Cerner Corporation
Q3 2015 Earnings Call Transcript

Published: 4 Nov 2015

[Operator:]

Welcome to Cerner Corporation's third quarter 2015 conference call. Today's date is November 3, 2015, and this call is being recorded. The company has asked me to remind you that various remarks made here today constitute forward-looking statements including, without limitation, those regarding projections of future revenues or earnings, operating margins, operating expenses, product development, new markets or prospects from for the company's solutions, and plans and expectations related to the Health Services business and other client achievements. 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 Item 1A in Cerner's Form 10-K together with the company's other filings. A reconciliation of non-GAAP financial measures discussed in this earnings call can be found in the company's earnings release, which was furnished to the SEC today and posted on the Investors section of Cerner.com. At this time, I'd like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corporation.

[Marc G. Naughton:]

Thank you, Bridget. Good afternoon, everyone, and welcome to the call. I'll lead off today with a review of the numbers. Zane Burke, our President, will follow me with results highlights and marketplace observations. Neal Patterson, our Chairman and CEO, will be available for Q&A. Now I'll turn to our results. Similar to recent quarters, our great success in the marketplace is reflected in our record bookings, but we delivered revenues slightly below expectations. Today we'll address the disconnect between our outstanding bookings and what remains a very strong marketplace and our near-term revenue shortfalls. While we are disappointed about delivering slightly lower than expected revenue, our bookings this year coupled with our strong pipeline sets us up for good revenue growth next year. Our bookings revenue in Q3 was $1.59 billion, which is an all-time high and reflects 44% growth over Q3 of 2014, including record amounts of new business activity. Our revenue backlog ended the quarter at $13.9 billion, which is up from $10.2 billion a year ago, and reflects the strong bookings in Q3 as well as the inclusion of backlog from Health Services. Revenue in the quarter was $1.13 billion, which is up 34% over Q3 of 2014, and includes approximately $250 million from Health Services. The total is about $20 million below the low end of our guidance range, with approximately half of the shortfall related to core Cerner and half attributable to Health Services. On the Cerner side, the shortfall is much lower than previous quarters mainly because we appropriately adjusted our forecast for lower services revenue, which was the primary issue in prior quarters. This quarter, the lower than expected revenue is mostly a function of lower than usual levels of upfront software revenue on some of our larger contracts and technology resale being slightly below our expectations. On the software portion, I'd like to note that we had an all-time high level of software bookings, but a larger than normal portion of the contracts were structured in a manner that resulted in revenue being spread over a longer period. This is obviously good for future periods, but did impact our current quarter revenue. Relative to Health Services, the lower revenue was spread among a few areas, including software, technology resale, and maintenance revenue, and also reflects that we are continuing to fine-tune our visibility in that space. Another factor we have not discussed that has impacted revenue this year is foreign currency fluctuations. In Q3 revenue would have been $20 million higher if you held exchange rates consistent with those in Q3 of 2014. While we have factored a portion of this into our guidance, it did have some impact beyond what we expected in Q3 and is also a contributor to the lower revenue for the year. Now I'll quickly go through the total revenue composition for Q3. Total system sales revenue was $325 million. Support and maintenance was $245 million. Services was $539 million, and reimbursed travel was $19 million. System sales revenue reflects a 45% increase over Q3 of 2014, with the growth mainly driven by an increase in subscriptions, which is where the addition of Health Services has had the biggest impact, as well as growth in licensed software and tech resale. Our software sales margin percent was 67.5%, which is up from 64.3% in Q2 due to a sequential decline in technology resale. The margin percentage is down year over year mainly because Q3 2014 had a very low mix of tech resale that resulted in an unusually high system sales margin percent. Moving to services, total services revenue, including professional and managed services, was up 30% compared to Q3 of 2014, mainly driven by the addition of Health Services as well as growth in core Cerner managed services. Support and maintenance revenue increased 38% over Q3 of 2014, reflecting growth in core support and maintenance and the addition of Health Services. Looking at revenue by geographic segment, domestic revenue increased 35% over the year-ago quarter to $998 million and global revenue grew 32% to $130 million, both driven largely by the addition of Health Services. Moving to gross margin, our gross margin for Q3 was 83.1%, which is basically flat both year over-year and sequentially. Looking at operating spending, our third quarter non-GAAP operating expenses, which excludes share-based compensation expense, voluntary separation plan expense, and acquisition-related adjustments, were $661 million, which is up 36% compared to adjusted Q3 2014 operating expenses. This growth was primarily driven by the addition of Health Services business. The total year-over-year growth for each expense category on a non-GAAP basis was 32% for sales and client service, 37% for software development, and 62% for G&A. Amortization of acquisition-related intangibles, which you'll recall is a new expense line we added in Q2, was basically flat. Note that similar to last quarter, this line is $25 million on our GAAP income statement and just $3 million in our non-GAAP results since we are excluding amortization related to Health Services. Moving to operating margins, similar to the past two quarters, we delivered basically in-line earnings on lower revenue, resulting in a higher operating margin percent than we projected at the beginning of the year. Our operating margin before share-based compensation expenses, voluntary separation expense, and acquisition-related adjustments was 24.5% in Q3. This is down 90 basis points year over year, due mostly to the very low tech resale in Q3 2014, and up 30 basis points from Q2 of 2015. Moving to net earnings and EPS, our GAAP net earnings in Q3 were $147 million or $0.42 per diluted share. Adjusted net earnings were $189 million and adjusted EPS was $0.54, which is up 29% compared to Q3 of 2014. Adjusted net earnings exclude share-based compensation expense, which had a net impact on GAAP earnings of $14 million or $0.04 per diluted share; as well as the voluntary separation plan expense, which had a net impact on GAAP earnings of $2.5 million or $0.01 per diluted share. Adjusted net earnings also reflect adjustments related to Cerner's acquisition of Health Services, including Health Services acquisition-related amortization, which reduced GAAP net earnings and diluted earnings per share by $15 million and $0.04 respectively; other acquisition-related adjustments, which reduced GAAP net earnings and diluted earnings per share by $4 million or $0.01 respectively; and the acquisition-related deferred revenue adjustment, which is not included in GAAP net earnings but increased adjusted net earnings and diluted earnings per share by $6 million and $0.02 respectively. The Q3 tax rate for adjusted net earnings was 32%, which is slightly below our expected range of 33% to 34%. Now I'll move to our balance sheet. We ended Q3 with $766 million of total cash and investments, which is down from $857 million in Q2, primarily due to the use of cash for our repurchase programs. During the quarter we finished the remaining $100 million of repurchases authorized in 2014 and purchased $100 million of the $245 million authorized in September of this year. In total we repurchased 3.2 million shares at an average price of $61.91. Moving to debt, our total debt including capital lease obligations is $631 million, which is basically flat compared to Q2. Total receivables ended the quarter at $1.05 billion, which is up $50 million from Q2. Our Q3 DSO was 85 days compared to 81 days in Q2 and 67 days in the year-ago quarter. The higher DSO is primarily a function of the lower revenue in the quarter, and we are also still working through some delayed billings for Health Services clients as part of the transition. We do expect DSO improvement in Q4. Operating cash flow for the quarter was $272 million, up from $109 million in Q2. Q3 capital expenditures were $88 million and capitalized software was $72 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was $111 million for the quarter, driven by strong operating cash flow. Now I'll go through Q4 and full-year 2016 guidance. For Q4, we expect revenue between $1.15 billion and $1.2 billion, with the midpoint reflecting growth of 27% over Q4 of 2014. Our Q4 revenue guidance combined with year-to-date results put us slightly below the low end of previously provided full-year guidance, as we have factored in the lower results from Q3 and lower Q4 to reflect a similar run rate. So far this year, a favorable mix of revenue, lower expenses, and Health Services synergies have allowed us to deliver mostly in-line earnings despite our lower revenue. Looking to Q4, we do expect the lower revenue to have some impact on earnings, mainly due to the continuing effect of lower services revenue and the impact of lower upfront software on some contracts. We expect Q4 adjusted EPS before share-based compensation, voluntary separation plan expense, and acquisition-related adjustments to be $0.56 to $0.58 per share, with the midpoint reflecting 21% growth over Q4 2014 adjusted EPS. This range is below consensus estimates and slightly below our original plan, but it does get us to the low end of our most recently provided full-year guidance. Also, the Q4 guidance combined with year-to-date results still reflect strong growth of 26% for the full year. Our estimate for the impact of share-based compensation expense is approximately $0.03 to $0.04 in Q4, which equates to $0.14 to $0.15 for the full year. Moving to bookings guidance, we expect bookings revenue in Q4 of $1.45 billion to $1.55 billion, with the midpoint reflecting strong growth of 29% over Q4 of 2014 and 31% growth for the full year. Now I would like to provide initial expectations for 2016. Note that these comments should be viewed as preliminary until we finalize our financial plan and provide more formal guidance when we report fourth quarter results. We currently expect 2016 revenues to be over $5 billion, which equates to growth of at least 13% on top of what is projected to be approximately 30% growth in 2015. We realize that the growth this year benefited from our acquisition and has come in below our original targets, but growing 13% on top of a 30% growth year is still strong. Our 13% target does include a benefit of having 12 months of Health Services revenue in 2016 compared to 11 months in 2015, but that only equates to about 2% of the growth for the year, so our full-year growth target is still double-digit even excluding the extra month. While there are obviously many assumptions that go into projecting future revenue, we do feel positive about our ability to deliver good growth in 2016. A key element to our confidence in 2016 revenues is our backlog, which has grown significantly this year due to our record bookings and the addition of Health Services business. This larger backlog translates into better visibility for 2016. As we look at the rollout of backlog in 2016, we currently expect approximately 75% of our revenue to come from backlog, which is higher than historical levels. Another key assumption is we do believe the market opportunity will remain strong, which Zane will discuss. For earnings, we currently expect adjusted diluted earnings per share before share-based compensation and acquisition-related adjustments between $2.30 and $2.40 per share, with the midpoint reflecting 13% growth over 2015 expected results. This range is below the current consensus estimate of $2.52, which was formed in the absence of company guidance. We believe the primary potential differences between our preliminary view and the consensus estimate may include higher non-cash expenses and professional services contributions. Regarding non-cash expenses, our current estimates reflect an increase in depreciation and amortization of more than $75 million in 2016, which equates to nearly $0.15 of earnings per share. And we believe consensus estimates have less than this for non-cash expense impact. The large increase in amortization is tied to a significant amount of previously capitalized software expected to become generally available. And the large increase in depreciation is related to recent increased levels of capital spending. Relative to services contribution, while we expect strong growth in services revenue and earnings contributions next year, the growth will be coming off of the lower 2015 levels we have discussed. We do not intend for these comments to precisely reconcile our preliminary view to analyst estimates, but more to provide our thoughts on potential differences. In summary, we realize this has been a challenging year relative to delivering against our revenue expectations. As I indicated, we believe revenue growth will be good next year and we have visibility to this growth, partially driven from a backlog that has benefited from what has been by far the best year of bookings in the history of our company. With that, I'll turn the call over to Zane, who can talk about why our bookings are so strong.

[Zane M. Burke:]

Thanks, Marc. Good afternoon, everyone. Today, I'll provide color on our results and make some marketplace observations. I'll start with our results. Our bookings revenue in Q3 of $1.59 billion reflects strong growth of 44% over Q3 2014. Bookings this quarter included another all-time high level of large contracts, with 45 contracts over $5 million, including 31 over $10 million. For long-term bookings, we did have two ITWorks contracts, but the overall mix of long-term bookings was more in the normal range of 31%, which makes the strength of these bookings even more impressive because it wasn't driven by elevated levels of longer-term contracts. A highlight of the quarter was that we again signed a record number of new footprints, with 39% of our bookings coming from outside our core Millennium installed base. So far this year, we have signed more new footprints measured by dollars and count of sites than any full year in our history. This success reflects our strong competitiveness and the continued large opportunity for competitive displacements. Our success this quarter and the opportunities in our pipeline span many market segments, including IDNs, regional hospitals, children and community hospitals, state and federal, behavioral health, ambulatory surgery centers, and physician groups. A particularly noteworthy area of success is large IDNs and investor-owned health systems. In addition to McLaren Health Care selecting Cerner for EHR revenue cycle and population health, which they announced last month, we also gained another large investor-owned health system as a new client during the quarter. In addition, one of our existing investor-owned clients chose to move forward with Cerner for an additional 24 sites. These are in addition to Baptist Health South Florida and the Department of Defense, which we talked about on our last call but occurred during the third quarter. As I mentioned before, I believe a key element of our success is driven by our track record for delivering projects on time and on budget as well as creating measurable value, which aligns well with our clients' focus on making ROI-based decisions. This ability to deliver value along with predictable costs and timelines serve as a differentiator relative to our primary competitor. I believe their list of clients, where the significant costs of deploying and maintaining their systems have been cited as a key reason for financial challenges, is starting to impact them in the marketplace. This not only differentiates us in the sales process, it has also contributed to some of their existing clients switching to Cerner, even after having spent $100 million-plus on their system. We are also continuing to sign Health Services clients to migrate to Millennium, including both IDNs and small hospitals. Overall, we remain pleased with our progress with Health Services base, with migrations continuing at a good pace. Now, I'd like to highlight an important announcement we made during the Cerner Health Conference that represents a major milestone for our HealtheIntent platform. During Neal's keynote address, we announced that Geisinger Health System, a national model for high-quality and high-value healthcare, decided to use our HealtheIntent Population Health platform to extend their data-driven population health capabilities. Cerner and Geisinger share a core belief that managing the health of populations requires access to information outside traditional healthcare domains. And we are excited to be a strategic part of Geisinger's ability to provide systems-level insight to manage population health at scale. This relationship builds on a proof-of-concept project that started last year when Geisinger leveraged HealtheIntent, our system-agnostic, near real-time platform that normalizes data to aggregate clinical and financial data from its core EHR and other sources, such as its insurance company. We believe this decision makes a clear statement to the market, as Geisinger uses our primary competitor for their core EHR and is one of their longest duration and most significant clients. We believe this demonstrates that our capabilities could not be equaled by a competitor, and the HealtheIntent platform is the right platform to support Geisinger's quest for ongoing innovation. I also think this makes clear that our investments in interoperability and open platforms that enable client and third-party innovation are paying off. This is a great example of why we believe Cerner is positioned to play a major role as healthcare continues to shift from a fee-for-service model to outcomes-based reimbursement models that intend on keeping people healthy. Moving to our revenue cycle business, we had a good third quarter. We continue to have a high take rate of revenue cycle in our new EHR footprint, which supports what we've been saying about the market looking to buy integrated systems. A key element of our success in the revenue cycle has been the increasing number of proof points with our clients. One quick example I'd like to share is something from a thank you note a client CFO sent us recently. In the note, he indicated that in the past year they had decreased AR days 19%, increased average daily revenue 22%, and reduced discharged not final billed days by 33%. These success stories are becoming more common and add to our momentum in the marketplace. Moving to the ambulatory market, where we had an all-time high level of bookings in Q3, surpassing a record we just set in the last quarter, the bookings were driven by success at displacing our key competitors, both by expanding our solutions to the ambulatory venues of our acute care clients and as part of new business footprints. In ambulatory business office services, we had two displacements of a certain cloud competitor. Our opportunity to displace this competitor resulted from their lack of execution, failure to meet established objectives, rising costs after teaser rates, and a realization by the client that they ended up needing similar or more staff even though they thought they had outsourced the function to our competitor because they left much of the harder work and complex work to the client. We also had a strong quarter in the small hospital market and passed the 100 client milestone with our cloud-based CommunityWorks offering. This quarter's success was again driven by a combination of traditional new footprints, extensions through our health system clients, and Health Services migrations. We expect the CommunityWorks offering to exceed 125 clients by year end. In addition, CommunityWorks opened two new markets by completing multiple client conversions within standalone orthopedic surgical hospitals along with a multi-site clinically integrated network in the state of Iowa. We believe there is good market opportunity for Cerner in the small hospital market and are very pleased with our competitiveness in this market. Outside of the U.S., we had a solid Q3, with revenue growth of 32% and good bookings in Australia, the United Kingdom, and the Middle East. We continue to make progress with integrating the global components of Health Services, which is augmenting our global presence and positioning us for good long-term contributions from our global business. In summary, I'm very pleased with the success we are having in the marketplace and maintain a positive outlook because of our large pipeline, broad solution and services offering, and strong competitive position. With that, I'd like to open the call for questions.

[Operator:]

Thank you. Our first question is from Dave Francis with RBC Capital Markets. Your line is open.

[David K. Francis:]

Hi, good afternoon, guys. Marc or Zane, can you help us understand a little bit more, as you talked about at the front end of the call, the difference between getting revenue growth and the backlog and the bookings? It's understood from the last quarter there were several contracts that had some meaningful revenue attached to them that didn't fall into the quarter. I'm just trying to true up the difference there so we can better understand the cadence of bookings and how that translates to revenue in the short term.

[Marc G. Naughton:]

Sure, this is Marc. Relative to license revenue, as we said, record bookings for licensed software in the quarter. We actually had record license revenue, very strong license revenue. However, it was lower than our projections primarily because certain contracts have some provisions, especially as we start addressing the new markets for new clients who are coming off of an unsatisfactory relationship where they are looking to hold the new suppliers' feet to the fire a little bit. So we do have those contracts that will have some payments tied to milestones. Traditionally as we've talked to you all in the past, most of our payments for licensed software are date-based and don't impact revenue recognition at all. We're now seeing some payments being tied to milestones, which is very reasonable for clients to do that in this current environment. That tying into a milestone defers that revenue to the milestone occurring. So that revenue goes in the backlog and comes out at a future point in time as part of the project is getting done. Good for the future, but when you go into a quarter end, you don't see those provisions up front as an expectation, but they are negotiated as we go forward. It does impact the amount of revenue we take in the initial quarter for particularly those new clients is where we're seeing that.

[David K. Francis:]

Let me ask it a different way then. As you look at your initial guidance for 2016 and talking about conversion out of backlog into revenue and what have you, the visibility issues that you guys have had relative to this year, what changes over the next coming several quarters to give you the kind of confidence that the revenue levels that you're looking at, up double digits year over year, are achievable relative to your ability to convert out of backlog? And I'll stop there, thanks.

[Marc G. Naughton:]

The key for 2016 when I'm looking at 2016 is the amount of backlog we have and the fact that I am having things such as licensed software rolling out based on a projection of the projects, as I do hours to be done. Another key factor for 2016 is that really in the last half of 2015, particularly in Q3, we saw a strong increase in professional services implementation bookings, and we expect to see that in Q4. That strong increase in those specific bookings is speeding the backlog, and those projects will be started and underway in 2016. Just from a number of bodies times number of hours perspective, we hired over 200 people into this professional services organization during Q3. So we ended Q3 with a larger workforce, which means we'll be able to go work additional hours, drive additional revenue from that backlog that's there. The 75% we referenced is coming as 2016 revenue is being driven from the backlog is the highest percent of revenue for a year that I've seen in my tenure here. Normally, I think recently it's been in the low 70%. And all of that at this point should be predictive work that we can drive with available head count. We're not going to be in HS mode of trying to decide should we hire, should we not hire. We're back into our mode of seeing the work, hiring the people, getting them up to speed. Unfortunately for us in 2015, the impact of that is going to be in 2016.

[Operator:]

Thank you. Our next question is from Robert Jones with Goldman Sachs. Your line is open.

[Robert Patrick Jones:]

I guess just one follow-up on that, Marc, just so I'm clear. I think the last few quarters, where the top line might have missed expectations, it was really more around services conversion obviously just being slower by nature, and then also some weakness in tech resale. Am I understanding it correctly that it's still a component of those two things, but now in addition to that there are some longer conversions around your more classic license software sales? Is that the message on this quarter's revenue shortfall?

[Marc G. Naughton:]

No, let me make sure I'm clear. This quarter we actually delivered our services number. The number we had projected, we delivered that. The difference in the revenue from external – from what we shared in our projections to what we delivered was really focused on two things, primarily licensed software from the Cerner side and from lower than expected tech resale. We had a fairly significant – a couple of significant tech resale deals primarily related to third party, the resale of third-party software that we expected to happen in the quarter and they did not happen. One of those actually was changed to be sold by the manufacturer. We'll get some profitability out of that, but we won't get the revenue out of that. So that was the primary driver on the license side for Cerner. Why the license was less than we had projected, even though it was strong and at record levels, we had projected even higher levels. Those contracts from new clients, we had a few of those that were larger that included milestone-based payments. So the payments for the license are tied to milestones. We can't take the revenue for that licensed software until the milestone occurs. Relative to the service businesses, we actually delivered the services number. That was the number we focused on internally and we actually delivered that. But for Q3, the difference was – half of it HS, half of it is Cerner. And on the Cerner side it was licensed software and those two tech resale deals that didn't materialize.

[Robert Patrick Jones:]

Got it, that's actually really helpful. And I guess just some back of the envelope math on the EPS guidance range for next year, assuming your guidance of roughly around $5 billion on the top line, it seems like at least directionally it would imply a tougher operating margin year than I think many were thinking. I guess first off, is that accurate? And then secondly, can you maybe just talk about the major components of what might be weighing on margins more than people expected?

[Marc G. Naughton:]

I think if I do the quick math, I think it basically looks at flat operating margins. They'll be around 25% if you use a revenue number that's around – that's at $5 billion. And to get to the earnings, I think we basically expected not to grow quite as much on the operating margin side clearly because of lower revenue. This year has actually gotten almost back to our prior operating margin levels. Next year it's really the impact of the non-cash expenses. That's a $75 million to $80 million hit that is going to impact my operating margins. It's not a cash hit but it is additional expense. And so I think if you go math out the numbers, you'll end up with about the same operating margin next year. It should be within 30 to 40 basis points to where we would end up with this year, which is somewhere around 24.5%, so somewhere in the 24.5% to 25% range would be my rough math for 2016. So we don't see a decrease. We do see because of the higher non-cash spending challenging to grow above that. But I think clearly we'll continue to invest in the business and should be able to get to a level where we start getting some more leverage back into businesses as those increases moderate.

[Robert Patrick Jones:]

Okay, thanks so much.

[Marc G. Naughton:]

Sure.

[Operator:]

Our next question is from Sean Wieland with Piper Jaffray. Your line is open.

[Sean W. Wieland:]

Hi, thank you. So first to confirm, I didn't hear you mention any contribution from DoD in the quarter or at least for 2015 or 2016. I want to confirm that that is the case.

[Marc G. Naughton:]

Once again, as we said, DoD will have certainly a slower impact on the bookings and a slower impact on the revenue that we recognize. We did have the first task order, task order number one. Our group, The Leidos Group, we got an order from that, but that number was less than 1% of my bookings for the quarter. So once again, those numbers are coming in smallish chunks on a just-in-time basis to some extent, so no contribution in 2015 from DoD from either earnings or for material bookings. And in 2016 we're not relying on DoD to be anything that provides additional uplift over the other business.

[Sean W. Wieland:]

Okay, and then one other question to follow up to Dave's on these milestone payments.

[Marc G. Naughton:]

Yes.

[Sean W. Wieland:]

What kind of milestone are we talking about? Are we talking about shipment of software? Are we talking about achieving certain savings metrics or clinical measures? Can you just tell us what kind of milestones you're baking in to the contracts?

[Zane M. Burke:]

Sure. Sean, this is Zane. I think it's more project-related items. So as you think about the projects and where these clients have come from, so there I just always describe it as they're getting divorced at the same time they're trying to get remarried, and their previous vendor has left them in a very challenging position and has basically failed then to deliver the kinds of solutions that they need long term. And so when you're in those kind of predicaments, as oftentimes happens as the client is getting divorced from their former vendor and getting married to Cerner, they come in with a pre-nup that looks a little bit different than what you would typically see. And then as we gain experience with that client and they gain the confidence in us to deliver, those kinds of things tend to go away in subsequent periods. So when we have the high level of new business bookings that we had in the quarter, there is a higher susceptibility to some of those types of activities impacting our results at the end of the day.

[Marc G. Naughton:]

One milestone could be go-live. That's a pretty standard one that they put in that we are saying we're going to get this done in this kind of timeframe. And they say that's great; let's tie a payment to us going live when we expect to go live.

[Sean W. Wieland:]

What about like performance like AR days or things like that?

[Marc G. Naughton:]

Yeah. Those aren't milestones. In our view, milestones are really events that occur relative to some payments that are at risk in some form or fashion. We'll have some of those in a contract on occasion. Usually, it's upside to us. So we get our base pricing, but at the last minute there will be an element of shared savings that we'll put into contracts because obviously the client want to see us focused on making them successful, and the best way to do that is to have some at-risk elements. But that doesn't really affect my revenue recognition because any at-risk payment doesn't get recognized until we actually receive the payment. Not only do we deliver the action that should get the payment, but we take a conservative position that I've got to get the check in my hand before we take that revenue. But that's outside what I would call revenue recognition thoughts.

[Sean W. Wieland:]

Okay, great. Thank you very much.

[Zane M. Burke:]

And I think I'd just – I wouldn't necessarily say this is a new trend. I think it's just one of those things that when you end up with a higher level of new business bookings that that's something that is part of the process. And so I wouldn't necessary say that's a new trend element. I think the trend part is the significant bookings, our increase of new bookings, a percentage of those go into our business.

[Sean W. Wieland:]

Thank you.

[Operator:]

Our next question is from Eric Percher with Barclays. Your line is open.

[Eric R. Percher:]

Thanks. I think I'll come back to the margin question. As we look at this year, you've been able to reduce expenses tremendously, and I know that Health Services was a big part of that. Can I ask you to just walk us through as you look that the underlying business and maybe the mix shift, it's really a mix question, out into next year there is obviously some non-cash elements. But do you expect that your mix continues to give you the opportunity to drive higher op margin, or have we entered a period where op margin and earnings look much closer to the revenue growth number?

[Marc G. Naughton:]

Eric, this is Marc. I don't think we're in a period where we would expect operating margins to stay at the same level. We continue to have opportunities, certainly on the combined HS and Cerner organization, to drive out additional synergies on the spend side as well as the operating and revenue side. I think that you'll see us in 2016 offsetting the impact of significantly higher non-cash expense, we will add resources at Cerner to the extent that they drive revenue, and that's been our philosophy at many points in time. We invested heavily in R&D and those types of areas more recently, but I don't think you're going to see a lot of needed additional investment in those areas. You'll see us hiring people to go work on projects, drive revenue. You'll see us hire people for managed services, which drives revenue, some of the support organization, which drives revenue. So that's really where we're going to focus our dollars on. I think once you get through a period of the software turning on and ramping up some of the software amortization, we should get back to a time when you'll start seeing improvements in operating margins. There's no real change in the mix of the business. Software is still really strong, and that strength in software should logically, as you get through some of this non-cash spending element, you should actually get to a point where operating margins can increase.

[Eric R. Percher:]

That's helpful. In the services investments, you maybe talked about 200 additional team members. Does that same type of ramp occur in Q4?

[Marc G. Naughton:]

We can give you the Q4 numbers once we have them. I think the hiring in Q2 or Q3 was related to the Q3 strong bookings that we expected. So I think we will be hiring based on our demand. I would expect to see that number go up. I can't tell you. There's a little bit of hiring at the end of the year and timing relative to when people graduate school and all this kind stuff that impacts a lot of people we don't bring in until January. So will we at the end of Q4 have another 200 people? I can't address that, but I can indicate that we are back on track to increasing that workforce.

[Eric R. Percher:]

Very good, thank you.

[Marc G. Naughton:]

Sure.

[Operator:]

Our next question is from David Larsen with Leerink Partners. Your line is open.

[David M. Larsen:]

Hi. Can you talk about Siemens Health Services? I guess the revenue came in slightly below expectations. Was that from Siemens hospitals buying other Siemens software solutions, or was it conversions over to Millennium that were slightly below expectations? Any more color around that would be helpful. Thanks.

[Marc G. Naughton:]

Sure, David. This is Marc. The HS was really not related to selling more Siemens software because we aren't expecting to sell a lot of additional Siemens software specifically. Migrations are doing well, but it's primarily just related to their business overall. Some maintenance contracts that people canceled was probably as big of an impact on revenue as anything. Those are dependent on that client having certain equipment or keeping that maintenance contract with Siemens, but it didn't reflect really a major change. It's just the expiration of certain maintenance. And in some cases, people just not renewing their maintenance contracts relative to the equipment that they had through Siemens. The rest of it was just spread throughout the piece of the organization, but nothing that reflected a trend relative to their selling more of their Siemens software, which we didn't expect and they didn't do, or migrations which are going well, and once again fall into a bucket that is not necessarily – we can't necessarily attribute it to Siemens as fulfilling selling the revenue. I think we're still working obviously through the visibility on the revenue side. But when we look at the net impact on Cerner, our overall accretion remains on track. It's primarily at this point just the top line forecasting timing we're trying to get through.

[David M. Larsen:]

Okay, that's great. Thanks very much. And then can you size how much bookings in the quarter came from the Siemens side of the house?

[Marc G. Naughton:]

It would be minimal.

[David M. Larsen:]

Minimal, okay, so that's all mainly organic.

[Zane M. Burke:]

This is Zane. We would have had a number of migrations that would impact the bookings, but pure Health Services – purchasing Health Services solutions would have been fairly minimal.

[Marc G. Naughton:]

Dave, we get into the element that we've been talking to you about is we're one company now. And so anything that we sell that's Cerner stuff we think of as a Cerner booking, but even if it's a migration to Cerner from a Siemens client. So the cross-sell in those elements are going to be coming through the Cerner bookings. The HS bookings for me is primarily things that they're selling their services or their own software. And as I said, we haven't really been focused on selling a lot of their own software at this point.

[David M. Larsen:]

Okay, that's great, and just one last one. I think you signed a couple large service engagements last quarter. Should we see the revenue flow through for those in 2016? Thanks.

[Marc G. Naughton:]

Sure, especially relative to our ITWorks business, we've actually had a very successful 2015. We signed two ITWorks deals each quarter in Q1, Q2, and Q3, so that's the rhythm that was talked about us wanting to achieve. And once we get those signed, that revenue stream usually starts up very quickly because those associates get rebadged very close to the timing of the signing of the contracts. So that revenue does kick in, and all six of those deals will be contributing to 2016 revenue.

[David M. Larsen:]

Okay, great. Nice bookings quarter, thanks a lot.

[Marc G. Naughton:]

Thanks.

[Operator:]

Our next question is from Mohan Naidu with Oppenheimer. Your line is open.

[Mohan Naidu:]

Thank you very much for taking my questions. Marc, maybe when I go back to your bookings and revenue conversion one more time, with your new guidance, it looks like you're going to do 30%-plus growth for the full 2015. That's great, but your revenue guidance for next year points to low teens growth. Can you help us understand what are the moving parts that translate from a 30% bookings growth to a teens revenue growth?

[Marc G. Naughton:]

Certainly the elements of bookings growing significantly. And keep in mind; in 2015 we are growing revenue 30%. We're growing earnings 26%. Obviously, you understand there's an element from the acquisition that impacts that. But when you look at our bookings, you've got the long-term component of them, which this quarter even on the larger number trended down, or trended to be more normal like the 31% rather than the mid-30% that we've been seeing. The longer-term bookings don't have an immediate effect. They spread out over a period of time. They will help 2016, but one-tenth of them help 2016. Relative to current quarters, the item we're talking about primarily was the license component. And you're talking about $10 million or $15 million of licensed software when you're talking about that relative to the overall total revenue growth, so it's not a significant difference. A lot of these contracts have a significant amount of professional services in them. That rolls out over a period of time, sometimes multiyear period of time. They all have a hosting element to them, which falls into our long-term bookings percentage. So really the mix of the business is actually pretty much normalized in Q3. The big difference is even with strong license based on that bigger number, we did not get as much revenue from the current quarter as we would have expected. That revenue flows forward. But I think from a growth perspective, if you look at 13%-plus revenue growth in 2016 off of a number that grew 30% in 2015, we've got an extra $1 billion or so of revenue that we're growing on top of. We've always targeted growing double digits, especially after a year where that was more challenging for us in 2015. We're actually pretty – feeling good about getting back to double-digit growth on a much higher number base than we have had in the past. So we actually think the growth in earnings and the growth in revenue being more aligned than normal is a matter of just not getting as much leverage in 2016 because of higher non-cash expense. And I think that, as I said, moderates over time.

[Mohan Naidu:]

Got it, that was very helpful. And if I understand that correctly, if we take out the Health Services revenue out of your 2015 and keep the bookings the same, we could have seen 25%-plus revenue growth. Is that fair?

[Marc G. Naughton:]

You would have certainly seen strong – you would have seen in 2016 stronger revenue growth, absolutely.

[Mohan Naidu:]

Thanks a lot, Marc.

[Marc G. Naughton:]

Sure.

[Operator:]

Our next question is from Steven Valiquette with UBS. Your line is open.

[Jonathan Yong:]

Hi, this is Jonathan Yong on for Steve today, just a question back on the margins. I get the non-cash expense side of things. But I guess some of the synergy targets that you originally laid out for the Siemens deal of the $175 million, are you guys still on track for that? Is there a way to – are you guys speeding up? Can I just get a sense of where you guys are in terms of the synergy levels there?

[Marc G. Naughton:]

Yes, relative to Siemens, we are absolutely on track for 2015 delivering the synergies that we expected. We might be slightly ahead, but things are going well there. I think in 2016 we continue to expect to deliver the synergies we originally expected. As we've indicated, the harder part for us now is because of the coming together of the organizations and the fact that there's some spending on the Cerner side that relates to the HS business. Now it is not cleanly that I could give you a P&L for HS. I don't have that visibility. I can't track the spending at that level, and so I can't specifically tell you exact numbers that it's driving out as a separate P&L. But based on all the metrics that we track, based on their spend, based on our spend, we see that those synergies are coming through, and that is part of the benefit we get on the spend side in 2016, so it does help offset some of the non-cash. But we're also growing – we're continuing to invest in revenue-producing associates, which should drive revenue, but also is going to drive up spending as well.

[Jonathan Yong:]

Okay. And then just on the RevWorks side, since we're past ICD-10 now and hopefully things are good in the market there, have you guys heard any chatter about clients particularly looking at your RevWorks solutions yet? Thanks.

[Zane M. Burke:]

This is Zane. I think we continue to see interest in revenue cycle in particular, and then obviously the business off a services perspective has been very strong on the physician side, so we continue to see good growth there. I think that you will see a return to that marketplace for broader RevWorks offerings there. And we continue to sell well as piece parts of that. But I do sense that that will return to the fold here as people get past ICD-10 and begin to think more long term about how to best handle their costs and the collections related to changing business models.

[Marc G. Naughton:]

This is Marc. Keep in mind, ICD-10 wasn't just flip a switch and okay, all the lights stay green, so we're good. Thirty days later, you're going to get – as one of payers come back and tell you if they agree with the claim, you're going to be tracking all the metrics you track. So even though people were post the technical ICD-10 go-live, there's still a good six months as people are going through and looking at making sure that they understand the impact of ICD-10, relook at what their needs are in case their environment has changed. So I think the demands are as Zane said. I don't think flipping that switch was going to trigger a bunch of demand. I think it will be something you see starting to hit us in 2016.

[Jonathan Yong:]

Okay, that's helpful. Thanks.

[Operator:]

Our next question is from George Hill with Deutsche Bank. Your line is open.

[George R. Hill:]

Hey. Good afternoon, guys, and thanks for taking the question. I guess, Marc or Zane, can either of you guys tell us what – I want to call it what like-for-like Cerner bookings are and what the growth has looked like year over year because I think there was probably some misunderstanding about the composition how this year includes Siemens bookings and last year did not, so real bookings growth year to date isn't actually 32%. What is the like-for-like Cerner bookings growth?

[Marc G. Naughton:]

This is Marc. Like-for-like, actually Siemens is negligibly impacting us. They aren't selling a whole lot of stuff. They're not selling a lot of tech resale. From a bookings perspective, there's not a lot of – they haven't had a lot of individual sales of what they offer separately. Almost anything that has been driven by that base has been migration-related. So I think you might take a few percent out of it if you want to relative to that increase. But the vast majority, certainly 95%-plus is related to Cerner and sale of our solutions and our services and our ITWorks and all those things. So if you're really looking – if you're trying to figure out is this bookings increase reflective of Cerner's opportunities in the marketplace, it is almost entirely related to our opportunities. Zane?

[Zane M. Burke:]

And I think the first place to start is by looking at the new business bookings. You had 39% new business bookings for the quarter, which is all Cerner, Cerner-Cerner. And as Marc said, it's a few percentage points as it relates to the current year impact of Health Services bookings on our total bookings, so it's very minimal.

[George R. Hill:]

Okay, then I guess the follow-up question then becomes, it would seem that there has to be an elongation in the backlog to a revenue recognition conversion period. We've talked about this before, and you said there hasn't been a meaningful change there. I guess can you help us bridge the gap from 32% bookings growth year to date, likely to stay that number as we go into the end of the year to the revenue guidance? You talked about the milestone payment, but you wouldn't even think that – that hasn't been impacting the business long enough to explain the change in the bookings growth rate to the rev-rec, to the delta in the rev-rec growth rate, or just what am I missing there?

[Marc G. Naughton:]

The milestones primarily impact current quarter bookings near term, and it does feed the backlog. Keep in mind, George. This year we had significantly higher levels of long-term bookings. The first two quarters were primarily – 35%, 37%, whatever the percent it was. It was significantly higher relative to the bookings. Certainly this quarter, it's more like it's back into the 31% range, which is normal, on a much bigger number. A lot of these new contracts that are getting signed by new clients have a significant amount of services and other items that roll into the backlog. So I'm not sure that it's elongating the backlog because things like software, and something to your point, if I have day-based (53

[George R. Hill:]

Okay, that's helpful. And then maybe one last quick question is, you referenced briefly the increased scale of the business now with the inclusion of Health Services. I guess should we be thinking of this 10% to 15% EPS growth as the new normal target range for the company, or is 15% to 20% closer to the right range? I guess I'm trying to think about what do we think as a sustainable number now given the new size of the business and given the growth profile of the legacy Siemens business. Thanks.

[Marc G. Naughton:]

Yeah. I do not intend that the current 2016 guidance, where revenue and margin – earnings are growing at the same rate, to be indicative of what we look to do in the future. We are a business that should have leverage. Keep in mind, we are growing off of a 2015 that we put in Siemens, and so certainly that helped us. But now in 2016, we're growing on top of that. So we're having to go grow revenue on top of a 30% revenue growth business. I have to grow earnings on top of a 26% earnings growth business. So it isn't illogical that in the year following that significant amount of growth particular year I'm getting hit with these non-cash expenses, that the growth might more track with revenue. I think over time, we would look to grow revenue double digit and that you would see us moving that earnings percentage growth up higher than our revenue growth. We will get leverage that way. The bigger the company we get as a software company, as we get more efficient in our services businesses, as we roll and continue to roll out the model system, which is an effective way to go implement our software, as we look to go make very quick migrations of Siemens clients, I think there are a lot of opportunities for us to certainly get efficiencies in the business. So yes, I'm not calling this the new normal. There's upside to our growth percentages.

[George R. Hill:]

Okay, thanks for that.

[Operator:]

Our next question is from...

[Marc G. Naughton:]

Okay. Go ahead.

[Operator:]

Our next question is from Ricky Goldwasser with Morgan Stanley. Your line is open.

[Zachary W. Sopcak:]

Hey, good afternoon, this is Zack for Ricky. I just wanted to ask a question, a bit of bookkeeping when thinking about bookings for 2016. Is the comp for 2016 bookings going to be tougher because 2015 is going to include the migration of Health Services clients to Millennium?

[Marc G. Naughton:]

The bookings comp since HS doesn't have a whole lot of impact, pure HS on the bookings, it won't really be a reason. But given, as we talked earlier, that overall bookings are growing 30%, I'd call that a pretty reasonable comp to grow above. But yes, it's a tough comp. But I think that's – keep in mind that most of the growth this year was pretty much organic. It wasn't impacted a lot by HS on the bookings side. Certainly on the earnings and revenue side it was impacted, but on the bookings side it wasn't. So we grew 30% relatively organically on the bookings side. We see a very active marketplace. So our goal is to grow on top of that 30% uptick in bookings we saw in 2015.

[Zachary W. Sopcak:]

Got you. And just quickly on the contracts, so you mentioned the strong growth in large contracts, and it looks like contracts over $10 million have already exceeded 2014. Can you give just a little bit more color on what's driving those and how that compared to your expectations going into the year?

[Zane M. Burke:]

This is Zane. I think what you're seeing is we had a large number of big systems making purchases. So we talked about our competitiveness in the IDN marketplace, in the investor-owned marketplace, and so just some pure very large new business and current clients that are out procuring solutions to standardize their businesses as they move forward on a standard platform and using Cerner to help drive cost down and leverage, create leverage for their organizations. And I think some of those larger contracts, they're all about actually creating leverage in their organization. So whether it's ITWorks type situations where our clients are utilizing our scale to help drive costs appropriately on their side and prepare for the future elements, I think some of those larger elements are reflective of a broad base to the business because we hit on pretty much every large contract in that space. Big IDNs, investor-owned, our ITWorks businesses, our regional and community hospital marketplace, they're going to drive significant large upfront bookings. So I think it's a combination of things and it's really about our clients are preparing for the future of healthcare, and that's what we're helping to provide them to help drive their costs down and to improve the quality of care.

[Zachary W. Sopcak:]

Great, thank you.

[Marc G. Naughton:]

Thanks. Why don't we take one more question?

[Operator:]

All right, your last question is Steve Halper with FBR. Your line is open.

[Steven P. Halper:]

Yes, hi. Could you just run through for me one more time the factors behind the reduction in the fourth quarter guidance? And also as a follow-up, what are the cash flow expectations for 2016 now that you've set the stage for the income statement?

[Marc G. Naughton:]

Sure. Relative to Q4, I think we continue to see lower revenue for Q4. I'm not looking to go – we hit services revenue in Q3. We had probably expected Q4 to grow a little bit from that number. I think our current projections based on the timing of hiring new people and based on the work is that Q4 would be relatively flat on the services side to Q3. So we're not looking to go increase that a significant amount. And I think we'll still see some of the impact of this milestone-based payments on contracts. It's going to have an impact on the timing of revenue recognition. So those are elements that as we look forward to the revenue coming out of Q4 that we expect it to probably be about $50 million lower probably from the midpoint as to what it previously had been out there. Half of that probably is HS continuing to be lower than we projected, and the other half is basically Cerner professional services and some of those Q3 elements rolling into Q4. So that's the primary difference you're going to see relative to the Q4 number. On the cash flow side, I think in Q4 we would expect – we have some larger cash CapEx items related to buildings that will hit us in Q4. So we would expect to end the year at about $475 million – $470 million of total CapEx including software CapEx. Next year there probably will be a little bit of an uptick on that as we finish out our Trails building. One of the key things in 2015 is we are purchasing our Lee's Summit data center building. We currently lease that. And given all of the data center activity that we have there, we want to own our future there. We don't want to be subject to the vagaries of a landlord, which has been a very good landlord to us, but we want to own that facility. So I think we've got – as you look at this year, we end up with about $405 million of CapEx, about $275 million of software CapEx, and those probably increment up a little bit as we go into 2016.

[Steven P. Halper:]

So just to clarify, the building purchase for the lease on the data center, is that going to be 2015?

[Marc G. Naughton:]

That will be Q4. That will be this quarter, Q4 of 2015.

[Steven P. Halper:]

So all-in CapEx and your capitalized software is $475 million this year?

[Marc G. Naughton:]

All in, it would be $675 million.

[Steven P. Halper:]

$675 million, okay.

[Marc G. Naughton:]

Yes, so about $400 million of CapEx and $275 million of software CapEx.

[Steven P. Halper:]

Got it. And then a little uptick from that next year?

[Marc G. Naughton:]

Correct.

[Steven P. Halper:]

Great, thank you.

[Marc G. Naughton:]

Certainly, Steve.

[Marc G. Naughton:]

With that, I'd like to close. I'd like to maybe just step back a little bit to provide a little perspective. We certainly understand our accountability to deliver against all our metrics. But Zane's commentary around our bookings and our current position in the marketplace gives us confidence regarding our success in that marketplace. We've been at this a very long time, and one thing we've always been driven by is delivering on the bigger vision. We're focused on long-term value, but also have been pretty good about delivering against nearer-term expectations. I think we're incredibly well-positioned to become a large company. It's not going to be a really perfectly straight path. But where we're situated between healthcare and IT I think gives us a lot of opportunities. We're investing $700 million a year in R&D to address those opportunities. And I think that level of investment, especially when you look at it in the context of other people trying to buy things that they're going to put together, is impressive and will generate a long-term benefit and an advantage for us. Many of you had a chance to attend our Healthcare Conference, where we had 14,000 attendees focused on solving major issues in healthcare. It's hard to come out of that conference not being energized with a belief that we are on the right track. We're actually now just getting to some of the fun stuff with the base level of digitization in healthcare, using data, predictive analytics. We think this can have a real disruptive impact on quality and outcomes and payment models, and we expect to be right in the middle of that disruption. What we do is hard and is complex, but we think we're well-positioned, and certainly I wouldn't trade our position for anybody else's. Thanks for listening and have a good evening.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day.