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CERN > SEC Filings for CERN > Form 10-K on 5-Feb-2014All Recent SEC Filings

Show all filings for CERNER CORP /MO/

Form 10-K for CERNER CORP /MO/


5-Feb-2014

Annual Report


Item 7. 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 our results of operations and financial condition. 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).

Our fiscal year ends on the Saturday closest to December 31. Fiscal years 2013, 2012 and 2011 each consisted of 52 weeks and ended on December 28, 2013, December 29, 2012 and December 31, 2011, respectively. All references to years in this MD&A represent fiscal years 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 one hundred percent (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 represents 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.

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 Cernerฎ solutions licensed by approximately 14,000 facilities around the world, including more than 3,000 hospitals; 4,900 physician practices; 60,000 physicians; 590 ambulatory facilities, such as laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics and surgery centers; 3,500 extended care facilities; 150 employer sites and 1,790 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 CareAwareฎ health care device architecture and devices, Cerner ITWorks services, revenue cycle solutions and 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 16% 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 good 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 2013.

New business bookings revenue in 2013, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $3.8 billion, which is an increase of 20% compared to $3.1 billion in 2012. Our 2013 revenues increased 9% to $2.9 billion compared to $2.7 billion in 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.


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Our 2013 net earnings were $398.4 million compared to $397.2 million in 2012. Diluted earnings per share were $1.13 in both 2013 and 2012. The 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 2013 net earnings and diluted earnings per share by $30.3 million and $0.09, respectively, and the 2012 earnings and diluted earnings per share by $23.5 million and $0.07, respectively. The 2013 net earnings and diluted earnings per share also reflect the impact of a settlement charge, as further described in Note (11) of our notes to consolidated financial statements. The effect of this charge reduced 2013 net earnings and diluted earnings per share by $68.1 million and $0.19, respectively. Absent this charge, there was growth in net earnings and diluted earnings per share 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 earnings growth.

We had cash collections of receivables of $3.1 billion in 2013 compared to $2.7 billion in 2012. Days sales outstanding was 67 days for the 2013 fourth quarter compared to 66 days for the 2013 third quarter and 74 days for the 2012 fourth quarter. Operating cash flows for 2013 were strong at $695.9 million compared to $708.3 million in 2012, with the primary reason for the decline being the aforementioned settlement charge.

Health Care Information Technology Market Outlook

We have provided an assessment of the health care information technology market under "Health Care and Health Care IT Industry" in Part I, Item 1 "Business."

Results of Operations
Fiscal Year 2013 Compared to Fiscal Year 2012
                                          % of                      % of
(In thousands)                 2013     Revenue        2012       Revenue     % Change
Revenues
System sales               $  847,809       29 %   $  902,799         34 %       (6 )%
Support and maintenance       661,979       23 %      604,247         23 %       10  %
Services                    1,330,851       46 %    1,103,082         41 %       21  %
Reimbursed travel              70,109        2 %       55,308          2 %       27  %

Total revenues              2,910,748      100 %    2,665,436        100 %        9  %

Costs of revenue
Costs of revenue              514,722       18 %      608,197         23 %      (15 )%

Total margin                2,396,026       82 %    2,057,239         77 %       16  %

Operating expenses
Sales and client service    1,173,051       40 %    1,020,640         38 %       15  %
Software development          338,786       12 %      301,370         11 %       12  %
General and administrative    308,177       11 %      163,567          6 %       88  %

Total operating expenses    1,820,014       63 %    1,485,577         56 %       23  %

Total costs and expenses    2,334,736       80 %    2,093,774         79 %       12  %

Operating earnings            576,012       20 %      571,662         21 %        1  %

Other income, net              12,042                  16,046
Income taxes                 (189,700 )              (190,476 )

Net earnings               $  398,354              $  397,232                     -  %


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Revenues & Backlog
Revenues increased 9% to $2.9 billion in 2013, as compared to $2.7 billion in 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 6% to $847.8 million in 2013 from $902.8 million in 2012. The decrease in system sales was driven by lower levels of technology resale, which more than offset growth in licensed software, subscriptions, and software as a service.

• Support and maintenance revenues increased 10% to $662.0 million in 2013 compared to $604.2 million in 2012. This increase was attributable to continued success at selling Cerner Millennium systems 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 21% to $1.3 billion in 2013 from $1.1 billion 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.

Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 24% in 2013 when compared to 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 total backlog at the end of 2013 and 2012 follows:

(In thousands)                      2013           2012

Contract backlog                $ 8,127,936    $ 6,534,564
Support and maintenance backlog     786,041        738,154

Total backlog                   $ 8,913,977    $ 7,272,718

Costs of Revenue
Cost of revenues as a percentage of total revenues was 18% in 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.
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 23% to $1.8 billion in 2013, compared with $1.5 billion in 2012.

• Sales and client service expenses as a percent of total revenues were 40% in 2013, compared to 38% in 2012. These expenses increased 15% to $1.2 billion in 2013, from $1.0 billion in 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 2013 that was driven by strong services revenue growth and the decline in technology resale revenue.


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• Software development expenses as a percent of revenue were 12% in 2013, compared to 11% in 2012. The increase in both expensed and capitalized software development expenditures reflects a focus on development and enhancement of solutions that support key initiatives to enhance physician experience, revenue cycle, and population health. A summary of our total software development expense in 2013 and 2012 is as follows:

                                                     For the Years Ended
(In thousands)                                       2013          2012

Software development costs                        $ 418,747     $ 319,828
Capitalized software costs                         (172,211 )     (98,067 )
Capitalized costs related to share-based payments    (2,438 )      (2,122 )
Amortization of capitalized software costs           94,688        81,731

Total software development expense                $ 338,786     $ 301,370

• General and administrative expenses as a percent of total revenues were 11% in 2013, compared to 6% in 2012. These expenses increased 88% to $308.2 million in 2013, from $163.6 million 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 2013 amount includes a $106.2 million settlement charge, as further described in Note
(11) of our notes to consolidated financial statements. Absent this charge, 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.

Non-Operating Items

• Interest income decreased to $15.3 million in 2013 from $16.5 million in 2012 due primarily to a slight decrease in investment returns. Interest expense decreased to $4.2 million in 2013 compared to $5.1 million in 2012 due primarily to payments on our long-term debt, offset by increased capital lease obligations. Other income in 2012 also includes a $4.5 million gain recognized on the disposition of one of our cost-method investments.

• Our effective tax rate was 32% in both 2013 and 2012. The rate includes net favorable permanent differences recognized in both periods. Refer to Note (13) of the notes to consolidated financial statements for further information regarding our effective tax rate.

In January 2013, the American Taxpayer Relief Act of 2012 (Act) became law. The Act reinstates the research and development tax credit retroactively from January 1, 2012 to December 31, 2013. In the first quarter of 2013, we recognized the research and development tax credit related to 2012 as a favorable discrete item. Research and development tax credits generated in 2013 were recognized pro-rata over that year as a component of the overall 2013 effective tax rate. We estimate the expiration of the research and development tax credit on December 31, 2013 will negatively impact our effective tax rate for 2014 by approximately one percentage point, unless such credit is reinstated.

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.


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The following table presents a summary of the operating information for the years ended 2013 and 2012:

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

Domestic Segment
Revenues                                     $ 2,550,115         100%       $ 2,341,304         100%          9%
Costs of revenue                                 458,540         18%            548,813         23%          (16)%
Operating expenses                               600,341         24%            506,249         22%           19%
Total costs and expenses                       1,058,881         42%          1,055,062         45%           -%

Domestic operating earnings                    1,491,234         58%          1,286,242         55%           16%

Global Segment
Revenues                                         360,633         100%           324,132         100%          11%
Costs of revenue                                  56,182         16%             59,384         18%          (5)%
Operating expenses                               115,281         32%            131,580         41%          (12)%
Total costs and expenses                         171,463         48%            190,964         59%          (10)%

Global operating earnings                        189,170         52%            133,168         41%           42%

Other, net                                    (1,104,392 )                     (847,748 )                     30%

Consolidated operating earnings              $   576,012                    $   571,662                       1%

Domestic Segment
• Revenues increased 9% to $2.6 billion in 2013 from $2.3 billion in 2012. This increase was primarily driven by strong growth across most of our business, partially offset by lower levels of technology resale.

• Cost of revenues was 18% of revenues in 2013, compared to 23% of revenues in 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 19% to $600.3 million in 2013 from $506.2 million in 2012, due primarily to growth in managed services and professional services expenses.

Global Segment
• Revenues increased 11% to $360.6 million in 2013 from $324.1 million in 2012. This increase was primarily driven by growth across most of our business, partially offset by lower levels of technology resale.

• Cost of revenues was 16% of revenues in 2013, compared to 18% of revenues in 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 decreased 12% to $115.3 million in 2013 from $131.6 million in 2012, due primarily to a decrease in non-personnel and 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 30% to $1.1 billion in 2013 from $847.7 million in 2012. The 2013 amount includes a $106.2 million settlement charge, as further described in Note (11) of our notes to consolidated financial statements. Absent this charge, the increase was primarily due to growth in corporate and development personnel costs, along with increased depreciation and amortization related to acquired intangibles. This was partially offset by increased software capitalization.


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Fiscal Year 2012 Compared to Fiscal Year 2011

                                          % of                      % of
(In thousands)                 2012     Revenue        2011       Revenue    % Change
Revenues
System sales               $  902,799       34 %   $  706,714         32 %       28 %
Support and maintenance       604,247       23 %      550,554         25 %       10 %
Services                    1,103,082       41 %      901,193         41 %       22 %
Reimbursed travel              55,308        2 %       44,692          2 %       24 %

Total revenues              2,665,436      100 %    2,203,153        100 %       21 %

Costs of revenue
Costs of revenue              608,197       23 %      441,672         20 %       38 %

Total margin                2,057,239       77 %    1,761,481         80 %       17 %

Operating expenses
Sales and client service    1,020,640       38 %      869,962         39 %       17 %
Software development          301,370       11 %      286,801         13 %        5 %
General and administrative    163,567        6 %      144,920          7 %       13 %

Total operating expenses    1,485,577       56 %    1,301,683         59 %       14 %

Total costs and expenses    2,093,774       79 %    1,743,355         79 %       20 %

Operating earnings            571,662       21 %      459,798         21 %       24 %

Other income, net              16,046                   9,896
Income taxes                 (190,476 )              (163,067 )

Net earnings               $  397,232              $  306,627                    30 %

Revenues & Backlog
Revenues increased 21% to $2.7 billion in 2012, as compared to $2.2 billion in 2011.

• System sales increased 28% to $902.8 million in 2012 from $706.7 million in 2011. The increase in system sales was driven by record levels of technology resale and solid growth in subscriptions and software.

• Support and maintenance revenues increased 10% to $604.2 million in 2012 compared to $550.6 million in 2011. This increase was attributable to continued success at selling Cerner Millennium systems and implementing them at client sites.

• Services revenue increased 22% to $1.1 billion in 2012 compared to $0.9 billion in 2011. 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 activities and growth in Cerner ITWorks services.

Contract backlog increased 21% in 2012 compared to 2011. This increase was driven by growth in new business bookings during 2012, including continued strong levels of managed services and Cerner ITWorks bookings that typically have longer contract terms.

A summary of total backlog at the end of 2012 and 2011 follows:

(In thousands)                      2012           2011

Contract backlog                $ 6,534,564    $ 5,401,427
Support and maintenance backlog     738,154        705,744

Total backlog                   $ 7,272,718    $ 6,107,171


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Costs of Revenue
Cost of revenues as a percentage of total revenues was 23% of total revenues in 2012, as compared to 20% of total revenues in 2011. The higher cost of revenues as a percent of revenue was primarily driven by a higher mix of technology resale, which carries a higher cost of revenue. Operating Expenses
Total operating expenses increased 14% in 2012 to $1.5 billion as compared to $1.3 billion in 2011.

• Sales and client service expenses as a percent of total revenues were 38% in 2012, as compared to 39% in 2011. These expenses increased 17% to $1.0 billion in 2012, from $870.0 million in 2011. The decrease as a percent of revenue reflects ongoing efficiencies in our implementation and operational processes.

• Software development expenses as a percent of revenue were 11% in 2012, as compared to 13% in 2011. These expenses increased 5% in 2012 to $301.4 million, from $286.8 million in 2011. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium platform, including investments in the next evolution of Cerner Millennium, Millennium+, which leverages the cloud and enables greater mobility. The reduction as a percentage of revenue reflects our efforts to control spending relative to revenue growth. Because of the strong platform we have built, we are able to continue advancing our solutions and investing in new solutions without large increases in spending. Expense was also limited by a higher percentage of our software development investments being capitalized, as a higher percent of our development initiatives are focused on new functionality versus maintenance. A summary of our total software development expense in 2012 and 2011 is as follows:

                                                     For the Years Ended
(In thousands)                                       2012          2011

Software development costs                        $ 319,828     $ 290,645
Capitalized software costs                          (98,067 )     (81,417 )
Capitalized costs related to share-based payments    (2,122 )      (1,525 )
Amortization of capitalized software costs           81,731        79,098

Total software development expense                $ 301,370     $ 286,801

• General and administrative expenses as a percent of total revenues were 6% in 2012, compared to 7% in 2011. These expenses increased 13% to $163.6 million in 2012 from $144.9 million in 2011. 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.

Non-Operating Items

• Interest income increased to $16.5 million in 2012 from $15.2 million in 2011 due primarily to growth in investments. Interest expense decreased to $5.1 million in 2012 from $5.3 million in 2011 due primarily to payments on our long-term debt, offset by increased capital lease obligations. Other income in 2012 also includes a $4.5 million gain recognized on the disposition of one of our cost-method investments.

• Our effective tax rate was 32% in 2012, as compared to 35% in 2011. This decrease was primarily due to an increase in net favorable permanent differences, along with a favorable adjustment to our unrecognized tax benefits, partially offset by the expiration of the research and development tax credit on December 31, 2011.


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Operations by Segment

The following table presents a summary of our operating segment information for
the years ended 2012 and 2011:
(In thousands)                                    2012        % of Revenue       2011        % of Revenue   % Change

Domestic Segment
Revenues                                      $ 2,341,304         100%       $ 1,894,454         100%          24%
. . .
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