The following Management Discussion and Analysis ("MD&A") is intended to help the reader understand the results of operations and financial condition ofCerner 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, and the information in Part II, "Item 1A. Risk Factors" below. All references to periods in this MD&A represent the respective three months ended on such dates, unless otherwise noted. Refer to Note (1) of the Notes for information regarding our fiscal period ends. Management Overview Our revenues are primarily derived by selling, implementing, operating 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. We may also supplement organic growth with acquisitions or strategic investments and partnerships.
Cerner 's long history of growth has created an important strategic footprint in health care, withCerner holding more than 25 percent market share in theU.S. acute care EHR market and a leading market share in several non-U.S. regions. Foundational to our growth going forward is delivering value to this core client base, including executing effectively on our largeU.S. federal contracts and cross-selling key solutions and services in areas such as revenue cycle. We are also investing in platform modernization, with a focus on delivering a software as a service platform that we expect to lower total cost of ownership, improve clinician experience and patient outcomes, and enable clients to accelerate adoption of new functionality and better leverage third-party innovations. We also expect to continue driving growth by leveraging our HealtheIntent® platform, which is the foundation for established and new offerings for both provider and non-provider markets. The EHR-agnostic HealtheIntent platform enablesCerner to become a strategic partner with health care stakeholders and help them improve performance under value-based contracting. The platform, along with our CareAware® platform, also supports offerings in areas such as long-term care, home care and hospice, rehabilitation, behavioral health, community care, care team communications, health systems operations, consumer and employer, and data-as-a-service. Beyond our strategy for driving revenue growth, we are also focused on earnings growth. After several years of margin compression related to slowing revenue growth, increased mix of low-margin services, and lower software demand due to the end of direct government incentives for EHR adoptions,Cerner implemented a new operating structure and introduced other initiatives focused on cost optimization and process improvement in 2019. To assist in these efforts, we engaged an outside consulting firm to conduct a review of our operations and cost structure. We made good progress in 2019 and expect this progress to be reflected in improved profitability in 2020 and beyond. We are focused on ongoing identification of opportunities to operate more efficiently and on achieving the efficiencies without impacting the quality of our solutions and services and commitments to our clients. We are also focused on delivering strong levels of cash flow which we expect to accomplish by continuing to grow earnings and prudently managing capital expenditures. We expect to use future cash flow and debt, as appropriate, to meet our capital allocation objectives, which include investing in our business, potential acquisitions or other strategic investments to drive profitable growth, and returning capital to shareholders through share repurchases and dividends. 18 -------------------------------------------------------------------------------- Table of Contents Results Overview Bookings, which reflects the value of executed contracts for software, hardware, professional services and managed services, was$1.09 billion in the first quarter of 2020, which is a decrease of 12% compared to$1.24 billion in the first quarter of 2019, with the decrease primarily reflecting lower than usual contracts being signed in the last two weeks of the quarter as clients focused on the Coronavirus disease pandemic ("COVID-19") and a more selective approach to low-margin, long-term contracts that typically represent large bookings values. Revenues for the first quarter of 2020 increased 2% to$1.41 billion , compared to$1.39 billion in the first quarter of 2019. The increase in revenue reflects ongoing demand from new and existing clients forCerner 's solutions and services driven by their needs to keep up with regulatory requirements, adapt to changing reimbursement models, and deliver safer and more efficient care. Net earnings for the first quarter of 2020 decreased 11% to$147 million , compared to$166 million in the first quarter of 2019. Diluted earnings per share decreased 8% to$0.47 , compared to$0.51 in the first quarter of 2019. 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$1.37 billion in the first quarter of 2020, compared to$1.36 billion in the first quarter of 2019. Days sales outstanding was 74 days for the 2020 first quarter, compared to 72 days for the 2019 fourth quarter and 76 days for the 2019 first quarter. Operating cash flows for the first quarter of 2020 were$284 million , compared to$317 million in the first quarter of 2019.
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. We continue to be focused on reducing operating expenses and generating other efficiencies that are expected to provide longer-term operating margin expansion. We are also considering exiting certain low-margin businesses and being more selective as we consider new business opportunities. To assist in these efforts, we engaged an outside consulting firm to conduct a review of our operations and cost structure. We continue to be focused on ongoing identification of opportunities to operate more efficiently and on achieving 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. Expenses recognized in the first quarter of 2020 primarily related to professional services fees and employee separation costs, which are included in operating expenses 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.
COVID-19
Our business and results of operations for the first quarter of 2020 were impacted by the ongoing COVID-19 pandemic. It has caused us to modify certain of our business practices, including encouraging most of our employees to work remotely; restricting employee travel; developing social distancing plans for our associates; and cancelling or postponing in person participation in certain meetings, events and conferences. It is not possible to quantify the full financial impact that the COVID-19 pandemic has had on our results of operations, cash flows, or financial condition, due to the uncertainty surrounding the pandemic, the difficulty inherent in identifying and measuring the various impacts that have or may stem from such an event and the fact that there are no comparable recent events that provide guidance as to how to predict the effect the COVID-19 pandemic may have on our business. However, we believe COVID-19 has impacted, and will continue in the near-term to impact, our business results, primarily, but not limited to, in the following areas: •Bookings - A decline in new business bookings as certain client purchasing decisions and projects are delayed to focus on treating patients, procuring necessary medical supplies, and managing their own organizations through this crisis. This decline in bookings flows through to reduced backlog and lower subsequent revenues. •Associate productivity - A decline in associate productivity, primarily for our services personnel, as a large amount of work is typically done at client sites, which is being impacted by travel restrictions and our clients' focus on the 19 -------------------------------------------------------------------------------- Table of Contents pandemic. Our clients' focus on the pandemic has also led to pauses on existing projects and postponed start dates for others, which translates into lower professional services revenues and a lower operating margin percentage. We are mitigating this by doing more work remotely than we have in the past, but we cannot fully offset the negative impact. •Travel - Associate travel restrictions reduce client-related travel, which reduces reimbursed travel revenues and lowers our costs of revenue as a percent of revenues. Such restrictions also reduce non-reimbursable travel, which lowers operating expenses. •Cash collections - A delay in client cash collections due to COVID-19's impact on national reimbursement processes, and client focus on managing their own organizations' liquidity during this time. This translates to lower cash flows from operating activities. Lower cash flows from operating activities may impact how we execute under our capital allocation strategy. We believe the impact of COVID-19 on our results of operations for the first quarter of 2020 was limited, with the largest impact in the area of reduced bookings and lower technology resale revenue, due to themid-March 2020 timing of when we implemented changes to our business practices in response to COVID-19 and the nature of the industry in which we operate. We expect a greater financial impact in the rest of 2020, particularly in the second quarter, as such practices will have been in place for a greater period of time. However, the impact will be difficult to quantify as there are many factors outside of our control, so any forward looking statements that we make regarding our projections of future financial performance, new solution, services and offering development, and capital allocation plans; cost optimization and operational improvement initiatives; and the expected benefits of our acquisitions, divestitures or other collaborations will all be subject to increased risks, as discussed further below and in Part II, Item 1A of this Quarterly Report on Form 10-Q. Additionally, we may make further modifications to our operations or business plans that have a negative financial impact as required by government authorities, our clients or as we determine are in the best interests of our associates, clients and business partners. While we expect COVID-19 to have an impact on our results of operations, cash flows, and financial position in the near-term, we believe the nature of our solutions and services offerings will continue to be in demand, regardless of this pandemic. However, the COVID-19 pandemic and related restrictive measures have created significant economic uncertainty and the duration and magnitude of the impact of the pandemic is unknown at this time; therefore, there can be no assurance that the ultimate impact of the pandemic will not adversely affect our future operational and financial performance. 20 -------------------------------------------------------------------------------- Table of Contents Results of Operations
Three Months Ended
The following table presents a summary of the operating information for the first quarters of 2020 and 2019:
% of % of (In thousands) 2020 Revenue 2019 Revenue % Change Revenues$ 1,411,741 100 %$ 1,389,877 100 % 2 % Costs of revenue 254,416 18 % 253,204 18 % - % Margin 1,157,325 82 % 1,136,673 82 % 2 % Operating expenses Sales and client service 636,649 45 % 640,187 46 % (1) % Software development 185,320 13 % 180,361 13 % 3 % General and administrative 139,852 10 % 96,196 7 % 45 % Amortization of acquisition-related intangibles 17,128 1 % 21,985 2 % (22) % Total operating expenses 978,949 69 % 938,729 68 % 4 % Total costs and expenses 1,233,365 87 % 1,191,933 86 % 3 %
Operating earnings 178,376 13 % 197,944 14 % (10) % Other income, net 5,595 8,432 Income taxes (36,812) (40,157) Net earnings$ 147,159 $ 166,219 (11) % Revenues & Backlog Revenues increased 2% to$1.41 billion in the first quarter of 2020, as compared to$1.39 billion in the same period of 2019. The growth in revenues was primarily driven by increased implementation activity within our federal business; inclusive of ongoing projects with theU.S. Department of Defense and theU.S. Department of Veterans Affairs . In the first quarter of 2020, 17% of our total revenues were attributable to our relationships (as the prime contractor or a subcontractor) withU.S. government agencies, compared to 10% in the same period of 2019. The growth was partially offset by a$42 million reduction in revenues in the first quarter of 2020 due to the termination of certain revenue cycle outsourcing contracts effective in the fourth quarter of 2019. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models. Backlog, which reflects contracted revenue that has not yet been recognized as revenue, was$13.47 billion atMarch 31, 2020 , compared to$14.87 billion atMarch 30, 2019 . This decrease was primarily driven by the termination of certain revenue cycle outsourcing contracts discussed above. We expect to recognize 30% 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$772 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 18% in the first quarter of both 2020 and 2019.
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
21 -------------------------------------------------------------------------------- Table of Contents 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 4% to
•Sales and client service expenses as a percent of revenues were 45% in the first quarter of 2020, compared to 46% in the same period of 2019. These expenses decreased 1% to$637 million in the first quarter of 2020, from$640 million in the same period of 2019. Sales and client service expenses include salaries and benefits of sales, marketing, support, and services personnel, depreciation and other expenses associated with our managed services business, communications expenses, unreimbursed travel expenses, expense for share-based payments, and trade show and advertising costs. The decrease in sales and client service expenses was primarily driven by a decrease in associate headcount in connection with our operational improvement initiatives discussed above; inclusive of associate headcount reductions in connection with the termination of certain revenue cycle outsourcing contracts, also discussed above. •Software development expenses as a percent of revenues were 13% in the first quarter of both 2020 and 2019. Expenditures for software development include ongoing development and enhancement of theCerner Millennium® and HealtheIntent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle, population health management, and health network solutions. In addition, the first quarter of 2020 includes costs incurred in connection with our efforts to modernize our platforms, with a focus on development of a software as a service platform. A summary of our total software development expense in the first quarters of 2020 and 2019 is as follows: Three Months Ended (In thousands) 2020 2019 Software development costs$ 198,164 $ 198,667 Capitalized software costs (72,504) (74,099)
Capitalized costs related to share-based payments (1,351) (452) Amortization of capitalized software costs
61,011
56,245
Total software development expense$ 185,320 $
180,361
•General and administrative expenses as a percent of revenues were 10% in the first quarter of 2020, compared to 7% in the same period of 2019. These expenses increased 45% to$140 million in the first quarter of 2020, from$96 million in the same period of 2019. 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, certain organizational restructuring and other expense. In the first quarter of 2020, general and administrative expenses include$40 million of expenses incurred in connection with our operational improvement initiatives, discussed above, compared to$2 million in the same period of 2019. We expect to incur additional expenses in connection with these efforts in future periods, which may be material. •Amortization of acquisition-related intangibles as a percent of revenues was 1% in the first quarter of 2020, compared to 2% in the same period of 2019. These expenses decreased 22% to$17 million in the first quarter of 2020, from$22 million in the same period in 2019. 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. The decrease in amortization of acquisition-related intangibles includes the impact of certain intangible assets from the Health Services acquisition inFebruary 2015 becoming fully amortized in the first quarter of 2020. 22 -------------------------------------------------------------------------------- Table of Contents Non-Operating Items •Other income, net was$6 million in the first quarter of 2020, compared to$8 million in the same period of 2019. The decrease is primarily attributable to increased interest expense from the$600 million of revolving credit loans we borrowed under our Credit Agreement inMay 2019 . •Our effective tax rate remained relatively flat at 20.0% for the first quarter of 2020, and 19.5% for the same period of 2019. Refer to Note (7) of the Notes for further discussion regarding our effective tax rate.
Operations by Segment
We have two operating segments: Domestic and International. The Domestic segment includes revenue contributions and expenditures associated with business activity inthe United States . The International segment includes revenue contributions and expenditures linked to business activity outsidethe United States , primarily fromAustralia ,Canada ,Europe , and theMiddle East . Refer to Note (11) of the Notes for further information regarding our reportable segments.
The following table presents a summary of our operating segment information for the first quarters of 2020 and 2019:
(In thousands) 2020 % of Revenue 2019 % of Revenue % Change Domestic Segment Revenues$ 1,246,415 100%$ 1,230,830 100% 1% Costs of revenue 228,567 18% 228,559 19% -% Operating expenses 570,094 46% 572,018 46% -% Total costs and expenses 798,661 64% 800,577 65% -% Domestic operating earnings 447,754 36% 430,253 35% 4% International Segment Revenues 165,326 100% 159,047 100% 4% Costs of revenue 25,849 16% 24,645 15% 5% Operating expenses 66,555 40% 68,169 43% (2)% Total costs and expenses 92,404 56% 92,814 58% -% International operating earnings 72,922 44% 66,233 42% 10% Other, net (342,300) (298,542) 15% Consolidated operating earnings$ 178,376 $ 197,944 (10)% Domestic Segment •Revenues increased 1% to$1.25 billion in the first quarter of 2020, from$1.23 billion in the same period of 2019. The growth in revenues was primarily driven by increased implementation activity within our federal business; inclusive of ongoing projects with theU.S. Department of Defense and theU.S. Department of Veterans Affairs . This growth was partially offset by a$42 million reduction in revenues in the first quarter of 2020 due to the termination of certain revenue cycle outsourcing contracts effective in the fourth quarter of 2019. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models. •Costs of revenue as a percent of revenues were 18% in the first quarter of 2020, compared to 19% in the same period of 2019. The marginally lower costs of revenue as a percent of revenues was primarily driven by a lower mix of reimbursed travel revenue, which carries a 100% cost of revenue.
•Operating expenses as a percent of revenues were 46% in the first quarter of both 2020 and 2019.
23 -------------------------------------------------------------------------------- Table of Contents International Segment •Revenues increased 4% to$165 million in the first quarter of 2020, from$159 million in the same period of 2019. The growth in revenues includes a$5 million increase in professional services revenue, driven by increased implementation activity. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models.
•Costs of revenue remained relatively flat at
•Operating expenses remained relatively flat at
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, certain organizational restructuring and other expense. These expenses increased 15% to$342 million in the first quarter of 2020, from$299 million in the same period of 2019. The increase is primarily due to increased expenses incurred in 2020 in connection with our operational improvement initiatives discussed above. 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 our share repurchase and dividend programs. Our principal sources of liquidity are our cash, cash equivalents, which consist of money market funds and time deposits with original maturities of less than 90 days, short-term investments, and borrowings under our Credit Agreement and other sources of debt financing. AtMarch 31, 2020 , we had cash and cash equivalents of$285 million and short-term investments of$113 million , as compared to cash and cash equivalents of$442 million and short-term investments of$100 million atDecember 28, 2019 . We have entered into a Credit Agreement with a syndicate of lenders that provides for an unsecured$1.00 billion revolving credit loan facility, along with a letter of credit facility up to$100 million (which is a sub-facility of the$1.00 billion revolving credit loan facility). We have the ability to increase the maximum capacity to$1.20 billion at any time during the Credit Agreement's term, subject to lender participation and the satisfaction of specified conditions. The Credit Agreement expires inMay 2024 . As ofMarch 31, 2020 , we had outstanding revolving credit loans and letters of credit of$600 million and$30 million , respectively; which reduced our available borrowing capacity to$370 million under the Credit Agreement. We believe that our present cash position, together with cash generated from operations, short-term investments and, as appropriate, 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 three months of 2020 and 2019:
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