Welcome to Cerner Corporation’s First Quarter 2021 Conference Call. Today’s date is May 05, 2021 and this call is being recorded. I’ll now like to turn the call over to your host, Allan Kells, SVP, Investor Relations.
Thank you. Good morning everyone and thank you for joining us.
On the call with me today are Brent Shafer, Chairman and CEO; Mark Erceg, our new Chief Financial Officer; Don Trigg, our President; and Travis Dalton, our Chief Client and Services Officer. Brent will start off the call with observations of our business and the market place, then hand it over to Mark to provide more detail on our results, outlook and capital allocation plans. We’ll then transition to Q&A and be joined by Don and Travis.
Before we start, I’d like to remind you that our comments will contain forward-looking statements, including projections for our business and other statements about future events. These comments are based on our current expectations and assumptions that are subject to risks and uncertainties.
Our actual results could differ materially from those indicated by our forward looking statements due to those factors identified in our Earnings Release, which is posted in the investor section of cerner.com and other filings with the SEC. Cerner assumes no obligation to update forward-looking statements or information except as required by law.
We will also be referring to adjusted or non-GAAP financial measures on this call for our discussion of operating margins, earnings per share and free cash flow. A reconciliation of non-GAAP financial measures to GAAP financial measures can be found on our earnings release. These non GAAP financial measures are not meant to substitute for – as a substitute for or superior to financial measures prepared in accordance with GAAP. With that, I'll turn the call over to Brent.
Thanks Alan and good morning everyone; thank you for joining us. Well, as we all know we are now a year into the pandemic and personally I remain so impressed by the resilience of our clients on the front lines and the efforts of our associates around the world supporting them. And as we move past the worst of the pandemic, hopefully in most regions, an increasing portion of our role and assisting clients has been related to vaccine distribution.
Now we've helped over 175 organizations with our mass vaccination solution, allowing clients to deploy and track vaccinations, document and report reactions and communicate with patients. We've also continued supporting our community and in partnership with local providers, and very proud to say we've now delivered over 90,000 COVID vaccinations as part of the Operations Safe initiative I mentioned on our last call.
As we discussed throughout the year, the pandemic accelerated many trends in healthcare that Cerner has been actively monitoring in building out capabilities to support for years. Among these is that providers face increasing pressure on cost and revenue, heightened consumer expectations and shifts in care venues.
So we continue to believe that we're well positioned to help our clients navigate these challenges, while also enabling them to deliver improved clinical outcomes.
Now for example, our real-time health system offerings bring near real time enterprise transparency to help health systems perform at their peak efficiency and streamline operations and improve care delivery.
In addition, our health networking capabilities enable our clients to coordinate across – care across multiple organizations regardless of the core EMR and help them optimize for either a fee for service or value based payment model.
Our enhanced consumer engagement solutions help providers meet the growing expectations by patients through our seamless digital experience.
We also continue to demonstrate our ability to bring innovation to the provider workflow to save time and address the very real issue of physician burnout. An example of this is our current, recently successful pilot of our AI powered Chart Assist, which extracts data from the patient's chart and helps ensure correct diagnosis and documentation. This replaces the process of having to do manual queries days after the patient has been seen, to capture missing or often an incomplete diagnosis. In summary, our ability to provide data driven insights to providers and patients is at the core of the value we are providing.
As a result, our clients are increasingly seeing value in our industry leading ability to aggregate and normalize data, so that meaningful insights can be gleaned. We're also excited about the opportunities and insights from data to play a role in improving the safety, efficiency and efficacy of clinical research. Consistent with this, we took a major step toward this goal with our recent acquisition of Kantar Health and we're really pleased to welcome their highly experienced management team that brings a deep understanding of the needs of the pharmaceutical industry. We believe this is an important step as we partner with our network of provider clients and to fundamentally change the time and cost of clinical trials. I also wanted to comment on the information blocking rules that went into effect last month and the broader Interoperability rules in the 21st Century Cures Act.
As you know we've been fully supportive of these rules and we believe they are an important step toward the healthcare industry, finally realizing the potential of broad digitization, which should lead to improved outcomes, lower cost and a better patient experience. And up to this point as you know, the industry has spent billions of dollars on a base level of digitization, but the absence of broad Interoperability has limited the return on this investment.
So as interoperability and secure access to data improves in the coming years, we expect our proven ability to drive insights from data and to push them to the right place at the right time will remain a key differentiator.
Now I'd like to provide a quick update on our federal business. The Department of Defense continues to move at full speed ahead with deploying MHS Genesis, their center power EHR. At the end of February they went live at Naval Medical Center in San Diego, which was their largest and most complex go-live to-date, and DoD officials said this was their smoothest go-live since the program began. In late April DoD went live with Wave Carson across 12 states, two time zones and more than double the number of DoD commands now live.
Now moving to Veterans Affairs, as most of you know, VA Secretary Dennis McDonough recently launched a strategic review of the VA’s EHRM program, while at the same time making it clear he is committed to Cerner and the program.
Now we believe this review is analogous to the steps taken by the DoD during their initial go live. We welcome and strongly support this review, because it allows us to bring new VA leadership up to speed on both the successes and challenges of the program, to capture their input and move forward together as we continue providing seamless care for our nation’s veterans.
We expect to exit this review stronger and ready to push forward with deployments at additional sites this year.
During this review, we expect the impact on our results will largely be mitigated since work on the ground continues as we prepare for go-lives at future sites.
However, the review could shave up to one point off our projected revenue growth this year versus what we had originally expected.
Moving to our results, we had a solid first quarter, and as Mark will share, we now expect to deliver stronger earnings than our prior outlook despite slightly lower top line growth due to the VA’s strategic review. This is possible because we have sharpened our focus and are moving forward with a renewed sense of urgency to continue delivering value to our clients and shareholders.
Specifically, we are going faster on efficiency initiatives already being actioned by our transformation office, continuing and broadening our product and business portfolio reviews, and adjusting our organizational design to centralize key functions. These actions all have a common goal, and that’s to tighten our strategic focus so we can more effectively deliver value to our clients, while also contributing to sustainable, long term, profitable growth for our shareholders.
You’ll hear Mark Erceg in a moment, but I’d like to say that in the two months he’s been our CFO, he has just been invaluable in helping us identify additional opportunities to improve our business and he’s done a terrific job of providing enhanced management reporting that is enabling much better informed decisions and we are delighted to have him as part of the Cerner family. I’d also like to comment on the recent passing of Linda Dillman, a longstanding member of the Cerner Board. She spent 10 years on our board and was a trusted advisor to many on the leadership team, and a great, wise counsel provided to all of us, including me, especially as I joined the company.
While there is no direct replacement for Linda as a person, we do have an open search actively seeking qualified candidates and Linda is deeply missed by all of us.
Before turning the call over to Mark, I’d like to comment on the news about my expected departure.
As noted in the press release, the board and I have started a process to identify Cerner’s next CEO. Once the board has named a successor, I plan to serve as an advisor to ensure a smooth transition. It’s been an honor to be part of Cerner these past three years and I can tell you, I connected with Cerner’s mission from the beginning, and the dedication of our associates and clients just inspires me every day. I am proud that Cerner is in such a strong position and I know we made good progress towards improving our operating model and strengthening our leadership team. Because of this progress, I believe my successor will take the reins at a time when Cerner is poised to accelerate its impact on healthcare. Mark, I’ll turn it over to you.
Thanks Brent and good morning everyone. Today I will cover our first quarter results and provide a guidance update, but first I’d like to share some early observations from my first two months at Cerner.
First, the people are incredible. Cerner associates are dedicated, passionate professionals who are fully committed to the cause, which is merging technology with healthcare to improve outcomes for those we serve and love.
As Brent often says, “Cerner is striving to bring the joy back to practicing medicine” and that is a mission I can proudly lend my full efforts against.
Second, the business is fundamentally sound. Cerner provides real solutions to real problems. Cerner has deep technical know-how, unique capabilities and significant competitive advantages, as well as an exceedingly strong balance sheet.
Third, while Cerner does have the associates and the capabilities, and has created significant value for clients and shareholders since its inception, there is a clear recognition that a lack of focus and at times sub-optimal execution has caused revenue growth to slow and margins to compress, which in turn has resulted in bottom quartile total shareholder return versus our proxy peer set over the past several years. This understanding is what led the board, Brent and the senior management team to initiate a series of actions to improve results. I believe the actions taken so far are a good start and I am excited to play a role in increasing the pace of change so Cerner can realize its full and considerable potential faster. We believe these actions will allow Cerner to help more people than ever before, whilst also generating leadership levels of Total Shareholder Return.
So with that understanding and my sincere thanks to Brent and the board for giving me the opportunity to be part of the team, let me move on to summarize our first quarter results. Please note that my commentary will focus on key points of emphasis since I have no intention of simply repeating information already contained within the press release. Overall we had a solid quarter. Bookings were up 13% versus a year ago to $1.23 billion, and we ended the quarter with a revenue backlog of $13.1 billion.
While this is admittedly down 3% from a year ago, that was primarily due to the impact of divestitures. Revenue in the first quarter of $1.39 billion was down 2% compared to last year and included lower than anticipated software, technology resale and reimbursed travel.
However, after adjusting for divestitures, our first quarter revenue grew roughly 2% year-over-year. Gross margin was up 140 basis points from a year ago to 83.4%, reflecting improved revenue mix due to lower levels of outsourcing, third party services and reimbursed travel and adjusted operating margin expanded 200 basis points from 19.4% last year to 21.4% this year. Adjusted operating margins benefited from our continued cost optimization efforts and divestitures, and to be fair, we also had some additional expense benefit related to COVID of approximately $10 million dollars in areas such as facilities and travel.
As Brent indicated, we are leaning into our operational improvement efforts and based on my initial assessment, I believe mid 20% adjusted operating margins should be obtainable by 2024 as per our pre-COVID commitments. To achieve this we are moving faster on our existing roadmap of cost optimization and process improvement initiatives and adding additional initiatives, including a full review where COVID era savings can be made permanent in areas such as facilities.
We are also going deeper on our product portfolio review, with an eye towards consolidating and focusing on items that create the most client value.
Finally, we are significantly building up our internal management reporting capabilities to enhance decision making and drive accountability.
Importantly, these actions will enhance, not dilute our primary focus, which is delighting our clients and motivating and encouraging our associates to reach their full potential, because we know that having fully engaged associates and satisfied clients is a clear recipe for marketplace success and strong shareholder return. To finish off the P&L, our tax rate was 21% for the quarter and adjusted diluted EPS was $0.76 a share. This was up 7% over last year, due primarily to operating margin expansion.
Moving to our balance sheet, we ended Q1 with $1.47 billion of cash and short term investments and $1.84 billion of debt after drawing $500 million on our Shelf agreement during the quarter. We did this at very attractive interest rates, placing $400 million of private placement 10 year debt at 2.59% and $100 million of 5 year debt at 2%. We did this to pre fund the Kantar Health acquisition which closed April 1 and to partially fund future stock repurchase efforts. Operating cash flow for the quarter was $450 million. After $76 million of capital expenditures and $83 million of capitalized software, free cash flow came in at $291 million.
As we move to capital allocation, let me take just a few seconds to share my views as it relates to cash and balance sheet management.
First, as an unapologetic capitalist, let me state very clearly that whatever cash we have on our balance sheet belongs to our shareholders, and we are simply the stewards of those funds.
As such, the first call on cash is managing and investing in the core business wisely behind high return propositions.
Second, we aim to provide a competitive dividend yield. Presently our dividend payout ratio is approximately 28%, but I anticipate that trending up over the next several years to somewhere in the low 30’s.
Third, we will consider strategic acquisitions if and only if we believe they will enhance our competitive position in the marketplace, exceed our cost of capital, be accretive over time and create shareholder value.
Finally, with any remaining excess cash or investment grade debt capacity, we may look to opportunistically repurchase our own shares if we believe the stock is trading below its intrinsic value.
So against that backdrop, we returned $417 million to shareholders during the first quarter, including $67 million in dividends and $350 million of share repurchases. And as noted in the earnings press release, our board just recently approved a new repurchase program that authorizes the purchase of up to $3.75 billion of shares through the end of 2023. With that new authorization in hand, we expect to repurchase up to $1.5 billion this year, up from our previous guidance of up to $1 billion.
Importantly, we believe this level of activity will make better use of our balance sheet and anticipated cash flow, while still maintaining ample access to capital for potential investments or acquisitions within the confines of a strong investment grade balance sheet.
Moving to guidance, we expect revenue in Q2 to grow organically by high single digits over Q2, 2020. This is because while Q2, 2020 included about $40 million of revenue from businesses that have since been divested, we expect Kantar Health to now contribute a similar offsetting amount.
For the full year we continue to expect mid-single digit revenue growth, which is generally consistent with the growth implied by the previously provided dollarized range, but the recent VA assessment which we fully support and the associated review had likely cost us somewhere between a half point and one full point of revenue growth this year as some deployment work gets shifted out of fiscal 2021.
For EPS we expect Q2 adjusted diluted EPS growth of approximately 20% over Q2, 2020, which you will recall included a large negative impact from COVID of approximately $0.10 to $0.15 per share.
For the full year we expect adjusted diluted EPS to be over $3.20 per share, reflecting growth of at least 13% over last year. This compares to our prior range of $3.10 to $3.20 per share, with the higher expected earnings being driven by additional margin expansion efforts and an increase in share repurchase, which collectively should more than offset any slight loss in revenue related to the VA assessment.
For the second quarter and the full year we are expecting a 21% tax rate and as it relates to cash, we expecting to generate around $900 million of free cash flow for the full year, up from $857 million last year.
So in summary, I’m very excited to be at Cerner.
I think we have a tremendous opportunity to positively impact healthcare, while also growing and creating significant shareholder value.
We are acting with urgency to achieve this and I look forward to sharing our progress with you as we move through the year. With that, I’ll turn the call over to the operator for your questions.
Thank you. [Operator Instructions].
Your first question comes from the line of Dave Windley of Jefferies.
Hi! Thanks for taking my question. I wanted to ask around, kind of industry trends toward value based care and value based reimbursement, which when we listen to some of the payers, as well as the providers, the thought seems to be that that is accelerated by COVID and in turn could be a stimulus for some of your more advanced analytics population health type software.
So I'm wondering what you see through a software healthcare IT lenses of the trends toward value based purchasing and value based reimbursement.
Hey Dave, this is Don. That’s a great question.
I think I sort of echo some of the industry level sentiment that you're describing.
I think we're seeing a lot of market interest in that topic.
You know providers have worked through surge recovery and to sort of, I'll call it margin expansion strategies inside traditional fee for services. They’ve look to recapture electives, but they are absolutely thinking on a parallel path about strategies around value and alternative payment models.
And so a lot of nice traction as you described for our EDW and advanced analytics capabilities; a lot of interest in healthy referrals and how you think about referral activities across your provider network, and we think over time a lot of traction around care management as they start taking elevated levels of first dollar risk.
So I think some nice post COVID tailwinds that will help the network business and those product offerings as we play through the year.
Don, I appreciate that. Is there a potential to put – I don’t know, put numbers on either bookings or client’s uptake on some of those products you just listed off.
Well, we recall that on a full year basis and last year we did 24 new footprints for healthy intent and I have every expectation we’ll exceed that number this year, and at the solution level I think there is some prioritization that you see playing out.
I think there's a lot of interest and EDW. That is our most aggressively deployed solution. A lot of interest in referrals, because it has a benefit both for fee for service use cases and fee for value, and then frankly a lot of weighted pipeline activity that Travis and team have been advancing around our maestro offering and our relationship with Lumeris, because I think providers still see Medicare advantage as a really logical starting point for how they think about moving into risk.
So those would be the three areas I’d particularly emphasize.
Your next question comes from the line of Stephanie Davis of SVB Leerink.
Thank you guys for taking my question. Don, not to put you in the hot seat, but I've always thought of Cerner’s President role as being kind of on deck with the CEO scene.
So first, is there a reason Cerner will go external versus internal for the CEO search. And maybe could you tell us a little bit more about the search priorities for the CEO role. And then I’ve got one follow-up for you.
Sure, I can start.
I think there's a thoughtful process that's been put in place by the board.
Looking forward to seeing that play itself forward.
I think in my conversations with the board and with the brand, I think we’re all aligned. This is a really interesting opportunity for the company. We're very well positioned to be successful in the quarters ahead, and I think the whole management team’s excited about continuing to deliver against the plan that we've been working on this year. And you had a follow-up I think?
Yes, so that having been in the seat before, I know there are many different types of CEOs. I know there’s a strategy focus CEO, there’s a portfolio manager CEO, kind of how do you see this role evolving from where you're looking at today.
Well, we made I think really great progress in clarifying our strategy and our direction and proving our emphasis around operations. There is a lot of work to do on the operational side, on execution and that path is laid out and I think having Martin join the team helps strengthen our ability to go after that.
So I see an operational emphasis and a clear path ahead to get that work done.
Alright, helpful guys. Thank you.
Your next question comes from the line of Charles Rhyee of Cowen.
Yeah hey, thanks for taking the question.
You know, I was curious if you can kind of – you know obviously a year into the pandemic here.
You know just kind of give us some updated thoughts on some of the specific growth to markets that you had outlined last year. Have that – you know has any of the opportunities kind of shifted around in terms of what you think are you know better opportunities or you know maybe a little bit less given sort of the dynamics in the market. Any kind of insights there would be helpful.
Yeah, it's a great question. I'll speak to both the upside and also talk about some places where I think there are tailwinds.
So from an upside perspective, I think inside the four walls of the hospital, big focus on real time hospital systems as Brent talked about in his prepared remarks. That was a big part of surge response and economic recovery.
So think about workforce management staffing capabilities, communications, hospital operations.
I think all of those areas have seen a lot of COVID related traction and trend.
I think the provider network space is absolutely a focus, both for fee-for-service and fee-for-value use cases. A lot of focus on consumer; we see a lot of traction and trend around our consumer offerings as folks try to think about what does it look like to engage the consumer outside the four walls of the hospital.
So those have been areas that have continued to see traction and trend over the course of the last four quarters reflected by our book revenue.
I think there have been some places that have been disrupted by COVID.
I think the post-acute space is one that obviously was massively impacted by prevalence data and fatality data and so I think that was a space that was negatively impacted on a four quarter basis. I also think the workforce health space is one that we talked about in the past.
I think employers are certainly thinking a lot about what it looks like to get the right mix of health and care strategies as they think about return to work and hybrid work strategies, but at the same time there's been a lot of disruption around those workforce populations.
So those would be two that I think I would put more in the headland or wild card status relative to go forward.
If I could follow-up on the consumer right, I think one of the big trends in this last year has been you know how do you deliver care into the patient home? Can you talk a little bit more about the consumer offering then and you know so how you're helping your clients really engage their patients you know in more of a home setting?
Yeah, I think first of all the big thing that we've attempted to do is to really create plug and play capabilities for our clients around how they think about their engagement strategy.
So the ability to leverage both, native software that we build, as well as third party capabilities around things like touchless reg and in-Keg [ph], so that's been a big emphasis.
I think unified communications strategy, sort of omnichannel communications capabilities as a way to reach the consumer has been a big area of emphasis and focus and where we're seeing a lot of book revenue growth. And then finally I think somewhat correlated to that, a lot of focus on CRM and relationship management strategies as folks think about coordination of care strategies across both, traditional venues and non-traditional venues like the home.
So those would be some particular areas of emphasis above and beyond things like televisits and telehealth, which had been a feature of a lot of discussions in previous calls around this topic.
Great! Thank you.
Your next question comes from the line of Sean Dodge of RBC Capital Markets.
Thanks, good morning. Mark, you mentioned some of the changes in the EPS guidance for the full year being a higher assumed margin. Can you give us sort of a more detail where you see kind of the incremental opportunity there; whether it’s certain other costs or parts of the organization you think that there are some I guess lower hanging fruit in.
No, thanks for the question, I think it's a great one.
So for example, you know we talked about the fact that we're putting better management reporting capability sets in place. That's allowing us to really unpack the business in a way that hitherto we haven't had the access to really have had visibility through and see.
So for example you heard us talk in the past about, we have 25,000 features which we’ve recently pounded down into 400 different products. Within those 400 products we had 82 product groups specifically, and what you'll find within those 82 product groups is that the top 25 account for you know greater than 85% of our total product revenue.
So that's just one example of where we're using better data to kind of penetrate and really understanding the business at a more granular level, and we’ll be able to take actions and clear decisions you know based on that knowledge.
So there are certainly things that we can do to tighten up the ship and tighten our belts that will not take anything away from our offerings set from our key clients which, is our focus always.
Okay, that's great, thanks. And then one of the big initiatives going back over the past year or so now, we're getting clients current.
You talked about the importance of that, just in terms of things like visibility and client satisfaction. Do you have any metrics you can share on how that has progressed? What proportion of clients are now on the most recent versions of Cerner software versus maybe 12 or 15 months ago?
Let me ask Travis Dalton to comment.
If you could Travis on some of the work going on along those lines.
Thanks, I appreciate it. Yeah, good morning, this is Travis. Yeah, we talked about the last time around, you know we’re focused real heavily in our core market and we're very intentional in our current upload programs, so we got a number of programs going here as we talked about.
We’re working through what we call blueprints where we’re looking at the clinical capabilities and efficiencies with our clients. We’ve got targeted investments in certain solution areas. Pediatrics and others that we think are there in the hospital.
We’re working closely with clients; we just got our Cerner health from, where we had over 5000 participants over several days doing education on net recessions with us. We think that’s important in this environment, to continue to provide through solid communications, on the education and then upgrades as to another portion of our pile up of investment upgrades. What I would say about it is that you know it's a – it's not keeping clients current and so that is not one thing. It’s like a holistic strategic approach and so we’re approaching it from multiple angles.
You know I can't give an exact number of the percentage of our clients, but what I can tell you is that we're getting the vast majority of our clients with – and some capacity with one of those approaches, strategies or tools, in order to make sure we cover the entirety of our client base, the persons having one focus, one program that takes us you know a much longer time to rollout.
So I think the comprehensive nature of what we're doing, our approach is, you know I think it’s accelerating our speed, the value to our clients, in keeping them current and relevant. And I'll just make one other note.
You know we talked about client currently, but from my perspective you know protection and depending in [inaudible] base is not our goal.
Our goal is to all our clients and as Don noted prior, you know I'm very encouraged that we’re on strategy based on the conversations I’m having with our clients globally, federally and in the U.S. client market. The conversations are trending very much into the things that we're working on and we’ve been a leader and we’ve been ahead out in the industry for a number of decades.
So I think we're in a good place in terms of you know our client's current being competitors and also as it relates to forward looking market trends accelerated by the pandemic.
Okay, that's great. Thanks again.
Your next question comes from the line of Kevin Caliendo of UBS.
Great! Thanks for the question. This is actually Adam Noble in for Kevin. I just wanted to ask you know two questions. One, first on the buyback authorization.
Just curious, you guys obviously gave a really helpful target for how much you expect to do this year as you think about the entirety of you know now more than $4 billion authorized total through 2023. That you know, is it the goal of the company to initially complete most of that or all of that by that date or do you think about that target as kind of a big opening and you guys will be opportunistic whether you reach that goal number?
Thanks for the question Adam. I guess what I would say is a couple of things.
You know clearly we had an intention to buy back additional shares, because as I said, when we believe the stock is below its intrinsic value, that’s a good action for our shareholders at large.
Second, we intend to do what we say we're going to do culturally, right.
So I think you should think about the targeted date of the end of ‘23. To complete the program is our clear intention. That said, you know things can change, right, and so we have to always be flexible and we don't know what else could happen over that time horizon, but certainly we don't ask to do things or intend to do things that we don't you know expect to fully action.
Got you. And I guess related to that yeah, I noticed when you were talking about kind of the updated capital allocation priorities, M&A was third.
You guys obviously have this very large share of repurchase authorization that you announced today. Does that signal any change in your kind of focus on strategic M&A or openness to large scale M&A.
Just any comment there on that would be helpful.
No, I wouldn't read too much into that.
I think it's a clear point of order that you know the business and the core business comes first, and that's where we'll put our first dollar. But we have the luxury of having a very strong balance sheet, a very strong investment grade balance sheet and we have the ability to do many things and it can meet our criteria.
Great! Thanks for the questions.
Your next question comes from the line of Michael Cherny of Bank of America.
Thanks so much for taking the question. Maybe to build on that last one just a little bit and go back to some of the commentary you had around the data on the server side, what are you seeing in the competitive landscape along those lines in terms of both, other EHR vendors using that as a base versus other non-traditional companies that want to leverage their own various different data sets and drive these incremental business opportunities. It seems like this is a market that there's a whole host of different entities that are focused on.
So can you give us a little more sense as well on where Cerner will be better competitively positioned to win over time?
Yeah, this is Don. It’s a great question.
I think a couple things; one, we’re very happy with where we're at relative to the Kantar acquisition. We closed that acquisition on April 1 and we're very happy with the forward progress around it. Two, and I think importantly relatively to your point on competitive differentiation, we continue to make very good progress in terms of building out our learning health network to activate our provider base in participating in that strategy around life sciences and pharma.
We have 61 members of the LHN representing almost 30,000 beds.
So we're ahead of KPI targets relative to approach on the LHN side. I guess just the final thing I would say is, I look at what’s going on with Truvada and other EMR players who have acquired their way into the space and I see it as very validating of the overall theses around our opportunity to organize one-third of provider healthcare, and create unique opportunities for them around life sciences and pharma.
So I see that competitive landscape as validating of thesis and now we need to execute well with the strategic differentiation that I think we do have, and it's playing out. I guess just one more thing I would say, you heard Travis talk about opportunities around data more broadly defined.
I think we're very focused on the life sciences and pharma strategy, but there’s multiple data strategies that I think represent themselves, including some interesting opportunities in the federal space, beyond what we're doing with the VA and DoD.
So look for us to continue to think about, how to put data to work and to monetize it in a way that has to Mark's point, attractive margin profiles around it.
Thanks. If can just drill a little bit on the commentary you had around the VA and the federal opportunity, clearly you remain one of the key partners there. There's also been some other dynamics around federal, I should say exactly when Coast Guard was announced, that was one. How do you think about where the remaining federal white space is and if you think about the growth over the next five years from federal, has anything changed on an underlying basis outside of the comments you made on the VA?
Travis, let me ask you to comment on that if you will please.
Yeah, happy to do so. I appreciate the question; this is Travis. Yes, I’ll make a quick note. I mean, we are very pleased as Brent noted in his comments with the operational and the execution progress on DoD and Cost Guard and thanks for noting that, that’s been a successful rollout for us as well.
So we are moving forward at speed and at scale with DoD. The Carson Go-live was 12 states, 10,000 users on a single day; that's a major accomplishment. VA, we support the strategic assessment, that's not being done in the back end.
We are working together with the VA daily on that, and so we feel that we’ll come out in a great place with them, in the new administration on a strict schedule and focus around it.
And so in terms of our core on-contract opportunities, we feel very good about the progress we're making and our ability to deliver our promises and requirements.
As it relates to growing the federal business, and where we see that, our strategies has been the same. Number one, it’s delivering on our promises and continue on contract growth. We've got you know a multi-billion dollar opportunity on our RDIQ, VA and DoD and that hinges on our keeping our commitments and promises. We've got new requirements, white space, and new opportunities.
With the DoD we got opportunity that help [inaudible], we got opportunity with solutions that we’ve been discussing this morning that hang off of that platform, that aggregation layer, and we are in active conversations with them.
So I see us having a good possibility there. TRICARE remains a great opportunity for us in value based care space.
I think that we're well positioned with our platform, with our data aggregation capabilities, to be a material, to provide longitudinal record and bring those clinical impaired data sets together for them and where material in that conversation. And then ultimately they are still in new footprint opportunities, renewed health services is one of the last remaining divestures within the system. We’ll likely make a decision and then we did sign an opportunity in our first quarter with CDC around real world data. I believe Don mentioned it, and so we’ve got a rich data set as you can imagine and so CDC and others are active and interested in that.
So we do view data as an opportunity for us on a go-forward basis.
So I think we’ve got multiple threads of opportunity in the federal business.
Your next question comes from the line of El Samuel of JP Morgan.
Hi guys. Thanks for taking the question. I was hoping, you know maybe you can provide a little bit more color around this VA strategic review.
Just in terms of what maybe some of the potential outcomes might be, and is there any potential for impact beyond this year? Thanks.
Sure, this is Travis.
So yes, this is an expected I think outcome of the new administration. This is one of the – this is the most strategic and largest program the VA is undertaking right now.
And so really I think the review is focused in a couple of core areas. One is, again looking at and evaluating the contract.
So are we – are all the things we set out to do three years ago, the things we set out to do today and we are working though that and we are making progress. But I think we'll be doing strength of schedule evaluation, so we'll be looking at the full schedule.
You know it's not loss on anyone that we've actually been able to accelerate our DoD rollout in the out years once we’ve been able to harden the solutions set.
So I think that you know we can look at the schedule holistically. We think we are in a good position to possibly accelerate the rollout in the years five through seven. But in the short term, it will cause some wave activity to push to the right, because we are undergoing the 12 week assessment and Mark noted that in this comments. But ultimately again, I just believe that we’ll come out with a clarified schedule with them, clear KPIs that we are going to hold ourselves accountable to and a clear focus collectively with the new administration and leadership.
So I think that's the direction that we're going with some short term headwinds, long term tailwind, potentially.
That's really helpful. Thanks very much.
Your next question comes from a line of Eric Percher of Nephron Research.
Thank you, and welcome to Mark.
With the focus on succession, I think we may have missed an opportunity to hear a bit of your early thoughts on process and goal posts. I know when it comes to long term revenue, which is a key question for the company right now, hence it’s typically a point where we get into some of the details, the targets this year. Do you feel like that's a good point for us to look for your perspective on where we go forward or what can you tell us about your process?
Thanks for the question. I guess I would offer a couple of things. One, it's still early days right. I've had at this point eight weeks under my belt and so I have a lot to learn and there's a lot that I continue to absorb and take in as I formulate my own views as it relates to that.
Second, I guess what I would say is, I think we have all the tools here to be very, very successful, you know in the years ahead.
We have nearly 3 million healthcare providers in each Cerner system each and every day.
We have 25,000 associates who have an unparalleled and unmatched knowledge of the healthcare and IT intersection.
You know we’re the top provider of IT to the federal government; we lead the acute EMR global market with 2,400 in-patient facilities worldwide; we have a strong balance sheet; we have 600 patents; we have $800 million a year we invest in R&D. I mean we have all the tools, and we have a team, right.
So I think we're going to be able to do considerably better vis-à-vis our shareholders in the years ahead, because there’s a clear acknowledge that on the CSR front you know we haven’t necessarily always delivered and this is a team that is committed to delivering for our clients and for our shareholders.
So I would simply say, you know stay tuned and good things are coming.
I appreciate that.
Your next question comes from the line of Elizabeth Anderson of Evercore.
Hi guys. Thanks so much for the question. I was wondering how you view sort of stock compensation in terms of the total compensation for employees in your different areas. Like how do you see that trending as we go forward, just as it impacts the operating margin line would be helpful.
You know it’s a great question.
You know look we are an IT company, we compete for IT talent and it's typical that in IT firms that you have equity fairly broadly distributed throughout the associate base in order to keep them fully aligned with the company goals and objectives. That's always been Cerner’s approach, and we have used that at times in lieu of salary increases.
So we will obviously continue to want to use that as part of the mix. We’ll need to make sure that we balance that and that we do it in a way that is representative of our deliverables to our shareholders themselves.
You know one could argue that over the last several years when our TSR hasn't really performed that maybe we were a little bit too generous in that regard, because we are clearly a pay-for-performance company, and the compensation committee and the board has made it clear that they are going to hold the management team accountable for performance in the years ahead, and with that understanding, I think equity will remain a key part of our compensation package, but we have to perform.
That’s helpful. Thank you.
Your next question comes from a line of Steve Halper of Cantor.
A couple of housekeeping questions.
So when you provide the guidance of $3.20 or greater than $3.20, is there an explicit sort of estimate for the potential delay in some of the VA revenues or is that – you know that will sort of determine as a TBD.
No, we’ve taken all of that into account.
So all the information that we know presently which Brent commented on and which I comment on in our prepared remarks. We think we probably lost somewhere between a half point and full point of revenue, you know based on the work that's going on, which again we fully support, so that's contemplated in our new guidance range.
Great! And then also in terms of your housekeeping, the CapEx line increased somewhat from the fourth quarter as well as the capitalized software costs. Could you just give us a little bit more detail on the increases?
Yeah, some of the capitalized software increase you're seeing relates to the 21st Century Cures Act where we have brought in some additional third parties to help us manage that since there's a relatively short time frame to get a lot of work done, and that's what's really bumping that up a little bit in the here and now.
And Steve, if you are talking about the, on the actually cap – this is Allan.
On the CapEx line aside from capitalized software, that is up a little bit and that's a little bit of COVID. We pushed out a lot of CapEx last year and there's just a little bit of catch up on data center CapEx in Q1, but for the year, you know CapEx should still be down when you look at it for the year.
Great! Very helpful, thank you.
Your next question comes from the line of Jeff Garro of Piper Sandler.
Yeah, good morning and thanks for taking the questions. I want to ask about M&A, and I appreciate Mark's framework for M&A consideration. I want to ask him as well as the rest of the team if there are any strategic areas that will get a deeper look under that financial framework.
Yes, this is Don and that’s a great question.
I think we continue to like RTHS related strategies inside the hospital.
I think you're going to continue to see us think about and focus on provider network activation strategy outside the four walls of the hospital, that’s a space we’ve talked about throughout the morning as having significant trend and that includes strategies around the home as venue. And then you know we're still very energized by what's playing out around the database and secondary data use strategies.
So all three of those areas are line of sight in terms of where we see the growth potential for the business and as Mark framed out, part of the dialogue that we’ll have around how we deploy capital and put it to work with the right return profile.
Excellent! That helps and may I follow-up there by asking about healthy referral? That’s a product that, I believe came from an acquisition that was small enough that you didn't need to disclose it last October, but it's already making a mark.
So I would be interested to hear about traction there and I think Travis might have alluded to it in the context of the VA, which is pretty interesting, but then also more broadly just the ability to integrate cloud native and EHR Agnostic Technology that's required in healthy impact.
Yes look, Mark alluded to it.
I think there's large strategic M&A activity and then I think we're also going to be smart in terms of thinking about tuck-ins as a component part of how we create total solution offering strategies, so that's certainly going to be a part of how we think about putting capital to work at a broad level. And then at a micro level relative to healthy referrals, look it's a great use case around what's playing out from a provider network perspective. It's an opportunity for our clients to really think about how they manage referrals for key service line areas, CV, oncology, neuro, orthopedic.
So they are figuring out how to manage supply/demand dynamics around that provider network as they recover from COVID. But it also begins to really help them understand what would it look like for me to take elevated rates of first dollar risk as part of a value strategy.
And so what we're excited about in the provider network space is the chance to help our provider clients, navigate that transition, maximize fee for service, but also begin to prepare for ships and payment. And then just the last thing I would say is, that the big opportunity from a growth perspective that Travis and I think and talk about every day is Mark’s right, we do have an enviable position with one-third of U.S. provider organizations, but there's a huge addressable market for us outside of the scope of our Cerner millennium base and part of what growth needs to look like for us going forward is strategies to address that piece of the market and referrals is a good example of how we can do that.
Excellent! Thanks for that.
Your next question comes from a line of George Hill of Deutsche Bank.
Hi! It’s Maxi [ph] on for George. Thanks for taking the question.
So last quarter you talked about the company expects around 15% CAGR in the strategic growth business with 2020 as the new baseline. Could you provide some more update on how the business is performing relative to your occupation, particularly Lumeris. Thanks.
You know I think at the end of the day we expect strategic growth to lead the company in its total revenue progression.
We have targeted to have that segment grow at you know 20%-plus per year. That will very based on a combination of organic growth and not organic growth depending on the circumstances.
We are very pleased with Kantar Health acquisition, which we just recently closed on and expect that to contribute about $40 million per quarter, about $125 million of incremental revenue this year.
So I would think the strategic growth business is collectively taken. It will probably grow closer to maybe 30% this year, but it will very you know as we go forward.
Your next question comes from the line of Robert Jones of Goldman Sachs.
Great! Thanks for taking my question. This is Jack Rogoff on for Bob. I wanted to ask if the strategic review with the VA, if those impacts to revenue affect mix one way or the other as it relates to margins in 2021.
Yeah, this is Allan. Yes, there is some software that would have been included in that, but also some services side. I don't think as a whole company level, probably not a huge impact on mix, but there's certainly some high margin mix within that that we are offsetting. But all of the work on the margin front is obviously more than offsetting any margin impact that that mix shift would cause.
Makes sense, thanks. And then it looks like the implied back half guidance has a step-up in the level of revenues versus the second quarter. Can you describe what drives that? Is it seasonality, is it the impact from the VA or is there anything that has to get better in the underlying business in the back half?
Yeah, I think a big part of that is the Kantar comes in Q2, and there is really, there is slight sequential increase factored in the next few quarters, but nothing that substantial, other than you know getting back on track on VA as you roll through the year and sort of getting that ramp continuing.
So it's not really anything unusual relative to sequential revenue increases as you go Q3 to Q4.
Great! Thanks a lot.
Your next question comes from the line of Richard Close of Canaccord.
Yes, thanks, Richard Close here. The lower software called out for the first quarter, is there any more details you can provide on that. And then second question Mark is maybe on the margin expansion expanding on Sean's earlier question. Longer term getting to that mid-20% level, are the efficiencies there that have been put in place so far, are those the main drivers and anything that maybe you put your hands on here and now that you're in the role of the CFO could drive that even higher than the mid-20% level.
Sure, thank you. I'll answer the second quarter, and then I’ll let Allen common on the first.
So I talked earlier about the need for us to really put in place world class management reporting systems.
Another good example of where that's going to be invaluable is in our areas of R&D spend.
You know in the last three years we spent $2.5 billion in R&D and the simple truth of the matter is, we haven't had the internal systems to allow us to take that spend all the way down to the individual product or project level, and our ability to do that going forward is going to dramatically enhance our ability to monetize that R&D investment.
Yeah, and on the software commentary relative to the quarter. I mean keep in mind we're reconciling a $7 million difference relative to the midpoint of our guidance, and we mentioned three things.
So I wouldn't site software as a huge impact in the quarter, so you could pick a lot of different things, but it was just, it was one of the few things that led to it being slightly below where we expected.
Okay, thank you.
Your next question comes from a line of Ricky Goldwasser of Morgan Stanley.
Yes hi, good morning. I have a couple of questions. Brent, the first one is for you. When you sort of reflect on a time at Cerner, and clearly you talked about sort of the shift in strategic direction, but what do you think has been sort of the limiting factor to further sort of accelerate the shift? And then the second question refers to something that Mark mentioned earlier on, in an idea that you're competing for Techtel; I mean clearly it's a very hard market.
So what are you seeing there in terms of that supply of individuals? Thank you.
Yes, no, I appreciate it. Well, I think you know going back to three years ago coming in the door, there's so much opportunity in Cerner, but in a lot of ways our systems and our ways of operating were not really conducive to speak. They've been built up over time, and at this scale we are not very efficient.
So it sounds kind of mechanical, but there's been a fair amount of time getting an operating model in place that’s clear, it is understandable when accountability is deployed throughout the organization.
And so the intent to move is pretty clear. The ability to move quickly requires organization alignment and great execution, and so I think we have – we are in a much stronger position to do that today and are ready to do that, and have a leadership team ready to move that forward.
So I think the stage has been set and the direction is clear and the ability to accelerate now is in front of us.
So on your second question about talent, yeah there's definitely a global war for talent in tech and we all know that.
So we are doing everything we can to make sure that we're an attractive employer for our associates, that this is a place that you can come and not only contribute to technology, but you can make a difference in the world, because its healthcare and that's somewhat unique.
You know in a lot of the other places in Tech, it may not be that bold a charter, but that is our mission and I think for especially technical talent that wants to be part of chaining the world, make it a difference, this is a great fit.
And so we're very much interested in getting that word about us as an employer and we're proud of some of the progress in our culture over the last year, and some things our associates have done to make a difference during COVID and to make a difference in the community, so – but it's a competitive landscape for sure.
Your final question comes from the line of Jonathan Young of Barclays.
Thanks for squeezing me in here.
Just on the operating margin, the 20% by 2024, given you are accelerating some of your operational improvements, is there a possibility that we could see that come in ahead of that current schedule time line. And then secondly you also mentioned going deeper down into your product portfolio and viewing what adds value to clients, does that suggests that you made that addition product set or is this more from a cost savings perspective? Thanks.
I guess I’d offer a couple of things.
You know at this point we have been able to reaffirm our pre-COVID commitments to our margin expansion endeavors. Whether we get there sooner than that, you know time will tell, but we are acting with a sense of urgency and we believe that we have a great opportunity in the years ahead to monetize all the investments that have been made to-date and to great leadership levels of TSR, that’s our clear objective.
As far as the product and portfolio review, you know with better data we are able to sharpen our thinking, and I think it will be a combination of various matters all the time balancing our internal needs for profitable growth with our client’s needs in order to better service the healthcare industry, which is our mission.
Alright, I think that’s it. Thank you everybody for joining us and we look forward to talking to you next quarter.
Thank you, all.
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