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CERN > SEC Filings for CERN > Form 10-Q on 25-Oct-2013All Recent SEC Filings

Show all filings for CERNER CORP /MO/

Form 10-Q for CERNER CORP /MO/


25-Oct-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 third fiscal quarter ends on the Saturday closest to September 30. The 2013 and 2012 third quarters ended on September 28, 2013 and September 29, 2012, respectively. All references to years in this MD&A represent the respective three or nine months ended on such dates, unless otherwise noted.

On May 24, 2013, the Board of Directors of the Company approved a two-for-one split of our common stock in the form of a 100% stock dividend, which was distributed on or about June 28, 2013 to shareholders of record as of June 17, 2013. In connection with the stock split, 3.0 million treasury shares, which represented the amount held in treasury on June 28, 2013, were utilized to settle a portion of the distribution. All share and per share data have been retroactively adjusted for all periods presented to reflect the stock split including the use of treasury shares, as if the stock split had occurred at the beginning of the earliest period presented.

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


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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, revenue cycle solutions, such as Cerner RevWorksSM services, and population health solutions and services. Finally, 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 accomplish by continuing to grow earnings and prudently managing capital expenditures.

Results Overview
The Company delivered strong levels of bookings and earnings, and solid revenue and operating cash flow in the third quarter of 2013.

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $928.0 million in the third quarter of 2013, which is an increase of 21% compared to $769.9 million in the third quarter of 2012. Revenues for the third quarter of 2013 increased 8% to $727.8 million compared to $676.5 million in the third quarter of 2012. The year-over-year increase in revenue reflects ongoing demand for Cerner's core solutions and services driven by the HITECH Act and other regulatory requirements, and increased contributions from newer areas, such as Cerner ITWorks and Cerner revenue cycle solutions and services.

Third quarter 2013 net earnings increased 17% to $115.3 million compared to $98.9 million in the third quarter of 2012. Diluted earnings per share increased 18% to $0.33 compared to $0.28 in the third 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 a decline in technology resale. Additionally, our margin expansion initiatives, which include creating efficiencies in our implementation and operational processes, have contributed to our earnings growth.

Third 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 third quarter 2013 net earnings and diluted earnings per share by $8.2 million and $0.02, respectively, and the third quarter 2012 net earnings and diluted earnings per share by $6.3 million and $0.02, respectively.

Our third quarter 2013 operating margin of 23% reflects an increase of 140 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 $766.1 million in the third quarter of 2013 compared to $661.7 million in the third quarter of 2012. Days sales outstanding was 66 days for the third quarter of 2013 compared to 68 days for the second quarter of 2013 and 73 days for the third quarter of 2012. Operating cash flows for the third quarter of 2013 were $164.2 million compared to $182.2 million in the third quarter of 2012.


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Results of Operations
Three Months Ended September 28, 2013 Compared to Three Months Ended
September 29, 2012
The following table presents a summary of the operating information for the
third quarters of 2013 and 2012:
                                         % of                     % of
(In thousands)                2013     Revenue       2012       Revenue     % Change
Revenues
System sales               $ 202,632       28 %   $ 229,925         34 %      (12 )%
Support and maintenance      166,308       23 %     154,333         23 %        8  %
Services                     342,212       47 %     277,948         41 %       23  %
Reimbursed travel             16,678        2 %      14,276          2 %       17  %

Total revenues               727,830      100 %     676,482        100 %        8  %

Costs of revenue
Costs of revenue             119,577       16 %     149,578         22 %      (20 )%

Total margin                 608,253       84 %     526,904         78 %       15  %

Operating expenses
Sales and client service     304,665       42 %     259,141         38 %       18  %
Software development          82,998       11 %      78,094         12 %        6  %
General and administrative    51,352        7 %      41,973          6 %       22  %

Total operating expenses     439,015       60 %     379,208         56 %       16  %

Total costs and expenses     558,592       77 %     528,786         78 %        6  %

Operating earnings           169,238       23 %     147,696         22 %       15  %

Other income, net              3,509                  3,351
Income taxes                 (57,403 )              (52,160 )

Net earnings               $ 115,344              $  98,887                    17  %

Revenues & Backlog
Revenues increased 8% to $727.8 million in the third quarter of 2013, as compared to $676.5 million in the third 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 $202.6 million in the third quarter of 2013 from $229.9 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 software as a service.

• Support and maintenance revenues increased 8% to $166.3 million in the third quarter of 2013 compared to $154.3 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 23% to $342.2 million in the third quarter of 2013 from $277.9 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 and Cerner RevWorks services.


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Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 26% in the third 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 and Cerner RevWorks services bookings that typically have longer contract terms. A summary of our total backlog follows:

(In thousands)                   September 28, 2013      September 29, 2012

Contract backlog                $          7,627,181    $          6,061,500
Support and maintenance backlog              769,847                 723,687

Total backlog                   $          8,397,028    $          6,785,187

Costs of Revenue
Cost of revenues as a percentage of total revenues was 16% in the third quarter of 2013, compared to 22% 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 16% to $439.0 million in the third quarter of 2013, compared with $379.2 million in the third quarter of 2012.

• Sales and client service expenses as a percent of total revenues were 42% in the third quarter of 2013, compared to 38% in the same period of 2012. These expenses increased 18% to $304.7 million in the third quarter of 2013, from $259.1 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 increase as a percent of revenue reflects a higher mix of services during the quarter that was driven by strong services revenue growth and the decline in technology resale revenue.

• Software development expenses as a percent of revenue were 11% in the third quarter of 2013, compared to 12% in the same period 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 third quarters of 2013 and 2012 is as follows:

                                                     Three Months Ended
(In thousands)                                       2013          2012

Software development costs                        $ 106,986     $ 82,873
Capitalized software costs                          (47,492 )    (25,126 )
Capitalized costs related to share-based payments      (552 )       (533 )
Amortization of capitalized software costs           24,056       20,880

Total software development expense                $  82,998     $ 78,094

• General and administrative expenses as a percent of total revenues were 7% in the third quarter of 2013, compared to 6% in the same period of 2012. These expenses increased 22% to $51.4 million in 2013, from $42.0 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


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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.

Non-Operating Items

• Other income was $3.5 million in the third quarter of 2013 and $3.4 million in the same period of 2012.

• Our effective tax rate was 33.2% for the third quarter of 2013 and 34.5% for the third quarter of 2012. This decrease was primarily due to reinstatement of the research and development credit in 2013. 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 Aruba, Australia, Austria, Brazil, Canada, Cayman Islands, Chile, Egypt, England, France, Germany, Guam, India, Ireland, Israel, Malaysia, Mexico, Qatar, Saudi Arabia, Singapore, Spain, Switzerland and the United Arab Emirates.

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

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

Domestic Segment
Revenues                                      $ 641,541         100%       $ 591,327         100%          8%

Costs of revenue                                107,560         17%          131,663         22%          (18)%
Operating expenses                              148,478         23%          131,787         22%           13%
Total costs and expenses                        256,038         40%          263,450         45%          (3)%

Domestic operating earnings                     385,503         60%          327,877         55%           18%

Global Segment
Revenues                                         86,289         100%          85,155         100%          1%

Costs of revenue                                 12,017         14%           17,915         21%          (33)%
Operating expenses                               34,078         39%           32,794         39%           4%
Total costs and expenses                         46,095         53%           50,709         60%          (9)%

Global operating earnings                        40,194         47%           34,446         40%           17%

Other, net                                     (256,459 )                   (214,627 )                     19%

Consolidated operating earnings               $ 169,238                    $ 147,696                       15%

Domestic Segment
• Revenues increased 8% to $641.5 million in the third quarter of 2013 from $591.3 million in the same period of 2012. This increase was driven by strong growth across most of our business, offset by lower levels of technology resale.

• Cost of revenues was 17% of revenues in the third quarter of 2013, compared to 22% 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 13% to $148.5 million in the third quarter of 2013 from $131.8 million in the same period of 2012, due primarily to growth in professional services expenses.


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Global Segment
• Revenues increased 1% to $86.3 million in the third quarter of 2013 from $85.2 million in the same period of 2012. This increase was primarily driven by growth in professional services.

• Cost of revenues was 14% in the third quarter of 2013 and 21% in the same period of 2012. The lower cost of revenues in 2013 was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue.

• Operating expenses were at $34.1 million in the third quarter of 2013, compared to $32.8 million in the same period of 2012, primarily due to an increase 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 19% to $256.5 million in the third quarter of 2013 from $214.6 million in the same period of 2012. This increase was primarily due to growth in corporate and development personnel costs, along with increased depreciation and amortization related to acquired assets. This was partially offset by increased software capitalization.
Nine Months Ended September 28, 2013 Compared to Nine Months Ended September 29, 2012
The following table presents a summary of the operating information for the first nine months of 2013 and 2012:

                                          % of                      % of
(In thousands)                 2013     Revenue        2012       Revenue     % Change
Revenues
System sales               $  602,037       28 %   $  651,040         33 %       (8 )%
Support and maintenance       491,824       23 %      450,584         23 %        9  %
Services                      969,899       46 %      811,647         42 %       19  %
Reimbursed travel              51,660        2 %       41,781          2 %       24  %

Total revenues              2,115,420      100 %    1,955,052        100 %        8  %

Costs of revenue
Costs of revenue              372,606       18 %      455,086         23 %      (18 )%

Total margin                1,742,814       82 %    1,499,966         77 %       16  %

Operating expenses
Sales and client service      853,213       40 %      746,090         38 %       14  %
Software development          246,343       12 %      222,746         11 %       11  %
General and administrative    150,995        7 %      119,912          6 %       26  %

Total operating expenses    1,250,551       59 %    1,088,748         56 %       15  %

Total costs and expenses    1,623,157       77 %    1,543,834         79 %        5  %

Operating earnings            492,263       23 %      411,218         21 %       20  %

Other income, net               9,286                   8,789
Income taxes                 (163,258 )              (134,583 )

Net earnings               $  338,291              $  285,424                    19  %

Revenues & Backlog
Revenues increased 8% to $2.1 billion in the first nine months of 2013, as compared to $2.0 billion in the first nine months of 2012.

• System sales decreased 8% to $602.0 million in the first nine months of 2013 from $651.0 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 software as a service.


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• Support and maintenance revenues increased 9% to $491.8 million in the first nine months of 2013 compared to $450.6 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 increased 19% to $969.9 million in the first nine months of 2013 from $811.6 million for the same period in 2012. This increase was driven by growth in CernerWorks 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 and Cerner RevWorks services.

Costs of Revenue
Cost of revenues as a percentage of total revenues was 18% in the first nine months of 2013, compared to 23% 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.

Operating Expenses
Total operating expenses increased 15% to $1.3 billion in the first nine months of 2013, compared with $1.1 billion in the same period of 2012.

• Sales and client service expenses as a percent of total revenues were 40% in the first nine months of 2013, compared to 38% in the same period of 2012. These expenses increased 14% to $853.2 million in the first nine months of 2013, from $746.1 million in the same period of 2012. The increase as a percent of revenue reflects a higher mix of services in 2013 that has been driven by strong services revenue growth and the decline in technology resale revenue.

• Software development expenses as a percent of revenue were 12% in the first nine months of 2013, compared to 11% in the same period 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 nine months of 2013 and 2012 is as follows:

                                                      Nine Months Ended
(In thousands)                                       2013          2012

Software development costs                        $ 302,928     $ 234,899
. . .
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