塞納 (CERN) 2008 Q2 法說會逐字稿

Welcome to Cerner Corporation's second quarter 2008 conference call. Today's date is July 22nd, 2008. 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 or prospects constitute forward-looking statements for the purpose of the Safe Harbor Provisions of the Securities and Litigations Reform Act of 1995.

Actual results may differ materially from those indicated by forward-looking statements. Additional information concerning factors that could cause actual results to differ from materially to those in forward-looking statements may be found under the heading risk factors under item 1A in Cerna'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.

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

I will lead off today with a review of the numbers followed by sales and operational highlights for Mike Valentine, Executive Vice President and General Manager of the US.

Trace Devanny, our President, will discuss our global efforts in our physician practice business. Trace will be followed by Jeffrey Townsend, Executive Vice President and Chief of Staff who will discuss innovation. Neal Patterson, our Chairman and CEO is traveling.

Now, I will turn to our results. Bookings, revenue, operating margin earnings, and cash flow were all at or above expected levels and outlook for 2008 remains strong. Move to bookings, our total booking revenue was $404.2 million, which is above the high end of our guidance range. Our bookings in the year ago quarter of $487 million included 98 million of UK bookings and about $20 million over attainment related to hardware.

Adjusting for those items, this quarters bookings are up 10% over last year. Moving to backlog, our total backlog increased 10% year-over-year and ended the quarter at $3.3 billion. Contract revenue backlog ended the quarter at $2.7 billion, which is 10% higher than a year ago.

Total backlog and contract backlog reflect $178 million adjustment related to the cancellation of the Fujitsu contract, which I will discuss in a minute. Support revenue backlog was $0.6 billion. Our revenue in the quarter increased 4% over Q2 07 to $402.8 million at the high end of the guidance.

Revenue composition for Q2 was $120.6 million in system sales, $109.7 million in support and maintenance, $161.8 million in services and $10.7 million in reimbursed travel. System sales revenue was down 7% compared to Q2 '07. This decline was expected in our guidance due to extremely tough hardware comparable.

As with last quarter, growth in software was offset by significant declines in hardware revenue. We expect system sales to grow in the second half of the year, as we now have the tough hard work comparables behind us.

Services revenue which includes managed services and professional services grew 9% compared to a year ago quarter driven primarily by strong managed services growth. Our professional services revenue up 1% year over year. Lower growth rate of professional services was a result of slightly lower billable head count in the US and less services revenue in the southern region of England related to contract [reset] discussions and subsequent exit of Fujitsu as a prime contractor.

As we mentioned last quarter, we are hiring in our US Services Organization. I expect our growth in the second half of the year to improve.

Support maintenance revenue grew a solid 12% reflecting our delivery on system implementations. Looking at a geographic view of revenue, our domestic revenue grew 6% year-over-year, and our global revenue declined 2%. As previously mentioned, the strength in hardware sells during the first half of 2007 was primarily driven by global hardware sales, particularly in Q2.

This tough comparable coupled with the lower services revenue in the southern region of England led to the lower year-over-year global revenue despite strong growth in most of our other global business models and regions. We remain bullish about our global prospects. I expect new global revenue growth in the second half of the year.

Moving to gross margin, our gross margin for Q2 is 82.2%. Which is up 31O basis points from a year ago. The higher gross margin percent reflects the lower hardware sales and growth in software. This is also reflected in the system sales margin per set, which increased from 57.3% in Q2 '07 to 62% this quarter. We had improvements in the support maintenance and services gross margins, which increased from 93.8% to 94.4% year-over-year, driven by lower third party costs.

Stronger gross margin percents again led to margin dollar growing faster than revenue with margin increasing 8%, well above the 4% growth in revenue. We view the 8% growth rate in gross margin as more reflective of our performance than the 4% growth in revenue. Given our gross margin neutralizes the impact of the fluctuating levels of third party sales.

Before covering operating expenses and earnings, I would like to provide a quick update on the status of the southern region in England. As most of you know, Fujitzu who is the prime contractor in the southern region withdrew from contract [reset] discussions with the government in May. The government has publicly stated the intention to replace Fujitzu with the existing prime contractors, which would be BT, who is our prime in London, or CSC who is a prime in other three regions where I -Soft is a software provider.

Until a new prime is named, we cannot predict the impact it will the have on us but we currently expect to play an ongoing role in the automation of the southern region.

Note that our balance sheet currently reflects billed and unbilled receivables related to Fujitsu. The Fujitsu contract that represent over 10% of total receivables. While there will be some period of time before Fujitsu and the government unwind their contract and we settle with Fijitsu, we expect to fully recover these receivables.

In the interim, we recently signed an agreement with Fujitsu to provide transition services for the eight trusts that have already gone live in the southern region. We expect this contract to provide a bridge until a new prime is named. In connection with the execution of this agreement, we did receive a payment towards the outstanding receivable balance.

As I mentioned, we also reduced our backlog by 178 million for bookings we had taken for the southern cluster but not recognized as revenue. Our expectation is that the future contracts in the region will result in bookings that are at least as much as this backlog adjustment.

Moving to operating expenses and earnings. Our operating expense in Q2 were $266.4 million, before options expense, and the third party supplier settlement mentioned in our release. This is up 6% over a year ago. Sales and client services were up 6% with managed services growth being the primary driver. Software development was up 5% which is in line with expected levels. G&A expense was up 4% year-over-year.

After having a large impact on G&A expense in Q1, foreign currency translation only had a $200,000 impact in Q2.

Moving to operating margins, operating margin in Q2 is 16.1% before options expense in the third party supplier settlement. Increase of 230 basis points over the last year. This quarter our operating margin was impacted by 80 basis points due to $20 million of zero margin revenue from the projects in England. We remain on tract for goal if achieving 20% operating margins in 2009.

Note that our path to 20% continues to include the assumption that we will be able to recognize margin on our UK contracts. We are making good progress on the work necessary to support margin recognition on the London contract and should be in good shape to begin recognizing margin by the end of 2008.

As we continue to work through the accounting, our current expectation is that it will be a one time catch up of margin, in the quarter we begin recognizing margin on the contract. This is a change from our initial view, which did not include a catch up entry but instead assumed the deferred margin would be spread over the balance of the contract.

In spite of this one time margin catch up, our current expectation is that the on going margin will still be adequate to support our path to 20% margins. We will break it out when it occurs, it is not included in our guidance. Given the status of the south region, there's some uncertainty as to when recognition will begin in that region.

However, we expect to be able to leverage the work supported market recognition on our London contract to support beginning margin recognition in the southern region, not too long after new prime contractor is put in place.

Moving to earnings in EPS, our GAAP net earnings in Q2 were 35.3 million, $0.42 per diluted share. GAAP net earnings include stock option expense, which had a net impact on earnings of 2.1 million or $0.03 per share. In addition, our settlement with the third-party software provider related to our hosting business impacted our sales and client service expense by $8 million and net earnings by $5 million. Excluding these items, adjusted net earnings were $42.5 million, which is 26% higher than our originally reported Q2 '07 adjusted net earnings of $33.8 million.

One note on the prior period comparison, recall that we had a R&D writedown, a tax item in Q4 '07 that had a prior period impact and was adjusted in the quarterly results for Q1 '07, Q2 '07 and Q3 '07. For Q2 '07, the impact of those items was a 4.2 million reduction to net earnings leading to Q2 '07 adjusted net earnings of $29.6 million in our release this quarter, instead of the originally reported $33.8 million.

Moving to EPS, the adjusted EPS for Q2 '08 was $0.51. Which is $0.01 higher than the consensus assessment and at the high end of our guidance range.

On the third-party supplier settlement, I would like to provide some background and perspective. As mentioned in our release, we reached a settlement during Q2 with a third party provider of software related to the use of their software and remote hosting business. The settlement included compensation for use of the software since inception of our hosting business. For perspective, the $8 million settlement only represents about 1% of the more than 500 million of revenue generated during the period for which we are settling.

As part of the settlement, we agreed to purchase approximately 15 million of additional software license through 2009, which is well supported by backlog in this business of nearly a billion dollars. The additional license purchases will be amortized over the hosting period for each applicable hosting contract.

I would also note that our tax rate of 35% was about 1% below our plan level. As required by FIN 48, the interest on a income tax refund we received this quarter was run through income tax expense. Resulting in a one time reduction to our tax expenses $700,000. As I will discuss in a minute, we had over 2 million more amortization than we expected in Q2, which more than offset the benefit from the lower tax rate.

Now, I will move to our balance sheet. We ended Q2 with $291 million of cash, $102 million of option rate securities. Total debt $185 million. The $102 million on the balance sheet reflected approximately 4 million reduction from par value. We continue to view this impairment as temporary due to the underlying credit rating of the securities, and are intent in ability to hold the securities until the market recovers.

As I mentioned last quarter, the vast majority of option rate securities are AAA rated and backed by United States government. Unlike many ARS that represent collateralized mortgages or corporate debt.

I would also note that $4 million temporary impairment does not impact the income statement but is reflected in comprehensive income on the balance sheet. We believe our $291 million of cash, available $90 million line of credit it and free cash flow should more than meet the company's cash needs.

Total accounts receivable end of Q2 at $398 million. Contracts receivable or the unbilled portion of receivables, was $99 million or 25% of total receivables. Which is down from 36% last year. Decline in our contracts receivable balance becoming billable based on the contracts, and a higher level of third party financing in the quarter. Third party financings were $29 million, or 7% to the $426 million of total cash collections.

Our DSO was 90 days in Q2, which is down two days compared to last quarter.

Operating cash flow for the quarter was $85 million, up from $62 million a year ago. Q2 capital expenditures were $23 million. Capitalize software in Q2 $18 million. Free cash flow defined as operating cash flow less capital expenditures and capitalized software was $44 million.

This compares favorably to the negative $5 million of free cash flow in Q2 of last year. Note that we do expect operating free cash flow to go down in Q3 from the record levels in Q2 but we still expect good free cash flow for the rest of the year. Year to date we've generated $47 million of free cash flow positioned us very well to meet our targets of $80 to $100 million for the year.

Moving to capitalized software, the $18.1 million of capitalized software in Q2, represents 26% of the $70.6 million of total spending on development activities. Software amortization for the quarter was $13.4 million. Resulting in net capitalization of $4.7 million or 7% of the total.

On software amortization, we had previously expected our amortization to increase, beginning in Q3 with an iterative release of Millennium. However, we now expect that release to be available in early 2009. Due to the longer period of time between releases, we identified a small amount of capitalized software, that had become generally available and should begin amortization before the next millennium release.

We triggered amortization on that software this quarter, resulted in a 2.4 million increase in amortization expense. Part of which was a catch up for prior quarters. We expect amortization expense to go back down by about a million next quarter compared to this quarter excluding the catch up.

Upon the release of the next generation of Millennium in early 2009, we would expect to increase amortization expense by about $4 to $5 million per quarter. This increase will be partially offset by the completion of amortization of amounts capitalized in 2003, which will reduce amortization by $3 million per quarter [given a] net anticipated increase in amortization expense of $2 million per quarter.

While we had previously expected the larger release to go GA some time this year, the increase in amortization expense associated with the smaller releases, starting at a quarter earlier will result in our full-year amortization basically being in line with what we expected.

Now, I'll go through the guidance. Looking at Q3 revenue, we expect revenue in the $410 to $425 million range, which is about 12% growth over last year. For the year we continue to expect revenue growth of approximately 10%. We expect Q3 EPS before options expense to be $0.55 to $0.56 per share. Q3 guidance is based on total spending before options expense of around $270 million.

For the year, we remain comfortable with consensus EPS before options expense and third-party supplier settlement of $2.17 plus the penny over attainment this quarter, leading to an estimated $2.18. Outside this guidance could be achieved if we are able to begin recognizing margin on our contract in London. Note that this guidance assumes we have no material negative impact for foreign currency exchange for the remainder of the year.

Estimates for options expense for Q3 '08 in 2008 is approximately $0.03 and $0.12 per share, respectively. For bookings expect revenue in Q3 of 370 to 400 million with a midpoint of that range reflecting growth of about 8% over Q3 of last year.

In summary, we are pleased with the results in Q2. Including exceeding the top end of our bookings guidance, delivering revenue at the high end of our guidance with an outlook for solid double digit growth the rest of the year. Continued progress on the margin expansion initiatives, strong earnings growth in excess of 20% and record free cash flow positioned us well for our full year free cash flow target of $80 to $100 million. With that, I will turn the call over Mike.

Thanks Marc. Good afternoon, everyone. Today I'm going to cover sales, operational highlights and some marketplace trends. From a sales perspective, we had a strong quarter. While the topline still reflects a large year-over-year decline in hardware, the rest of our business is performing well.

In Q2, we did $404.2 million of booking, which is an all time high level of bookings for a second quarter that doesn't include UK bookings. As Marc mentioned earlier, our results in Q2 last year included $20 million of hardware over attainment. Our growth against Q2 of last year adjusted for this was about 10%.

We had a good mix with 10 contracts over $5 million. Seven of which were $10 million. We continue to have good bookings contribution from outside of the Millennium installed base with 23% of contract bookings for new Millennium footprints coming in this quarter.

Our RFP activity is strong and our pipeline is at record levels with a continued strong level of net new footprint opportunities in our radar. We also had another record level of activity in our vision center, which eclipsed the all time high level set last quarter.

To put it in perspective, year to date, our client activity is up more than 40% in our vision center, which is encouraging given that vision center visits have historically been a good leading indicator of sales activity in coming quarters. Operationally, we had a good quarter that included a wide range of solutions going live at a wide range of venues around the world.

Last quarter, I indicated we were going away from reporting conversion counts and transitioning to providing relevant color about our different groups and initiatives. This quarter I want to provide you with some perspective on the professional services organization, as I that think the breadth of services and quality of results is impressive.

The organization is the largest in most experienced health care IT focus consulting group in the world with over 2,000 associates that have an average Cerner experience of nearly five years. In addition, 20% of our professional services associates have a average of nearly six years of clinical experience prior to Cerner, which further distinguishes our experience levels from other health care consulting groups.

In addition to traditional implementations, we continue to have great success with our solutions center, which accounts for 20% of implementations around the globe. This solution center includes a structured implementation process, several steps of which are done at our headquarters where clients find a enhanced ability to focus on their project and have direct access to Cerner experts.

We now see some of our competitors are trying to copy this approach because of its strong reputation in the marketplace. In both our traditional implementations and solution center projects, we continue to benefit from our bedrock tools that help automate much of the design and build stages of the implementation and our Method M Methodology that provides the structure that leads to predictable outcomes. Something that is increasingly important in today's market of more risk adverse buyers.

These tools and methodologies have helped us improve the quality of our implementations at a lower cost of ownership for our clients, while also contributing to consistently increasing profitability in our services business.

As some of our client base begins to balance their focus between implementing new software solutions and gaining the full benefit of what is already installed, we are positioning a portion of our consulting staff to be the driving force behind the proliferation of good practices and other learnings harvested from our experiences.

Essentially, the strategy here is to tap into our learnings across our client base to help clients improve their bottom line and quality by leveraging their invest in Millennium.

We see this as a growth opportunity for our services business and a real win-win with our clients. Over all, I think the depth and breath of our services organization is an important differentiation for Cerner. Particularly when compared to others who rely more heavily on third-party consultants.

Looking at the overall market place, we believe the market remains solid. We are still seeing most of our demand being driven by CPOE and surrounding solutions such as clinical documentation, decision support and close loop medication administration. And we are very well positioned with the most proven and comprehensive solutions in these areas.

We are also seeing a pick up in revenue cycle demand. We believe this is being driven by the regulatory and reimbursement changes that are emphasizing pay for performance and quality. Most of the benefits attributed to the revenue cycle functions require a sound clinical foundation to already be in place.

We see our clients approaching this in a two-step fashion. Clinicals first, then revenue cycle. Given this environment, going forward we feel that we have a solid target market opportunity in the 170 plus clients in our client base that haven't updated their revenue cycle solutions over the last ten plus years. And with some recent successful revenue cycle go lives and increasing sales, we are starting to see the momentum build.

As I discussed last quarter, other areas of emerging opportunity that represent what we call white space include risk packs, device connectivity, and additional services, such as application management services or AMS and transformational services. Both AMS and transformational services have been strong contributors to booking so far already this year.

Looking at the overall market, our clients continue to be in solid financial condition and we are not seeing material impacts from the credit market issues. There also continues be bi-partisan awareness and support of health care information technology.

While we don't believe there is any one piece of legislation that will create a flood of demand for health care IT, we believe the ongoing recognition that IT is an important part of addressing the unsustainable increases in health care costs will support continued strong adoption of our solutions. With that, I will turn the call over to Trace.

Thanks Mike. Hello, everyone. Today I would like to discuss some good progress in our international business and physician practice business. On the global front, we had a very solid Q2. As Marc mentioned, our global revenue declined slightly year-over-year primarily due to declining hardware sales. But that's not reflective of the continuing progress we have made or of our strong international opportunity going forward.

Specifically, we had good bookings contribution from global and more importantly, we have a strong outlook for the second half of the year. We also had a positive year-over-year increase in profitability despite the lower revenue, which is consistent with the revenue decline being driven by hardware.

In the Middle East we had a very strong bookings quarter and very positive Millennium deployment success. In the past 90 days three important sites have gone live in the Emirate of Abu Dhabi including Sheek, Colisa, Medical City, Cornis Hospital and Tulam Hospital, as part of the contract with the Abu Dhabi Health Service. I believe the successful solution Go Live positions us well for continued success in this region.

In the United Kingdom while uncertainty in the south has captured some media headlines, important progress is being made on the ground. We continue to grow the number of sites and solutions live in England and we now have a total of 67 sites and 430 city solutions live, which was up from 61 sites and 313 solutions last quarter.

In addition, we continue to be very pleased with our progress on the Choose and Book Program, as we see continued to see increased utilization, with the total number of bookings to date now approaching 10,000,000. In fact, today more than half of all appointments are being booked directly.

Beyond increased volume, solution is most importantly impacting the patient experience. Recently respected doctors such as the Department of Health, Doctor Jillian [Brownhold] has shared positive feedback about the benefits of Choose and Book with the British House of Commons. Choose and Book along with the flagship website, NHS Choices is at the heart of the government's push for enhanced patient choice. We are pleased this solution is becoming central to the NHS's focus on high quality, personalized care for patients.

In addition to Choose and Book, we continue to deliver results with our partner, British Telecom in London. Royal Free Hampstead is now live with the version of Cerner's 2007 release called LC-1. Royal Free represents several firsts, including connectivity to the national data spine, the use of Smart Cards and the integration to Choose and Book. While there is still significant and on-going work to be done there, the opportunity to build momentum in the second half of the year is most promising.

Indeed as the author of the NHS review commented to the media last week, in London, it is starting to look very positive.

Finally, in the southern cluster the agreement that Marc described earlier in the call allows us to continue to work with the live sites in that region to allow them to progress as the government transitions to a new local service provider, or LSP. We are more committed than ever to seeing these trusts realize continued success in the near term and of equal importance, as they chart their IT strategies over time.

Jeff Townsend spent last week in England talking with government officials working with partners on several new initiatives and interacting with key hospital trusts. Like my own visit in early July, Jeff's view coming out of last week is that we remain very well positioned. We are committed to driving a demonstrable clinical benefit. We are focused on true value for the investments made. We believe suppliers that deliver on this objective will have the opportunity to play an active role in the program in the future.

Moving to our PowerWorks position practice business where we continue to make good progress. As I have mentioned in previous calls, our biggest opportunity continues to be the leveraging of our large Acute Care Base and ability to support both in-patient and out-patient environments on a unified architecture. On this front, we continue to gain momentum with initiatives where acute care clients are offering PowerWorks to physicians in their respective communities.

Last quarter, I announced the go-live of our first ambulatory surgery center using the PowerWorks solution. We are already building on this success, as we recently signed another surgery center, and a promising pipeline of additional opportunities continues to grow.

In addition, we signed a PowerWorks deal with our first ever critical access hospital, this quarter. We expect to continue expanding the reach of PowerWorks -- of the PowerWorks model to rural health, urgent care facilities and small specialty hospitals. We are also gaining traction in our business office outsourcing solution as well.

I would like to comment on a positive development for the overall physician practice market. We view the recent passage of the Medicare Bill into law as a positive. This measured delay as proposed 10.6% cut to Medicare physician payments and allows for 18 months of stable payments to the medicine -- to the medical physician community. Additionally the bill will foster adoption of electronic prescribing by providing incentives for its use between 2009 and 2013 with penalties for not using it starting in 2012.

Clearly this delay in reimbursement cuts helps physicians. We also think providing incentives for e-prescribing is an important positive statement. To align with e-prescribing incentives, we have introduced a very low-cost e-prescribe solution on a per provider per month basis that can be purchased separate from our EMR.

This directly competes with the otherwise free e-prescribe offerings with the Cerner advantage of being connected with running in our PowerWorks EMR domain. This will allow clients to easily add other EMR components in the future as they become comfortable with this new technology. With that, I'll turn the call over to Jeff.

Thanks, Trace. Today I'm going to make some brief comments on our CareWare platform and then turn it over for q-and-a.

In the second quarter, we continued to advance our CareWare platform, both from a capability standpoint and from a market awareness standpoint. The core principal around our CareWare platform is the premise that electronic medical records create a new digital medium for care delivery. From there, the entire delivery experience can be redesigned to include a contextual awareness of the entire experience, well beyond the work flow represented on the screen.

Our CareWare [MD-BUS] device connectivity solution allows medical devices to be connected to the MR through a USB-like plug 'n play connection. It is more than just connectivity. These devices require human interaction to adjust to the changing treatment or context of patient care. Making the devices in the EMR aware of each other introduces a new paradigm in what is possible.

The level of client interest in this solution continues to exceed our expectations. In the Q2 we signed several new clients and an expansion agreement with an existing client. We continued to expand our library of device drivers, completing another 100 new drivers, which increased our library to over 250.

The second quarter also included good progress with RX Station our medication dispensing unit. IRX Station has a strong differentiation in the marketplace because it is directly connected to the EMR. Turning what was once an island of information in an isolated work flow into a comprehensive workflow with a single source of truth.

After our first implementation of RX Station production units in April, we are now doing the second phase of implementation at that site. We also sold another new footprint in Q2 and several more implementations scheduled in the coming months. Our pipeline remains strong and we believe we are well positioned for contributions from RX Station to accelerate after we complete implementations at the earlier adopter sites and credit strong reference base.

I mentioned last quarter that we planned to launch a unique marketing campaign for our CareWare suite of solutions. Including MD Bus, RX Station, My Station, and other solutions that collectively allow us to show a smart hospital room of the future and the complete redesign of the care experience. Because you have to see these solutions in context to understand them, we created the Cerner Smart Semi through a collaborative effort with Steel Case. After starting in May, the Smart Semi has already made more than 20 stops and we have 60 more scheduled in 2008,

which represents a increase from our original schedule because of strong interest. We are averaging more than 100 clients at each stop, including many C suite executives from our clients and perspective clients.

In addition to the lead generation created by the Smart Semi, we are seeing an added benefit of getting our clients re-energized about the potential for technology and the relationship with Cerner.

In addition, the media interest in the Smart Semi has been strong. Many clients have used this as an opportunity to tell their story about using technology to improve patient care in their communities. With that, I will turn it over to the operator to take questions.

(OPERATOR INSTRUCTIONS). First question will come from the line of Charles Rhyee of Oppenheimer.

Mark, you talked about the catch up on the margin for the UK contract. Can you go over that again and sort of explain -- is it for the southern cluster or is it for the London cluster? You kind of went over it quickly, I just want to get a better understanding of what you meant and what we should expect.

It's a good idea, prior to obviously the Fujitsu contract stopping the answer was the same to both.

Relative to BT, we continue to do the accounting work relative to ability to estimate to get to the point where we can start recognizing margin. We continue to look to be on track to getting that done by the end of this year. So we will begin to be able to start taking margin at that time.

As we have gone through the accounting, it's our expectation that there will be a certain catch up. So there will be a certain level of margin from the date the contract started to the date that we can begin recognizing margin, that will catch up margin to that point. So there will be a one time tranche of margin that would get recognized and then post that we would begin recognizing our margin on a monthly basis, as we do the work just like under normal long-term contract accounting.

That is a little different than what our initial view was. We wanted to make sure people were aware of that. We haven't quantified what that amount would be. But we feel very good that relative to our [path] of 20%, and the fact that we were looking in '09 to having some of the margin from the UK helping us get there. The go forward level of margin on the BT contract will be enough to support the 2009 view of the 20% margin.

If I'm not mistaken, the original assumption was that the margin that we were not recognizing under the cost recovery method from the start of the contract until the recognition point, that was going to be recognized ratably over the remainder of the contract?

Correct. That was our original expectation as well; what we discussed. As we continue to go through the account -- it is fairly complex accounting for these things. It is the guidance of our auditors there will be some amount of catch up.

Once again, we don't -- until we get the quantified, we want to just preview that with investors. We don't know if that will be a very large amount at all and our expectation is it's not going to be huge with respect to the entire contract. But there will be some level of that and we want to preview that.

The southern cluster, as we work through and a new prime is named, and we contract under that new prime going forward, it actually this cut off will probably be fairly affective in that the prior period was under a revenue and expense approach will get settled out as part of the Fujitsu settlement.

And then going forward, as I indicated in my comments, we think we would pretty quickly get to a margin recognition in that new contract in the south, and then it will be that margin on that new contract being recognized ratably or as costs are incurred over that period.

Okay. Great. Thanks a lot, I appreciate it.

Sure.

Your next question will be from the lines of Brett Jones of Leerink Swann.

I just have a quick question, a follow up on the previous question. Just to make sure that I understand, the southern region with determination any profitability associated with the work that has already been completed would have to be recognized right away? Am I understanding that correctly?

The southern contract just terminates and a separate -- well a separate contract that we will certainly be negotiating with Fujitsu a settlement on. We have taken revenue equal to expense, so to date we have taken no profit there. Certainly as we go through our settlement discussions with Fujitsu, we would look to be able to realize profit on that activity that we had. That would all be part of the settlement.

So rather than having a one time margin occurrence as you convert from revenue equal expense to recognizing margin, in that case you will have the Fujitsu settlement being -- you know, being the determinant of what margin would get recognized and that would be tied to the time frame of the settlement occurring. And then you'll have a separate contract, which as I indicate we would expect to fairly quickly get to margin recognition.

In that case, it's going be split between two contracts, one of which as part of the settlement will bring with it the potential for margin recognition in a relative lump sum but then they'll be ongoing for the second contract which we would expect to see the margin occurring ratably.

We will end up in the same impact for both contracts but they will get there through two different paths.

If we could turn to -- to the financial system upgrade cycle that you eluded to with revenue cycle. An increase in interest and revenue cycle management. I believe at the HFMA Conference, there was talk that there was expected to be a new release of a financial system this fall. I was wondering if you could provide an update on that.

This is Mike. If you're speaking relative to our revenue cycle solutions, there were updates that were included in our 2007 release. And we implemented those updates in our [sol] base. If that's what you're referring to, it was essentially advancing the solution in the profit front as well as registration and scheduling.

Most of the next big move forward on revenue cycle will occur when we release the next iteration of Millennium '07, which as I indicated in my comments will be early 2009.

So what you may be referencing at the HFMA was more of our initial dates that we thought would be towards this fall. Those will be now in the early '09, which will be good for us because we will have a chance to review the code with our clients in our October Cerner Health Care Conference and that will give us some good insight as we go and finalize the code for release.

Ok great, one more quick question and then I'll jump back in the queue. The $8 million settlement for the third party software, did that hit in the support maintenance line for revenues?

For well it's not the revenue would have come through on sale of the client service or on the client services line. Part of the managed services business. The revenue stream that it would have supported, would be in the services line basically.

Great, thank you very much.

Sure.

Your next question comes from Anthony Vendetti from Maxim Group.

Just a quick follow up as well. Do you have any sense for the timetable to when the NHS will make a decision on this and if it is British telecom since you're working with in London, is it your understanding that you would be the sub there?

Obviously, there is hypotheticals involved in your question. The discussions are ongoing. Certainly, one of the of the scenarios that we talked about, it has got to be one of the existing primes to take over. Should British Telecom be the prime that takes over, given our implementations already in that region. That would be very logical for us to continue to expand in that region.

There hasn't been any timetable established by the government, and connecting for health, as far as, when they expect to work through all of this. I think they certainly want to get a resolution in a timing of coming up with the next year's budget. We would expect to make progress as we kind of roll through the end of this year and into early next year.

But I think there hasn't been a timetable established. We will obviously provide updates as we learn more. The key for us is that we have a transition agreement in place. We can affectively support those eight trusts that are out there running live in southern cluster today but we certainly look forward to meeting some of the additional demand that we see in the south for people who have not yet gone live on the Millennium.

Then just a quick follow up to that. The way you are accounting for it, if you were to pick up the southern cluster, again, would that just be upside to the way you're currently accounting for it?

In essence, the southern contract we had with Fujitsu is kind of now a historical document. It has related to it some receivables and a variety of payments that we believe we are due under the contract. So that kind of stands alone and to the extent we receive reimbursement in excess of what we have on the revenue equal cost level of receivables, that would represent additional margin on that contract.

Going forward, if we are selected to continue in the south which we certainly think is a strong possibility, we will have a brand new contract. We would just backlog this quarter to take out what was left of the Fujitsu contract. So basically, it would be just like signing a new contract, going forward. And the difference between that rather than being revenue equals expense for a long period of time on that new contract, we think we will be able to leverage the British Telecom work and get to margin recognition more quickly, which will really make it of a more of a normal long-term contract for us.

Depending on our work share, if our work share would increase that booking could be significantly bigger than what we originally had in the southern region.

Perfect, thanks, Marc.

Your next question will come from the line of Ross Muken of Deutsche Bank. Please proceed.

It's Mike in for Ross here. I want to talk a little bit more about the PowerWorks push you guys have made recently. Obviously, it's been a very competitive market for the long-term. And you guys have definitely been able to differentiate yourself by the folks in the acute care.

Can you talk about just when you go in to a stand alone doctor's office what the sale cycle looks like and what the competitive dynamic looks like there.

Yes, Mike, this is Trace. We have been talking about our PowerWorks physician office strategy now for a number of quarters. And as we've said from the very beginning, we think that with a lot of the activities going on around the Medicare reimbursement, a lot of the activities around some of our competitors, we like the fact that we have the ability to put on a single platform both ambulatory as well as acute care facilities.

So we sell -- obviously it's very difficult to sell to a single practitioner or even two to three practitioners. We've perfected in large case the ability to do that via the internet, so phones -- phone work and our ability to show our system without showing up, has kept the cost down to continue to make progress in that very important part of the market.

We also have an important strategy relative to working with our clients, that's where our biggest opportunity lies and that's what the advantage we bring of our large IDM clients that often times represent huge market share in a given MSA. That setting up that hub capability to connect all physicians within that given market service area has really been a positive for our business as well.

We like that space, we continue to make it a very important of our subscription model and fully expect to continue to lead in that space.

Great. I think all my questions about the UK contract have been answered. I will let someone else jump in, thanks.

Your next question is from the line of Richard Close from Jefferies. Please proceed.

Great, thank you just a couple of quick questions here. Marc, I was just curious on the backlog, you said you pulled $178 million out, is that correct?

Right.

That's Fujitsu?

Correct.

Okay. Then on receivables I think you said 10% of receivables, should we looking at the net -- I think the net receivables number of 398?

Yes, net receivables at 398. We basically said from a concentration view, that it's over 10% of that number.

Just to be clear, in talking about those numbers, I think you mentioned that you have received some payment from Fujitsu in terms of this transition discussions. Is the 10% receivables less that payment that you received or is that payment been received after the end of the quarter?

The payment was received after the end of the quarter.

That 10% now is lower?

The number we ended the quarter with is lower than it was when we ended the quarter -- keep in mind a fair amount of that receivable qualifies as unbilled.

Okay.

So that's the real key element here. We've incurred cost recognized revenue equal to expense and have not under the contract gotten to the point where we could invoice it in the normal terms. That's part of the settlement discussions obviously is what are we entitled to relative to payments on a contract that kind of stopped in midterm before some of the payment stream would have been triggered relative to that work.

Okay. Thanks, that's helpful there.

With respect to the system sales you mentioned, hardware went down but you also realized some software growth, did you or can you elaborate maybe on the percentage year-over-year decrease in hardware and maybe the percentage of growth in the software in the quarter?

We don't break out the elements, kind of offset some sales between those two items. We do at the end of the year talk about our tech resale and our license software business. So you will get more view of that as we head out of the year and give you analyzed numbers. But the number in Q2 '07 was an all time record for hardware. It was very, very large.

I guess I'm more concerned on the software growth side of things, if you feel comfortable with where the software number is maybe versus where it was in the first quarter. Are we seeing year-over-year growth possibly accelerate in software?

I think when you look at Q1 and Q2, we had good software growth and it was within our expectations. We do our forecast, we actually are forecasting stronger sales. As you all recall in '07, we saw an impact of the new release of Millennium 07. And that did take some of the focus off of buying new software relative to doing upgrade projects. The good thing is we are getting the upgrades done now in about 90 to 100 days.

That's taking much less focus and we are seeing more interest -- not only in our installed base from a license perspective, but from new clients. Our client development team which is focused only on new business is actually -- has been building a pipeline for a while and they are now starting to execute on that. That coupled with some of the view that we have for software on the global side is making the last half of the year look pretty attractive from a pipeline perspective in software.

Just one final to be clear, you said you had about $2.4 million in amortization expense higher than you were expecting, correct?

That is correct.

Okay. Thank you so much.

Sure.

Your next question will be from the line of Atif Rahim from JP Morgan. Please proceed.

If you could just remind us how much had been booked for Fujitsu contract, when you initiated this contract and perhaps how much revenue recognized to date and then trying to also if you could provide information on how much you feel you're entitled to at this time in terms of what could be the profit that comes in.

For most of those things we really can't comment a lot especially on last part as far as what we expect.

We certainly feel very comfortable that the amounts that are on the balance sheet which are in essence equal to our expenses are fully recoverable. We have not taken reserve against that number. We are very comfortable in that amount.

We wouldn't want to presuppose you know what the settlement will be. We will certainly aggressively pursue our rights under the contract to be fairly paid for all the work that we did.

Okay, fair enough. And then perhaps on the rational for excluding the software settlement related to the (inaudible) business. The $3 million that is excluded for this quarter, I'm just wondering why that's been excluded from sales and client services. Going forward, the $15 million that is going to be amortized is that also going to be excluded from your non-GAAP results as you report them or will that be included within the non-GAAP results.

Let me clarify that. The key relative to that item was the difficulty with that was that the supplier of that software did not have a pricing methodology for people that had a hosting agreement. We spent a lot of time negotiating that. In absence, settled in Q2 for $8 million.

As we went back and looked at the facts surrounding that settlement, we -- it looked like we could have potentially in hindsight accrued $5 million of that in Q1. That would have all been hitting in the period from 2001 forward. So there was no material impact on any one period of that amount if you'd accrued $5 million Q1 and taken it backward. So it was all right to recognize that $5 million impact in the initial view of what that could have been in Q2.

In Q2 we did finally settle it after we filed the 10-Q, which is a cut off time frame where something could have hit Q1. The settlement was $8 million rather than $5 million.

In Q2 you have what is in essence a change in estimate. Under the accounting rule, that change in estimate hits the period in which the estimate changed so that is fully a Q3 number still relating to a settlement. That's why it's a unique item.

Going forward we will take the expense related to the $50 million software, we are going to be buying and certainly for all the additional software we will buy as we continue to see huge growth in that business. That will all just be normal expense. The only reason that that $8 million is broken out is because it relates to prior period. Everything else is future will obviously be included as a normal operating expense we wouldn't adjust it out.

Just a quick question for Chris, I was curious about the Power ERX module that you have. Can you give us any idea on the pricing there?

The power specific to the physician per month solution?

Correct. Not just for the MR but for the specific e-prescription new product that you talked about.

Sure. Yes. For the power e-prescribe is $25 per month per provider.

Excellent, thank you.

Your next question will come from the lines of Sean Wieland of Piper Jaffrey.

One more question on UK and Fujitsu. Marc, help me understand what the process is of achieving a settlement request Fujitsu and the timing of this and kind of walk me through that process.

Currently, Connecting for Health and Fujitsu are working together on settling out their contract. Because they have a contractual relationship. So they have got to go through that work.

We are certainly looking to push our time line as quickly as we possibly can. The reality is it probably occurs sometime after they get their work done relative to settling out their contract.

So current course and speed that would occur first and then we would they will be able to focus their efforts on us getting our's settled. To the extent that we can accelerate that, as I said, we would. But that will take a period of time and it will take the time that it takes. Given the facts set, that's fine.

Our key focus is being able to move forward and to be able to address the market that we see in the south and the transition agreement does help us do that relative to the existing clients and then we look forward to the government also as they work to exit Fujitsu naming a new prime. So that we can get that really begin back to the getting them back on path similar to what we were doing in London.

Do you expect to get a settlement with Fujitsu by the end of the year?

I'm not going to make estimate of timing. When we know more, we'll let you. It's still very early in the process. I'm not looking for anything near term to happen.

As soon as we get a better view, we will let you all know. At this point we don't really have any sense of when it will be completed.

Okay. One other quick one. How many pro-fit customers are you at now?

We have 33 live sites and we sold two more. I think our total count is probably in the near 50 range.

Okay. Thank you very much.

Your next question will be from the line of Sandy Draper of Raymond James. Please proceed.

Thank you, good afternoon. Just a quick question, Mark, on the software development costs. I saw the amortization went up but the total spending was down. I'm trying to see if that's a function, I'm talking sequentially. Was that a function -- was there abnormally high spending in the first quarter or what caused the total R&D -- the gross R&D number to come down sequentially by about $5 million.

What you will see, Sandy, is in Q1, if you look back at '07, Q1 to Q2, it's just the payroll taxes. It stopped hitting. Q1 is fully taxed. Q2 is not so much. So you're going to naturally see kind of a $3 million or so decrease. I think that's what you were seeing last year in the Q1 to Q2. So that's kind of historically what you will see.

Probably the difference -- the other million or so dollars difference in the delta that you're talking about will be related to just having a little bit lower head count in the US. A little bit more in India. And then in Q2, we hire a lot of those people off campus in the US to the extent that positions open up in Q2, we will save them open until we hire the person in from campus on Q3. That could be a million, million two which would get you pretty much your difference.

Okay, that's very helpful. Then you would expect the gross R&D number to build back up a little over the next two quarters.

It should be -- we continue to work in India and put more resources there. To the extent that we are successful in doing more of that, it will not build up as much. My expectation in Q3 will be probably fairly similar to what you saw in '07.

Okay. Great, thanks.

Next question from the line of Steve Halper of Thomas Weisel Partners. Please proceed.

Hi, just two questions. First on profit, it's a product you have been working on for a very long time. So what changed to account for this renewed momentum in the product? Do you think you finally got it right? Talk to me about what is happening there.

This is Mike.

Hi, Mike.

I think a couple of things. In the comments I made earlier, we see in our client base, I will make a client based statement first. We see our client base the desire to have a solid clinical foundation prior to prioritization of dollars going towards the revenue cycle front.

Specifically, in our client base there's really two tacks. The ones that make the decision and go with a big bang and do revenue cycles and clinicals together and the ones that are doing the -- the ones that are deploying the clinicals first, getting a solid foundation there and then moving forward.

What I really see in front of us now is 170 plus clients in our client base that haven't made a recent decision or an upgrade and are a great target opportunity for us. So I just think the condition of the marketplace is evolving and our clients are maturing on the clinical front, to the point where they would feel comfortable with approaching the revenue cycle side.

At the same time I think we've advanced our solution over the years and the biggest things are really around our reporting and just the core work flow in the back office that have made the difference in clients being ready to move forward with the pro-fit solution in our base. I think that experience is going to get us lift outside of our base in a stand alone market.

We still don't see a huge buying behavior in the stand alone revenue cycle space, but we expect it's going to come at sometime. We want to be ready for it.

So then my other question, thanks -- my other question resolves around the accounting for the BT contract. Mark, you know, you're going through your accounting process that you need to do in order to recognize margin maybe by the end of this year but definitely in 2009. Can you try to summarize what needs to happen there from an accounting perspective?

The key thing we are working on is ability to estimate and going through and getting the detail records and being able to show you know, over cross periods of time what we estimated items would take relative to effort and time what they ended up appropriately taking and that's done at very detailed levels.

We made a lot of progress kind of as we were exiting Q2 and the last 45 to 60 days. So we actually -- I feel I'm more bullish on our ability to be looking at something at the end of '08 and have it in place by the time we start '09..

So is the goal really is to accurately estimate the undelivered elements, so you can recognize the profit on the stuff that you delivered?

It's really more related to our ability to estimate the time frame -- in the element of the contract.

The implementation, any of the R&D work, any of development work, so it's more broad than just specifically focused on those. So that's why it's not something you can do in a weekend and get done, you got a lot of work to do, interviews to do, tracking a lot of time sheets to review. So once again it's a process the good news is we are kind of focused on what we need to get accomplished.

This is a complex area, there was a variety of things we had to get through to make sure that getting this answer kind of completes the task. So we -- I believe at this point are at that point, should be able to complete the work by the end of the year.

So there is a dollar -- there are dollars being used here in terms of this component in order to be able to be in that position to capture the margin because your alternative is to let it go, and indefinite amount of time before you can recognize the margin if you don't go through the process, is that the right way to look at it?

Software accounting has a variety of flavors. The first view we had of some of these UK projects when we were bidding, we were going to take all of the revenue on the last day of the contract. Fortunately, the accounting of all to get to the point of revenue equal expense.

Now we are looking to continue to meet the requirements under 81-1 in the related software provisions that let us get in to what really from the rest of the world is a fairly normalized recognize a margin on every hour that you work to provide on this project based on a large bucket of estimated hours.

Fair enough. Thanks.

Sure. One more question.

Final question will come from the line of Dushan Batrovic of Canaccord Adams.

Hi, thank you. Just one quick one on the whole credit crunch issue, you mentioned you weren't seeing much of a impact.

Wonder if you can go through detail as to how your customers are responding to the auction rate securities, are they refinancing? How are they going through the whole process from a macro standpoint there seems to be something happening there, I'm wondering how they are dealing with it.

This is Mike. I would say that they aggressively dealt with it as it hits their radar and as it affects them directly a lot of activity in Q3, Q4 of last year on this front.

So it's not like its been on their radar in consuming cycles. What I would say is by in large have and continue to manipulate their way through this. To the extent that it hasn't had a dramatic negative effect on our business.

I think that they are doing an effective job of doing it. What you're seeing is your initiatives represent priorities in their strategies as operational entities. So we continue even though there are effects from the ARS fallout that they continue to prioritize us as a strategic investment in the grand scheme of things.

We haven't seen a huge negative impact from it. It continues to be on their radar.

Dushan, this is Marc. I think we saw a fair amount of our clients actually go refinance their bonds.

Many of them are through that process or have the process in place to change if from the ARS to variable floating rate bonds. For the most part, that's what I'm seeing when I talk to CFO's. One of the reasons it doesn't seem to be having a impact on our businesses, they see this as something they go do. Not see their interest rate to go up other than normal current rates. That's what I see when I talk to CFO's.

Is it safe to say that the issues behind us then?

We indicated it wasn't a Q1 issue and didn't come up in Q2. We are keeping an eye out to make sure, feels like we weathered that storm.

All right. Thank you.

Final comment. As you can tell from our remarks today, we are pleased with strong results in the quarter. Specifically around bookings and earnings and cash flow. We continue to believe that Cerner's breadth and depth and scalability of solutions are unmatched in this industry. We are particularly pleased that in the challenging economic times, health care providers, our clients, are viewing investments as strategic and making them a high priority. Not only here but around the world.

Let me make sure that you know that we are looking forward to seeing you as the Annual Cerner Health Conference coming up here, October 5 through 8th in Kansas city. Surely, this year's conference will be the biggest and best ever. Hopefully, we will see you there. Thank you for joining us and have a good rest of the day.

Thank you for your participation in today's conference. This concludes our presentation and you may now disconnect. Have a great day.