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CERN > SEC Filings for CERN > Form 10-Q on 25-Apr-2014All Recent SEC Filings

Show all filings for CERNER CORP /MO/

Form 10-Q for CERNER CORP /MO/


25-Apr-2014

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 2014 and 2013 first quarters ended on March 29, 2014 and March 30, 2013, respectively. All references to years in this MD&A represent the respective three 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 and other combinations; the potential for losses resulting from asset impairment charges; risks associated with volatility and disruption resulting from 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 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


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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 solutions 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, Cerner ITWorksSM 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 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, revenue, earnings, and operating cash flow in the first quarter of 2014.

New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $910.2 million in the first quarter of 2014, which is an increase of 14% compared to $801.6 million in the first quarter of 2013. Revenues for the first quarter of 2014 increased 15% to $784.8 million compared to $680.0 million in the first quarter of 2013. 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 Cerner ITWorks and Cerner revenue cycle solutions and services.

First quarter 2014 net earnings increased 9% to $119.5 million compared to $110.0 million in the first quarter of 2013. Diluted earnings per share increased 10% to $0.34 compared to $0.31 in the first quarter of 2013. 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.

First quarter 2014 and 2013 net earnings and diluted earnings per share reflect the impact of stock-based compensation expense. The effect of these expenses reduced the first quarter 2014 net earnings and diluted earnings per share by $9.6 million and $0.03, respectively, and the first quarter 2013 net earnings and diluted earnings per share by $6.9 million and $0.02, respectively.

We had cash collections of receivables of $867.7 million in the first quarter of 2014 compared to $784.0 million in the first quarter of 2013. Days sales outstanding was 66 days for the first quarter of 2014 compared to 67 days for the fourth quarter of 2013 and 69 days for the first quarter of 2013. Operating cash flows for the first quarter of 2014 were $155.8 million compared to $213.6 million in the first quarter of 2013.


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Results of Operations
Three Months Ended March 29, 2014 Compared to Three Months Ended March 30, 2013
The following table presents a summary of the operating information for the
first quarters of 2014 and 2013:
                                         % of                     % of
(In thousands)                2014     Revenue       2013       Revenue    % Change
Revenues
System sales               $ 206,687       26 %   $ 198,902         29 %        4 %
Support and maintenance      174,930       22 %     160,957         24 %        9 %
Services                     382,499       49 %     305,599         45 %       25 %
Reimbursed travel             20,645        3 %      14,571          2 %       42 %

Total revenues               784,761      100 %     680,029        100 %       15 %

Costs of revenue
Costs of revenue             129,099       16 %     127,229         19 %        1 %

Total margin                 655,662       84 %     552,800         81 %       19 %

Operating expenses
Sales and client service     330,901       42 %     267,356         39 %       24 %
Software development          91,545       12 %      81,063         12 %       13 %
General and administrative    55,213        7 %      47,812          7 %       15 %

Total operating expenses     477,659       61 %     396,231         58 %       21 %

Total costs and expenses     606,758       77 %     523,460         77 %       16 %

Operating earnings           178,003       23 %     156,569         23 %       14 %

Other income, net              2,990                  3,044
Income taxes                 (61,467 )              (49,573 )

Net earnings               $ 119,526              $ 110,040                     9 %

Revenues & Backlog
Revenues increased 15% to $784.8 million in the first quarter of 2014, as compared to $680.0 million in the first quarter of 2013.

• System sales, which include revenues from the sale of software (including perpetual license sales and software as a service), technology resale (hardware, devices, and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions, increased 4% to $206.7 million in the first quarter of 2014 from $198.9 million for the same period in 2013. The increase in system sales was primarily driven by strong growth in software of $21.9 million, which was partially offset by a $19.8 million decline in technology resale.

• Support and maintenance revenues increased 9% to $174.9 million in the first quarter of 2014 compared to $161.0 million during the same period in 2013. 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 25% to $382.5 million in the first quarter of 2014 from $305.6 million for the same period in 2013. This increase was driven by growth in CernerWorksSM managed services of $11.9 million as a result of continued demand for our hosting services and a $65.0 million increase in professional services due to growth in implementation and consulting activities.


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Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 24% in the first quarter of 2014 when compared to the same period in 2013. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services, Cerner ITWorks, Cerner revenue cycle solutions and services bookings that typically have longer contract terms. A summary of our total backlog follows:

(In thousands)                   March 29, 2014      March 30, 2013

Contract backlog                $      8,448,933    $      6,831,667
Support and maintenance backlog          795,902             747,872

Total backlog                   $      9,244,835    $      7,579,539

Costs of Revenue
Cost of revenues as a percentage of total revenues was 16% in the first quarter of 2014, compared to 19% in the same period of 2013. 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 21% to $477.7 million in the first quarter of 2014, compared with $396.2 million in the first quarter of 2013.

• Sales and client service expenses as a percent of total revenues were 42% in the first quarter of 2014, compared to 39% in the same period of 2013. These expenses increased 24% to $330.9 million in the first quarter of 2014, from $267.4 million in the same period of 2013. 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 12% in the first quarters of 2014 and 2013. 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 2014 and 2013 is as follows:

                                                     Three Months Ended
(In thousands)                                       2014          2013

Software development costs                        $ 110,988     $ 93,381
Capitalized software costs                          (43,984 )    (33,820 )
Capitalized costs related to share-based payments      (560 )       (514 )
Amortization of capitalized software costs           25,101       22,016

Total software development expense                $  91,545     $ 81,063

• General and administrative expenses as a percent of total revenues were 7% in the first quarters of 2014 and 2013. These expenses increased 15% to $55.2 million in 2014, from $47.8 million for the same period in 2013. 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


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currency and expense for share-based payments. The increase in general and administrative expenses was primarily driven by a $2.7 million increase in corporate personnel costs, as we have continued to increase such personnel to support our overall revenue growth, and a $1.2 million increase in amortization expense due to acquired intangibles.

Non-Operating Items

• Other income was $3.0 million in the first quarters of 2014 and 2013.

• Our effective tax rate was 34.0% for the first quarter of 2014 and 31.1% for the first quarter of 2013. This increase is a result of the favorable discrete item recorded in the first quarter of 2013 for the retroactive extension of the 2012 research and development credit and the expiration of the same credit at the end of 2013. Refer to Note (5) 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 first quarters of 2014 and 2013:

(In thousands)                                   2014       % of Revenue      2013       % of Revenue   % Change

Domestic Segment
Revenues                                      $ 697,704         100%       $ 576,639         100%          21%

Costs of revenue                                115,345         17%          106,697         19%           8%
Operating expenses                              161,066         23%          147,756         26%           9%
Total costs and expenses                        276,411         40%          254,453         44%           9%

Domestic operating earnings                     421,293         60%          322,186         56%           31%

Global Segment
Revenues                                         87,057         100%         103,390         100%         (16)%

Costs of revenue                                 13,754         16%           20,532         20%          (33)%
Operating expenses                               33,342         38%           25,630         25%           30%
Total costs and expenses                         47,096         54%           46,162         45%           2%

Global operating earnings                        39,961         46%           57,228         55%          (30)%

Other, net                                     (283,251 )                   (222,845 )                     27%

Consolidated operating earnings               $ 178,003                    $ 156,569                       14%

Domestic Segment
• Revenues increased 21% to $697.7 million in the first quarter of 2014 from $576.6 million in the same period of 2013. This increase was driven by growth across most of our business, partially offset by a $9.5 million decline in technology resale.

• Cost of revenues was 17% of revenues in the first quarter of 2014, compared to 19% of revenues in the same period of 2013. 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 9% to $161.1 million in the first quarter of 2014 from $147.8 million in the same period of 2013, due primarily to growth in professional services expenses.


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Global Segment
• Revenues decreased 16% to $87.1 million in the first quarter of 2014 from $103.4 million in the same period of 2013. This decrease was primarily driven by a decline in technology resale revenue. The first quarter 2013 comparable period included significant contributions to technology resale revenues from expansion of our footprint in the Middle East.

• Cost of revenues was 16% in the first quarter of 2014 and 20% in the same period of 2013. The lower cost of revenues in 2014 was primarily driven by a lower mix of technology resale, which carries a higher cost of revenue.

• Operating expenses were at $33.3 million in the first quarter of 2014, compared to $25.6 million in the same period of 2013, 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 27% to $283.3 million in the first quarter of 2014 from $222.8 million in the same period of 2013. This increase was primarily due to a $51.5 million increase in corporate and development personnel costs, as we have increased such personnel to support our overall revenue growth and development initiatives. This was partially offset by a $7.1 million increase in net software capitalization.

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 primarily consist of money market funds and time deposits with original maturities of less than 90 days, and short-term investments. At March 29, 2014, we had cash and cash equivalents of $219.9 million and short-term investments of $811.3 million, as compared to cash and cash equivalents of $202.4 million and short-term investments of $677.0 million at December 28, 2013.
The non-U.S. subsidiaries for which we have elected to indefinitely reinvest earnings outside of the U.S. held approximately 15% of our aggregate cash, cash equivalents and short-term investments at March 29, 2014. As part of our current business strategy, we plan to indefinitely reinvest the earnings of these foreign operations; however, should the earnings of these 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 29, 2014, we were in compliance with all debt covenants. As of March 29, 2014, we had no outstanding borrowings under this agreement; however, we had $15.8 million of outstanding letters of credit, which reduced our available borrowing capacity to $84.2 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 2014.


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The following table summarizes our cash flows in the first three months of 2014 and 2013:

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