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Cerner Corporation (NASDAQ:CERN)

January 10, 2012 1:30 pm ET

Executives

Neal Patterson - Co-Founder, Chairman, Chief Executive Officer and President

Marc G. Naughton - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Atif A Rahim - JP Morgan Chase & Co, Research Division

Atif A Rahim - JP Morgan Chase & Co, Research Division

Okay. Good morning, everyone. My name is Atif Rahim, I'm the Health care IT analyst at JPMorgan. We're very pleased to have Cerner with us this morning. And to tell us more about the company, we have Neal Patterson, CEO. And after this, we will have a breakout in the Essex Room. Sorry we're a couple of minutes over, but we'll let it go. Thank you. Neal?

Neal Patterson

Great, Atif. Thank you very much. Welcome. Good morning. So I don't know if I was the only one -- I was hoping to get Occupy San Francisco while we're here, but the security is very good in this place. So it probably won't be as exciting as that would have been.

So we're looking forward to our comments here, this is our Safe Harbor. As you well know, we're a public company and what we'll be sharing stuff here is inside of our Safe Harbor statement.

So we're a company. We're a little over 30 years old, myself and 2 other individuals were founders. All 3 of us are still very much involved in the company. We have a very experienced team around health care IT, and it's a very -- it's a great team. We are the largest standalone health care IT company in the world. We have the largest strategic global client footprint of any company.

We've built the company really organically leading with a very large investment in R&D, and we continue that. Cumulatively, we spent over $3 billion on our systems and platforms. Inside the company, we have over 1,000 clinical associates. Over -- we just, this week, hit 10,000 Cerner associates total, as far as worldwide. Our architecture is a very -- is the most contemporary architecture in the industry from the back to the front, and I'll talk a little bit about some of the things we've been working on the last couple of years. And we have a very comprehensive set of solutions across a great part of the continuum of health care.

From a financial point of view, there are 2010 numbers, so they're now literarily 1 year old, we're a $1.8 billion company with a $250 million net earnings. Our CAGR on the top line is, over the last 10 years, is 16%. And our CAGR on the bottom line has been, over the last 10 years, 29%.

So we're in a -- as a company, we're in a very good industry. We're at the intersection of health care and IT. And most of the societies around the world are beginning to clearly understand that health care IT is the single -- one of the single things that they can do systematically to address modernization of health care delivery.

Now I'm going to shift a little bit out away from the traditional PowerPoints that you are all very used to here. This is -- the rest of my slides are from a Prezi presentation I did at our own health care conference a couple of months ago. And when I reviewed the slides that Allan provided me, and I'm not sure you guys are really quite up for all Prezi, but this is kind of a hand-driven art. So but you're going to get kind of a Patterson view of the health care industry as a whole, and specifically things that we're doing from IT point of view.

So if I'm talking to a group of health care leaders, I will start with this basic -- this slide or this concept. But fundamentally what is driving our business is a 50-year trend in this country, and the trend is present in most other countries. And it's the fact the cost of healthcare is growing faster than the rate of our economies are growing. So the national expenditure on healthcare for 50 years has outpaced the growth rate of the economies.

So over time, and so in 1960, we were -- 5% of our economy was consumed by health care. Basically, we're heading toward very quickly to hit that 5%, is now going to consume 20% of our economy. And until that total expenditure, the cost of healthcare in our society, meets the growth rate of our economy, that -- health care is going to consume more and more.

So there is a fundamental pressure from the policy side to change the total cost of health care. Most other companies, the company that you were just -- that was in the room right before us, was -- had the next big drug that was probably going to increase the cost of health care. We're the industry and we're the single -- we're the industry and I think we're the single company that thinks broadly about where our long-term role will be, and it's driven by this basic premise right here.

Now health care, and what we do in health care, cannot be put in a bottle, a box. We are fundamentally infrastructure to the delivery side, and most of you see us from the delivery side, of health care. But the delivery side of health care in this country and other countries fits inside an overall health economy. And so the relationships of the overall health of the -- the parts of the health economy are going to drive fundamental at a minimum requirements that we have to meet and on a -- as an entrepreneur, opportunities that we see as this decade unfolds.

So now I'm going to take you through a little couple of the pieces of what I would call the health economy. He talks louder than I do. The centerpiece of the health economy is us as individuals, and it really starts at home. And all of health care in any country, including the U.S., all of healthcare is fundamentally financed by productive members of society. So those of us that produce are paying for all of healthcare, whether it's the safety nets in the U.S. that are Medicare or Medicaid, or whether it's through our employer who's aggregated our lives to basically go create a benefit plan that we help fund directly, or that we take less salary because we're getting those in return for those benefits. So all of the cost of health care is being financed by us as individuals.

The fact that there's a deficit out there, okay, in this country and around the world, that deficit is fundamentally going to force fundamental reform on how health care is delivered in this country and how it's paid for in this country. That's the opportunities for a Cerner in the last half of the decade.

Now health care as a -- health care delivery is probably the single -- a lot of people will -- now you can't even hear me -- I assume there's an A/V guy going to work on that a little bit.

Health care delivery, so hospitals, doctors, they're -- some people will criticize them for being laggards as far as the use of IT and there's a valid part of that criticism, but that is not valid today, in my personal opinion. But one of the things that health care has failed to do is understand that we're all members -- that they don't understand the concept of a membership, okay?

So every place else, whether it's the Church, whether it's the country club, whether it's the -- whether it's a part of an organization we belong to, and those organizations learn a lot about us. Health care, fundamentally, has been in a counter-based system. So you come in to see your doctor, you leave. It does the assessment basically -- well, do a diagnosis and start you on a treatment, but you leave, and there's been no connection to you from that point forward. So there's a lot of fundamental changes going on and health care is going to create a rethink around how health care connects to all of us as individuals, health care providers, not the payer system.

So now the center part of health care delivery is all delivered local. So healthcare is a local function. Most care is sought and delivered locally. Locally, I describe it basically as a battle zone, and there is huge competition typically around somewhat of oligopoly-like organization. So health care delivery, hospitals have consolidated over the last 20 years. And increasingly, physicians are joining those health systems as an overall health system. And most communities have the competition at the health system level, but it's a form of what I would call an oligopoly.

The other point I'd make in this slide is the complexity...

[Technical Difficulty]

So I guess I'm part of the battle zone -- the battle inside the zip code. So remarkably, even though there's some large national organizations in health care, the actual marketplace for health care is at the local level. And there is a lot of components to health care. So all the way from -- certainly the physicians' office, the hospital, the emergency, and -- the emergency access, the retail pharmacies, the urgent care. So there's -- the competition locally is a key part of the dynamics inside our marketplace.

Now most all of healthcare providers are paid -- their form of commerce and the flow of funds basically comes from the intermediaries or managed-care companies or insurance companies. There is a lot of dynamics going on now and will be going on over the next 2 years how healthcare providers and healthcare, the carriers and the insurance companies, are going to interact.

I have never seen the level of -- typically the insurance company and the health system are adversarial, because there is pressures, one has always tried to manage the other, they negotiate fiercely on price, so there's an adversarial relationship. Over the last year, there's been a remarkable change based on anticipated changes in policy in this country, driving providers and payers closer together. They're all whining around specific strategies on a local basis, including some of the payers have gone and started acquiring providers. So the UnitedHealth Group basically bought the Southern California physician, about 3,000 physician practice. In Pittsburgh, Highmark which basically the Blue Cross system, bought a major competitor to the UMPC ( sic) [UPMC] system, the University of Pittsburgh system in Pittsburgh. So there's a lot of dynamic in all levels of health care.

Now specifically around IT, there is -- just to restate, for most every country we're dealing with there's kind of a national -- it's either direct or there's a certainly awareness in a drive toward policies that facilitate healthcare providers investing in major IT, enterprise-wide IT systems.

In this country, through the stimulus package back in 2009, there was a specific set of provisions, as most of you I think well know, around setting a set of standards for providers in this country. When they hit those standards, basically, it would receive -- it received funds from the federal government in 3 different stages. Meaningful use Stage 1, Stage 2 and Stage 3. When that basically happened, I stood here on this platform and says, "That will basically sort out the competition in our marketplace, and we will get -- define winners and losers." And I also said, "I think there's going to be more losers than winners."

So there are -- because there is basically a set of -- there is a defined standard on which your systems have to be able to meet. And if you don't meet them, there is economic consequences to not meeting them in the form of, basically, it's a carrot and stick. So initially, it is a carrot that I will get payments or I won't get the payments based on meeting those standards. And then in the legislation, there are also sticks associated. If you don't meet them, then you're going to pay, you're going to have to write checks to the federal government. So that has created a fair amount of dynamic in the industry, and it's changed the structure of our industry.

So fundamentally, going forward, there's really just a couple companies that are doing well in this environment. And we are one of those companies. So now there's still -- there's a huge battle going on, and most of it around the IT.

Now our long-term view of where health care IT will go is that there will be a layer that is built above the current EMR-type systems that automates the workflows of physicians, doctors, nurses, laboratories and pharmacies.

That current state, what we're all doing, is automating the current medical record. The next layer that we build on that, will basically be a -- it will be a layer of metadata built on top of that. And there will be another set, most at the end of the decade, most -- many of the things we will be doing will be done off of that layer.

Now that layer is a fairly significant investment, and this is one which we started several years ago. That layer will be the layer which we will be managing the health of populations versus the workflow of a patient who's presented with a specific condition. It's a big difference. It is one that's going to kind of unfold over the next 4 or 5 years.

A specific example of that will be CMS basically announced that they will stop paying hospitals that -- when they discharge a patient, if that patient reappears within the next 30 days, they will not -- that hospital will not receive payment on it. So that, all of a sudden, is starting to have -- the whole industry is going to have to start managing people who have conditions that are outside of the traditional boundaries of the health care system. So this layer is going to be a very big part of that.

Okay. Now you're in for a treat. Marc Naughton, our CFO. Marc, by my definition, is the funniest CFO in this industry. Now I'm usually the only one who gets his jokes, but he always tells a joke and I usually forget to kind of warn you about it. So Marc?

Marc G. Naughton

It's actually good to be back here at the JPMorgan Conference. I spent the past year preparing for this meeting. I lost 50 pounds and I spent most of December at the shopping mall, pushing my way through crowds just so I could get up my energy and get through here. So I think it's really paying off. I got a personal best time getting from my one-on-one room to this meeting room, so it's working well.

Before I go on, I also wanted to thank -- unfortunately, being the funniest CFO is a pretty low bar, so -- he should have warned you about that before he told you that. Yes, I also -- I do want to put out a thank you to the Fort Knox Security Team for helping the conference this year on security detail. At least we do have a chance to get to the hallways with the smaller crowd, I guess it is.

I always like a full room. It's great. It's even better when one of your board members gets to stand in the back of the room.

And then with that, let me proceed with the financial highlights. I'm going to quickly go through these slides. They are available on our website, so if you want to check out. Clearly, income statement, we've had some outstanding performance. 2010 certainly through Q3 which is our last announced quarter, strong EPS, operating margin, revenue bookings across the board.

Balance sheet remains strong, We have $1.1 billion of cash and investments against $134 million of debt. And our free cash flow nearly doubled in 2010 for the full year last reported to $273 million. Through the year-to-date in Q3 of '11, we were at $240 million. So on track to set a record again for this year. So very strong.

As we talk -- we have spent a lot of time talking about the future of what we see in health care. And I want to kind of quantify that a little bit, at least in the medium-term view of that. So relative to 2020, what do we see as additional opportunities to grow this company during the rest of this decade?

The bar on the left of this graph talks about some of these initiatives that are listed on the right: Global, cloud/New Middle, Healthe employer, DeviceWorks, Lighthouse, RevWorks and ITWorks, all of those initiatives kind of what they represent today, which is about $500 million. We expect to see -- be able to see those businesses grow to a level that's reflected on the right side. So what is about $500 million of approximately $2 billion of revenue these days, we expect to be able to grow that by about $3 billion by the end of the decade, coming through the income statement.

And I think all of those are reasonable expectations. A lot of the things, such as RevWorks and ITWorks, only assume that we might sign another 50 or 75 clients in those initiatives over the course of that decade, and I think those are reasonable things to achieve. So certainly have a great opportunity for growth.

Probably of all of those, the nearest-term one you'll see us talking about on our calls is ITWorks, which is us outsourcing the IT department of one of our clients. That's probably revenues between $7 million and $10 million annually per hospital on that, or per client depending on if they have multiple hospitals. So that's a significant level that we can pull in from basically taking money they are already spending on their IT organization and spending it with us. It also helps us implement our systems because we're working both sides of the fence now. So strategic in addition to a way to grow the top line.

The visibility relative to our income statement continues to increase. Recurring and visibles: so recurring like support, subscriptions; and visible, which are things in the backlog, such as services that are already signed, already contracted that are going to roll out over a period of time. In 2010, we were up about 73% of that being visible, started that decade at about 41%.

So you see our backlog growing. That's not an indication we're not getting to things and getting them done. It's an indication that we're layering in more things that rollout over a period of time, and that strong backlog helps us increase our visibility as we move forward.

This business model slide is our annual report. I'm not going to go through all the details for it. The middle set of 6 boxes kind of give you the different businesses we really have: Software, Resale of Technology, Subscriptions, Transactions. And then Services, Professional Services, which our implementation. Managed services, which is hosting and Support and Maintenance. The key element of this is when you go through and look at the numbers, Licensed Software basically is kind of 15% to 16% of our total revenue. So that's why we have the ability to be highly visible relative to our income statement, because those one-time fees are a smaller portion of our revenue. But certainly, that drives the rest of our business.

We've done a good job of really expanding margins over time. We grew 230 basis points in 2010. We continue to -- since '03, of expanding them significantly, achieving over 20%. And we're targeting another 100 to 200 basis points on an annual basis of the margin growth. It is a very leveragable model, as we sign more clients for many of these initiatives, we don't need to hire a linear number of people to go deliver those services.

So in closing, I'd just tell you that this is the guidance we provide in our conference call. That's when we can provide guidance. So those are the -- that's the guidance we provided. And given time, I'll bring it to a close.

Thank you, all, for your attention.

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Source: Cerner Corporation Presents at The 30th Annual JPMorgan Chase Healthcare Conference, Jan-10-2012 10:30 AM
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