CERNER CORPORATION
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.
All references to years in this MD&A represent fiscal years unless otherwise
noted. Refer to Note (1) of the Notes for information regarding our fiscal year
end.
Information regarding our 2018 results of operations, including a year-to-year
comparison against 2019, may be found in Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations in our annual report
on Form 10-K for the period ended December 28, 2019 , which was filed with the
Securities and Exchange Commission on February 10, 2020 .
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 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 collaborations.
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 adoption,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 have made good progress since we kicked off our transformation in 2019 and expect this progress to be reflected in improved profitability going forward. 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.
COVID-19
Our business and results of operations in 2020 were impacted by the ongoing COVID-19 pandemic. It has caused us to modify certain of our business practices, including requiring most of our associates to work remotely; restricting associate
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travel; developing social distancing plans for our associates; and canceling 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 measure or predict the effect the COVID-19
pandemic may have on our business. However, we believe COVID-19 has impacted,
and could continue in the near-term to impact, our business results, primarily,
but not limited to, in the following areas:
•Bookings, backlog and revenues - 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
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, and a higher days sales outstanding metric. Lower
cash flows from operating activities may impact how we execute under our capital
allocation strategy.
•Capital expenditures - A decline in capital spending as certain capital projects are delayed.
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 areas 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 believe the impact of COVID-19 on our results of operations for the second through fourth quarters of 2020 was much greater than in the first quarter of 2020 as the pandemic and practices we implemented inmid-March 2020 were ongoing for the full period, with the largest impact in the areas of reduced bookings and lower licensed software, technology resale, professional services, and reimbursed travel revenues. We expect a negative financial impact to continue into 2021. 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 solutions and services; 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 I, Item 1A of this annual report on Form 10-K. 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 products 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.
Operational Improvement Initiatives
Throughout 2020, the Company has continued to focus on leveraging the impact of
our new operating structure, which was rolled out in the first quarter of 2019,
and identifying additional efficiencies in our business. 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
continuing our portfolio management, which includes ongoing evaluation of our
offerings,
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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. As
part of our portfolio management, we closed on the sale of certain of our
business operations, primarily conducted in Germany and Spain , in July 2020 , and
the sale of certain of our revenue cycle outsourcing business operations in
August 2020 . We expect to continue to evaluate and complete divestiture
transactions that are strategic to our operational improvement initiatives. 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. We recognized $168 million and $221
million of expenses related to these efforts in 2020 and 2019, respectively,
which are included in operating expenses in our consolidated statements of
operations. We expect to incur additional expenses in connection with these
initiatives in 2021, which may be material.
Results Overview
Bookings, which reflect the value of executed contracts for software, hardware, professional services and managed services, was$5.58 billion in 2020, which is a decrease of 7% compared to$5.99 billion in 2019.
Revenues for 2020 decreased 3% to
Net earnings for 2020 increased 47% to$780 million , compared to$529 million in 2019. Diluted earnings per share increased 53% to$2.52 in 2020, compared to$1.65 in 2019. We had cash collections of receivables of$5.70 billion in 2020, compared to$5.79 billion in 2019. Days sales outstanding was 76 days for the 2020 fourth quarter, compared to 81 days for the 2020 third quarter and 72 days for the 2019 fourth quarter. Operating cash flows for 2020 were$1.44 billion , compared to$1.31 billion in 2019.
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,"
which is incorporated herein by reference.
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Results of Operations
Fiscal Year 2020 Compared to Fiscal Year 2019
% of % of
(In thousands) 2020 Revenue 2019 Revenue % Change
Revenues $ 5,505,788 100 % $ 5,692,598 100 % (3) %
Costs of revenue 932,941 17 % 1,071,041 19 % (13) %
Margin 4,572,847 83 % 4,621,557 81 % (1) %
Operating expenses
Sales and client service 2,582,615 47 % 2,675,337 47 % (3) %
Software development 749,007 14 % 737,136 13 % 2 %
General and administrative 491,586 9 % 520,598 9 % (6) %
Amortization of acquisition-related intangibles 55,595 1 % 87,817 2 % (37) %
Total operating expenses 3,878,803 70 % 4,020,888 71 % (4) %
Total costs and expenses 4,811,744 87 % 5,091,929 89 % (6) %
Gain on sale of businesses 220,523 4 % - - %
Operating earnings 914,567 17 % 600,669 11 % 52 %
Other income, net 76,906 53,843
Income taxes (211,385) (125,058)
Net earnings $ 780,088 $ 529,454 47 %
Revenues & Backlog
Revenues decreased 3% to
•The impact of the ongoing COVID-19 pandemic on our 2020 operations, with the largest impact in the areas of licensed software, technology resale, professional services, and reimbursed travel revenues, as further discussed above.
•The 2020 period includes a
•The 2020 period includes a$43 million reduction in revenues due to the sale of certain of our business operations primarily conducted inGermany andSpain , as further discussed in Note (9) of the Notes. We expect the disposition of such operations to reduce future International Segment revenues by approximately$83 million on an annualized basis. •The 2020 period includes a$39 million reduction in revenues due to the sale of certain of our revenue cycle outsourcing business operations, as further discussed in Note (9) of the Notes. We expect the disposition of such operations to reduce future Domestic Segment revenues by approximately$77 million on an annualized basis. These declines are partially offset 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 2020, 18% of our total revenues were attributable to our relationships (as the prime contractor or a subcontractor) withU.S. government agencies, compared to 13% in 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$13.04 billion at the end of 2020, compared to$13.71 billion at the end of 2019. This decline in backlog is primarily attributable to the divestiture 29 -------------------------------------------------------------------------------- Table of Contents transactions discussed above, along with the impact of the ongoing COVID-19 pandemic on our bookings during 2020, as further 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$1.08 billion 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 17% in 2020, compared to 19% in 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel revenue, which carries a 100% cost of revenue; a lower mix of technology resale revenue, which carries a high cost of revenue; and reduced utilization of third-party resources associated with professional services and support and maintenance 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 decreased 4% to
•Sales and client service expenses as a percent of revenues were 47% in both 2020 and 2019. These expenses decreased 3% to$2.58 billion in 2020, from$2.68 billion in 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$41 million reduction in associate travel costs; a$30 million reduction in charges incurred in connection with the termination of certain revenue cycle outsourcing contracts, discussed above; and the impact of 2019 including a$30 million charge in connection with a client dispute. The divestiture transactions, as further discussed in Note (9) of the Notes, also contributed to the reduction in expenses. These reductions were partially offset by a$21 million pre-tax charge recorded in 2020 to provide an allowance against certain non-current receivables from a former client. 30 -------------------------------------------------------------------------------- Table of Contents •Software development expenses as a percent of revenues were 14% in 2020, compared to 13% in 2019. Expenditures for software development include ongoing development and enhancement of theCerner Millennium and HealtheIntent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle, population health management, and health network solutions. In addition, 2020 includes an increase in costs incurred in connection with our efforts to modernize our platforms, with a focus on development of a software as a service platform. A summary of our total software development expense in 2020 and 2019 is as follows: For the Years Ended (In thousands) 2020 2019 Software development costs$ 796,971 $ 783,593 Capitalized software costs (287,869) (270,948)
Capitalized costs related to share-based payments (7,408) (2,923) Amortization of capitalized software costs
247,313 227,414
Total software development expense$ 749,007 $
737,136
•General and administrative expenses as a percent of revenues were 9% in both 2020 and 2019. These expenses decreased 6% to$492 million in 2020, from$521 million in 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. The decrease in general and administrative expenses includes the impact of 2019 including a$7 million charge to settle disputes with a former vendor. The divestiture transactions, as further discussed in Note (9) of the Notes, also contributed to the reduction in expenses. In 2020, general and administrative expenses include$137 million of expenses incurred in connection with our operational improvement initiatives, discussed above, compared to$149 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 2020, compared to 2% in 2019. These expenses decreased 37% to$56 million in 2020, from$88 million 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 is primarily due to the impact of certain intangible assets from the Health Services acquisition inFebruary 2015 becoming fully amortized in the first quarter of 2020. The divestiture transactions, as further discussed in Note (9) of the Notes, also contributed to the reduction in expenses.
Gain on Sale of Businesses
In 2020, we recognized a$221 million gain on sale of businesses. Refer to Note (9) of the Notes for further information regarding divestiture transactions that closed during the third quarter of 2020. We expect to continue to evaluate and complete divestiture transactions that are strategic to our operational improvement initiatives discussed above.
Non-Operating Items
•Other income, net was$77 million in 2020, compared to$54 million in 2019. The 2020 period includes a$76 million gain recognized on the disposition of one of our equity investments. The 2019 period includes a$14 million unrealized gain recognized on that same equity investment; and a$16 million gain recognized on the disposition of another one of our equity investments. The remaining difference is primarily attributable to increased interest expense in 2020, from the$600 million of revolving credit loans we borrowed under our Credit Agreement inMay 2019 , and the$300 million of Series 2020-A Notes we issued inMarch 2020 . Refer to Note (13) of the Notes for further information regarding the components of other income, net. •Our effective tax rate was 21% in 2020, compared to 19% in 2019. The increase in the effective tax rate in 2020 is primarily due to a decrease in net excess tax benefits recognized as a component of income tax expense in connection with the exercise of stock options and the vesting of restricted share and share unit awards. Also contributing to the increase, are taxes associated with the divestiture transactions that closed in the third quarter 31 -------------------------------------------------------------------------------- Table of Contents of 2020, as further discussed in Note (9) of the Notes. Refer to Note (14) of the Notes for further discussion regarding our effective tax rate. We do not expect significant changes to our overall effective tax rate in 2021, from what is reported for 2020. Operations by Segment We have two operating segments: Domestic and International. The Domestic segment includes revenue contributions and expenditures associated with business activity inthe United States . The International segment includes revenue contributions and expenditures linked to business activity outsidethe United States , primarily fromAustralia ,Canada ,Europe , and theMiddle East . Refer to Note (20) of the Notes for further information regarding our reportable segments.
The following table presents a summary of our operating segment information for 2020 and 2019:
(In thousands) 2020 % of Segment Revenue 2019 % of Segment Revenue % Change Domestic Segment Revenues$ 4,879,769 100%$ 5,038,127 100% (3)% Costs of revenue 854,574 18% 967,035 19% (12)% Operating expenses 2,339,624 48% 2,398,422 48% (2)% Total costs and expenses 3,194,198 65% 3,365,457 67% (5)% Domestic operating earnings 1,685,571 35% 1,672,670 33% 1% International Segment Revenues 626,019 100% 654,471 100% (4)% Costs of revenue 78,367 13% 104,006 16% (25)% Operating expenses 242,991 39% 276,914 42% (12)% Total costs and expenses 321,358 51% 380,920 58% (16)% International operating earnings 304,661 49% 273,551 42% 11% Other costs and expenses, net (1,296,188) (1,345,552) (4)% Gain on sale of businesses 220,523 - Consolidated operating earnings$ 914,567 $ 600,669 52% Domestic Segment
•Revenues decreased 3% to
•The impact of the ongoing COVID-19 pandemic on our 2020 operations, with the largest impact in the areas of licensed software, technology resale, professional services, and reimbursed travel revenues, as further discussed above.
•The 2020 period includes a
•The 2020 period includes a
These declines are partially offset 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 . Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models. 32 -------------------------------------------------------------------------------- Table of Contents •Costs of revenue as a percent of revenues were 18% in 2020, compared to 19% in 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel revenue, which carries a 100% cost of revenue; a lower mix of technology resale revenue, which carries a high cost of revenue; and reduced utilization of third-party resources associated with professional services and support and maintenance revenue. •Operating expenses as a percent of revenues were 48% in both 2020 and 2019. These expenses decreased 2% to$2.34 billion in 2020, from$2.40 billion in 2019. The decrease in operating expenses was primarily driven by a$32 million reduction in associate travel costs; a$30 million reduction in charges incurred in connection with the termination of certain revenue cycle outsourcing contracts, discussed above; and the impact of 2019 including a$30 million charge in connection with a client dispute. These reductions were partially offset by a$21 million pre-tax charge recorded in 2020 to provide an allowance against certain non-current receivables from a former client.
International Segment
•Revenues decreased 4% to$626 million in 2020, from$654 million in 2019. The decline in revenues is primarily due to a$43 million reduction from the sale of certain of our business operations primarily conducted inGermany andSpain , as further discussed in Note (9) of the Notes. Additionally, we believe the ongoing COVID-19 pandemic has negatively impacted our operations for 2020, as further discussed above. These declines are partially offset by 2020 revenue growth from increased implementation activity inSweden and theUnited Kingdom . 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 13% in 2020, compared to 16% in 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel revenue, which carries a 100% cost of revenue; and reduced utilization of third-party resources associated with professional services and support and maintenance revenue. •Operating expenses as a percent of revenues were 39% in 2020, compared to 42% in 2019. These expenses decreased 12% to$243 million in 2020, from$277 million in 2019. The decrease in operating expenses is primarily due to the sale of certain of our business operations inGermany andSpain , as further discussed in Note (9) of the Notes. Other, net Operating costs and expenses 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 decreased 4% to$1.30 billion in 2020, from$1.35 billion in 2019. The decrease is primarily due to lower personnel expenses in 2020 as a result of our operational improvement initiatives, as discussed above.
The effects of inflation on our business during 2020 and 2019 were not significant.
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 primarily consist of money market funds, time deposits and commercial paper with original maturities of less than 90 days, short-term investments, borrowings under our Credit Agreement and other sources of debt financing. At the end of 2020, we had cash and cash equivalents of$616 million and short-term investments of$442 million , as compared to cash and cash equivalents of$442 million and short-term investments of$100 million at the end of 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 33 -------------------------------------------------------------------------------- Table of Contents expires inMay 2024 . At the end of 2020, we had outstanding revolving credit loans and letters of credit of$600 million and$34 million , respectively; which reduced our available borrowing capacity to$366 million under the Credit Agreement. We have also entered into note purchase agreements pursuant to which we may issue and sell unsecured senior promissory notes to those purchasers electing to purchase. Refer to Notes (1) and (11) of the Notes for additional information regarding our sources of debt financing. We believe that our present cash position, together with cash generated from operations, short-term investments and, as appropriate, remaining availability under our Credit Agreement and other sources of debt financing, will be sufficient to meet anticipated cash requirements for the next 12 months.
The following table summarizes our cash flows in 2020 and 2019:
For the Years Ended
(In thousands) 2020 2019
Cash flows from operating activities$ 1,436,705 $
1,313,099
Cash flows from investing activities (801,237)
(640,408)
Cash flows from financing activities (461,497)
(601,380)
Effect of exchange rate changes on cash (199)
(3,594)
Total change in cash and cash equivalents 173,772
67,717
Cash and cash equivalents at beginning of period 441,843 374,126
Cash and cash equivalents at end of period$ 615,615 $ 441,843 Free cash flow (non-GAAP)$ 857,447 $ 567,710
Cash from Operating Activities
For the Years Ended
(In thousands) 2020 2019
Cash collections from clients $ 5,704,730 $ 5,787,180
Cash paid to employees and suppliers and other (4,082,664) (4,348,438) Cash paid for interest
(36,302) (25,639)
Cash paid for taxes, net of refunds (149,059) (100,004) Total cash from operations$ 1,436,705 $ 1,313,099 Cash flows from operations increased$124 million in 2020 compared to 2019, due primarily to a reduction in cash used to fund working capital requirements. This includes the impact of$76 million of certain federal payroll taxes related to pay cycles in the second through fourth quarters of 2020, for which we have deferred remittance to the taxing authority as permitted under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). Such remittances are expected to be paid to the taxing authority in equal amounts at the end of 2021 and 2022, respectively, as permitted by the CARES Act. Days sales outstanding was 76 days in the fourth quarter of 2020, compared to 81 days for the third quarter of 2020 and 72 days for the fourth quarter of 2019. 34 -------------------------------------------------------------------------------- Table of Contents Cash from Investing Activities For the Years Ended (In thousands) 2020 2019 Capital purchases$ (283,981) $ (471,518) Capitalized software development costs (295,277)
(273,871)
Purchases of investments, net of sales and maturities (363,387) 215,107 Purchases of other intangibles
(38,243) (35,587)
Sale of businesses 229,471
-
Acquisition of businesses, net of cash acquired (49,820)
(74,539)
Total cash flows from investing activities$ (801,237) $
(640,408)
Cash flows from investing activities consist primarily of capital spending, investment, acquisition, and divestiture activities.
Our capital spending in 2020 was driven by capitalized equipment purchases primarily to support growth in our managed services business, investments in a cloud infrastructure to support cloud-based solutions, building and improvement purchases to support our facilities requirements and capitalized spending to support our ongoing software development initiatives. Capital purchases in 2020 were below 2019 levels, primarily driven by reduced purchases to support our facilities requirements, reflective of the completion of construction on the current phases of our Innovations Campus in the third quarter of 2020. Capital purchases are expected to further decrease in 2021, with these construction phases now complete. Short-term investment activity historically consists of the investment of cash generated by our business in excess of what is necessary to fund operations. The 2020 activity includes the investment of proceeds from the sale of certain business operations in the third quarter of 2020, as discussed below. The 2019 activity was impacted by changes made to our investment mix, such that our excess funds were more heavily held in cash and cash equivalents versus short-term and long-term investments. Investment activity also includes the sale of one of our equity investments inAugust 2020 for cash proceeds of$90 million . Refer to Note (4) of the Notes for further information regarding this investment. OnJuly 1, 2020 , we sold certain of our business operations, primarily conducted inGermany andSpain , for cash proceeds of$224 million . We also sold certain of our revenue cycle outsourcing business operations onAugust 3, 2020 . Refer to Note (9) of the Notes for further information regarding these sales. We expect to continue to evaluate and complete divestiture transactions that are strategic to our operational improvement initiatives discussed above. In 2020 and 2019, we completed certain business acquisitions of entities providing solutions to clients in the health care industry. Refer to Note (8) of the Notes for further information regarding our business acquisitions. InDecember 2020 , we entered into an agreement to acquireKantar Health , a division ofKantar Group , for$375 million in cash, subject to adjustment.Kantar Health provides data, analytics, commercial research, and consulting services to the life sciences industry. The acquisition is anticipated to close in the second quarter of 2021, subject to certain conditions. We expect to continue seeking and completing strategic business acquisitions, investments, and relationships that are complementary to our business. 35 -------------------------------------------------------------------------------- Table of Contents Cash from Financing Activities For the Years Ended (In thousands) 2020 2019 Long-term debt issuance$ 300,000 $ 600,000 Repayment of long-term debt (2,500) -
Cash from option exercises (net of taxes paid in connection with shares surrendered by associates)
229,933 241,435
Treasury stock purchases (756,950) (1,320,542)
Dividends paid (221,461) (113,823)
Other (10,519) (8,450)
Total cash flows from financing activities InMarch 2020 , we issued$300 million aggregate principal amount of 2.50% senior unsecured Series 2020-A notes. InMay 2019 , we borrowed$600 million of revolving credit loans under our Credit Agreement. Refer to Note (11) of the Notes for further information regarding these obligations. We may incur additional indebtedness in the next 12 months, which will primarily be dependent on cash flows from operations as well as the timing of business acquisition and capital allocation activity. The proceeds from such indebtedness would be deployed in accordance with our capital allocation strategy, which may include share repurchases and dividend payments (as discussed further below), as well as for general corporate purposes, including acquisitions and investments. The terms and availability of any such debt financing may be impacted by economic and financial market conditions, as well as our financial condition and results of operations at the time we seek such financing, and there can be no assurances that we would be able to obtain such financing on terms that will be acceptable or advantageous to us. Cash inflows from stock option exercises are dependent on a number of factors, including the price of our common stock, grant activity under our stock option and equity plans, and overall market volatility. We expect net cash inflows from stock option exercises to continue in 2021 based on the number of exercisable options at the end of 2020 and our current stock price. Refer to Note (16) of the Notes for additional information regarding our stock option and equity plans. During 2020 and 2019, we repurchased 10.6 million and 18.8 million shares of our common stock for total consideration of$757 million and$1.30 billion , respectively. As ofDecember 31, 2020 ,$927 million remains available for repurchase under our share repurchase program. We may continue to repurchase shares under this program, but such repurchases will be dependent on a number of factors, including the price of our common stock and other cash flow needs. There is no assurance that we will repurchase up to the full amount remaining under the program. Refer to Note (16) of the Notes for further information regarding our share repurchase program.
Refer to Note (16) of the Notes for a summary of cash dividend activity in 2020 and 2019. Subject to declaration by our Board of Directors, we expect to continue paying quarterly cash dividends as a part of our current capital allocation strategy. Future dividends will be subject to the determination, declaration and discretion of our Board of Directors and compliance with covenants under our outstanding debt agreements.
The source of funds for such repurchases and dividends may include cash generated from operations, liquidation of investment holdings and other dispositions of assets, and the incurrence of indebtedness.
Free Cash Flow (Non-GAAP)
For the Years Ended
(In thousands) 2020 2019
Cash flows from operating activities (GAAP) $ 1,436,705
$ 1,313,099 Capital purchases (283,981)
(471,518)
Capitalized software development costs (295,277) (273,871) Free cash flow (non-GAAP) $ 857,447$ 567,710 36
-------------------------------------------------------------------------------- Table of Contents Free cash flow increased$290 million in 2020, compared to 2019, primarily due to reduced capital expenditures. Free cash flow is a non-GAAP financial measure used by management, along with GAAP results, to analyze our earnings quality and overall cash generation of the business, and for management compensation purposes. We define free cash flow as cash flows from operating activities reduced by capital purchases and capitalized software development costs. The table above sets forth a reconciliation of free cash flow to cash flows from operating activities, which we believe is the GAAP financial measure most directly comparable to free cash flow. The presentation of free cash flow is not meant to be considered in isolation, nor as a substitute for, or superior to, GAAP results, and investors should be aware that non-GAAP measures have inherent limitations and should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP. Free cash flow may also be different from similar non-GAAP financial measures used by other companies and may not be comparable to similarly titled captions of other companies due to potential inconsistencies in the method of calculation. We believe free cash flow is important to enable investors to better understand and evaluate our ongoing operating results and allows for greater transparency in the review and understanding of our overall financial, operational and economic performance, because free cash flow takes into account certain capital expenditures necessary to operate our business. 37 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations, Commitments and Off Balance Sheet Arrangements
The following table represents a summary of our contractual obligations and commercial commitments at the end of 2020, except short-term purchase order commitments arising in the ordinary course of business.
Payments Due by Period
2026 and
(In thousands) 2021 2022 2023 2024 2025 thereafter Total
Balance sheet obligations(a):
Long-term debt obligations $ - $ 225,000 $ - $ 600,000 $ 211,662 $ 300,000 $ 1,336,662
Interest on long-term debt
obligations 27,368 23,989 20,885 17,610 11,080 33,750 134,682
Other obligations:
Operating lease obligations 33,611 27,131 20,347 12,199 7,438 37,224 137,950
Purchase obligations 67,126 40,026 37,921 31,630 41,213 521,297 739,213
Total $ 128,105 $ 316,146 $ 79,153 $ 661,439 $ 271,393 $ 892,271 $ 2,348,507 (a) At the end of 2020, liabilities for unrecognized tax benefits were
Off-Balance Sheet Arrangements
Refer to Note (11) of the Notes for information regarding our interest rate swap agreement, which is accounted for as a cash flow hedge in accordance with ASC Topic 815, Derivatives and Hedging. LIBOR is scheduled to be phased out by the end of 2021. When LIBOR ceases to exist, we will need to agree upon a replacement index with the lenders under our Credit Agreement at the time, and such new rates may not be as favorable to us as those in effect prior to any LIBOR phase-out. If the swap and the Credit Agreement replacement rates are not identical, our hedge could be less effective.
Recent Accounting Pronouncements
Refer to Note (1) of the Notes for information regarding recently issued accounting pronouncements.
Critical Accounting Policies
We believe that there are several accounting policies that are critical to
understanding our historical and future performance, as these policies affect
the reported amount of revenue and other significant areas involving our
judgments and estimates. These significant accounting policies relate to revenue
recognition, software development, and income taxes. These accounting policies
and our procedures related to these accounting policies are described in detail
below and under specific areas within this MD&A. In addition, Note (1), Note
(2), and Note (14) of the Notes expands upon discussion of our accounting
policies for these areas.
38
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Table of Contents
Revenue Recognition
In the first quarter of 2018, we adopted Accounting Standards Update ("ASU")
2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09, as
amended, replaced most existing revenue recognition guidance in U.S. GAAP. This
guidance requires a significant amount of judgments and estimates in
implementing its five-step process to be followed in determining the amount and
timing of revenue recognition and related disclosures. Refer to Note (2) of the
Notes for further discussion regarding significant judgments involved in our
application of ASU 2014-09.
Software Development Costs
Costs incurred internally in creating computer software solutions and
enhancements to those solutions are expensed until completion of a detailed
program design, which is when we determine that technological feasibility has
been established. Thereafter, all software development costs are capitalized
until such time as the software solutions and enhancements are available for
general release, and the capitalized costs subsequently are reported at the
lower of amortized cost or net realizable value.
Net realizable value is computed as the estimated gross future revenues from
each software solution less the amount of estimated future costs of completing
and disposing of that product. Because the development of projected net future
revenues related to our software solutions used in our net realizable value
computation is based on estimates, a significant reduction in our future
revenues could impact the recovery of our capitalized software development
costs. If we missed our estimates of net future revenues by 10%, the amount of
our capitalized software development costs would not be impaired.
Capitalized costs are amortized based on current and expected net future revenue
for each software solution with minimum annual amortization equal to the
straight-line amortization over the estimated economic life of the software
solution. We are amortizing capitalized costs over five years. The five-year
period over which capitalized software development costs are amortized is an
estimate based upon our forecast of a reasonable useful life for the capitalized
costs. Historically, use of our software programs by our clients has exceeded
five years and is capable of being used a decade or more.
We expect that major software information systems companies, large information
technology consulting service providers and systems integrators and others
specializing in the health care industry may offer competitive products or
services. The pace of change in the HCIT market is rapid and there are frequent
new product introductions, product enhancements and evolving industry standards
and requirements. As a result, the capitalized software solutions may become
less valuable or obsolete and could be subject to impairment.
Income Taxes
We make a number of assumptions and estimates in determining the appropriate
amount of expense to record for income taxes. These assumptions and estimates
consider the taxing jurisdictions in which we operate as well as current tax
regulations. Accruals are established for estimates of tax effects for certain
transactions, business structures and future projected profitability of our
businesses based on our interpretation of existing facts and circumstances. If
these assumptions and estimates were to change as a result of new evidence or
changes in circumstances, the change in estimate could result in a material
adjustment to the consolidated financial statements.
We have discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and the Audit Committee has reviewed our disclosure contained herein.
Forward-Looking Statements
Statements made in this report, the annual report to shareholders of which this report is made a part, other reports and proxy statements filed with theSEC , communications to shareholders, press releases and oral statements made by representatives of the Company that are not historical in nature, or that state the Company's or management's intentions, hopes, beliefs, expectations, plans, goals or predictions of future events or performance, may constitute "forward-looking statements" within the meaning of Private Securities Litigation Reform Act of 1995. Forward-looking statements can often be identified by the use of forward-looking terminology, such as "could," "can," "should," "will," "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "positioned", "forecast," "plan," "guidance," "opportunity," "prospects" or "estimate" or the negative of these words, variations thereof or similar expressions. Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. It is important to note that any such performance and actual results, financial condition or business, could differ materially from those expressed in such forward-looking statements. Significant factors that could cause or contribute to such differences 39
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Table of Contents include, but are not limited to, those discussed in this Item 1A. Risk Factors and elsewhere herein or in other reports filed with theSEC . Other unforeseen factors not identified herein could also have such an effect. Any forward-looking statements made in this report speak only as of the date of this report. Except as required by law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in our business, results of operations, financial condition or business over time.
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