塞納 (CERN) 2007 Q3 法說會逐字稿

Welcome to the Cerner Corporation's third quarter 2007 conference call.

Today's date is October 18, 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, perspectives and prospects constitute forward-looking statements for the purpose of the Safe Harbor provision of the Security & Litigations 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 statement may be found under the heading "Risk Factors" under 1A in Cerner's Form 10-K, together with other reports that are filed with the SEC.

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

Thank you, Katina. Good afternoon, everyone, and welcome to the call.

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

Now I will turn to the Q3 results. In summary, our results included bookings and revenue that were below our projections primarily due to a large sequential and year-over-year decline in hardware, however, the lower hardware only impacted the revenue and bookings as we still delivered strong gross margins and operating margins with both at record levels as a percent of revenue. We view this ability to drive strong earnings despite some lumpiness of bookings revenue as reflective of the increasing maturity and diversity of the business models.

Moving to bookings. Our total bookings revenue was $356.7 million, which is basically flat compared to last year, and is about $8 million below our guidance. As I mentioned we had much lower contribution of hardware in Q3 which led to the slightly lower level of bookings. The flow through of the lower hardware is reflected in record gross margins which I will discuss in a minute.

Further, recall that we had significant bookings over attainment in the first two quarters. So year-to-date bookings growth is still strong at 19%. Bookings margin in the quarter was $313.2 million, or 88% of bookings revenue, again, a higher percent than historical levels because of lower hardware.

Moving to backlog, our total backlog increased 31% year-over-year and ended the quarter at $3.12 billion. Contract revenue backlog ended the quarter at $2.59 billion, which is 34% higher than a year ago and is another indication of our strong year-to-date bookings performance. Support revenue backlog was $528.9 million.

From a top line perspective, our revenue increased 8% over Q3 of '06 to $372.9 million, the revenue composition was $115.3 million in system sales, $102.1 million in support and maintenance, $147 million in services, and $8.5 million in reimbursed travel. System sales revenue was down 8% compared to Q3 '06, drive by the significant decline in hardware sales to a multi-year low during the quarter. For perspective, note that hardware revenue was more than $20 million lower than our record Q2 hardware levels, accounting for essentially all of the difference between our results and guidance. As we discussed last quarter, these sales can be lumpy, but they generally don't significantly impact our targeted gross margin dollars.

Services revenue grew 19% compared to the year ago quarter driven by continued strong managed services and professional services growth. Support and maintenance revenue grew 17%. My gross margin for Q3 was 84.5%, which is up 470 basis points from a year ago and 540 basis points from Q2, due to the lower level of hardware sales. This impact is more pronounced when you look specifically at the system sales margin, which increased from 57.3% in Q2 of '07, to 70.6% this quarter.

Both gross margin and system sales margin are all time highs. This strength in margin is also reflected in the gross of gross margin dollars which increased 14%, well above the 8% growth in revenue. Our operating expenses before option expense in Q3 were $254.4 million, which is up 12% over a year ago, with professional services and managed services growth being the primary drivers.

Moving to earnings our GAAP net earnings in Q3 were $35.8 million, or $0.43 per diluted share. GAAP net earnings include stock options expense, which had a net impact on earnings of $2.6 million or $0.03 per share. Adjusted net earnings were $38.4 million, which is 30% higher than Q3 of last year. Our adjusted EPS was $0.46, which is $0.01 higher than the consensus estimate and our guidance range. Please refer to our press release and Form 8K for a reconciliation of GAAP earnings to adjusted earnings.

Our operating margin before options expense in Q3 was 16.3%. This quarter our operating margin was impacted by about 110 basis points due to approximately $25 million at zero margin revenue from our projects in Southern England and London with Fujitsu and BT. Our Q3 operating margin without this revenue was 17.4% which is up 260 basis points compared to Q3 of last year.

Now I will move to our balance sheet. We ended Q3 with $308 million of cash and short term investments. Total debt was $205 million. Total accounts receivable ended Q3 at $366 million, which is flat compared to last quarter. Contract receivables or the unbilled portion of the receivables were $141 million, or 38% of total receivables which is up from 33% last quarter.

Our DSO was 89 days in Q3, which is down four days compared to a year ago and up three days from Q2. Third party financings were $21 million, or 5% of the $402 million of total cash collections. Operating cash flow for the quarter was $80 million, which is up from $63 million in Q2, and $53 million a year ago, and brings our year-to-date operating cash flow growth to 14%.

Q3 capital expenditures were $49 million, including the $15 million of property expenditures related primarily to our new data center and new building. Capitalized software in Q3 was $17 million. Free cash flow defined as operating cash flow less capital expenditures and capitalized software was $14 million. Free cash flow before property expenditures was $29 million. This improvement in free cash flow is consistent with what we communicated last quarter and we expect continued improvement in Q4 and 2008 as capital expenditures moderate.

Moving to capitalized software, the $16.9 million of capitalized software in Q3 represents 24% of the $69.1 million of total spending on development activities. Software amortization for the quarter was $13.4 million, resulting in net capitalization of $3.5 million or 5% of the total. Going forward, we expect the net capitalization rate to remain in the low single digits.

One note regarding software capitalization, as Jeff will discuss, we are going to do some additional development using the Millennium 2007 code set as a base. This approach will likely push the next major release out beyond 2008, however, there will be some amortization triggered as the functionality we add to Millennium 2007 becomes generally available. Because these will be short release cycles, the amount of amortization increases will come in small increments and should not have a major impact on any one period. I will continue to update you on this as we move forward.

Now I will go through the guidance. Looking at Q4 revenue, we expect revenue in the $405 million to $415 million range which is approximately 9% higher than Q4 '06. This brings full year 2007 revenue to between $1.53 billion, and $1.54 billion, which reflects growth of 11% to 12%. This full year guidance is about $20 million lower than our previous guidance due to the lower hardware revenue in this quarter. We expect Q4 EPS before options expense to be $0.50 to $0.51 per share which reflects growth in the mid-20% range.

The Q4 guidance is based on total spending before options expense of around $255 million to $260 million. This guidance brings EPS before options expense for the full year 2007 to $1.73 to $1.74, with the high end of the range, reflecting $0.01 increase for more consensus was the last time we provided guidance. Our estimate for options expense for Q4 '07 and 2007, is approximately $0.04 and $0.13 per share respectively. This brings Q4 '07 GAAP EPS to a range of $0.46 to $0.47 and full year 2007 GAAP EPS to a range of $1.60 to $1.61.

For bookings we expect bookings revenue in Q4 of $380 million to $400 million, which is in the range of the all time high level of $389 million of adjusted bookings in Q4 '06. Note that unadjusted bookings in Q4 '06 were $543 million and included $154 million booking related to the London region of the national program for IT. Attaining this guidance range would put us at a full year bookings growth of 12% to 14%.

Finally we are in early planning stages for 2008 and as in the past, I want to provide you an initial view of our outlook. Currently we are still looking at top line growth in low double digit range, and earnings growth in the 20% to 25% range. This is consistent with what we have laid out in our long-term revenue and margin expansion goals and is also in line with current consensus estimates.

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

Okay. Thank you, Marc. Good afternoon, all.

Today I'm going to cover sales and operational highlights, market place trends and our recent health conference event. From a sales perspective, we had a solid quarter with a lower level of hardware sales being the exception. Our contract volume was very high in Q3 with a record 391 contracts, 14 of these contracts were over $5 million, eight of which were over $10 million. 24% of contract bookings were for new Millennium footprints. This is up from 15% last quarter due to solid performance from our client development organization.

From a leading indicator standpoint we continue to see strong levels of vision center visits, site visits and RFP activity and our pipeline remains strong with a continued strong level of new footprint opportunities over the next several quarters. We also had excellent attendance at our health conference and received great feedback from our clients which I will discuss in just a minute. Operationally we had a strong quarter of execution in our professional services organization. We turned on a record 458 Cerner Millennium applications, bringing our cumulative conversions of applications to more than 7,200 at over 1,200 facilities. The go-lives included another 12 acute care CPOE sites bringing our industry leading total to 147. This was a record for us in terms CPOE go-lives in a given quarter.

As I have mentioned not only do we have the largest number of clients live on CPOE but we believe our clients are deriving more value than clients of other suppliers because, as measured by the HIMSS Analytics EMR Adoption Model, our clients are more advanced in their use of IT. We continue to extend this differentiation by raising our standards while also lowering our clients total cost of ownership by leveraging our Cerner Works hosting capabilities, our implementation tools and methodologies and initiatives like our Lights On network, which Jeff Townsend will discuss further in just a moment.

On the competitive front our progress at driving quality up and cost of ownership down, coupled with the industrial strength of our architecture and solutions puts us in a good competitive position. While there have been no major changes recently in the competitiveness of other HIT players it remains a very competitive market and we have to compete hard every day to earn business.

Looking at the overall market place, the macro environment remains favorable for healthcare IT. Most hospitals remain in solid financial condition and IT continues to be high on their priority list. Last quarter I mentioned the increased presence of pay for performance plans as one of the drivers of IT spending because these plans require reporting on safety and quality outcomes as part of the reimbursement process. Another measure that will link quality and safety directly to the economics of our clients is what we call the never-pay list.

On August 1st, CMS published its final rule for changes in the 2008 inpatient perspective payment system and beginning in October of 2008, hospitals will not receive additional payment for treatment of conditions acquired while in the hospital if the condition is deemed reasonably preventible through the application of evidence-based guidelines. This change emphasizes the importance of using a system to insure compliance with evidence-based guidelines and this is good news for Cerner as this is an area where we are leading the way.

Another part of the changes include increasing the number of DRGs by almost 40% which also increases pressure on the need for systems to document care and submit for reimbursement. These rule changes underscore the need for the integration of clinical and financial information which, again, match as Cerner's approach to the revenue cycle.

I would like to close by spending a minute discussing the just concluded Cerner health conference event. More than 6,700 total attendees from hospital clients to physician practices, industry partners to associates participated last week in an annual conference. As we returned to Kansas City, it was impossible not to be struck by how this event has evolved with client growth of 82% since the last event held in Kansas City in 2003.

This year's conference centered thematically on our role venue condition designed methodology. It also represented another strong amplification of our all together brand positioning where clients literally shared their industry leading experiences firsthand with other attendees. In fact, over the course of the week, our clients led a total of over 400 educational sessions across 27 different tracts. This total not only greatly eclipses other comparable HIT supplier events, it also exceeds the educational session counts of the largest industry events including RSNA, HIMSS, and Tepper.

We believe that the concrete learning that comes out of these sessions is one key reason that over 70% of 2,000 attendees called Cerner health conference the most important industry event that they attend. We also believe that it represents a highly beneficial cycle for the Company, elevating our strategic alignment with our current clients while solidifying a key Cerner differentiator with perspective clients as they continue to cite experience with a similar hospital as the most important supplier selection criteria.

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

Thanks, Mike. Good afternoon, everyone.

Today I would like to discuss progress in several of our business units including our international business, our physician practice business and our healthy employer and healthy government initiatives. On the global front we had another solid quarter with continued strength from multiple regions. Our momentum continues to build and thus we remain broadly optimistic around our global business.

In England we continue to make progress of bringing solutions live in the national program for IT, as a software provider in two regions, representing 40% of the country of England. Since last quarter we have brought many more solutions live at several more sites. We now have a total of 39 sites and 228 solutions live, which is up from 30 sites and 149 solutions last quarter. This is perhaps the largest IT project in the world, so it has had its share of challenges, but we are confident we will continue to make steady progress going forward.

Looking ahead, our pipeline of global opportunities remains very strong, and as I mentioned, we continue--expect continued strength from this business. Moving to our PowerWorks position practice business, our third quarter included a solid bookings performance, driven by continuing traction within our acute care client base, as they extend their Millennium PowerWorks solution at the strategic link to community-based physicians. This activity reinforces our belief that a common architecture and platform supporting both the inpatient and outpatient environments delivers strategic advantage for our clients.

On the PowerWorks implementation front, we continue to make excellent progress. In fact, last quarter we installed an EMR solution at one of our physician practices in less than a week's time. We were able to accomplish this due to our ability to leverage increasingly more effective implementation tools and our web-based training approach. We expect these improvements to become the norm, yet we still envision a point at which we can do a weekend install, which will further differentiate our offering from the competition and help accelerate the growth of our physician office client base.

We also continue to gain momentum across several of our employer focused initiatives that we have branded Healthy Employer Services. As we mentioned in previous calls, we are working closely with a Fortune 500 technology company to provide a fully automatic clinic based on our own successful on campus clinic. In addition, we have been selected by three employers to provide our healthy exchange third party administrator services or TPA. And our first client went live with our TPA services on October 1st and has gone very well so far with about 1,200 individuals now carrying the healthy card.

These people are benefiting from the same enhanced experience our associates have enjoyed since 2006 when Cerner terminated our own TPA and became the first employer to utilize the Healthy Exchange platform. We are excited about extending this important initiative to other employers as we reduce the administrative friction in their own healthcare environments.

Finally, there's been noteworthy progress with the Kansas City Care and Trust initiative, an employer driven record bank formerly known as Healthy Mid-America. Care and Trust is using our proven Millenium software to create secure web-based community health records for more than 100,000 employee's independence of 24 Kansas City are employers. Currently there are five companies representing 15,000 lives live on the network and we expect that this number will continue to grow in coming months.

The potential of Care and Trust is impressive with participating employers expecting to save $16 million through 2010. They will do so while increasing healthcare quality, reducing adverse drug reactions, medical errors, and duplicative tasks. We are also continuing to make progress on our state and local government initiatives which we operate through our Healthy Governments group.

Over the past several quarters we have generated significant momentum in this area, including an agreement with an indigent care collaborative to create a shared record for the uninsured in Austin, Texas, and surrounding communities. A contract to create a health record for all foster children enrolled in Medicaid in the State of Texas, an agreement to create personal health records for members of the Leukemia and Lymphoma Society diagnosed with multiple myeloma. A contract with the University of Utah to create a health record to better manage the State of Utah's Medicaid hemophiliac population. A contract with Missouri's Primary Care Association where we are building a health record for members served by Safety Net providers in Kansas City, St. Joseph's and Columbia, Missouri.

Continued progress on rolling out a CHR initiative in Sedgwick County, Wichita, Kansas, which now covers 200,000 Kansas Medicaid recipients. And finally we have made great strides with our juvenile diabetes initiatives which now includes nearly 12,000 children and over 700 clinicians in the network. We have recently stepped up our adoption efforts by aligning with three NFL teams through our innovative Tackle Diabetes programs. Working with the Kansas City Chiefs, the Indianapolis Colts and the Washington Redskins we expect to increase awareness, boost enrollment and improve the health status of this defined population coping with this terrible disease.

In summary, we are pleased with our progress on these employer, government and regional initiatives. Innovation is an important element in the Cerner success story and these initiatives represent a big part of our role in the transformation of the health economy. The health economy has many players, with the consumer at the core as the end user. Providers and employers and governments as drivers, and insurers, employers, think tanks, policy makers, and others acting as influences.

Our vision and strong commitment to innovation uniquely positions us at the nexus of this rapidly emerging health economy. This position enables us to create enormous value through connecting consumers and providers across care venues to advance interoperability, reducing costs and improving productivity via person-centric model with models such as our Healthy Exchange, TPA services, and Healthy Clinic, as well as Healthy Government programs. Integrated clinical and financial transactions should drive out waste and provide realtime payment with the elimination of the clipboard in physician offices, realtime eligibility checking, claims generation and payment processing, driving a fundamental shift in the health care industry.

Clearly we have a lot going on. It is all very important, and it is all very hard, and we believe there's no one better positioned to deliver strategic value to this industry than Cerner.

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

Thanks, Trace.

Today I'm going to make some brief comments on the progress we have made at creating new innovative solutions. As Mike referenced, we recently had the opportunity to showcase these capabilities to a broad cross section of our clients during joint presentations and experiences through our solutions gallery. The core of our innovation is our Cerner Millennium architecture. The depth and breadth of which provides clear differentiation for Cerner in the market place.

Last November, we delivered Cerner Millennium 2007, our largest code release on the Millennium platform to date. It included an improved user interface and new clinician work flow experience which has contributed to an increased competitiveness. The demand in our install base for this release has exceeded our expectations with more than half of the install base running on this platform by year end putting us on trajectory to have most of our install base running on a single release, a very good thing.

As a result, we have decided to use the Millennium 2007 code as a baseline for a series of smaller releases that we will target in 90 day cycles. The feedback from clients regarding this approach was very positive at our healthcare conference, as they liked the ability to gain access to new innovations more quickly in smaller amounts rather than waiting for another major release.

Unlike our competition, we are building off a decade of experience with Millennium which has been successfully deployed in complex healthcare organizations around the world. The breadth and depth of automation of clinical and financial processes is remarkable. We are at the center of the most complex processes in medicine, eliminating the errors, variance, waste, delay and friction. It is an exciting time and this approach to release management keeps both our clients and Cerner focused on constantly moving the bar. Our clients are demanding things that aren't even on the drawing board for many of our competitors and we are positioned to deliver.

Now, I would like to discuss some specific progress on the innovation front. I will start with an update on our Lights On network. This grew out of our commitment to our clients to achieve 3.9 system availability and response times less than two seconds. This network is a surveillance system to identify system performance issues in realtime, and in the future of being able to predict the issues which will create system vulnerability.

The Lights On network uses hundreds of built-in Millennium timers, measurements and audits to constantly measure system performance and end user experience for our clients 24 hours a day providing for a quick identification of and reaction to issues affecting the end user experience. It also allows for each client to benchmark their system performance with peer groups. After announcing Lights On only a year ago, we already have 270 of our largest Cerner Millennium clients connected to the network representing an estimated 15% of acute care in the US. The feedback from Lights On users have been great, and this level of transparency is unmatched in the industry.

We will continue to expand the power of the Lights On network to include realtime clinical and revenue cycle dashboards that will be critical to our clients as quality and reimbursement continue to become a more closely linked element in coming years. This will leverage already impressive work we have done in our lighthouse organization, where we have demonstrated that we have the skills and methodologies to identify whether our clients are practicing medicine appropriately, committing medical errors, inappropriately wasting resources from unnecessary or redundant tests or causing patients needless delays in getting the correct diagnosis for their medical conditions. These capabilities, combined together will create the potential for realtime evidence-based network.

In addition, the potential reach of these capabilities goes well beyond the care delivery setting. We believe we are entering an era where the FDA will be pressured to have a system of active pharmaco vigilance. This era will be completely dependent on a digitized health care delivery system and Cerner is a core enabler of such system.

Another area in which we have made significant progress in the short amount of time is our CareAware platform. Our CareAware medical device bus solution allows medical devices to be connected to the EMR through a USB-like plug-and-play connection. Year-to-date we have signed 14 clients to this solution with two already live and the rest expected to be live in the coming months. The live clients have experienced almost 100% up time and are very happy with the early results.

We are continuing to move at a fast pace in this area, and we already have the ability to connect more than 100 common medical devices found in both the hospital and physician office and expect to more than double this level by the end of next year. We are also making good progress towards rolling our line of medication dispensing devices, calling CareAware RX Station. We are still targeting shipment of production units this quarter.

At our healthcare conference, we unveiled an extension in the CareAware platform, called the CareAware Patient Storyboard which we expect to release next year. Patient Storyboard allows clinicians to build customizable views with realtime information from medical devices and informant from the EMR such as medications, vitals, lab results and x-rays.

The views can be tailored for specific type of venues such as pediatric intensive care, a specific complex patient such as a triple transplant, or a specific medical specialty or individual doctor or nurse preference. On this platform, we are also designing new experience capabilities such as instant on and always on. We believe this opens a new era of critical thinking applications for healthcare.

In summary, the level of client interest in our CareAware solutions and devices is very strong, as this was evidenced by the fact that this area of our solutions gallery was consistently three to four people deep at our healthcare conference. Another unveiling at our conference was our new PACS ProVision work station that has recently received FDA 510K clearance. This new work station complements our Unified Risk PACS offering creating a truly cohesive suite of radiology solutions operating on the Cerner Millennium architecture. This significantly reduces our reliance on third parties and brings our offering to a whole new level. Medical images are pervasive across healthcare and this step solidifies Cerner's ability to capture, store and present this data in a manner that is completely integrated into a complex diagnostic and therapeutic work flow.

In summary, I believe Cerner has a very strong worldwide strategic position in the healthcare IT space. With an unmatched depth and breadth of solutions and services and a strategic footprint across acute care and ambulatory care, retail pharmacy, laboratory, pharmaceutical companies and employers, Cerner is uniquely positioned to have a meaningful impact on the worldwide health economy. We have a lot of hard work to do, and it's not easy but there are very few boundaries to what we can accomplish.

Thank you. (OPERATOR INSTRUCTIONS)

Your first question comes from the line of Ross Muken representing Deutsche Bank. Please proceed.

Hi, guys.

Hi there.

So in terms of the sort of shortfall on the revenue line, on the bookings line, could you just go into a little more depth sort of how you are thinking about hardware going forward? I mean, obviously, it's not really as you said impacting your gross margin dollars or the profitability, given how low margin is of an item. How should we think about this as we are sort of building out our model for next year as well, and just sort of your thoughts on whether or not this is just a seasonability issue or sort of a variability issue or something that is strategic and that you are going to want to include less hardware in the overall mix going forward?

Yes, Ross, this is Marc.

I will just start off a little bit from the numbers and let Mike comment on the--from the client community and market place, but I think clearly 84.5% gross margin is higher than we would expect to have. This was a multi-year low on hardware, so in the Q2 number, was 79%, which I think is lower, because of the record level we had there. So I think gross margins that are in the 80% to 81% range are probably realistic. We are not giving up hardware as a marketplace for us to go--to go sell into and I think that there's still that opportunity outside. So that's kind of from at least from a guidance standpoint, what I'd put out.

Mike, what would your comments be?

Yes, what I would add is as Marc mentioned, we had a big Q2 in terms of technology resell in the hardware space. We actually see going forward the combination of the 2007 release and the demand for that and the growth of utilization. We expect the hardware business to continue to be a good business for us. Because of the combination of the 2007 release and the fact that one of our major suppliers, HP is migrating from an open BMS platform, to an HP US platform, it does cause our clients to pause a bit and do an analysis. The good news in that analysis is the business will come our way, but it does--those pauses may make the technology resell business a little bit lumpier than it has been traditionally, but in any outcome, whether it's an HP platform, IBM platform, or a hosted decision, all three of those are good answers for us.

Okay, and one other thing on RFP activity. Could you sort of break that down in between sort of what you are seeing in the small, medium and large-sized hospitals and then also if Trace, you can contrast that to what you are seeing internationally. I mean is it still sort of broad across the globe or are there certain regions where we are seeing a lot more activity than we had over say the last six months?

I will take the first part of your question, Ross, the breakdown in the composition of the RFPs hasn't changed quarter-over-quarter. So as it was last quarter, we see equal demand across all of our segments that we focus on. So pediatrics, academic, community hospital, IDN, the core mix of those hasn't changed in the U.S.

Trace?

Yes, I think Ross, globally, we see single pair systems in most countries around the world. Most countries are very active in the healthcare space at this point, but relatively speaking it's mostly governments that are taking a hard look at their cost of care. To Mike's point it's broadly spread across all segments but what we see and given our ability to scale, we are spending more time with the large providers, the government branches, if you will, the large (inaudible) medical centers but that doesn't in anyway demean the activity at all across all segments.

Great, thanks, guys.

Your next question comes from the line of George Hill representing Leerink Swann. Please proceed.

Hey, guys, good afternoon. I guess one thing, Marc, I'll ask you first, are we still targeting $60 million to $70 million in free cash flow for 2007?

I don't think we have been targeting that for quite sometime. For 2007?

Yes, well, okay.

On the last call we kind of indicated that we would--it would be a stretch to get kind of within $10 million of last year's, which was 40, so that kind of would put have us around the 30. We had strong cash flow performance this quarter, relative to getting back on track. Our expectation is to go into Q4, with kind of a run rate that you would expect to see the ability to deliver somewhere in the $80 million to $100 million range in 2008.

Right. You are right. I was looking in the wrong column in my model. I apologize about that.

No, that's all right. I think--but I do think if you look forward to '08, that if you take just the increase in net earnings, the--this CapEx does turn into depreciation expense which benefits you on the cash flow line. So you take the net earnings you add somewhere in the neighborhood of $25 million for DNA benefit over what we got this year, maybe use up a little bit of working capital incrementally, but not much and then you take the CapEx down $40 million, I think the math would tell you that that is an $80 million to $100 million free cash flow number in '08, and we currently would expect to kind of hit Q4 as it would be in a range that would illustrate our ability to drive toward that number.

Okay, and I'll say Marc or Trace, are we still expecting the UK to be a profitable business, the National Program for IT in 2008?

The current expectation is that the undelivered elements that currently mean that we don't--are unable to take margin on that contract, we expect to be revolved in 2008, and therefore we would expect to start getting margin from that contract sometime in '08, and we have indicated that's probably in the last part of the year, but that is still our expectation. No change there.

Okay, and then the last question, I will ask is, let's say we are now looking for 12% bookings growth--or in my model, we'll call it low double digit bookings growth for the back half--for this year in total. You guys are still guiding to double digit top line growth in 2008 versus what were low single digit quarters in the back half of the year. Does this mean that we should expect a reacceleration of the bookings growth in the first half of '08?

Well, I think you kind of see it in '07 and '06, some of the lumpiness of the bookings. In '06, we have big bookings quarters in the last half of the year and in '07, we see big bookings for the first half of the year. I think that overall, George, I think that kind of low double digits, so your 12% on bookings and 12% on revenue probably isn't a bad way to start out on the modeling. I think that's pretty consistent with what our guidance is on those areas to date.

Okay. I will hop back in the queue. Thanks.

Your next question comes from the line of James Kumpel, representing Friedman, Billings, Ramsey. Please proceed.

Hi, good afternoon.

Hi there.

Marc, can you just remind us about how much of a mix total bookings hardware tends to be?

The--from the revenue standpoint, it varies pretty significantly. So it can--it could be anywhere from somewhere in the 5% range to where it's going to be 15%. So, the interesting thing in this quarter is the kind of contribution from all the other elements of business stayed relatively constant. So software, managed services, services, those all stayed pretty consistent. They all went up a little bit as a percentage because hardware was a much lower percentage, but it will vary anywhere between kind of that rate--

It appears that the market seems to be reacting pretty heavily to the revenue side of the equation this quarter, at least after hours, and I think a lot of it has to do with not necessarily getting the visibility on kind of that mix because it looks like software and services were pretty much in line. Does it make sense, do you think at some point if the future, to really focus bookings guidance on the non-hardware element, the stuff that you are a little bit more in control of?

Jim, we're the only company that provides booking guidance at the level that we provide, and I think we try to do it in a way that would allow people to see what the business is going to deliver. I think it is pretty clear from the numbers that the shortfall that occurred in Q3 was related to hardware. We said many times on this call, we manage to the margin level, that's how we manage the business. That's one of the reasons that we were able to over attain earnings by $0.01. We are managing the business at that level. The mix is always going to change, and we're going to give you our shot at bookings guidance when we come into a quarter, put that number out there and in Q3, we blew it out by $30 million, and this quarter we were short by a little bit. So there's going to be some variability, but we think if long-term investors understand that and they're going to focus on the fundamentals.

Okay, and then also I just wanted to check on your--on your current ambulatory offerings, if you could talk a little bit about how effectively your products are penetrating current marketplace. I think it's--a lot of people have a view that the ambulatory side is really where a lot of the near term growth is, so I just want to see where you fit in and if you are developing any new products that might kick start that much more opportunity.

Yes, James, we obviously agree. We are very, very focused on the position opportunity. About 85% of the physicians in the U.S. do not have an electronic medical record, so we like that opportunity, and we have a long history of success, multi-generation success around building that type of technology and providing it for our clients.

Where I think Cerner separates itself from the rest of the players, of which there's a great number, is that we can bring across a common platform across both the ambulatory and the inpatient settings we can bring that critical information that's not available by other players that don't have access to lab information, for radiology information, to that critical pharmacy or that med information. They can get access to it but it can't run on a platform as we have delivered on Millennium.

So we think we have a very good story. The subscription model has had great acceptance in the marketplace, and I think you will see us focus more and more as we spread our wings across other opportunities in the ambulatory space.

Do you have any kind of metrics that you can point to in this past quarter that maybe gives us a sense of how well it's being adopted and the kind of maybe pipeline that you see going forward?

Jim, this is Marc. We've kind of indicated in this business that we are a little ways off from providing metrics. As we went to a subscription model, the revenue growth is not significant because of the method we use going subscription based. I think probably the next milestone you will see from us is talking about some of our provider clients looking to promote under Stark and provide this across a broad range of--of physicians or in the case of certain other providers, maybe not assisting in the payment, but indicating that that's what we are running inside our four walls and that's what we want you to connect with if you are going to be an affiliated physician especially since it's available at such a reasonable cost to the market place.

Okay, thank you very much, guys.

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

Hi, just a follow-up on the hardware component and the impact of margins as best as you can forecast, given the lumpiness in the hardware, are you still on track to get to that 20% margin goal in 2009 or could that be sooner now?

Yes, actually, Steve, interesting question. I was doing some of the math earlier this afternoon, and basically the results that we have right now and based on the guidance kind of that we put out for Q4, would indicate that we were within 30 basis points of attaining our interim level of operating margins on the path to get to that. So we actually are right on track with delivering those--the operating margins.

So Q4 assumes that you have another soft quarter of hardware, correct?

It assumes--it certainly is some place between the all-time high and the multi-year low. But we would-- we don't assume it will be the same level as Q3. The interesting--after Q2, we actually bumped up our revenue side of our guidance, which now we are--now we are slower than that, so people--we are getting some comments on that. The reality is we think putting in a conservative number for hardware in Q4 is good. If some the platform changes that Mike has indicated comes to fruition and people make the decision and order we can exceed that, but I think we have taken a conservative approach to our hardware bookings relative to our Q4 numbers.

And you mentioned--my last question is you mentioned in 2008 $80 million to $100 million in free cash flow, could you just confirm that?

Yes, I think just doing the basic math, would put you in that range, Steve.

So you--you would like to have free cash flow into Q4 that annualizes to $80 million to $100 million, is that what you are saying?

Yes, I think we would be pleased if we were somewhere in the $20 million to $25 million free cash flow range in Q4, or something that certainly would annualize given the volatility you get in a quarter sometimes with cash flow, to get it to that range.

Right.

We think it should be relatively indicative.

Right, but you are not expecting any huge building projects again in 200--in new building projects 2008?

In answer to the same question you asked last quarter, we have not added anything to the list and we certainly are--our budget process as we speak and the capital budget is certainly the focus of everyone in this room.

Okay, just asking. Thank you.

Nobody problem.

Your next question comes from the line of Atif Rahim representing JP Morgan. Please proceed.

Thanks, guys. Marc, could you talk about the softer amortization that you talked about. It kind of marks the reversal from what you did a couple of years ago, actually last year when you went to one release schedule. So how are numbers going to be affected? You said there would be a small increase in amortization but does everything you've capitalized so far for Millennium '08 start getting amortized prior to the launch and when would we expect that '08 launch at this point which you said would be delayed?

Yes, that's a good question.

For the relative '08, we still--we will continue to have a next release of Millennium. Most likely it's going to be on the Java platform and it will be significant different release from Millennium 2007. So we're continuing--the work we are doing on '08 is going to continue to roll forward on '08. It's--it still remains capitalized, it will trigger when we release, whatever that release is called, which it may not be obviously 2008 at this point. Our marking department will come up with a great name, I guarantee you.

But what it means in the near term, relative to the adoption of Millennium '07, obviously we would love to be able to go on 12 to 18 month releases. We just think the opportunity to go to the marketplace with some enhancements to '07, that build on the adoption that we are getting is too great an opportunity for us to pass up. So we are going to be putting out some interim releases.

What will be different from what we would have done in the past, where we had interim releases or continuing releases is rather than aggregating them all during the year and beginning amortization in January, those will begin amortizing when they go GA. So, we will keep you apprised of when something has gone GA. The net impact in any one quarter is going to probably be less than $1 million. So it will be something that--not to be a major impact to the models but you will be able to kind of see it and then flow it through your models going forward.

Okay, I guess what I'd just like to clarify is are we expecting amortization expense to go down just cause the capitalization associated with '08 won't be amortized next year?

Well, the anticipation has always been that relative to '08, continuing to be capitalized is not amortized until '08 went GA, is that you wouldn't have any additional amortization hit that line until '08, and in January, you would have had whatever fully amortized and its five-year life in December, would have rolled off in January. At this time, what you are going to find is a little bit of reduction for the stuff that rolls off, but you'll start seeing incremental additions to that amortization throughout the year in 2008 as we go roll out two or three of these releases during the year.

All right. Okay, and then just quickly the revenue guidance that you provided, I think you definitely indicated you're being conservative about the hardware sales but what percentage of your current quarter is hardware bookings, actually flowing to revenues. My assumption was that it doesn't necessarily mean 100% of current hardware booked to flow into the current quarter's revenues, is that--?

That's pretty close, Atif.

The hardware is the one thing, they order it, we put in the order to our supplier who are really excited to get the thing shipped for their revenue and so a lot of those orders happen and get revenued in the same quarter they book. So if the bookings and the revenue are--for that is one element where they are very much in sync.

Okay, all right. Thank you.

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

Anthony?

Why don't we go to the next caller.

Your next question comes from the line of Sean Wieland, representing Piper Jaffray, please proceed.

Hi, thanks. I just want to go back to this hardware issue and see if I can get my arms wrapped around the story behind both the under performance in Q3, and the--the over performance in Q2. Can we talk about any kind of things going on in the market that's causing that, was it related to, as you mentioned in your comments HP sunsetting the alpha server in halfway through the second quarter, was there a rush to go out and buy these things and then no demand in the third quarter? Does it have anything to do with a movement over to managed services, can you just help me kind of explain the trend in hardware?

Anthony, this is Marc.

It's actually Sean.

Or Sean, I'm sorry.

Sean, hardware tends to be lumpy and there is no systemic issues that we have seen, I think the issues that Mike talked about relative to platform, that will occur over time as people look to migrate from that platform. So that's not something that's kind of got a drop dead date, at least currently built in for most of our clients. It depends on large clients who are going to host themselves that make large hardware purchases in Q2. Some of that, we have a little bit of some global participation from some clients there that were buying hardware, to populate data centers. So it really just depends on what client is in the pipeline and when they are pulling the trigger.

For the most part, new clients that are coming in from the pipeline and that we are signing, the majority of those are hosting. So they are not impacting our hardware at all, it's really our install base. The hard part is the visibility to that is pretty short term. As I said, they buy it, they order it, get it and install it all within kind of a 90 day period. It's hard for us to get really good visibility on all of those orders.

Yes, and Sean, the only thing I would add to that and just extending Marc's point, the move towards managed services, or a hosted environment for our new clients and even our install base, that's been going on for a while now and so we have been actively backfilling that revenue and that volume by taking more of the IT spend of our clients, broadening out into handheld devices, mobility, architecture, infrastructure decisions. So we have been very, very active over the last two or three years in recognizing that there's a certain percentage of the spend that will go away, given a hosting client environment.

So we are actively pushing the boundaries on how we go backfill that, and I would just reiterate again, I don't think there's anything going on in our marketplace and/or our solutions that leads me to believe that there's a--this one quarter represents a trend in a different direction.

Sean, keep in mind that hardware is a nice thing for us to sell, their clients buy it. We can make some money off of it, but it is not a huge driver of our gross margin or of our earnings. So, we could sell no hardware and still make our numbers. The impact is going to be on the revenue line and that's once again why internally we manage the margin line where it's much more--it rounds out the items that have high costs, and the items that have no cost directly such as software.

All right. I understand that. It's just that the market I think is a little bit wrapped up in it right now. Do you know how many of your customers are still on the old alpha servers?

This is Mike.

There's a--I wouldn't give you a specific number, but you have to realize that our classic clients, so the pre-Millennium clients, are almost entirely on an HP platform. So it's a combination of the Millennium platform, plus the classic platform and I would say that it probably represents between--probably in the 40% to 50%--30% to 40% range of our install base out there.

Okay, and just one last question. Partners Healthcare in Boston just recently announced--I know they are not your customer but just announced that they are going to be mandating EHR adoption by community physicians. I'm wondering if you see that as a trend for hospitals to--to put away the carrot and break out the stick to get doctors to adopt an EHR.

This is Mike again. I will give you my opinion.

I think it's actually--we see more of the opposite. We see more of our clients leveraging the Stark venue to allow themselves to go reach out to the physician community, so, and I know that I saw probably a similar press release. It wasn't clear to me whether or not there would be any level of funding for the actual system, other than just training, but I think we--our marketplace, we see it, the Stark Laws being received and acted on through our client base, and we actually view that as very good news.

Yes, I think if there is a trend, you're going to see more and more providers reaching out to the physician community to create that sticky network. In that regard, I believe it is a trend.

Okay, thank you very much.

Thanks, Sean.

Your next question will come from the line of Richard Close representing Jefferies & Company. Please proceed.

Great, thank you. I'm going to stay unfortunately on this hardware thing. The variance versus your guidance on bookings and revenue in the grand scheme of things is relatively small, but with that being said, I think coming out of last quarter, you guys did talk a little bit about ratcheting up some new footprints in the back half of this year, which it appears that you did and now saying that most of your new footprints are hosting, wouldn't you have had better visibility with respect to the lower hardware sales in the quarter as you entered the quarter?

The visibility comes from the fact that a lot of those come from our install base. A lot of the hardware e purchases are not coming from new deals, if they were assigned to a new deal, so it's a new client that's going to host it themselves, we'd have great visibility to that, because we track those sales, we know there's going to be a hardware component. We are not seeing a lot of that, we are seeing most of those come in as a hosted agreement so there isn't hardware.

So what we get is the phone call that says we've now made our technology decision, put in my order for hardware and I want it shipped at my location within 30 days. So a lot of those are very tactical by the client, very quick. We have been working with them on road maps but the triggering of your technical infrastructure is something that you can't land on a 12 month sales cycle like we do on most of our other deals. So it's going to be volatile and like you say, apparently it's getting a fair amount of focus here.

It isn't a major part of our business. It's a nice to have, and we--we will deliver earnings regardless of what our hardware bookings are. So it's good stuff. We are not going to walk away from the business because it's easy for us to get it, but it isn't a material part of our business.

Okay, and then just to be clear, the guidance in the remainder part of this year assumes similar, existing client percentage hardware purchases as the third quarter?

It will be--as I said, between the multi-year low that that represents and the record high of Q2's, but it's closer to the low.

Okay.

So it's a conservative number.

And then when we think about the hosting, obviously the data center is impressive and new footprints seem to be going to the hosting or managed services side of things in great numbers. Can you talk a little bit--or provide us sort of picture on existing customers and their transition to your hosted services?

In terms of what they are--the rate of which they are coming into our data centers?

Yes, I mean, at your conference several weeks ago, at least in the short time we were there, we talked with several people that are moved--plan on moving to you guys having--or hosting the software. Can you talk about the overall trends you see with existing customers on that front, and then wouldn't that imply maybe lower hardware sales on a go forward basis?

I think that to your first question, we are--and you probably saw the Lights On network if you were at the CAC event that Jeff spoke about earlier. We are fully transparent in terms of what our capabilities are in our data center, and that includes not only the results in terms of availability, performance, things of that nature, but it also includes how we manage the system, the rigor in which we manage the system and the timeliness in which we can move and advance the platform, and I think that that transparency has a very direct effect on our install base, which they realize that in addition to it being a very nice facility, the engine that drives the performance--our people performance is very, very impressive and then we have a very unfair advantage at delivering computing results in that environment.

And I think they--as they learn more about our hosting capability, absolutely look to be a part of that because economically, and from a performance perspective, it's a winning situation for them. So the answer to your first question is we expect over time more and more of our install base that our client hosted to become part of our data center operation, and we see that on every quarter anywhere from two to five of our install base come into our data center. So, and we plan for that going forward.

The second part of your question, I tried to address in my earlier response which is we know this has been a trend for quite sometime, and we--we have been working to backfill that revenue and backfill that margin in our tech resell business by expanding the breadth of the technologies that we offer. So everywhere from mobile computing, more in the care delivery process, expanding high availability into a client's environment, there's--there's a lot of areas that we are pushing the boundaries from a tech resell perspective, and we fully expect that that--that we have to offset to continue to grow that business.

Yes, Richard this is Marc.

Just one comment on if you look at Q1, we had huge over attainment in hostings bookings and we still drove out a decent hardware sale.

Okay if we were looking for, or expecting in the future for a great number of existing customers to transfer over, then there obviously there wouldn't be the need for all the hardware possibly and I just wanted to make sure that I was understanding that and understanding that you guys understood.

If we see a trend that's consistent, we will certainly let everyone know.

Thank you.

But at this point it's an anomaly.

Thanks, appreciate it.

Why don't we take one more call, based on the time we have.

Your final question will come from the line of Dushan Batrovic representing Canaccord Adams. Please proceed.

Hi, thank you.

I was hoping you could help me develop a better sense of what impact some of the new initiatives could have to the financials later on in '08 and even '09, and by new initiatives, I'm talking about the PowerWorks, the CareAware, the employer services, if you want to call it the non-core business. Could that be material enough to even cause a reacceleration in '09 or is it just too early to tell at this stage?

Yes, this is Marc.

I think going into '08, the things that are basically in our outside the U.S. box graphic that we present, are a lot of the device area is going to be something that we look for contribution in '08. So some of the CareAware architecture, some of the things Mike talked about that were going on the technology side, the connectivity side. We think that business has already got a good start and will contribute--will be a contributor in '08 to those results. Our cabinet business, we are on track, I think, to getting that off the ground. So I think you should start seeing that contributing to both the top line and the bottom line as we go forward. I think on the healthy and the employer initiatives, we are still on the initial stages of a lot of that work, and so I think '08 would be a little early to see a material impact from that, but I think that from the other two certainly we would expect to start to see in '08 opportunities come up.

Would you ever split that revenue, that contribution?

We would probably--at some point we may talk to it separately as we do our annual slide relative to business model. At some point when it gets to be large enough, we certainly will look to break it out in that model.

Okay, thank you.

Okay, this is Neal.

I'm going to wrap up here. Just a comment. First, let me ask actually comment on hardware. It's always been the lowest margin part of our business model. We have had a number of discussions whether we should stay in that business or not. It could be fairly easy to still get a check from hardware manufacturers because we generate the demand for them and not be the direct sales.

Our answer has always been the more we actually can spec and control the overall environment, the better we are. So we've stayed in that business, it is by--we never managed to a top line, we manage to a gross margin. The margin on the hardware side is because it's always been the margin on the hardware side. So we have always--it's been a long debate. We will stay in the hardware business, but the--the systemic--there has been the systemic impact of the managed services.

So we have taken what was a one-time revenue and contribution through the margin, and we have basically improved our business model by converting that to a fee that we charge on a monthly basis to our clients. So that has decreased where our hardware shows up in our basic hardware cycle, and also, hardware is very lumpy, and there's more variability in it. So we don't notice it quite as much as you all do because we actually manage it to the other line. But--so if we have one part of our business model that wasn't working as well, this would be the one I'd want.

And then also, I'll just comment, third quarter is always the hardest because there's no--it's not the start of the year, it's not the finish of the year which usually motivates clients, and it's the summer months too, which everybody has more vacation and all that. So we never look forward to a third quarter, and we come out of this one pretty pleased internally. And then if you were at the health conference, or if you have actually been here, one thing that you will see at Cerner, is we are getting a lot better at almost everything we do and I might say--except managing hardware revenue. But the cylinders are really hitting quite well here, and it's hitting at a very, very good time.

Let me make one other comment just at the business model level. In the physician marketplace, which is undoubtedly the most exciting big-growth opportunity on a year-to-year basis out there, we have made another business model decision and that was to go out there with a true ASP-type model where we are charging on a monthly basis something that we historically have used, licenses and selling hardware which was very lumpy revenues but they were kind of one-time revenues and margins.

So we have committed to you all to improve the business model and you are seeing us make big decisions, strategic decisions, long-term decisions that do do that. It is adding some more--it is slowing the growth, the topline growth down, at the same time, it's improving the quality of the overall business platform and it's improving our ability to drive--manage to increasing operating margins.

Marc was very clear, we are on path to 20% operating margins. That's one of the first things I look at when everything gets pulled together, is that trend, and you are also seeing the acceleration of really the--back to the free cash flow and accelerating that. So we are--things are--things inside Cerner are good, and getting better, and the marketplace, I mean we looked at it really close here. Marketplace still has a lot of life in it in the U.S. and then we really do love the global marketplace for this business.

And then Dushan, I really liked your last question. Thank you for asking something other than hardware. But the impact--we're very transparent so you all know that we have to--we are strategically--I wouldn't say this is outside the core Dushan, I would say we are expanding the core. So we have a lot of strategic initiatives that have a lot of upside and we are cautious on saying to you what date and time to put that in your models, but most everything we are doing on the strategic basis, quite honestly feels really good to me and I'm actually becoming one of the seniors in this industry. So I have been doing this a long time.

These are really exciting times, and we are going to always be investing for the next decade. The next decade is only a couple of years away. I really like the way 2010 and that decade is lining up. So the core is--the core, we think, is going to be very strategic to us, and we think we'll expand the core.

Thank you very much for your time. Have a great evening and I hope we'll see you later.

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