associates that will be assisting in that project. Over time those 50 associates will more depend on what is necessary. But we will -- I mean the day after we announced we got 150 resumes from people who are very interested in the U.K., in talking with us about working on Cerner projects.

Okay, so you may hire people over there, as well.

We will absolutely hire people on the ground in England which has been our policy. But we also have, as Marc mentioned, we have a very strong partner in Fujitsu who will make available 500 associates to assist us and augment where we don't have the requisite skills, which we think we are well positioned to cover that.

We have over 100 people on the ground today just working on current projects that they will be able to roll off and assist. So we have experienced people available.

Okay. And the last question is for next year. I know you mentioned CapEx $75 million for this year. Do you expect that to remain the same or go down in 2006?

We haven't really provided projections or guidance. My estimate given the success of our managed services business would be, it will be within -- could be in a similar range.

Similar range. Okay. Great.

$75 - that includes $10 million purchase of an office building, which probably is not-- would not be something we necessarily would look to do next time. It's as good an estimate as we have today.

Great. Thanks.

Why don't we take one more question.

Our final question for today comes from the line of Bob Hutchison of Merrill Lynch Investments. Please proceed. .

Thank you very much. Congratulations on an excellent quarter. Just one question with respect to looking at the southern cluster. I applaud your diligence in continuing to pursue that. I was wondering, are we going to get any quantification of the opportunity there, say, post the signing, or is this something that is kind of open-ended for you going forward?

Bob, I mentioned a little earlier as far as the quantification, the opportunity, the initial contract for Fujitsu, $1.6 billion and we are estimating 25%, 30% of that value will be supplied by Cerner. So kind of take the math and you can get an estimate of what we would expect to flow to Cerner over the eight-year period of the contract. We would also anticipate change orders that will be -- that will add to that amount.

Is there the opportunity to perhaps pick up some of the other business in the other clusters or are they not -- are they delivering like they are supposed to at this point or is there any likelihood you could also see shifts there as well?

Yes. We are -- we are very, very pleased to have been selected and -- understand we don't have the final contracts in the final cluster to do business with Fujitsu to support the NHF initiative. We got there for having done good work in the previous contracts in which we were asked to engage. Our going-forward strategy is to execute, do the best possible job and let the chips fall where they may.

I guess that is a qualified yes. There is an opportunity in the other clusters as well.

We just wouldn't want to speak to that, Bob.

Okay. Thank you.

All right. I would like to thank everybody for being on the call. And as usual, Al and I will be available for questions if you have them afterwards. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference call. This does conclude your presentation. You may now disconnect. Good day.