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MarketScreener Homepage  >  Equities  >  Nasdaq  >  Cerner Corporation    CERN

CERNER CORPORATION

(CERN)
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CERNER : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-Q)

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07/25/2019 | 04:08pm EDT
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
condensed consolidated financial statements and the accompanying notes to
condensed consolidated financial statements ("Notes") found above. Certain
statements in this quarterly report on Form 10-Q contain forward-looking
statements within the meanings of the Private Securities Litigation Reform Act
of 1995, as amended, regarding our future plans, objectives, beliefs,
expectations, representations and projections. See the end of this MD&A for more
information on our forward-looking statements, including a discussion of the
most significant factors that could cause actual results to differ materially
from those in the forward-looking statements.

Our second fiscal quarter ends on the Saturday closest to June 30. The 2019 and
2018 second quarters ended on June 29, 2019 and June 30, 2018, respectively. All
references to years in this MD&A represent the respective three or six months
ended on such dates, unless otherwise noted.

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 and other stakeholders secure access to clinical,
administrative and financial data in real or near-real time, helping them to
improve quality, safety and efficiency in the delivery of health care.

Our core strategy is to create organic growth by investing in research and
development ("R&D") to create solutions and tech- enabled 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 13%
and 12%, respectively. This growth has also created an important strategic
footprint in health care, with Cerner® solutions in more than 27,500 contracted
provider facilities worldwide, including hospitals, physician practices,
laboratories, ambulatory centers, behavioral health centers, cardiac facilities,
radiology clinics, surgery centers, extended care facilities, retail pharmacies,
and employer sites. Selling additional solutions and services back into this
client base is an important element of our future revenue growth. We are also
focused on driving growth 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 suppliers. We may also
supplement organic growth with acquisitions or strategic investments.

We expect to drive growth through solutions and tech-enabled 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
HealtheIntent® population health solutions and services. Finally, we continue to
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 10% and 13% over the most recent five- and
ten-year periods, respectively. We expect to drive earnings growth as we
continue to grow our revenue. We also believe we have opportunities to expand
our operating margins over time, as discussed further below.

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
Bookings, which reflects the value of executed contracts for software, hardware,
professional services and managed services, was $1.43 billion in the second
quarter of 2019, which is a decrease of 19% compared to $1.78 billion in the
second quarter of 2018, with the decrease primarily reflecting a decline in
long-term contracts, which tend to be larger but have little impact on near-term
revenue.

Revenues for the second quarter of 2019 increased 5% to $1.43 billion, compared
to $1.37 billion in the second quarter of 2018. The increase in revenue reflects
ongoing demand from new and existing clients for Cerner's solutions and
tech-enabled services driven by their needs to keep up with regulatory
requirements, adapt to changing reimbursement models, and deliver safer and more
efficient care.


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Net earnings for the second quarter of 2019 decreased 25% to $127 million,
compared to $169 million in the second quarter of 2018. Diluted earnings per
share decreased 24% to $0.39, compared to $0.51 in the second quarter of 2018.
The overall decrease in net earnings and diluted earnings per share was
primarily a result of increased operating expenses, including expenses incurred
in connection with our operational improvement initiatives discussed below,
partially offset by increased revenues.

We had cash collections of receivables of $1.38 billion in the second quarter of
2019, compared to $1.32 billion in the second quarter of 2018. Days sales
outstanding was 78 days for the 2019 second quarter, compared to 76 days for the
2019 first quarter and 77 days for the 2018 second quarter. Operating cash flows
for the second quarter of 2019 were $207 million, compared to $300 million in
the second quarter of 2018.

Operational Improvement Initiatives


We transitioned to a new operating structure in the first quarter of 2019. The
Company has been focused on leveraging the impact of this reorganization and
identifying additional efficiencies. Currently, we are focused on reducing
operating expenses and generating other efficiencies that are expected to
provide longer-term operating margin expansion. To assist in these efforts, we
have engaged an outside consulting firm to conduct a review of our operations
and cost structure. Our goal is to identify opportunities to operate more
efficiently and achieve and improve upon the efficiencies without impacting the
quality of our solutions and services and commitments to our clients.

In the near term, we expect to incur expenses in connection with these efforts.
Such expenses may include, but are not limited to, consultant and other
professional services fees, employee separation costs, contract termination
costs, and other such related expenses. For the six months ended June 29, 2019,
we recognized $57 million of expenses related to these efforts, which are
included in general and administrative expense in our condensed consolidated
statements of operations. We expect to incur additional expenses in connection
with these initiatives in future periods, which may be material.

Results of Operations

Three Months Ended June 29, 2019 Compared to Three Months Ended June 30, 2018

The following table presents a summary of the operating information for the second quarters of 2019 and 2018:

                                                           % of                       % of
(In thousands)                               2019        Revenue        

2018 Revenue % Change


Revenues                                 $ 1,431,061        100 %   $ 1,367,727        100 %        5  %
Costs of revenue                             268,673         19 %       238,783         17 %       13  %

Margin                                     1,162,388         81 %     1,128,944         83 %        3  %

Operating expenses
Sales and client service                     678,895         47 %       635,105         46 %        7  %
Software development                         181,047         13 %       168,278         12 %        8  %
General and administrative                   149,788         10 %        95,464          7 %       57  %
Amortization of acquisition-related
intangibles                                   21,541          2 %        21,810          2 %       (1 )%

Total operating expenses                   1,031,271         72 %       920,657         67 %       12  %

Total costs and expenses                   1,299,944         91 %     1,159,440         85 %       12  %

Operating earnings                           131,117          9 %       208,287         15 %      (37 )%

Other income, net                             23,006                      6,597
Income taxes                                 (27,154 )                  (45,527 )

Net earnings                             $   126,969$   169,357                   (25 )%




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Revenues & Backlog


Revenues increased 5% to $1.43 billion in the second quarter of 2019, as
compared to $1.37 billion in the same period of 2018. This increase was
primarily driven by a $38 million increase in professional services revenue due
to growth in implementation activity, and growth in licensed software revenue of
$25 million as a result of continued demand for our solutions. Refer to Note (2)
of the notes to condensed consolidated financial statements for further
information regarding revenues disaggregated by our business models.

Backlog, which reflects contracted revenue that has not yet been recognized as
revenue, was $14.98 billion in the second quarter of 2019, compared to $14.79
billion in the same period of 2018. This increase was driven by solid levels of
new business bookings during the past four quarters, including strong levels of
managed services bookings that typically have longer contract terms. We expect
to recognize approximately 29% of our backlog as revenue over the next 12
months.

We believe that backlog may not necessarily be a comprehensive indicator of
future revenue as certain of our arrangements may be canceled (or conversely
renewed) at our clients' option, thus contract consideration related to such
cancellable periods has been excluded from our calculation of backlog. However,
historically our experience has been that such cancellation provisions are
rarely exercised. We expect to recognize approximately $551 million of revenue
over the next 12 months under currently executed contracts related to such
cancellable periods, which is not included in our calculation of backlog.

Costs of Revenue

Costs of revenue as a percent of revenues were 19% in the second quarter of 2019, compared to 17% in the same period of 2018. The higher costs of revenue as a percent of revenues was primarily driven by higher third-party costs associated with professional services revenue.


Costs of revenue include 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, and services) carrying different margin
rates changes from period to period. Costs of revenue 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 12% to $1.03 billion in the second quarter of 2019, compared to $921 million in the same period of 2018.

• Sales and client service expenses as a percent of revenues were 47% in the

second quarter of 2019, compared to 46% in the same period of 2018. These

expenses increased 7% to $679 million in the second quarter of 2019, from

$635 million in the same period of 2018. Sales and client service expenses

include salaries and benefits of sales, marketing, support, and services

personnel, depreciation and other expenses associated with our managed

services business, communications expenses, unreimbursed travel expenses,

expense for share-based payments, and trade show and advertising costs.

The increase in sales and client service expenses was primarily driven by

an $8 million increase in personnel expenses, inclusive of hiring

personnel to support growth in professional services revenue; an $8

million increase in bad debt expense related to client receivables; and a

$20 million charge in connection with a client dispute recognized in the

second quarter of 2019. Refer to Note (11) of the notes to condensed

consolidated financial statements for further information regarding such

       client dispute.




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• Software development expenses as a percent of revenues were 13% in the

second quarter of 2019, compared to 12% in the same period of 2018.

Expenditures for software development include ongoing development and

enhancement of the Cerner Millennium® and HealtheIntent platforms, 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 second quarters of 2019 and 2018 is as
       follows:


                                                     Three Months Ended
(In thousands)                                       2019          2018

Software development costs                        $ 195,393$ 185,486
Capitalized software costs                          (69,675 )     (68,786 )

Capitalized costs related to share-based payments (676 ) (563 ) Amortization of capitalized software costs

           56,005        52,141

Total software development expense                $ 181,047$ 168,278

• General and administrative expenses as a percent of revenues were 10% in

the second quarter of 2019, compared to 7% in the same period of 2018.

       These expenses increased 57% to $150 million in the second quarter of
       2019, from $95 million in the same period in 2018. General and
       administrative expenses include salaries and benefits for corporate,

financial and administrative staffs, utilities, communications expenses,

professional fees, depreciation and amortization, transaction gains or

losses on foreign currency, expense for share-based payments,

organizational restructuring and other expense. The increase in general

and administrative expenses includes $55 million of expenses incurred in

the second quarter of 2019 in connection with our operational improvement

       initiatives discussed above; inclusive of $41 million of charges
       associated with the 2019 VSP, as further discussed in Note (1) of the
       notes to condensed consolidated financial statements. We expect to incur

additional expenses in connection with these efforts in future periods in

       2019, which may be material.


• Amortization of acquisition-related intangibles as a percent of revenues

was 2% in the second quarter of both 2019 and 2018. These expenses

remained flat at $22 million in the second quarter of both 2019 and 2018.

Amortization of acquisition-related intangibles includes the amortization

       of customer relationships, acquired technology, trade names, and
       non-compete agreements recorded in connection with our business
       acquisitions.



Non-Operating Items

• Other income, net was $23 million in the second quarter of 2019, compared

       to $7 million in the same period of 2018. The second quarter of 2019
       includes a $16 million gain recognized on the disposition of one of our
       equity investments.


• Our effective tax rate was 17.6% for the second quarter of 2019, compared

to 21.2% in the same period of 2018. The decrease in the effective tax

rate in the second quarter of 2019 is primarily due to increased excess

tax benefits recognized as a component of income tax expense during the

quarter due to elevated stock option exercise activity. Refer to Note (8)

of the notes to condensed consolidated financial statements for further

discussion regarding our effective tax rate.

Operations by Segment


We have two operating segments: Domestic and International (formerly referred to
as Global). The Domestic segment includes revenue contributions and expenditures
associated with business activity in the United States. The International
segment includes revenue contributions and expenditures linked to business
activity outside the United States, primarily from Australia, Canada, Europe,
and the Middle East. Refer to Note (12) of the notes to condensed consolidated
financial statements for further information regarding our reportable segments.


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The following table presents a summary of our operating segment information for
the second quarters of 2019 and 2018:
(In thousands)                               2019        % of Revenue       2018        % of Revenue   % Change

Domestic Segment
Revenues                                 $ 1,266,112         100%       $ 1,202,064         100%          5%

Costs of revenue                             243,926         19%            208,185         17%           17%
Operating expenses                           605,636         48%            551,468         46%           10%
Total costs and expenses                     849,562         67%            759,653         63%           12%

Domestic operating earnings                  416,550         33%            442,411         37%          (6)%

International Segment
Revenues                                     164,949         100%           165,663         100%          -%

Costs of revenue                              24,747         15%             30,598         18%          (19)%
Operating expenses                            73,258         44%             73,407         44%           -%
Total costs and expenses                      98,005         59%            104,005         63%          (6)%

International operating earnings              66,944         41%             61,658         37%           9%

Other, net                                  (352,377 )                     (295,782 )                     19%

Consolidated operating earnings          $   131,117$   208,287                      (37)%



Domestic Segment

• Revenues increased 5% to $1.27 billion in the second quarter of 2019, from

$1.20 billion in the same period of 2018. This increase was primarily

driven by a $42 million increase in professional services revenue due to

growth in implementation activity, and growth in licensed software revenue

of $20 million as a result of continued demand for our solutions. Refer to

       Note (2) of the notes to condensed consolidated financial statements for
       further information regarding revenues disaggregated by our business
       models.


• Costs of revenue as a percent of revenues were 19% in the second quarter

of 2019, compared to 17% in the same period of 2018. The higher costs of

       revenue as a percent of revenues was primarily driven by higher
       third-party costs associated with professional services revenue.


• Operating expenses as a percent of revenues were 48% in the second quarter

of 2019, compared to 46% in the same period of 2018. The higher operating

expenses as a percent of revenues was primarily driven by the $20 million

charge in connection with a client dispute discussed above.

International Segment

• Revenues remained relatively flat at $165 million in the second quarter of

       2019, and $166 million in the same period of 2018. Refer to Note (2) of
       the notes to condensed consolidated financial statements for further
       information regarding revenues disaggregated by our business models.


• Costs of revenue as a percent of revenues were 15% in the second quarter

       of 2019, compared to 18% in the same period of 2018. The lower costs of
       revenue as a percent of revenues was primarily driven by a lower mix of
       technology resale revenue, which carries a higher cost of revenue.


• Operating expenses remained flat at $73 million in the second quarter of

       both 2019 and 2018.



Other, net

Operating results not attributed to an operating segment include expenses such
as software development, general and administrative expenses, share-based
compensation expense, certain amortization and depreciation, organizational
restructuring and other expense. These expenses increased 19% to $352 million in
the second quarter of 2019, from $296

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million in the same period of 2018. The increase is primarily due to $55 million
of expenses incurred in the second quarter of 2019 in connection with our
operational improvement initiatives discussed above; inclusive of $41 million of
charges associated with the 2019 VSP, as further discussed in Note (1) of the
notes to condensed consolidated financial statements.

Six Months Ended June 29, 2019 Compared to Six Months Ended June 30, 2018 The following table presents a summary of our operating information for the first six months of 2019 and 2018:

                                                           % of                       % of
(In thousands)                               2019        Revenue        2018        Revenue     % Change

Revenues                                 $ 2,820,938        100 %   $ 2,660,588        100 %        6  %
Costs of revenue                             521,877         19 %       470,061         18 %       11  %

Margin                                     2,299,061         81 %     2,190,527         82 %        5  %

Operating expenses
Sales and client service                   1,319,082         47 %     1,225,053         46 %        8  %
Software development                         361,408         13 %       329,895         12 %       10  %
General and administrative                   245,984          9 %       187,758          7 %       31  %
Amortization of acquisition-related
intangibles                                   43,526          2 %        

44,319 2 % (2 )%


Total operating expenses                   1,970,000         70 %     1,787,025         67 %       10  %

Total costs and expenses                   2,491,877         88 %     2,257,086         85 %       10  %

Operating earnings                           329,061         12 %       403,502         15 %      (18 )%

Other income, net                             31,438                     11,461
Income taxes                                 (67,311 )                  (85,605 )

Net earnings                             $   293,188$   329,358                   (11 )%


Revenues
Revenues increased 6% to $2.82 billion in the first six months of 2019, as
compared to $2.66 billion in the same period of 2018. This increase was
primarily driven by an $87 million increase in professional services revenue due
to growth in implementation activity, and growth in managed services revenue of
$48 million as a result of continued demand for our hosting services. Refer to
Note (2) of the notes to condensed consolidated financial statements for further
information regarding revenues disaggregated by our business models.
Costs of Revenue
Costs of revenue as a percent of revenues were 19% in the first six months of
2019, compared to 18% in the same period of 2018. The higher costs of revenue as
a percent of revenues was primarily driven by higher third-party costs
associated with professional services revenue.

Operating Expenses
Total operating expenses increased 10% to $1.97 billion in the first six months
of 2019, as compared to $1.79 billion in the same period of 2018.

• Sales and client service expenses as a percent of revenues were 47% in the

first six months of 2019, compared to 46% in the same period of 2018.

These expenses increased 8% to $1.32 billion in the first six months of

2019, from $1.23 billion in the same period of 2018. The increase in sales

and client service expenses was primarily driven by a $48 million increase

in personnel expenses, inclusive of hiring of personnel to support growth

       in professional services revenue; a $14 million increase in bad debt
       expense related to client receivables; and a $20 million charge in
       connection with a client dispute recognized in the first six months of

2019. Refer to Note (11) of the notes to condensed consolidated financial

       statements for further information regarding such client dispute.



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• Software development expenses as a percent of revenues were 13% in the

first six months of 2019, compared to 12% in the same period of 2018.

Expenditures for software development include ongoing development and

enhancement of the Cerner Millennium® and HealtheIntent platforms, 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 six months of 2019 and 2018 is
       as follows:


                                                      Six Months Ended
(In thousands)                                       2019          2018

Software development costs                        $ 394,060$ 370,704
Capitalized software costs                         (143,774 )    (141,857 )

Capitalized costs related to share-based payments (1,128 ) (1,094 ) Amortization of capitalized software costs 112,250 102,142


Total software development expense                $ 361,408$ 329,895

• General and administrative expenses as a percent of revenues were 9% in

the first six months 2019, compared to 7% in the same period of 2018.

       These expenses increased 31% to $246 million in the first six months of
       2019, from $188 million in the same period of 2018. The increase in
       general and administrative expenses includes $57 million of expenses
       incurred in the first six months of 2019 in connection with our
       operational improvement initiatives discussed above; inclusive of $41

million of charges associated with the 2019 VSP, as further discussed in

Note (1) of the notes to condensed consolidated financial statements. We

       expect to incur additional expenses in connection with these efforts in
       future periods in 2019, which may be material.


• Amortization of acquisition-related intangibles as a percent of revenues

       was 2% in the first six months of both 2019 and 2018. These expenses
       remained flat at $44 million in the first six months of both 2019 and
       2018.



Non-Operating Items

• Other income, net was $31 million in the first six months of 2019,

compared to $11 million in the same period of 2018. The first six months

of 2019 includes a $16 million gain recognized on the disposition of one

of our equity investments.

• Our effective tax rate was 18.7% for the first six months of 2019,

compared to 20.6% in the same period of 2018. The decrease in the

effective tax rate in the first six months of 2019 is primarily due to

increased excess tax benefits recognized as a component of income tax

expense due to elevated stock option exercise activity. Refer to Note (8)

of the notes to condensed consolidated financial statements for further

       discussion regarding our effective tax rate.





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Operations by Segment


The following table presents a summary of our operating segment information for
the first six months of 2019 and 2018:
(In thousands)                               2019        % of Revenue       2018        % of Revenue   % Change

Domestic Segment
Revenues                                 $ 2,496,942         100%       $ 2,337,160         100%          7%

Costs of revenue                             472,485         19%            414,859         18%           14%
Operating expenses                         1,177,654         47%          1,071,339         46%           10%
Total costs and expenses                   1,650,139         66%          1,486,198         64%           11%

Domestic operating earnings                  846,803         34%            850,962         36%           -%

International Segment
Revenues                                     323,996         100%           323,428         100%          -%

Costs of revenue                              49,392         15%             55,202         17%          (11)%
Operating expenses                           141,427         44%            142,551         44%          (1)%
Total costs and expenses                     190,819         59%            197,753         61%          (4)%

International operating earnings             133,177         41%            125,675         39%           6%

Other, net                                  (650,919 )                     (573,135 )                     14%

Consolidated operating earnings          $   329,061$   403,502                      (18)%


Domestic Segment • Revenues increased 7% to $2.50 billion in the first six months of 2019,

from $2.34 billion in the same period of 2018. This increase was primarily

driven by a $100 million increase in professional services revenue due to

growth in implementation activity, and growth in managed services revenue

of $38 million as a result of continued demand for our hosting services.

Refer to Note (2) of the notes to condensed consolidated financial

statements for further information regarding revenues disaggregated by our

business models.

• Costs of revenue as a percent of revenues were 19% in the first six months

of 2019, compared to 18% in the same period of 2018. The higher costs of

       revenue as a percent of revenues was primarily driven by higher
       third-party costs associated with professional services revenue.


•      Operating expenses as a percent of revenues were 47% in the first six

months of 2019, compared to 46% in the same period of 2018. The higher

operating expenses as a percent of revenues was primarily driven by the

$20 million charge in connection with a client dispute discussed above.

International Segment • Revenues remained relatively flat at $324 million in the first six months

of 2019, and $323 million in the same period of 2018. Refer to Note (2) of

       the notes to condensed consolidated financial statements for further
       information regarding revenues disaggregated by our business models.

• Costs of revenue as a percent of revenues were 15% in the first six months

       of 2019, compared to 17% in the same period of 2018. The lower costs of
       revenue as a percent of revenues was primarily driven by a lower mix of
       technology resale revenue, which carries a higher cost of revenue.


•      Operating expenses as a percent of revenues were 44% in the first six
       months of both 2019 and 2018.



Other, net
These expenses increased 14% to $651 million in the first six months of 2019,
from $573 million in the same period of 2018. The increase is primarily due to
$57 million of expenses incurred in the first six months of 2019 in connection
with our operational improvement initiatives discussed above; inclusive of $41
million of charges associated with the 2019 VSP, as further discussed in Note
(1) of the notes to condensed consolidated financial statements.


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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, capital expenditures, and in recent years,
the amount we use for our share repurchase programs and dividends.
Our principal sources of liquidity are our cash, cash equivalents, which consist
of money market funds, commercial paper and time deposits with original
maturities of less than 90 days, short-term investments, and borrowings under
our Credit Agreement. At June 29, 2019, we had cash and cash equivalents of $703
million and short-term investments of $251 million, as compared to cash and cash
equivalents of $374 million and short-term investments of $401 million at
December 29, 2018.

We maintain a $700.0 million Credit Agreement, which expires in May 2024. The
Credit Agreement provides an unsecured revolving line of credit, along with a
letter of credit facility. We have the ability to increase the maximum capacity
to $1 billion at any time during the Credit Agreement's term, subject to lender
participation and the satisfaction of specified conditions. As of June 29, 2019,
we had outstanding revolving credit loans and letters of credit of $600 million
and $30 million, respectively; which reduced our available borrowing capacity to
$70 million. Refer to Note (5) of the notes to condensed consolidated financial
statements for additional information regarding our Credit Agreement.

We believe that our present cash position, together with cash generated from
operations, short-term investments and, if necessary, remaining availability
under our Credit Agreement and other sources of debt financing, will be
sufficient to meet anticipated cash requirements for the next 12 months.
The following table summarizes our cash flows in the first six months of 2019
and 2018:

© Edgar Online, source Glimpses

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