Q2 2019 Earnings Call
The company has asked me to remind you that various remarks made here today constitute forward looking statements, including without limitation those regarding projections of future revenues or earnings.
Operating margins operating and capital expenses bookings.
New solutions services, and offering development capital allocation plans cost optimization and business simplification initiatives and future business outlook, including new markets or prospects for the company solutions and services.
Actual results may differ materially.
From those indicated by the forward looking statements. Please see Cerners earnings release, which was furnished to the S. You see today and posted on the investors section of Cerner Dot com.
And other filings with the FCC for information on the most significant factors that could cause actual results to differ materially from those in the forward looking statements.
Additionally, a reconciliation of non-GAAP financial measures discussed in this earnings call can also be found in the company's earnings release available on Cerner Dot com.
Cerner assumes no obligation to update any forward looking statements or information, except as required by law.
At this time I'd like to turn the call over to Brent Shaver, Chairman and CEO of Cerner Corporation.
Thank you Daniel.
Good afternoon, everyone and welcome to the call.
I'll spend the first few minutes, providing some thoughts and commentary on the business.
Then ask our CFO mark not to take you through the financial results.
When Mark concludes Chief client Officer Officer, John Peter Sulick will provide some marketplace commentary and finally, a vast dawn trig or he VP of strategic growth to talk about sort of growth strategies in adjacent markets.
Today I'd like to share some thoughts on the early stages of Cerners transformation.
Internally, we're referring to as sooner Dot next a term that signifies to our associates that the future is now.
We spent the past four decades inventing building implementing an operating DHR as for our clients around the world.
Over that time center hubs help digitize nearly 50% of healthcare in the United States and in the near term secured the two largest contracts in the history of health care I team.
The next chapter for Cerner involves helping our clients drive higher order of benefits from the digitized platforms that have been created.
Our clients are focused on rising health care costs.
The industry consolidation payment reform pushing toward risk.
Heightened impact of consumerism in the emerging role of artificial intelligence and machine learning.
Sure. It is in the enviable position of being able to address all these issues with evolving knowledge driven platforms that can impact the moment of decision for clinicians.
Through financial and clinical analytics, driven by high quality curated data.
This position is hard to replicate and we recognize our strategies and actions must leverage this foundational market position.
Going forward, we will be Recalibrating the company around our new operating model a series of transformative actions to drive efficiencies.
In strategies that we believe will drive long term growth and profitability.
Since introducing our new operating model earlier this year, we've made considerable progress in realigning the company had a more client centric manner.
Additionally, we've identified and we'll be implementing cost optimization and business simplification initiatives that we expect to drive greater business efficiencies.
Mark will provide an update on these initiatives in his remarks, but we expect these process improvements to deliver operating margin targets to deliver the operating margin targets. We established for Q4 19 in Q4, it's funny.
As we embrace the macro trends affecting health care and our market position.
We've really refined our strategic framework around three key areas that will guide our direction over the next several years.
First cerner expects to deliver the software as a service platform for healthcare.
A modernized millennium platform utilizing fast approach.
Should help drive speedier adoption of advanced features and innovations for our clients and significantly greater user satisfaction.
This platform can fuel, an even higher level digital disruption and enhance the ability to drive collaboration with third parties.
Second we plan on being the Premier strategic healthcare partner as Cerner pursues adjacent markets outside the traditional hospital environment.
We all recognize that health care is changing and profound ways.
The convergence of political economic demographic and technological factors are leading to new venues in models of care.
As pressure mounts to deliver value based care providers are increasingly building network strategies to enhance contracting power improve patient retention and manage risks more predictably.
These require robust next generation intelligence and analytical capabilities that cerner is well positioned to provide.
Third we expect to be acknowledged and reliance source for curated health data.
We have a rich history of aggregating normalizing and disseminating patient data.
As we acknowledge data source, we plan to develop a monetizable distribution model that provides access to legacy client segments and adjacent market prospects, such as Biopharma Payors and actuaries to name a few.
This big data strategy could be the key for new drug discoveries and the foundation for other use cases outside of the traditional healthcare space.
We believe cerners approach to curated data will provide significant value to clients.
John will speak more on this topic, including sharing news of a new senior leader dedicated to this strategy.
These strategies, coupled with our work to streamline the business underpin our long term growth and profitability. We believe these strategies are well aligned with the needs of our clients and will increase our ability to create value for them.
I'd also like to commend our Cerner associates, we have an incredible talent pool and I believe the right culture to drive the transformation process and deliver the next chapter Cerners growth.
As it relates to financial results I'm pleased with our second quarter results.
And now I'll ask mark to provide a more comprehensive commentary on the numbers Mark.
Thanks, Brett good afternoon, everyone.
I'm going to cover our Q2 results and future guidance. This quarter, we delivered solid bookings revenue and earnings.
I'll start with bookings, which were 1.432 billion in Q2 and near the high end of our guidance range. This is down from Q2 18 bookings of 1.17 1.775 billion, primarily due to a decline in long term bookings, which we previewed last quarter.
In addition, two of 18 included the initial V.A. task orders, making it a tough compare.
We ended the quarter with a revenue backlog of 14.98 billion, which is up 1% over a year ago.
Recall that our backlog calculation under the new revenue standard excludes revenue from contracts with termination clauses, even though such clauses are rarely exercised.
When you combine the expected revenue from our backlog and the additional revenue expected from contracts not included backlog.
Our revenue visibility remains at approximately 85% over the next 12 months.
Revenue in the quarter was 1.431 billion up 5% over Q2 of 18 and in line with our expectations.
I'll now go through the business model detail in year over year growth compared to Q2 of 18.
License software revenue in Q2 was $197 million up 14% over Q2 of 18, driven by strong bookings and good growth in both SaaS offerings and traditional software.
Tech resale 61 million decreased 19% compared to Q2 of a team which is the strongest quarter of last year and up 9% sequentially over Q1.
Subscriptions revenue grew 8% to 90 million.
Professional services revenue grew 8% to $485 million, primarily driven by solid growth and implementation services.
Managed services increased 4% to $298 million.
Support and maintenance was basically flat, which is in line with our expectations.
And finally reimbursed travel was down 5% from Q2 of 18, and essentially flat sequentially at 24 million.
Looking at revenue by geographic segment domestic revenue was up 5% from the year ago quarter at $1.266 billion in international revenue of $165 million was flat year over year.
Note that similar to last quarter, our non us revenue growth was impacted by foreign currency rates and with that mid single digit on a constant currency basis.
Moving to gross margin our gross margin for Q2 was 81.2% down from 81.8% in Q1, and 19 and 82.5% year over year, driven by higher third party services.
Now I will discuss spending operating margin and net earnings.
Are these these items, we provide both GAAP and adjusted or non-GAAP results.
The adjusted results exclude share based compensation expense share based compensation permanent tax differences.
Acquisition related adjustments.
DSP and other organizational restructuring expenses and other adjustments that I'll discuss in a moment and are also detailed and reconciled for GAAP in our earnings release.
Looking at operating spending our second quarter GAAP operating expenses of 1.031 billion were up 12% compared to $921 million in the year ago period.
In addition to the previously mentioned items, our GAAP expenses included a $7 million.
For the former vendor and a $20 million charge related to a client dispute that had been excluded from our adjusted results.
Note that we also had a $16 million non operating gain related to the sale of our equity investment in the former vendor that was also excluded from our adjusted results.
Our adjusted operating expenses were up 4% compared to Q2 of 18.
Looking at the line items for Q2 sales and client service expense increased 4% year over year, primarily driven by an increase in personnel expense related to our services businesses.
Software development expenses increased 9% over Q2 of 18, driven by a 5% increase in gross R&D, a 7% increase amortization and flat capitalized software.
GA expense was down 8% driven in part by lower personnel expense.
Amortization of acquisition related intangibles decreased slightly year over year.
Moving to operating margins, our GAAP operating margin in Q2 was 9.2% compared to 15.2 in the year ago period.
Our adjusted operating margin for the quarter was 18.0% down from 18.7% in Q2 of 18, but up from 17.5% last quarter and in line with our expectations.
Our guidance for Q3 reflects flat margins compared to Q2 due to normal seasonality of revenue mix in Q3, and the fact that most of our initial cost optimization efforts won't have a meaningful impact until Q4.
We believe we remain on track to deliver our targeted 20% operating adjusted operating margin in Q4, as our forecasted revenue mix is better and we expect to benefit from the initial impact of our operational improvement efforts.
Further our ongoing work with Alixpartners continues to support our targeted Q4 2020 imperative.
Adjusted operating margin of 22.5%.
Now I'll provide an update on our business optimization efforts.
Since our last call. We have created a detailed list of opportunities and kicked off projects to achieve our targeted cost optimization and process improvements.
In total there are 165 initiatives focused on cost optimization portfolio and product management and business simplification.
The benefits from these initiatives are expected over three ways with the initial benefits expected in Q4 of 19, followed by a second wave of benefits by the middle of 2020 with a third wave expected to drive benefits in the second half of 2020 and beyond.
We expect these initiatives to result in control that or reduced expenses across all of our operating expense lines and to positively impact the profitability of all business models.
The current expected phase in the lines with both our Q4 19 in Q4 20, adjusted operating margin targets and our expectation is that these benefits and related margin expansion opportunities will extend beyond 2020 is longer term benefits of the businesses simplification initiatives should have an impact into 2021 and beyond.
Finally, I'd like to share how we are approaching this from a government standpoint, we have created a transformation management office the led by Cerner COO Mike Mill.
Our chief of staff, Kimberly Gerard and two leaders from Alixpartners transformation management office will oversee the execution of the 165 initiatives and be responsible for change management and resolving issues that arise.
This includes weekly and biweekly weekly reporting and tracking across all initiatives, Our executive Committee and the financing said committee of our board our updated regularly on the progress.
As I indicated on our last call. This will be harder work, but I am pleased by the rigor with which the executive team is embracing the effort. We believe the enhanced efficiency better processes improve focus we are delivering ongoing profitable growth, while also accelerating and value creation.
For our clients.
Moving to net earnings and EPS, our GAAP net earnings in Q2 were 127 million or 39 cents per diluted share, which is down from 51 cents in Q2 was a.
Adjusted net earnings in Q2, the $215 million and adjusted diluted EPS was 66 cents compared to 62 cents in Q2 of 18.
Our GAAP tax rate was 17.6% for the quarter, our non-GAAP tax rate was 19%, which is 2% lower than last quarter and contributed to our EPS upside this quarter.
Moving to our balance sheet. We ended Q2 with 954 million of cash and short term investments, which is up from $904 million last quarter.
Our total debt our total debt increased by 600 million from last quarter to 1.039 billion as we took on debt to repurchase 8.7 million shares in the second quarter for $600 million, an average price of $60.91.
Following the Q2 repurchases, we have $883 million of remaining authorization under the current program.
Total receivables ended the quarter at $1.29 billion up from $1.159 billion in Q1 of the 19.
Our Q2 Dsos were 78 days, which is up from 76 days in Q1 of 1977 days in the year ago period.
Operating cash flow for the quarter was $207 million was impacted by the VSP and other organizational restructuring expenses I mentioned earlier.
Q2 capital expenditures were $159 million in capitalized software was $70 million free cash flow defined as operating cash flow less capital purchases and capitalized software development costs was negative $22 million for the quarter driven by a combination of lower operating cash flow and higher capital spending as previewed on our last quarter quarter recall.
While we continue to expect cash flow to be impacted by organizational restructuring costs and elevated capital spending we do not expect we do expect to improve operating and free cash flow for the rest of the year. We also expect operating cash flow growth and a decline in capital expenditures to lead to good free cash flow growth in 2020.
Moving to capital allocation.
As I indicated we've repurchased $600 million of stock through during Q2, leaving $883 million on our current authorization.
We still expect to execute the majority of the repurchase authorization by the end of Q1 of next year subject to market conditions and other factors. We intend to continue funding. This with a combination of cash from operations and debt with the amount of debt depending on the timing of our repurchases and whether we use cash for other purposes, such as M&A.
Regarding our dividend program, we officially declared our first quarterly dividend during the quarter with a payment date of July 26, The board approved the quarterly dividend at 18 cents, which is up from our initial estimate of 15 cents that we provided when we first announced our intent to initiate a dividend.
Our initiation of a dividend combined with our creased share repurchase activity reflects our commitment to returning capital to shareholders and our belief in Cerner has long term potential.
Now I'll go through guidance.
We expect revenue in Q3 to be between 1.45 and $1.455 billion. The midpoint of this range reflects growth of 7% over Q3 of 18.
For the full year, we continue to expect revenue between 5.65 and $5.85 billion with the $5.75 billion midpoint, reflecting 7% growth over 2018.
We expect Q3 adjusted diluted EPS to be 65 to 67 cents per share the midpoint of this range is 5% higher than Q3 of 18.
For the full year, we continue to expect adjusted diluted EPS to be between $2.64 in $2.72, which reflects 9% growth at the midpoint.
Moving to bookings guidance, we expect bookings revenue in Q3, the 1.5 billion to $1.7 billion. The midpoint of this range reflects a 1% percent increase compared to the third quarter 2018, which had increased 43% over the prior third quarter.
In summary, we're pleased with our solid results in the second quarter and we remain focused on delivering improved operating performance and creating shareholder value as we position cerner for long term profitable growth with that I will turn the call over to John .
Thanks Mark.
Good afternoon, everyone today, I'm going to cover our bookings and provide a quick update on our federal business then in turn turn it over to Don to discuss strategic growth.
I'll start with our bookings, which were at the high end of our guidance with solid contributions from all key areas of our business as we projected we had a lower level of long term bookings compared to last year with the percentage of bookings coming from long term contracts in the quarter at 22% compared to 35% in Q2 of last year.
As we discussed last quarter, the lower level of long term bookings is in part driven by our decision to be more selective as we consider certain low margin long term contract opportunities. This does not mean, we are not pursuing revenue cycle that Nike services contracts just that we are being more disciplined about the role we play and how we structure. The contracts. We believe this discipline will allow us to focus on high quality business that aligns with our emphasis on profitable growth.
Moving to new business mix, we had a solid quarter with 33% of bookings coming from outside our core Cerner millennium installed base, including a contract with a large investor owned health system to replace their existing DHR and revenue cycle systems at seven hospitals, 25 clinics and 12 freestanding emergency departments.
In the federal space, our projects with Adobe and V.A. are both progressing as planned for video D.. We are continuing our work on the first wave of sites beyond the initial operating capability side. What's go lives on track for this fall.
Similarly, our work with the VA has continued as planned and we remain on track to ramp our work on the project as we go through the remainder of this year and into next year with the initial sites still expected to go live in 2020 with that I'll turn the call over to Don.
Thanks, John Good afternoon, everyone.
Prince spoke at the outset about the strategic push by health systems to build out provider networks and when the ZIP codes in which they operate.
It's a cord multiyear growth strategy solid progress was made in the second quarter to advance it.
While the macro health network trend as part of an overall shift to value, we're seeing near term traction in areas such as out of network referrals that are generating revenue today and our preparatory for risk contracting overtime.
We're also seeing buying activity around foundational network capabilities, ranging from enterprise security to quality and regulatory compliance.
Enterprise Security was a particular bright spot in the first half of the year bookings exceeded $50 million and our pipeline supports a strong second half that would reflect 30% growth year over year from tap and go access with a persistent consecutive connected desktop to multi factor authentication for meds management. They have a fair value proposition in an area with significant trend.
Post acute sales, which include behavioral health home health long term care and rehab was another component of the health network with solid first half performance. The team delivered 25 discrete contracts driving over 30% bookings growth was 70% of the signed business occurring outside our millennium Hospital client base.
Post acute sales trends position us well on several fronts, including our Navihealth partnership focused on BPCI advanced.
But also discussed our strategic ambitions to grow our curated data services asset.
Our global market share, our clinical research practice, and our overall platform leverage right natural points of differentiation in the segment with the significant 60 plus billion dollar addressable market.
So part of our push into the data services space. Our Glasgow has joined Cerner within the strategic growth organization are not only as the former CIO, Duke University health system.
He also served as the chief product officer and Optum.
During the returns have been positive we've made progress in the pharma and life Sciences space, leveraging our Healtheintent data labs asset and our collaboration with the Duke Clinical Research Institute. They're also has good traction in our healthy history business, which provides great record retrieval for life insurance legal and other administrative use cases for health network business and our investment and the data space. Both are part of an overall portfolio management model seeking to maximize our return on invested capital.
Another area of progress related to the portfolio management review process that Brent initiated relates to product areas, where weve targeted an alternative go to market strategy.
A near term example of this is the agreement we recently signed with Getwellnetwork. It's part of the relationship will migrate cerner clients off our inpatient patient engagement solution. My station, we also will be adding get well Luke to our larger consumer framework as we push to accelerate our consumer revenue beyond the patient portal space.
We're constantly striving to embody the same entrepreneurial spirit that we used to build the company. Our team has always impatient to go faster.
I believe we've made reasonable progress in the second quarter on accelerating our health network businesses laying the foundation for meaningful data business and advancing our efforts at company level portfolio management.
With that I'll turn the call back over to Brent.
Thanks, Don.
As you heard from Marc John and on were making good progress on several fronts.
We've established a rigor around our cost optimization and process improvement efforts that I believe will not only help us deliver our near term targeted financial results, but also position us for high quality growth going forward.
We've demonstrated good execution in our core markets, including solid booking results from our core clients and ongoing execution on our federal business.
Which includes the largest healthcare projects in the history of our industry.
And we're making good progress at creating growth from emerging market opportunities that will be important to centers long term growth.
Im pleased with the team's execution during that time with significant change occurring both inside and outside Cerner.
Now I will turn the call back over to our operator, and we'll open up for questions. Thank you.
Thank you ladies and gentlemen, if you have a question at this time. Please press. The Star then the number one key on your touched on telephone. If your question has been answered or you wish to remove yourself from the queue. Please press the pound key.
Again Star then one to ask a question and the interest of time, we ask that you. Please limit yourself to one question and one follow up.
Our first question comes from Charles Rhyee with Cowen. Your line is now open.
Yes, hey, thanks for taking the question guys.
I wanted to talk about some of your efforts you're moving the stated guidance.
Oh, sorry, sorry surfaces area, and maybe you can give us a sense on timeline is where.
That we can look at in terms of milestones and guide post for.
Well when you think we will expect to monetize this product more.
I guess.
Significantly and just maybe give more color around there.
Yes. This is Don so I think as as longtime followers of the stock now. This is a space that we've always had an interest and if you go back to some of the original design strategies around millennium.
Well, we talked about the opportunity to structure store in study the data and then push those insights back into the care process. So this is an area of long time interest and focus secondly, I think we feel like there is a near term opportunity for us to really build on both.
Strategies and the life science in pharma space.
Starting with the work we did with do and also in the medical retrieval space again, leveraging strategies around de identified data and consent based use cases, and then I think finally, we're very excited about our class kind of joining the organization. He brings particular competency in this space.
Including competency as it relates to the provider network.
And how we think about activation or research enablement of our client base. So I think as I said in the script, we're cautiously optimistic about the progress we've made.
And we see that a much larger potential.
But we're going to continue to work on that effort in the back half of the year.
And just a follow up you're sitting already on the data itself.
You mentioned earlier about the Healtheintent lab, and obviously a lot of capabilities or is this something where we should expect it really internal development or is this something where you.
You would look externally maybe to make an acquisition to increase our capabilities in this area. Thank you.
Well I think it's a great question I think a comprehensive strategy at the magnitude we'd want to see to really enable this strategy probably as the combination of build buy and partner and that's certainly part of the analysis that we continue to do in the back half of the year.
But I'd certainly won't be an exclusive build strategy and partnership has already been a pretty significant feature of the strategy in the approach and one of things that we really like here as we think Theres a win for not only for patients as Brent described but a real opportunity for us to bring to gather life sciences, and pharma and our provider organizations in a way that allows particularly community hospitals the opportunity to participate and research economics in a way that hasn't historically been the case. So there is a lot of positives here and and we've got a strong leader with some early traction and trend.
Okay. Thank you.
Thank you.
And our next question comes from Michael Cherny with Bank of America Merrill Lynch. Your line is now open.
Good afternoon, and thanks for all the details so far.
Mark I want to dive into the comments about some of the process efficiency enhancements that you're focused on.
Thank you said 165 different initiatives that you're looking at I guess, how do you think about attacking them and lining them up and prioritizing them at a point, where you're also going to make sure that you're not doing anything to starve the business and meaningfully impact the growth rate on the topline going forward as well.
Yes.
Clearly one of the reasons, we have 165 as we want each of these cases to be a very discrete targeted area.
For which we can.
Determined what the impact on the business is going to be both positive and if there are any potential negative impact. So that's why we have that level of targets.
The majority of these things are focused around things, we've talked about including.
Spans and layers portfolio management facilities Nonpersonnel costs process improvements all the all the things that you normally go after in these spaces and I think we definitely have a view relative to the business and a promise among ourselves, but we're not going to screw up what we think is a really good business and the opportunities. We have in front of us. So we are going to deliver for our clients were going to deliver for the VA video D. All of our clients that we have commitments with we're going to deliver for those.
Relative to portfolio management, we're going make decisions. So that we actually choose the things, we're going to really work on and deliver.
Ideally things to deliver value for our clients, including the data business.
And we're not going to invest in the things that don't so I think it's going to be a well reasoned that's.
There's probably a little bit of banks does too so when am I going to start seeing the benefits flowing from those and as we've talked about kind of Q4 is when we start seeing the benefits and thats because we are trying to take a reasoned approach we're executing in Q3 to get these things go to really start.
Driving the benefits with a goal to buy time, we hit Q4, we've got the the first phase benefits underway and will drive them into the PML I'd just add to that Mark This is Brent.
I think the approach, we're taking and it is very rigorous and very deep and and is really intended to be very thoughtful. So that we're not doing damage as opposed to sort of a peanut butter spread.
Across the line item across the company, which could be.
Could have the opposite effect so.
It's.
It is a detailed laborious approach, but I think is going to yield very good.
Good results for us.
Great. Thanks.
Thank you.
And our next question comes from Jamie Stockton with Wells Fargo. Your line is now open.
Hey, good evening, Thanks for taking my question.
I guess I think maybe it was in brents comments.
There was a comment about moving to more of a SaaS platform.
I know you guys.
You have the Communityworks model.
And then you also have a number of tools that already web based flight healtheintent.
Should we read into that that maybe there is going to be more aggressive push to migrate millennium broadly.
Outside of the Communityworks model to fast over the next few years.
Just any color on that would be great.
Sure This is mark.
Yeah, we didnt I don't mean to indicate that we're converting to a SaaS business model anytime in the near future.
I think we we see SaaS approach.
As a way to keep our clients current and on the group deliver the value for what they paid for by giving on the most recent release. Our Communityworks example is probably the best example, we have of that but we host 80% of our clients. So to a great extent, they're used to the benefits of says and that they are not having to run the technology. Your worry about those elements, but what they're not getting is the currency and being on the current version. So I think you will see us kind of be a more of a community work style model of fewer releases on a more current basis and giving our clients to that given our already.
Hosted model.
The economics will evolve over time, there won't be as quick cut off or a quick move in fact, many of the benefits us as the currency elements. We can do today, even running millennium in our Datacenters as we do so it will be an evolution picking the better parts of the SaaS model until we've really evolve over to basically a pure SaaS model, but it's not going to be something that's going to happen in the near term from an economic standpoint.
Okay. Thank you.
And then maybe one quick one mark the bookings number.
The guidance for Q3.
It's a nice step up.
Sequentially.
Hey should we if you commented I apologize if I missed it but should we read into that that maybe the long term deal flow does bounce back somewhat.
No John So do you guys aren't totally walking away from those businesses.
Our is there anything else like you know the way that we should think about as notably contributing to that number.
Yes, there isn't anything large from a government perspective that that's impacting Q3.
I think it's.
John talked we've got a very strong pipeline, we continue to see a lot of business.
And I think the.
Q3, while the seasonality tends to impact you a little bit.
The.
The opportunities are there and that's why you're seeing us with.
With the numbers, we talk about once again, we still do our rigorous forecast we've been this year, we've been pretty successful.
And having our results aligned with that forecast so.
We're we're basically forecasting what we see on the on the horizon, what we see in our.
<unk> ability to deliver so.
That's the basis for that number I think you are still going to see.
Some of the little bit lower level of long term.
We are being selective.
We are looking at those deals making sure they meet our margin targets.
And that will.
Result in some business that we don't do in fact and in Q Q2, you could look at the number of that we delivered at the top end of our guidance.
There were opportunities that we had to sign business that didnt meet our targets and we did not pursue that business. So that number could have been a higher long term percentage and over the top end of our guidance, but we understood that we were going to do some of those and Thats. Why are we ended up in our guidance range, albeit at the top end.
Thank you.
Sure.
Thank you and our next question comes from Sean Wieland with Piper Jaffray. Your line is now open.
Hi, Thank you. So when you talk about being a little more selective on your long term contracts can you give us a sense of what you mean are you looking at it from a just a financial perspective are you looking at it from a strategic perspective, a client specific perspective, what are the what are the criteria that you're applying there.
Yes. This is this is John and we look at all those aspects that.
You had mentioned so.
We look at it from a from a client perspective to make sure that we're products, providing a service that it is highly value to the client, which in essence can drive higher margins for us we look at it from a.
From a capability component.
And our acquisition of either talent from the client and those type of things to not only margin targets, but to be strategic targets as it may relate to workforce in those those type of things and then absolutely.
A lens, we look at is truly the margin target and if we can't kind of if we don't provide a high value to the client a a return to cerner within the margin parameters, we like and it has some strategic benefit for actually yes, Sir and our clients.
And then we question, whether we want to go forward on that and for the ones that we do when you get all three of those aligned it works for everybody. It works for our clients and it works or SAR.
So without a question naming names I mean could you give us a sense of the kind of or profile of an opportunity that that you would say no to now that you would have said, yes to prior.
I would I would say that.
If we look at some of our acquired workforce space that bringing on.
Clients' workforce just.
At a low margin to us is something that we would only do in the context of a very strategic relationships are not as.
Not as it looking at it from a revenue perspective, a truly from a revenue and margin perspective, and we think of different ways to accomplish the same thing for our clients without having to bring on a.
A component that may be low margin for us maybe maybe one example, our ability to leverage.
Our varying degrees of works that are varying locations or workforce, whether it's our us domestic our some of our capabilities. We have outside for us those type of things all play into what we look at to create both more margin to more value for our clients.
All right. That's helpful. Thank you very much.
Thank you and our next question comes from Steve Halper with Cantor Fitzgerald. Your line is now open.
Hi, I don't know if you're willing to disclose this number but when you're all said and done on the cost efficiency.
Yes.
Process, how much do you plan on taking out in terms of total fuel costs. What do you think it's possible or is it or is it just ongoing.
Yes. This is mark as it were.
Is it somewhat.
In specific relative to total because obviously, we are right in the process of.
Finalizing and announcing and giving our associates face up to speed and understanding with what the impacts are going to be.
Clearly I think if you if you look at the numbers.
You can figure that.
It's in excess of $200 million and I think that's pretty clear. If you just look at the economics and the what's necessary to get to our targets our operating margin targets, but I think it is a matter of.
Picking those initiatives that aren't onetime they have to be things that have continuing benefit because once I get that savings that savings needs continue forever and that's that's the focus we're having right now but I think.
So we'll we'll provide more updates as we get further along but I think in general.
Debt over 200 leased is give us a ballpark.
That's consistent with what our guidance is once again as I said in my comments.
We don't expect the benefits to stop at the end of 2020, we expect them to to continue to be able to to harvest. Some of the benefits that we're going to get especially from our process improvements.
Into 2021 and beyond.
Sure and one one other follow up just on the new debt that you put on the balance sheet to facilitate share repurchase what's the interest rate on that debt.
It is it's a variable debt that weve rate swaps, 3.06%.
Thats why youre paying right now.
Yes, and Thats, where we will pay over the life of the debt because of the swap.
Yes, the swaps all right.
Attractive capital Thanks.
Thank you.
Thank you.
And our next question comes from Eric Percher with Nephron Research. Your line is now open.
Thank you process question for you you mentioned that wave one this year versus.
Wave two and three next year can you give us a little bit of a feel for what.
Activities will be targeted as you progress through those wage and your thoughts on.
How you take on SGN, a relative to R&D over time.
Sure. This is mark I think the near the reasoning for some of the ways, we will certainly be.
Based on how quickly we can get to the benefits right certain things such as third party supplier such as.
T. any those types of things, we can get to we can get to really quickly I think the.
The things that require process improvements the things that require investment in tools. Those types of things those are the things that tend to be more in the wave two and three.
So I think thats, they're all kind of target is based on the ability to put in place whatever needs to happen in order to to drive those benefits I think you'll see us certainly worked very hard to look at accelerating anything thats in wave two or wave three look away thats, we can pull maybe a portion of those benefits for work because we certainly are aware of the dollar saved today or or definitely have more value and waiting to for a year and a half or whatever it is to save it. So.
But that that's generally the difference between the wave two and wave three is the investment or the actions that have to be in place before we can go execute on those initiatives.
And when you think about what Alex is doing with you internally how do you think about what capabilities you want to build and it sounds like the throughput Mike and Kim is.
To internalize some of those.
Responsibilities, how are you thinking about how the organization needs to change.
Yes, I mean, obviously the transformation management office is key we don't we don't expect or want our partners to be here for effort, where we want them to help us through using their expertise on these initiatives on what they've learned over their history.
But we want to set up the ability to manage change we want to do this.
Set up the lean capabilities all of those elements that will help our business as we as we go forward I don't know that the transformation management office that certainly has an end date I mean, I think that there is always going to be areas that we can benefit from those types of services and we're creating an internal capability that can do those types of things.
That we really didnt have before but we're doing that in context and working with Alex.
But once their work is done we'll still have that capability and will be a levers that going forward.
Sounds healthy thank you.
Thank you.
And our next question comes from Matthew Gilmore with Baird. Your line is now open.
Hey, Thanks for the question.
Maybe asking about the client base you talked about getting clients on a current version of millennium and some of the strategies.
Can you give us some sort of sense for what portion you would classify as being on sort of newer software versions and then what are the things you can do to encourage clients to to migrate.
Yes. This is John so as we're working through this year and going into the early part of next year.
We have some regulatory components that are actually driving the need to upgrade and be current so with our with our most recent release, we should be half the vast majority of our client based on our current released by by mid next year, so using the opportunity.
Of the certified our release structure that we have that we have to follow right now with US regulations. That's a great opportunity to help our clients remain have a motivation to be current remain current and stay current so by the end of mid next year. The vast majority of our clients should be on the most current release.
Got it and then one follow up probably for Mark the managed service revenue line that looks like it ticked down a little sequentially in the second quarter.
Relative to the first quarter I guess I normally think of that line is being flat to up was there anything to call out either that was in this quarter or last quarter that caused that sequential decline.
There wasn't anything material during that period that that business can have some impact based on new signings that occur.
Depending on various elements. So in essence, it was pretty flat by the downtick.
Few million dollars, but nothing thats that was consequential or creating a trend we would expect it to get back on a slight increase year over years quarter over quarter year over year as we go.
Got it fair enough. Thank you.
Sure. This is what were made prior to going to the next question I just want to circle back.
On the question around capabilities, and where we are with our processes as Mark was addressing this around the transformation off so just want to point out we did announce since we talked last some new Chr ROE Tracy plat, joining us from Medtronic part of her charter is to really help us work through our strategic workforce planning and ensure that the capabilities and our workforce and leadership were in line with our strategy and direction and where we're going so it's.
I thought it was important to tie that back to that part of the work. We are doing now it's just been onboard a week and where we're glad to have her joining the team. Yeah. This is mark I think.
We'll look for an opportunity to to introduce traces to our investors because I think she's she's a.
We certainly appreciate everything Julie Wilson do for the company is in her role as leader of HR.
Tracy brings a lot of skills a lot of experience in the transformation efforts were undergoing including lean and all those other other things that we're going to focus on so.
I think bringing her in she has also got a very business focused as well so she wants to be a partner with the business.
And and help us drive and help us understand the business and I'm sure. He is listening to the call today, So Tracy will welcome to Cerner.
Next question.
Thank you. Our next question comes from Jeff Garro with William Blair. Your line is now open.
Yes. Good afternoon, thanks for taking the questions I want to ask about the strategic growth areas that Brent discuss it seems like there's a bit of a mix of both near and long term opportunities. There. So I was hoping you could provide a little more detail say an expectations for specific opportunities on on timing of when those areas will contribute to growth.
I'm going to I'm going to ask John to address that's kind of his area on the water you have to do we we spent some time in energy a walking through a high level of Yale and some of the projections on a five year basis add hands.
Really kind of laying out the core pop health business and what it would look like to have sustained 25% growth rates in that space as we work our way towards 2023.
And then coupled with that as we think about what you know high single digit to to double digit growth looks like the need for us to think about a combination of organic inorganic and partner based revenue too.
Over attain against those targets so.
We havent deviated from that kind of broad view that we put forth in Q1.
As I said in my in my section scrapped I think we've made some good progress in several areas.
And we're keen to see all of the market segments that we've identified for gross consistently begin to deliver in excess of 25% CAGR is.
And that's what I'm spending time and energy with the team working on.
Great that helps maybe as a.
A follow up to that thinking high level on revenue mix and those strategic areas and other growth initiatives.
Maybe a little bit more targeted towards higher margin areas. So wanted to get thoughts on on the evolution of the revenue mix over time, and how that can impact gross margin.
Yes. This is mark I mean.
Clearly as we as we move forward I think.
Especially as we.
Focus on.
Selectively pursuing certain service opportunities.
That's going to help us from a mix standpoint, with higher margin services revenue compared to what we might have in the business today.
Certainly many of the things in the strategic growth area are dependent on the Healtheintent platform, which is a software as a service. So it has strong margins.
That are an integral part and what that that business is going to rely on so.
Part of our focus is.
Kind of replacing over time some of the traditional software.
With some of that SaaS based software, especially when it's the healtheintent platform because that once again thats not big millennium converting to a says approach and then eventually converting to a SaaS business model Healtheintent. The SaaS business model in many respects today and supports a lot of these businesses that we're talking about so from a margin perspective all of those elements.
Should have a positive impact on overall margins.
And given that most of the costs related to two to that driving the topline that go into the cost of goods sold our service some third party related.
That can.
Be a positive impact to gross margin that is certainly a positive impact operating margins.
Yes, just to amplify on that from from from my perspective, If you look at several of the businesses in that space, which represent interesting kind of non provider adjacencies for us such as the work were doing the state Medicaid space specific to MMS.
Or the work we're doing in the employer services space again to Mark's good point using healtheintent as the enabling technology strategy for both of those go to market efforts.
With not only a growth trajectory, but we also think of a margin profile that's attractive.
Great. Thanks for taking the questions.
Sure.
Thank you and our next question comes from Robert Jones with Goldman Sachs. Your line is now open.
Great. Thanks for the questions I guess just to generally around.
Margins I guess, one during the quarter you guys saw some nice strength in the licensed software.
Area I'm wondering how much of that came from the seven hospital win that you mentioned during your prepared remarks.
And then just obviously related to that.
Margins ticked up sequentially, but not that much given what seemed like pretty strong growth in that area and then Mark I guess, just as it relates to the expectation for kind of sequential flat margins.
Into Threeq, you and then a pretty healthy step up into Fourq, you I know theres a lot of areas behind that just wondering if you could maybe just highlight some of the specific areas line of sight as we think about that what seems to be probably around a 200 basis point step up from Threeq to Fourq you. Thanks.
Sure.
Yes, I think I think from an <unk> mix.
Elements certainly the software in Q3 was a strong point it was strong across various issue various areas, including SaaS and traditional software.
So it did not to the the new the single transaction you knew indicated.
Contributor, but not not not in a significant.
Manner.
I think we're starting to see some of the seasonality that we used to see in the business. So you see Q2, having some strengths to see Q4, having some strength.
With Q3, a little bit little bit lighter on the software revenue. So I think thats the thats a little bit of what you're seeing relative to why margins look a little bit flattish as you go into Q3 clearly were we as Weve talked we're not going to start seeing the real benefits from from the operating from the expense side and some of the optimists optimization efforts really till Q4, and therefore that.
Q3, given that you're not really moving the meter on the revenue mix a significantly that's going to basically be relatively flat. When you come to Q4, we start to see in our in our forecast and our pipeline. So once again some strength from the software side, we see the benefits from the from the cost optimization. So those are the things that give us some.
The some confidence in looking at the ability to ramp up to that 20% in Q4, and I think thats.
As we go look at that that's all within the expectation we have obviously the full year numbers Weve talked about are still intact still in place.
But the ramp up is going to be stronger in Q4.
But because of the seasonality in the other elements of the business, it's actually pretty logical to me that that's that's a quarter, we're going to go hit that.
Okay, great. Thanks, so much.
Sure.
Thank you.
And our next question comes from Ricky Goldwasser with Morgan Stanley . Your line is now open.
Yes, thanks, Mark going back to your comments about kind of like the long term benefit that should have an impact on 2021 from margins.
Do you mean that we should take effect for Q2 0, Brian Graden extrapolated to 2021 or are you guiding to another margin step up.
From Fourq, you 20 level into 2021 period.
Yes, I am doing anything but guiding to anything between 21 at this point, but.
The logic is that if I'm, increasing and end up with a higher margin in Q4 of 2020 than I did in the other quarters.
With the way I'm approaching it that should be a sustainable element and there will be things that are driven in 2020 that don't have a full year benefit.
So as I capture that full year benefit in 2021, its logical that I should be able to have full year margins of increment up from what I have for a full year 2020.
Relative to Q4 of 2020 versus full year 2021, we'll have to get closer to that for me to be able to give you give you a better view of that but certainly.
As we roll forward.
We do expect.
Full year benefits that aren't going to be fully.
Hit in 2022 fully hit 2021 so.
Without putting any solid numbers around that so for a year, yes, I think 2021 full year operating margin will be higher than 2020.
Okay, and then you highlighted in the press release and on the call.
The voluntary separation plan had an impact on the cash flows.
Can you quantify for us what it is as a percent of total workforce.
From a percent of total workforce. It is a pretty small amount I think the total impact from that that item is probably $40 million someplace in that it from.
From a salary perspective and Thats a.
I want to $650 million personnel number so.
Once again it was voluntary was people that were qualified to be in it which means you have to have a certain level of tenure.
With the company. So it was very successful.
But I think it's certainly.
We're pleased to have.
Gotten through that we're pleased to start getting the benefits of that.
But were.
Certainly as it were more excited about the benefits will get from from our additional optimization work.
Thank you.
Sure.
Thank you.
And our next question comes from Richard close with Canaccord Genuity. Your line is now open.
Great. Thanks for the question just maybe to drill down on Jamies question from earlier on software as a service and possibly transition there I'm thinking about it from the data center aspect is there the opportunity to move stuff to ADW answer as Youre.
Going forward just curious your thoughts on that potential in and how big of an impact would that be for you.
Yes. This is mark certainly as we go and look at our capital structure return on invested capital.
That's one of the things that we'll look at.
I think thats.
As we move to a model of that's more community works.
A.
We saw a very limited number of releases that are being used by our clients.
It would fit well with us.
A third party hosting but.
Clearly that's something that we still have to decide and still have to move forward on but.
The good news for our clients is is basically nothing that there is something that wouldn't really impact them significantly they already have it hosted an offsite data center.
And I think thats.
For them, it's not going to impact the service they get from us or the value that they get from it but for US certainly we're doing analysis based on the cost to determine what the best approach for us as we move forward on this new.
Says approach to the business not necessarily the business model, but the overall approach that says represents.
And looking at all our options.
Okay, and then I was interested in the Getwellnetwork commentary.
And that being one of the 165 opportunities that you see if you look at the 165.
How large is the opportunities I guess with maybe moving people off certain of your products.
Or capabilities to other partners.
But this is mark just to clarify.
That the partnering strategy is not one of the 100 165 initiatives to a great extent right. Those are those are targeted on an optimization basis.
Thats additional topline growth alternatives.
Potentially part of portfolio management, but I'd be happy Don if you want to comment a little bit on the benefits of get well and kind of ours.
He just that bridging comment and so this is Brent in this this is back to.
Our discussions last quarter about an active portfolio management process and really looking at where it is where does it make sense to build versus partner or buy in this that John referred to Thats. As an example, as we looked at it there is a there is a desirable solution. It is well accepted in the model it's a win.
It's it makes sense and Don do you want to.
Maybe describe it no I think I think get well was one of the set of partnerships that I alluded to or excited specifically in my section of the scrap so get well would fit that the work we're doing with Salesforce from CRM perspective, I mentioned navihealth from the bundled payment space certainly the work we're doing with numerous as it relates to your provider sponsored plan in M&A. So we have some very strategic partnerships that we've entered into that we expect to make meaningful contributions to revenue as we work into 2020.
And.
And as part of that we want to think about.
When does it make sense in this case to move away from the my station solution engage in a partnership strategy that is highly penetrated today in our in our client base and also create some opportunities for us around their loop asset to begin to really build out our consumer framework and drive some net new revenue growth relative to that piece of our business.
I think it's emblematic of something that's been part of a multi quarter trend.
And on and I think we'll continue to update you guys on what that partnership contribution looks like for those key tier one relationships as we move into the back half of the year in the first half of 2020.
Okay. Thank you.
Thank you why don't we take one more question.
Thank you and our final question comes from Ross Muken with Evercore ISI. Your line is now open.
Hey, guys.
Thank you for the question.
My questions around margins have all been answered. So thank you for all the detail I guess I'll ask with the organizations initiatives and driving cost cuts from margin expansion fully in motion now is there any color you can provide on.
Feedback you've been receiving from your clients or maybe have you gotten any sense that your competition may be transforming its strategy or maybe becoming more aggressive.
On the face of.
The organizational changes.
Yes. This is John from a client perspective, we hit this little bit last.
The last call we had is that.
That one of our key premises as we work through our efficiency efforts is that we do not impact our clients do not impact the commitments to them.
Or strategically where they're going and and all of the initiatives. We're looking at we're looking at through that through that lands.
The majority of our clients that that I've talked to in that we've talked to I feel very comfortable from the fact that the things that we can do around efficiency. The things that we can do around portfolio management is a benefit to them. It gets.
It gets new innovations to the market quicker it allows them to.
To plan for things a little better because they are they are much more.
Aware of when things will become to the market and those type of things so in general.
That as long as we don't.
We continue to fulfill our commitments that we currently have and that we can that we are more focused on what we're doing in the future.
We should be fine with the clients and I think they understand that.
And they are looking forward to the benefits it as opposed to worrying about what some of the negative impact. This is Brent I would just add that course in healthcare delivery. The large providers. Almost every one of them has some sort of initiative like this going themselves. So in the executive suite is very familiar and they understand it and they know its party part of doing business in healthcare. So it it is familiar.
Got it thank you for squeezing me in.
You bet. Thank you.
Thank you everyone for being on the call. We look forward to talking to you soon take care. Thank you all.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program you may all disconnect everyone have a wonderful.