塞納 (CERN) 2006 Q4 法說會逐字稿

Welcome to the Cerner Corporation's fourth quarter 2006 conference call. Today's date is February 1, 2007, 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, prospective and prospects, constitute forward-looking statements for the purpose of the Safe Harbor provisions of the Security and Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading, " Factors that may affect future results of operations, financial conditions, or business," in the management discussions and analysis section of Cerner's Form 10-K, together with other reports that are filed 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, [Cami]. Good afternoon, everyone. Welcome to the call. I would lead off today with a review of the numbers, followed by operational and sales highlights from Paul Black, Executive Vice President and Chief Operating Officer. Trace Devanny, our President, will follow Paul and discuss our global business, our physician practice strategy, and our acquisition of Etreby Computer Company that we announced today. Neal Patterson, our Chairman and CEO, is traveling and will not be able to join us today.

Now let me turn to the results. We had a good finish to 2006, with a strong Q4 that included another record level of new business bookings, good margin expansion, and strong free cash flow. Starting with bookings, our total bookings revenue was $543.2 million, which is 41% higher than Q4 '05. Our Q4 '06 bookings include initial booking of $154.2 million on our contract with BT to be the software provider for the London cluster in England. And our Q4 '05 bookings included $65.5 million booking for the southern cluster of England. Adjusting both quarters for these unique large bookings results in bookings revenue of $389 million for Q4 '06 and $320.8 million for Q4 '05, or 21% year-over-year growth. Booking margin in Q4 was $486.6 million, including the BT booking, and $332.4 million, excluding it. With respect to our bookings on the BT contract, our initial booking of $154 million includes expected revenue associated with the first phase of the project, and revenue that is not directly tied to future releases of software. The total contract value is in the $300 million range. But that whole value won't be booked because it includes support that we don't include in our bookings.

Going forward, we expect some additional bookings related to both the Fujitsu contract, and BT contract, to occur in smaller increments as we meet various milestones, and we'll continue to break out bookings related to those milestones. Given the similar milestones driving both projects, we'll group the bookings for both projects together going forward. Looking at our full year 2006 bookings, we delivered $1.47 billion of bookings revenue, including the BT booking. Full year bookings revenue, excluding the BT booking, were $1.32 billion or 15% higher than 2005. Moving to backlog, our total backlog increased 24% year-over-year and ended the quarter at $2.66 billion. Contract revenue backlog ended the quarter at $2.19 billion, which is 27% higher than a year ago. Support revenue backlog was $469 million.

Moving to the income statement, we delivered strong revenue growth in Q4. Total revenue in Q4 was $380.8 million, up 17% compared to the year-ago period. The revenue composition was $149.3 million in system sales, $89.1 million in support and maintenance, $132.1 million in services, and $10.3 million in reimbursed travel. System sales revenue grew 11% over the year-ago quarter, which was a very tough comparable as it had grown 35% over the prior year. Services revenue grew 26%, compared to the year-ago quarter, and support and maintenance revenue grew 15%. Looking at the full year, our total revenue grew 19% to $1.38 billion. System sales growth was 12.5%, with software growing at 14%, technology resale at 8%, and subscription and transaction revenue growing at 20%. Support, maintenance, and services growth was 23%, with support and maintenance growing 15% and services growing 29%. Within the services line, professional services grew 26%, and managed services grew 45%.

Our gross margin for Q4 was 76.6%, which is down about 60 basis points year-over-year, and about 300 basis points compared to Q3. The decline in gross margin was driven by an all-time record level of hardware revenue in Q4. Note that we still delivered strong gross margin dollars. It's just that the higher levels of hardware were a primary driver of our revenue being $15 million higher than our guided range, resulting in the gross margin percentage being lower. Our full year gross margin was 78.9% which is up 80 basis points from 2005, and reflective of the stronger growth and licensed software, compared to technology resale that occurred in 2006. Our operating expenses before options expense in Q4 were $236.9 million, which is up 16% over a year ago. The increase in total spending was driven by growth in our professional services and managed services businesses, and an increase in global spending primarily related to our UK activities.

Moving to earnings, our GAAP net earnings were $39.1 million in Q4. GAAP net earnings include stock options expense and also reflect a lower tax rate of 23%. The tax rate reflects a benefit related to the extension of the federal research and development credit that was signed into law in December, and some recognized federal, state, and foreign tax benefits. Our normalized tax rate is about 39%. Net earnings using the normalized tax rate, excluding options expense, was $34 million in the fourth quarter, which is up 24% compared to $27.4 million a year ago. Adjusted diluted EPS, prior to options expense and the tax benefits, was $0.41 per share compared to $0.34 a year ago, a 22% increase. For the full year, net earnings grew over 30%, making it the third consecutive year the annual growth in net earnings was over 30%.

Our operating margin before options expense in Q4 was 14.4%. This quarter, operating margin was impacted by about 100 basis points due to approximately $25 million in zero margin revenue from our projects in southern England and London, with Fujitsu and BT. Our operating margin without this revenue was 15.4%, which is up 80 basis points year-over-year. Our full year operating margin was 13.4% including the zero margin revenue, and 14.1% excluding it. Our full year 2006 operating margin of $185 million is in line with the amount associated with our path to 20% operating margins. The margin percentage is about 60 basis points behind our target for 2006, indicating we got to the target operating margin dollars on higher revenue. While we'd like to have both the stronger revenue growth and higher margin expansion, we are pleased that we drove out 26% growth in our operating earnings on 19% revenue growth. We also still believe we can get to 20% operating margins and drive 20 to 25% earnings growth in the coming years, and we'll provide a more detailed update at our HIMSS analyst meeting on February 27.

Now move to our balance sheet. We ended the year with $309 million of cash and short term investments. Total debt ended the year at $208 million, which is basically flat compared to last quarter. Accounts receivable ended the year at $361 million, which is up $10 million compared to last quarter. Contracts receivable or the unbilled portion of receivables were $133 million or 37% of total receivables, which is 1% higher than last quarter. The increase in both total receivables and the contracts receivable portion is primarily attributable to our project in the southern cluster of England. As we mentioned last quarter, we have some working capital requirements related to this project which are reflected in receivables. We expect acceptance of our next release of software, known as R1, to occur in Q1, which will trigger our ability to bill for a large milestone payment and reduce the contract's receivable. Recall that the revenue driving this contract receivable is currently being recognized based on expenses incurred, and there is no margin benefit.

Our DSO is 87 days in Q4, which is down 6 days compared to last quarter, and down 2 days compared to a year ago. The solid improvement in DSO is driven by record cash collections of $409 million. Third party financings were $35 million or 9% of total cash collections. Note that without the working capital associated with the southern cluster project, our DSO would be several days lower. Operating cash flow for the quarter was $69 million. Q4 capital expenditures were $39 million, including $19 million of property expenditures. Capitalized software for Q4 was $14 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was $16 million. Free cash flow before property expenditures was $35 million. The property expenditures were primarily related to our new data center.

For the year, our operating cash flow was $233 million. Our total capital expenditures were $131 million, and our capitalized software was $61 million, leading to free cash flow of $41 million. Free cash flow before property expenditures was $100 million. Operating cash flow is slightly below our expectations, but our CapEx was $20 million lower than originally projected, and our capitalized software was flat compared to last year. So our free cash flow was still in line with what we expected. Also note that our 2005 operating cash flow benefited from approximately $22 million more in operating cash flow related to options exercised as compared to 2006, due to a higher level of options exercised in 2005 and the SFAS 123-R requirement that the excess tax benefit related to options expense be treated as a financing activity, beginning in 2006. Adjusting for this, 2006 operating cash flow growth is 13% on an apples-to-apples basis.

On capital spending, the main reasons our CapEx was lower than projected in 2006 was that we did not complete the acquisition and initial build out of the Kansas City office building complex we expected to occur in Q4, and we did not spend on our new data center as early in the process as we expected. The spending for both of these items will now occur in 2007. We also significantly exceeded our bookings targets for our Cerner Works Managed Services business, booking over $200 million in 2006, which will require an increase in equipment purchases. These items will lead to an increase in CapEx in 2007, relative to 2006, but we still expect to generate strong free cash flow, based on strong operating cash flow growth and relatively flat levels of capitalized software in 2007.

As a person who signs off on every large capital expenditure, I can tell you that I believe our capital spending represents a good investment for Cerner and our shareholders. We expect to spend approximately $34 million to acquire and completely furnish 750,000 square feet of class A office space in Kansas City, which we believe is an attractive value. We expect this additional space will meet our facility needs for several years, and our spending on CernerWorks Managed Services generates a strong financial return for Cerner, while also strengthening our relationship with our clients. Moving to capitalized software, the $14 million of capitalized software in Q4 represents 21% of the $65.5 million of total spending on development activities. Software amortization for the quarter was $13.3 million, resulting in net capitalization of $.6 million or 1% of the total. For the full year, our net cap rate was 5.8%, which is down from 6.3% in 2005. Going forward, we expect our net cap rate to remain in the low single digits.

Now I'll go through the guidance. Looking at Q1 revenue, we expect revenue in the 365 to $375 million range, which is approximately 15% higher than Q1 '06. The revenue range is slightly lower than Q4, which is not unusual, due to seasonality and the record level of hard work in Q4. We expect Q1 EPS before options expense to be 34 to $0.35 per share, which reflects growth in the mid 20% range. The Q1 guidance is based on total spending before options expense of around $245 million. Our estimate for options expense for Q1 '06 is approximately $0.04 per share, bringing Q1 to a range of 30 to $0.31 after options expense.

For bookings, we expect bookings revenue in Q1 of 285 to $300 million, and the midpoint of this range reflects 12% growth over Q1 of last year. For the year 2007, we still expect EPS before options expense to grow in the low to mid 20% range, and current consensus of $1.69 EPS for 2007 reflects growth in this range. Our estimate for options expense in 2007 is approximately $0.16 for the year. With respect to 2007 revenue, we expect revenue between $1.54 billion and $1.57 billion or 12 to 14% over 2006. Our 2007 revenue guidance assumes approximately $100 million of revenue expense with the UK contracts in London and southern England, yielding no net margin, as we have discussed. With that, I'll turn the call over to Paul.

Thanks, Marc. Good afternoon, everyone. Today I'm going to cover some of the normal sales and operational metrics, and then highlight progress we achieved on key initiatives in 2006, and key areas of focus in 2007. From a sales perspective, we had another strong quarter with good contribution from all major segments, including academic medical centers, children's hospitals, integrated delivery networks, community hospitals, and physician practices. Our contract volume was very high in Q4, with a record 366 contracts, with an all-time high, 18 of them, over $5 million, nine of which were over $10 million. 21% of contract bookings were for new Millennium footprints. From a business model standpoint, we had a solid mix of contribution from each business model, with particular strength in license software, managed services, both of which were at record levels in Q4 and for the year.

We also continue to see strong levels of vision center, site visit, and RP activity. Operationally, we turned on another 262 Cerner Millennium applications, bringing the total for the year to almost 1300. Cumulative conversions for Millenium applications now exceed 6100, at nearly 1100 facilities. Progress with CPOE continued in Q4, with ten additional acute care CPOE sites going live, bringing our industry-leading total to 126. We believe this is more than the rest of the industry combined when considering currently marketed CPOE systems that have a high level of physicians using them.

2006 included some important accomplishments across Cerner that I would like to highlight. Our intellectual property organization had a big year in 2006. The Cerner Millennium 2007 release, which became generally available on November 15, is foremost among this organization's accomplishments. With Millennium 2007, we delivered the largest set of new functions we have ever included in a single release, while setting new quality standards for the industry. It included a major change in design philosophy around role, venue, condition, process modeling, that resulted in a new physician user interface and work flow. We also redefined our approach to quality by implementing new testing and performance standards. Early feedback from our clients on Millennium 2007 is very positive.

A second major accomplishment by the IT organization was the completion of significant work around major extensions of Millennium. Examples include the CareAware architecture and the creation of the [MD Bus], or the USB for healthcare, and the [Health-E] network, creating a new consumer, government, and employer services. These innovations extend the reach of Millennium, opening up new opportunities for Cerner's growth. CernerWorks, our six year old hosting business, had another great year. CernerWorks revenue increased 45% to $110 million and maintains good profitability. CernerWorks also had strong bookings growth, continuing to feed the backlog for future revenue visibility.

Our remote hosted clients continue to experience great system availability and performance with 99.98% scheduled system availability in Q4. Less than three years ago, we indicated we would guarantee 99.9% system availability for unscheduled downtime. At the time, this level of availability, referred to as three 9's, was considered a brave standard. We are now advancing to four 9's, which will set a new standard that we believe is a meets-minimum requirement for healthcare's 24 x 7 x 365 needs. In 2006, we also introduced the concept of the Lights On network, a surveillance system and service that monitors client-hosted and Cerner-hosted systems in near realtime, allowing the capability to predict future system issues and prevent them before the end user is ever impacted. On January 15, 2007, this Lights On network officially went live with 192 connected clients. We are redefining the standards in the industry for reliability, performance, and up time.

2006 was also a year during which we redesigned our implementation methodology with Method M, Cerner's single engagement delivery model for providing value through solutions. We are expending the productivity gains we have made with Bedrock, the Solutions Center, and our Upgrade Center. With these initiatives and continued efficiencies in CernerWorks, we are striving to reduce the effort of implementing and operating our systems in half, by the end of this decade. Collectively, these improvements in quality and total cost of ownership have, and will continue to, positively impact our success in the marketplace. We believe reducing client's TCO will provide Cerner with a competitive advantage in all settings around the globe, as we further distinguish our ability to create value for clients.

Looking ahead at 2007, a major focus of ours will be on worldwide execution. Operationally, we will focus on expanding the benefits of the initiatives I've discussed that are designed to lower the total cost of ownership. Our focus on this, coupled with the Millennium release being well received, should translate into continued strengthening of our competitive position, which will help our sales organization in continuing our long history of strong, top line growth. Financially, you will see continued focus on expanding operating margins and generating free cash flow. On the strategic initiative front, I will personally be taking a direct role in two of our new growth engines. One of these areas' focus will be on -- will be taking our CareAware RX station dispensing devices and MD Bus to market, through a newly formed organization called DeviceWorks.

The level of interest in CareAware has continued to build, and clients are telling us we can't bring it to market fast enough. Our clients recognize that their Cerner Millennium EMR will be the single source of truth for the complex physician, pharmacist, nurse interaction that occurs during the medication process of ordering, dispensing, and administration. The CareAware RX station device is at all times aware of the right person, drug, dose, route of administration, and time for a medication order, as well as who is assigned to administer the medication. Our competitors' devices require a cumbersome work flow for the hospital staff in dual maintenance of formula and information, a potential source of error and delay. As for our roll out status, we've made good progress working with our CareAware alpha client and have a strong pipeline of prospects. We expect to be shipping units more broadly by late this year.

The second area of my focus in 2007 will be formalizing a group called Health-E Employers to focus on Cerner solutions for employers. Employers finance a great deal of the healthcare in the United States. They represent millions of healthcare consumers and represent a great potential market for innovative Cerner solutions. As an employer, Cerner has already made great strides in demonstrating the ability to remove friction from the healthcare system. Like many companies in the U.S., Cerner is a self-insured employer. In 2006, we eliminated our insurance company third party administrator, and became the first employer to utilize the Health-E exchange. This approach is proving to take friction out the process of paying providers, with 90% of our associates' claims being paid within ten days. In addition, it is driving health plan related administrative cost savings of 20%. We believe other employers will find this savings opportunity attractive. We also plan to franchise our Cerner Health-E Employer based clinic model, as we believe other employers will find the productivity and cost savings we have achieved to be compelling reasons to adopt our approach.

Another area of increased focus for 2007 is our Light House consulting practice. As more of our clients create truly digital hospitals, they will see the significant opportunity to use our Light House clinical process optimization to fully reap the benefits of the investments they have made in technology. From an organizational structural standpoint, we are further emphasizing our approach of aligning client results executives, of all major clients, because of the constant feedback from our clients that they like having a single point of contact for all elements of their Cerner relationship. We will continue to have a separate group focused on developing new client relationships. We are also creating more streamlined organizations for sales and services for the several thousand clients we have that are valuable to us and need our daily attention, such as home health, Cerner Classic and single solution Millenium clients. With that I'll turn the call over to Trace Devanny.

Thanks, Paul. Good afternoon. Today I'd like to discuss several topics: our global business, our position practice business, our Health-E Governments organization, and an exciting new acquisition, Etreby Computer Company, that we announced earlier today. On the global front, we have another banner year. In England, we finished the year in a great position. We continue to provide the software for the national [shoes] and book scheduling system, which exceeded the 2 million bookings milestone during 2006. We also won a new contract with European consulting firm, [HS] Origin, to provide an imaging diagnostic solution in the southwest and northwest of England. And as you know, we are the software provider for approximately 40% of the country, with NH contracts for the south of England and more recently the city of London.

I would also like to mention as widely reported in the British press, there have been delays in bringing some trusts live in the southern region. These delays are primarily related to requests for further testing, the holiday period, and a recent NHS reorganization. We have been working closely with the trust, Fujitsu and the NHS, to ensure progress with the testing, and while we're all disappointed with the impact on the deployment schedule, it has a relatively small affect on the broader scope of the overall project. We remain confident in our ability to deliver significant clinical value, and we will continue to keep you posted on our progress.

While the national contracts in England get most of the headlines, we also had our best year of sales in the United Kingdom outside of these contracts, and a very strong performance across the globe. In France, we finished the year with good momentum by signing another academic medical center in Q4. We also had a strong year in Australia, expending our presence and ending the year as the state-wide system clinical IT provider for the two largest states, Victoria and New South Wales. We also made solid progress in the Middle East, Malaysia, and Canada. To put our global momentum in prospective, consider that just five years ago, only 4% of our revenue came from outside of the U.S. In 2006, 15% of our revenue came from the global markets. And this has occurred during a time when our domestic revenue has grown at a robust 17% compound annual growth rate.

I also want to comment on our PowerWorks physician practice business. 2006 was the second year of our PowerWorks organization, and it too had several major accomplishments. We went to market with our 595 per physician per month single price point for automating a physician practice front office, their clinical work flow to include an electronic medical record in their back office. We revamped our sales approach for this market to fit this low cost model, using a newly created telemarketing and telesales model. We redesigned our implementations approach utilizing a teleservice model, as well as a web-based training approach that significantly reduces, and in some cases eliminates the need for on-site implementation personnel. And we developed a much lower cost of operation by leveraging our CernerWorks hosting organization. This work is starting to pay off in the form of steadily increasing levels of new physician practice footprints. In addition, this approach has caught the attention of many of our large acute care clients, who are looking to sponsor or directly offer this approach to their physician communities. This momentum has led to substantial increases in our PowerWorks top line, and positions us well going into 2007.

2006 also included progress in our state and local government initiatives, which we operate through our Health-E Governments organization. In Tennessee, our partner Shared Health expanded the number of lives covered by our community health records to nearly 2 million people. We did so by adding commercially insured live to the already included medicaid recipients. We also launched similar initiatives in Kansas, Florida, and Oklahoma. With the next presidential race already starting to heat up, it is clear that healthcare will be an important topic. We expect healthcare information technology to be a core part of every candidate's platform, and currently many governors have announced programs to improve healthcare, make it more accessible, and most importantly, more affordable.

Before closing the call, I'd like to comment on the acquisition of Etreby Computer Company that we announced earlier today. For more than two decades, Cerner has developed and provided technology solutions for pharmacies associated with hospitals and health systems. Today Cerner employs more than 50 pharmacists who are committed to developing and implementing solutions and services that are tailored to meet the specific needs of pharmacists and patients. Etreby Computer Company bring retail pharmacy solutions for the independent grocery-based and chain pharmacies. They have a 25-year history of developing and selling a comprehensive suite of retail pharmacy management solutions on a single platform.

Etreby is a well run company with strong margins, a high percentage of recurring revenue, and more than 1200 installed pharmacies. A retail pharmacy plays an important role in community healthcare, not only because of the physical dispensing of medication, but because they touch millions of consumers through condition management, patient education, patient safety, and now through emerging in-store clinics. Growth drivers for retail pharmacy IT include Medicare Part D requirements, a shortage of pharmacists, diverging state regulatory requirements, and the adoption of pharmacy automation technology. We are proud to welcome Etreby clients and associates to Cerner Corporation.

In closing I think you can tell we have a lot going on at Cerner. We are very pleased with our results in 2006 and feel well positioned for successful execution in 2007. We expect to continue moving boundaries as we transform Cerner from a leading healthcare IT Company to a leading healthcare and IT Company. With that, I will open it up for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Ross Muken with Deutsche Bank. Please proceed.

Hey, guys. It is actually Mike here for Ross. First of all, congratulations on another strong quarter and especially on the top line growth. One thing I want to get into a little bit further is on your update on the CareAware station. I know that you said that you really should start shipping them later in the year, but when do you expect for that really to be a meaningful impact on revenue?

This is Marc. Relative to revenue, obviously, the initial shipments won't be a big impact to revenue. So today we would tell you that in '07, we wouldn't expect to see a large top line impact from cabinets. We would expect it to ramp up in '08, and can give you kind of more guidance towards the second half of the year of what those expectations are. But '07 is primarily just kind of getting to market, not a big top line impact.

Okay. And then just one other question. I know during the last quarter we had actually talked about the Cerner LifeSciences effort. I was just wondering if you had any updates on that in terms of how that is going and where you guys plan on driving that going forward.

Yes. This is Paul. We continue to have a lot of conversations with a number of different people around what I consider is the LifeSciences, I consider that to be devices. So the implantable device industry is pharma, and it's also the research element that many clients are talking to us about. With a number of the different things we're working on, the number of different initiatives around the genomics pieces, we're getting quite a bit of traction with our Millennium Helix application, as well as some of the other solutions that we're bringing to bear. But there's a pretty wide, if you will, net or web we've cast out there across the entire industry to have a lot of meaningful discussions with folks. We're pretty pleased with where that business got kicked off last year. It's been going on for a number of years, but the results from last year, is what -- as well as what we have teed up for this year in that regard.

All right. Well, you know that covers both our spaces so we're happy to hear that. Great. Thanks again, guys.

Your next question comes from the line of [John Green] with Merrill Lynch. Go ahead, sir.

Thanks, and nice quarter also. Just first quick on the tax rate benefits that you saw in the quarter. Is any of that sustainable as we go into '07? And then, secondly, on this idea of franchising the clinic model under the Health-E Employers, is that something you're doing totally in-house or are you partnering there, or just how do you think about running that going forward? Thanks.

Just a quick one on the tax. We think a portion of that is sustainable, John. So if we want to look at '07, we think a 38% tax rate is something -- is what we would model going forward.

And on the clinic piece, we expect to be turn-keying that ourselves. So as we take our clinic, and we are showing lots of people how it works and the benefit that we're having from a productivity standpoint, and the benefits we're getting from a -- that being perceived from our associates as an over-all healthcare benefit to them, that's being pretty well received in the marketplace. And our approach is different than the other normal traditional suppliers in that regard. And we're bidding on a number of employer-based clinics today, and we expect to prevail there, and we will do that as a turn-key, including the hiring of those people, and in some cases we'll partner with Cerner clients, provider clients that are out there in the marketplace. We'll be as flexible as we need to be, but we want to be the prime contractor in those endeavors.

Great. Thanks very much.

You bet.

Your next question comes from the line of Atif Rahim with JPMorgan.

Hi, Paul. Just as a follow up to the previous question. You say you're bidding on a number of those employer-based clinics. Does that mean, are you looking to acquire them, or would it just be contracts with them and then have a separate follow up?

Contracts with them, and specifically, there are -- there has been a quite a big interest in this. I don't think it's necessarily new, but our approach to it is different, and we're out proactively presenting this to people, as well was there are some RPs that were actually out in the marketplace that we're now in on. And we expect to prevail on some of those this year.

Okay. And then separately, just on the UK contract, Marc, I think you said the London region is somewhere in the $300 million range. Is that 300 to 400? Could you narrow that perhaps? And then the revenue that you expect, could you break that out between the revenues that you expect in 2007? Could you break that out between the London region and the southern region, if possible? Thanks.

The number I gave of 300 is probably as narrow a range as we would provide, relative to the contract. I think that's a pretty accurate number for people to use, and relative to the revenue, we will not be breaking out the two separate. In our mind, those are ongoing projects, and the difference between the revenue in either one of them is not relevant, necessarily, we don't think, as you look and analyze the financials. So we'll be reporting that number kind of as a single number. But we wouldn't plan on breaking that between BT and the southern cluster at this point, anyway.

Okay. And then the margin expectations for the London region, does that also kick in around '08?

Our expectation would be that the goal would be to obviously keep the IP very similar in both regions. And if we are successful in that, then delivery of the IP should be on a similar schedule for both regions, since delivery of IP is the key element that kicks off margin recognition. That would put those together relative to the expected time frame when that occurs.

Okay. And is that mid '08?

We would -- indicated that we would expect '08 to be the delivery time frame.

Okay. Thank you.

Gentlemen, your next question comes from the line of George Hill with Leerink Swann. Please go ahead.

Hey guys, good afternoon. Marc, I'll jump in with some number questions first. You had said that some CapEx slipped from '06 to '07. Are you guys still targeting $100 million in free cash flow in '07?

I think based on the fact that we were looking at, kind of, going into the two-year period, spending somewhere between around $280 million, only spent $130 million of that in '06 is obviously going to make throwing off $100 million in cash flow, if you include all spending including buildings in '07, unlikely. Clearly if you exclude the buildings in '06, we delivered $100 million in cash flow. We expect to do the same in '07. You will see improvement in our free cash flow over '06, even with a higher CapEx spend.

Okay.

But I think '08 is when we would look to really drive those -- the free cash flow, given the deferral that we've seen in some of the major spending that we thought would kick off in '06 a little bit more heavily.

Okay. And in a recent investor presentation, you guys highlighted that you are still targeting what I'll call a 19% EBITDA margin on an apples-to-apples basis for Q4, and a 20% in '08. Could you talk a little bit about the ramp of the EBITDA margin through the course of the year? Should it be straight line type of lumpiness, we should say?

I think at this point, George, the -- our history is that, our HIMSS update that we do in -- relative to investor meetings, it ends on, I believe, it's the 27th of February, we'll take you through in detail, but the paths are 20% operating margins and the EBITDA margins. We are still committed and believe on track to get to the 20% operating margins. But that's the time when we've had time to go back and really lay it out for investors and give you an up close view of that. So not meaning to dodge the question, but I think we will spend a lot of time at that meeting going through that.

Fair enough. Then I'll just sneak one more in. Total R&D growth was a little lower than I was looking for during the quarter. I would assume part of that is tied to the Millenium '07 being GA. Should we expect to see more leverage in the R&D line in 2007?

I think you will. I think the spending that you saw in '06 is something that you'll see rolling forward.

Good deal. All right. Thank you very much.

Your next question comes from the line of Steve Halper with Thomas Weisel. Please proceed.

Just to focus a little bit on the free cash flow, and it sounds like you're definitely backing off the 2007 number, what certainty can you provide us that, in 2007, we're pretty much done with the major capital projects?

Yes, hello Steve, this is Marc. When you look at what we're doing, relative to basically adding 750,000 square feet of office space to the Company, which certainly sets us, from a housing of associates in Kansas City perspective, puts us in great shape relative to that. So spending more money in Kansas City on housing our associates, which has always been an issue for us to make sure we had enough room, this gives us not only room to house them today, but gives us plenty of room for growth, relative to housing associates. So that's one thing that I don't have to worry about post 2007.

And then obviously the data center spend is a huge dollar amount that's adding significant capacity to our ability to host solutions. So that, once again, is a major spend that should be done, and we expect that to be able to fund that, from a space standpoint, be able to house that business for a period of time. Obviously, the more business we get in managed services, the shorter that time could be. But we should be set relative to '08. There's nothing on our longer term capital plan that comes into play, other than just modest increases in some of our global offices that are basically lease space.

All right. Is the office space going to be on the campus in Kansas City or outside of it?

The office space in Kansas City is basically creating another campus which will house our R&D organization. So it will basically create what we're calling an innovation campus. So it is not continuous with the world headquarter campus, but it will be a very exciting place to see the creation of software. We're talking pony tails and blue jeans, and your typical IP organization. And that's what you want in this business. You've got a -- we have to attract those new young software engineers, which we're seeing fewer and fewer of those coming out of college every year. We already have kind of an athletic center and daycare on our site here. But that's going to have all of those elements, plus some very cool things that you see that are state-of-the-art relative to attracting those types of people. So, it's not on this campus, but it's very close. It's probably 15 minutes away, so --

Okay. And the last question is, do you have a cabinet live yet with a customer?

No. Very shortly.

Does that mean this month?

Steve, we're probably not prepared to give a specific day relative to those. We've indicated we're going to make sure we get these things right. Obviously, our alpha clients are eager to get their test boxes in, and we'll be placing those in the first half of the year in preparation of basically moving that to a GA status at the end of -- toward the end of this year.

Okay. Thanks.

Your next question comes from the line of Glenn Garmont with First Albany Capital.

Hi. Just if we were to sort of deconstruct your bookings in the quarter, can you give us a little more detail about the specific modules, the specific products that are selling, and maybe how that's evolved over the past couple of quarters?

This is Paul. As I said in the comments, the overall -- what we're seeing in Company across the globe is that CPOA still continues to be hot, the acute care marketplace is hot. The ambulatory marketplace is hot, and there's just a lot of activity everywhere we look. When you look at 18 contracts over $5 million, nine of which over $10 million, it's a lot of activity that's out there. So we're not seeing a particular weakness, quite frankly, anywhere. The lab information systems, we talk about that on an annual basis. That had another great year.

So if you go back to the, if you will, to the solution that started the Company, we continue to see growth in stand alone laboratory information system business. The breadth and depth of what we do is pretty remarkable. And there's a lot of business that's out there that's new, a lot of business that's replacement business, and we're continuing because of our implementation and deployment strategy, and have a lot of systems in production, you're getting a lot of cross sell opportunities into the base. I think we've said in the past, our average Millenium client has about six applications implemented, and we have a menu of which they could have 60. So we have about a 10% penetration in our own base and the rest of the marketplace is still out there.

Okay. And then just to follow up, I think, also, in your prepared remarks, Paul, you mentioned 21% of bookings were sort of new Cerner footprint clients. Are these competitive swap outs, or are these customers that hadn't been using systems in the past?

In this day and age, it's actually -- it's pretty hard to find somebody that doesn't have some element of their organization, whether it's inpatient or outpatient, already automated. So to do a complete swap out, in some cases we are doing that. In other cases they have -- let's say they have seven or eight applications. Let's say it's a community hospital, and they might have seven or eight different departments that are automated, and we're going to go in, if you will, digitize the entire house.

On the ambulatory side, on the outpatient side, we are going in and seeing a lot of places that may have a practice management solution already in there, but they don't have an EMR, and they're swapping both of those -- swapping the practice management out in order to put in our integrated practice management EMR, and have us host it and run it for them. Our hosting business is driving a lot of sales force, both with installed base as well as with new, and that's a pretty important key distinguishing feature that we have that most of our other competitors don't have. And you heard my statistics on the up time, the reliability and the performance of an installed Cerner client today that we're hosting is pretty solid.

Okay. That's all, Paul. Thank you.

All right.

Your next question comes from the line of Richard Close with Jefferies. Please go ahead.

All right. Thank you. First question, I guess, Paul, you said something about cutting in half the time to implement by the end of the decade. I was wondering if you could quickly remind us how that has progressed over the last several years.

I don't have specific data on how it's progressed over the last couple years, but our initiative there encompasses a broad variety of things inside the Company. So one is our deployment methodology, which we call Method M, which is a different approach to how we work with clients to implement our solutions. Secondly, with Bedrock, that removes a bunch of the work that we had to do and that the client had to do in order to actually build the database and maintain the database. We think that's a key element of our total cost of ownership. Third element of that is from a total cost of ownership visibility for us to help client and perform a lot of the work around upgrading systems. So a client that has a version that's two or three years old, we will actually perform a substantial portion of that upgrade for them so that all they have to do is do the final testing and do the validation that, in fact, the system is performing in processing all the clinical transactions in the manner that it was supposed to be doing.

And last but not least, on the total cost of ownership, as we continue to host our own systems, we continually work to take out cost elements of that, because those cost elements that we are paying a third party, are the same cost elements that our clients would be paying a third party. So any time that we can get a cheaper infrastructure spend for our data center or for our clients, that reduces the cost. So we are making great strides towards that overall total cost of ownership reduction of 50%, and it is foremost on a number of key executives' minds to, in the IT organization, to bring that to fruition.

Okay. And maybe if you could talk a little bit about customer service or customer satisfaction. Any commentary around that, how that's -- any feedback you've been getting?

Yes, the clients are, as I mentioned in the script, pretty pleased with how we're doing with the single point of accountability. So we assign an executive. We call them client results executives, and the emphasis on results. We want the person that has accountability for that client to have accountability for delivering results on behalf Cerner for that client. That has -- that structure and that strategy for us has worked -- proved to be very effective. There is a whole host of strategies that surround that, but a single point of accountability and empowering that person on the front line to be aligned at the strategy level, as well as a tactical level, has proven to be pretty important, and our clients are pleased with that, and the install base is responding by getting more systems turning on, and, quite frankly, spending money, and paying their bills faster.

Okay. And I guess one final question is, you classified everything being hot, quote, unquote. I was wondering if you could just elaborate how long you think this hot market lasts, and is going into the devices and the clinics and all of that sort of an indication that this hot market is about over?

Not at all. I think that the market -- as our domestic revenue grows 12%, as Trace talked about, there is a bunch of activities around the globe that we're working on, and we're prevailing very well there. And in our domestic marketplace, there is still a very big marketplace, as I talked about earlier. I think that the ability for the Cerner Corporation to be a multi-billion dollar Company is also predicated on the fact that our ability to expand into new net addressable opportunities, which is what we will and it's always been a hallmark of the Company. We've done that over the course of the last 27 years, and we will continue to do that.

We think the devices, as an example, are a natural extension of the EMR as being the single source of truth. And many people, whether that's the cabinets, or whether it's people that want to connect their monitoring system to ours, there's a lot of opportunities, both inpatient, outpatient, implantibles, and pharma, to have this single source of truth in a network of connectivity that will deliver better patient outcomes.

Great, thank you. Congratulations.

Thank you.

Your next question comes from the line of [Dashan Bartrolic] with Cannacord Adams. Please proceed.

Hi, thank you. I wanted to also touch on the operating margin topic. At this point, how would you rate your performance of getting to that 20% target or maybe, in other words, are you where you thought you would be at this stage?

Yes, this is Marc. We are -- we indicated, I think, in our comments that if we looked at our original path we laid out, we're about 60 basis points behind that path today. So I think, as far as rating our performance, I probably look at -- that's the path we established for operating margins. The reason we have a path for operating margins is to grow earnings, and over the last three years we've grown earnings, basically, over 30% each year. So I think the results that we're looking for, earnings growth, is being delivered.

Actually, I'm pleased that if we can deliver that level of earnings growth and still be moving our margins up, there's still room for expansion. We will get to 20% operating margins. So the fact that we're 60 basis points behind and still hitting our earnings targets means I've got 60 basis points more room to go use to grow earnings going forward. So we're very clear. As I indicated earlier, when we do our HIMSS analyst meeting, we'll lay out and give you very much, here we are relative to the path, and here is what we expect going forward. So we try to be very transparent, and we're saying we're slightly behind, but we are really pleased with the net results on the earnings line.

Okay. And just one more quick one, and that is on the physician practice space, whether you're seeing any possible impact from the Stark Law revisions at all to your business?

Yes. Dashan, this is Trace, and I would tell you we are seeing some impact from the Stark Laws. I think the provider organizations have become much more interested in reaching out to their community physician -- the community of physicians, and we think the Stark Law, loosening the Stark Laws has really helped motivate them to faster discussions. So that's, I mean, that's been, in part, a driver for the increase in our ambulatory success in 2006.

Great. Thank you.

Your next question comes from the line of Anthony Vendetti with Maxim Group. Please go ahead.

Thank you. Marc, I was wondering if you could talk a little bit about the timing, I know we've discussed this before, but a little bit of the timing of when the UK contracts will switch into a, and I think this is some time in '08, will switch into a positive cash flow situation?

Yes, the -- relative to the UK contracts, as we've discussed, the two elements, obviously, revenue equal expense on the income statement, as we move forward, with no margin being recognized until we fully deliver the IP. On the cash side, each of those R1, R2, R3 deliverables, brings with it a large chunk of cash. So as we go forward, our expectation, which is being born out in reality, is that we would have some working capital requirements kind of in the first two years of those contracts, while we deliver the IP and get those large payments. But in -- what we would expect to see is in 2008, both full delivery of the IP, triggering the margins, plus basically going cash flow positive on those deals because of the delivery of the IP. So very much tied in together relative to those two positive items happening.

Okay. And right now that's just some time in '08? Nothing more specific at this point?

Don't have anything more specific at this point. We'll continue to update as we get closer and have any dates established. But that's our expectation currently.

Okay. And then one last question, maybe for Paul. If you could talk a little bit about the opportunity relative to the other clusters that you're not a subcontractor for, where Eye-Soft is a subcontractor. Is there a possibility or could you at least elaborate on what you think the opportunity is there potentially in any one of those clusters for you?

Yes, and this is Trace. I'll take a crack at that one. First of all, let me say again, as I've said in the past, we're very pleased to be a part of the largest healthcare IT project in the world, and I think we're very proud of the fact that we've been selected to do business in both the southern cluster in the south of England, as well as London. We think our performance will speak for itself over time, and to answer your question specifically, yes, we will have opportunities outside the core contracts that we have won with our partners, Fujitsu and British Telecom, for additional business opportunities. We think that will also bode well for us, in not only other parts of the United Kingdom, but in broadly across Europe and the rest of the world as well.

Okay, excellent. Thanks.

Your next question comes from the line Duane Pfennigwerth with Raymond James. Please go ahead.

Thanks for taking the question. Wondering if you've seen any change in the competitive position relative to Epic, in light of their publicized issues with Kaiser or based on your sort of repositioning based on total cost of implementation?

Yes, this is Paul. You know, as I make three or four things -- points, number one: 21% of our new business dollars came out of new business from -- 21% of our money came out of new business dollars last year. The PowerWorks business is growing, it's strong. That's our ability to take and offer a practice management system and an EMR, put it together and offer that up through our CernerWorks organization or remotely host that. Our 2007 release, we think, is very, very competitive. The work that we did on process modeling to present a new user interface for physicians and nurses and all caregivers has been pretty widely received in demonstrations, as well as when the clients have put it in. So I think our competitiveness overall has become even stronger than it has historically been, it's become even stronger as we enter into the year.

I think that specifically in response to your question, I think they -- this Company is now a bigger Company than they were four or five years ago, and we -- the question will be can a big Company continue to distinguish itself as a small Company? The points they always make are that they are a small Company and now they're actually a lot larger than that. So it will be interesting. It's a great country of lots of competitors. It's a big marketplace. There's a lot of markets that are doing extraordinarily well, and we'll see lots of competitors over the course of the next decade.

Are you feeling more optimistic about your relative position?

We have high expectations that we will do extremely well every time we compete.

Great. Marc, just wondering if you can give me D&A for the quarter.

Yes, I should be able to. Why don't we go to the next question, and I'll get that and --

Sure. Wondered if you'd just give out a head count number, what it was at the end of the year versus last quarter and versus this time last year.

I will do that as well.

Sorry.

You're making me do homework here. Okay, why don't we go ahead -- why don't we take -- the D&A is $36 million, and head count at the end of the year was 7400. A year ago was probably about 6900.

And your next question comes from the line of Sandy Draper with JMP Securities.

Thanks. Just a couple of quick questions. Marc, I think you said this in your prepared remarks and I missed it. A what was the actual UK revenue in the quarter?

$25 million.

How much?

$25 million.

$25 million. Okay. Great. And on the hardware, you commented that it was higher. Is that, you think, is a focus from Cerner? Is that a push from the customers, or could it be just as you're growing internationally, there's more hardware needs internationally? Just trying to understand. Is that something sustainable? Or are we sort of hitting the two or three quarter bubble of hardware, and it would expect to go back down?

I think we've traditionally seen Q4 be kind of strong, relative to hardware, Sandy. It is primarily a U.S. phenomena. Most of those sales are in the U.S. Given our hosting business, which does not bring with it hardware sales, a lot of those hardware sells are back into our install base who are hosting their own solutions, but it tends to be something that they've got budgetary ability to go buy some. So they expand their platform by purchasing hardware. So I think you'll continue to see our focus on that.

You have to remember back in '04, we kind of took away a little bit of focus on trying to sell hardware because of the lower margins. We reversed that effectively in '05, and are continuing that reversal in '06. Because, in our opinion, any margin we get on hardware is still bottom line earnings, and we should go and take all of that that we possibly can, plus it brings with it the maintenance stream that's nice relative to the hardware sales, that's even more profitable than the margin from hardware.

Okay. Great. And two other quick questions. One, the software amortization stepped up, as you'd expect, with the release. So is this a level of, I think you said 13 - 1 or 13 - 3 and a quarter, so at that level are we going to see a couple steps ups in '07 of software amortization as you hit new releases, or how should I be thinking about that trajectory?

Keep in mind we expect to have releases more on an annualized basis. So you'll see impact on that when you, kind of, when you see a new release come out, which isn't going to -- certainly not scheduled for any time in the first part of 2008. So what you see this quarter, 13 - 3, it will actually be what you see in Q1 and Q2 and basically should be the plan that you would put into the model relative to 2007 for each quarter at this point.

Okay. And then the final, just to make sure I understand. The total -- so what would your estimated total CapEx be, and then what, for '07 what was the break out again between sort of normal CapEx and then the buildings?

We basically indicated that our total CapEx this year is about $130 million. But we think that will go up a little bit. And we said that we looked in the two-year period, around $280 million. So that would mean that there's about $150 million that would be flowing into '07. We didn't have a breakdown that we provided at this point, Sandy.

Okay. Great. Thank you.

Why don't we take -- I know we're past time, but why don't we take one more call?

Your last question comes from the line of Frank Sparacino with First Analysis.

Hi, guys. Just curious on the physician side, if the size of the practice has changed and sort of where that's at right now?

Yes, Frank, this is Trace. We continue to see broad based interest in our 595 per physician per month offering. So anywhere from single practitioners all the way up to very large complex clinics associated with integrated delivery networks and academic medical centers. So it spans the spectrum. I think the points I made in my comments about our reducing the cost to do business in that high volume model has been a very effective strategy for us in 2006, and we expect to continue to leverage that -- those capabilities in 2007.

Any other questions? Yes, let me make just a couple of quick closing comments. 2006 was a great year for Cerner both in the global and U.S. marketplace. Our continued commitment to our unified millennium architecture has allowed us to continue to expand our level of innovation across the continuum of care. As we've said in the past, and as you'll hear us continue to say in the next few years, it will be difficult to describe Cerner as a U.S. based IT Company, but rather a global healthcare Company. Look for 2007 to be a year of focused execution, we expect to continue to perform. Thanks very much for joining us today, and make it a great new year.

Thank you for attending today's conference. This concludes the presentation. You may now disconnect. Good day.