Cerner Corporation

Welcome to Cerner's Corporations Fourth Quarter 2020 Conference Call. Today's date is February 10, 2021, and this call is being recorded. The company has asked me to remind you that various remarks made here today constitute forward-looking statements, including without limitation, those regarding projections of future revenues or earnings, operating margins, operating and capital expenses, bookings, new solutions, services, and offering development, and capital allocation plans, cost optimization and operational improvement initiatives, future business outlook, the expected benefits of our acquisitions, the investitures, or other investments or collaborations, and the expected impact of the COVID-19 pandemic. Actual results may differ materially from those indicated by the forward-looking statements. please see Cerner's earnings release, which was furnished to the SEC today and posted to the investor section of Cerner.com, and other filings with the SEC for information concerning factors that could cause actual results to differ materially from those in the forward-looking statements. The extent to which the COVID-19 pandemic and measures taken in response thereto could materially adversely affect our financial conditions Future routines and results of operations will depend on future developments, which are highly uncertain and difficult to predict. Our consolidation of non-GAAP financial measures discussed in this earnings call can also be found in the company's earnings release. CERNER assumes no obligation to update any forward-looking statements or information except as required by law. At this time, I'd like to turn the call over to Brent Schaefer, Chairman and CEO of Cerner Corporation.

Well, thanks very much, and good afternoon, everyone. I'd like to start with a few comments on our fourth quarter and full year performance, and then I'll hand it over to CFO Mark Naughton and our new Chief Client and Services Officer, Travis Dalton, and then our President, Don Trigg, for some more marketplace commentary. Well, 2020 was a remarkable year for all of us. And given the circumstances, Cerner delivered solid results by executing on our plans and really focusing on supporting our clients. The pandemic challenged Cerner and our clients on several fronts. We continue to be extremely proud to support clients who are battling COVID on the front lines each and every day. And we're very pleased with the way our associates seamlessly transitioned to a remote work environment last March, and have really remained productive and focused on our client success throughout this whole period. I'm also proud that Cerner recently began hosting a series of mass vaccination events at our world headquarters. This is done through a collaboration with North Kansas City Hospital, Liberty Hospital, Clay County Public Health Center, and cities within Clay County. This initiative, called Operation Safe, is being staffed by volunteers from Cerner, North Kansas City Hospital, and several partners in the community. And together, we've vaccinated nearly 5,000 people through one week, and we have additional events planned in the weeks ahead. You know, I've often said that Cerner's, one of Cerner's strongest assets is how mission-driven our people are, and the willingness of our associates to rise to the challenge of this pandemic has really presented a strong demonstration of that commitment throughout the whole year. In addition to supporting our clients and communities, we continue to advance our growth strategies and make operational improvements as part of Scherner's ongoing transformation in 2020. As COVID accelerated healthcare macro trends, it also validated our growth initiatives, including the creation and expansion of health networks, our real-time health system capabilities, and consumer-facing health strategies. Cerner is providing data-driven insights that can improve our clients' clinical, operational, and financial outcomes. Our recent investment in Elego Health Research in agreement to acquire Kantar Health are examples of how we're deploying capital to advance Cerner's growth strategies. And Don will provide more detail about how these investments accelerate Cerner's presence in life sciences and create a strong foundation for our data-as-a-service business. We also continue toward our transformation goals. Cerner's transformation has been focused on simplifying the business, creating operational efficiencies, and delivering profitable growth. And we're nearing 300 million in annualized cost reductions since beginning our transformation efforts about two years ago. And we believe those efficiencies and our resilient business model really help mitigate the impacts of COVID on our business. As part of our portfolio management process, We simplified our product set to go from offering more than 25,000 features to really fewer than 400 products. And we also divested RevWorks outsourcing business in some non-core global assets. Importantly, our work to deliver seamless care for 18 million service members and veterans remains on track. And for the first time in history, the US Department of Defense, US Department of Veterans Affairs, and the U.S. Coast Guard are using the same electronic health record. And the number of patients in our joint health information exchange grew from 700,000 to 4 million since April of last year. Finally, we supported the evolution and transformation of our business by adding proven leaders who are already bringing a new perspective. Chief Technology Officer Jerome Labatt joined us in June. bringing more than 30 years of CTO and product development experience at Fortune 500 and leading global tech companies like Hewlett Packard Enterprise, Intuit, and Oracle. In September, Chief Strategy Officer Will Mintz came to Cerner after working with leading healthcare and technology businesses, including Aetna and Blue Cross Blue Shield. You probably know Chief Client and Services Officer Travis Dalton from his leadership in our federal business. and we're excited to have Travis now bringing that same leadership to our global client base while retaining oversight of our critically important federal work. Mark Ersig is our most recent appointment and will replace longtime Center CFO Mark Naughton on February 22nd. Mark is a high-energy leader who will bring more than 25 years of financial leadership experience, including driving transformation across complex global operations and leveraging balance sheets to drive growth and shareholder value. In addition to those leaders, we are also honored to have Major General Elder Granger join the Cerner Board of Directors in November. Dr. Granger is a proven leader with experiences in clinical, military, and business environments. Before I close, I'd like to acknowledge that this is our last earnings call with CFO Mark Naughton. who after nearly 30 years of service and 101 earnings calls, will be leaving Cerner at the end of the first quarter. I know many of you share my appreciation for Mark and wish him the best of luck in his future endeavors. And Mark, I just have to say, I cannot imagine anything more fun than 101 earnings calls. In summary, I'm very pleased with what we accomplished in 2020. We delivered toward our revised expectations while deriving It's driving a significant amount of change in what we all have to say was a very unusual year in healthcare. This is very hard work, and I sincerely appreciate all CERN associates and their contributions to this progress. And Mark, let me now turn it over to you for call number 101.

Thanks, Brent. They always say the second hundred are the easiest, so hopefully that's true. Good afternoon, everyone. I'm going to cover Q4 results and future guidance. This quarter we delivered all key metrics in line with our expectations. I'll start with bookings, which were $1.68 billion, over $30 million above the midpoint of our guidance range. Full-year bookings were $5.585 billion, which is down from $5.99 billion in 2019, primarily driven by the impact of pandemics and vestiges of our commercial RevWorks and certain global businesses in Q3. We ended the year with a revenue backlog of $13.04 billion, which is down 5 percent from a year ago, due primarily to the impact of divestitures. Our backlog revenue, combined with other contracted revenue that is excluded from the ASC 606 backlog definition, still provides visibility to more than 85 percent of expected revenue over the next 12 months. Revenue in the quarter of $1.395 billion was above the midpoint of our guidance range and represents roughly 1 percent year-over-year growth after adjusting for divestitures. Total revenue for the year was $5.506 billion which also reflects approximately 1 percent growth from 2019 after adjusting for divestitures. I'll now go through the business model detail in year-over-year growth compared to Q4 2019 and full year 2019. Licensed software revenue in Q4 was flat year-over-year at 174 million. Full-year licensed software revenue declined 4 percent from 2019 to 656 million due to pandemic-driven declines in traditional software partially offset by growth in software and service revenue, which now makes up approximately 60% of total software revenue. To date, this shift has been driven primarily by growth in SAS revenue related to healthy intent-based solutions. Going forward, we expect this shift to continue for additional factors and for additional factors to contribute, including changes this year in how we deliver in contracts for CareAware and Community Works. Given the relatively small sizes of these businesses, the impact of the changes will not be significant. We would expect to use this transition as a guide for a broader move to SaaS with Millennium, which will occur as we continue to advance our platform and modernization. Technology resale in Q4 was down 8% year-over-year to $56 million, and in line with our expectations. Full-year technology resale revenue was down 20% to $197 million, primarily due to a tough overall environment for technology resale and the impact of the pandemic. Subscriptions revenue grew 6% in Q4 to $98 million and grew 5% for the full year to $378 million. Professional services revenue was down 6% in Q4 to $478 million and was down 3% for the full year to $1.93 billion due primarily to the impact of the pandemic, divestitures, the termination of our large revenue agreement in 2019, and lower third-party services. Declines driven by these factors were partially offset by continued strength in federal professional services. Managed services was up 2% in Q4 to $317 million and up 3% for the full year to $1.245 billion. Support and maintenance of $263 million was down 4% in Q4 and down 3% for the full year to $1.071 billion due to the impact of divestitures, attrition, and reduced hardware maintenance revenue. And finally, reimbursed travel of $8 million was down 63% in Q4 to down 71% for the full year at $28 million due to pandemic-driven travel restrictions. Looking at revenue by geographic segment, domestic revenue was down 3% from the year-ago quarter at $1.23 billion, and non-U.S. revenue of $161 million was also down 3% from the year-ago quarter, primarily due to the divestiture of assets in Germany and Spain. For the full year, domestic revenue was down 3%, and non-U.S. revenue declined 4% due to the impact of the pandemic as well as divestitures. Moving to gross margin, our gross margin for Q4 was up 240 basis points from a year ago to 83.2%, and full year was up 190 basis points over 2019 to 83.1%, reflecting improved revenue mix due to less outsourcing, third-party services, technology resale, and reimbursed travel. Now I will discuss spending operating margin net earnings. For these items, we provide both GAAP-adjusted and non-GAAP results. The adjusted results exclude share-based compensation expense, acquisition-related adjustments, organizational restructuring and other expenses, COVID-19-related expense, an allowance on a non-current asset, gains on the sale of businesses, and other adjustments that are detailed and reconciled to GAAP and our earnings release. Looking at our operating spending, our fourth quarter GAAP operating expenses of $987 million were basically flat compared to $982 in the year going forward. Full-year gap operating expenses were $3.879 billion, down 4% from $4.021 billion in 2019. Our adjusted operating expenses of $860 million in the fourth quarter were down 1% compared to Q4 of 2019, and full-year 2020 decreased 3% year-over-year, primarily due to our continued cost optimization efforts, divestitures, and lower travel expense. Looking at the line items for Q4, Sales and client service expense decreased 2% year-over-year, driven by lower non-personnel expense in divestitures. Software development expense increased 4% from Q4 of 2019, with gross R&D up 6% and a slight increase in net capitalized software. G&A expense in Q4 was down 9%, driven by a decline in both personnel and non-personnel expenses. Moving to operating margins, our GAAP operating margin in Q4 was 12.7%, flat to the year-ago period. Our GAAP operating margin for the quarter of 2020 was 16.6% compared to 10.6% in 2019. Our adjusted operating margin for the quarter was 21.5%, up from 20.3% in Q4 of 2019 and 20.4% last quarter, reflecting the impact of our cost optimization efforts and improved revenue mix. Our full-year adjusted operating margin was 19.9%, representing 140 basis points in full-year margin expansion over 2019. We are happy with our operating margin improvement in 2020, given the circumstances, and expect to continue improving margins as we deliver ongoing optimization efforts and aim to realize a longer-term benefit from platform modernization. Moving to net earnings and EPS, our gap net earnings in Q4 were $142 million, with $46 per diluted share, down from $0.49 in Q4 of 2019. The full year gap net earnings were $780 million, or $2.52 per diluted share, and includes gains from divestitures and investment sales. Adjusted net earnings in Q4 were $241 million, and adjusted diluted EPS was $0.78, up 4% compared to 75%, and Q4 of 2019. For the full year, adjusted net earnings were $879 million, and adjusted diluted EPS was $2.84, up 6% in 2019. Our gap tax rate was 20% for the quarter and 21% for the full year. Our non-gap tax rate was 19% for Q4 and 20% for the full year. For 2021, we expect our gap and non-gap tax rates to be in the 21% to 22% range. Moving to our balance sheet, we ended the year with $1.06 billion in cash and short-term investments and $1.34 billion in debt. Our receivables ended the year at $1.17 billion, down $50 million from last quarter. Our Q4 DSO was 76 days, which is down from 81 days in Q3 20 and up from 72 days in the year-ago period. Looking forward, we expect DSOs to remain in the 70s. Operating cash flow in Q4 is very strong at $513 million, capital expenditures were 46 million, and capitalized software was 71 million. Free cash flow was a record high of 396 million for the quarter. For the full year, operating cash flow was 1.437 billion, capital expenditures were 284 million, and capitalized software was 295 million. Full year free cash flow was 857 million, which is up 290 million from 2019, driven by solid operating cash flow and nearly $200 million reduction in capital expenditures. For 2021, we expect an increase in free cash flow driven by operating cash flow growth, continued CapEx control. This growth is expected to be partially offset by the CARES Act payroll tax deferral ending and an expected increase in capitalized software related to some focused use of third-party developers to assist with platform modernization work. In total, these two items are expected to impact free cash flow by about $150 million, with over three-fourths being tied to payroll taxes. Moving to capital allocation, in December we announced an agreement to acquire Kantar Health for $375 million in cash, subject to adjustment. As Don will discuss, this acquisition is a strong complement to our existing data as a service efforts and represents a meaningful entry to the pharmaceutical market. We expect the transition to close in the second quarter. We also resumed our share repurchase program in Q4 and repurchased 1.5 million shares for 107 million. This brings our total for the year to 10.6 million shares repurchased for 757 million, an average price of $71.07 per share, and leaves us with 927 million remaining on our current authorization. Subject to Board approval, we currently expect to repurchase up to $1 billion plus this year, with the exact amount depending on the amount of cash used for other purposes such as acquisitions beyond the previously discussed Kantar Health Deal. Moving to our dividend program, in October, we paid a dividend of 18 cents per share or $55 million. In December, we announced a 22% increase for our quarterly dividend, bringing it to 22 cents, which was paid on January 12th. In summary, we expect to increase capital deployment in 2021 as we fund additional share repurchases, increase quarterly dividend, the Kantar Health acquisition, and possibly other acquisitions or investments. We expect these actions to make better use of our balance sheet after getting to a low net leverage position in 2020 as we pause repurchases during the pandemic and receive large cash inflows relating to divestitures and investment gains. Moving to guidance. As we previously discussed, while we have executed fairly well through the pandemic so far, a considerable amount of uncertainty still exists so please note that our guidance remains subject to a higher than normal amount of risk. I'll start with revenue. We expect revenue in Q1 to be between $1.37 and $1.42 billion. As a reminder, Q1 of 20 included about $45 million of revenue from our commercial, rev works, and global divested businesses, which is not included in Q1 21 revenue. The $1.395 billion midpoint of this range represents 2% growth from Q1 20 after adjusting for these divestitures. For the full year, we expect revenue between 5.75 and 5.95 billion. In addition to the 45 million of revenue impact from divestitures in Q1, the remaining headwind is approximately 40 million in Q2 and about 4 million in Q3, for a total of approximately 90 million. More than offsetting this impact for the year is an expected contribution from the Kantar Health acquisition, which we expect to contribute approximately $125 million in Q2 to Q4 based on anticipated closing in early Q2. The $5.85 billion midpoint of the 2021 guidance range represents 6% growth over 2020. Adjusting for both the vestiture headwinds and the acquisition also results in 6% growth. Moving to EPS, we expect Q1 adjusted diluted EPS to be $0.72 to $0.76 per share. The midpoint of this range represents 4% growth over Q1 of 2020. For the full year, we expect adjusted diluted EPS to be $3.10 to $3.20, with a $3.15 midpoint reflecting 11% growth over 2020. Moving to bookings guidance, we expect bookings revenue in Q1 of $1.15 billion to $1.35 billion. The midpoint of this range reflects 15% growth over the first quarter of 2020, which included some initial impact from the pandemic, which took hold in the last part of the quarter. In summary, our 2021 outlook reflects a return to mid-single-digit revenue growth, with over 100 basis points of margin expansion driving double-digit EPS growth. This guidance is consistent with the long-term framework we shared at our last investor day and referenced again when we previewed 2021 on our Q320 call. We note that current adjusted EPS consensus is slightly above our guidance range. It is impacted by a couple of estimates that are not consistent with this framework. Adjusting for these estimates will result in consensus being in our guidance range. Note that we don't plan to do an investor day as we want Mark Ersig to have time to get up to speed. However, we have updated our long-term plan that is the source of our financial messaging at investor meetings, and the updated plan reflects similar revenue growth, margin expansion, and EPS growth as the framework we shared last year. We also continue to expect our organic top line to be driven by our federal and strategic growth businesses and likely augmented by M&A. Mark will work with the team to determine the best timing for our next investor event, but our strategy and long-term plan remain consistent with past communication, so we think it makes sense to hold off for now. In summary, we are pleased with our solid results in the fourth quarter and full year, as well as our positive outlook. Before turning the call over to Travis, I want to say one more time how much of an honor it has been to be CFO at Cerner. Having spent time with Mark Ersig ahead of his upcoming start date, I'm confident he's going to step in and quickly add value to Cerner, our clients, and shareholders. With that, I'll turn the call over to Travis.