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CERN > SEC Filings for CERN > Form 10-Q on 26-Apr-2013All Recent SEC Filings

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Form 10-Q for CERNER CORP /MO/


26-Apr-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following Management Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Cerner Corporation (Cerner, the Company, we, us or our). This MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to the financial statements (Notes) found above.

Our first fiscal quarter ends on the Saturday closest to March 31. The 2013 and 2012 first quarters ended on March 30, 2013 and March 31, 2012, respectively. All references to years in this MD&A represent the respective three months ended on such dates, unless otherwise noted.

Except for the historical information and discussions contained herein, statements contained in this quarterly report on Form 10-Q may constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements can often be identified by the use of forward-looking terminology, such as "could," "should," "will," "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast," "plan," "guidance" or "estimate" or the negative of these words, variations thereof or similar expressions. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including without limitation: the possibility of product-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities; our proprietary technology may be subject to claims for infringement or misappropriation of intellectual property rights of others, or may be infringed or misappropriated by others; risks associated with our non-U.S. operations; risks associated with our ability to effectively hedge exposure to fluctuations in foreign currency exchange rates; the potential for tax legislation initiatives that could adversely affect our tax position and/or challenges to our tax positions in the United States and non-U.S. countries; risks associated with our recruitment and retention of key personnel; risks related to our reliance on third party suppliers; risks inherent with business acquisitions; the potential for losses resulting from asset impairment charges; risks associated with the uncertainty in global economic conditions; managing growth in the new markets in which we offer solutions, health care devices and services; changing political, economic, regulatory and judicial influences; government regulation; significant competition and market changes; variations in our quarterly operating results; potential inconsistencies in our sales forecasts compared to actual sales; volatility in the trading price of our common stock and the timing and volume of market activity; the authority of our Board of Directors to issue preferred stock and anti-takeover provisions contained in our corporate governance documents; material adverse resolution of legal proceedings; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials incorporated herein or therein by reference. Forward looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as to the date they are made. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.

Management Overview
Our revenues are primarily derived by selling, implementing and supporting software solutions, clinical content, hardware, devices and services that give health care providers secure access to clinical, administrative and financial data in real time, allowing them to improve quality, safety and efficiency in the delivery of health care.

Our fundamental strategy centers on creating organic growth by investing in research and development (R&D) to create solutions and services for the health care industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 12% or more. This growth has also created an important strategic footprint in health care, with Cerner® solutions licensed by approximately 10,000 facilities around the world, including more than 2,700 hospitals; 4,150 physician practices; 45,000 physicians; 550 ambulatory facilities, such as laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics and surgery centers; 800 home health facilities; 45 employer sites and 1,750 retail pharmacies. Selling additional solutions back into this client base is an important element of our future revenue growth. We are also focused on driving growth through market share expansion by strategically aligning with health care providers that have not yet selected a supplier and by displacing competitors in health care settings that are looking to replace their current supplier.

We expect to drive growth through new initiatives and services that reflect our ongoing ability to innovate and expand our reach into health care. Examples of these include our CareAware® health care device architecture and devices, employer services, Cerner ITWorksSM services, Cerner RevWorksSM services, and solutions on our Healthe IntentSM platform. Finally,


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we believe there is significant opportunity for growth outside of the United States, with many non-U.S. markets focused on health care information technology as part of their strategy to improve the quality and lower the cost of health care.

Beyond our strategy for driving revenue growth, we are also focused on earnings growth. Similar to our history of growing revenue, our net earnings have increased at compound annual rates of more than 20% over the most recent five- and ten-year periods. We expect to drive continued earnings growth through ongoing revenue growth coupled with margin expansion, which we expect to achieve through efficiencies in our implementation and operational processes and by leveraging R&D investments and controlling general and administrative expenses.

We are also focused on continuing to deliver strong levels of cash flow, which we expect to do by continuing to grow earnings and prudently managing capital expenditures.

Results Overview

The Company delivered strong levels of bookings, revenues, earnings and cash flows in the first quarter of 2013.

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $801.6 million in the first quarter of 2013, which is an increase of 23% compared to $652.3 million in the first quarter of 2012. Revenues for the first quarter of 2013 increased 6% to $680.0 million compared to $641.2 million in the first quarter of 2012. The year-over-year increase in revenue reflects improved economic conditions, ongoing demand related to the HITECH Act, and increased contributions from new initiatives, such as Cerner ITWorks and Cerner RevWorks. Revenue growth in the quarter was negatively impacted by a decline in technology resale. This decline did not materially impact earnings, because the decline was primarily related to the resale of lower margin devices.

First quarter 2013 net earnings increased 24% to $110.0 million compared to $88.7 million in the first quarter of 2012. Diluted earnings per share increased 22% to $0.62 compared to $0.51 in the first quarter of 2012. The growth in net earnings and diluted earnings per share was driven by strong growth in services and higher margin components of system sales that more than offset the decline in technology resale. Additionally, our margin expansion initiatives, which include creating efficiencies in our implementation and operational processes and controlling general and administrative expenses, have contributed to our earnings growth.

First quarter 2013 and 2012 net earnings and diluted earnings per share reflect the impact of stock-based compensation expense. The effect of these expenses reduced the first quarter 2013 net earnings and diluted earnings per share by $6.9 million and $0.04, respectively, and the first quarter 2012 net earnings and diluted earnings per share by $5.5 million and $0.03, respectively.

Our first quarter 2013 operating margin of 23% reflects an increase of 300 basis points compared to 2012, which was driven by the previously discussed margin expansion efforts and a lower mix of low-margin technology resale revenue.

We had cash collections of receivables of $784.0 million in the first quarter of 2013 compared to $683.2 million in the first quarter of 2012. Days sales outstanding was 69 days for the first quarter of 2013 compared to 74 days for the fourth quarter of 2012 and 76 days for the first quarter of 2012. Operating cash flows for the first quarter of 2013 were strong at $213.6 million compared to $162.7 million in the first quarter of 2012.


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Results of Operations
Three Months Ended March 30, 2013 Compared to Three Months Ended March 31, 2012
The following table presents a summary of the operating information for the
first quarters of 2013 and 2012:
                                         % of                     % of
(In thousands)                2013     Revenue       2012       Revenue     % Change
Revenues
System sales               $ 198,902       29 %   $ 225,820         35 %      (12 )%
Support and maintenance      160,957       24 %     145,754         23 %       10  %
Services                     305,599       45 %     258,150         40 %       18  %
Reimbursed travel             14,571        2 %      11,488          2 %       27  %

Total revenues               680,029      100 %     641,212        100 %        6  %

Costs of revenue
Costs of revenue             127,229       19 %     158,008         25 %      (19 )%

Total margin                 552,800       81 %     483,204         75 %       14  %

Operating expenses
Sales and client service     267,356       39 %     245,074         38 %        9  %
Software development          81,063       12 %      71,145         11 %       14  %
General and administrative    47,812        7 %      39,546          6 %       21  %

Total operating expenses     396,231       58 %     355,765         55 %       11  %

Total costs and expenses     523,460       77 %     513,773         80 %        2  %

Operating earnings           156,569       23 %     127,439         20 %       23  %

Other income, net              3,044                  2,624
Income taxes                 (49,573 )              (41,355 )

Net earnings               $ 110,040              $  88,708                    24  %

Revenues & Backlog
Revenues increased 6% to $680.0 million in the first quarter of 2013, as compared to $641.2 million in the first quarter of 2012.

• System sales, which include revenues from the sale of licensed software, software as a service, technology resale (hardware, devices, and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions, decreased 12% to $198.9 million in the first quarter of 2013 from $225.8 million for the same period in 2012. The decrease in system sales was driven by lower levels of technology resale, which more than offset growth in subscriptions and licensed software.

• Support and maintenance revenues increased 10% to $161.0 million in the first quarter of 2013 compared to $145.8 million during the same period in 2012. This increase was attributable to continued success at selling Cerner Millennium® applications and implementing them at client sites. We expect that support and maintenance revenues will continue to grow as the base of installed Cerner Millennium systems grows.

• Services revenue, which includes professional services, excluding installation, and managed services, increased 18% to $305.6 million in the first quarter of 2013 from $258.2 million for the same period in 2012. This increase was driven by growth in CernerWorksSM managed services as a result of continued demand for our hosting services and an increase in professional services due to increased implementation and consulting activities and growth in Cerner ITWorks services.

Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 23% in the first quarter of 2013 when compared to the same period in 2012. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services and Cerner ITWorks services bookings that typically have longer contract terms. A summary of our total backlog follows:


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(In thousands)                   March 30, 2013      March 31, 2012

Contract backlog                $      6,831,667    $      5,569,764
Support and maintenance backlog          747,872             704,243

Total backlog                   $      7,579,539    $      6,274,007

Costs of Revenue
Cost of revenues as a percentage of total revenues was 19% in the first quarter of 2013, compared to 25% in the same period of 2012. The lower cost of revenues as a percent of revenue was driven by a lower mix of technology resale, which carries a higher cost of revenue.
Cost of revenues includes the cost of reimbursed travel expense, sales commissions, third party consulting services and subscription content and computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, devices, maintenance, support, services and reimbursed travel) carrying different margin rates changes from period to period. Cost of revenues does not include the costs of our client service personnel who are responsible for delivering our service offerings. Such costs are included in sales and client service expense.
Operating Expenses
Total operating expenses increased 11% to $396.2 million in the first quarter of 2013, compared with $355.8 million in the first quarter of 2012.

• Sales and client service expenses as a percent of total revenues were 39% in the first quarter of 2013, compared to 38% in the same period of 2012. These expenses increased 9% to $267.4 million in the first quarter of 2013, from $245.1 million in the same period of 2012. Sales and client service expenses include salaries of sales and client service personnel, depreciation and other expenses associated with our CernerWorks managed service business, communications expenses, unreimbursed travel expenses, expense for share-based payments, sales and marketing salaries and trade show and advertising costs. The slight increase as a percent of revenue reflects a higher mix of services during the quarter.

• Software development expenses as a percent of revenue were 12% in the first quarter of 2013, compared to 11% in the first quarter of 2012. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium platform, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. A summary of our total software development expense in the first quarters of 2013 and 2012 is as follows:

                                                     Three Months Ended
(In thousands)                                       2013          2012

Software development costs                        $  93,381     $ 74,836
Capitalized software costs                          (33,820 )    (22,651 )
Capitalized costs related to share-based payments      (514 )       (429 )
Amortization of capitalized software costs           22,016       19,389

Total software development expense                $  81,063     $ 71,145

• General and administrative expenses as a percent of total revenues were 7% in the first quarter of 2013, compared to 6% in the same period of 2012. These expenses increased 21% to $47.8 million in 2013, from $39.5 million for the same period in 2012. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency and expense for share-based payments. The increase in general and administrative expenses was primarily driven by an increase in corporate personnel costs, as we have continued to increase such personnel to support our overall revenue growth, and an increase in amortization expense due to acquired intangibles.


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Non-Operating Items

• Interest income was $4.1 million in each of the first quarters of 2013 and 2012. Interest expense decreased to $1.1 million in the first quarter of 2013 compared to $1.5 million in the same period of 2012 due to payments on our long-term debt and capitalized interest related to the construction of our new campus, partially offset by increased capital lease obligations.

• Our effective tax rate was 31.1% for the first quarter of 2013 and 31.8% for the first quarter of 2012. This decrease was primarily due to the retroactive reinstatement of the research and development credit in 2013. The effective tax rates in the first quarters of 2013 and 2012 were both favorably impacted by discrete items. Refer to Note (6) of the notes to condensed consolidated financial statements.

Operations by Segment
We have two operating segments: Domestic and Global. The Domestic segment includes revenue contributions and expenditures associated with business activity in the United States. The Global segment includes revenue contributions and expenditures linked to business activity in Argentina, Aruba, Australia, Austria, Canada, Cayman Islands, Chile, China (Hong Kong), Egypt, England, France, Germany, Guam, India, Ireland, Italy, Japan, Malaysia, Mexico, Morocco, Puerto Rico, Qatar, Saudi Arabia, Singapore, Spain, Sweden, Switzerland and the United Arab Emirates.

The following table presents a summary of the operating information for the first quarters of 2013 and 2012:

(In thousands)                                   2013       % of Revenue      2012       % of Revenue   % Change

Domestic Segment
Revenues                                      $ 576,639         100%       $ 554,274         100%          4%
Costs of revenue                                106,697         19%          134,303         24%          (21)%
Operating expenses                              147,756         26%          120,438         22%           23%
Total costs and expenses                        254,453         44%          254,741         46%           -%

Domestic operating earnings                     322,186         56%          299,533         54%           8%

Global Segment
Revenues                                        103,390         100%          86,938         100%          19%
Costs of revenue                                 20,532         20%           23,705         27%          (13)%
Operating expenses                               25,630         25%           32,751         38%          (22)%
Total costs and expenses                         46,162         45%           56,456         65%          (18)%

Global operating earnings                        57,228         55%           30,482         35%           88%

Other, net                                     (222,845 )                   (202,576 )                     10%

Consolidated operating earnings               $ 156,569                    $ 127,439                       23%

Domestic Segment
• Revenues increased 4% to $576.6 million in the first quarter of 2013 from $554.3 million in the first quarter of 2012. This increase was primarily driven by strong growth in professional services, managed services and support, which was largely offset by a decrease in technology resale.

• Cost of revenues was 19% of revenues in the first quarter of 2013, compared to 24% of revenues in the same period of 2012. The lower cost of revenues as a percent of revenue was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue.

• Operating expenses increased 23% to $147.8 million in the first quarter of 2013 from $120.4 million in the first quarter of 2012, due primarily to growth in managed services and professional services expenses.

Global Segment
• Revenues increased 19% to $103.4 million in the first quarter of 2013 from $86.9 million in the first quarter of 2012. This increase was driven by growth in most business models, slightly offset by a decrease in technology resale.


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• Cost of revenues was 20% in the first quarter of 2013 and 27% in the same period of 2012, due to a lower mix of technology resale.

• Operating expenses were at $25.6 million in the first quarter of 2013, compared to $32.8 million in the first quarter of 2012, primarily due to a decrease in bad debt expense.

Other, net
Operating results not attributed to an operating segment include expenses, such as centralized professional services costs, software development, marketing, general and administrative, stock-based compensation, depreciation, and amortization. These expenses increased 10% to $222.8 million in the first quarter of 2013 from $202.6 million in the same period of 2012. This increase was primarily due to growth in corporate and development personnel costs.

Liquidity and Capital Resources
Our liquidity is influenced by many factors, including the amount and timing of our revenues, our cash collections from our clients and the amount we invest in software development, acquisitions and capital expenditures.
Our principal sources of liquidity are our cash, cash equivalents, which consist of money market funds and time deposits with original maturities of less than 90 days, and short-term investments. At March 30, 2013, we had cash and cash equivalents of $281.5 million and short-term investments of $723.7 million, as compared to cash and cash equivalents of $317.1 million and short-term investments of $719.7 million at December 29, 2012.
Approximately 16% of our aggregate cash, cash equivalents and short-term investments at March 30, 2013 were held outside of the United States. As part of our business strategy, we plan to indefinitely reinvest the earnings of our foreign operations; however, should the earnings of our foreign operations be repatriated, we would accrue and pay tax on such earnings, which may be material.

Additionally, we maintain a $100.0 million multi-year revolving credit facility, which expires in February 2017. The facility provides an unsecured revolving line of credit for working capital purposes, along with a letter of credit facility. Interest is payable at a rate based on prime, LIBOR, or the U.S. federal funds rate, plus a spread that varies depending on the leverage ratios maintained. The agreement provides certain restrictions on our ability to borrow, incur liens, sell assets and pay dividends and contains certain cash flow and liquidity covenants. As of March 30, 2013, we were in compliance with all debt covenants. As of March 30, 2013, we had no outstanding borrowings under this agreement; however, we had $14.4 million of outstanding letters of credit, which reduced our available borrowing capacity to $85.6 million.

We believe that our present cash position, together with cash generated from operations, short-term investments and, if necessary, our available line of credit, will be sufficient to meet anticipated cash requirements during 2013. The following table summarizes our cash flows in the first three months of 2013 and 2012:

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