塞納 (CERN) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to Cerner Corporation's third quarter 2005 conference call. Today's date is October 20, 2005, and this call is being recorded. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of today's conference. If at any time during the call you require audio assistance, please press star followed by zero, and a coordinator will be happy to assist you.

The Company has asked me to remind you that various remarks made here today by Cerner's management about future expectations, plans, prospectives, 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 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 Form 10-K together with other reports that are on file with the SEC. At this time, I'd 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. Don Trigg, our Chief Marketing Officer, will follow Paul with some comments on strategic initiatives and our recent health conference and leadership forum. Neal Patterson, our Chairman and CEO, will join us for Q and A. And Trace Devanny, our President, is traveling today.

Now let me turn to the results. Our results were strong across the board in Q3. Our new business bookings were an all-time record. Our income statement and balance sheet also reflect very strong performance. Starting with bookings, we delivered an all-time record again this quarter. Our total bookings revenue was 450.5 million, which includes 149.4 million of bookings for the initial phase of our project with Fujitsu in the southern region of England. Our initial booking for the Fujitsu contract includes expected revenue associated with the first phase of the project and revenue that is not tied directly to future releases of software. We expect the remainder of the bookings related to the Fujitsu contract to occur in increments over the next several years as we meet various milestones. Our bookings revenue, excluding Fujitsu, was 301.1 million, which is up 40% over Q3 '04 and is a new all-time high, beating the record set last quarter. Bookings margin was 251.6 million this quarter before the Fujitsu booking and 401 after it.

Moving to backlog, our total backlog increased 35% year-over-year and ended Q3 at 1.97 billion. Contract revenue backlog ended the quarter 1.58 billion which is 40% higher than a year ago. Support revenue backlog was 389.6 million.

Moving to the income statement, we delivered very strong revenue growth in Q3. Total revenue in Q3 was 294.6 million, up 28% compared to the year ago period. Excluding about 17 million in revenue related to the physician practice management business acquired from Bioworks in Q1, our revenue growth was still very strong at 20%. The revenue composition was 110.2 million system sales, 75.1 million in support and maintenance, 100.1 million in services and 90.2 million in reimbursed travel. System sales revenue grew 33% over the year ago quarter with a much higher hardware contribution than a year ago. Services revenue grew 28% compared to the year ago quarter, driven mostly by organic growth of professional and managed services. Support and maintenance revenue grew 21% over the year ago quarter with about half of that growth coming from Bioworks support revenue.

The gross margin for the quarter was 77.8%, which is down 70 basis points from Q2 and 270 basis points from Q3 of '04. The large year-over-year decline is driven by a very high level of hardware sales in Q3 of this year versus a multi-year low level of hardware in the year ago quarter. The decline in gross margin percent was largely offset by our ability to contain expense growth relative to revenue growth. Our operating expenses for the quarter were 192.1 million, which is up 23% over a year ago. The increase in total spending was driven by the inclusion of Bioworks medical practice, bridge and Axia acquisitions as well as growth in our services organization and increase in global spending related to our UK activities. The 23% growth in spending compares favorably to our 28% revenue growth. As a result, total spending as a percent of revenue is down 250 basis points compared to Q3 of last year. Sales and services efficiencies and the decline in R&D as a percentage of revenue are the primary drivers of this leverage.

Moving to earnings, net earnings before inclusion of a one-time 4.8 million tax benefit related to the 2004 sale of Zynx which we discussion in our release, we're 21.8 million in the third quarter, which is up 29% compared to 16.9 million a year ago. Diluted EPS was $0.55 per share compared to $0.45 a year ago. Including the one-time tax benefit, net earnings was 26.6 million and diluted EPS was $0.67. Our operating margin in Q3 was 12.6%. This is up slightly from last quarter and is down 30 basis points from the year ago quarter due primarily to the much higher level of hardware in this quarter as compared to a year ago. We continue to focus on delivering 20% operating margins and are pleased that improvements in professional services margins and leverage of R&D offset a significant portion of this quarter's lower gross margin percentage. It's important to note that we grew our earnings 29% year-over-year even with basically flat operating margins. Our focus remains on expanding margins to 20% by executing in areas where we have good leverage opportunities, and we still expect to drive greater than 20% earnings growth over the next several years regardless of the revenue mix.

Turning to a quick update on the Fujitsu deal, as announced by Fujitsu, we signed the final contract during the third quarter. As for the income statement impact, it is being treated as a licensed software and services contract for a specific term with certain software elements that will be delivered in the future. The treatment of such contracts provides for the recognition of revenue in the 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 over the remaining term of the agreement. This revenue started in Q3 with less than 5 million of revenue offset by an equal amount of expense in the quarter. We expect this amount to ramp up each quarter over the next couple of years and likely peak in 2007 or 2008. We expect to deliver the final software elements sometime in 2008, at which point the recognition of margin will be triggered.

Now I'll move on to our balance sheet which remains strong. We ended the quarter with 134.2 million of cash and total debt of 132 million. Looking forward to Q4, as part of our strategy to hedge against currency fluctuations on a portion of the Fujitsu contract, we plan to borrow 65 million British pounds in Q4 and immediately convert those funds to U.S. dollars. We will then repay the debt with British pounds received under the Fujitsu contract. We expect the debt to carry a rate of 5.54%, making it an attractive and low cost hedge. The funds will be used to pay down our existing line of credit and augment our cash position. The cost of carrying the debt, net of interest income, is expected to be around a million to 1.5 million annually.

Accounts receivable ended the quarter at 316.7 million, up 17 million compared to last quarter. Contracts receivable, or the unbilled portion of receivables, were 106.8 million or 33.7% of total receivables. The unbilled receivables as a percent of revenue are flat compared to last quarter and the year ago quarter. Our DSOs were 98 days which is down six days compared to a year ago and are the same as last quarter. We again delivered strong cash flow. We had record cash collections of 298.9 million in Q3 and operating cash flow was strong at 46.9 million. Third party financings were 15.4 million or 5% of total cash collections.

Moving down the cash flow statement, Q3 capital expenditures were 22 million, and capitalized software was 15. Our capital expenditures included 12 million for equipment in our data center and 2 million in property improvements. Total cash used by investing activities was 48 million, which includes 11 million for acquisition of Bridge Medical. Precash flow, defined as operating cash flow as capital expenditures and capitalized software, was 10 million. Net cash provided by financing activities during the quarter was 4 million, which is comprised of 21 million of debt reduction offset by proceeds from option exercises.

With respect to capitalized software, the 15.2 million of capitalized software in Q3 represents 26.6% of the 57.0 million of cash spent on development activities. Software amortization for the quarter was 12.1 million resulting in net capitalization of 3.1 million or 5% of the total. For the full year, we expect operating cash flow of 180 to 190 million. We expect capital expenditures for 2005 to be in the 80 million range. This would put free cash flow approaching 50 million which is similar to last year's free cash flow. Note, however, that our 2005 free cash flow will be after investing approximately $50 million in equipment and facilities for our rapidly growing managed services business.

Moving to revenue and earnings guidance. Looking at Q4, we expect revenue in the 305 to 310 million range. We expect Q4 EPS to be between $0.67 and $0.68 per share, which is over 20% growth compared to Q4 of last year. This guidance is based on total Q4 spending in the low 200 million range and for bookings we expect bookings revenue in Q4 of 300 to 315 million which reflects growth of approximately 25% over Q4 of last year. Our initial view of 2006 is that we are comfortable with the current consensus of 2.66 per share which reflects 23% EPS growth and is consistent with our long-term growth target. We expect 2006 revenue to be in a range of 1.3 billion and 1.34 billion, reflecting a mid teens growth rate. Our 2006 revenue guidance assumes approximately 50 to 70 million of revenue and cost from the Fujitsu contract, yielding no net margin as we have discussed. The revenue from the Fujitsu contract is currently expected to be split, about 20% to system sales and 80% to support maintenance and services, while the costs are expected to be split 80% to sales and client service and 20% to R&D.

I would note that our guidance does not include any impact from the expensing of stock options. As a point of reference, our Faz 123 estimated impact of stock options expense for Q3 '05 is approximately $0.07 per share or about 13% of our EPS. While there are many variables that can impact future expense options, we believe the impact in '06 will not be significantly different than 2005 on a percent of earnings basis. We believe this compares favorably to other technology companies. With that, I'll turn the call over to Paul.

Thanks, Mark. I will start by covering our sales and operational results and make some comments on the competitive environment. Q3 was a great quarter from a sales perspective. As Mark mentioned, we had all-time record levels of bookings, and our outlook remains very strong. We signed 267 contracts in the third quarter, an increase of 30% compared to a year ago. We continue to drive a good number of larger relationships in Q3 with 12 contracts over 5 million, six of which were over $10 million. Q3 included success across a broad range of solutions with particular strength in emergency, home health, knowledge and content, laboratory, surgery, intensive care, computerized physician order entry or CPOE, and PAX. Worth noting on PAX is that we signed our largest PAX deal yet in Q3 and continue to see a strong demand for integrated risk PAX solutions. From a segment standpoint, we had strength across several segments, including children's, community hospitals, academic medical centers, and integrated delivery networks. Our mix of contract bookings from new Millenium clients is 26% which is in our targeted range. Note that this is excluding our large booking on the Fujitsu contract.

Our leading indicators also remain strong. Activity in the vision center was again at record levels in Q3, topping a record set in Q2, and our pipeline remains very strong.

There are a couple of strategically significant contracts I would like to mention. First, as we announced in August, the U.S. Department of Defense elected Cerner to supply our Millenium Pap Net lab system to the military health systems, more than 100 hospitals and 400 clinics. This ten-year commitment will extend our solutions to all military clinical laboratories, including medical facilities in war theaters and the naval fleet. The total opportunity, including support, is more than $50 million, but you should note that this deal had almost no impact on Q3 bookings. The bookings will come in as the work orders are signed for each location.

Another unique and strategic relationship we began in Q3 was with the Rehabilitation Institute of Chicago. RIC selected Cerner as their partner in a quest to operate as one of the nation's first rehabilitation hospitals to implement healthcare IT. Also worth noting is that RIC will provide Cerner rehabilitation clinical content to be leveraged in our Millennium solutions so we can provide future rehabilitation clients with leading clinical content.

On the global front, we had several positive developments. As Mark mentioned, we had our initial booking related to our involvement in England's country wide connecting for help initiative. We are off to a good start on this project and look toward to proving we were the right choice. Beyond England, we had another strong quarter globally from a bookings and financial performance perspective. One example is that we were selected in Q3 by CHU Saint Etienne, an 1800-bed academic medical center located in southeast France. CHU Saint Etienne is viewed as a thought leader in France and chose Cerner because they understand the value of a strong architecture and the benefits of implementing a truly unified solution. We will be implementing a suite of solutions including CPUE, scheduling, surgery, pharmacy, and emergency at each of the four CHU Saint Etienne hospitals. This is our first Cerner Millennium footprint in France. We believe that this relationship, coupled with the expansion of our local presence through last quarter's Axia Systems acquisition, strengthens our position in the emerging French healthcare IT marketplace.

Operationally, we also had a strong Q3. During the quarter we turned on 233 Millennium applications. This brings our total count to over 4,500 live Millennium applications at nearly 900 facilities. The go live during the quarter included 37 different types of solutions going live at facilities throughout the world at a variety of health care organizations. Our go live again included good progress bringing clients live on CPOE. Cerner now has almost 430 live CPOE locations, including 90 acute care sites.

Our ability to develop value to our client in a profitable manner continues to improve. This is reflected in our continued improvements in the productivity and profitability of our continued -- excuse me -- of our consulting organization. As Mark mentioned, we are experiencing strong sequential and year-over-year increases in services revenue and operating margins. Accelerated Solutions Center, Cerner's evidence based rapid delivery model, had a record quarter. The ASC turned on 64 applications for seven clients during Q3. This approach has been a key element of the improved productivity and predictability of our professional services organization.

The next tier of productivity is our Bedrock initiative. As we have described before, Bedrock is a layer of technology that builds and manages our Cerner Millennium information platform. This approach has the potential to reduce implementation time to less than six months for a typical hospital and to a much shorter time frame for physician offices. Just as important, Bedrock can have a major impact on how we do routine upgrades and migrations from Classic to Millenium. So far we have tested elements of Bedrock with nine clients and we are very pleased with the results. For the remainder of this year and throughout next year, we'll continue to roll out Bedrock across more clients and solution categories. This initiative will further distinguish Cerner's capabilities from our competition.

Before handing the call over to Don, I'd like to make a quick comment on the competitive landscape. We think the recently announced acquisition of IDX by GE validates the interest of the big caps in HIT. However, we do not believe it will have a near term impact on a competitive landscape as there will be a lot of challenging integration work that needs to take place. We strongly believe that we have the right strategy and are in a strong position with our industrial strength common architecture while most of the competitive landscape is still focused on building or buying their solutions and creating a strategy. Cerner is focused on finding better ways to deliver solutions to our clients and ways to get optimal value for our clients after they have automated their systems. This is a big differentiator, and we intend to sustain this competitive advantage. With that, I'll turn the call over to Don.

Good afternoon. There are three areas that I'd like to address during my portion of the call. First, I'll provide a set of key metrics from the Cerner health conference. Second, I'll share several marketplace observations from a handful of industry analysts that presented at that event. And third, I'll offer a synopsis of activities on the public policy stage given the flurry of HHS press releases in recent weeks.

Let me begin the Cerner health conference. Last week, we hosted our annual client gathering at the Gaylord Palms in Orlando, Florida. It not only was the largest gathering in Company history with just under 3,000 attendees but the largest user group meeting in the entire industry for 2005. Client growth year-over-year was greater than 20%, and client speakers at the 316 educational sessions were up 50%. The status is something important, I would contend, about a client base that has become what Meg Whitman would call a true community of users and also speaks to the highly advantageous desire of our clients to share their successes as they continue the journey towards digital healthcare. It's a virtuous cycle and one that year-over-year data suggests is accelerating. In addition to our clients, we also heard from key industry analysts. The Gardiner Group was among them, participating just weeks after the publication of their healthcare provider forecast. Key findings of that report include the fact that healthcare providers are relying less on internal staff and more on consulting and outsourcing. Gardiner's view that reduction of medical errors continues to be the number 1 priority for healthcare worldwide. And the reality that governments around the world are spurring healthcare spending growth through new incentives. We believe each of Gardiner's key findings correlate well with Cerner's experience in healthcare IT, our enterprise wide architectural approach, and our growing track record for performance in non-U.S. markets.

Beyond Gardiner, we also heard from Moody's Investor Services. Lisa Goldstein shared findings from their May, 2005 report in which Moody's concluded that there not only are clear quality and safety benefits to be derived from clinical information technology but also that hospitals failing to make these investments may be at a competitive disadvantage as compared to their peers that do. Goldstein also noted that year-to-date ratings upgrades for not-for-profits are equal to downgrades. That ratio is superior to all but three of the past 17 years. S&P, for their part, echoed that view last week when they reported more upgrades than downgrades for 2005 and also a strong financial outlook going forward due to favorable volume trends, rate increases, and cost containment.

Finally, Rand Health, Dick Hillestad presented findings from his peer review study that concluded IT could save the U.S. healthcare system 162 billion per year. The study was released in Health Affairs on September 14 and has won significant mind share within the industry and of equal import on Capitol Hill. The potential savings detailed in Health Affairs have been the subject of numerable national press articles, have been highlighted in paid advertising and publications such as Roll Call, National Journal, and The Hill, and have been shared with more than 100 congressional offices on both sides of the political aisle. We believe the timing of the study is fortuitous given the elevated level of attention that healthcare IT has garnered with national policy makers. Indeed, HHS Secretary Leavitts spent a significant portion of early October announcing additional steps around his healthcare IT strategy and convening his American Health Information Community for the first time. On October 5, Leavitts announced a new regulatory proposal to create exceptions to the current Medicare referring prohibition for healthcare entities with which the physician has a financial relationship. The proposed rule has been published in the Federal Register and now is in the midst of the required 60-day comment period. If and when the changes are adopted, hospitals would be able to furnish hardware, software, and training to referring physicians. The administration believes lifting these regulatory shackles will help close the adoption gap in the physician practice phase.

In addition to the proposed stark adjustments, HHS also announced 3 RFPs totaling 17.5 million. The scope of activity was in three areas: standardization, compliance certification, and privacy and security. While it's easy to question whether a collection of acronym heavy nonprofits can be true change agents, Cerner wholeheartedly believes that the core tenants behind the Administration's strategic framework are the right ones. In the words of the animating 2004 document entitled "The decade of health information technology," HHS is striving to inform the clinical practice, interconnect clinicians, personalize care, and improve population health. It is the right agenda. In the end, however, it's our equally fervent conviction that the private sector will be fundamental to making the promise of that report's title a reality.

Consistent with that philosophical view, we're continuing to focus on several important state and regional initiatives. Working in conjunction with BlueCross BlueShield, we're implementing a community health record for Tennessee's Medicaid population. There are currently over 200 sites and 1,000 providers accessing the system. The end result is a level of care coordination for the 10 care population that was impossible in the paper based world with resulting benefits for preventing medical errors, mitigating redundant testing, and decreasing fraud and abuse. We remain on schedule to have all 1.1 million 10 care lives on the system by the end of 2005. And with regard to functionality, we also are including the prescribing as an additional service. Finally, we expect to include BlueCross BlueShield's commercial lives beginning in 2006.

Beyond Tennessee, Cerner also was involved in helping to facilitate the creation of another RIO here in Kansas City called Health E. It is a first elimination employer driven RIO. It was announced on September 26, along with such nationally recognized private sector names as American Sentry Investments, Applebee's, H&R Block, Sprint Nextel, and Yellow Roadway. While these employers may represent different industries, they share a similar passion for enhanced healthcare quality. They believe that healthcare IT can be part of an approach that has better health outcomes, elevated efficiency and, over time, more predictability around their healthcare spending. Sponsored employers are looking to finalize key details in the weeks ahead. The current plan calls for HealthE to be incorporated during the fourth quarter and to begin rolling out a community health record in the Kansas City MSA in 2006. We hope that this innovative model will not only positively shape care delivery within Kansas City but also shape the national conversation around healthcare IT.

Thank you very much for your comments. I have one housekeeping item in my comments. This is Mark. I indicated that travel reimbursed for the quarter was 90.2 million. The number is 9.2 million. So I don't want anybody getting that wrong in their models. Anyway, at this time, we'd like to open the conference up for questions.

Thank you, sir. Ladies and gentlemen, if you wish to ask a question, please key star followed by 1 on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, please key star followed by 2. Once again, that is star 1 to ask a question. Our first question comes from the line of James Kumpel of Friedman Billings Ramsey.

Hi. Good afternoon. Congratulations on all those bookings. Can you talk a little bit about the French deal and to what extent that implementation is focused on true Millennium applications and what extent it's relying on the local Axia offerings.

This is Paul Black. There will be a blend between the two on the administrative side. The applications will be from Axia. On the clinical side, they'll be from Cerner Millennium.

How much customization or adaptation do you have to do to basically make it more Gallic?

This is Mark. It's primarily a translation effort. The actual underlying software for the most part doesn't require a great deal of work. So we are ready to go forward with that project fairly quickly with us translating primarily the screens that the users see.

And how long is that implementation again?

We haven't disclosed a time frame, but it should -- we would expect to start probably in the next six months.

Great. This is going to relate basically to Rios and maybe more of the long-term visioning, I guess, but can you talk a little bit about the role that Vitalworks has played so far in your work on Rios and to what extent you see you prescribing becoming an increasingly important part of your overall offerings? It seems to me at least initially that prescribing is certainly a great thing to do. It's hard to get physicians convinced to do it. I think the concern might be that, much like HIPAA, it's sort of half heartedly rolled out.

This is Neal. I'll take a shot at that. In regards to the first part, in the short-term, I would say Vitalworks is not the key ingredient to the Rio activities. In our opinion, that shifts over as the platform becomes part of the community, I think that shifts. At the end, I think the Vitalworks acquisition is a key component to that strategy. With regards to e-prescribing, I would say that I think it's a very key -- it's probably the real community transaction that will work in the short-term. So we think it's very important. I agree on the adoption, but keep in mind current e-prescribing activities, if you will, efforts, have been where that's kind of a stand-alone thought out there. You wrap that with a whole bunch of personal health records around the individual. You wrap that with a broader context. The transaction, I think, becomes more compelling for physicians.

And the final question, Mark. If you can talk a little bit about where you see the capitalization of R&D going over time? You've done a very good job, you guys, in taking it down from 33% down to 26 and change I guess. Where do you see that going over the course of '06 and '07?

I think, Jim, we've made some good strides and are particularly proud of the net cap rate which continues to decline. It's probably going to end this year closer to 7% which is an all-time low. I think the current quarter of 26%, I wouldn't expect it to continue to trend down from that point. I think overall we probably finished last year closer to 31%. My guess is '05 we finish closer to 29% for the year, keeping under 30%. And then, thereafter, it probably could decline slightly. With the UK work we're going to be working on, there's probably, that could flatten it out in the upper 20s.

Thanks very much.

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

Could you mention whether or not the recent deal in France was one of the deals over $10 million?

This is Mark. It is not.

And secondly, it would seem that last week at the leadership forum, Neal may have taken a swipe at David Braler and David Braler may have taken a, fired a salvo back this week at a HEMA. One of the things Braler eluded to was the government taking a more proactive role in standard setting. It sounds like they're planning on coming up with some money for some type of regional health infrastructure. Are you guys partaking in this? And how much do you know about it?

This is Neal. I actually haven't heard the shot back yet.

Oh. Well, from what he said, he said supposedly somebody disagreed with how I've been doing things for the last year and a half and forgot to tell me. I think it was pretty obvious that that was eluding to you, your comment.

As I shared with you there, George, in the crowd, I actually did tell him before I said it to you. So no. I think David is doing a good job. I think his direction is in the right direction. It's a little -- some of my difference of opinions have to do with how we'll get there, not necessarily where we need to go. And I think we are waiting to see if there's real money behind the regional efforts. We really do believe fundamentally the money is in the system, and we think it is probably not necessarily wise to go fund special projects that don't have inherent business models to keep them sustained.

Okay. And I guess my last question was you briefly commented on using Bedrock on the deployment in the physician office. Can you talk about the Company's efforts in the ambulatory setting and what the future looks like there?

This is Paul. We are making great strides with that, and that will be a very important part of the Bedrock initiative here over the course of the next six months. The products in the ambulatory market we're quite pleased with looking at what we have installed there today and where we're going with our solutions there. We will continue to evolve Millennium. We've got a solution there today. And that will over time continue to evolve and continue to more accurately or more quickly reflect a workflow that's out there in the marketplace for the people that want to see 40 patients a day. We have some work to go do to make that even better. We will be making some pretty important strides there in the 2006 timeframe.

I have more, but I'll circle back later. Thanks.

Our next question comes from the line of Sandy Draper of JMP Securities. Please proceed.

Thanks, and congratulations on a nice quarter. Mark, I just have a quick question. You made some comments around the decline in gross margin. One question, when you split it out between system sales and support and maintenance, I can understand the higher hardware costs impacting system sales, but what drove the gross margin down in support maintenance and services? Is that more of a faster growth in managed services and professional services versus support or is there something else going on?

I'm trying to look at the number that you're looking at because I don't show declines in the margin on support and maintenance.

Basically it's flat every year but down sequentially. I'm trying to figure out if there's something that made the second quarter stronger or maybe --

The point is a pretty nominal change. You're going to have some third party costs, maintenance costs in that component, so that can vary a few basis points. I wouldn't read anything into that as a differentiator.

And longer term, as you look at the margins in that business, as you ramp up professional services and managed services, eventually it grows the top line. Does that start to have a material impact one way or the other on the gross margin there?

The support maintenance number?

For the total support maintenance and services as you start to mix in more professional services and especially more managed services. Longer term should we be thinking about any switch or is that really not going to be a difference?

It's just continued growth in those businesses. The support maintenance line is a very -- you can track that growth pretty consistently over time since it is a higher margin than our system sales, it will obviously contribute to our gross margin. Services is the same way as it continues to grow and deliver more revenue, you'll see it contributing. I don't think there's anything drastic that you'll see other than just continued progress on those fronts, kind of what we laid out.

Great. Thanks.

Our next question comes from the line of Sean Jackson of Avondale Partners.

Good afternoon. Real quick on the numbers. Can you quantify the hardware sales or at least give some kind of indication of how large it was compared to last year?

Yes. We don't necessarily talk about the number, but the revenue from hardware in the quarter was probably close to double what it was in the year ago quarter. That being said, it still wasn't more than 10% of our revenue.

Okay. And also, on the professional services side, can you just comment on the margin expansion you have seen? What margins are you getting right now in that business, and how much longer can you continue to eke out margin gain there?

Well, we're growing that margin on basically hundreds of basis points a year, so I'm not sure we're eking out improvements there. But our goal for '05 was to grow them from 23 to 26% from a contribution, so we had a 300 basis point improvement. We will equal or exceed that for '05 and believe that actually positions us well to deliver our '06 targets. I think, keep in mind as Paul talked about Bedrock, we have not seen the true reflection of that in our projects yet. When we start seeing that, as we've talked about before, that takes us from the upper 20% contribution margins to the low 30% contribution margins. I think we're right on track with where we want to be in that business and are very pleased with the significant increases in the margins of that business.

I'm sorry. You cut out there a little bit. When you said you went from 23% to 26, what was the timeframe again?

One year. Our goal, basically we want to grow from 23% to 26% in '05. We'll exceed that target in '05 which keeps us on our path to getting to the low 30s as we pull Bedrock into our projects more prevalently.

Thanks a lot.

Our next question comes from the line of Steve Halper of Thomas Weisel Partners. Please proceed.

Just a follow-up on the margin discussion. Your revenue estimate now assumes the 50 to 70 million from the UK project. Is that correct?

That is correct.

So if you back out alike cost for next year, where does that put you relative to your 20% margin goal?

I think relative to our 20% margin goal, Steve, you're looking at a couple of components right there. There are five or six different items relative to spending and certain business improvements that we've been focused on. As we go into '06, we believe number 1 we're on track to deliver almost all of those for '05, such as the professional services margin to 26%. I think the key for us for certainly this quarter was the higher revenue. We estimated our path at 20% based on 10% revenue growth. It was higher this quarter, significantly higher, a hardware component. As we go forward, our past never contemplated the UK contract. We've kind of talked about the path without that. As we go into next year, we'll probably start trying to create a path that includes the UK element so everybody can be looking at the total revenue picture.

So after the UK contract, now that you're another quarter into it, are you still on -- were you still on track to get to that 20% in your stated timeframe?

Yes, for the executable elements of the path, we are absolutely on track. The hardware revenue and the higher revenue probably has us within 50 basis points as we close out this year, and that's probably, we're within a range of 50 to 100 as we go into '06 right now.

The 50 to 100 being?

Basically we're within that as our operating margin target. And any time we talk about operating margins, I always want to point out our earnings growth is going to continue to be in excess of 20% on annual basis. So I love to focus on operating margins, but bottom line is we want to grow earnings to 20 plus percent on an annual basis, and we think we're well set up to continue doing that.

Right. And just one housekeeping question. I'm assuming that you're comfortable with 266. Is that with option expense or without?

As we indicated earlier, we are not including option expense at this time. We've still got work to go do. This quarter, based on the current fast computation, it was about $0.07 impact. As we look at '06, we currently believe it will be similar as a percent of earnings. So I think that's the best we can provide right now. Obviously, at the end of the year, we'll provide you a more accurate indication.

Great. Thanks.

Our next question comes from the line of Lisa Gill of JP Morgan. Please proceed.

Thanks. It's Ott Faheem in for Lisa. I have a couple questions surrounding the NHS contract. Could you provide any details as to why it's been structured the way it is essentially in almost a third of what the total contract is worth and when do you plan to get the rest of the contract in terms of bookings, et cetera?

Your question is what is the approach to recognizing the bookings on that contract?

Correct. Right.

There are four phases of that contract. Each phase has a distinct set of deliverables that are required. What we did is booked -- and there's some -- one of those phases doesn't have any direct requirements. We recorded bookings for Phase One and the phase that doesn't have any direct requirements. When we complete the delivery of Phase One requirements, which we expect to happen in '06, we will then book the Phase Two balance and then the Phase Three balance once we deliver Phase Two. Each of those has a different set of deliverables. We are basically taking the bookings once we deliver the preceding phase. We think that is appropriate, because really until you deliver that preceding phase, you're not ready for that next phase of revenue.

And contractually are you contracted for all three phases?

All the phases of under contract and bound. Those are merely delivery dates that we have used to try to put the bookings in a similar phase as compared to the rest of our business so that we get as close to apples to apples as we can. We clearly said today-- we stated them separately so people can know what they are. We think that approach to bookings recognition is more conservative and therefore the approach we're taking.

How about the cash flow streams associated with the different phases? Are you seeing them close to the recognition is, the guidelines you gave us, close to 5 million for this quarter?

The cash can be all over the place. It's tied to a variety of different events and milestones. So there is not necessarily any linkage directly between the cash and the revenue, so it in some quarters will be -- we might have more cash than we've taken revenue on cumulatively. Some quarters we might have less. Overall it evens out. Given that we're taking revenue equal to cost, the conservatism should basically get cash ahead of us, the revenue, at some point in time here.

Lastly on the balance sheet, I noticed inventories declined about a couple million sequentially. Any explanation around that?

Which balance was that?

Inventories.

We probably sold some.

Hardware?

Our inventory will consist of not very much hardware but occasionally we will buy licenses, third party software licenses, that we keep in inventory. We do a bulk purchase of those. We get a much better deal. As we use those up, they'll come out of inventory. If we don't have any buy of third party software for inventory in the quarter, you'll see a decline.

Thanks very much.

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

Hi. A quick question with regard to the contract in France. Could you maybe discuss some of the competitive dynamics there? And obviously it seems relatively strategic since it looks like there's going to be a pretty big procurement process going on in late '06. A second follow-up would be with regard to -- I'm trying to understand sort of the normalized system sales growth number excluding the real large hardware number. Would that be roughly around 20% growth year-over-year? And then just a final question with regard to revenue in the quarter. It seems like, given how strong bookings was and not a ton of that seemed to drop to the bottom line, are we just seeing a lot more revenue coming from recurring sources if you can maybe help us with that as well?

Let me hit the -- the booking side, we're about 40 million over the top of our range. A portion of that was hardware, but the majority of it was increases in over -- delivery in our managed services, professional services and our subscription business this quarter were the main components. As you indicated, those items don't drop into the income statement revenue initially, but they are highly visible revenue streams that we've added to our backlog. That's what we've been focusing on for the past few years. We're pretty pleased with that. The question about system sales, you're probably -- the system sales absent the additional hardware component -- probably was in the low 20s growth.

This is Paul. On the competitive environment, it's somewhat similar to that in the United States and somewhat dissimilar. Similarities are there are some big cap players over there who bring in a software provider. When we go to compete there, at least that's what we saw that showed up on this one. There's also local small companies, niche players, that compete for this as well. I think, as we find ourselves competing in the continent, a lot of people are looking towards the UK, looking toward that lead to see what is going on there. We automatically put on lists. We have field troops on the ground as well. We get quite a bit of acknowledgement and recognition from being able to perform in the UK, so that's giving us some lift as well.

We wouldn't discount the small acquisition we did of Axia, the French company there, which that combined with winning the UK deal has really given us some credibility in the market place. There's probably another five or six of those academic medical centers similar to the one that we signed in this quarter that will be making decisions over the next 12 months. We think they communicate obviously between each other to a significant level, and we think winning this first one could be beneficial relative to the remainders. There's also several national procurements that are underway as well as at least one or two large, large health systems that are going out to bid. France is actually heating up as an active market probably a little bit ahead of what we would have expected.

Great. Thank you.

Our next question comes from the line of Michael Baker of Raymond James. Mr. Baker, your line is open, sir.

Yes. I was wondering if you could give us what percentage of your head count is now related to international and where you expect that to be -- that percentage to be -- by the end of 2006.

This is Mark. I'd say certainly less than 10% of our head count is related to global. As we continue to staff the UK effort, particularly knowing that there will be developers in Kansas City that will be focused solely on that UK initiative, so we'll treat them as focussed in a global way. Our expectation is that number probably gets closer to 10% of our workforce.

Thank you.

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

Most of my questions were answered, so I just have a couple quick ones. The percent of revenue from signings in the quarter that you guys have actually done very well on the bookings, so I'm just wondering what percent actually came from signings in the quarter. And then I missed the actual hardware number.

We didn't give a hardware number. The question was asked can you give me a sense of how big it is relative to the year ago quarter. It was about double what it was in the year ago quarter, but it's still not more than 10% of revenue for the quarter. To be honest, the amount of revenue from the signings become such a small percent, I don't really track it to a great extent anymore.

Okay. Thanks.

We appreciate everyone being on the call, and thanks for the questions. Alan and I, as always, are available if you have further questions. And we wish you a good afternoon.

Ladies and gentlemen, thanks for your participation in today's conference call. This does conclude your presentation, and you may now disconnect. Have a great day.