塞納 (CERN) 2005 Q4 法說會逐字稿

Welcome to Cerner Corporation's fourth quarter 2005 conference call. Today's date is February 2nd 2006, 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 headings, factors that may affect future results of operations financial condition or business in the management discussion and analysis section of Cerner's form 10K together with other reports that are on file with the SEC.

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

Thank you and good afternoon, everyone, welcome to the call.

I will lead off today with a review of the numbers, followed by sales and operational detail for Mike Valentine, Senior Vice President and General Manager of the United Sates. Paul Black, Executive Vice President and Chief Operating Officer will follow Mike with some reflections on 2005 and thoughts on 2006. Neal Patterson, our Chairman and CEO will join us for Q&A. Trace Devanny, our President is travelling globally on business.

Now, let me turn to the results. Our results were strong across the board in Q4 and for the year 2005. Our new business bookings were another all time record and our income statement and balance sheet also reflect a very strong performance.

Starting with bookings, we delivered another all-time record this quarter, our total bookings revenue was $386.3 million, which includes $65.5 million of bookings for the second phase of our project with Fujitsu in the southern regions of England. The booking for the Fujitsu contract was triggered by our delivery of the first phase of the project, which we will discuss later.

We expect the remainder of the bookings related to the Fujitsu contract to occur in smaller increments over the next several years as we meet the remaining milestones.

Our bookings revenue excluding Fujitsu was $320.8 million, which is up 31% over Q4 '04 and as a new all-time high, beating the record set last quarter. Bookings margin was $269.8 million this quarter before the Fujitsu booking and $335.3 million including it.

Full year 2005 bookings growth was strong at 48% with the Fujitsu bookings and 24% without it.

Moving to backlog. Our total backlog increased 39% year-over-year and ended the year at $2.14 billion. Contract revenue backlog ended the quarter at $1.72 billion which is 45% higher than a year ago and support revenue backlog was $415.6 million.

Moving to the income statement, we delivered very strong revenue growth in Q4. Total revenue in Q4 was $325.8 million, up 31% compared to the year ago period and 11% over Q3.

The revenue composition was $134.4 million in system sales, $77.2 million in support and maintenance, $105 million in services and $9.2 million in reimbursed travel. Full year 2005 revenue was $1.16 billion, an increase of 25% over 2004.

Excluding revenue from the position practiced management business we acquired from VitalWorks at the beginning of 2005, our Q4 and full-year growth rates were still very strong at 25% and 18% respectively. System sales revenue grew 35% over the year ago quarter with strong licensed software growth and a continued high level of low margin hardware.

Services revenue grew 32% compared to the year ago quarter, driven mostly by organic growth and professional and managed services. The quarter maintenance revenue grew 25% over the year ago quarter with about half of that growth coming from VitalWorks support revenue.

Our gross margin for the quarter was 77.2%, which is down 60 basis points from Q3 and 100 basis points from Q4 of '04. The decline in gross margin was driven by a very high level of hardware fails in Q4 that were also below our normal levels of margin for hardware.

Declining gross margin percent was somewhat offset by our ability to contain expense growth relative to revenue growth. Our operating expenses for the quarter were $205.1 million, which is up 30% over a year ago.

The increase in total spending was driven by the inclusion of VitalWorks medical practice, bridge and Axya acquisition, as well as growth in our services organization and an increase in global spending related to our U.K. activity. The 30% growth in spending was slightly below our 31% revenue growth and as a result total spending as a percent of revenue is down 50 basis points compared to Q4 of last year. Services efficiencies were the primary drivers of that leverage.

Moving to earnings, net earnings were $27.4 million in the fourth quarter, which is up 28% compared to $21.4 million a year ago. Split adjusted diluted EPS was $0.34 per share compared to $0.28 a year ago. Full year net earnings were up 32% before the Q1 end process R&D charge and the Q3 tax benefit on the sale of [inaudible].

Turning to operating margins, our operating margin in Q4 was 14.2%. This is up 160 basis points from third quarter, and down 60 basis points from the year ago quarter.

The higher level of lower margin hardware in this quarter, compared to a year ago had a negative impact on Q4's operating margin of more than 50 basis points. Q4's operating margin was also impacted by about 40 basis points due to approximately 9 million of zero margin revenue from the Fujitsu contract.

For the full year 2005, operating margin percent was 12.6%, about 80 basis points below our target of 13.4%, which is where we had modeled the 2005 operating margin on our path to 20%. While hardware and the zero margin U.K. revenue had a significant negative impact, other elements of the business delivered at or above their target contribution rate.

While we are pleased, we still drove out strong earnings growth at 28% in 2005, we'd like to see a greater level of margin expansion than we achieved. We are working on spending leverage initiatives we believe will drive out stronger margin expansion going forward.

Our investment community meeting in [inaudible] on February 14th will provide more detail on each component of our 2005 margin, and update our path to 20%. I want to emphasize that we still expect to drive greater than 20% earnings growth over the next several years regardless of any impact revenue mixes had on our margin percentage.

Turning to a quick update on the Fujitsu contract, as reported in December, we had an initial go live in South Suster during the quarter, less than four months after signing the contract with Fujitsu. Since this go live met the requirements for the first phase of our project, we took the bookings associated with the next phase.

There are two more phases that will be booked over the next couple of years. These bookings had no impact on our current quarter income statement. As we have stated, our revenues being recognized equal to cost until all elements of software have been delivered, which we expect to occur in 2008. At which point the recognition of margin will be triggered.

This revenue started in Q3 with about $5 million in revenue, offset by an equal amount of expense. We had another $9 million in Q4 for a total of $14 million in 2005.

Now move on to our balance sheet, which remains strong. We ended the year with $274.3 million of cash and short-term investments, comprised of $113.1 million of cash, $161.2 million of short-term investments. Total debt ended the year at $223 million.

The increase in cash and short-term investments resulted from our strong cash flow and proceeds from the debt we issued in Q4 as part of our hedging strategy for our project in the U.K.

As we previewed in our Q3 call, we borrowed 65 million pounds in Q4 and immediately converted the funds to U.S. dollars. We'll repay the debt with pounds received on the Fujitsu contract.

Accounts receivable ended the quarter at $317.0 million, which is flat compared to last quarter, despite the $31 million sequential increase in our revenue. Contracts receivable, or the unbilled portion of receivables were $100.7 million or 32% of total receivables compared to last quarter.

Our DSOs were 89 days in Q4, which is down 15 days compared to a year ago, and 9 days lower than last quarter. The significant improvement in DSO was driven by record cash collections of $345 million.

We did have a slightly higher level of third party financings, which were about 8% of total cash collection, but DSOs would have improved significantly even with a normalized level of third party financing.

DSOs will likely return to the low to mid-90s in Q1, which is still an improvement compared to the upper-90s level during the first three quarters of 2005. Broadcast collections led to very strong operating cash flow of $93 million.

Q4 capital expenditures were $36 million and capitalized software was $15 million. Cash used by investing activities also included approximately $160 million for an increase in short-term investments. Total investing activities were approximately $211 million.

Free cash flow defined as operating cash flow less capital expenditures and capitalized software was $42 million. Net cash provided by financing activities during the quarter was approximately $100 million, including $8 million of option exercises, $112 million from our debt issuance, less a $20 million reduction in our line of credit.

With respect to capitalized software, the $14.7 million of capitalized software in Q4 represents 23.5% of the $62.6 million of cash spent on development activities. Software amortization for the quarter was $11.6 million, resulted in net capitalization of $3.1 million or 5% of the total.

The longer items in our Q4 capital expenditures were approximately $4 million in global facilities, mostly related to the opening of the new office in London, $2 million for a clinic we're opening on our campus, and $24 million for expanding our data center facility and equipment related to our managed services business known as CernerWorks.

As Mike will discuss, we have had significant growth in our CernerWorks business and anticipate further growth. This strong growth and ongoing demand led to 2005 being a heavy investment year for the business.

This high level investment will continue in 2006 as we will be building a new data center on our campus to support the strong demand. Our full year 2005 operating cash flow was $229 million, which is up 36% over last year. The full year capital expenditures were $101 million and capitalized software was $62 million.

Free cash flow for the year was $66 million which is up $13 million over last year even after $45 million more in capital spending. We expect 2006 capital expenditures to be flat to slightly lower compared to 2005 excluding approximately $50 million for the new data center on our campus.

For 2006, we expect operating cash flow growth of approximately 10%, which should allow for continued solid free cash flow generation.

Moving to revenue and earnings guidance. Looking at Q1, we expect revenue in the $310 to $320 million range. We expect 2006 revenue to be in the range of $1.3 billion to $1.34 billion reflecting a mid-teens growth rate.

Our 2006 revenue guidance assumes approximately $50 to $70 million of revenue and costs from the Fujitsu contract yielding no net margins as we have discussed. Revenue from the Fujitsu contract is 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.

We expect Q1 EPS before options expense to be $0.26 to $0.27 per share which is 21% to 26% growth compared to Q1 of last year, and consistent with our long-term growth target.

Note the Q1 consensus was at $0.29 which is 35% growth and not consistent with any guidance we provided. For the full year 2006, we expect EPS of $1.34 to $1.35 before options expense which is $0.01 to $0.02 higher than our prior guidance and reflects 24% EPS growth.

Our estimates for options expensed in 2006 is approximately $0.04 per share each quarter, bringing Q1 to a range of $0.22 to $0.23 and the full year to $1.18 to $1.19. The options expense estimate equals--equates to about 12% of total earnings which we believe will compare favorably to most other health care IT and technology companies.

Q1 guidance is based on total spending and the $210 to $215 million range. For bookings, we expect bookings revenue in Q1 of $255 to $270 million which reflects growth of approximately 10% to 15% over Q1 of last year.

Before turning the call over to Mike, I want to remind you that we are having our investor meeting during [inaudible] on February 14th. If you are interested in attending, please contact Allan Kells, our Director of IR. This contact information is available on www.cerner.com under the investors section. The meeting will held--will be available via Webcast for those unable to attend.

With that, I turn the call over the Mike.

Thanks, Marc, good afternoon everyone.

I'm going to go through our sales and operational results and also talk about our CernerWorks business.

Starting with sales, Q4 was a very strong quarter from a sales perspective and 2005 was another year in which we set many new records, and performed very well in many areas of the business. Here are some highlights.

Cerner experienced strong contributions from both the U.S. and global businesses in 2005 with double digit bookings growth across all business models, including licensed software, technology, subscriptions, professional services, and managed services.

From a segment standpoint, we had strength across several segments, including academic medical centers, children's hospitals, community hospitals, and integrated delivery networks. We've signed a near-record, 292 contracts in the fourth quarter and 1,079 contracts for the year, compared to 942 in 2004.

We continue to secure a good number of large relationships in Q4 with 11 contracts over $5 million, five of which were over $10 million.

In total for 2005, we completed 37 contracts over $5 million with 19 over $10 million. Our mix of contract bookings from new millenium clients was 20%. Our leading indicators continue to look strong as we head into 2006.

We experienced strong year-over-year increases in our P-volumes, vision center visits, sight visits, and our multi-billion dollar pipeline remains very strong.

On the competitive front, we see a mix of some competitors doing well and others struggling. With the overall environment remaining relatively consistent.

There was also some consolidation in 2005 which has proven to benefit Cerner in the past as the consolidating companies tend to have a strong focus on integration, thus reinforcing our core and long standing strategy.

Overall, we continue to feel very good about our competitive position and we believe we have the potential to widen our leadership position if we execute well against our key initiatives.

Operationally, we had a strong Q4 end year. During the quarter, we turned on 296 millennium applications. This brings our total count to over 4,800 live millenium applications at over 925 facilities, 29% and 23% year-over-year increases respectively.

We enter 2006 with by far the biggest base of clients operating on a contemporary architecture and driving real value out of their IT investments. Moving to CPOE, we continue to widen our lead in the CPOE market. Cerner ended the year with over 460 live CPOE locations, including 94 acute care sites, an increase of 42% over 2004.

We continue to believe we have more live acute care CPOE implementations than our competitors combined.

The Accelerated Solution Center, or ASC, Cerner's evidence based rapid delivery model had another good quarter in full year. In 2005, we completed nearly 20% of all total -- of our total conversions using this model. Also, we are implementing more than ten solutions per site on average through the ASC compared to just over five on average using the traditional implementation approach.

We also continue to enhance our services ability by making progress on Bedrock, which is our wizard like technology that automates the implementation and management of our Cerner millennium information platform. This approach has the potential to reduce implementation times to less than six months for a typical hospital, and to a much shorter time frame for physician offices.

So far, 17 clients have used or are using elements of Bedrock, and we are seeing significant reductions in effort by both Cerner and our clients during the design and build portions of these projects. We have also noted a significant decline in service requests after go-live, which provides further evidence that Bedrock is enhancing the implementation experience for our clients.

Going forward, we are expanding and enhancing Bedrock by applying Bedrock functionality to global projects, using Bedrock wizards to simplify systems operations, expanding Bedrock to a broader range of solutions, and by making Bedrock a standard component of every implementation and upgrade project going forward. As we continue to expand the scope of Bedrock , we believe it will have a major positive impact on our client's total cost of ownership and become a significant competitive advantage for Cerner.

Moving on to managed services. I'll provide you with some data on our CernerWorks Managed Services Business. With CernerWorks, we are proving that we can provide our clients with a more effective way of running their Cerner software while lowering their total cost of ownership.

In addition, CernerWorks is a core element of our approach to the physician office market, where we're able to offer a much lower cost solution and to our state wide and regional community health record efforts, such as our Tennessee and healthy mid-America initiatives.

A key attraction of CernerWorks and the driver of its success is that clients want a very predictable service, and we are delivering that industry-leading reliability. For example, in Q4 of 2005, our CernerWorks clients experienced overall system up time of better than 99.9% with a majority of these clients experiencing 100% up time.

Financially, we have been pleased with the results of CernerWorks, which has gone from generating $6 million of revenue in 2001 to $76 million this year. During the same time, CernerWorks profitability has gone from break even to a 25% contribution margin. And in 2005, the leverage in this recurring revenue model was illustrated with revenue increasing 50% from $50 million in 2004 to $76 million and contribution margin increasing 90% from $10 million to $19 million.

Even with this large increase in revenue, strong CernerWorks bookings in 2005 grew the backlog to more than $500 million. This backlog will provide strong visibility as it rolls out over the next five to seven years.

In closing, I am very pleased with our sales and operational results in 2005 and look forward to a strong 2006.

With that, I'll turn the call over to Mr. Paul Black.

Thanks, Mike.

I may begin my remarks by commenting briefly on the state of health care in general and on health care information technology in specific as we move into the 2006 calendar year. First, acute care hospital marketplace is strong. As Moody's reported in January, hospital upgrades beat downgrades for the first time since 1997.

Profit margin as detailed last month in USA Today reached a six-year high at an average of 5.2%. As we look out at 2006, we believe that S&P is right in stating that while there will be pockets of challenges for providers dealing with issues like an unfavorable pair mix and serving a growing uninsured population, S&P expects the coming year to be "a stable one for hospital organizations".

Second, the number of health care IT companies competing in our marketplace is decreasing as big cap players continue to show an interest in HIT acquisitions. Last month, GE health care completed its purchase of IDX. There continues to be speculation that some of our competitors are taking steps to position themselves for acquisition.

At a time in our opinion when health care provider organizations are looking for suppliers that bring both financial stability and a deep commitment to health care IT, the current competitor landscape is a favorable one for Cerner.

Third, we believe we are at the inflection point that will accelerate adoption of the MRs inside physician office practices. Physicians increasingly believe that there is a demonstrable ROI associated with health care IT investment.

In addition, as Health Affairs noted last September, physicians are dealing with an evolving care environment that will require such capabilities as E-prescribing to handle the millions of new part -D patients with multi-tier formularies. We believe that the 2005 acquisition of the VitalWorks medical division gives Cerner a strategic presence in the small to medium-sized physician office practices.

Moreover as an externalities ranging from the certification commission for health care information technology certification process to the enactment of the recent Stark Law exceptions play out, Cerner should be well positioned to take advantage of them.

Fourth, 2005 was a year in which state Government began focusing on information technology as a key strategy to control costs and effectively manage their Medicaid program. We saw initiatives like ShareHealth in Tennessee gain significant momentum. Soon, over 2,500 users across 500 sites will have access in electronic community health care record, hosted by Cerner to help coordinate care for all 1.1 million lives in the Tennessee Medicaid program.

Of equal note, Kansas Governor, Kathleen Sebelius recently committed to a similar initiative with Cerner for the Medicaid population in Wichita, Kansas. Like Tennessee, we are confident that the Kansas initiative will meet with equal success.

At the federal level, national policy makers are also looking into health care IT. Indeed, 2005 saw meaningful progress towards bipartisan consensus on Capital Hill around the view that HIT can deliver significant returns. The RAND Corporation study published in Health Affairs clearly helped shape that perspective by detailing the potential savings of $162 billion per year through error reduction, elevated efficiency and improved condition management.

Again, this week, President Bush used the state of the union to express his support for electronic health records. While we were pleased with the affirmative mention, Cerner viewed the President's comments on entitlement reform as of at least equal significant. The President highlighted the fact that the first of 78 million baby boomers turn 60 in 2006, putting unprecedented strains on the federal government.

Whether or not his bipartisan entitlement commission comes to fruition, mandatory spending will continue to grow as an issue. And it is in the context of a nation conversation on Medicare and Medicaid that you are likely to see meaningful action on health care IT.

With these positive macro drivers we believe opportunities in health care and specifically health care IT have very few limits. Cerner is very well positioned to benefit from the lax boundaries in our industry because of our proven ability to leverage our investments and create new opportunities through innovation.

A big part of our future success will be related to how well we can scale and we think we are very scalable. In 2005, we broke the $1 billion revenue threshold and achieved a market capitalization of more than $3 billion.

In addition to our financial scalability, Cerner has also proven that our millennium architecture can scale to run large enterprises, even countries. Further, we have built the largest health care IT professional services and intellectual property organizations in the world, thus we are poised to continue to scale our Company both here and abroad.

This size and scalability has made us more relevant around the world. In 2005, Cerner's global business had a breakout year with revenue increasing more than 75% to $115 million. Clearly our replacement as a competitor in the southern region of England was a big part of our global story in 2005. Even more important than winning the business has been our execution after we got the job.

We brought our first site live less than four months after we signed the contract, a feat that has taken 18 or more months in other regions. We will continue to focus on execution on this project as we have a lot of work yet to do, but we are pleased with our fast start.

Beyond that, our contract in the southern region of England, other parts of our global business also had an outstanding year. On strength in the Middle East, Asia Pacific, France, and Canada, we grew our global revenue more than 50%, excluding revenue from our British contract.

Our size, scale, and ability to execute and innovate also allowed Cerner to make progress on several important initiatives in 2005 while still delivering outstanding results from our core businesses.

Each of these initiatives has the potential to grow into meaningful businesses. One example is establishing a first of its kind regional health information organization or RHIO in Tennessee working with Shared Health a Blue Cross/Blue Shield company and the extension of this concept to a pilot in Kansas as I previously mentioned.

Cerner also engaged in facilitating an employer driven RHIO in Kansas City, called Health E Mid-America it is the first in the nation employer-driven RHIO. Health E includes nationally recognized private sector employers including Sprint, Applebees, H&R Blocks, YRC Worldwide and American Century.

Since the September announcement, the number of employer participants has doubled, and we anticipate that the first pilot will launch during the first half of this year. We also launched our juvenile diabetes network which we believe will redefine the management of chronic diseases.

In our first year, we built a national network of 38 pediatric and academic centers connecting 550 clinicians with nearly 6,000 kids who are using the system to manage their medical condition connected to their physicians. We are also looking to globalize this initiative in 2006.

Finally, we made progress in developing our Light House Consulting practice, which uses incredibly rich clinical and operational data inside our structured EMR to truly transform our client's clinical practices, making their health care delivery safer, more efficient and more effective.

We entered 2006 a great deal of momentum. In fact, [inaudible] this month, we will use a unique approach that will demonstrate that we have obtained a critical massive client, achieving measurable benefits through the use of Cerner systems. Our message will be very clear. No one in the world has a real wide momentum of Cerner and our clients.

As we begin 2006, we are focused on four imperatives. Number one, execute at a high level in areas of the business. Number two, continue to grow our Company. Three, expand our operating margins, and four, continue to innovate and create new, highly valued solutions and services for our clients.

With, that I'll close and turn the call over to the operator for questions. Thank you.

Thank you very much, sir.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of James Kumpel of Friedman, Billings, Ramsey, please proceed.

Marc, you've done, you guys have done a great job in really taking down your DSOs and it's meaningfully below 100 days now. What further actions do you think you can take and how low can this go? Because we've seen some DSOs in the industry get into the 60s and 70s, but that's usually been about the limit?

Yeah, Jim. I think we continue to make good progress. Currently given our perpetual license model, that's our business model, we think somewhere around 90 is a very good result for us. We're very pleased obviously with the 89 result we drove out.

Some of the things we talked about on the call today including Bedrock and the ability to get projects done more quickly is really going to be the key driver to getting those DSOs down. Because as we get projects done more quickly, the cash will come in more quickly, and it will overall decrease DSOs.

A lot of benefit we've gotten so far is because our projects were going well and clients are paying us on time. As we've talked about in prior calls, we have day based payments in most of our contracts these days. It's just the scope of being a large company who's delivering with our clients, we have still not gotten as low as we need to get.

We are -- while we're very pleased with where we're at, we're not settling for it, not committing to 60 day DSOs, but I think we would like to over time continue to improve, right now, we think in the low 90s is a reasonable place to rest at this time.

And just overall, it looks like -- I think you guys mentioned that 20% of the contracts were actually from new clients. Are you finding that at this point, you've gotten to a level of positioning in the market where really it's much more about cross selling, rather than greenfield opportunities, because they've been hashed over so well, or do you see it settling more in the 30% or 40% range, like it's traditionally been, maybe over the last couple of years?

James, this is Paul Black, I think the range that we've had in the past of anywhere from 20% to 40% is the range we'll continue to guide. At any given quarter, it goes back and forth. In Q4 we did sell a lot back into the base, a substantial amount back into the base. We think there's still plenty of greenfield opportunity out there for a lot of the applications that we have and solutions that we have. Not only for cross selling opportunities in the base, but also to take new applications back into places and replace players that are already out there.

An example of that would be our laboratory information systems business again in 2005. I said this now for the last three years, as we close the year, the laboratory information systems business had the best year that it ever had and it had a record again in 2005. That's clearly new greenfield business for us, and that is also business where we're typically displacing another supplier.

Most of those laboratory information systems businesses in the U.S. have been automated for a period of ten to fifteen years. We still do well at the enterprise level and at this specific domain level and we still do well when we compete at the enterprise level. My expectation is that we are executing at the new level as well as at the installed base level.

Finally on VitalWorks, can you comment on whether or not there's some growth opportunities for that discreet unit? And if you're intent on establishing more RHIO's in 2006?

This is Paul again, on the RHIO answer, we expect we will establish more of them as we are working with clients in many cases and with some employers in other cases and with states in the third case, where we've gotten some traction from our success thus far and our reputation there is bringing us into some discussions that two or three years ago we couldn't have had.

Our success in Tennessee is gaining traction. That governor of that state talks about it when they speak about their Medicaid issue and what players they look to to help solve that problem, that's helped us get into a couple other discussions with other state players. On the VitalWorks piece, we expect to have substantial growth in the physician office practice marketplace.

We think that the EMR inside those physician office practices has very low penetration and that is a solution we are extraordinarily comfortable with and a solution that we have been providing to this marketplace for over a decade. So, there's a lot of opportunity in the physician office marketplace for new placements as well as for EMR placements inside of our current VitalWorks base.

Thank you very much, your next question comes from Steve Halper of Thomas Weisel Partners, please proceed.

Sure, relative to the NHS project earlier this week. One of the vendors there kind of shocked the world and told everybody about delays in scope and the scaling of the project. Was any of that a surprise to you as you went -- in hind sight, were you aware of a lot of these changes when you entered into your contract with Fujitsu and has the project in the south proceeded according to your estimate?

Yes, Steve, this is Marc. Relative to that announcement, our contract with Fujitsu has deliverables and dates. We are signed up for those.

We are meeting those deliverables and dates based on the time of our contract, it has little or no impact on us. So relative to whatever indications that other company provided, we are not seeing that in our business.

We'll continue to work the projects, recognizing the revenue equal to our costs until mid 2008 when we'll start recognizing margins. There's no impact on our business from their statement and we don't know that that really would have impacted our contract anyway.

Right. So do you think that you'll achieve profitability from that contract--some profitability in that contract by the end of '07, '08?

Keep in mind, Steve, that we will report no margins from that business, revenue equal cost, until mid 2008.

Right, mid 2008.

Right, that's when the last deliverable software is due. Once that all the elements of the contracts from a software perspective are delivered, we then can recognize all of the margin on that contract, starting at that point over the remainder of the life. So there will be no margins recognized until mid 2008. But at that point, there'll be all of the pent up margins that's accumulated to now, plus the margin going forward. So it will be a significant margin contributor beginning right now, projecting to be mid 2008.

Right. And my last question is, the expectation of mid 2008, that is unchanged from when you started the project with Fujitsu?

Absolutely. It's always been the milestone delivery schedule that we've always had.

Great, thanks.

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Atif Rahim of J.P. Morgan, please proceed.

Thanks. Could you comment or elaborate a little bit on your Bedrock initiative? You've talked about it a little bit in the past and you said you had 17 clients utilize it this quarter. That seems a little low compared to the 292 goal you had, so what do you think is stopping clients and where do you think your adoption rate could go to with the Bedrock initiative?

This is Mike Valentine. The fact that only a portion of the 17 that I mentioned are using Bedrock is attributed to the fact of when we launched Bedrock into the consulting methodology. My expectation going forward is that 100% of the projects that are launched going forward will be -- have an opportunity to leverage the Bedrock.

Our expectation is that it becomes a standard part of our methodology. It also becomes a standard part of how we manage systems, that once they go live so the current feeding of the applications as well as the iterations on top of the systems once they're live.

So upgrades are part of that category as well. It is a part of our methodology, it's a tool set that we'll utilize going forward. So the fact that it's only a proportion of the conversions we talked about before is just a matter of the timing of when we launched it.

Okay. Is this a feature that you'd sell for an additional value to your customers or is it something you just offer as part of your ongoing contract?

This is Marc, it's part of our service provision. Basically, we bring it in as part of our activity.

Okay. Thanks. And then just on capitalized software, I think you said the rate was about 23.5% this quarter as a percentage of R&D. Is that something you see going lower than this, or any guidance in terms of that and any fluctuations going forward?

Yeah, I think, you see about 26.5% last quarter, 23.5% this quarter. I think probably a range around that going forward is probably reasonable. A year ago we were closer to 30%. We've brought that down and I think we're comfortable that's kind of the range it will probably stay in at least until we look to 2006.

Okay, that's great. Thank you.

Thank you very much, sir.

[OPERATOR INSTRUCTIONS]

Our next question comes from the line of Richard Close of Jefferies, please proceed.

Yes, congratulations.

Thank you.

Quick question, maybe with respect to the U.K., you guys obviously doing a good job there. Have you guys started to see any additional business or interest, maybe if you could sort of give us some details with respect to other initiatives that maybe in the U.K. or other countries based on your success in the U.K?

Richard, this is Neal. I think what we'd say there is that being part of that project now, and our role certainly helps us, or creates a resume for Cerner that is a very attractive resume for other governments when they look to do large-scale projects of this type. We -- it is a very -- it's a positive to us to be involved in that and delivering actual value on time.

We think our performance there will basically set us apart. Now, what other countries are going to do, there are certainly activity levels around the globe, but I don't -- we don't know where that's going to end.

In this country, we had the President's -- per my count, this is the third state of the union that he made reference to electronic medical records. I'm not convinced they know exactly what that is, but it is at least in the rhetoric phase, the policy side in this country. We feel good, we like our position in the U.K. right now.

Okay. Moving back, maybe to electronic medical records and the ambulatory setting in VitalWorks, you mentioned pretty significant growth there, opportunity going forward. Are you saying in 2006 that that is going to be a major growth area for you guys and maybe if you could provide some details around that?

Let me do it. Yeah, Richard, this is Neal again. I think 2006 is a year where we're probably still investing, building organizations out. I think you know we're -- part of what we're doing there at the strategy level is, if you will, change the game.

We're out there with a fixed price per physician for a high set of functions, so it's 595 per month per physician. With a very low cost implementation. Our strategy there is to be high value by bringing high function in with probably the -- if not the lowest price point, one of the lowest price points you can find. And develop low-cost sales model, low-cost delivery models, and low-cost operation models, and low-cost support models.

I feel good where we -- how we start this year on that. I think the growth, the real impact on the Company will be in 2007 and beyond.

Okay. Great. Thank you. I guess one final question. I guess, with respect to our estimates and stuff like that, maybe did it incorporate the first quarter's seasonality as much as maybe needed? If you could give a little bit of detail with respect to your feeling on the bookings numbers, is that a conservative number in your mind for the first quarter, or maybe any thoughts surrounding that?

Yeah Richard, this is Marc.

As we do every quarter, we go in, we have quarterly forecast meetings right after the quarter ends to look at the next quarter, see what business we see. And we base our guidance off of those meetings. Traditionally, we've seen some delivery that is in line with that. We've seen delivery over that.

As of today of the numbers we provide as our guidance, it's our best estimate of what we expect to deliver. So we can't really comment on conservatism otherwise, we'll just tell you that's our best estimate today.

And you can look historically to see what difference it is. It's basically a 10% to 15% increase over the year ago number and relative to the EPS guidance, it's within the 24% range that we have guided for the entire year.

And then Marc, just to be clear on the bookings, that doesn't include any U.K., correct?

Absolutely. The U.K. booking in Q4 was accelerated because of our performance in delivering those milestones actually probably a little ahead of what we expected. The next milestone won't be until probably later in 2006, perhaps 2007. And we'll once again make sure everybody understands that impact.

We've taken about half the bookings of that contract to date, around $200 million and there's another half still remaining to be taken and we'll specify that and break it out separately at the point that happens.

Thanks for your time and congratulations again.

Thank you very much sir. Ladies and gentlemen, your next question comes from the line of Sean Wieland of Piper Jaffray & Co, please proceed.

Hi, guys, thanks. Just one other question on the U.K. opportunity. Given the announcement earlier this week and maybe some delays in some of the other regions, could you comment or speculate on your opportunity to maybe pick up another region in the U.K.?

You're trying to predict the behavior of the federal government, John, so I don't think any of us can do that. We like our position, we're focusing on delivering and executing, and our report to you there is we're doing -- we're giving you a good report there. We believe we are delivering. There's all kinds of variables that come into your question, which most of them are out of our control. The parts in our control, we're giving you a very positive report.

Okay, that's fair. One other thing is--just to talk about the domestic market and CPOE. We've been talking about your success in the CPOE market for several years. Can you just give us some insight on what you think might be around the corner of what is the next big thing to happen beyond CPOE, not that that's over, but what's the next thing that you think hospitals are going to be looking for in the coming year?

This is Neal. We probably all have some input here, so I didn't mean to grab the mic, but I think it's a great question.

Frankly, I think the next real thing is physician office and really getting the paper -- getting that record out and then connecting the home and the person to the home. It's extending the platform outside the four walls. And it is really what we call here roll venue. It's following the roll across all the venues, since they really have to navigate.

There is a big, much earlier in the trend on the physician office side. We like our timing there on the low end, via the VitalWorks, it was like most things in life, you'd kind of like to be two years earlier, but we're okay there.

There's a lot of -- and then even down to the legislation, the regulation changes around the Stark Amendment, there's relief there that lets these hospital based organizations get closer to positions using electronic medium. We certainly think that's a piece of it. The other piece really is kind of broadly referred to in this country RHIOs. We really don't, and I get myself in trouble speaking too clearly about this, but there's a lot of activity there. Most of those are science projects, but there is a clear need in a value of creating a record for the people in a community that moves across the community.

Something's going to happen in this space above the individual fragmented providers. And if you look what the U.K. is doing, they're basic taking a more systems approach to that. All of that spec really has that, that spec has this fixed.

This country will have to fix it. What you're seeing us do with the state Medicaid initiative and what we're doing with employer initiate is creating a potential next big thing. And then frankly, inside these hospitals, really, the values you're going to create, you create by having this electronic record.

There's a -- there is a very large amount of work then to do that all creates absolute bottom line returns to these organizations, what we call optimizing both their business and clinical processes. Once you have that information available, you can't believe what you can discover about things they're doing wrong, either from a quality side, from safety or from an economic -- so there's an unbelievable amount of work to be done there.

And then, let me then just, I'll end here, let me also say, there is big opportunities in just the device area. Because once you have automated the core processes of a health care system, most all of the devices that are inside that organization would be significantly improved if you had -- they had the awareness of the contractual information about the person that's in that record.

So there is a big opportunity of rethinking how a lot of the peripheral now, somewhat independent stand alone pieces of equipment, how it really needs and will operate. You'll see us do some stuff there. Now, I'm sure Mike and Paul have other thoughts. Additional thoughts. You guys got comments.

I think in a hot market, critical care and automating the things in critical care and what Neal alluded to in terms of connecting the devices to the medical record and what value that brings, I think we're seeing that first hand in the value profit in the critical care space, that is bringing a new set of opportunities to the market. And then the, I think the first part of devices hitting the marketplace and bringing that extra level of data to the bare, as Neal mentioned, is really in the bedside devices.

Whether that'd be a nurse or meds administration process, whatever the process may be, having -- facilitating work flow in a different way vis-a-vis these devices, and then capturing that data in a different way to use it for optimizing the processes and the outcomes is becoming a real meaningful second order business for us. I think that will be a growth area as we move into the future.

Next question.

Thank you very much, sir. Your next question comes from the line of Frank Sparacino of First Analysis, please proceed.

Hi, I just wanted to go back to the Bedrock question. What would you expect the -- to be using Bedrock with all the projects, at what point in time?

This is Paul Black. The Bedrock, as Mike said earlier, the solution that we have has been very successful. We've got that today--we've got what we call wizards created for a portion of solution. So we don't today have 100% of all of our solution Bedrock enabled. We expect that to be finished by the end of calendar year 2006.

So as we start projects today, depending upon what the client has selected as part of our solution with them, some aspects of that are able to be Bedrock enabled, not everything can be. But of those that have Bedrock enablement, we expect 100% of those projects in 2006 to be started with Bedrock as part of the overall Cerner methodology for how we deploy systems.

Frank, this is Neal. Let me just back up and give a little perspective on Bedrock.

The origin of Bedrock was the very long flights back in 2003 that we would take to the U.K. thinking that we were going to win one or several of those contracts. And those were basically fixed fee contracts. So you're really bidding to go do the delivery, the implementation of automating the health care systems for an entire country and you're doing it on a fixed fee basis.

So as, frankly as innovators and systems folks, plus having time on long flights, we knew one of the risks in there was our cost in building these systems out for an entire country. So that's the origin of Bedrock.

Basically, it has the opportunity of taking 30% to 50% of the effort to build these systems, removing that workload. Today, that workload is shared between our staff and our client's staff.

The business opportunity is to do two things. One, more and more of our arrangements we'll do on a fixed fee basis. Because the amount of variance we have is very predictable now. We have very -- we're very confident what our effort is going to be. So we do the -- we do more and more arrangements on fixed fee, including all the U.K. work.

And when we fix fee something, if we can take the costs out, our margins on that service really go up a bunch. Plus, it also gives us the opportunity to actually bid the engagement a lower cost, which will increase in reality increase our market share. Specifically as it relates to that physician marketplace, I talk about the low cost capabilities of the Company, one of them is to be able to go build out these systems really at very low costs for these physician offices.

So there's a whole -- there's a whole set of business strategy around that, and as most good innovation, it comes out of a necessity or a fearful moment you have in your life. So we like what we're doing. We're basically automating what we do, which is kind of exciting for us. You would think we'd figured it out earlier, though.

Frank, just to be very clear on this front, and I've heard this in the marketplace, what Bedrock is is both the automation of the design process as well as helping it automates the build of the system. There are systems and solutions that are in the industry that really capture design requirements and that is a part of what Bedrock is, but Bedrock's most valuable component is the way it correlates that into the way the system is built and doing that in an automated fashion.

Mike earlier made the comment, we will use that capability, that technology to manage these systems long-term too. And as an increasing amount of our contracts were hosting the work, we're also managing those systems for our clients. We're automating a big chunk of building the infrastructure out for health care.

Thank you, that's helpful.

Time for one more question.

Our last question comes from the line of George Hill of Leerink Swann, please proceed.

Thanks, I'll try and make this worth everybody's time. I think this is probably a question for Paul and Mike. As we see the products develop in the marketplace between you and your competitors, we see a lot of gravitation towards the products looking the same on the front end. I guess, looking forward, how do you think about how the Company protects itself from severe price competition as the functionality and the utility of the products pretty quickly starts to gravitate towards being the same.

This is Paul, I think the marketplace looks at functionality, but they also look at experience and they also look at--as Neal said earlier, the resume. When clients are out there looking for solutions, they're also looking for somebody who's going to have the capabilities of getting that successfully deployed in their environment and if you will, customizing it to make sure that it's adopted broadly by all their caregivers, their clinicians, their pharmacists, their nurses, their doctors and anybody else that's involved in that patient care experience or an outpatient care experience.

They look at that and in totality, and most people know that the software expense itself is a fraction of the overall expense that they will go through over a 5-10 year period. Most people when they're looking at these things look at it over the long haul. And, we don't find ourselves in a, if you will, commodity marketplace battle all the time.

There are some places where we are very, very competitive from a price standpoint, and we will be continue to be so. In some instances, that's what the market bears. In most cases, we are talking about a number of things, one of which happens to be the price of the software.

George, the other thing -- this is Mike -- the other thing I would add is the good news is is that the work flows continue to change. And they continue to take advantage of newer and different technologies.

So there's a continuous requirement for us to evolve our solutions so the chances of there becoming a vanilla flavor I think are quite slim. We spend a lot of time focused on usability and how we can leverage new technologies to enhance usability and the adoption of the system.

I think it's a little bit of a moving target and the good news is, we seem to be very close to target on a regular basis.

Are there any types of metrics you can give us to kind of support that, I guess one of the things I'm trying to back out here as you look at year-over-year system origins down 500 basis points. I recognize the inclusion of VitalWorks, I recognize the recent addition of the U.K. contract, but is there -- do you guys look at a price per physician seat license at the hospital or any --

George, this is Marc, the main reason for that decline is hardware. Which wouldn't be impacting. The software prices are not -- have not changed significantly for the most part relative to the last four quarters.

Just -- have you seen any changes in the competitive environment in the last two quarters. We hear about Epic stumbling a little bit out west, we hear about McKesson putting on a better dog and pony show with some customers.

I would say broadly, this is Paul, that the competitive marketplace has not changed that much during the course of 2005.

Okay. I'll say, if you'll grant me one more, the PowerWorks offering that Neal alluded to earlier, can you tell me how the Company came to the conclusion that the more -- I guess the lower up front cost, higher recurring cost subscription model was a better way to go than the enterprise license model?

I can tell you how we did it, we just basically -- we looked at that marketplace physicians, there's an awful lot of price elasticity there. That is, they're very price sensitive and we have said for probably 18 months now that our basic strategy here is to make that marketplace a utility.

So that needs to be -- there's very--there's virtually no skill sets in those offices, particularly the small offices, there's no skill set there to manage applications. We want just complete turnkey and we think it's a price sensitive marketplace. And quite frankly we want volume.

It makes sense to us.

We want volume. We think there's other business models to build off of. You have connectivity, tens of thousands of doctors. There's other value there. There not just the application value.

Okay.

Great questions. Let me then just wrap up here, I think we're past our time. The questions are good.

Obviously, we feel good about the year that we just finished. We have confidence as we go into the next year, nothing in this business is particularly easy. This is a very hard business. And I think it's a hard business to understand, because to a large degree, I suspect most of you view us as a software company and your comparables are the SAPs of the world and [inaudible] that are all gone, but this is -- we do an awful lot of software, but there's a uniqueness and a difference to health care -- we did not approach health care from the administrative financial side, we approached it from a clinical side.

We are automating some of the most complex processes in our society and we're doing it with--inside of a health care delivery system that has some fundamental peculiarities and a structural peculiarities, but out of all that, this creates a unbelievable wealth of opportunities to continue to grow this Company and our business.

I'm not apologizing for the fact that sometimes we're abstract in our thinking, but there is -- I've tried to reflect a little bit as to how to describe our business, there's not a good comparable out there, outside of our industry.

We like where we're at, we like our Company, we think we're creating probably the right size -- we're a Company that's got scale, but we're also a Company that's very entrepreneurial and very nimble.

If the next big thing is there, we will find it and will probably be the ones to invent it. In the meantime, we've got the global market is very strong for us, the U.S. market is very strong for us, we're going to continue working very hard and we're going to grow our Company, we're going to expand our operating margins. And we're going to make this a better franchise here.

Thank you very much. Have a good afternoon.

Thank you very much and thank you ladies and gentlemen for your participation in today's conference call. This concludes your presentation and you may now disconnect. Have a good day.