Cerner Corporation Fourth Quarter 2011 Earnings Conference Call February 7, 2012

Transcription

1 Moderator Cerner Corporation Fourth Quarter 2011 Earnings Conference Call February 7, 2012 Welcome to Cerner Corporation s fourth quarter 2011 conference call. Today s date is February 7, 2012, and this call is being recorded. The company has asked me to remind you that various remarks made here today by Cerner s management about future expectations, plans, perspectives and prospects constitute forwardlooking statements for the purpose of the Safe Harbor provisions of the Private Security and Litigation Reform Act of Actual results may differ materially from those indicated by the forward looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward looking statements may be found under the heading Risk Factors under Item 1A in Cerner s Form 10 K together with other reports that are on file with the SEC, including the Company s earnings release. A reconciliation of non GAAP financial measures disclosed in this earnings call can be found in the Company s earnings release filed with the SEC and available at and posted on the Company s website at [under the About Cerner section (click Investor Relations, then Presentations and Webcasts)]. At this time, I'd like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corporation. 2/7/2012, 5:10 PM Page 1 of 13 Cerner Q411 Earnings Script_FINAL.docx

2 Marc Naughton Thank you. Good afternoon everyone and welcome to the call. I will lead off today with a review of the numbers. Zane Burke, Executive Vice President of our client organization, will follow me with sales highlights and marketplace trends. Mike Nill, Executive Vice President and Chief Operating Officer will discuss our Works businesses and 2012 imperatives. Mike will be followed by Jeff Townsend, Executive Vice President and Chief of Staff, who will discuss strategic initiatives. Neal Patterson, our Chairman, CEO and president, is traveling today. Now I will turn to our results. Our strong fourth quarter results capped off a record year across all key measures. Bookings were very strong and exceeded the high end of our guidance range. Our income statement performance was excellent with revenue and adjusted EPS above expected levels and continued margin expansion and strong earnings growth. And we had very strong cash flow performance. Bookings, Backlog and Revenue Moving to the details, our total bookings revenue in Q4 was a record $899 million. Bookings exceeded the high end of our guidance range by more than $200 million and were up 44% from Q410. Bookings margin in Q4 was $755 million, or 84% of total bookings. For the full year, bookings revenue was $2.72 billion, up 37% from As Zane will discuss, the strength of bookings in Q4 spanned across all business models and included 2 ITWorks contracts and 1 RevWorks contract. Our bookings performance drove a 24% increase in total backlog to $6.11 billion. Contract revenue backlog of $5.40 billion is 26% higher than a year ago. Support revenue backlog totals $706 million, up 8% year over year. Revenue in the quarter was $615.6 million, which is up 23% over Q410. The revenue composition for Q4 was $220 million in System Sales, $142 million in Support and Maintenance, $242 million in Services, and $11 million in Reimbursed Travel. The upside relative to our guidance was largely driven by higher system sales and strong services. For the full year, revenue grew 19% to $2.20 billion. System sales revenue reflects 34% growth from Q410. This was driven by strong growth in licensed software, subscriptions and device resale, with the growth in these items slightly offset by flat levels of traditional hardware and sublicensed software. For the full year, systems sales revenue grew 28%. Services revenue was up 24% compared to Q410 and 20% for the full year, with strong growth in both managed services and professional services. Support and Maintenance revenue increased 7% over Q410 and 6% for the full year. 2/7/2012, 5:10 PM Page 2 of 13 Cerner Q411 Earnings Script_FINAL.docx

3 Looking at revenue by geographic segment, domestic revenue increased 21% year over year to $524 million. Global revenue was $92 million and grew 35% compared to the year ago period. For the full year, domestic revenue grew 21% to $1.89 billion and global revenue grew 7% to $309 million. As a preview to the annual update of our detailed business model that we ll provide at our investment community meeting on February 22 nd, I d like to provide you with the total revenue and growth by business model for the full year Licensed Software grew 21% to $325 million; Technology Resale was up 39% to $246 million, driven by growth in device resale; Subscriptions and Transactions increased 28% to $136 million; Professional Services revenue grew 21% to $550 million, Managed Services increased 20% to $351 million; Support & Maintenance was up 6% to $551 million, and Reimbursed Travel was $45 million, which is up 38% We ll go into more business model detail at our investment community meeting. Moving to gross margin. Our gross margin for Q4 was 78.6%, which is basically flat compared to 78.9% in Q3 and down compared to 81.0% a year ago. The year over year decline in gross margin was driven by the strong levels of technology resale that I discussed as well as an increase in 3 rd party services. For the full year, gross margin was 80.0%. As we have noted in the past, while revenue mix can impact gross margins in any given period, we continue to drive operating margin expansion, as I ll discuss in a moment. Operating Expense and Earnings Looking at operating spending, our fourth quarter operating expenses were $337.8 million before share based compensation expense of $8.0 million. Total operating expense was up 15% compared to Q410, with the majority of the growth driven by an increase in revenue generating associates in our services businesses. For the full year, operating expenses were $1.27 billion, up 11% from This compares to revenue growth for the year of 19%, reflecting strong operating efficiencies. Sales and client service expenses increased 19% compared to Q410 and 13% for the full year, driven primarily by growth in managed services and professional services. Our investment in Software Development increased 4% compared to Q410 and 5% for the full year. We expect to continue growing our R&D investments in coming years to accelerate innovation in areas Mike and Jeff will discuss. We expect to be able to do this with R&D still growing slower than revenue, so we maintain the leverage we have achieved from our R&D investments. 2/7/2012, 5:10 PM Page 3 of 13 Cerner Q411 Earnings Script_FINAL.docx

4 G&A expense increased 10% compared to Q410 and 11% for the full year, driven by personnel and other expenses related to an increase in hiring and training. Operating Margins Moving to operating margins. Our operating margin in Q4 was 23.7% before share based compensation expense and was up 160 basis points compared to Q410. For the full year, operating margins increased 140 basis points to 22.2%. Going forward, we believe we can continue to expand operating margins basis points annually through efficiencies across our business models and expense leverage. Net Earnings / EPS Moving to earnings and EPS, our GAAP net earnings in Q4 were $91.2 million, or 52 cents per diluted share. GAAP net earnings include share based compensation expense, which had a net impact on earnings of $5.0 million, or 3 cents per share. Adjusted net earnings were $96.2 million and adjusted EPS was 55 cents, which is up 26% compared to Q410. For the year, adjusted net earnings were $324.9 million and adjusted EPS was $1.87, which is up 26% from The tax rate for adjusted net earnings was 35%, which is in line to slightly below what we expected. For 2012, we expect our effective tax rate to be 35 36%, with the rate in Q1 likely being lower due to a favorable tax settlement. Balance Sheet / Cash Flow Now I ll move to our balance sheet. We ended Q4 with $1.13 billion of total cash and investments, up from $1.09 billion in Q3. Total cash and investments include $775 million of cash and shortterm investments and $359 million of highly rated corporate and government bonds with maturities over 1 year. Our total debt, including capital lease obligations, is $127 million. Total receivables ended the quarter at $563 million, which is up $15 million from Q3. Contracts receivable, or the unbilled portion of receivables, were $91 million and represent 16% of total receivables compared to 19% in Q3. Cash collections were a record at $638 million. Our DSO in Q4 was 83 days, which is down from 87 days in Q3 and Q410. Operating cash flow for the quarter was a record at $168.5 million. Q4 capital expenditures were $29.2 million, and capitalized software was $21.1 million. Free cash flow, defined as operating cash flow less capital expenditures and capitalized software, was also a record $118.2 million. For the full year, operating cash flow grew 20% to $546.3 million, and free cash flow grew 31% to $358.6 million, with capital expenditures of $104.8 million and capitalized software of $82.9 million. Free cash flow represents more than 100% of net earnings for both Q4 and the full year, demonstrating strong earnings quality. 2/7/2012, 5:10 PM Page 4 of 13 Cerner Q411 Earnings Script_FINAL.docx

5 Looking at 2012, we expect an increase in capital expenditures compared to the low $100 million range we have been at the last two years. Some of this will be driven by the construction of additional space at our new Kansas City, Kansas, campus that is needed for our growing associate base. We do not expect this to have a material impact on our free cash flow as the construction will span multiple years and we will also be receiving incentives that will offset a portion of the construction costs. Moving to capitalized software, the $21.1 million of capitalized software in Q4 represents 28% of the $75.2 million of total spending on development activities. Software amortization for the quarter was $19.2 million, resulting in net capitalization of $1.9 million, or 2.5% of our total R&D investment. Guidance Now I ll go through Q1 and 2012 guidance. For Q1 revenue, we expect revenue between $565 and $585 million, with the midpoint reflecting growth of 17% over Q1 11. For the full year, we expect revenue between $2.425 and $2.5 billion, with the midpoint reflecting growth of 12%. We expect Q1 adjusted EPS before share based compensation expense to be.48 to.50 cents per share, with the midpoint reflecting 23% growth over Q1 11. For the full year, we expect adjusted EPS between $2.20 and $2.30, with the midpoint reflecting growth of 20%. Q1 guidance is based on total spending before share based compensation expense of approximately $335 to $340 million. Our estimate for the impact of share based compensation expense is 3 cents in Q1 and 12 to 14 cents for the full year. Moving to bookings guidance, we expect bookings revenue in Q1 of $560 to $600 million. The midpoint of this range reflects 10% growth over Q1 11. In closing, we are pleased with our strong results in Q4 and the full year, with all key metrics at or above our expected ranges, including record bookings, revenue, earnings, and cash flow and strong margin expansion. With that I will turn the call over to Zane. 2/7/2012, 5:10 PM Page 5 of 13 Cerner Q411 Earnings Script_FINAL.docx

6 Zane Burke Thanks Marc. Good afternoon everyone. Today I am going to provide highlights of our sales results and cover marketplace trends. Results Starting with our results, we had another quarter of record bookings driven by robust demand in our client base and strong competitiveness in new footprint opportunities. Our bookings revenue in Q4 of $899 million reflects 44% growth over last year and is an all time high. For the year, bookings revenue was up 37% to $2.7 billion. As Marc mentioned, we signed two ITWorks contracts and one RevWorks contract in the quarter. These contributed to the percent of our bookings from long term contracts being 34%, which is slightly above historical levels, but recall that Q4 of last year also had two ITWorks contracts and a RevWorks contract, so it had a similar mix. And these contracts were clearly not our only large contracts as we had an all time high level of 32 contracts over $5 million, including a record 19 over $10 million. Another driver of the strength in both bookings and revenue this quarter was strong results from our DeviceWorks organization was a breakthrough year for DeviceWorks as our clients interest in using Cerner as a single source for connected devices increased, and more device manufacturers looked to us to be resellers because they recognize the value of our device connectivity platform and the strategic relationships we have with our clients. We have been saying for several years that DeviceWorks can offset the flat to declining trend of traditional hardware sales, and we saw this play out this year as essentially all of the 39% growth in total technology sales in 2011 was driven by device resale. This strength came from broad sources, including CareFusion Pyxis medication dispensing devices, RxStation, infusion pumps, beds, and monitoring devices. Another highlight for Q4 and the year was the traction we gained in the small hospital market with our CommunityWorks offering. Recall that CommunitWorks is our SaaS offering for small hospitals where we leverage our hosting and services capabilities to provide a complete suite of clinical and financial solutions at a very competitive price. In 2011, we added over 20 new small hospital footprints and expect this to accelerate in Moving to our physician solutions, we had a strong Q4 that contributed to the best year in our history, with ambulatory bookings growing 60% in I believe this strength is the result of enhancements we have made to our solutions over the past few years coupled with the marketplace s desire to have an integrated solution across inpatient and outpatient venues. Evidence of this trend is that we continue to partner with many clients in our installed base to extend our solutions to their employed and affiliated physicians. In 2011 alone, we partnered with 42 of our large health system clients to offer physician solutions. In many cases, our clients are displacing an existing ambulatory EHR supplier so they can move to our integrated offering. The 2/7/2012, 5:10 PM Page 6 of 13 Cerner Q411 Earnings Script_FINAL.docx

7 recently announced expansion of our relationship with Adventist Health to include 130 outpatient clinics is a good example of this. In addition to this example where we are replacing the ambulatory solutions of our primary inpatient competitor, we also displaced all of the major bestof breed ambulatory competitors at least once during We believe this trend will continue as we have several large clients that chose best of breed ambulatory providers in the last 3 to 5 years that are now coming back to market for an integrated solution. Additionally, significant greenfield still exists in the smaller end of the market and we are well positioned for this opportunity as well. Our competitive position in both replacement and greenfield opportunities will be further strengthened by our current focus on enhancing our solutions to improve the physician experience and productivity with PowerChart Touch and our Project Go initiative, which Mike will discuss in more detail. Global Moving to our global results. As Marc mentioned, we had a strong quarter outside the U.S. as well, with 35% revenue growth in Q4. After a slow start to the year, these strong results bring the full year growth to 7%. Overall, we continue to see gradual improvements in most global markets, and had strong years in Canada, Australia, and the Middle East. The strength in the Middle East included an agreement with Hamad Medical Corporation to digitize the entire public health system of Qatar. This agreement significantly expands our leadership position in the region, and strengthens our position for other large opportunities. In England, despite continued coverage of changes to the National Program, we are continuing to execute. In Q4, our Choose and Book contract was extended and we expanded our relationship with two trusts. Going forward, we believe we are well positioned for growth in the UK as we expect more opportunities to sell directly to Trusts in all regions. Marketplace Moving to the overall marketplace and our competiveness, we gained share again in Q4 with 35% of bookings coming from outside of our core Millennium installed base. For the year, 32% of our bookings were from outside of our base, which is up from 28% last year. We continue to see significant new footprint opportunities. While many hospitals will use their existing supplier to get to Stage 1 of Meaningful Use, we expect many of them to switch suppliers as they face the rising bar for Stage 2 and Stage 3 and additional requirements for Value Based Purchasing, ACOs, and data analytics capabilities. With two major installed bases largely up for grabs due to challenges with transitioning to a new platform and uncertainty around their ability to keep up with future requirements, we believe we are still in the early stages of a multi year market share shift. And since only one competitor presents a consistent challenge, we have a great opportunity to gain a significant share of these vulnerable installed bases in coming years. 2/7/2012, 5:10 PM Page 7 of 13 Cerner Q411 Earnings Script_FINAL.docx

8 I am also pleased that we had our best win rate against our single toughest acute competitor in 2011, and I believe this will continue to improve for two reasons. First, we have already enhanced and are making significant incremental improvements in the one area that has historically led to their success the physician experience. We now offer a very competitive physician experience and believe our efforts this year with Project Go and PowerChart Touch will change the game in our favor. Second, we strongly believe we are the smart choice for anyone looking beyond the early stages of Meaningful Use. Our investments in interoperability, data analytics, and our Healthe Intent platform provide a meaningful differentiator against a company that has a platform that makes interoperability and data analytics challenging. From a macro view, while we recognize health care is likely to be targeted as part of the solution to the U.S. deficit, we believe the stimulus plan will remain intact and that other programs, such as Value Based Purchasing, will drive ongoing IT adoption. While some levels of cuts to our clients funding are likely, we expect any future adjustments to be tied to quality and outcomes, which will make IT adoption essential for organizations looking to remain competitive. In summary, I am very pleased with our record results in 2011, and I think we are well positioned for a strong 2012 and beyond. With that, I ll turn the call over to Mike. 2/7/2012, 5:10 PM Page 8 of 13 Cerner Q411 Earnings Script_FINAL.docx

9 Mike Nill Thanks Zane. Good afternoon everyone. Today I am going to discuss ITWorks, RevWorks, and Cerner s areas of focus for Cerner ITWorks I ll start with ITWorks, which had a great Q4 that included two new ITWorks clients, bringing our total to nine. One of them is a long time client that chose to expand their relationship with Cerner by adding both CernerWorks hosting and ITWorks. The second client is brand new to Cerner and chose Cerner to displace their existing EMR provider and to provide hosting and ITWorks services. This is the second example of ITWorks being part of a new client win, and it demonstrates that ITWorks is not just something we sell into our base but is also part of our competitive differentiation. The success of our existing ITWorks clients is a key factor in the decision making process for potential clients. Future clients can directly observe the speed of progress against clinical roadmaps and they can easily conclude that the ITWorks alignment with Cerner is very powerful. It is the best way to accelerate their path to Meaningful Use and to ensure compliance with future regulatory requirements. Another noteworthy observation about ITWorks is that almost all of our ITWorks clients have executed some form of scope expansion since they signed their initial contract. In total, we had over $50 million worth of scope expansion contracts in This activity proves the benefit of the tighter alignment that is created with ITWorks and is evidence that there is still room to grow after the initial ITWorks relationship is established. Cerner RevWorks Moving to RevWorks, we also signed a RevWorks client in Q4. This marks our fourth RevWorks client and is our first Critical Access Hospital to choose RevWorks. The signing was an existing CommunityWorks client that is already live with a suite of clinical and revenue cycle solutions. The RevWorks relationship allows them to advance their current system and deploy new capabilities to optimize revenues and generate cost savings. In addition to adding a RevWorks client, we also had a great deal of success in 2011 with clients increasing adoption of revenue cycle solutions and services that can become the foundation for a broader RevWorks relationship. In total, our revenue cycle bookings more than doubled over 2010 levels, with the strength driven by patient accounting, access management, care management, and health information management. We also continue to execute operationally, and in 2011 we brought patient accounting live at 31 hospitals and 95 clinics. We now have a total of 76 hospitals and 365 clinics live. Looking ahead, we remain confident that revenue cycle will be a big contributor to our long term growth. We are building a good foundation in our installed base by increasing penetration of core revenue cycle solutions and establishing strong examples with our initial RevWorks clients. We also believe that as the industry shifts from the current volume based reimbursement model to a 2/7/2012, 5:10 PM Page 9 of 13 Cerner Q411 Earnings Script_FINAL.docx

10 value and quality based model, providers will increasingly look to clinical solution providers that can offer integrated revenue cycle solutions versus relying on stand alone solutions. In summary, we remain bullish about the outlook for our all of our Works offerings. We believe strongly that if we provide high quality services that deliver superior value to our clients, these offerings will create a compelling value proposition and client adoption will accelerate. A key element that makes these offerings compelling is that they do not require incremental spending by our clients. They are just shifting existing spending to Cerner and getting better performance for the same dollars. We have proven this with CernerWorks over the last decade, and now our new Works offerings are following the same pattern Focus Before handing the call over to Jeff, I wanted to discuss the 2012 imperatives that I recently shared with our clients, as I think they are relevant to you as well. The imperatives are: drive Meaningful Use adoption, dramatically improve physician experience with our solutions, and powering population health management. First, Meaningful Use continued to be a very powerful driver across our client base in 2011 and will continue to be the focus of significant activity in 2012 and beyond. By the end of 2012, the majority of our clients will have attested for Stage I. The Meaningful Use wave of activity combined with ICD 10 will require our entire client base to migrate to a current version of our software, which is a big undertaking but also a big positive from an ongoing support standpoint. In the process, we will significantly impact the workflows and activities of our clients physicians, and it is imperative that we make this a smooth process and provide the best experience possible. This leads me to our second imperative: dramatically improve physician experience with our solutions. Meaningful Use has driven, and will continue to drive, physician adoption to unprecedented levels. We believe we have the best underlying technology to support Meaningful Use and, with the acceleration in physician adoption, we continue to increase our focus on physician productivity and the physician experience. During the Cerner Health Conference in 2011, Neal launched Project Go and PowerChart Touch. The core message and driving principles behind these efforts are to make the solutions Fast, Smart and Easy. We are focused on speeding up workflows, reducing clicks, and ensuring our solutions provide each user the information they need at the right point in the workflow in context of the person, condition and venue. We are also building applications that require limited training and support the natural movement of the user throughout the day across the tablet, desktop and phone. In short, we are focused on enabling health care delivery anytime and anywhere. Meaningful Use is but one set of requirements in a growing wave of measures and mandates that will continue to impact our clients in the future. Cerner s focus is to future proof our clients organizations by providing the technology to withstand the changes in reimbursement models and the associated quality and regulatory reporting requirements. This brings me to our third imperative for 2012: powering population health management. The current narrative uses terms like medical home and Accountable Care Organization. Our 2/7/2012, 5:10 PM Page 10 of 13 Cerner Q411 Earnings Script_FINAL.docx

11 population health management solutions will help our clients exchange and aggregate clinical data to support the advanced analytics required to predict and prescribe the patterns of care that deliver the highest quality outcomes at the lowest cost. This is where our competitive differentiation begins to widen. In summary, we executed very well in 2011, and we are set up for 2012 to be a year that includes significant growth in client adoption and substantial advancements in Cerner s capabilities and competitiveness. With that, I ll turn the call over to Jeff. 2/7/2012, 5:10 PM Page 11 of 13 Cerner Q411 Earnings Script_FINAL.docx

12 Jeff Townsend Thanks Mike. Today my comments are going to pick up where Mike left off, and expand on how we are getting ready for the second order effects that are emerging as health care is digitized. In 2011, we made good progress on this front, and our focus in 2012 on future proofing our clients and facilitating population health management is a continuation of this progress. As we have discussed, we are building a meta data layer, agnostic to the source EMR, to better position our clients for the increasing use of quality standards, performance measures and managing the health of populations. We call this layer Healthe Intent, and 2011 was a foundational year for this platform. In just over a year, our Chart Search efforts went from a nascent offering to having 115 clients engaged. We are currently adding about 6 million documents and 150 million results on a daily basis quickly building foundational data for the Healthe Intent platform. There are several differentiators when comparing the Healthe Intent platform to other attempts to aggregate and analyze data. Interoperability is a key one by being EMR agnostic, we can operate in the reality that not all information will come out of a Cerner system. We have already proven leadership in the area of interoperability with our Cerner Network and Health Information Exchange offerings, which create better clinical integration and coordination of care by facilitating secure electronic flow of data between hospitals, physician practices, and other stakeholders, regardless of the EHR system being used. We exited 2011 with approximately 100 million clinical and financial transactions being sent across this network each month. This is double the level of transactions from a year ago. Another differentiator of Healthe Intent is that we are able to capture research, evidence, and claims data that, when combined with real time clinical data from the EHR, significantly enhances the power of the platform. We can be predictive and help identify risks as they occur so care plans can be changed versus just reporting on them after it is too late. A key element of our ability to be predictive is the deployment of agents across the Healthe Intent platform. Concurrent with the rapid growth in data being captured on our platform, we are deploying sophisticated machine learning algorithms to support mapping of clinical concepts and clinical decision support agents, such as Sepsis. And to advance this progress, we recently launched Cerner Math, which is an initiative aimed at accelerating our ability to discover and develop clinical agents using a hybrid of published evidence and our Health Facts research platform. These tools will be critical to our clients as the health care landscape evolves to having payments tied to quality, outcomes, and the ability to manage the health of populations. The dynamic nature of these changes to reimbursement structures will require the ability to quickly adapt to new requirements. As a result, we believe our cloud deployment model is important because we can help our clients be ready for the next requirement without major upgrades or implementation projects. 2/7/2012, 5:10 PM Page 12 of 13 Cerner Q411 Earnings Script_FINAL.docx

13 In closing, I would remind you of the Wednesday Analyst Event at HIMSS. As Zane, Mike and I have outlined, there is a lot of innovation now coming to the surface, not only in the EMR and Physician space, but also in interoperability, population management and new care delivery models beyond the enterprise. We will be using this year s event to formally launch several of these new solutions. We made great progress in 2011 at building a foundation that will help future proof our clients while also positioning Cerner for the next wave. Now I would like to open up the call for questions. 2/7/2012, 5:10 PM Page 13 of 13 Cerner Q411 Earnings Script_FINAL.docx