Cerner Earnings 2019-03-30
CERN 10Q Quarterly Report
| Balance Sheet | Income Statement | Cash Flow |
|---|---|---|
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 30, 2019
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number: 0-15386
CERNER CORPORATION |
(Exact name of registrant as specified in its charter) |
Delaware |  | 43-1196944 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
2800 Rockcreek Parkway North Kansas City, MO | 64117 | |
(Address of principal executive offices) | (Zip Code) | |
(816) 221-1024
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ ] Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of the issuer's classes of common stock, as of the latest practicable date.
Class | Outstanding at April 17, 2019 | |
Common Stock, $0.01 par value per share | 325,420,595 shares | |
CERNER CORPORATION
TABLE OF CONTENTS
Part I. | Financial Information: | |
Item 1. | Financial Statements: | |
Item 2. | ||
Item 3. | ||
Item 4. | ||
Part II. | Other Information: | |
Item 1A. | ||
Item 2. | ||
Item 6. | ||
Signatures | ||
Part I. Financial Information
Item 1. Financial Statements
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of March 30, 2019 (unaudited) and December 29, 2018
(In thousands, except share data) | 2019 | 2018 | |||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 503,161 | $ | 374,126 | |||
Short-term investments | 400,509 | 401,285 | |||||
Receivables, net | 1,159,215 | 1,183,494 | |||||
Inventory | 24,104 | 25,029 | |||||
Prepaid expenses and other | 336,817 | 334,870 | |||||
Total current assets | 2,423,806 | 2,318,804 | |||||
Property and equipment, net | 1,790,116 | 1,743,575 | |||||
Right-of-use assets | 134,137 | — | |||||
Software development costs, net | 915,149 | 894,512 | |||||
Goodwill | 846,740 | 847,544 | |||||
Intangible assets, net | 385,128 | 405,305 | |||||
Long-term investments | 283,596 | 300,046 | |||||
Other assets | 219,840 | 198,850 | |||||
Total assets | $ | 6,998,512 | $ | 6,708,636 | |||
Liabilities and Shareholders' Equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 290,947 | $ | 293,534 | |||
Current installments of long-term debt and capital lease obligations | — | 4,914 | |||||
Deferred revenue | 337,811 | 399,189 | |||||
Accrued payroll and tax withholdings | 230,407 | 195,931 | |||||
Other current liabilities | 81,459 | 69,122 | |||||
Total current liabilities | 940,624 | 962,690 | |||||
Long-term debt and capital lease obligations | 438,823 | 438,802 | |||||
Deferred income taxes | 343,788 | 336,379 | |||||
Other liabilities | 146,128 | 42,376 | |||||
Total liabilities | 1,869,363 | 1,780,247 | |||||
Shareholders' Equity: | |||||||
Common stock, $.01 par value, 500,000,000 shares authorized, 362,919,192 shares issued at March 30, 2019 and 362,212,843 shares issued at December 29, 2018 | 3,629 | 3,622 | |||||
Additional paid-in capital | 1,591,138 | 1,559,562 | |||||
Retained earnings | 5,742,744 | 5,576,525 | |||||
Treasury stock, 37,905,013 shares at March 30, 2019 and December 29, 2018 | (2,107,768 | ) | (2,107,768 | ) | |||
Accumulated other comprehensive loss, net | (100,594 | ) | (103,552 | ) | |||
Total shareholders' equity | 5,129,149 | 4,928,389 | |||||
Total liabilities and shareholders' equity | $ | 6,998,512 | $ | 6,708,636 | |||
See notes to condensed consolidated financial statements (unaudited).
1
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended March 30, 2019 and March 31, 2018
(unaudited)
Three Months Ended | |||||||
(In thousands, except per share data) | 2019 | 2018 | |||||
Revenues | $ | 1,389,877 | $ | 1,292,861 | |||
Costs and expenses: | |||||||
Costs of revenue | 253,204 | 231,278 | |||||
Sales and client service | 640,187 | 589,948 | |||||
Software development (Includes amortization of $56,245 and $50,001, respectively) | 180,361 | 161,617 | |||||
General and administrative | 96,196 | 92,294 | |||||
Amortization of acquisition-related intangibles | 21,985 | 22,509 | |||||
Total costs and expenses | 1,191,933 | 1,097,646 | |||||
Operating earnings | 197,944 | 195,215 | |||||
Other income, net | 8,432 | 4,864 | |||||
Earnings before income taxes | 206,376 | 200,079 | |||||
Income taxes | (40,157 | ) | (40,078 | ) | |||
Net earnings | $ | 166,219 | $ | 160,001 | |||
Basic earnings per share | $ | 0.51 | $ | 0.48 | |||
Diluted earnings per share | $ | 0.51 | $ | 0.48 | |||
Basic weighted average shares outstanding | 324,573 | 332,395 | |||||
Diluted weighted average shares outstanding | 327,003 | 336,534 | |||||
See notes to condensed consolidated financial statements (unaudited).
2
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended March 30, 2019 and March 31, 2018
(unaudited)
Three Months Ended | |||||||
(In thousands) | 2019 | 2018 | |||||
Net earnings | $ | 166,219 | $ | 160,001 | |||
Foreign currency translation adjustment and other (net of taxes (benefit) of $(183) and $920, respectively) | 2,321 | 2,794 | |||||
Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $210 and $(293), respectively) | 637 | (898 | ) | ||||
Comprehensive income | $ | 169,177 | $ | 161,897 | |||
See notes to condensed consolidated financial statements (unaudited).
3
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended March 30, 2019 and March 31, 2018
(unaudited)
Three Months Ended | |||||||
(In thousands) | 2019 | 2018 | |||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net earnings | $ | 166,219 | $ | 160,001 | |||
Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||
Depreciation and amortization | 166,671 | 152,592 | |||||
Share-based compensation expense | 19,860 | 24,935 | |||||
Provision for deferred income taxes | 3,998 | (3,047 | ) | ||||
Changes in assets and liabilities: | |||||||
Receivables, net | 13,789 | (70,608 | ) | ||||
Inventory | 928 | 1,445 | |||||
Prepaid expenses and other | (13,318 | ) | 125,550 | ||||
Accounts payable | (10,891 | ) | 7,608 | ||||
Accrued income taxes | 4,256 | 7,195 | |||||
Deferred revenue | (61,547 | ) | (7,205 | ) | |||
Other accrued liabilities | 27,301 | 10,499 | |||||
Net cash provided by operating activities | 317,266 | 408,965 | |||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Capital purchases | (119,261 | ) | (79,711 | ) | |||
Capitalized software development costs | (74,551 | ) | (73,602 | ) | |||
Purchases of investments | (90,953 | ) | (151,387 | ) | |||
Sales and maturities of investments | 110,104 | 101,674 | |||||
Purchase of other intangibles | (8,994 | ) | (8,472 | ) | |||
Net cash used in investing activities | (183,655 | ) | (211,498 | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Repayment of long-term debt | — | (75,000 | ) | ||||
Proceeds from exercise of stock options | 15,281 | 10,036 | |||||
Payments to taxing authorities in connection with shares directly withheld from associates | (1,730 | ) | (1,723 | ) | |||
Treasury stock purchases | (20,542 | ) | (87,624 | ) | |||
Net cash used in financing activities | (6,991 | ) | (154,311 | ) | |||
Effect of exchange rate changes on cash and cash equivalents | 2,415 | (680 | ) | ||||
Net increase in cash and cash equivalents | 129,035 | 42,476 | |||||
Cash and cash equivalents at beginning of period | 374,126 | 370,923 | |||||
Cash and cash equivalents at end of period | $ | 503,161 | $ | 413,399 | |||
See notes to condensed consolidated financial statements (unaudited).
4
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the three months ended March 30, 2019 and March 31, 2018
(unaudited)
Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Loss, Net | ||||||||||||||||||
(In thousands) | Shares | Amount | ||||||||||||||||||||
Balance at December 30, 2017 | 359,205 | $ | 3,592 | $ | 1,380,371 | $ | 4,938,866 | $ | (1,464,099 | ) | $ | (73,382 | ) | |||||||||
Exercise of stock options (including net-settled option exercises) | 667 | 7 | 8,331 | — | — | — | ||||||||||||||||
Employee share-based compensation expense | — | — | 24,935 | — | — | — | ||||||||||||||||
Cumulative effect of accounting change (ASU 2014-09) | — | — | — | 7,600 | — | — | ||||||||||||||||
Other comprehensive income (loss) | — | — | — | — | — | 1,896 | ||||||||||||||||
Treasury stock purchases | — | — | — | — | (87,624 | ) | — | |||||||||||||||
Net earnings | — | — | — | 160,001 | — | — | ||||||||||||||||
Balance at March 31, 2018 | 359,872 | $ | 3,599 | $ | 1,413,637 | $ | 5,106,467 | $ | (1,551,723 | ) | $ | (71,486 | ) | |||||||||
Balance at December 29, 2018 | 362,213 | $ | 3,622 | $ | 1,559,562 | $ | 5,576,525 | $ | (2,107,768 | ) | $ | (103,552 | ) | |||||||||
Exercise of stock options (including net-settled option exercises) | 706 | 7 | 11,716 | — | — | — | ||||||||||||||||
Employee share-based compensation expense | — | — | 19,860 | — | — | — | ||||||||||||||||
Other comprehensive income (loss) | — | — | — | — | — | 2,958 | ||||||||||||||||
Net earnings | — | — | — | 166,219 | — | — | ||||||||||||||||
Balance at March 30, 2019 | 362,919 | $ | 3,629 | $ | 1,591,138 | $ | 5,742,744 | $ | (2,107,768 | ) | $ | (100,594 | ) | |||||||||
5
CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) Interim Statement Presentation
Basis of Presentation
The condensed consolidated financial statements included herein have been prepared by Cerner Corporation ("Cerner," the "Company," "we," "us" or "our") without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our latest annual report on Form 10-K.
In management's opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position and the results of operations and cash flows for the periods presented. Our interim results as presented in this Form 10-Q are not necessarily indicative of the operating results for the entire year.
The condensed consolidated financial statements were prepared using GAAP. These principles require us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.
Fiscal Period End
Our first fiscal quarter ends on the Saturday closest to March 31. The 2019 and 2018 first quarters ended on March 30, 2019 and March 31, 2018, respectively. All references to years in these notes to condensed consolidated financial statements represent the respective three months ended on such dates, unless otherwise noted.
Supplemental Disclosures of Cash Flow Information
Three Months Ended | |||||||||
(In thousands) | 2019 | 2018 | |||||||
Cash paid during the period for: | |||||||||
Interest (including amounts capitalized of $3,797 and $2,811, respectively) | $ | 7,288 | $ | 8,199 | |||||
Income taxes, net of refunds | 22,511 | (97,506 | ) | ||||||
Voluntary Separation Plan
In January 2019, we adopted a voluntary separation plan ("2019 VSP") for eligible associates. Generally, the 2019 VSP was available to U.S. associates who met a minimum level of combined age and tenure, excluding, among others, our executive officers. Associates who elected to participate in the 2019 VSP received financial benefits commensurate with their tenure and position, along with vacation payout, medical benefits, and accelerated vesting of certain share-based payment awards. The irrevocable acceptance period for associates electing to participate in the 2019 VSP ended in early April 2019. We expect the resulting pre-tax charge in the second quarter of 2019 to approximate $41 million. Such charge will be included in general and administrative expense in our condensed consolidated statements of operations.
Accounting Pronouncements Adopted in 2019
Leases. In the first quarter of 2019, we adopted new lease accounting guidance. Refer to Note (6) for further details.
Callable Debt Securities. In March 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities, which shortens the amortization period for certain investments in callable debt securities purchased at a premium by requiring the premium be amortized to the earliest call date. Such guidance would impact how premiums are amortized on our available-for-sale investments. We adopted ASU 2017-08 in the first quarter of 2019. Such guidance did not have an impact on our condensed consolidated financial statements and related disclosures.
6
Accumulated Other Comprehensive Income. In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income ("AOCI") to retained earnings for "stranded tax effects" resulting from certain U.S. tax reform enacted in December 2017. Such "stranded tax effects" were created when deferred tax assets and liabilities related to items in AOCI were remeasured at the lower U.S. corporate tax rate in the period of enactment. We adopted ASU 2018-02 in the first quarter of 2019, and did not elect to reclassify "stranded tax effects" from AOCI to retained earnings.
Shareholders' Equity. In August 2018, the SEC issued Final Rule Release No. 33-10532, Disclosure Update and Simplification. Such guidance, among other things, extends to interim periods the annual requirement in SEC Regulation S-X, Rule 3-04 to disclose changes in shareholders' equity. Under the requirements in SEC Regulation S-X, Rules 8-03(a)(5) and 10-01(a)(7), as amended by this new guidance, registrants must now analyze changes in shareholders' equity, in the form of a reconciliation, for the current and comparative year-to-date interim periods, with subtotals for each interim period. This guidance is effective for filings submitted on or after November 5, 2018. We have presented a separate condensed consolidated statement of changes in shareholders' equity in this Form 10-Q in order to satisfy this new disclosure requirement.
Recently Issued Accounting Pronouncements
Credit Losses on Financial Instruments. In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which provides new guidance regarding the measurement and recognition of credit impairment for certain financial assets. Such guidance will impact how we determine our allowance for estimated uncollectible receivables and evaluate our available-for-sale investments for impairment. ASU 2016-13 is effective for the Company in the first quarter of 2020, with early adoption permitted in the first quarter of 2019. We are currently evaluating the effect that ASU 2016-13 will have on our consolidated financial statements and related disclosures, and we did not early adopt.
Collaborative Arrangements. In November 2018, the FASB issued ASU 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606, which clarifies when transactions between participants in a collaborative arrangement are within the scope of the FASB's new revenue standard (Topic 606). Such guidance clarifies revenue recognition and financial statement presentation for transactions between collaboration participants. ASU 2018-18 is effective for the Company in the first quarter of 2020, with early adoption permitted. The standard requires retrospective application to the date we adopted Topic 606, December 31, 2017. We are currently evaluating the effect that ASU 2018-18 will have on our consolidated financial statements and related disclosures, and we do not expect to early adopt.
(2) Revenue Recognition
Disaggregation of Revenue
The following table presents revenues disaggregated by our business models:
Three Months Ended | |||||||||||||||||||
2019 | 2018 | ||||||||||||||||||
(In thousands) | Domestic Segment | International Segment | Total | Domestic Segment | International Segment | Total | |||||||||||||
Licensed software | $ | 140,445 | $ | 14,032 | $ | 154,477 | $ | 124,094 | $ | 10,725 | $ | 134,819 | |||||||
Technology resale | 49,158 | 6,382 | 55,540 | 58,249 | 5,127 | 63,376 | |||||||||||||
Subscriptions | 77,702 | 6,589 | 84,291 | 69,852 | 6,784 | 76,636 | |||||||||||||
Professional services | 437,229 | 53,210 | 490,439 | 379,844 | 61,424 | 441,268 | |||||||||||||
Managed services | 277,325 | 27,068 | 304,393 | 246,145 | 22,160 | 268,305 | |||||||||||||
Support and maintenance | 226,481 | 50,482 | 276,963 | 234,236 | 50,328 | 284,564 | |||||||||||||
Reimbursed travel | 22,490 | 1,284 | 23,774 | 22,676 | 1,217 | 23,893 | |||||||||||||
Total revenues | $ | 1,230,830 | $ | 159,047 | $ | 1,389,877 | $ | 1,135,096 | $ | 157,765 | $ | 1,292,861 | |||||||
7
The following table presents our revenues disaggregated by timing of revenue recognition:
Three Months Ended | |||||||||||||||||||
2019 | 2018 | ||||||||||||||||||
(In thousands) | Domestic Segment | International Segment | Total | Domestic Segment | International Segment | Total | |||||||||||||
Revenue recognized over time | $ | 1,135,982 | $ | 142,211 | $ | 1,278,193 | $ | 1,028,495 | $ | 144,135 | $ | 1,172,630 | |||||||
Revenue recognized at a point in time | 94,848 | 16,836 | 111,684 | 106,601 | 13,630 | 120,231 | |||||||||||||
Total revenues | $ | 1,230,830 | $ | 159,047 | $ | 1,389,877 | $ | 1,135,096 | $ | 157,765 | $ | 1,292,861 | |||||||
Transaction Price Allocated to Remaining Performance Obligations
As of March 30, 2019, the aggregate amount of transaction price allocated to performance obligations that are unsatisfied (or partially unsatisfied) for executed contracts approximates $14.87 billion of which we expect to recognize approximately 29% of the revenue over the next 12 months and the remainder thereafter.
Contract Liabilities
Customer payments received in advance of satisfaction of the related performance obligations are deferred as contract liabilities. Such amounts are classified in our condensed consolidated balance sheets as deferred revenue. During the three months ended March 30, 2019, we recognized $150 million of revenues that were included in our contract liability balance at the beginning of such period.
(3) Receivables
A summary of net receivables is as follows:
(In thousands) | March 30, 2019 | December 29, 2018 | |||||
Client receivables | $ | 1,233,419 | $ | 1,237,127 | |||
Less: Allowance for doubtful accounts | 74,204 | 64,561 | |||||
Client receivables, net of allowance | 1,159,215 | 1,172,566 | |||||
Current portion of lease receivables (under ASC Topic 840) | — | 10,928 | |||||
Total receivables, net | $ | 1,159,215 | $ | 1,183,494 | |||
During the first three months of 2019 and 2018, we received total client cash collections of $1.36 billion and $1.27 billion, respectively.
8
(4) Investments
Available-for-sale investments at March 30, 2019 were as follows:
(In thousands) | Adjusted Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Cash equivalents: | ||||||||||||||||
Money market funds | $ | 77,709 | $ | — | $ | — | $ | 77,709 | ||||||||
Time deposits | 63,300 | — | — | 63,300 | ||||||||||||
Commercial paper | 72,965 | — | — | 72,965 | ||||||||||||
Total cash equivalents | 213,974 | — | — | 213,974 | ||||||||||||
Short-term investments: | ||||||||||||||||
Time deposits | 35,011 | — | — | 35,011 | ||||||||||||
Commercial paper | 85,631 | 17 | (30 | ) | 85,618 | |||||||||||
Government and corporate bonds | 280,119 | 84 | (323 | ) | 279,880 | |||||||||||
Total short-term investments | 400,761 | 101 | (353 | ) | 400,509 | |||||||||||
Long-term investments: | ||||||||||||||||
Government and corporate bonds | 1,319 | — | (2 | ) | 1,317 | |||||||||||
Total available-for-sale investments | $ | 616,054 | $ | 101 | $ | (355 | ) | $ | 615,800 | |||||||
Available-for-sale investments at December 29, 2018 were as follows:
(In thousands) | Adjusted Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Cash equivalents: | ||||||||||||||||
Money market funds | $ | 76,471 | $ | — | $ | — | $ | 76,471 | ||||||||
Time deposits | 71,461 | — | — | 71,461 | ||||||||||||
Commercial Paper | 10,000 | — | — | 10,000 | ||||||||||||
Total cash equivalents | 157,932 | — | — | 157,932 | ||||||||||||
Short-term investments: | ||||||||||||||||
Time deposits | 31,947 | — | — | 31,947 | ||||||||||||
Commercial paper | 75,445 | — | (91 | ) | 75,354 | |||||||||||
Government and corporate bonds | 294,941 | 1 | (958 | ) | 293,984 | |||||||||||
Total short-term investments | 402,333 | 1 | (1,049 | ) | 401,285 | |||||||||||
Long-term investments: | ||||||||||||||||
Government and corporate bonds | 18,247 | — | (55 | ) | 18,192 | |||||||||||
Total available-for-sale investments | $ | 578,512 | $ | 1 | $ | (1,104 | ) | $ | 577,409 | |||||||
Other Investments
At March 30, 2019 and December 29, 2018, we had cost method investments of $277 million. Such investments are included in long-term investments in our condensed consolidated balance sheets. We did not record any changes in the measurement of such investments for the three months ended ended March 30, 2019 and March 31, 2018, respectively.
9
(5) Fair Value Measurements
We determine fair value measurements used in our consolidated financial statements based upon the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
• | Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access. |
• | Level 2 – Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities. |
• | Level 3 – Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. |
The following table details our financial assets measured and recorded at fair value on a recurring basis at March 30, 2019:
(In thousands) | ||||||||||||||
Fair Value Measurements Using | ||||||||||||||
Description | Balance Sheet Classification | Level 1 | Level 2 | Level 3 | ||||||||||
Money market funds | Cash equivalents | $ | 77,709 | $ | — | $ | — | |||||||
Time deposits | Cash equivalents | — | 63,300 | — | ||||||||||
Commercial paper | Cash equivalents | — | 72,965 | — | ||||||||||
Time deposits | Short-term investments | — | 35,011 | — | ||||||||||
Commercial paper | Short-term investments | — | 85,618 | — | ||||||||||
Government and corporate bonds | Short-term investments | — | 279,880 | — | ||||||||||
Government and corporate bonds | Long-term investments | — | 1,317 | — | ||||||||||
The following table details our financial assets measured and recorded at fair value on a recurring basis at December 29, 2018:
(In thousands) | ||||||||||||||
Fair Value Measurements Using | ||||||||||||||
Description | Balance Sheet Classification | Level 1 | Level 2 | Level 3 | ||||||||||
Money market funds | Cash equivalents | $ | 76,471 | $ | — | $ | — | |||||||
Time deposits | Cash equivalents | — | 71,461 | — | ||||||||||
Commercial Paper | Cash equivalents | — | 10,000 | — | ||||||||||
Time deposits | Short-term investments | — | 31,947 | — | ||||||||||
Commercial paper | Short-term investments | — | 75,354 | — | ||||||||||
Government and corporate bonds | Short-term investments | — | 293,984 | — | ||||||||||
Government and corporate bonds | Long-term investments | — | 18,192 | — | ||||||||||
We estimate the fair value of our long-term, fixed rate debt using a Level 3 discounted cash flow analysis based on current borrowing rates for debt with similar maturities. The fair value of our long-term debt, including current maturities, at March 30, 2019 and December 29, 2018 was approximately $438 million and $431 million, respectively. The carrying amount of such debt at both March 30, 2019 and December 29, 2018 was $425 million.
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(6) Leases
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which introduces a new accounting model that requires most leases to be reported on the balance sheet. It also establishes disclosure requirements, which are more extensive than those required under prior U.S. GAAP. The standard requires use of the modified retrospective (cumulative effect) transition approach and was effective for the Company in the first quarter of 2019. We selected the effective date of ASU 2016-02 as the date of initial application on transition, as permitted by ASU 2016-02, as amended ("Topic 842"). Under this transition method, the cumulative effect from prior periods upon applying the new guidance to arrangements containing leases was recognized in our condensed consolidated balance sheets as of December 30, 2018. We did not recast comparative periods.
A summary of such cumulative effect adjustment is as follows:
(In thousands) | Increase / (Decrease) | ||||
Right-of-use asset | $ | 129,652 | |||
Prepaid expenses and other | 3,968 | ||||
Other current liabilities | 22,767 | ||||
Other liabilities | 110,853 | ||||
Arrangements Containing Leases
The cumulative effect adjustment above, is primarily comprised of arrangements where we are the lessee under operating leases for real estate (office, data center, and warehouse space) and certain dedicated fiber optic lines within our infrastructure. The duration of these agreements ranges from several months to in excess of 20 years. Generally, variable lease payments under these operating lease agreements relate to amounts based on changes to an index or rate (i.e. percentage change in the consumer price index). We do not have any arrangements where we are the lessee, classified as finance leases in our condensed consolidated financial statements.
In addition to the items described above, we also procure hotel stays and rental cars related to associate business travel, and the use of certain equipment for trade shows, client presentations, conferences, and internal meetings. We have made the policy election to classify such arrangements as short-term leases, as defined in Topic 842. As such, we have not recognized lease liabilities and right-of-use assets for such arrangements in our condensed consolidated financial statements. The duration of these arrangements is less than one month. Therefore, we do not disclose any short-term lease expense, as permitted by Topic 842. Expense for such items is recognized on a straight-line basis over the term of such arrangements.
Arrangements in which we are the lessor, are not significant to our condensed consolidated financial statements.
Amounts Included in the Condensed Consolidated Financial Statements
The following table presents a summary of lease liability and right-of-use asset amounts included in our condensed consolidated balance sheets as of March 30, 2019, under operating lease arrangements where we are the lessee:
(In thousands) | ||||||
Description | Balance Sheet Classification | March 30, 2019 | ||||
Right-of-use asset | Right-of-use assets | $ | 134,137 | |||
Lease liability - current | Other current liabilities | 29,746 | ||||
Lease liability - non-current | Other liabilities | 112,606 | ||||
Lease liabilities recorded upon the commencement of operating leases during the three months ended March 30, 2019, were $16 million.
For the three months ended March 30, 2019, operating lease cost was $9 million and variable lease cost was less than $1 million.
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Maturity Analysis
Aggregate future payments under operating lease arrangements where we are the lessee (by fiscal year) are as follows:
(In thousands) | Operating Lease Obligations | ||||
Remainder of 2019 | $ | 26,506 | |||
2020 | 31,186 | ||||
2021 | 26,576 | ||||
2022 | 20,890 | ||||
2023 | 14,092 | ||||
2024 and thereafter | 46,689 | ||||
Aggregate future payments | 165,939 | ||||
Impact of discounting | (23,587 | ) | |||
Aggregate lease liability at March 30, 2019 | $ | 142,352 | |||
At March 30, 2019, the weighted-average remaining lease term and weighted-average discount rate for our operating lease arrangements where we are the lessee were 7.15 years and 3.7%, respectively.
(7) Income Taxes
We determine the tax provision for interim periods using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment. Our effective tax rate was 19.5% and 20.0% for the first three months of 2019 and 2018, respectively.
(8) Earnings Per Share
A reconciliation of the numerators and the denominators of the basic and diluted per share computations are as follows:
Three Months Ended | |||||||||||||||||||||
2019 | 2018 | ||||||||||||||||||||
Earnings | Shares | Per-Share | Earnings | Shares | Per-Share | ||||||||||||||||
(In thousands, except per share data) | (Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | |||||||||||||||
Basic earnings per share: | |||||||||||||||||||||
Income available to common shareholders | $ | 166,219 | 324,573 | $ | 0.51 | $ | 160,001 | 332,395 | $ | 0.48 | |||||||||||
Effect of dilutive securities: | |||||||||||||||||||||
Stock options and non-vested shares | — | 2,430 | — | 4,139 | |||||||||||||||||
Diluted earnings per share: | |||||||||||||||||||||
Income available to common shareholders including assumed conversions | $ | 166,219 | 327,003 | $ | 0.51 | $ | 160,001 | 336,534 | $ | 0.48 | |||||||||||
For the three months ended March 30, 2019 and March 31, 2018, options to purchase 13.7 million and 11.2 million shares of common stock at per share prices ranging from $47.99 to $73.40 and $51.19 to $73.40, respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.
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(9) Share-Based Compensation and Equity
Stock Options
Stock option activity for the three months ended March 30, 2019 was as follows:
(In thousands, except per share data) | Number of Shares | Weighted- Average Exercise Price | Aggregate Intrinsic Value | Weighted-Average Remaining Contractual Term (Yrs) | ||||||||
Outstanding at beginning of year | 21,792 | $ | 52.31 | |||||||||
Granted | 39 | 55.28 | ||||||||||
Exercised | (750 | ) | 19.16 | |||||||||
Forfeited and expired | (329 | ) | 62.92 | |||||||||
Outstanding as of March 30, 2019 | 20,752 | 53.34 | $ | 138,631 | 6.12 | |||||||
Exercisable as of March 30, 2019 | 10,663 | $ | 46.77 | $ | 131,285 | 4.40 | ||||||
The weighted-average assumptions used to estimate the fair value, under the Black-Scholes-Merton pricing model, of stock options granted during the three months ended March 30, 2019 were as follows:
Expected volatility (%) | 26.1 | % | ||
Expected dividend rate (%) | 1 | % | ||
Expected term (yrs) | 7 | |||
Risk-free rate (%) | 2.6 | % | ||
Fair value per option | $ | 15.62 | ||
As of March 30, 2019, there was $132 million of total unrecognized compensation cost related to stock options granted under all plans. That cost is expected to be recognized over a weighted-average period of 3.08 years.
Non-vested Shares and Share Units
Non-vested share and share unit activity for the three months ended March 30, 2019 was as follows:
(In thousands, except per share data) | Number of Shares | Weighted-Average Grant Date Fair Value | ||||
Outstanding at beginning of year | 882 | $ | 62.82 | |||
Granted | 10 | 54.47 | ||||
Vested | (4 | ) | 59.22 | |||
Forfeited | (6 | ) | 59.62 | |||
Outstanding as of March 30, 2019 | 882 | $ | 62.76 | |||
As of March 30, 2019, there was $26 million of total unrecognized compensation cost related to non-vested share and share unit awards granted under all plans. That cost is expected to be recognized over a weighted-average period of 1.84 years.
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Share-Based Compensation Cost
The following table presents total compensation expense recognized with respect to stock options, non-vested shares and share units, and our associate stock purchase plan:
Three Months Ended | |||||||
(In thousands) | 2019 | 2018 | |||||
Stock option and non-vested share and share unit compensation expense | $ | 19,860 | $ | 24,935 | |||
Associate stock purchase plan expense | 1,542 | 1,362 | |||||
Amounts capitalized in software development costs, net of amortization | 187 | 160 | |||||
Amounts charged against earnings, before income tax benefit | $ | 21,589 | $ | 26,457 | |||
Amount of related income tax benefit recognized in earnings | $ | 4,201 | $ | 5,300 | |||
Treasury Stock
In May 2018, our Board of Directors approved an amendment to our share repurchase program that allowed for the Company to repurchase up to an aggregate $1.0 billion of shares of our common stock, excluding transaction costs. In April 2019, our Board of Directors approved a further amendment to this share repurchase program. Under this new amendment, the Company is authorized to repurchase up to an additional $1.2 billion of shares of our common stock, for an aggregate of $2.2 billion, excluding transaction costs. The repurchases are to be effected in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers. No time limit was set for the completion of the program. As of the date of this filing, $1.5 billion remains available for repurchase under the amended program.
(10) Contingencies
We accrue estimates for resolution of any legal and other contingencies when losses are probable and reasonably estimable, in accordance with Accounting Standards Codification Topic 450, Contingencies.
The terms of our software license agreements with our clients generally provide for limited indemnification of such clients against losses, expenses and liabilities arising from third party claims based on alleged infringement by our solutions of an intellectual property right of such third party. The terms of such indemnification often limit the scope of and remedies for such indemnification obligations and generally include a right to replace or modify an infringing solution. To date, we have not had to reimburse any of our clients for any judgments or settlements to third parties related to these indemnification provisions pertaining to intellectual property infringement claims. For several reasons, including the lack of a sufficient number of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the terms of the corresponding agreements with our clients, we cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.
In addition to commitments and obligations in the ordinary course of business, we are involved in various other legal proceedings and claims that arise in the ordinary course of business, including for example, employment and client disputes and litigation alleging solution and implementation defects, personal injury, intellectual property infringement, violations of law and breaches of contract and warranties. Many of these proceedings are at preliminary stages and many seek an indeterminate amount of damages. At this time, we do not believe the range of potential losses under such claims to be material to our condensed consolidated financial statements.
No less than quarterly, we review the status of each significant matter and assess our potential financial exposure. We accrue a liability for an estimated loss if the potential loss from any legal proceeding or claim is considered probable and the amount can be reasonably estimated. Significant judgment is required in both the determination of probability and the determination as to whether the amount of an exposure is reasonably estimable, and accruals are based only on the information available to our management at the time the judgment is made. Furthermore, the outcome of legal proceedings is inherently uncertain, and we may incur substantial defense costs and expenses defending any of these matters. Should any one or a combination of more than one of these proceedings be successful, or should we determine to settle any one or a combination of these matters, we may be required to pay substantial sums, become subject to the entry of an injunction or be forced to change the manner in which we operate our business, which could have a material adverse impact on our business, results of operations, cash flows or financial condition.
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(11) Segment Reporting
We have two operating segments, Domestic and International (formerly referred to as Global). Revenues are derived primarily from the sale of clinical, financial and administrative information solutions and services. The cost of revenues includes the cost of third party consulting services, computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, expenses associated with our managed services business, marketing expenses, communications expenses and unreimbursed travel expenses. "Other" includes expenses that have not been allocated to the operating segments, such as software development, general and administrative expenses, acquisition costs and related adjustments, share-based compensation expense, and certain amortization and depreciation. Performance of the segments is assessed at the operating earnings level by our chief operating decision maker, who is our Chief Executive Officer. Items such as interest, income taxes, capital expenditures and total assets are managed at the consolidated level and thus are not included in our operating segment disclosures. Accounting policies for each of the reportable segments are the same as those used on a consolidated basis.
The following table presents a summary of our operating segments and other expense for the three months ended March 30, 2019 and March 31, 2018:
(In thousands) | Domestic | International | Other | Total | |||||||||||
Three Months Ended 2019 | |||||||||||||||
Revenues | $ | 1,230,830 | $ | 159,047 | $ | — | $ | 1,389,877 | |||||||
Costs of revenue | 228,559 | 24,645 | — | 253,204 | |||||||||||
Operating expenses | 572,018 | 68,169 | 298,542 | 938,729 | |||||||||||
Total costs and expenses | 800,577 | 92,814 | 298,542 | 1,191,933 | |||||||||||
Operating earnings (loss) | $ | 430,253 | $ | 66,233 | $ | (298,542 | ) | $ | 197,944 | ||||||
(In thousands) | Domestic | International | Other | Total | |||||||||||
Three Months Ended 2018 | |||||||||||||||
Revenues | $ | 1,135,096 | $ | 157,765 | $ | — | $ | 1,292,861 | |||||||
Costs of revenue | 206,674 | 24,604 | — | 231,278 | |||||||||||
Operating expenses | 519,871 | 69,144 | 277,353 | 866,368 | |||||||||||
Total costs and expenses | 726,545 | 93,748 | 277,353 | 1,097,646 | |||||||||||
Operating earnings (loss) | $ | 408,551 | $ | 64,017 | $ | (277,353 | ) | $ | 195,215 | ||||||
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following Management Discussion and Analysis ("MD&A") is intended to help the reader understand the results of operations and financial condition of Cerner Corporation ("Cerner," the "Company," "we," "us" or "our"). This MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes to condensed consolidated financial statements ("Notes") found above. Certain statements in this quarterly report on Form 10-Q contain forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995, as amended, regarding our future plans, objectives, beliefs, expectations, representations and projections. See the end of this MD&A for more information on our forward-looking statements, including a discussion of the most significant factors that could cause actual results to differ materially from those in the forward-looking statements.
Our first fiscal quarter ends on the Saturday closest to March 31. The 2019 and 2018 first quarters ended on March 30, 2019 and March 31, 2018, respectively. All references to years in this MD&A represent the respective three months ended on such dates, unless otherwise noted.
Management Overview
Our revenues are primarily derived by selling, implementing and supporting software solutions, clinical content, hardware, devices and services that give health care providers and other stakeholders secure access to clinical, administrative and financial data in real or near-real time, helping them to improve quality, safety and efficiency in the delivery of health care.
Our core strategy is to create organic growth by investing in research and development ("R&D") to create solutions and tech- enabled services for the health care industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 13% and 12%, respectively. This growth has also created an important strategic footprint in health care, with Cerner® solutions in more than 27,500 contracted provider facilities worldwide, including hospitals, physician practices, laboratories, ambulatory centers, behavioral health centers, cardiac facilities, radiology clinics, surgery centers, extended care facilities, retail pharmacies, and employer sites. Selling additional solutions and services back into this client base is an important element of our future revenue growth. We are also focused on driving growth by strategically aligning with health care providers that have not yet selected a supplier and by displacing competitors in health care settings that are looking to replace their current suppliers. We may also supplement organic growth with acquisitions or strategic investments.
We expect to drive growth through solutions and tech-enabled services that reflect our ongoing ability to innovate and expand our reach into health care. Examples of these include our CareAware® health care device architecture and devices, Cerner ITWorksSM services, revenue cycle solutions and services, and HealtheIntent® population health solutions and services. Finally, we continue to believe there is significant opportunity for growth outside of the United States, with many non-U.S. markets focused on health care information technology as part of their strategy to improve the quality and lower the cost of health care.
Beyond our strategy for driving revenue growth, we are also focused on earnings growth. Similar to our history of growing revenue, our net earnings have increased at compound annual rates of 10% and 13% over the most recent five- and ten-year periods, respectively. We expect to drive earnings growth as we continue to grow our revenue. We also have opportunities to expand our operating margins over time, as discussed further below.
We are also focused on continuing to deliver strong levels of cash flow, which we expect to accomplish by continuing to grow earnings and prudently managing capital expenditures.
Results Overview
Bookings, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $1.24 billion in the first quarter of 2019, which is a decrease of 11% compared to $1.40 billion in the first quarter of 2018, with the decrease primarily reflecting a decline in long-term contracts, which tend to be larger but have little impact on near-term revenue.
Revenues for the first quarter of 2019 increased 8% to $1.39 billion, compared to $1.29 billion in the first quarter of 2018. The increase in revenue reflects ongoing demand from new and existing clients for Cerner's solutions and services driven by their needs to keep up with regulatory requirements, adapt to changing reimbursement models, and deliver safer and more efficient care.
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Net earnings for the first quarter of 2019 increased 4% to $166 million, compared to $160 million in the first quarter of 2018. Diluted earnings per share increased 6% to $0.51, compared to $0.48 in the first quarter of 2018. The overall increase in net earnings and diluted earnings per share was primarily a result of increased revenues, partially offset by a lower operating margin, which reflects the hiring of personnel to support revenue growth.
We had cash collections of receivables of $1.36 billion in the first quarter of 2019, compared to $1.27 billion in the first quarter of 2018. Days sales outstanding was 76 days for the 2019 first quarter, compared to 79 days for the 2018 fourth quarter and 73 days for the 2018 first quarter. Operating cash flows for the first quarter of 2019 were $317 million, compared to $409 million in the first quarter of 2018.
Operational Improvement Initiatives
We transitioned to a new operating structure in the first quarter of 2019. The Company has been focused on leveraging the impact of this reorganization and identifying additional efficiencies. Currently, we are focused on reducing operating expenses and generating other efficiencies that are expected to provide longer-term operating margin expansion. To assist in these efforts, we have engaged an outside consulting firm to conduct a review of our operations and cost structure. Our goal is to identify opportunities to operate more efficiently and achieve and improve upon the efficiencies without impacting the quality of our solutions and services and commitments to our clients.
In the near term, we expect to incur expenses in connection with these efforts, which may be material. Such expenses may include, but are not limited to, consultant and other professional services fees, employee separation costs, contract termination costs, and other such related expenses. For the three months ended March 30, 2019, we recognized $2 million of expenses related to these efforts, which is included in general and administrative expense in our condensed consolidated statements of operations. Additional expenses in the second quarter of 2019 will include charges associated with the 2019 VSP, as further discussed in Note (1) of the notes to condensed consolidated financial statements, as well as consultant and other professional services fees, and other related costs.
Results of Operations
Three Months Ended March 30, 2019 Compared to Three Months Ended March 31, 2018
The following table presents a summary of the operating information for the first quarters of 2019 and 2018:
(In thousands) | 2019 | % of Revenue | 2018 | % of Revenue | % Change | |||||||||||
Revenues | $ | 1,389,877 | 100 | % | $ | 1,292,861 | 100 | % | 8 | % | ||||||
Costs of revenue | 253,204 | 18 | % | 231,278 | 18 | % | 9 | % | ||||||||
Margin | 1,136,673 | 82 | % | 1,061,583 | 82 | % | 7 | % | ||||||||
Operating expenses | ||||||||||||||||
Sales and client service | 640,187 | 46 | % | 589,948 | 46 | % | 9 | % | ||||||||
Software development | 180,361 | 13 | % | 161,617 | 13 | % | 12 | % | ||||||||
General and administrative | 96,196 | 7 | % | 92,294 | 7 | % | 4 | % | ||||||||
Amortization of acquisition-related intangibles | 21,985 | 2 | % | 22,509 | 2 | % | (2 | )% | ||||||||
Total operating expenses | 938,729 | 68 | % | 866,368 | 67 | % | 8 | % | ||||||||
Total costs and expenses | 1,191,933 | 86 | % | 1,097,646 | 85 | % | 9 | % | ||||||||
Operating earnings | 197,944 | 14 | % | 195,215 | 15 | % | 1 | % | ||||||||
Other income, net | 8,432 | 4,864 | ||||||||||||||
Income taxes | (40,157 | ) | (40,078 | ) | ||||||||||||
Net earnings | $ | 166,219 | $ | 160,001 | 4 | % | ||||||||||
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Revenues & Backlog
Revenues increased 8% to $1.39 billion in the first quarter of 2019, as compared to $1.29 billion in the same period of 2018. The growth in revenues includes a $49 million increase in professional services revenue, driven by increased implementation activity. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models.
Backlog, which reflects contracted revenue that has not yet been recognized as revenue, increased 2% to $14.87 billion in the first quarter of 2019, compared to $14.63 billion in the same period of 2018. This increase was driven by solid levels of new business bookings during the past four quarters, including strong levels of managed services bookings that typically have longer contract terms. We expect to recognize approximately 29% of our backlog as revenue over the next 12 months.
We believe that backlog may not necessarily be a comprehensive indicator of future revenue as certain of our arrangements may be canceled (or conversely renewed) at our clients' option, thus contract consideration related to such cancellable periods has been excluded from our calculation of backlog. However, historically our experience has been that such cancellation provisions are rarely exercised. We expect to recognize approximately $640 million of revenue over the next 12 months under currently executed contracts related to such cancellable periods, which is not included in our calculation of backlog.
Costs of Revenue
Costs of revenue as a percent of revenues were 18% in the first quarter of both 2019 and 2018.
Costs of revenue include the cost of reimbursed travel expense, sales commissions, third party consulting services and subscription content and computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, devices, maintenance, support, and services) carrying different margin rates changes from period to period. Costs of revenue does not include the costs of our client service personnel who are responsible for delivering our service offerings. Such costs are included in sales and client service expense.
Operating Expenses
Total operating expenses increased 8% to $939 million in the first quarter of 2019, compared to $866 million in the same period of 2018.
• | Sales and client service expenses as a percent of revenues were 46% in the first quarter of both 2019 and 2018. These expenses increased 9% to $640 million in the first quarter of 2019, from $590 million in the same period of 2018. Sales and client service expenses include salaries and benefits of sales, marketing, support, and services personnel, depreciation and other expenses associated with our managed services business, communications expenses, unreimbursed travel expenses, expense for share-based payments, and trade show and advertising costs. The growth in sales and client service expenses is primarily due to the hiring of services personnel to support growth in services revenue. |
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• | Software development expenses as a percent of revenues were 13% in the first quarter of both 2019 and 2018. Expenditures for software development include ongoing development and enhancement of the Cerner Millennium® and HealtheIntent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle and population health solutions. A summary of our total software development expense in the first quarters of 2019 and 2018 is as follows: |
Three Months Ended | |||||||
(In thousands) | 2019 | 2018 | |||||
Software development costs | $ | 198,667 | $ | 185,218 | |||
Capitalized software costs | (74,099 | ) | (73,071 | ) | |||
Capitalized costs related to share-based payments | (452 | ) | (531 | ) | |||
Amortization of capitalized software costs | 56,245 | 50,001 | |||||
Total software development expense | $ | 180,361 | $ | 161,617 | |||
• | General and administrative expenses as a percent of revenues were 7% in the first quarter of both 2019 and 2018. These expenses increased 4% to $96 million in the first quarter of 2019, from $92 million in the same period in 2018. General and administrative expenses include salaries and benefits for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency, expense for share-based payments, acquisition costs and related adjustments. The increase in general and administrative expenses includes $2 million of expenses incurred in the first quarter of 2019 in connection with our operational improvement initiatives discussed above. We expect to incur additional expenses in connection with these efforts in future periods in 2019, which may be material. Such additional expenses include charges associated with the 2019 VSP, as further discussed in Note (1) of the notes to condensed consolidated financial statements. |
• | Amortization of acquisition-related intangibles as a percent of revenues was 2% in the first quarter of both 2019 and 2018. These expenses remained relatively flat at $22 million in the first quarter of 2019, and $23 million in the same period in 2018. Amortization of acquisition-related intangibles includes the amortization of customer relationships, acquired technology, trade names, and non-compete agreements recorded in connection with our business acquisitions. |
Non-Operating Items
• | Other income, net was $8 million in the first quarter of 2019, compared to $5 million in the same period of 2018. The increase is primarily attributable to increased interest income on our cash and investment balances, due to rising interest rates. |
• | Our effective tax rate remained relatively flat at 19.5% for the first quarter of 2019, and 20.0% in the same period of 2018. Refer to Note (7) of the notes to condensed consolidated financial statements for further discussion regarding our effective tax rate. |
Operations by Segment
We have two operating segments: Domestic and International (formerly referred to as Global). The Domestic segment includes revenue contributions and expenditures associated with business activity in the United States. The International segment includes revenue contributions and expenditures linked to business activity outside the United States, primarily from Australia, Canada, Europe, and the Middle East. Refer to Note (11) of the notes to condensed consolidated financial statements for further information regarding our reportable segments.
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The following table presents a summary of our operating segment information for the first quarters of 2019 and 2018:
(In thousands) | 2019 | % of Revenue | 2018 | % of Revenue | % Change | ||||||||
Domestic Segment | |||||||||||||
Revenues | $ | 1,230,830 | 100% | $ | 1,135,096 | 100% | 8% | ||||||
Costs of revenue | 228,559 | 19% | 206,674 | 18% | 11% | ||||||||
Operating expenses | 572,018 | 46% | 519,871 | 46% | 10% | ||||||||
Total costs and expenses | 800,577 | 65% | 726,545 | 64% | 10% | ||||||||
Domestic operating earnings | 430,253 | 35% | 408,551 | 36% | 5% | ||||||||
International Segment | |||||||||||||
Revenues | 159,047 | 100% | 157,765 | 100% | 1% | ||||||||
Costs of revenue | 24,645 | 15% | 24,604 | 16% | —% | ||||||||
Operating expenses | 68,169 | 43% | 69,144 | 44% | (1)% | ||||||||
Total costs and expenses | 92,814 | 58% | 93,748 | 59% | (1)% | ||||||||
International operating earnings | 66,233 | 42% | 64,017 | 41% | 3% | ||||||||
Other, net | (298,542 | ) | (277,353 | ) | 8% | ||||||||
Consolidated operating earnings | $ | 197,944 | $ | 195,215 | 1% | ||||||||
Domestic Segment
• | Revenues increased 8% to $1.23 billion in the first quarter of 2019, from $1.14 billion in the same period of 2018. The growth in revenues includes a $57 million increase in professional services revenue, driven by increased implementation activity. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models. |
• | Costs of revenue as a percent of revenues were 19% in the first quarter of 2019, compared to 18% in the same period of 2018. The marginally higher costs of revenue as a percent of revenues is impacted by the mix of technology resale revenue, whereas the first quarter of 2019 included a higher mix of hardware and devices, which carry a higher cost of revenue than sublicensed software. |
• | Operating expenses as a percent of revenues were 46% in the first quarter of both 2019 and 2018. |
International Segment
• | Revenues remained relatively flat at $159 million in the first quarter of 2019, and $158 million in the same period of 2018. Refer to Note (2) of the notes to condensed consolidated financial statements for further information regarding revenues disaggregated by our business models. |
• | Costs of revenue remained flat at $25 million in the first quarter of both 2019 and 2018. |
• | Operating expenses remained relatively flat at $68 million in the first quarter of 2019, and $69 million in the same period of 2018. |
Other, net
Operating results not attributed to an operating segment include expenses such as software development, general and administrative expenses, acquisition costs and related adjustments, share-based compensation expense, and certain amortization and depreciation. These expenses increased 8% to $299 million in the first quarter of 2019, from $277 million in the same period of 2018. The increase is primarily due to increased software development expenses, including increased amortization of capitalized software costs resulting from releases of new and enhanced solutions over the last four quarters.
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Liquidity and Capital Resources
Our liquidity is influenced by many factors, including the amount and timing of our revenues, our cash collections from our clients and the amount we invest in software development, acquisitions, capital expenditures, and in recent years, our share repurchase programs and future dividends.
Our principal sources of liquidity are our cash, cash equivalents, which consist of money market funds, commercial paper and time deposits with original maturities of less than 90 days, and short-term investments. At March 30, 2019, we had cash and cash equivalents of $503 million and short-term investments of $401 million, as compared to cash and cash equivalents of $374 million and short-term investments of $401 million at December 29, 2018.
We maintain a $100.0 million multi-year revolving credit facility, which expires in October 2020. The facility provides an unsecured revolving line of credit for working capital purposes, along with a letter of credit facility. We have the ability to increase the maximum capacity to $200 million at any time during the facility's term, subject to lender participation. As of March 30, 2019, we had no outstanding borrowings under this facility; however, we had $30 million of outstanding letters of credit, which reduced our available borrowing capacity to $70 million.
We believe that our present cash position, together with cash generated from operations, short-term investments and, if necessary, our available line of credit and other sources of debt financing, will be sufficient to meet anticipated cash requirements for the next 12 months.
The following table summarizes our cash flows in the first three months of 2019 and 2018: