Cerner Corporation (CERN) Q3 2021 Earnings Conference Call October 29, 2021 9:00 AM ET
David Feinberg - President, Chief Executive Officer
Mark Erceg - Executive Vice President, Chief Financial Officer
Travis Dalton - Chief Client and Services Officer
Allan Kells - Senior Vice President, Investor Relations
Conference Call Participants
James - Cowen & Co.
Stephanie Davis - SVB Leerink
Sean Dodge - RBC Capital Markets
Michael Cherny - Bank of America
Elizabeth Anderson - Evercore
Craig Hettenbach - Morgan Stanley
Donald Hooker - Keybanc
Eric Percher - Nephron Research
George Hill - Deutsche Bank
Jeff Garro - Piper Sandler
Welcome to Cerner Corporation’s third quarter 2021 conference call. Today’s date is October 29, 2021 and this call is being recorded.
I’d now like to turn the call over to your host, Allan Kells, Senior Vice President of Investor Relations. Sir, please go ahead.
Thank you. Good morning everyone and thank you for joining us. On the call with me today are Dr. David Feinberg, President and CEO, and Mark Erceg, our Chief Financial Officer. David will begin the call with his initial observations since joining at the beginning of the month, then hand it over to Mark to discuss our results and outlook. We’ll then transition to Q&A and be joined by Travis Dalton, our Chief Client and Services Officer.
Before we start, I’d like to remind you that our comments will contain forward-looking statements, including projections for our business and other statements about future events. These comments are based on our current expectations and assumptions and are subject to risks and uncertainties. Our actual results could differ materially from those indicated by our forward-looking statements due to those factors identified in our earnings release, which is posted to the Investors section of cerner.com, and other filings with the SEC. Cerner assumes no obligation to update forward-looking statements or information except as required by law.
We will also be referring to adjusted or non-GAAP financial measures for our discussion of operating earnings, operating margin, earnings per share, and free cash flow. A reconciliation of non-GAAP financial measures to GAAP financial measures can be found in our earnings release. These non-GAAP financial measures are not meant to be a substitute for or superior to financial measures prepared in accordance with GAAP.
With that, I’ll turn the call over to David.
Thanks Allan. Good morning everyone and thank you for joining us. This morning, I’m going to start by sharing a bit about myself and why I chose to join Cerner, then I’ll provide some early observations and areas of focus.
For 30 years, my career has been making healthcare more accessible, more understandable, more equitable and more affordable. Early in my career, I developed a strong conviction that focusing on the patient is the only way to be successful. This was true at UCLA where our focus on patient satisfaction was foundational to an operational and financial turnaround. As such, this patient-first philosophy has underpinned my approach to everything.
At Geisinger, once we established the patient as being the center of everything we do, we were able to expand that focus to the entire community. Having an integrated care and payment model, we showed that healthcare can be of the highest quality and affordable. We also created the world’s largest biobank of whole exome sequencing because we knew that in that DNA was information we could use to keep our community healthy.
As part of our extensive use of technology at Geisinger, I built an important relationship with Google which ultimately led to an opportunity to run Google Health. I am proud of the work we did there. On Search, YouTube, Maps, we provided the world with timely and authoritative medical information, including our work on COVID, COVID symptoms, vaccines, community mobility reports, exposure notifications, and more. Our YouTube COVID information page had over 500 billion impressions.
We worked in partnership with Ascension to help organize disparate medical records, including Cerner’s, so that nurses, doctors and other caregivers could easily find information about their patients. Now transitioning to Cerner, I feel that I’ve left an amazing tech company that was playing a role in health and joined an amazing health company that is using tech to improve people’s lives.
I’d like to share initial observations.
Cerner and, frankly, other electronic health record companies have done a good job of automating processes and digitizing medical records for more than 40 years. By itself, that’s a huge accomplishment, but it’s very important that we acknowledge the fact that we haven’t reached our full potential. Digitized records, for one, need to be more useable and provide actionable information. They need to be measured by how they enable caregivers to spend more time at the bedside and less time at the terminal. Improving the usability of Cerner’s solution is at the top of my list of things to get done, and usability is just the beginning, not the true promise of the digital age.
EHRs need to do a better job of helping patients avoid unnecessary tests and medications, of helping clinicians avoid errors and suggest what treatments may work best, allowing us to understand the health of our communities, those at risk, and what interventions are working. They also need to be predictive so we can prevent unnecessary admissions and readmissions. They need to help identify risk of conditions before they become chronic, and potentially help the world avoid or at least minimize the effects of the next pandemic.
Achieving these improvements will also require industry cooperation and compliance with interoperability requirements, something Cerner has been and will remain passionate about. The pipes are laid, which is wonderful, but we must make it easier to get the right information to the right people at the right time.
Cerner has made good progress at improving the flow of information, gleaning insights from data, and helping optimize the coordination of care through offerings like analytics, registries, referrals and real time health. These capabilities remain important to our clients and to Cerner’s growth, and we will continue to enhance them as we fortify the EHR.
We also continue to believe the potential of harnessing data to accelerate discoveries and the deployment of therapies and ultimately improve patient outcomes. We have a great opportunity to do this through Cerner Enviza, which combines the expertise of the Cerner and Kantar health teams.
Something else I’ve heard plenty about is how important it is that Cerner make enhancements to our revenue cycle solutions. We need to simplify billing for patients and providers, and that starts with making the billing more integrated and seamless. We think the RevElate patient accounting offering we announced during our health conference earlier this month will do just that.
Importantly as we work together to strengthen our solutions and make them more dependable, we have an opportunity to improve job satisfaction for caregivers who are increasingly burned out by the complexity and inefficiency inherent in today’s EHRs. I know this focus will strengthen our client relationships and reduce client attrition. We are going to set reasonable expectations with our clients and meet them. This will require discipline and focus.
In the past, Cerner has tried to do too many things, often by ourselves. Going forward, we’re going to change that approach and only focus on a small number of important high value areas, some of which we plan to achieve by partnering with highly capable organizations we believe can help us achieve our mission of improving the lives of others. This new approach will provide the best and most efficient path to engage clients, providers and patients, as well as the best way for Cerner to deliver sustainable and profitable long term growth.
The current leadership team has done a lot of good work to address this ahead of my arrival. Their progress is showing up in improved performance with clients and strong financial results. For example, Jerome Labat, our Chief Technology Officer has made progress on platform modernization, advancing our approach to development. This is critical to driving needed R&D efficiencies, improving quality, increasing the speed at which we get capabilities to our clients, and lowering the cost of running and supporting our products. Travis Dalton, our Chief Client and Service Officer, continues to grow our federal business while simultaneously strengthening our client and services organization. Tracy Platt, our Chief Human Resource Officer has helped Cerner navigate a period of significant change while driving improvements in compensation practices, associate satisfaction, and diversity, equity, inclusion and belonging; and since joining earlier this year, Mark Erceg has quickly created and put in place new management reporting capabilities that are helping us make more informed decisions relative to our capex spending, R&D investment, product portfolio, partnership arrangements, and our operating structure. Mark has also helped us expand our adjusted operating margin and improved free cash flow. We’re making better use of our balance sheet by increasing our share repurchase program.
While I’ve been pleased with my direct leadership team, I’ve also been wildly impressed by the passion and enthusiasm of my 25,000-plus Cerner associates. I’ve already had numerous interactions that make it clear to me that they understand our job is much bigger than digitizing records. I believe Cerner is well positioned to better serve patients, create meaningful value across healthcare, and drive long term, profitable growth. All of Cerner has already taken important initial steps for better execution and focus, and this is showing up in our business results.
A big piece of that has been our success with the federal business, which Mark will now discuss before he provides his customary financial update. Thanks.
Thanks David, and good morning everyone.
Our federal business remains solid with the Department of Defense and United States Coast Guard continuing to deploy their Cerner-powered EHR. For example, in August the Coast Guard specific wave went live, bringing with it an additional 14 clinics and 17 sick bays located in Alaska, California, Guam, Hawaii, and Washington State. In addition, at the end of September the DoD experienced another successful deployment, expanding their footprint by 4,800 end users across 130 locations in Hawaii. The DoD is now using Cerner solutions in 17 states, over 1,000 locations, and serving around 64,000 end users. Together, we are on pace to meet their full deployment schedule on time and on budget by the end of calendar year 2023.
Moving to Veterans Affairs, in July VA officials released the findings of their 12-week strategic review. Throughout the review, the VA Secretary remained committed to Cerner, and we remain committed to the Secretary and all of America’s veterans. During that same month, our team also worked with VA leadership and providers at Mann-Grandstaff Medical Center to implement additional capabilities as we continue providing seamless care for our nation’s veterans, and just last month we secured additional VA funding to support deployments to future locations.
Now moving to our financial results, overall we’re very pleased with our third quarter results. Bookings were up 23% versus a year ago to $1.8 billion. Bookings this quarter included strong contributions from our federal business and also reflect new footprints. That said, please note that some of the booking strength was the result of some larger transactions getting done in the third quarter than we had originally expected to transact in the fourth quarter. The strong bookings this quarter brings year-to-date bookings growth to 13%.
Our revenue backlog also grew, ending the third quarter at $13.1 billion, which is up 1% versus a year ago. Revenue of $1.47 billion was up 7% over the year ago quarter, driven in large part by strong growth in federal and approximately $45 million of incremental revenue from the Kantar Health acquisition we completed earlier this year. Organic growth in the quarter was approximately 4%.
Just like bookings, our revenue in the third quarter was a little bit stronger than our initial expectations with about a half point of growth, which we originally expected to post in the fourth quarter, finding its way into the third quarter driven by the bookings upside.
Gross margin was down 20 basis points from a year ago at 82.9%, primarily due to a slightly higher mix of third party services. Adjusted operating margin, however, expanded 150 basis points from 20.4% to 21.9%, driven primarily by continued expense cost control, including the initial impact of the actions we discussed last quarter, namely a reduction in force, the classification of several properties as held for sale, and the write-down of certain in-process R&D for products that we deprecated as part of our drive to focus on the core, which David referenced during his remarks.
Those actions were a good start, but we have identified and are actively pursuing additional opportunities to improve profitability as we work towards our goal of delivering a mid-20% adjusted operating margin by fiscal 2024. For example, we continue to shrink our physical footprint, as evidenced by the designation of two additional buildings as held for sale during the third quarter. These two buildings represent an additional 435,000 square feet of space, bringing the total amount of square footage we have already sold or plan to disgorge up to 1.5 million square feet since the start of the year.
We are continuing to critically review and evaluate our product set and take end-of-life decisions so our R&D investment can be channeled towards the products with the highest return profiles. We are systematically reviewing our extensive list of partnerships which currently number in the hundreds. While we have a tremendous opportunity to improve the top and bottom line performance of many of our partnerships, we also plan to reduce or eliminate some non-value added arrangements so we can focus our precious resources on the most impactful or promising relationships.
In addition, we recently completed a comprehensive analysis of third party software and discovered we are running over 750 unique titles, which currently costs us over $330 million annually for perpetual licenses, subscriptions, and support. We will be taking concerted steps to actively manage and hopefully reduce this number and the associated costs going forward.
I could continue, but let me comment on just one more area, because I am particularly excited about it.
Over the past several years, and in large part because our client satisfaction has not been as high as it should be, it has been hard for Cerner to consistently pass along CPI escalators which are embedded within many of our contracts. Going forward as we take up David’s challenge to focus on the patient and only do a few critically important things really well, we plan to stop or jettison side pursuits that in many cases have proven to be nothing but resource drains and distractions. As we do this, we should have an opportunity to strengthen our price integrity in the marketplace, which I believe has the potential to be a significant source of incremental and profitable revenue growth in the years ahead.
In summary, we’ve made good progress at improving margins this year and plenty of opportunities remain to help us achieve our goal of mid-20% adjusted operating margin by 2024.
Wrapping up the P&L, adjusted diluted EPS was $0.86 per share, which is up nearly 20% over last year due to stronger adjusted operating earnings, a lower tax rate, and a lower share count.
Moving to our balance sheet, we ended Q3 with $782 million of cash and short term investments, which is down from $885 million last quarter, primarily driven by $375 million which we spent on share repurchases during the quarter. This brings our purchases through the end of the third quarter up to $1.1 billion. Our quarter ending debt position was unchanged versus Q2 at $1.8 billion.
Operating cash flow for the quarter was $435 million. After $48 million of capital expenditures and $76 million of capitalized software, free cash flow came in at $312 million, which is 32% higher than a year ago. Year-to-date free cash flow is $765 million, which is up 66% compared to the same period year ago.
Moving to guidance, we expect revenue in Q4 to grow upper mid single digits compared to Q4 of 2020. This includes approximately $50 million of revenue from the Kantar Health acquisition, which is now part of Enviza, bringing fourth quarter organic growth to the low to mid single digit range. This guidance also implies full year 2021 revenue growth of approximately 5%, which is consistent with our prior guidance. Organic growth for the year would also be in the mid single digit range.
We expect fourth quarter adjusted diluted EPS growth of 10% to 13% over Q4 of 2020. The high end of this range would bring full year adjusted diluted EPS to $3.30 a share, which would be growth of about 16% over last year. Importantly, this is $0.05 higher than the full year guidance we provided last quarter and $0.15 higher than the midpoint of original guidance we provided at the beginning of the year.
For the fourth quarter, we expect our tax rate to be approximately 19%, and I am very happy to communicate that we now expect to generate more than $950 million of free cash flow for the year. If achieved, that would be a new record amount, breaking last year’s $857 million, which was also a new record high at the time, by roughly $100 million.
Finally, we remain on track to repurchase up to $1.5 billion of stock this year, which we believe will make better use of our strong balance sheet and free cash flow while still maintaining ample access to capital to fund high return organic growth opportunities and potential future acquisitions, provided of course that those acquisitions are attractive both strategically and financially.
In summary, I’m very pleased with how the entire Cerner team has been performing, which has directly contributed to our strong third quarter results and year-to-date results. I also want to take a moment to extend my warmest welcome to David and express my genuine excitement upon his arrival. David has quickly bonded with the entire Cerner family, connected with an impressive number of clients, and sharpened Cerner’s strategy and focus. We are all energized by David’s presence and feel like all the pieces are quickly coming together, which we believe will over time allow Cerner to fully realize its significant potential to positively impact healthcare while also generating meaningfully higher levels of total shareholder return.
With that, I’ll turn the call over to the Operator for your questions.
Your first question comes from the line of Charles Rhyee at Cowen. Your line is open.
Hi, it’s actually James on for Charles. Can you maybe talk more about the recently launched Cerner Enviza and maybe what the financial profile of that operating unit looks like and how we should think about that growth profile going forward? If I recall correctly, at the 2020 investor community meeting, I think you sized the TAM of data as a service at about $45 billion and the four-year CAGR at around 40%. Has that opportunity changed since then, because it seems like with the pandemic, there’s been an acceleration in demand for these types of solutions.
Thank you for the question. I’ll say a few things just about the financial profile, then I’ll let David comment more fully on the strategy element.
At this point, we’re really very pleased with how the integration is performing. I can tell you that versus the going-in acquisition economics, we’re running about $2 million high on revenue and about $5 million high in both adjusted EBITDA and adjusted operating margin. We’re actually running about 300 full basis points ahead of our plan as it related to that, and we’re looking at an adjusted operating margin of roughly 19% at this point in time, so from a financial standpoint this thing is playing out really very well. We feel really good about where we are. We’re going to have about $130 million of full year revenue, and of course that’s a partial effect since we closed on the acquisition on April 1.
Then as far as how we think about it more holistically, I’ll turn that over to David.
Thanks James. To me, it’s pretty straightforward that there’s a tremendous amount of data that we have the privilege of sharing with the healthcare providers that we work with, and what we need to do, and I think it’s been a promise all along, is to make that data understandable and actionable. We think that bringing in the folks from Kantar combined with our team allows us to understand that data in a better way, analyze that data, and then really provide it back to our partners in a way that they can take actions to improve people’s health.
Okay, and just one follow-up. As we approach 2022, is there any large customer attrition we should be mindful of?
There’s been some known losses in the past that will continue to play out over time, but as we think about our growth algorithm, all that has already been contemplated and I think it’s reasonable to assume that when we do come forward with guidance, it’ll be along the lines of what we indicated previously, which is mid single digit top line revenue growth and us then moving our way towards a mid-20 adjusted operating margin by fiscal ’24.
James, let me add to that. My sense is that we may have attrition because of mergers and acquisitions, and while that’s disappointing and that’s built into our models, it might be difficult to avoid. The attrition when it’s not due to mergers and acquisitions but rather disappointment in our products and services, it’s something that’s completely unacceptable to me, and I’ve challenged the team to make sure I’m in front of those clients in my first 100 days so that I can build those relationships and show them how important they are, and that we can actually deliver and solve some of their problems. I would expect that attrition over time to become less of an issue at Cerner.
Okay, thank you for the color.
Your next question comes from the line of Stephanie Davis from SVB Leerink. Your line is open.
Hi guys, thank you for taking my questions. David, I want to touch on one of your first memos to the firm regarding some of the layoffs. Those sound to me a little bit more team-specific than [indiscernible] overall as we’ve seen in the past, so I was hoping you and Mark could give us some thoughts on how you’re optimizing the structure and maybe how it’s different than some of the historical approaches.
Yes, let me ask Mark first to talk about the structure, and then I’m happy to cover layoffs and my philosophy in general.
Yes, I think we’ve talked about the fact that we have six business models that are really revenue recognition constructs, so what we’ve been doing is putting in all the piping so that we can have a real world-class management reporting system that’s going to be based on a number of operating units that will have fully allocated P&Ls. That, I think, is going to enable us to drive our cost profile and, frankly, operate more efficiently so that we can serve our patients and our clients better.
A big part of that is then being able to drive operating efficiency through all the processes that we are building out, and that goes all the way through the R&D side of the house and through everything else that we’re doing. I think we’re starting to see some early results and wins as it relates to that, because when you understand your product level profitability, your client level profitability, your fully allocated operating unit profitability, you can make better decisions.
For example, for the past five years through fiscal 2020, we had our revenue growing roughly 4% per year, but our operating expenses were growing by 6%. During that time frame, we saw a 440 basis point contraction in our adjusted operating margin, and that’s to be expected because you’re 200 basis points to the bad when your expenses are growing 6 and your revenue’s growing 4. Well, fiscal year to date for 2021, our revenue’s been growing 4.9%, our operating expenses have been growing 1.4%, so now we’ve increased our margin by 190 basis points on an adjusted basis year-to-date because we’re operating 350 basis points to the good. That’s a huge reversal of 550 basis points.
The management reporting structures we’re putting in place are allowing us to do that and do that efficiently and effectively, and I think that’s critical to our long term success, and that’s why I’m so frankly confident that we’re going to be able to get to the mid-20s by fiscal ’24.
Stephanie, let me add my philosophy. My sense is that when you lay off a person, you’re actually not laying off a person, you oftentimes are impacting an entire family, so I like to multiply any layoff in my mind by four or five about how many people are being affected, and I think it’s terrible. I think if oftentimes is a reflection of management not predicting where the business is going and getting folks retrained for areas of growth so that this stuff doesn’t happen. We need to right the ship and I think that’s part of the process here, but in some ways to me it’s been lack of discipline and lack of focus. Not only do layoffs affect the individuals and their families, it also affects those that remain at the organization because there’s survivor guilt and there’s fear about what’s coming next, so we will work our way through this.
Going forward, we will be more disciplined about thinking about where our business is going and how we can retrain our folks to be best positioned to help us as we’re going forward. There’s no way we’re going to shrink our way to greatness, so while these are some immediate measures and I think they are corrective and I am supportive of them, they don’t fit with my philosophy going forward.
Let’s pull on that thread a little bit more, then. How should we think about R&D spend? Will it be shrinking less and more pivoting folks to new teams and new initiatives and that will have less internal investment as a result, or is this something that you’re going to be thinking as more of an out year project given where we are right now?
Yes, it’s a great question. I think we talked about the fact that we had 671 scrum teams, we now have a system in place that allows us to actively manage where those teams are assigned and what the output from their work is. We do have a meaningful investment in that area - it’s about $800 million a year. I would expect as we think about our modeling that that $800 million will probably stay relatively constant for the next couple years, but I wouldn’t expect it to increase necessarily, and as we continue to grow the top line, I would expect R&D as a percent of sales then to drop. For us to get to a mid-20s adjusted operating margin by fiscal ’24, we can’t continue to spend R&D as a percent of sales at the rates we’ve been spending in the past.
Now the good news is I think as we continue to spend roughly $800 million a year, we’re going to get a whole lot more for it. The automation tools that Jerome putting in place, the digital factory that he’s standing up, the simple fact that we’re going to be a lot more disciplined and focused about where we put our scrum teams and what we expect them to generate and produce is going to, I think, be somewhat revolutionary around here, so I’m very, very excited. I think we can get a lot more traction with the same amount of spending, or potentially even a little less over time certainly as a percent of sales.
Super helpful. Looking forward to how you guys are going to right the ship.
Your next question comes from the line of Sean Dodge from RBC Capital Markets. Your line is open.
Thanks, good morning. David, you mentioned narrowing your focus on a small number of high value areas. Can you give us a little more specificity on what you see those being, and then what are a couple examples of the side pursuits that, Mark, you mentioned you expect to be winding down here in the near term?
Thanks Sean. Yes, we’ve had quite a bit of discussion with the team since I’ve been here over the last few weeks around this particular area, so I don’t know that I’d have the perfect words to describe it, but I’ll tell you where we’re at and I think it starts to make sense.
To me, we need to make the EHR reliable and usable, and when I say make the EHR reliable and usable, when I say that, that of course in my mind means--and that means billing works too, so I describe the EHR of today, it’s not only the digital record but the ability to conduct the business that’s needed for health systems all over, and that same EHR in my mind also needs to be a tool that allows grandma’s blood sugar to get to where it needs to get to, so it has to be interoperable, it has to have on top of it analytics that you can make predictions around individual patients, around communities. You have to be able to use that EHR in a way that allows you to be successful in a fee-for-service or a fee-for-value model.
That’s the list of what we’re doing. When I say fix the EHR, to me it’s broader than what Millenium does right now, but it’s really parts of Millenium or all of Millenium along with what we’ve done around billing in addition to the population health tools, the predictive tools that are so important in today’s ecosystem of taking care of people.
Then we have actually--you asked the second question to Mark, but I’m going to answer it. You also asked for the list of what are the things we’re not doing. We kind of went down that rabbit hole and what we came to is instead of saying that, what we’re going to say is here are the things we’re doing, and if it’s not on the list, that means we’re not doing it. What we’re doing is fixing the EHR to make it usable, make it reliable, make sure that the billing works and make sure it has on top of it that layer that allows information to flow freely, so that patients and families can get the information where they need to get it. That’s the list of what we’re doing, and everything else is on the do-not-do list.
Okay, that’s helpful, thank you.
Then maybe going back to Enviza, can you help us just better understand the scale and the composition of the data set you’re able to leverage there, and maybe the extent to which that gives you an advantage versus what others in the market are offering? I guess you said you had the privilege to use data from health systems. What proportion of your footprint do you have rights to and are able to draw from?
I don’t know the specifics to that, and we can get back to you on that.
I can give you a real high level on that. You’ve probably heard us talking about HealtheIntent having several hundred million records in it, but there’s also a subset for which, as part of the data as a service strategy, we went and worked with--now I think we’re updating 80 or so clients as part of the learning health network, where we got basically new clean data rights agreements with them that is part of the overall data as a service strategy. I think those clients represent close to 100 million records, so that’s how I would think of that as part of the data set.
Okay, great. Thank you.
Your next question comes from the line of Michael Cherny from Bank of America. Your line is open.
Good morning. Thanks for taking the questions. David, welcome to your first call as well.
I want to dive in a little bit on the cash flow dynamics. You’ve seen some pretty nice step-up in cash flow, which I know has been a big focus point of the team. That being said, I know there’s also been a pretty large increase in stock-based compensation, so as you think about, and I’m not necessarily looking for longer term guidance, but how do you balance the dynamics of rewarding your employees, especially the ones that are so crucial for this rebooting thought process, against managing where that could eventually become a bit of a dynamic issue in terms of the actual cash payouts as that stock-based compensation comes to fruition.
Well, it’s like you said - it’s a balancing act, right, so we have been generating a lot of additional free cash flow, we drive our revenue profitably and we expand our margins, that gives us a lot more cash to work with. We’re also making some very specific and measured steps as it relates to payables and receivables. We’ve been doing a really good job working through the client org, on collections and managing any bad debt expense, or anything else that would come along those ways, and that is giving us a lot of discretion then to do things like share repurchase and potentially future M&A, dividend increases, and any number of other things.
As far as how we think about using equity to incentivize and reward folks, we want everyone to have skin in the game. We want to have an ownership mentality across all the associates - that’s important to me, that’s important to David, it’s important to the board, and we certainly aren’t going to do anything that gets us too far out over our skiis, but we constantly monitor the marketplace for best pay practices and certainly with respect to equity, we make sure that everything that we’re doing is long benchmarked, so we feel good about the balance we’ve struck as we sit here today.
Mike, this is Allan. I’d like to add one thing, just so you understand the increase you’ve seen in share-based comp. Some of that is temporary. As you may have noticed over the last few years, we’ve shifted from what used to be options that vested over five years to restricted shares that vest over three, so what you’re seeing now is overlap in vesting that’s impacting that. We also had some retention grants during that period of the early transformation, and when you’ve seen some senior people leave and had some accelerated vesting, that’s impacted it.
There’s several factors that have increased the growth rate that are temporary. I think as you go forward, you’ll see that the growth slows quite a bit after this year.
Thanks, that’s really helpful color on both. If I could just ask a question on the bookings, it’s never a bad thing to sign things earlier than expected. Can you just give us a little sense in terms of what was signed earlier and what was pulled forward from fourth quarter, maybe even first quarter? What was the decision process on the part of your customers to decide that now is the time to make sure we’re moving forward?
Travis, that’d be a great one for you.
Thanks Mark. Yes, thanks for the question, I appreciate it.
Yes, we had a really solid Q3, a great Q3, and our year-to-date results were good. I would say we had good contribution from all of our business units. One other thing I said when I entered the role was we were going to operate with energy and enthusiasm, and we were going to compete. We’re doing that in all of our market segments.
I think one thing that’s really important for us on the client retention side is that we have a lot of extension and expansion opportunities inside of our client base, and we have better insights into those activities. I think we’re getting to our clients sooner than we were before because of some of the hard work we’ve done to run the business with more data and discipline, and so we have the opportunity to go to clients in a more proactive way versus a reactive way at a renewal time to, one, keep them, but two, drive value and, three, to continue the conversation of how we best serve them and the caregivers.
We were able to move some things forward on the extensions, so we had some very large opportunities. We had a great opportunity in the Middle East sign, we secured one of our biggest clients inside the U.S. at Medstar, which is a great client of ours, and we also had really good federal activity and we had several task orders that came in that we were expecting early in our fourth quarter there and the fiscal year.
I would say it was great contribution across the board from all the market segments, better data, better insights, and competing harder. That’s how I would categorize it.
Great, thank you.
Your next question comes from the line of Elizabeth Anderson from Evercore. Your line is open.
Hi guys, thanks so much for the question, and welcome to Cerner, David.
Maybe as a follow-on to Michael’s question, can you just talk about any sort of residual COVID impacts you’re seeing, whether that’s employees being able to visit sites or they’re now allowed to basically access everywhere, and then any kind of demand shift as we’re exiting the COVID period, that would be helpful, thanks.
Elizabeth, I’ll take the first part. It seems different by regions, that it seems very regional. I’ve met with a lot of customers via video conference and many actually onsite now, but some have said we’re not taking visitors yet, and that’s just me but I think it’s the same for the rest of our team, so it really depends. However, it seems much better than it was 60 days ago, so it seems like it’s going in the right direction with the exception of a few hotspots.
Then as far as the workforce goes, our plan is after the first of the year, to bring folks back in, in a hybrid, and right now it’s a scattering of people coming in and of course that have to be here, so that’s kind of where we’re at. I don’t want to be overly optimistic, but it seems like there’s a little bit of light at the end of the tunnel.
Got it, and so would it be fair to say, though, from the client perspective that even though there are some hotspots and broader focus on obviously with COVID, that they are sort of willing to and able to engage in longer term strategic planning and thought process in terms of looking at your product solutions or extending things, that kind of thing?
Yes, I would actually say a couple of things. One, they’re burned out, so our focus on usability is going to be crucial; and two, what COVID showed the world in healthcare is how important understanding and using data is. I don’t want to say a silver lining, but I think it really sets us up in a way to be even more helpful as people start to think about how much care is going to remain virtual, how do we better predict who’s coming into the hospital, what kind of supplies we need, workforce issues - all of those things, I think set us up in a positive way. Folks are, besides being tired and burned out, I think are very receptive to continuing to work with us to improve healthcare, and in particular healthcare operations.
Got it, that’s helpful. Thank you.
Your next question comes from the line of Craig Hettenbach from Morgan Stanley. Your line is open.
Yes, thank you. A question for David just on the message of a focus on a few evaluated opportunities, and there was commentary of R&D staying flat at $800 million, which is consistent with prior commentary. How do you think about just the implications for longer term growth and how you’re approaching it from kind of an organic, as well as potential M&A opportunities?
Yes, so for me the opportunity, if we’re able to make electronic health records in that broader way that I define it reliable and usable and provide the analytics and the predictions that would allow caregivers and health systems to make better decisions about caring for patients, I think the--I’m wildly optimistic about our outlook for long term growth. If doctors and nurses start saying, this thing is really helping me, I think we will continue to see significant growth going forward.
As far as organic versus M&A, I’m still getting up to speed. One of the rules I have is to really learn more about the organization before we make any big moves, and I’ve had a team that’s got me up to speed quickly, so we’ll continue to evaluate what’s out there, and also as Mark mentioned, think about being more thoughtful about partnerships too.
Great, thank you. Then just a follow-up for Mark, you mentioned the potential to save on software, that $330 million. Is that included in your expectation to get the operating margins to the mid-20s, or if you get some savings there, could there be some upside?
No, I think everything we’re doing right now is geared towards getting to that mid-20s by fiscal ’24, so that’s just another example of the areas that we’re going to be using to affect and utilize our abilities to drive towards that. Last time, we talked a lot about the write-down of the capitalized R&D, the designation of the number of properties as held for sale, and then the reduction in force that we effected last quarter. You’ll recall that there was charges associated with each of those three - it was $48 million, $68 million, and $54 million respectively. Those things at the time combined for about $70 million worth of annualized savings.
We’ve put additional properties up for sale now. We do have an additional limited reduction in force that is being effected now, that’s going to affect about 150 associates. You put those two things on top of it, that’s another $20 million of annualized run rate savings, and it’s also important to note that we really are trying to manage our cost take-out through attrition wherever possible, to David’s point earlier, and we are down literally 1,000 associates from the end of Q2 to the end of Q3. Now, half of that was because of the reduction in force that we effected, the other half was from managing the attrition and managing that well.
We have a lot of things that we can do and a lot of things that we can deploy in order to get to that mid-20s by fiscal ’24, and the software example was just another illustrative case of things where we spend a lot of money, where we could do a lot better by just managing things tighter.
Great, thanks for the color.
Your next question comes from the line of Donald Hooker from Keybanc. Your line is open.
Great, thank you. I’m just trying to get my--you guys have obviously had great outcomes here around operating margin improvement. Just trying to get my bearings here. My understanding of this is there might be some seasonality to that in the fourth quarter, so operating margins could step up even more kind of sequentially in the fourth quarter, but then you mentioned earlier there is some timing around some large--it sounded like there was some timing around some software purchases that might have been pulled forward into the quarter that might cause margins to be artificially inflated in Q3. Can you just maybe walk through the seasonality this year of your operating margins?
Yes, what I’d say there--this is Allan. The seasonality is going away over time, right? If you go back a few years ago, we had a much higher portion of our licensed software coming in, in any given quarter, and in a five-year period it switched from total licensed software being one-third recurring and two-thirds upfront to the reverse of that today - it’s about two-thirds recurring, so because of that, you have less fluctuation in that upfront, high margin revenue and as a result, you’re going to have a little bit less fluctuation in your margins. They can progress as you go through the year, which is what our Q4 guidance implies, that it will go up sequentially, but there’s not necessarily some big one-time thing that’s going to cause it go up dramatically.
Okay, super. That’s helpful.
One quick follow-up, maybe just around the new Enviza life sciences business model. Are you envisioning this business competing with CROs? Is this kind of a--going to be doing things that a lot of CROs are doing, or are you going to partner with them? How do you interact with those types of organizations?
Hey Donald, we’re still trying to get up to speed on it, but my take would be this is not a CRO. This is really more about helping that ecosystem have better insight into what’s happening, real world evidence, and then maybe that allows CROs to be more focused on what they’re going after. It’s really understanding the data and having those insights, which I think then really positions us well to partner with CROs and other academics.
Okay, thank you.
Your next question comes from the line of Eric Percher from Nephron Research. Your line is open.
Thank you. David, welcome, and appreciate the candor.
A question for the team. The rev cycle product consolidation seems very significant. I think it’s fair to say that there have been challenges there when we talk to your client base. Can you provide some context for how long you’ve been developing the new combined product and is it safe to assume this is a multi-year rollout, and I think there’s maybe a question there as well for Mark relative to headwinds for this, given no incremental license or consulting fees. How do you think about headwind turning to tailwind?
I guess what I’d offer is, look, we’ve been working on our rev cycle products for a number of years. It’s a key portion and key part of what we do, so we’re going to continue to invest behind that. You are right - we do have a large installed base that’s out there, and so for us to uplift them over to the new product suite, it’s going to take a number of years, but it’s something that’s part of our thinking and it’s part of our planning process, so all that’s been taken into account as we think about our going forward growth algorithms.
Yes Eric, let me just add that this decision was made before I got here, and my input when I was brought up to speed was this should have been done before. I think we should have made this move earlier. There was kind of a philosophy of if it isn’t built here, it’s not the best, and I think--and actually talking with customers, really their initial response is, finally, then they get to well, how’s is the transition going to be and there’s issues, etc. But I think it’s the right decision.
Can I ask you a question, Eric? Is Nephron based on the kidney?
That’s right, the filter.
The filter? So you’re an analyst that has a background in the kidney. That’s fascinating.
A quick follow-up there. That initial response as you introduced this a couple of weeks ago, are people lining up or is there a wait-and-see approach, given the history in rev cycle?
I think our team has reached out to folks and they’ve been--we have a planned rollout over a number of years to get folks onboard, and so that’s being worked on right now, but I do think we have the first couple of rounds already scheduled.
Perfect, thank you.
Your next question comes from the line of George Hill from Deutsche Bank. Your line is open.
Good morning guys. Thanks for taking my question, and David, I’ll echo the welcome aboard.
I guess my question is about population health and HealtheIntent, which I think a handful of years ago we were expecting this to be a very large product, and we’re seeing a lot of capital markets activity and a lot of provider activity around risk taking and the various flavors of risk taking. David, how do you feel like Cerner is positioned here, either as a provider of technology or as a provider of services, where we’re seeing a lot of smaller companies make a lot of traction here and a lot of provider organizations, particularly in the ambulatory space, who kind of want to take this risk and manage this risk themselves? I know Cerner had a plan at one point to offer a lot of services in this space, but would like to hear how you’re thinking about that segment of the market.
Yes, thanks George. My philosophy on population health, especially if you’re not an organization that’s been doing it for a long time, more than anything it’s a cultural shift. The data is really, really important, but it’s about changing how you think about running your health system.
What we want to do, and I think Cerner was right early on thinking of this platform as a way to collect disparate data sets, including registries, including electronic health records, social determinants of health, genomic information--I mean, the more data the better to be able to make those predictions and manage it. I don’t know that we’ve executed very well, and what I think you see in the market are some point solutions that are probably beating us head-to-head on some of those point solutions, but to fundamentally change healthcare you need to have that broad view of everything that’s going on, otherwise there’s a lot of incumbents to sort of push you out.
I think we are positioned if we execute well here to really be able to bring in multiple sources of information to allow our partners, those caregivers not only to manage an individual patient but to think about communities and populations in a way that allows them to think of hospitalization as failures of outpatient care, and outpatient care as failures of home care, and home care as failures of self care and community care. But that is a cultural change.
It’s really important for us to get the data right and to help them with that, but the big lift is really in the mindset and thinking of not how many transplants did we do this month but rather how many organs did we save this month. It’s a big shift, and I’ve been fortunate to be in systems where they’ve had long histories of doing that, and even in those integrated systems there is often a pull towards the old way of doing things, so we think that--or I think that the HealtheIntent was the right strategy. I think we have to streamline it. Some of it is falling behind some of the competition - we’ll bring it up to speed, and then I think it puts us in a great position to help, which is great because if we really achieve population health, we’re talking about improving health for everyone, really working on the equity issues, and we’re also talking about decreasing the cost of care as well as improving the quality, so we’re all in, we just need to figure out exactly how we take HealtheIntent from today and get it more up to speed.
Great, and if I could have a very quick follow-up, I’d love to know what is the one biggest thing that you take from your experience at Google that you think can add value at Cerner?
The user is super important. I mean, I think EHRs have been built as billing machines, I think they’ve been built as lab machines, and nobody has built an EHR for a nurse in the ER, no one has built an EHR for a busy ambulatory care physician, no one has built an EHR that said, our goal is to make it easy for this interventional cardiologist, or for that population healthcare manager nurse. What I learned at Google was--well, I was surrounded by some of the smartest engineers and product people, but the UX team was why I think Google and some of these other tech companies have been so successful in getting products that have billions of users.
Thank you very much.
Our last question comes from the line of Jeff Garro from Piper Sandler. Your line is open.
Yes, good morning. Thanks for squeezing me in. Maybe we’ll close it out by returning to the theme of taking the noise out of healthcare and improving provider satisfaction. Was hoping you could provide more detail on what needs to be done on the software side and compare that with what needs to be done on the implementation and training side to improve usability, and maybe help us think about the appropriate range of timelines over which those changes can be made to impact the end users.
Hey Jeff, I think the key to this is to build the products, kind of going back to the last question, with the user in mind, and the best way to do that is to make sure that everything we’re building is clinically infused. If it’s clinically infused and that nurse that’s worked 40 years in the ER will go, hey, this makes my job worse, then we won’t build it that way. We need that kind of input, and we’ll build our own internal team to make sure everything we’re doing is synced up with our product folks and our engineering folks, and that that clinical person has a very, very important voice in that, as well as, and I heard this over the last month as I’ve been visiting our customers, they want to help us. The folks that have picked Cerner as their electronic health record partner are actually very tied into our success, as we are to theirs. What they’re saying to us is we have ideas and you haven’t listened, so I think we need to be clinically focused here as we’re building products and wide open to our current customers to make sure we’re taking their feedback to improve it.
What it looks like means you’re not clicking 70 times to get to Tylenol, it means you’re not looking through a record to try to find did somebody have a pneumovax vaccine. It means that when you think about diabetes, the record says to you, well yes, here’s everything on diabetes, and by the way, there’s no LDL on this patient, have you thought about that. That’s what we’re talking about usability.
Where you start--currently when you’re a frontline doc or nurse and you’re using our system or, if I may be so bold to say any of the systems, there are so many things you need to do that send you a message that you don’t matter. You become a data clerk, and all we’re doing is trying to improve billing or documentation, but you don’t matter as a clinician. We need to flip that on its head, that says we’ve been thinking about you, we know the work you’re going to need to be doing, and we’ve been anticipating that, so when you type a couple of letters, the auto complete fills out what you’re thinking about, or when you’re looking for a temperature, we’ve put all the temperatures together, including the T-max and the temperature over the last 36 hours, and when you’re looking for things, it’s not a record that’s really just a compiled cut and paste, but really about that story of that patient or that story about that community population.
That’s what we mean by taking the noise out and really saying back to the doctors and nurses and pharmacists and social workers on the frontline and care managers, we’ve got your back, we’re going to help you do your job.
Thanks, that really helps. Maybe to follow up a little bit on clients wanting to help. Maybe you could provide a little bit more detail on what the broad client base could learn from some of your top performing clients in particular areas that are using the product efficiently and are satisfied, and just reapplying those learnings broadly to maybe more swiftly make some changes versus rebuilding things from the ground up.
Yes, some clients are doing really well with med reconciliation. We need to spread that around. Some clients are using really our OB product very well. There’s clients that are using our care management tools really well and others saying, I’m having trouble with care management, so there’s--by just being out and about and listening to folks, or med administration for nurses at the bedside, I’ve heard a lot of that.
I’ve also heard about our HealtheIntent, where in the U.K we used HealtheIntent to evaluate the population, and that team there found that for the flu, having a risk factor of learning disabilities increased your chance of hospitalization for the flu two times greater than those that had COPD, so that’s not something that I learned in med school. That’s something that the data, and that was the team there using our HealtheIntent, found that learning disabilities is a bigger predictor of hospitalization for the flu than a history of chronic obstructive pulmonary disease. Now, that becomes actionable and then they set up a flu clinic for people with learning disabilities, 92% of the folks came in to get the flu shot and that not only decreases hospitalization and decreases cost, that saves lives.
Now, our job is to say, okay, that learning happened there, now how do we set up flu clinics for people with learning disabilities all over the world, because that will probably save more lives than I ever could do as an individual doc - I’m positive. That’s the promise of taking what some folks have done with our information and getting it out to everyone else. I’ve only been here 28 days or something like that. I know there’s more out there, and we need to tap into that and we need to create that system where that sharing of information is such that it really starts to accelerate really what we came here for, is to make a lot of people’s lives better when they get sick and to prevent a lot of people from getting sick.
That’s a great example, thank you.
All right, with that we’re going to thank everybody for joining, and happy to take any follow-up calls.
Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.