塞納 (CERN) 2007 Q4 法說會逐字稿

Ladies and gentlemen, welcome to the Cerner Corporation's fourth quarter 2007 conference call.

Today's date is January 31, 2008, and this call is being recorded. At this time all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS) We will be taking questions at the conclusion of the presentation.

Please be advised the Company has asked me to remind you that various remarks made here today by Cerner's management about future expectations, plans, perspectives, and prospects constitute forward-looking statements for the purpose of the Safe Harbor provisions of the Security and Litigation Reform Act of 1995. Actual results may differ materially from those indicated by the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements may be found under the heading Risk Factors under item 1A in Cerner's Form 10-K, together with other reports that are on file with the SEC.

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

Thank you, Mike. Good afternoon, everyone, welcome to the call.

I will lead off today with a review of the numbers, followed by sales and operational highlights from Mike Valentine, Executive Vice President and General Manager of the U.S. Trace Devanny, our President, will discuss our global efforts, our physician practice business and and employer 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, is traveling abroad.

Now I will turn to our results. Bookings, operating margin, earnings and cash flow performance were all strong and our outlook for 2008 is unchanged. In fact, we delivered strong results in Q4 in all areas except revenue growth. Like last quarter we delivered expected levels of gross margin but our systems sales revenue was less than expected, again, primarily due to lower hardware revenue. Today we will provide some additional comments on the factors created in the lower levels of sales--systems sales revenue in 2007 and why we believe the outlook will improve in 2008.

Moving to bookings, our total bookings revenue was $406.6 million, which is $7 million over the top end of our guidance and up 5% compared to Q4 of last year which was an all time record of $389 million. Note that I'm excluding $154 million booking related to our U.K. projects from Q4 '06 for comparable purposes. For the year, our total bookings excluding a $98 million UK booking in Q2 of '07 were $1.51 billion or 14% over 2006 levels.

Moving to backlog, our total backlog increased 22% year-over-year and ended the quarter at $3.25 billion. Contract revenue backlog ended the quarter at $2.71 billion which is 24% higher than a year ago. Support revenue backlog was $541.1 million. Our revenue in the quarter increased 4% over Q4 '06 to $394.5 million, which is about $10 million below the low end of our guidance driven by year-over-year decline in system sales which I will discuss in a moment. Note that our gross margin dollars which we managed to and view as reflective of our business grew 12% year-over-year.

While we were pleased with our ability to again deliver against our gross margin and earnings targets, we are disappointed about being below our revenue guidance levels. This revenue composition for Q4 was $132.1 million in systems sales, $104.0 million in support and maintenance, $149.6 million in services and $8.8 million in reimbursed travel. Systems sale revenue was down 12% compared to Q4 '06 driven largely by a decline in hardware sales to a level that was only modestly better than the multi-year low level in Q3.

We also had some hardware deals that did not ship until December 31st which is outside of our Q4, and therefore not included in revenue for the quarter. Shipment of this hardware would have put us closer to the low end of our guidance range, but hardware revenue still would have been below what we expected for the quarter even after we had moderated our expectations coming out of Q3. In addition to the decline in hardware, software revenue was down year-over-year although we had factored most of the decline into our projections. It should be noted that Q4 '06 was a very tough comparable for system sales with fourth quarter systems' sales growing 35% and 11% in 2005 and 2006 respectively.

Services revenue grew 13% compared to the year ago quarter driven by continued strong managed services and professional services growth. Support and maintenance revenue grew a strong 17% reflecting our delivery on system implementations. For the full year 2007 our total revenue of $1.52 billion was 10% higher than 2006, with strong professional services, managed services and support growth offsetting flat system sales.

Our gross margin for Q4 was 82.5%, which is up 590 basis points from a year ago and down 200 basis points from an all-time high in Q3. The higher year-over-year gross margin percent in the quarter reflects the lower hardware sales and better margins on our software revenue that was driven by lower levels of third party costs and lower commission. This is reflected in the systems sales margin percent which increased from 59.6% in Q4 of '06 to 65.7% this quarter.

We also had improvements in our support, maintenance and services gross margins which increased from 91.7% to 94.2% year-over-year driven by lower third party costs. These stronger gross margin percents led to margin dollars growing much faster than revenue with margin increasing 12%, well above the 4% growth in revenue.

As we've indicated, we manage our business to gross margin dollars, and view the 12% growth rate in gross margin as more reflective of our quarterly performance than the 4% growth in revenue. For the year, our gross margin was 81.6% which is up 270 basis points over 2006. Gross margin dollars grew 14% for the year compared to the 10% revenue growth.

I would like to take a moment at this time to walk you through some of the trends impacting our revenue growth. We provide a great level of transparency on our business model dynamics but I think it's important to understand the complexity of some of the underlying dynamics. There are several trends inside this business where we are trading near-term revenue growth for a larger amount of high quality long-term revenues. This has a near-term impact on revenue growth but the long term impact is favorable for both revenue and profitability.

Many of you recall Neal's comments on our last call that the resale of hardware, while the lowest margin part of our business is an area where we have consciously decided to engage as the channel to meet our client technology platform needs. We leverage our status as the largest reseller of HP and IBM into healthcare to provide a low cost source of equipment to our clients; however, there is a fundamental shift in this business driven by the tremendous success we were having with our new and existing clients adopting our Cerner hosted model. The result of the shift is lower up-front revenue from hardware sales with that opportunity being replaced by a higher margin recurring managed services revenue stream.

The traditional hardware sale where we would record revenue and cost at shipment is replaced by a five to seven year revenue stream with hardware costs spread over time to depreciation. Even though the cash impact of the hardware is immediate. This dynamic has had a slightly negative impact on our revenue growth over the past few years with a larger impact on the second half of 2007. We plan to continue our role as our client's technology platform and look for opportunities to grow this business, however, we think it is prudent to assume the lower level of hardware revenue will continue in 2008.

I mentioned the cash flow impact of the shift where our managed services business requires an up front cash investment to generate future revenues. The good news is that the scale of our managed services business has gotten to the point where the cash flow from our recurring revenue streams generated by the business are funding the purchases of hardware required to bring on a new host of clients, which is why you have seen, and will continue to see improvements in free cash flow. In the end, we believe this is a much better way for Cerner to work with our clients and is making a stronger company in the long-term.

The second area impacting sales growth is our approach to the physician market. The fundamentals of our physician practice business are solid and our goal is to have 100,000 physician practices on a Cerner EMR and practice management system utilizing our Power Works strategy. We were extremely well positioned with a large acute care base of clients, many with dominant or significant market share in their local markets. Despite this momentum, we are getting little short-term revenue growth because our subscription model has little up-front revenue and many of our acute care clients that are selecting Power Works are rolling it out to their physicians using a phased approach.

Another dynamic affecting our top line is the very high adoption of our latest version of Millennium or Millennium 2007. This is another item that has some short-term consequences that is very good in the long-term. As you know, we provided perpetual license for Cerner Millennium making upgrades to clients free of any additional license fees. In 2007, our install base has been extremely busy upgrading to the Millennium 2007 release with about 30% of our Millennium footprints completed during the year and a similar amount in processes scheduled to be completed by the middle of 2008.

For much of our client base this has been their number one priority in 2007, which has limited our opportunity to sell what we call white space Millennium applications back into our base. Importantly, this upgrade process has significant benefits including the reduction in the number of releases being supported and a reduction in support calls after the first 100 days post upgrade.

Now to discuss some the dynamics impacting our system sales let me drill down on the numbers. The two largest components of system sales are software and technology resale, which is mostly hardware. In the second half of the year, technology resale revenue was down 13% due to significant declines in hardware sales. Our solid Q1 at an all-time record level hardware in Q2 offset this decline which allowed technology resell revenue to grow 8% in 2007.

As I mentioned before, going forward we have reset our expectations for hardware revenue given the popularity of our hosting solution with both new and existing clients. That said, there is still an opportunity for us to improve hardware sales as we build our global hardware sales channel. We are also exploring reselling devices for some device manufacturers, although we do not expect this to have a near-term impact.

Also impacting our systems' sales revenue growth in 2007 was a decline in software revenue of 12% compared to 2006 primarily driven by lower software in Q2 and Q4. We discussed on our call in Q2 that we had lower level of software and partly due to a tough comparable with Q4 '06 we also had a decline in Q4. It's important to note that the margin dollars on our software only declined 4% for the year because of less third party costs and lower commissions. So while software revenue was down $34 million, the margin was only down $10 million because of the lower cost. As I discussed, we belive the rollout of Millennium 2007 was a primary driver of our lower software revenue.

Another factor was the reduction in the amount of U.K. revenue treated as software. Under the revenue equaled expense approach for U.K. contracts, a reduction in IP expenses reduces the amount of revenue treated as software. In 2007, we had 4 million less software development expense related to these projects and a corresponding lower amount of software revenue and margin. While this had no net impact on our earnings, it did contribute to $4 million of the $10 million decline in software margin.

In summary, we remain cautious on hardware sales going forward because of our success with our hosting business while understanding that our comparables for hardware will be much better by the second half of 2008. As for software, we believe that as we move through 2008 and increase the number of existing clients on the Millennium 2007 release, that our opportunities for sales of software backed into the base will increase. In addition, as Mike has discussed over the past two quarters, our pipeline for opportunities outside of our base is very strong which also gives us an opportunity for incremental software growth.

Let me get back to the numbers. Moving to operating expenses and earnings. Our operating expenses before options expense in Q4 were $258.6 million which is up 9% over a year ago with professional services and managed services growth being the primary drivers. Our GAAP net earnings in Q4 were $41.3 million or $0.49 per share diluted.

GAAP net earnings include stock option expense which had a net impact on earnings of $2.6 million or $0.03 per share, and R&D write-off that had a net impact in Q4 of $2.9 million or $0.03 per share and two tax adjustments that had a net positive impact of $3.4 million or $0.03 per share. Excluding these items adjusted net earnings were $43.3 million, which is 27% higher than Q4 of last year. Our adjusted EPS was $0.52 which is $0.01 than the consensus estimate and guidance range. For the year, our adjusted net earnings was $131.2 million and diluted earnings per share was $1.75, which is up 26% over 2006.

Now let me provide some comments on the adjustments for the quarter and prior period impact we reflected in our press release. The R&D write-off is related to our RX station dispensing units. In connection with the deliver of the first RX station units in the fourth quarter, we reviewed our accounting to determine the write-off of certain amounts previously capitalized was necessary. The write-off is related to functionality and features that were earned--that were in early production units that we have now determined will not be used. The current design and functionality we shipped in Q4 is being very well received by the market. We remain very excited about the opportunities for our RX station.

The two tax items that were adjusted in the quarter, one is related to our determination that our effective state income tax rate should be lower which decreased our taxes; and the other is primarily related to a recent decrease in the income tax rate in Germany which results in a decrease in the value of a deferred tax asset relating to our German NOL carry forward. Each of these items have an immaterial level of prior period impact and we have added a schedule to our press release that reflects the impact for the first three quarters of 2007. We can also refer to our press release in Form 8-K for more detail on these items and a reconciliation of GAAP earnings to adjusted earnings.

Moving to operating margins, our operating margin before options expense in Q4 was 17%, up 260 basis points over the prior year. This quarter, our operating margin was impacted by about 100 basis points due to approximately $23 million of zero margin revenue from our projects in Southern England and London with Fujitsu and BT. Our operating margin for the year was 15.1% including $97 million of zero margin revenue from the U.K. and 16.1% excluding it.

These margin levels are consistent with the 2007 portion of our path to 20% operating margin we laid out at the beginning of the year and our 2008 guidance keeps us on track for our goal of achieving 20% margins in 2009. Note that our path to 20% continues to include the assumption that we will be able to recognize margin on our U.K. contracts by the end of 2008 which remains our current expectation.

I have one final comment on our income statement results for 2007 and then I'll move to the balance sheet. I believe in many ways our 2007 results provided evidences of strength (inaudible) in our business. While some of the dynamics I discussed led to short-term negatives such as the flat systems sales, we still drove 27% earnings growth because of economies of scale in our business that led us to strong margin expansion.

The mix of our revenue and margin sources has also improved to include more recurring and visible sources. To put this in perspective, in the year 2000, 55% of our revenue and 41% of our contribution margin came from recurring our visible sources such as important maintenance and professional services. In 2007, 72% of our revenue and 68% of our contribution margin came from recurring or visible services. In other words, we are now at a point where over two-thirds of both our revenue and contribution margin comes from recurring or visible sources and we expect this positive trend to our high quality sources of revenue will continue for the foreseeable future.

This substantial improvement in visibility and profitability is being driven by strong revenue growth and margin expansion of our professional services business due to efficiencies gained by tools and methodologies; strong growth and support revenue as a result of the strong professional services performance and a scalability of our support organization that has allowed us to control expenses related to revenue and led to higher support margins; and the creation of our managed service business in 2001 to grow to 10% of revenue quickly and become a strong contributor to profitability.

I'll move to balance sheet. We ended Q4 with $345 million of cash and short-term investments. The total debt was $192 million. Total accounts receivable ended Q4 with $391 million. Contracts receivable or the unbilled portion of receivables were $130 million or 33% of total receivables which is down from 38% last quarter. Our DSO was 90 days in Q4 which is up one day compared to last quarter and two days from a year ago. This increase is driven by an increase in billed receivables as opposed to unbilled items so we expect DSO to come down next quarter.

The third party financings were $25 million or 6% of the $413 million of total cash collections. Operating cash flow for the quarter was $92 million, which is up from $80 million in Q3 and $69 million a year ago. Q4 capital expenditures were $34 million including $11 million of property expenditures primarily related to our new data center and new building. Capitalized software in Q4 was $17 million, free cash flow defined as operating cash flow, less capital expenditures and capitalized software was $41 million.

Free cash flow before property expenditures was $52 million. The strong improvement of free cash flow was consistent with what we communicated last quarter. For the year, our operating cash flow increased 20% to $278 million. Capital expenditures were $184 million, and capitalized software was $66 million leading to free cash flow of $28 million. We continue to target $80 million to $100 million of free cash flow in 2008 based on capital spending of approximately $150 million, which is down from the $184 million in 2007 and continued growth in operating cash flow. Note that our Q1 free cash flow could be lower, slightly negative, due to a large scheduled tax payment, but we still expect $80 million to $100 million for the year.

Moving to capitalized software, the $16.8 million of capitalized software in Q4 represents 24% of the $71.1 million of total spend on development activities. Software amortization for the quarter was $13.4 million resulting in net capitalization of $3.4 million or 5% of the total. On software amortization we expect a decline of $2.5 million in Q1 relative to Q4, which reflects the completion of the amortization of amounts capitalized in 2002.

We expect amortization to increase in the second half of the year when we roll out our next release of Millennium 2007, which as I discussed is being rolled out in smaller, faster cycles. Rollout of the next release will trigger an increase of approximately $4 million per quarter. We expect part of this increase to incur in Q3 with the exact amount depending on when the release occurs.

Now I will go through the guidance. Looking at Q1 revenue, we expect revenue in the $390 million to $400 million range which is approximately 7% to 10% higher than Q1 '07. This assumes a conservative stance on hardware revenue. For the full year 2008, we continue to expect 10% to 12% growth over 2007 with growth rates expected to be slightly higher in the back half of the year given the lower comparables in the back half of 2007.

We expect Q1 EPS before options expense to be $0.43 to $0.44 per share. The Q1 guidance is based on total spending before options expense of around $265 million. We note that Q1 EPS guidance is $0.01 below current consensus which was formed without us having provided guidance for the quarter. Our outlook for the year is unchanged and we continue to expect diluted EPS before options expense to grow more than 20% and are therefore comfortable with the current consensus of $2.14 per share which reflects 22% growth.

Our estimate for options expense for Q1 '08 and 2008 is approximately $0.03 and $0.14 per share respectively. For bookings, we expect bookings revenue in Q1 of $330 million to $350 million with the high end of this range equaling the record Q1 level for last year which included $50 million of over-attainment related to our hosting business. This guidance represents growth of 10% to 17% compared to Q1 '06 bookings adjusted for this hosting over-attainment.

Before turning the call over to Mike, I wanted to let you know that in 2008 our quarterly earnings release dates are going to be five days later than our historical dates to accommodate our schedule of quarter end activities. This means we'll report on the fourth Tuesday following our quarter end. We will continue to officially announce the day of the call and provide the dial-in information at least 10 days prior to the call.

With that, let me turn it over to Mike.

Thanks, Mark. Good afternoon, all.

Today I'm going to cover sales, operational highlights and some marketplace trends. From a sales perspective we had a solid quarter with a lower level of hardware sales again being the exception. Our contract volume was very high in Q4 with a record 409 contracts leading to a new high water mark for bookings at $407 million. We had a good mix--a good sized mix with 17 contracts over $5 million, six of which were over $10 million. 30% of the contract bookings were for new Millennium footprints, which is the highest level since Q2 of 2005, and consistent with what we have been communicating about an increase in opportunities outside our installed base.

From a leading indicator stand-point we continue to see strong levels of vision center visits, RFP activity, and our pipeline has grown consistently with a continued strong level of new footprint opportunities over the next several quarters. Operationally we had another solid quarter of execution in our professional services organization. We turned on 339 Cerner Millennium applications bringing the cumulative conversions of Millennium applications to more than 7,500 at over 1,200 facilities. The go-lives included another 14 acute care CPOE sites, bringing our industry leading total to 161 and beating our single quarter record of 12 set just last quarter.

This operational success is also reflected in strong financial performance of our professional services organization, which achieved good revenue growth and margin expansion in 2007. As Marc mentioned earlier, the growth in expanding profitability of our professional services organization, coupled with our high growth and profitable managed services business have contributed to the improvements in Cerner's visibility to both revenue and margin. The capabilities and expanding suite of services from these organizations continue to be in high demand by our clients and will remain key elements of our growth in 2008.

On the competitive front, we see no new factors as it remains a very competitive market, but we continue to like our position. Our industrial strength architecture and depth and breadth of solutions continue to be a differentiator along with the Cerner brand. Over the course of this decade, we have expanded our differentiation to include our size and scale, our skilled professional services organization, and our ability to leverage investments and implementation tools and methodologies to help our clients drive quality and predictability up while at the same time driving total cost of ownership down.

Looking at the overall marketplace, we believe the fundamental set up well going into 2008. We believe there is an uptick in new buyers that come from a broad base of demand including an increasing number of hospitals and health systems who gave up on their prior strategy and a fair number of the "wait and see" risk adverse organizations as well. As a result, we think bookings from new footprints will remain strong. Good examples of these types of opportunities include the relationships we announced just last week, MedStar, a large Washington, D.C., based heal organization and HealthQuest, the largest healthcare system in New York's Hudson Valley.

As Marc mentioned earlier, while there was somewhat of a pause in our client base related to Millennium 2007 release adoption, we believe there will be another wave of purchasing as we finish the decade and continue to increase the penetration of Millennium solutions in our client base. At the center of this will be an increased adoption of Millennium applications throughout the acute care organization into areas which had legacy systems in the earlier phases of our work, and as mentioned, we believe much of this base will pursue the physician connectivity strategy using Cerner as the trusted third party to provide robust EMR in practice management solution and Cerner hosting and co-branding with our local and regional clients.

Another major new trend is the innovations we have brought in the area of medical device connectivity, EMR centric devices such as RX station and the new high touch high tech environment such as the Smart Room. These innovations have quickly gained good traction in the marketplace. In closing, I am pleased with our record bookings performance, strong margin expansion, earnings and cash flow in 2007; and with our strong pipeline and expanding suite of offerings, I believe we were well positioned for a good 2008.

With that I will turn the call over to Trace.

Thanks, Mike. Good afternoon.

Today I would like to discuss progress in several areas of our business including our growing international business, our physician practice business where we are connecting the major pieces of health care infrastructure and significant innovation around our various healthy employer services initiatives.

On the global front we had a strong Q4 and a very strong year. In 2007, our global revenue increased 40% to $290 million and now represents 19% of total Cerner revenue. For perspective, in 2002, our total global revenue was just $29 million. So it has increased 10 fold in just the last five years.

While our participation in the national program in England has been a significant contributor to the growth in our business, it's still represents only about a third of our global revenue. In fact, we have six reasons besides the U.K. contribute $10 million or more of revenue in 2007 including Asia, Australia, Canada, Central Europe, France, and the Middle East. 2007 also included a signing of our first millennium client in Africa where we signed an agreement with a prestigious hospital in Egypt.

In addition to our financial and market success in 2007, we also made good operational progress. In England, we continue to successfully bring solutions live in the national program for IT as a software provider in two of the five regions representing 40% of the country of England.

Since last quarter, we have launched many more solutions in numerous other acute care facilities. We now have a total of 55 sites and 255 solutions live which is up from 39 sites and 228 solutions last quarter. Because of our long-term commitment to oversea's markets, as well as our proven ability to deliver scalable solutions, we feel strongly that we have substantial opportunities for continued international expansion in 2008 and beyond.

Moving to our Power Works physician practice business, 2007 was a good year with strong growth in bookings of our ASP offering. The relaxed STARK provisions clearly have the attention of the marketplace and we made a lot of progress at bringing our PowerWork solution to our large acute care installed base. During the year, 25 of our acute care clients signed some form of a Power Works agreement ranging from designating Power Works as the preferred EMR in their network to agreements where they are strategically pushing our solution out into their physician provider communities.

These clients believe that Cerner's unified architecture supporting both the in-patient and out-patient environments is an important competitive advantage. The opportunity to leverage our installed base is substantial with the potential to more than double the number of physicians using Power Works over the next three to five years. We also began expanding the boundaries of our Power Works market during 2007 by signing our first out-patient surgery center.

2007 was also a great year of progress with our employer focused initiatives that we brand as the healthy employer services. After launching this organization just last year, we are already providing our healthy exchange third party administrator services or TPA to three employers representing over 10,000 covered lives. These members are benefiting from the same enhanced experience our own associates have enjoyed since 2006 when Cerner terminated it's TPA and became the first employer to utilize the healthy exchange platform.

Finally, another success registered by our healthy employer services team in 2007 was being selected by a fortune 500 technology company to provide a fully automated employee based clinic based on our own on-campus clinic. We continue to be very pleased with our own clinic and the clinical benefits our associates have received. We are optimistic that other employers will recognize the benefits of this innovative wellness approach and we expect to work with other large employers with interest in these on-site clinics in the future.

With that I will turn call over to Jeff.

Thanks, Trace,

Today I'm going to provide highlights of our innovation in 2007 and some thoughts on 2008 and beyond. I'll start with highlights of our innovation as we take on the challenge of systematizing healthcare delivery. First we made substantial progress our our CareAware platform in 2007. This platform is complimentary to Millennium but also forms non-Millennium layer designed around the presence of any EMR. It's a light web based application that is designed not only to sell on our base, but also creates another opportunity to sell outside of our base by offering a solution that helps health systems get the most out of their existing technologies.

Our CareAware MD device connectivity solution allows medical devices to be connected to the EMR through a USB-like plug and play connection. We signed more than 20 clients for this solution in 2007 with several already live and experiencing great results. As I mentioned last quarter, we also unveiled the major application framework of the CareAware platform. We were calling this [I-Aware] which allows clinicians to build customizable views with realtime information for medical devices and EMRs. It has had a very strong set of reviews by all that have experienced it and will be in alpha clients this spring.

Recently we announced a new offering that is a centerpiece to our smart room design. The patient console was successfully piloted by Spectrum Health and then launched at the consumer electronic show this month with our development partner of Spectrum Health and Microsoft. The console allows patients to access personal health information, educational materials, care provider information, treatment schedules and even Xbox games and other entertainment at the bedside.

We've also shipped our first CareAware RX station medication dispensing devices in December. We have shipped over 40 production units and have received good initial feedback from our early adopters. 2007 was a year of great progress for our CareAware line, and we will be using our HIMSS booth next month as a more complete launch of the suite of offerings with the all-together message going beyond just clients to include the rest of the industry. There will be suppliers in our booth and Cerner and supplies booth's showing the capabilities across the floor.

Other major progress during 2007 on innovation included: we delivered Cerner Millennium 2007. Our largest code release on the Millennium platform today. This release included an improved user interface and a new clinician workflow experience which has contributed to increased competitiveness. As marc mentioned we have had rapid adoption and good feedback from our clients and we've decided to use the Millennium 2007 code as baseline for a series of smaller releases in order to leverage this momentum.

The year also included a very fast start for our Lights-On network which is a surveillance system that identifies system performance issues in realtime and has the ability to predict issues that could create system vulnerability. After announcing Lights-On just over a year ago, we have nearly 300 of our Cerner Millennium clients connected to the network representing an estimated 20% of acute care in the U.S. We will continue to expand the Lights-On network to include realtime clinical and revenue cycle dashboards and ultimately create a realtime evidence based network. And as we announced last quarter we delivered our new PAX Provision work station. The compliments are unified risk PAX offering and significantly reduces our reliance on third parties.

Finally, I would like to provide some thoughts on the evolution of Cerner. As we have reflected on 2007, and are entering 2008, a clear theme has emerged. That theme is finish the decade. The first part of the decade has been very good for Cerner. We began it as a company with $400 million of revenue and are now nearly four times that size and much stronger financially.

We have a good chance of finishing the decade as a company with more than $2 billion in revenue. The underlying premise of the Cerner vision has been validated and accepted worldwide. Health care delivery now depends on information technology to integrate its [dispaired] organizations and silos and departments that historically operated inefficiently and unsafely. The amount of work remaining to fully digitize healthcare is substantial, so finishing the decade represents a large opportunity for Cerner. With successful execution by 2010 we will have completed version one of the platform to integrate healthcare delivery across the community.

In the next decade, we will still be perfecting and hardening the core platform but we will also continue to move the boundaries to build other products and solutions that work on top of that platform. Cerner Millennium is a foundation and we are going to build on it for decades to come. While this decade has been very good, the next decade has a chance to be extraordinary. The dimensions of Cerner will be much more dynamic. We are creating the new center of the $2 trillion U.S. healthcare market and are simultaneously doing the same for other countries.

At Cerner we envision eliminating all avoidable errors, inappropriate medical variance, unnecessary waste of resources, needless delay of care delivery and costly administrative friction from healthcare. We think this is the largest value proposition in healthcare, and we believe Cerner's on path to deliver this value to countries, communities, healthcare organizations, and professionals in all major roles of health care including the person. The key stakeholders in a better healthcare system, employers and governments who are the primary purchasers of healthcare as well as consumers will see benefits from this value proposition.

In closing, 2008 is a year of execution. Solid execution of our financial and operational plans will result in a strong revenue and earnings growth and accelerating free cash flow. We will also continue to innovate and execute on our strategic initiatives which will allow us to redefine our boundaries as we approach the next decade. A few years ago Neal started predicting that people would have a hard time classifying our company as we enter the next decade. We are on path to make his prediction come true.

With that, I'll turn it over to the operator to take questions.

Thank you, sir.

(OPERATOR INSTRUCTIONS)

And our first question comes from the line of Atif Rahim with JP Morgan. Please proceed.

Thanks.

Just like to understand the sales issue better. I think a year ago with bookings coming in at a record and hardware sales wasn't an issue, although you say $50 million of the bookings came from managed services. What is the percentage that is coming in from managed services now, and is hardware--is it a leading indicator in the sense that managed services are increasing in a big way, why are bookings, I guess, flat just year-over-year if managed services are increasing in such a big way?

Yes, Atif, this is Marc.

I think managed services has traditionally kind of been around 20% of our total bookings and that's fairly consistent. Relative hardware impact we were seeing over time as we continue to sell more and more of our clients into the managed services hosting business, those clients are not out separately buying hardware from us anymore, for the most part. We do try to sell back in that base for other suppliers solutions, but we've kind of taken those out of the market and therefore we have to be more aggressive in our existing clients relative the hardware. I'm not sure if I'm being responsive to your question.

I guess what I'm trying to say is since I know you recognize the bookings over the present value of the five year contract or so, but that should theoretically increase the level of bookings that you are recognizing. So software bookings essentially are slowing more and it seems like with hardware coming down your managed services bookings would be increasing even more now. Is that accurate or not, I guess?

Relative to the mix, you're going to have slightly lower software. You are actually having slightly more consulting in the services side with managed services, at least if you look at '07 being a fairly consistent percentage of the total. So, yes, there is a little bit of a mix between hardware certainly. When you look at--especially when you look at bookings revenue line which is, once again, we managed the margin line. But that's a significant difference when you look at the last half of the year, but we have been successful in selling more of our professional services.

In fact, as we go into 2008 part of our focus is to expand that consulting workforce to take advantage of the bigger demand that we are seeing. The managed services and hosting business does not impact our ability to go put consultants out in the field. Because clients are still doing projects, still trying to maximize the value they get from our systems. The fact that it's hosted at Cerner doesn't change their appetite to go get consultants to help them do implementation and enhance utilization of the systems.

Okay. Interesting. Thank you.

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

Mr. Vendetti, your line is open.

Want to go on, Mike.

And the next question comes from the line of Bret Jones with Leerink Swann. Please proceed.

Good afternoon, I was wondering if we could get a little more insight into exactly how much of the hardware was off this quarter compared to your expectations and relative to Q3 because I would have thought the gross margin would have been a little closer sequentially to Q3 if hardware was only slightly better.

Well, when you look at--Q3 was a huge multi-level--multi-year low relative to hardware, and we did expect hardware to increase from that multi-level low. We did not expect it to increase to prior levels because we thought we had pulled in some conservatism, especially with Q4 being the time when people are trying to spend their budget and trying to--often are looking to go make purchases which actually can include hardware for the non-hosted clients. So it's a little bit difficult to quantify.

I can tell you the $10 million shortfall below the bottom of our guidance range was driven primarily by hardware. There was probably a couple of other elements, little bit lower software, but we factored most of that in as we looked at the projections. The key thing that we don't have is as much visibility to as we do for the rest of the business is those hardware sales, and I will take full responsibility for over estimating--relative projecting for hardware. I can tell you that in our 2008 guidance we provided, we have taken that down another step to one that we believe at this point hardware should provide an upside to our numbers.

Okay, and if I could switch gears, I was curious about if you could give us an update on U.K. profitability? With everything that's being reported with Fujitsu and NHS not meeting their deadline to restructure that contract, can you kind of outline your contingency plan should Fujitsu walk away and what affect that would have on the timeline for profitability?

Obviously we don't comment on any processes that actually still remain ongoing. So that--we can't specifically talk about that. The U.K. contracting rules are a little bit unique. BT had a reset in their contracts and many of these resets are more a culmination of change orders than they are anything else. So we will continue delivery.

We have a contract in place with a series of change orders that have already been enacted and attached to that and we're going to continue delivering on that contract. We still expect to be able to recognize margin on those contracts by the end of 2008, whether or not a reset occurs.

Okay, great. Thank you.

And the next question comes from the line of Sean Wieland with Piper Jaffray. Please proceed.

Thanks.

Just following up on that question. Does your guidance for 2008 include any U.K. margin?

It does not.

Okay.

Basically as we lay it out, Sandy--

Sean.

Sean, I'm sorry.

Second quarter in a row--no, I'm just kidding.

Sorry.

Basically our estimates would include expectation that it would be toward the end of '08, so for the most part it will be minimal impact. Our primary impact is that we should see in '09 the full year impact of having those in, and when we talk about our 20% operating margin guidelines, we do factor in '09 we will have that full year margin. I think sometimes people are not clear that that is factored in our numbers and isn't going to be complete upside to our '09 numbers, but currently expected in '09. Not really negligible impact in '08 currently.

Okay.

Second question I had was can you just dive into it a little bit more detail on the conversion cycle or the upgrade cycle of the Millennium '07 customers? When did it it start? What percentage of your Millennium base is upgraded to '07?

Yes, this is Mike, I will take that one.

We released in November of 2006. So the first early adopters took 2007. As of right now as Marc mentioned we have about 25% of--a third of our clients that are actively using 2007 in production. By mid-year 2008 we think it will be probably about half of our Millennium based. And because of the road mapping exercises we do with our clients we know that it's also on the horizon, the near-term horizon so we'd expect a lot of the second half of our base to start down that journey in 2008 or early 2009.

When do you expect the upgrade cycle to be complete?

We actually released to our clients that we're going to continue to build out the capabilities of 2007. So--the 2007 release. So I would expect that there will be people that take the release over the next two years or so until they have the option to take the 2008 release or the next release that we make available to them.

Keep in mind that the upgrade center which is the centralized entity that performs the bulk of the labor associated with the upgrade process for our clients has been heavily adopted and we've actually shrunk the cycle time for it. So the cycle time is literally around 90 days to 110 days whereas it used to be six to nine month process. Once people make the decision, we can turn that around fairly quickly and move in a different direction. And starting in the early part--mid-part of 2007, we started to also bundle with those upgrades new software deployments as well.

So we now--people now have an opportunity to not only upgrade but bundle in some new applications on the route as well. That gives us a little more flexibility and as Marc mentioned in his comments, it takes away the stall factor where they may not move down another application decision waiting out for an upgrade. This gives us the ability to do both at the same time.

Okay. Thanks, and one last question. Haven't heard much recently about the Galt acquisition, Health Fax, anything new to report there?

Nothing at this point.

Okay. Thank you very much.

And our next question comes from the line of Sandy Draper with Raymond James.

Thanks. A couple quick questions. First, Marc, can you just tell me the research R&D write-off, what line did that show up on the P&L?

It would have been in R&D--I mean, that's where the charge would go.

Okay, so if you could pull out about $4.5 million from the step-up in the software line at normalized rate?

Correct.

Okay, and then can you just--I missed a little bit what you were talking about in terms of when we would expect to see a step-up in the amortization and what the rollout or sort of trend of software development would be like in '08?

Sure. At this point we've obviously got a bucket of dollars and we have been capitalizing post the cost related to Millennium '07. As we start doing the sequential rollouts, which we are kind of expecting the next one to be in the second half of the year so targeting Q3, we will trigger amortization of the big portion of that bucket. So you will see about a $4 million a quarter impact from amortization expenses. We start amortizing that bucket once we make that inner release. So big impact on that one, and that will continue on for the five years that we amortize.

What you'll see subsequent to that, as we go to these shorter release cycles is incrementally smaller amounts added to that amortization, and we will certainly give guys visibility as to when we were rolling those out and when that's going to trigger and start amortizing. In 2007, you're going to see an impact in the back half of the year of amortization expense going up--or in '08. Let me correct the year I'm in here.

In last half of '08 you will see it go up as we talked about in the script of some of the 2002 stuff that rolled off completed its amortization and first half you will get a little bit of a benefit of about $2.5 million a quarter from that going away. It will be somewhat offset by the increase in the last half of the year of the iterative Millennium '07. So net-net it's probably a $3 million net impact on '07 between the stuff rolling off and the new stuff that we expect to roll on.

Okay, and then the final one that, and I may have missed it, did you comment on the fairly sharp drop in G&A in the fourth quarter?

I did not. It's a combination of some incentive payments that normally hit us relative to Q4. And then there is--there will be some affect of foreign exchange rates that get us in more in Q4 as normal.

Okay, thanks.

And the next question comes from the line of Anthony Petrone with The Maxim Group.

Thanks for taking my question. There's just a couple first on hardware sales. You mentioned I think in your prepared comments that you may be employing some initiatives to perhaps increase hardware sales, I guess, within the managed service base. Could you just elaborate on what some of those efforts might be?

Yes, this is Marc.

I think the comments were probably more in line with that we would look to augment what we saw from a hardware perspective. The opportunities for growth in that business are globally to go some more hardware in our global client base which is not as heavily hosted or is not hosted by us which still allows us to sell hardware even to the hosting entity. And from a device works perspective going in reselling more of the devices that we are connecting through our CareAware strategies. Those are really the opportunities for growth in that business, and I did not mean to imply our hosting clients are going to be a source of more purchases, that's--it's actually the opposite. They will actually be a market that we don't expect sell back into.

What would be the extent, I guess, in the gross margin outlook that you have reflected to pick up if that may happen in the next couple of years? Because it seems like that could somewhat offset some expansion going forward.

Clearly I think when you look at 2008 we ended in '07 with gross margins at 81.6% and I think probably the last quarter we talked about 80% to 81% being a reasonable estimate. I think with our new lowered hardware expectations that sometime placed around 81.5 is going to be where we--more where we land. You are correct to the extend that we do sell more hardware and its lower margin, it will impact our operating margins.

Realistically in the 2008, 2009 time frame I don't see a huge impact from that. The device business certainly will take sometime to ramp up, and the global business will be--will be very lumpy coming in and we will just have to highlight it when it impacts it. We clearly have been very clear that our goals to get 20% operating margins, but we're not going to walk away from low hanging fruit relative to earnings. Operating margins are important, driving earnings above 20% annually is our bottom line goal.

Sure, and I guess a final big picture question, and I know it's a little preliminary here, but just some comments that came across the wire early today about President Bush's '09 annual budget which may include some significant cuts in Medicare spending over the next five years. Just getting into that, and the one that sticks out to me is a $23 billion cut over the next five years to teaching hospitals and $20 billion cut on CapEx for hospital building and purchase of equipment.

I mean, I know this is preliminary and still has to go through Congress and such and we could imagine what the hurdles would be there. If this was to go through or even a fraction of this was to go through, how would you I guess--how has this changed the outlook? Two to three is domestically and maybe if you could elaborate on what percentage of your customers right now are teaching hospitals and maybe what percentage within the pipeline right now at teaching hospitals?

Yes, I think from--let me just briefly take about that initiative. I think your comment is right that Congress has the power of the purse. Kind of the comments from not to be disrespectful, but from a lame-duck President or more of a political statement than they are a policy statement. At this point we would think that while interesting, it merely would be an element of added debate, it's not going to have a lot of power behind it.

When we look at things--when we look at Congress, when we look at the bipartisan support for healthcare IT and healthcare in general, it's hard to see how those things would become enacted. In addition, we think that the best way to approach that is to look at the pay-for-performance and the never pay list initiatives that actually allocate the funds--more funds to those who are IT enabled and can actually measure the quality that they are doing.

When we look at our client base, our existing and target clients right now are relatively healthy. In fact, when we go--we have actually financing companies, our partners that do financing for us coming to us, wanting to pump more money into this sector given the attractiveness of the sector and we are having a hard time placing that money because it's not something that our client base is looking for.

So we think given that, there have always been haves and have nots in healthcare. We tended to be fortunate enough to sell to the haves. And if this would become enacted, it clearly would hurt the have knots which fortunately for us are not really our target market.

Excellent. Thank you very much.

And I guess just one follow-up to that would be you mentioned your finance partners. I would assume specifically to the channel you are in, no impact from I guess the current credit markets doesn't seem at this point--?

There is cash out there, and they are looking for a safe place to put it and healthcare jumps to the top of their list because of the quality of those providers and the ratings that they get.

Excellent. Thank you very much.

And our next question comes from the line of Frank Sparacino with First Analysis. Please proceed.

Hi, Marc. Are you willing to disclose the actual managed services revenue during the quarter?

We don't break out the revenue on a quarterly basis, but we are--we will break it out on an annual basis which we do relative to--and let me make sure that I think in our HIMSS meeting is on--I think is currently scheduled for February 26th, we will kind of break that number before the quarter. Managed services--for the year managed services revenue that you'll see in that is somewhere around 145 to 150 will be the the number that I give you as a preliminary view. If you're familiar with us at HIMSS, we will break out each of the business models and the revenue from each of the business models on an annual basis at HIMSS, so you can get a good sense what each of those is contributing to the total revenue number.

Okay, and lastly, Marc, on the cash flow, just wanted to make sure my expectation level wasn't wrong. When I look at 2008, I thought the CapEx spend would be coming down more substantially than what you are projecting at 150. Is there something new or different?

I think if you look at our $80 million to $100 million target for 2008, if you just kind of walk through the math, we ended this year at $28 million. And if you assume that based on consensus estimates that we add $30 million of income to that on a year-over-year basis, we get another $30 million benefit from depreciation amortization which is our expected increase there; and then you take the $30 million plus benefit of lower Cap Ex, that basically is $90 million that you would add to the 28 which actually gets you over our target someplace in the $120 million range. We expect to eat some of that up for working capital. So if working capital is in the 20, $30 million range, that should put you kind of in the middle of our $80 million to $100 million guidance. I think all of the numbers we talked about today are consistent with our overall guidance of the $80 million to $100 million.

Okay, thank you.

Ladies and gentlemen, this does conclude the Q&A session and our presentation. Thank you very much for joining today. Have a good afternoon.