UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended: September 30, 2020
or
For the transition period from ___________ to ___________
Commission File Number: 0-15386
(Exact name of registrant as specified in its charter)
 | |||||||||||||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||||||||||||||
| (Address of principal executive offices) | (Zip Code) | ||||||||||||||||
(816 ) 221-1024
(Registrant's telephone number, including area code)
_________________________________________________________________
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
| Class | Outstanding at October 21, 2020 | |||||||
| Common Stock, $0.01 par value per share | ||||||||
CERNER CORPORATION
TABLE OF CONTENTS
| Part I. | Financial Information: | |||||||
| Item 1. | Financial Statements: | |||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| Part II. | Other Information: | |||||||
| Item 1. | ||||||||
| Item 1A. | ||||||||
| Item 2. | ||||||||
| Item 6. | ||||||||
| Signatures | ||||||||
Part I. Financial Information
Item 1. Financial Statements
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 30, 2020 (unaudited) and December 28, 2019
| (In thousands, except share data) | 2020 | 2019 | |||||||||
| Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Short-term investments | |||||||||||
| Receivables, net | |||||||||||
| Inventory | |||||||||||
| Prepaid expenses and other | |||||||||||
| Total current assets | |||||||||||
| Property and equipment, net | |||||||||||
| Right-of-use assets | |||||||||||
| Software development costs, net | |||||||||||
| Goodwill | |||||||||||
| Intangible assets, net | |||||||||||
| Long-term investments | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities and Shareholders' Equity | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Deferred revenue | |||||||||||
| Accrued payroll and tax withholdings | |||||||||||
| Other current liabilities | |||||||||||
| Total current liabilities | |||||||||||
| Long-term debt | |||||||||||
| Deferred income taxes | |||||||||||
| Other liabilities | |||||||||||
| Total liabilities | |||||||||||
| Shareholders' Equity: | |||||||||||
Common stock, $ | |||||||||||
| Additional paid-in capital | |||||||||||
| Retained earnings | |||||||||||
Treasury stock, | ( | ( | |||||||||
| Accumulated other comprehensive loss, net | ( | ( | |||||||||
| Total shareholders' equity | |||||||||||
| Total liabilities and shareholders' equity | $ | $ | |||||||||
See notes to condensed consolidated financial statements (unaudited).
1
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and nine months ended September 30, 2020 and September 28, 2019
(unaudited)
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| (In thousands, except per share data) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Revenues | $ | $ | $ | $ | |||||||||||||||||||
| Costs and expenses: | |||||||||||||||||||||||
| Costs of revenue | |||||||||||||||||||||||
| Sales and client service | |||||||||||||||||||||||
Software development (Includes amortization of $ | |||||||||||||||||||||||
| General and administrative | |||||||||||||||||||||||
| Amortization of acquisition-related intangibles | |||||||||||||||||||||||
| Total costs and expenses | |||||||||||||||||||||||
| Gain on sale of businesses | |||||||||||||||||||||||
| Operating earnings | |||||||||||||||||||||||
| Other income, net | |||||||||||||||||||||||
| Earnings before income taxes | |||||||||||||||||||||||
| Income taxes | ( | ( | ( | ( | |||||||||||||||||||
| Net earnings | $ | $ | $ | $ | |||||||||||||||||||
| Basic earnings per share | $ | $ | $ | $ | |||||||||||||||||||
| Diluted earnings per share | $ | $ | $ | $ | |||||||||||||||||||
| Basic weighted average shares outstanding | |||||||||||||||||||||||
| Diluted weighted average shares outstanding | |||||||||||||||||||||||
See notes to condensed consolidated financial statements (unaudited).
2
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three and nine months ended September 30, 2020 and September 28, 2019
(unaudited)
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| (In thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Net earnings | $ | $ | $ | $ | |||||||||||||||||||
Foreign currency translation adjustment and other (net of taxes (benefit) of $ | ( | ( | ( | ||||||||||||||||||||
Unrealized gain (loss) on cash flow hedge (net of taxes (benefit) of $ | ( | ( | ( | ||||||||||||||||||||
Unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $( | ( | ||||||||||||||||||||||
| Comprehensive income | $ | $ | $ | $ | |||||||||||||||||||
See notes to condensed consolidated financial statements (unaudited).
3
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2020 and September 28, 2019
(unaudited)
| Nine Months Ended | |||||||||||
| (In thousands) | 2020 | 2019 | |||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||||||
| Net earnings | $ | $ | |||||||||
| Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | |||||||||||
| Share-based compensation expense | |||||||||||
| Provision for deferred income taxes | |||||||||||
| Gain on sale of businesses | ( | ||||||||||
| Investment gains | ( | ( | |||||||||
| Changes in assets and liabilities (net of businesses acquired): | |||||||||||
| Receivables, net | ( | ||||||||||
| Inventory | |||||||||||
| Prepaid expenses and other | ( | ( | |||||||||
| Accounts payable | ( | ( | |||||||||
| Accrued income taxes | ( | ||||||||||
| Deferred revenue | ( | ( | |||||||||
| Other accrued liabilities | |||||||||||
| Net cash provided by operating activities | |||||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||||||
| Capital purchases | ( | ( | |||||||||
| Capitalized software development costs | ( | ( | |||||||||
| Purchases of investments | ( | ( | |||||||||
| Sales and maturities of investments | |||||||||||
| Purchase of other intangibles | ( | ( | |||||||||
| Sale of businesses | |||||||||||
| Acquisition of businesses, net of cash acquired | ( | ||||||||||
| Net cash used in investing activities | ( | ( | |||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||||||
| Long-term debt issuance | |||||||||||
| Repayment of long-term debt | ( | ||||||||||
| Proceeds from exercise of stock options | |||||||||||
| Payments to taxing authorities in connection with shares directly withheld from associates | ( | ( | |||||||||
| Treasury stock purchases | ( | ( | |||||||||
| Dividends paid | ( | ( | |||||||||
| Other | ( | ( | |||||||||
| Net cash used in financing activities | ( | ( | |||||||||
| Effect of exchange rate changes on cash and cash equivalents | ( | ( | |||||||||
| Net increase (decrease) in cash and cash equivalents | ( | ||||||||||
| Cash and cash equivalents at beginning of period | |||||||||||
| Cash and cash equivalents at end of period | $ | $ | |||||||||
See notes to condensed consolidated financial statements (unaudited).
4
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the three and nine months ended September 30, 2020 and September 28, 2019
(unaudited)
| Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Loss, Net | |||||||||||||||||||||||||||||||
| (In thousands) | Shares | Amount | |||||||||||||||||||||||||||||||||
| Balance at December 28, 2019 | $ | $ | $ | $ | ( | $ | ( | ||||||||||||||||||||||||||||
| Exercise of stock options and vests of restricted shares and share units | — | — | — | ||||||||||||||||||||||||||||||||
| Employee share-based compensation expense | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Cumulative effect of accounting change (ASU 2016-13) | — | — | — | ( | — | — | |||||||||||||||||||||||||||||
| Other comprehensive income (loss) | — | — | — | — | — | ( | |||||||||||||||||||||||||||||
| Treasury stock purchases | — | — | — | — | ( | — | |||||||||||||||||||||||||||||
| Cash dividends declared ($0.18 per share) | — | — | — | ( | — | — | |||||||||||||||||||||||||||||
| Net earnings | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Balance at March 31, 2020 | ( | ( | |||||||||||||||||||||||||||||||||
| Exercise of stock options and vests of restricted shares and share units | — | — | — | ||||||||||||||||||||||||||||||||
| Employee share-based compensation expense | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Other comprehensive income (loss) | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Cash dividends declared ($0.18 per share) | — | — | — | ( | — | — | |||||||||||||||||||||||||||||
| Net earnings | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Balance at June 30, 2020 | ( | $ | ( | ||||||||||||||||||||||||||||||||
| Exercise of stock options and vests of restricted shares and share units | — | — | — | ||||||||||||||||||||||||||||||||
| Employee share-based compensation expense | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Other comprehensive income (loss) | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Cash dividends declared ($0.18 per share) | — | — | — | ( | — | — | |||||||||||||||||||||||||||||
| Net earnings | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Balance at September 30, 2020 | $ | $ | $ | $ | ( | $ | ( | ||||||||||||||||||||||||||||
See notes to condensed consolidated financial statements (unaudited).
5
CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (continued)
For the three and nine months ended September 30, 2020 and September 28, 2019
(unaudited)
| Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Loss, Net | |||||||||||||||||||||||||||||||
| (In thousands) | Shares | Amount | |||||||||||||||||||||||||||||||||
| Balance at December 29, 2018 | $ | $ | $ | $ | ( | $ | ( | ||||||||||||||||||||||||||||
| Exercise of stock options and vests of restricted shares and share units | — | — | — | ||||||||||||||||||||||||||||||||
| Employee share-based compensation expense | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Other comprehensive income (loss) | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Net earnings | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Balance at March 30, 2019 | ( | ( | |||||||||||||||||||||||||||||||||
| Exercise of stock options and vests of restricted shares and share units | — | — | — | ||||||||||||||||||||||||||||||||
| Employee share-based compensation expense | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Other comprehensive income (loss) | — | — | — | — | — | ( | |||||||||||||||||||||||||||||
| Treasury stock purchases | — | — | — | — | ( | — | |||||||||||||||||||||||||||||
| Cash dividends declared ($0.18 per share) | — | — | — | ( | — | — | |||||||||||||||||||||||||||||
| Net earnings | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Balance at June 29, 2019 | ( | ( | |||||||||||||||||||||||||||||||||
| Exercise of stock options and vests of restricted shares and share units | — | — | — | ||||||||||||||||||||||||||||||||
| Employee share-based compensation expense | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Other comprehensive income (loss) | — | — | — | — | — | ( | |||||||||||||||||||||||||||||
| Treasury stock purchases | — | — | — | — | ( | — | |||||||||||||||||||||||||||||
| Cash dividends declared ($0.18 per share) | — | — | — | ( | — | — | |||||||||||||||||||||||||||||
| Net earnings | — | — | — | — | — | ||||||||||||||||||||||||||||||
| Balance at September 28, 2019 | $ | $ | $ | $ | ( | $ | ( | ||||||||||||||||||||||||||||
See notes to condensed consolidated financial statements (unaudited).
6
CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) Interim Statement Presentation
Basis of Presentation
The condensed consolidated financial statements included herein have been prepared by Cerner Corporation ("Cerner," the "Company," "we," "us" or "our") without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our latest annual report on Form 10-K.
In management's opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position and the results of operations and cash flows for the periods presented. Our interim results as presented in this Form 10-Q are not necessarily indicative of the operating results for the entire year.
Fiscal Period End
Prior to fiscal year 2020, our third fiscal quarter ended on the Saturday closest to September 30. The third quarter and year-to-date periods for 2019 presented herein consisted of 91 days and 273 days, respectively, and ended on September 28, 2019.
In December 2019, our Board of Directors approved the change of our fiscal year to a calendar year, commencing with fiscal year 2020. Accordingly, the third quarter and year-to-date periods for 2020 presented herein consisted of 92 days and 277 days, respectively, and ended on September 30, 2020.
All references to periods in these notes to condensed consolidated financial statements represent the respective periods described above ending on September 30, 2020 and September 28, 2019, unless otherwise noted.
Supplemental Disclosures of Cash Flow Information
| Nine Months Ended | |||||||||||||||||
| (In thousands) | 2020 | 2019 | |||||||||||||||
| Cash paid during the period for: | |||||||||||||||||
Interest (including amounts capitalized of $ | $ | $ | |||||||||||||||
| Income taxes, net of refunds | |||||||||||||||||
| Non-cash items: | |||||||||||||||||
| Lease liabilities recorded upon the commencement of operating leases | |||||||||||||||||
| Capital purchases | |||||||||||||||||
CARES Act
Cash flows from operating activities for the first nine months of 2020 include the impact of $56 million of certain federal payroll taxes related to pay cycles in the second and third quarters of 2020, for which we have deferred remittance to the taxing authority as permitted under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). We expect to continue to defer the remittance of such payroll taxes for the remainder of 2020, as permitted by the CARES Act, for which the remittances to the taxing authority are to be paid in equal amounts at the end of 2021 and 2022, respectively. At September 30, 2020, these deferred remittances are included in "Accrued payroll and tax withholdings" in our condensed consolidated balance sheets.
7
Accounting Pronouncements Adopted in 2020
Credit Losses on Financial Instruments. In the first quarter of 2020, we adopted new guidance regarding impairment assessment for certain financial assets. Refer to Notes (3) and (4) for further details.
Collaborative Arrangements. In November 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606, which clarifies when transactions between participants in a collaborative arrangement are within the scope of the FASB's recent revenue standard (Topic 606). Such guidance clarifies revenue recognition and financial statement presentation for transactions between collaboration participants. We adopted ASU 2018-18 in the first quarter of 2020. Such guidance did not have an impact on our consolidated financial statements and related disclosures.
Recently Issued Accounting Pronouncements
Reference Rate Reform. In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides optional financial reporting alternatives to reduce the cost and complexity associated with the accounting for contracts and hedging relationships affected by reference rate reform, such as the upcoming discontinuance of the London Interbank Offered Rate ("LIBOR"). The accommodations within ASU 2020-04 may be applied prospectively from the beginning of our 2020 first quarter through December 31, 2022. We are currently evaluating the effect that ASU 2020-04 may have on our contracts that reference LIBOR, specifically, our Third Amended and Restated Credit Agreement (as amended, the "Credit Agreement") and related interest rate swap. As of the date of this filing, we have not elected to apply any of the provisions of this standard.
(2) Revenue Recognition
Disaggregation of Revenue
The following tables present revenues disaggregated by our business models:
| Three Months Ended | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| (In thousands) | Domestic Segment | International Segment | Total | Domestic Segment | International Segment | Total | |||||||||||||||||
| Licensed software | $ | $ | $ | $ | $ | $ | |||||||||||||||||
| Technology resale | |||||||||||||||||||||||
| Subscriptions | |||||||||||||||||||||||
| Professional services | |||||||||||||||||||||||
| Managed services | |||||||||||||||||||||||
| Support and maintenance | |||||||||||||||||||||||
| Reimbursed travel | |||||||||||||||||||||||
| Total revenues | $ | $ | $ | $ | $ | $ | |||||||||||||||||
8
| Nine Months Ended | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| (In thousands) | Domestic Segment | International Segment | Total | Domestic Segment | International Segment | Total | |||||||||||||||||
| Licensed software | $ | $ | $ | $ | $ | $ | |||||||||||||||||
| Technology resale | |||||||||||||||||||||||
| Subscriptions | |||||||||||||||||||||||
| Professional services | |||||||||||||||||||||||
| Managed services | |||||||||||||||||||||||
| Support and maintenance | |||||||||||||||||||||||
| Reimbursed travel | |||||||||||||||||||||||
| Total revenues | $ | $ | $ | $ | $ | $ | |||||||||||||||||
The following tables present our revenues disaggregated by timing of revenue recognition:
| Three Months Ended | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| (In thousands) | Domestic Segment | International Segment | Total | Domestic Segment | International Segment | Total | |||||||||||||||||
| Revenue recognized over time | $ | $ | $ | $ | $ | $ | |||||||||||||||||
| Revenue recognized at a point in time | |||||||||||||||||||||||
| Total revenues | $ | $ | $ | $ | $ | $ | |||||||||||||||||
| Nine Months Ended | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| (In thousands) | Domestic Segment | International Segment | Total | Domestic Segment | International Segment | Total | |||||||||||||||||
| Revenue recognized over time | $ | $ | $ | $ | $ | $ | |||||||||||||||||
| Revenue recognized at a point in time | |||||||||||||||||||||||
| Total revenues | $ | $ | $ | $ | $ | $ | |||||||||||||||||
Transaction Price Allocated to Remaining Performance Obligations
As of September 30, 2020, the aggregate amount of transaction price allocated to performance obligations that are unsatisfied (or partially unsatisfied) for executed contracts approximates $13.01 billion of which we expect to recognize approximately 30% of the revenue over the next 12 months and the remainder thereafter .
Contract Liabilities
Customer payments received in advance of satisfaction of the related performance obligations are deferred as contract liabilities. Such amounts are classified in our condensed consolidated balance sheets as "Deferred revenue". During the nine months ended September 30, 2020, we recognized $306 million of revenues that were included in our contract liability balance at the beginning of such period.
Significant Customers
A certain customer within our Domestic segment comprised 19 % and 12 % of our consolidated revenues for the third quarters of 2020 and 2019, respectively; and 17 % and 11 % for the first nine months of 2020 and 2019, respectively. Amounts due from this same customer comprised 14 % of client receivables as of September 30, 2020.
9
(3) Receivables
A summary of net receivables is as follows:
| (In thousands) | September 30, 2020 | December 28, 2019 | |||||||||
| Client receivables | $ | $ | |||||||||
| Less: Provision for expected credit losses | |||||||||||
| Total receivables, net | $ | $ | |||||||||
A reconciliation of the beginning and ending amount of our provision for expected credit losses is as follows:
| (In thousands) | |||||
| Provision for expected credit losses - balance at December 28, 2019 | $ | ||||
| Cumulative effect of accounting change (ASU 2016-13) | |||||
| Additions charged to costs and expenses | |||||
| Deductions | ( | ||||
| Provision for expected credit losses - balance at September 30, 2020 | $ | ||||
During the first nine months of 2020 and 2019, we received total client cash collections of $4.09 billion and $4.23 billion, respectively.
Expected Credit Losses
A summary of such cumulative effect adjustment is as follows:
| (In thousands) | Increase/(Decrease) | ||||
| Receivables, net | $ | ( | |||
| Retained earnings | ( | ||||
The cumulative effect adjustment is the result of providing an allowance on unbilled client receivables, for which we have an unconditional right to invoice and receive payment in the future.
Our estimates of expected credit losses for client receivables at both December 29, 2019 and September 30, 2020, were primarily based on historical credit loss experience and adjustments for certain asset-specific risk characteristics (i.e. known client financial hardship or bankruptcy). Exposure to credit losses may increase if our clients are adversely affected by changes in healthcare laws, reimbursement or payor models; economic pressures or uncertainty associated with local or global economic recessions; disruption associated with the COVID-19 pandemic; or other client-specific factors. Although we have historically not experienced significant credit losses, it is possible that there could be an adverse impact from potential adjustments to the carrying amount of client receivables as clients' cash flows are impacted by the COVID-19 pandemic and related economic uncertainty, which may be material.
10
(4) Investments
Available-for-sale investments at September 30, 2020 were as follows:
| (In thousands) | Adjusted Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||||||||||||
| Cash equivalents: | ||||||||||||||||||||||||||
| Money market funds | $ | $ | — | $ | — | $ | ||||||||||||||||||||
| Time deposits | — | — | ||||||||||||||||||||||||
| Commercial Paper | — | — | ||||||||||||||||||||||||
| Government and corporate bonds | — | — | ||||||||||||||||||||||||
| Total cash equivalents | — | — | ||||||||||||||||||||||||
| Short-term investments: | ||||||||||||||||||||||||||
| Time deposits | — | — | ||||||||||||||||||||||||
| Commercial paper | ( | |||||||||||||||||||||||||
| Government and corporate bonds | ( | |||||||||||||||||||||||||
| Total short-term investments | ( | |||||||||||||||||||||||||
| Long-term investments: | ||||||||||||||||||||||||||
| Government and corporate bonds | ( | |||||||||||||||||||||||||
| Total available-for-sale investments | $ | $ | $ | ( | $ | |||||||||||||||||||||
Available-for-sale investments at December 28, 2019 were as follows:
| (In thousands) | Adjusted Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||||||||||||
| Cash equivalents: | ||||||||||||||||||||||||||
| Money market funds | $ | $ | — | $ | — | $ | ||||||||||||||||||||
| Time deposits | — | — | ||||||||||||||||||||||||
| Total cash equivalents | — | — | ||||||||||||||||||||||||
| Short-term investments: | ||||||||||||||||||||||||||
| Time deposits | — | — | ||||||||||||||||||||||||
| Government and corporate bonds | ( | |||||||||||||||||||||||||
| Total short-term investments | ( | |||||||||||||||||||||||||
| Long-term investments: | ||||||||||||||||||||||||||
| Government and corporate bonds | ( | |||||||||||||||||||||||||
| Total available-for-sale investments | $ | $ | $ | ( | $ | |||||||||||||||||||||
We sold available-for-sale investments for proceeds of $5 million and $181 million during the nine months ended September 30, 2020 and September 28, 2019, respectively, resulting in insignificant gains/losses in each period.
Other Investments
At September 30, 2020 and December 28, 2019, we had investments in equity securities that do not have readily determinable fair values of $320 million and $314 million, respectively, accounted for in accordance with Accounting Standards Codification Topic ("ASC") 321, Investments-Equity Securities. Such investments are included in "Long-term investments" in our condensed consolidated balance sheets. We did not record any changes in the measurement of such investments during the nine months ended September 30, 2020 and September 28, 2019, respectively.
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At June 30, 2020 and December 28, 2019, we had investments in equity securities with readily determinable fair values of $41 million and $14 million, respectively, accounted for in accordance with ASC 321. Such investments were included in "Short-term investments" in our condensed consolidated balance sheets. Changes in the measurement of such investments favorably impacted "Other income, net" by $49 million and $76 million for the three and nine months ended September 30, 2020, respectively, and $9 million for both the three and nine months ended September 28, 2019. In August 2020, we sold these investments for cash proceeds of $90 million.
At September 30, 2020 and December 28, 2019, we had investments in equity securities reported under the equity method of accounting of $11 million and $9 million, respectively. Such investments are included in "Long-term investments" in our condensed consolidated balance sheets.
Impairment Assessment
We adopted ASU 2016-13 in the first quarter of 2020, which made certain amendments to the model used to assess available-for-sale debt securities for impairment. Such guidance provides that an available-for-sale debt security is impaired if the fair value of the security is less than its amortized cost basis. A determination is made whether the decline in fair value below the amortized cost basis has resulted from a credit loss or other factors, such as market liquidity or changes in interest rates. Impairment related to credit losses is recognized in net earnings, whereas impairment related to other factors is recognized as a component of accumulated other comprehensive loss, net. During the nine months ended September 30, 2020, we did not recognize any impairment on our available-for-sale debt securities through net earnings.
(5) Long-term Debt
The following is a summary of indebtedness outstanding:
| (In thousands) | September 30, 2020 | December 28, 2019 | |||||||||
Credit agreement loans due | $ | $ | |||||||||
| Senior notes: | |||||||||||
Series 2020-A due | |||||||||||
Series 2015-A due | |||||||||||
Series 2015-B due | |||||||||||
| Other | |||||||||||
| Total indebtedness | |||||||||||
| Less: debt issuance costs | ( | ( | |||||||||
| Long-term debt | $ | $ | |||||||||
Credit Agreement
As of September 30, 2020, the interest rate on revolving credit loans outstanding under our Credit Agreement was 0.95 % based on LIBOR plus the applicable spread.
Series 2020-A Senior Notes
In March 2020, we issued $300 million aggregate principal amount of 2.50 % senior unsecured Series 2020-A notes (the "Series 2020-A Notes") due March 11, 2030 , pursuant to a Master Note Agreement we entered into in November 2019, and subsequently amended on October 8, 2020 (collectively and as amended, the "2019 Shelf Agreement"). Interest on
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(6) Fair Value Measurements
We determine fair value measurements used in our consolidated financial statements based upon the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
•Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
•Level 2 – Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
•Level 3 – Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following table details our investments in available-for-sale debt securities measured and recorded at fair value on a recurring basis at September 30, 2020:
| (In thousands) | Fair Value Measurements Using | |||||||||||||||||||||||||
| Description | Balance Sheet Classification | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||
| Money market funds | Cash equivalents | $ | $ | — | $ | |||||||||||||||||||||
| Time deposits | Cash equivalents | — | ||||||||||||||||||||||||
| Commercial paper | Cash equivalents | — | — | |||||||||||||||||||||||
| Government and corporate bonds | Cash equivalents | — | — | |||||||||||||||||||||||
| Time deposits | Short-term investments | — | ||||||||||||||||||||||||
| Commercial paper | Short-term investments | — | ||||||||||||||||||||||||
| Government and corporate bonds | Short-term investments | — | ||||||||||||||||||||||||
| Government and corporate bonds | Long-term investments | — | ||||||||||||||||||||||||
The following table details our investments in available-for-sale debt securities measured and recorded at fair value on a recurring basis at December 28, 2019:
| (In thousands) | Fair Value Measurements Using | |||||||||||||||||||||||||
| Description | Balance Sheet Classification | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||
| Money market funds | Cash equivalents | $ | $ | — | $ | |||||||||||||||||||||
| Time deposits | Cash equivalents | — | ||||||||||||||||||||||||
| Time deposits | Short-term investments | — | ||||||||||||||||||||||||
| Government and corporate bonds | Short-term investments | — | ||||||||||||||||||||||||
| Government and corporate bonds | Long-term investments | — | ||||||||||||||||||||||||
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Our investments in equity securities with readily determinable fair values accounted for in accordance with ASC 321 were measured and recorded at fair value on a recurring basis using a Level 2 valuation. The fair value of such arrangements was based on quoted prices in active markets, reduced by a percentage reflecting a discount for lack of marketability.
Our interest rate swap agreement is measured and recorded at fair value on a recurring basis using a Level 2 valuation. The fair value of such agreement is based on the market standard methodology of netting the discounted expected future variable cash receipts and the discounted future fixed cash payments. The variable cash receipts are based on an expectation of future interest rates derived from observed market interest rate forward curves. Since these inputs are observable in active markets over the terms that the instrument is held, the derivative is classified as Level 2 in the hierarchy.
(7) Gain on Sale of Businesses
Germany and Spain
The following table presents a reconciliation of the sale price to the net gain recognized on the disposed business operations which is included in "Gain on sale of businesses" in our condensed consolidated statements of operations:
| (In thousands) | ||||||||||||||
| Sale price | $ | |||||||||||||
| Net assets/(liabilities) removed | ( | |||||||||||||
| Transaction expenses | ( | |||||||||||||
| Foreign currency | ||||||||||||||
| Gain on sale of businesses | $ | |||||||||||||
The following table presents a reconciliation of the sale price to the cash proceeds received from CGM which are included in "Sale of businesses" in our condensed consolidated statements of cash flows:
| (In thousands) | |||||||||||
| Sale price | $ | ||||||||||
| VAT and other transaction taxes, net | ( | ||||||||||
| Cash received from sale of businesses | $ | ||||||||||
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Amounts included in our condensed consolidated balance sheets related to the disposed business operations immediately prior to the sale on July 1, 2020 were as follows:
| (In thousands) | Asset/(Liability) | ||||||||||
| Receivables, net | $ | ||||||||||
| Inventory | |||||||||||
| Prepaid expenses and other | |||||||||||
| Property and equipment, net | |||||||||||
| Right-of-use assets | |||||||||||
| Software development costs, net | |||||||||||
| Goodwill | |||||||||||
| Intangible assets, net | |||||||||||
| Accounts payable | ( | ||||||||||
| Deferred revenue | ( | ||||||||||
| Accrued payroll and tax withholdings | ( | ||||||||||
| Other current liabilities | ( | ||||||||||
| Net assets/(liabilities) | $ | ||||||||||
Revenue Cycle Outsourcing
(8) Income Taxes
15
(9) Earnings Per Share
A reconciliation of the numerators and the denominators of the basic and diluted per share computations are as follows:
| Three Months Ended | |||||||||||||||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||||||||||||||
| Earnings | Shares | Per-Share | Earnings | Shares | Per-Share | ||||||||||||||||||||||||||||||
| (In thousands, except per share data) | (Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | |||||||||||||||||||||||||||||
| Basic earnings per share: | |||||||||||||||||||||||||||||||||||
Income available to common shareholders | $ | $ | $ | $ | |||||||||||||||||||||||||||||||
| Effect of dilutive securities: | |||||||||||||||||||||||||||||||||||
| Stock options, non-vested shares and share units | — | — | |||||||||||||||||||||||||||||||||
| Diluted earnings per share: | |||||||||||||||||||||||||||||||||||
Income available to common shareholders including assumed conversions | $ | $ | $ | $ | |||||||||||||||||||||||||||||||
For the three months ended September 30, 2020 and September 28, 2019, options to purchase 3.9 million and 7.7 million shares of common stock at per share prices ranging from $55.24 to $76.49 and $54.87 to $75.83 , respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.
| Nine Months Ended | |||||||||||||||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||||||||||||||
| Earnings | Shares | Per-Share | Earnings | Shares | Per-Share | ||||||||||||||||||||||||||||||
| (In thousands, except per share data) | (Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | |||||||||||||||||||||||||||||
| Basic earnings per share: | |||||||||||||||||||||||||||||||||||
| Income available to common shareholders | $ | $ | $ | $ | |||||||||||||||||||||||||||||||
| Effect of dilutive securities: | |||||||||||||||||||||||||||||||||||
| Stock options, non-vested shares and share units | — | — | |||||||||||||||||||||||||||||||||
| Diluted earnings per share: | |||||||||||||||||||||||||||||||||||
Income available to common shareholders including assumed conversions | $ | $ | $ | $ | |||||||||||||||||||||||||||||||
For the nine months ended September 30, 2020 and September 28, 2019, options to purchase 4.4 million and 10.1 million shares of common stock at per share prices ranging from $52.32 to $76.49 and $51.87 to $75.83 , respectively, were outstanding but were not included in the computation of diluted earnings per share because they were anti-dilutive.
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(10) Share-Based Compensation and Equity
Stock Options
Stock option activity for the nine months ended September 30, 2020 was as follows:
| (In thousands, except per share and term data) | Number of Shares | Weighted- Average Exercise Price (Per Share) | Aggregate Intrinsic Value | Weighted-Average Remaining Contractual Term (Yrs) | |||||||||||||||||||
| Outstanding at beginning of year | $ | ||||||||||||||||||||||
| Granted | |||||||||||||||||||||||
| Exercised | ( | ||||||||||||||||||||||
| Forfeited and expired | ( | ||||||||||||||||||||||
| Outstanding as of September 30, 2020 | $ | ||||||||||||||||||||||
| Exercisable as of September 30, 2020 | $ | $ | |||||||||||||||||||||
The weighted-average assumptions used to estimate the fair value, under the Black-Scholes-Merton pricing model, of stock options granted during the nine months ended September 30, 2020 were as follows:
| Expected volatility (%) | % | |||||||
| Expected dividend rate (%) | % | |||||||
| Expected term (yrs) | ||||||||
| Risk-free rate (%) | % | |||||||
| Fair value per option | $ | |||||||
As of September 30, 2020, there was $58 million of total unrecognized compensation cost related to stock options granted under all plans. That cost is expected to be recognized over a weighted-average period of 2.12 years.
Non-vested Shares and Share Units
Non-vested share and share unit activity for the nine months ended September 30, 2020 was as follows:
| (In thousands, except per share data) | Number of Shares | Weighted-Average Grant Date Fair Value Per Share | |||||||||
| Outstanding at beginning of year | $ | ||||||||||
| Granted | |||||||||||
| Vested | ( | ||||||||||
| Forfeited | ( | ||||||||||
| Outstanding as of September 30, 2020 | $ | ||||||||||
As of September 30, 2020, there was $223 million of total unrecognized compensation cost related to non-vested share and share unit awards granted under all plans. That cost is expected to be recognized over a weighted-average period of 1.96 years.
17
Share-Based Compensation Cost
The following table presents total compensation expense recognized with respect to stock options, non-vested shares and share units, and our associate stock purchase plan:
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| (In thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Stock option and non-vested share and share unit compensation expense | $ | $ | $ | $ | |||||||||||||||||||
| Associate stock purchase plan expense | |||||||||||||||||||||||
Amounts capitalized in software development costs, net of amortization | ( | ( | ( | ||||||||||||||||||||
| Amounts charged against earnings, before income tax benefit | $ | $ | $ | $ | |||||||||||||||||||
| Amount of related income tax benefit recognized in earnings | $ | $ | $ | $ | |||||||||||||||||||
Treasury Stock
Under our current share repurchase program, which was initially approved by our Board of Directors in May 2017 and most recently amended in December 2019, the Company is authorized to repurchase up to $3.70 billion of shares of our common stock, excluding transaction costs. The repurchases are to be effectuated in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers. No time limit was set for the completion of the program. During the nine months ended September 30, 2020, we repurchased 9.2 million shares for total consideration of $650 million under the program. The shares were recorded as treasury stock and accounted for under the cost method. No repurchased shares have been retired. As of September 30, 2020, $1.03 billion remains available for repurchase under the program.
Dividends
On September 10, 2020 , our Board of Directors declared a cash dividend of $0.18 per share on our issued and outstanding common stock, which was paid on October 13, 2020 to shareholders of record as of September 25, 2020 . On May 21, 2020 , our Board of Directors declared a cash dividend of $0.18 per share on our issued and outstanding common stock, which was paid on July 17, 2020 to shareholders of record as of June 5, 2020 . On March 19, 2020 , our Board of Directors declared a cash dividend of $0.18 per share on our issued and outstanding common stock, which was paid on April 17, 2020 to shareholders of record as of April 3, 2020 . In connection with the declaration of such dividends, our non-vested shares and share units are entitled to dividend equivalents, which will be payable to the holder subject to, and upon vesting of, the underlying awards. Our outstanding stock options are not entitled to dividend or dividend equivalents. At both September 30, 2020 and December 28, 2019, our condensed consolidated balance sheets included liabilities for dividends payable of $56 million, which are included in "Other current liabilities".
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Accumulated Other Comprehensive Loss, Net (AOCI)
The components of AOCI, net of tax, were as follows:
| Foreign currency translation adjustment and other | Unrealized loss on cash flow hedge | Unrealized holding gain (loss) on available-for-sale investments | Total | ||||||||||||||||||||
| (In thousands) | |||||||||||||||||||||||
| Balance at December 28, 2019 | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||
| Other comprehensive income (loss) before reclassifications | ( | ( | ( | ( | |||||||||||||||||||
Amounts reclassified from AOCI | |||||||||||||||||||||||
Balance at March 31, 2020 | ( | ( | ( | ( | |||||||||||||||||||
| Other comprehensive income (loss) before reclassifications | ( | ||||||||||||||||||||||
Amounts reclassified from AOCI | |||||||||||||||||||||||
| Balance at June 30, 2020 | ( | ( | ( | ||||||||||||||||||||
| Other comprehensive income (loss) before reclassifications | ( | ( | |||||||||||||||||||||
| Amounts reclassified from AOCI | |||||||||||||||||||||||
| Balance at September 30, 2020 | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||
| Foreign currency translation adjustment and other | Unrealized loss on cash flow hedge | Unrealized holding gain (loss) on available-for-sale investments | Total | ||||||||||||||||||||
| (In thousands) | |||||||||||||||||||||||
| Balance at December 29, 2018 | $ | ( | $ | $ | ( | $ | ( | ||||||||||||||||
| Other comprehensive income (loss) before reclassifications | |||||||||||||||||||||||
| Amounts reclassified from AOCI | |||||||||||||||||||||||
| Balance at March 30, 2019 | ( | ( | |||||||||||||||||||||
| Other comprehensive income (loss) before reclassifications | ( | ( | ( | ||||||||||||||||||||
| Amounts reclassified from AOCI | ( | ( | |||||||||||||||||||||
| Balance at June 29, 2019 | ( | ( | ( | ||||||||||||||||||||
| Other comprehensive income (loss) before reclassifications | ( | ( | ( | ||||||||||||||||||||
| Amounts reclassified from AOCI | ( | ||||||||||||||||||||||
| Balance at September 28, 2019 | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||
19
The effects on net earnings of amounts reclassified from AOCI were as follows:
| (In thousands) | Three Months Ended | Nine Months Ended | ||||||||||||||||||||||||||||||
| AOCI Component | Location | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||||||||||
| Unrealized loss on cash flow hedge | Other income, net | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||||||||||
| Income taxes | ( | |||||||||||||||||||||||||||||||
| Net of tax | ( | ( | ( | |||||||||||||||||||||||||||||
| Unrealized holding gain (loss) on available-for-sale investments | Other income, net | |||||||||||||||||||||||||||||||
| Income taxes | ( | ( | ||||||||||||||||||||||||||||||
| Net of tax | ||||||||||||||||||||||||||||||||
| Total amount reclassified, net of tax | $ | ( | $ | ( | $ | ( | $ | |||||||||||||||||||||||||
(11) Contingencies
We accrue estimates for resolution of any legal and other contingencies when losses are probable and reasonably estimable in accordance with ASC 450, Contingencies ("ASC 450"). No less than quarterly, and as facts and circumstances change, we review the status of each significant matter underlying a legal proceeding or claim and assess our potential financial exposure. We accrue a liability for an estimated loss if the potential loss from any legal proceeding or claim is considered probable and the amount can be reasonably estimated. Significant judgment is required in both the determination of probability and the determination as to whether the amount of an exposure is reasonably estimable, and accruals are based only on the information available to our management at the time the judgment is made, which may prove to be incomplete or inaccurate or unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. Furthermore, the outcome of legal proceedings is inherently uncertain, and we may incur substantial defense costs and expenses defending any of these matters. Should any one or a combination of more than one of these proceedings be successful, or should we determine to settle any one or a combination of these matters, we may be required to pay substantial sums, become subject to the entry of an injunction or be forced to change the manner in which we operate our business, which could have a material adverse impact on our business, results of operations, cash flows or financial condition.
20
The terms of our agreements with our clients generally provide for limited indemnification of such clients against losses, expenses and liabilities arising from third party or other claims based on, among other things, alleged infringement by our solutions of an intellectual property right of third parties or damages caused by data privacy breaches or system interruptions. The terms of such indemnification often limit the scope of and remedies for such indemnification obligations and generally include, as applicable, a right to replace or modify an infringing solution. For several reasons, including the lack of a sufficient number of prior indemnification claims relating to IP infringement, data privacy breaches or system interruptions, the inherent uncertainty stemming from such claims, and the lack of a monetary liability limit for such claims under the terms of the corresponding agreements with our clients, we cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.
In addition to commitments and obligations in the ordinary course of business, we are involved in various other legal proceedings and claims that arise in the ordinary course of business, including for example, employment and client disputes and litigation alleging solution and implementation defects, personal injury, intellectual property infringement, violations of law, breaches of contract and warranties, and compliance audits by various government agencies. Many of these proceedings are at preliminary stages and many seek an indeterminate amount of damages. At this time, we do not believe the range of potential losses under any claims to be material to our consolidated financial statements.
(12) Segment Reporting
21
The following table presents a summary of our operating segments and other expense for the three and nine months ended September 30, 2020 and September 28, 2019:
| (In thousands) | Domestic | International | Other | Total | |||||||||||||||||||
| Three Months Ended 2020 | |||||||||||||||||||||||
| Revenues | $ | $ | $ | — | $ | ||||||||||||||||||
| Costs of revenue | — | ||||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||
Total costs and expenses | |||||||||||||||||||||||
| Gain on sale of businesses | |||||||||||||||||||||||
| Operating earnings (loss) | $ | $ | $ | ( | $ | ||||||||||||||||||
| (In thousands) | Domestic | International | Other | Total | |||||||||||||||||||
| Three Months Ended 2019 | |||||||||||||||||||||||
| Revenues | $ | $ | $ | — | $ | ||||||||||||||||||
| Costs of revenue | — | ||||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||
Total costs and expenses | |||||||||||||||||||||||
| Operating earnings (loss) | $ | $ | $ | ( | $ | ||||||||||||||||||
| (In thousands) | Domestic | International | Other | Total | |||||||||||||||||||
| Nine Months Ended 2020 | |||||||||||||||||||||||
| Revenues | $ | $ | $ | — | $ | ||||||||||||||||||
| Costs of revenue | — | ||||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||
Total costs and expenses | |||||||||||||||||||||||
| Gain on sale of businesses | |||||||||||||||||||||||
| Operating earnings (loss) | $ | $ | $ | ( | $ | ||||||||||||||||||
| (In thousands) | Domestic | International | Other | Total | |||||||||||||||||||
| Nine Months Ended 2019 | |||||||||||||||||||||||
| Revenues | $ | $ | $ | — | $ | ||||||||||||||||||
| Costs of revenue | — | ||||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||
Total costs and expenses | |||||||||||||||||||||||
| Operating earnings (loss) | $ | $ | $ | ( | $ | ||||||||||||||||||
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following Management Discussion and Analysis ("MD&A") is intended to help the reader understand the results of operations and financial condition of Cerner Corporation ("Cerner," the "Company," "we," "us" or "our"). This MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes to condensed consolidated financial statements ("Notes") found above. Certain statements in this quarterly report on Form 10-Q contain forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995, as amended, regarding our future plans, objectives, beliefs, expectations, representations and projections. See the end of this MD&A for more information on our forward-looking statements, including a discussion of the most significant factors that could cause actual results to differ materially from those in the forward-looking statements, and the information in Part II, "Item 1A. Risk Factors" below.
All references to periods in this MD&A represent the respective three or nine months ended on such dates, unless otherwise noted. Refer to Note (1) of the Notes for information regarding our fiscal period ends.
Management Overview
Our revenues are primarily derived by selling, implementing, operating and supporting software solutions, clinical content, hardware, devices and services that give health care providers and other stakeholders secure access to clinical, administrative and financial data in real or near-real time, helping them to improve quality, safety and efficiency in the delivery of health care.
Our core strategy is to create organic growth by investing in research and development ("R&D") to create solutions and tech-enabled services for the health care industry. We may also supplement organic growth with acquisitions or strategic investments and collaborations.
Cerner's long history of growth has created an important strategic footprint in health care, with Cerner holding more than 25 percent market share in the U.S. acute care electronic health record ("EHR") market and a leading market share in several non-U.S. regions. Foundational to our growth going forward is delivering value to this core client base, including executing effectively on our large U.S. federal contracts and cross-selling key solutions and services in areas such as revenue cycle. We are also investing in platform modernization, with a focus on delivering a software as a service platform that we expect to lower total cost of ownership, improve clinician experience and patient outcomes, and enable clients to accelerate adoption of new functionality and better leverage third-party innovations.
We also expect to continue driving growth by leveraging our HealtheIntent® platform, which is the foundation for established and new offerings for both provider and non-provider markets. The EHR-agnostic HealtheIntent platform enables Cerner to become a strategic partner with health care stakeholders and help them improve performance under value-based contracting. The platform, along with our CareAware® platform, also supports offerings in areas such as long-term care, home care and hospice, rehabilitation, behavioral health, community care, care team communications, health systems operations, consumer and employer, and data-as-a-service.
Beyond our strategy for driving revenue growth, we are also focused on earnings growth. After several years of margin compression related to slowing revenue growth, increased mix of low-margin services, and lower software demand due to the end of direct government incentives for EHR adoption, Cerner implemented a new operating structure and introduced other initiatives focused on cost optimization and process improvement in 2019. To assist in these efforts, we engaged an outside consulting firm to conduct a review of our operations and cost structure. We have made good progress since we kicked off our transformation in 2019 and expect this progress to be reflected in improved profitability in 2020 and beyond. We are focused on ongoing identification of opportunities to operate more efficiently and on achieving the efficiencies without impacting the quality of our solutions and services and commitments to our clients.
We are also focused on delivering strong levels of cash flow which we expect to accomplish by continuing to grow earnings and prudently managing capital expenditures. We expect to use future cash flow and debt, as appropriate, to meet our capital allocation objectives, which include investing in our business, potential acquisitions or other strategic investments to drive profitable growth, and returning capital to shareholders through share repurchases and dividends.
23
COVID-19
Our business and results of operations for the first nine months of 2020 were impacted by the ongoing Coronavirus disease ("COVID-19") pandemic. It has caused us to modify certain of our business practices, including requiring most of our employees to work remotely; restricting employee travel; developing social distancing plans for our associates; and canceling or postponing in person participation in certain meetings, events and conferences. It is not possible to quantify the full financial impact that the COVID-19 pandemic has had on our results of operations, cash flows, or financial condition, due to the uncertainty surrounding the pandemic, the difficulty inherent in identifying and measuring the various impacts that have or may stem from such an event and the fact that there are no comparable recent events that provide guidance as to how to measure or predict the effect the COVID-19 pandemic may have on our business. However, we believe COVID-19 has impacted, and will continue in the near-term to impact, our business results, primarily, but not limited to, in the following areas:
•Bookings, backlog and revenues – A decline in new business bookings as certain client purchasing decisions and projects are delayed to focus on treating patients, procuring necessary medical supplies, and managing their own organizations through this crisis. This decline in bookings flows through to reduced backlog and lower subsequent revenues.
•Associate productivity – A decline in associate productivity, primarily for our services personnel, as a large amount of work is typically done at client sites, which is being impacted by travel restrictions and our clients' focus on the pandemic. Our clients' focus on the pandemic has also led to pauses on existing projects and postponed start dates for others, which translates into lower professional services revenues and a lower operating margin percentage. We are mitigating this by doing more work remotely than we have in the past, but we cannot fully offset the negative impact.
•Travel – Associate travel restrictions reduce client-related travel, which reduces reimbursed travel revenues and lowers our costs of revenue as a percent of revenues. Such restrictions also reduce non-reimbursable travel, which lowers operating expenses.
•Cash collections - A delay in client cash collections due to COVID-19's impact on national reimbursement processes, and client focus on managing their own organizations' liquidity during this time. This translates to lower cash flows from operating activities, and a higher days sales outstanding metric. Lower cash flows from operating activities may impact how we execute under our capital allocation strategy.
•Capital expenditures - A decline in capital spending as certain capital projects are delayed.
We believe the impact of COVID-19 on our results of operations for the first quarter of 2020 was limited, with the largest impact in the areas of reduced bookings and lower technology resale revenue, due to the mid-March 2020 timing of when we implemented changes to our business practices in response to COVID-19, and the nature of the industry in which we operate. We believe the impact of COVID-19 on our results of operations for the second and third quarters of 2020 was much greater than in the first quarter of 2020 as the pandemic and practices we implemented in mid-March 2020 were ongoing for the full quarter, with the largest impact in the areas of reduced bookings and lower licensed software, technology resale, professional services, and reimbursed travel revenues.
We expect a negative financial impact to continue for the remainder of 2020 and into 2021. However, the impact will be difficult to quantify as there are many factors outside of our control, so any forward looking statements that we make regarding our projections of future financial performance, new solution, services and offering development, and capital allocation plans; cost optimization and operational improvement initiatives; and the expected benefits of our acquisitions, divestitures or other collaborations will all be subject to increased risks, as discussed further below and in Part II, Item 1A of this quarterly report on Form 10-Q. Additionally, we may make further modifications to our operations or business plans that have a negative financial impact as required by government authorities, our clients or as we determine are in the best interests of our associates, clients and business partners. While we expect COVID-19 to have an impact on our results of operations, cash flows, and financial position in the near-term, we believe the nature of our solutions and services offerings will continue to be in demand, regardless of this pandemic. However, the COVID-19 pandemic and related restrictive measures have created significant economic uncertainty and the duration and magnitude of the impact of the pandemic is unknown at this time; therefore, there can be no assurance that the ultimate impact of the pandemic will not adversely affect our future operational and financial performance.
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Operational Improvement Initiatives
The Company has been focused on leveraging the impact of our new operating structure, which was rolled out in the first quarter of 2019, and identifying additional efficiencies in our business. We continue to be focused on reducing operating expenses and generating other efficiencies that are expected to provide longer-term operating margin expansion. We are continuing our portfolio management, which includes ongoing evaluation of our offerings, exiting certain low-margin businesses, and being more selective as we consider new business opportunities. To assist in these efforts, we engaged an outside consulting firm to conduct a review of our operations and cost structure. As part of our portfolio management, we closed on the sale of certain of our business operations, primarily conducted in Germany and Spain, in July 2020, and the sale of certain of our revenue cycle outsourcing business operations in August 2020. We expect to continue to evaluate and complete divestiture transactions that are strategic to our operational improvement initiatives. We continue to be focused on ongoing identification of opportunities to operate more efficiently and on achieving the efficiencies without impacting the quality of our solutions and services and commitments to our clients.
In the near term, we expect to continue incurring expenses in connection with these efforts. Such expenses may include, but are not limited to, consultant and other professional services fees, employee separation costs, contract termination costs, and other such related expenses. Expenses recognized in the first nine months of 2020 are primarily related to professional services fees and employee separation costs, which are included in operating expenses in our condensed consolidated statements of operations. We expect to incur additional expenses in connection with these initiatives in future periods, which may be material.
Results Overview
Bookings, which reflect the value of executed contracts for software, hardware, professional services and managed services, was $1.47 billion in the third quarter of 2020, which is a decrease of 11% compared to $1.65 billion in the third quarter of 2019.
Revenues for the third quarter of 2020 decreased 4% to $1.37 billion, compared to $1.43 billion in the third quarter of 2019.
Net earnings for the third quarter of 2020 increased 335% to $357 million, compared to $82 million in the third quarter of 2019. Diluted earnings per share increased 346% to $1.16, compared to $0.26 in the third quarter of 2019.
We had cash collections of receivables of $1.43 billion in the third quarter of 2020, compared to $1.50 billion in the third quarter of 2019. Days sales outstanding was 81 days in the third quarter of 2020 and the second quarter of 2020, compared to 74 days for the third quarter of 2019. Operating cash flows for the third quarter of 2020 were $382 million, compared to $351 million in the third quarter of 2019.
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Results of Operations
Three Months Ended September 30, 2020 Compared to Three Months Ended September 28, 2019
The following table presents a summary of our operating information for the third quarters of 2020 and 2019:
| (In thousands) | 2020 | % of Revenue | 2019 | % of Revenue | % Change | ||||||||||||||||||||||||
| Revenues | $ | 1,368,673 | 100 | % | $ | 1,429,428 | 100 | % | (4) | % | |||||||||||||||||||
| Costs of revenue | 231,889 | 17 | % | 271,778 | 19 | % | (15) | % | |||||||||||||||||||||
| Margin | 1,136,784 | 83 | % | 1,157,650 | 81 | % | (2) | % | |||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||||||||
| Sales and client service | 625,402 | 46 | % | 707,743 | 50 | % | (12) | % | |||||||||||||||||||||
| Software development | 186,826 | 14 | % | 187,526 | 13 | % | — | % | |||||||||||||||||||||
| General and administrative | 116,816 | 9 | % | 152,321 | 11 | % | (23) | % | |||||||||||||||||||||
| Amortization of acquisition-related intangibles | 12,789 | 1 | % | 21,283 | 1 | % | (40) | % | |||||||||||||||||||||
| Total operating expenses | 941,833 | 69 | % | 1,068,873 | 75 | % | (12) | % | |||||||||||||||||||||
| Total costs and expenses | 1,173,722 | 86 | % | 1,340,651 | 94 | % | (12) | % | |||||||||||||||||||||
| Gain on sale of businesses | 216,869 | 16 | % | — | — | % | |||||||||||||||||||||||
| Operating earnings | 411,820 | 30 | % | 88,777 | 6 | % | 364 | % | |||||||||||||||||||||
| Other income, net | 48,020 | 13,535 | |||||||||||||||||||||||||||
| Income taxes | (103,164) | (20,377) | |||||||||||||||||||||||||||
| Net earnings | $ | 356,676 | $ | 81,935 | 335 | % | |||||||||||||||||||||||
Revenues & Backlog
Revenues decreased 4% to $1.37 billion in the third quarter of 2020, as compared to $1.43 billion in the same period of 2019. The decline in revenues is primarily attributable to the following:
•The impact of the ongoing COVID-19 pandemic on our third quarter 2020 operations, with the largest impact in the areas of technology resale, professional services, and reimbursed travel revenues, as further discussed above.
•The third quarter of 2020 includes a $42 million reduction in revenues due to the termination of certain revenue cycle outsourcing contracts effective in the fourth quarter of 2019.
•The third quarter of 2020 includes a $22 million reduction in revenues due to the sale of certain of our business operations primarily conducted in Germany and Spain, as further discussed in Note (7) of the Notes. We expect the disposition of such operations to reduce future International Segment revenues by approximately $83 million on an annualized basis.
•The third quarter of 2020 includes a $20 million reduction in revenues due to the sale of certain of our revenue cycle outsourcing business operations, as further discussed in Note (7) of the Notes. We expect the disposition of such operations to reduce future Domestic Segment revenues by approximately $77 million on an annualized basis.
These declines are partially offset by increased implementation activity within our federal business, inclusive of ongoing projects with the U.S. Department of Defense and the U.S. Department of Veterans Affairs. In the third quarter of 2020, 19% of our total revenues were attributable to our relationships (as the prime contractor or a subcontractor) with U.S. government agencies, compared to 12% in the same period of 2019. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models.
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Backlog, which reflects contracted revenue that has not yet been recognized as revenue, was $13.01 billion at September 30, 2020, compared to $13.71 billion at December 28, 2019. This decline in backlog is primarily attributable to the divestiture transactions discussed above, along with the impact of the ongoing COVID-19 pandemic on our bookings during the first nine months of 2020, as further discussed above. We expect to recognize 30% of our backlog as revenue over the next 12 months.
We believe that backlog may not necessarily be a comprehensive indicator of future revenue as certain of our arrangements may be canceled (or conversely renewed) at our clients' option; thus contract consideration related to such cancellable periods has been excluded from our calculation of backlog. However, historically our experience has been that such cancellation provisions are rarely exercised. We expect to recognize approximately $1.16 billion of revenue over the next 12 months under currently executed contracts related to such cancellable periods, which is not included in our calculation of backlog.
Costs of Revenue
Costs of revenue as a percent of revenues were 17% in the third quarter of 2020, compared to 19% in the same period of 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel revenue, which carries a 100% cost of revenue; a lower mix of technology resale revenue, which carries a higher cost of revenue; and reduced utilization of third-party resources associated with professional services revenue.
Costs of revenue include the cost of reimbursed travel expense, sales commissions, third party consulting services and subscription content and computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, devices, maintenance, support, and services) carrying different margin rates changes from period to period. Costs of revenue does not include the costs of our client service personnel who are responsible for delivering our service offerings. Such costs are included in sales and client service expense.
Operating Expenses
Total operating expenses decreased 12% to $942 million in the third quarter of 2020, compared to $1.07 billion in the same period of 2019.
•Sales and client service expenses as a percent of revenues were 46% in the third quarter of 2020, compared to 50% in the same period of 2019. These expenses decreased 12% to $625 million in the third quarter of 2020, from $708 million in the same period of 2019. Sales and client service expenses include salaries and benefits of sales, marketing, support, and services personnel, depreciation and other expenses associated with our managed services business, communications expenses, unreimbursed travel expenses, expense for share-based payments, and trade show and advertising costs. The decrease in sales and client service expenses was primarily driven by an $11 million reduction in associate travel costs, and the third quarter of 2019 included a $60 million charge in connection with the termination of certain revenue cycle outsourcing contracts, discussed above. The divestiture transactions, as further discussed in Note (7) of the Notes, also contributed to the reduction in expenses.
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•Software development expenses as a percent of revenues were 14% in the third quarter of 2020, compared to 13% in the same period of 2019. Expenditures for software development include ongoing development and enhancement of the Cerner Millennium® and HealtheIntent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle, population health management, and health network solutions. In addition, the third quarter of 2020 includes costs incurred in connection with our efforts to modernize our platforms, with a focus on development of a software as a service platform. A summary of our total software development expense in the third quarters of 2020 and 2019 is as follows:
| Three Months Ended | |||||||||||
| (In thousands) | 2020 | 2019 | |||||||||
| Software development costs | $ | 198,565 | $ | 197,122 | |||||||
| Capitalized software costs | (71,525) | (65,684) | |||||||||
| Capitalized costs related to share-based payments | (1,792) | (698) | |||||||||
| Amortization of capitalized software costs | 61,578 | 56,786 | |||||||||
| Total software development expense | $ | 186,826 | $ | 187,526 | |||||||
•General and administrative expenses as a percent of revenues were 9% in the third quarter of 2020, compared to 11% in the same period of 2019. These expenses decreased 23% to $117 million in the third quarter of 2020, from $152 million in the same period of 2019. General and administrative expenses include salaries and benefits for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency, expense for share-based payments, certain organizational restructuring and other expense. The decrease in general and administrative expenses is primarily due to a reduction in expenses incurred in connection with our operational improvement initiatives, discussed above. We expect to incur additional expenses in connection with these efforts in future periods, which may be material. The divestiture transactions, as further discussed in Note (7) of the Notes, also contributed to the reduction in expenses.
•Amortization of acquisition-related intangibles as a percent of revenues was 1% in the third quarter of both 2020 and 2019. These expenses decreased 40% to $13 million in the third quarter of 2020, from $21 million in the same period in 2019. Amortization of acquisition-related intangibles includes the amortization of customer relationships, acquired technology, trade names, and non-compete agreements recorded in connection with our business acquisitions. The decrease in amortization of acquisition-related intangibles is primarily due to the impact of certain intangible assets from the Health Services acquisition in February 2015 becoming fully amortized in the first quarter of 2020. The divestiture transactions, as further discussed in Note (7) of the Notes, also contributed to the reduction in expenses.
Gain on Sale of Businesses
The third quarter of 2020 includes a $217 million gain on sale of businesses. Refer to Note (7) of the Notes for further information regarding divestiture transactions that closed during the third quarter of 2020.
Non-Operating Items
•Other income, net was $48 million in the third quarter of 2020, compared to $14 million in the same period of 2019. The third quarter of 2020 includes a $49 million gain recognized on the disposition of one of our equity investments. The third quarter of 2019 includes a $9 million unrealized gain recognized on that same equity investment. The remaining difference is primarily attributable to increased interest expense in the third quarter of 2020, from the $600 million of revolving credit loans we borrowed under our Credit Agreement in May 2019, and the $300 million of Series 2020-A Notes we issued in March 2020.
•Our effective tax rate was 22.4% for the third quarter of 2020, compared to 19.9% for the same period of 2019. The increase in the effective tax rate in the third quarter of 2020 is primarily due to taxes associated with the divestiture transactions that closed in the third quarter of 2020, as further discussed in Note (7) of the Notes. Refer to Note (8) of the Notes for further discussion regarding our effective tax rate.
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Operations by Segment
We have two operating segments: Domestic and International. The Domestic segment includes revenue contributions and expenditures associated with business activity in the United States. The International segment includes revenue contributions and expenditures linked to business activity outside the United States, primarily from Australia, Canada, Europe, and the Middle East. Refer to Note (12) of the Notes for further information regarding our reportable segments.
The following table presents a summary of our operating segment information for the third quarters of 2020 and 2019:
| (In thousands) | 2020 | % of Revenue | 2019 | % of Revenue | % Change | ||||||||||||||||||||||||
| Domestic Segment | |||||||||||||||||||||||||||||
| Revenues | $ | 1,230,769 | 100% | $ | 1,265,263 | 100% | (3)% | ||||||||||||||||||||||
| Costs of revenue | 219,938 | 18% | 246,634 | 19% | (11)% | ||||||||||||||||||||||||
| Operating expenses | 566,777 | 46% | 639,590 | 51% | (11)% | ||||||||||||||||||||||||
| Total costs and expenses | 786,715 | 64% | 886,224 | 70% | (11)% | ||||||||||||||||||||||||
| Domestic operating earnings | 444,054 | 36% | 379,039 | 30% | 17% | ||||||||||||||||||||||||
| International Segment | |||||||||||||||||||||||||||||
| Revenues | 137,904 | 100% | 164,165 | 100% | (16)% | ||||||||||||||||||||||||
| Costs of revenue | 11,951 | 9% | 25,144 | 15% | (52)% | ||||||||||||||||||||||||
| Operating expenses | 58,626 | 43% | 68,153 | 42% | (14)% | ||||||||||||||||||||||||
| Total costs and expenses | 70,577 | 51% | 93,297 | 57% | (24)% | ||||||||||||||||||||||||
| International operating earnings | 67,327 | 49% | 70,868 | 43% | (5)% | ||||||||||||||||||||||||
| Other costs and expenses, net | (316,430) | (361,130) | (12)% | ||||||||||||||||||||||||||
| Gain on sale of businesses | 216,869 | — | |||||||||||||||||||||||||||
| Consolidated operating earnings | $ | 411,820 | $ | 88,777 | 364% | ||||||||||||||||||||||||
Domestic Segment
•Revenues decreased 3% to $1.23 billion in the third quarter of 2020, from $1.27 billion in the same period of 2019. The decline in revenues is primarily attributable to the following:
◦The impact of the ongoing COVID-19 pandemic on our third quarter 2020 operations, with the largest impact in the areas of technology resale, professional services, and reimbursed travel revenues, as further discussed above.
◦The third quarter of 2020 includes a $42 million reduction in revenues due to the termination of certain revenue cycle outsourcing contracts effective in the fourth quarter of 2019.
◦The third quarter of 2020 includes a $20 million reduction in revenues due to the sale of certain of our revenue cycle outsourcing business operations, as further discussed in Note (7) of the Notes.
These declines are partially offset by increased implementation activity within our federal business; inclusive of ongoing projects with the U.S. Department of Defense and the U.S. Department of Veterans Affairs. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models.
•Costs of revenue as a percent of revenues were 18% in the third quarter of 2020, compared to 19% in the same period of 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel revenue, which carries a 100% cost of revenue; a lower mix of technology resale revenue, which carries a higher cost of revenue; and reduced utilization of third-party resources associated with professional services revenue.
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•Operating expenses as a percent of revenues were 46% in the third quarter of 2020, compared to 51% in the same period of 2019. These expenses decreased 11% to $567 million in the third quarter of 2020, from $640 million in the same period of 2019. The decrease in operating expenses was primarily driven by a $9 million reduction in associate travel costs, and the third quarter of 2019 included a $60 million charge in connection with the termination of certain revenue cycle outsourcing contracts, discussed above.
International Segment
•Revenues decreased 16% to $138 million in the third quarter of 2020, from $164 million in the same period of 2019. The decline in revenues is primarily due to a $22 million reduction from the sale of certain of our business operations primarily conducted in Germany and Spain, as further discussed in Note (7) of the Notes. Additionally, we believe the ongoing COVID-19 pandemic has negatively impacted our third quarter 2020 operations, as further discussed above. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models.
•Costs of revenue as a percent of revenues were 9% in the third quarter of 2020, compared to 15% in the same period of 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel revenue, which carries a 100% cost of revenue; a lower mix of technology resale revenue, which carries a higher cost of revenue; and reduced utilization of third-party resources associated with professional services and support and maintenance revenue.
•Operating expenses as a percent of revenues were 43% in the third quarter of 2020, compared to 42% in the same period of 2019. These expenses decreased 14% to $59 million in the third quarter of 2020, from $68 million in the same period of 2019. The decrease in operating expenses is primarily due to the sale of certain of our business operations in Germany and Spain, as further discussed in Note (7) of the Notes.
Other Costs and Expenses, Net
Operating costs and expenses not attributed to an operating segment include expenses such as software development, general and administrative expenses, share-based compensation expense, certain amortization and depreciation, certain organizational restructuring and other expense. These expenses decreased 12% to $316 million in the third quarter of 2020, from $361 million in the same period of 2019. The decrease is primarily due to a reduction in expenses incurred in connection with our operational improvement initiatives, discussed above.
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Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 28, 2019
The following table presents a summary of our operating information for the first nine months of 2020 and 2019:
| (In thousands) | 2020 | % of Revenue | 2019 | % of Revenue | % Change | ||||||||||||||||||||||||
| Revenues | $ | 4,110,763 | 100 | % | $ | 4,250,366 | 100 | % | (3) | % | |||||||||||||||||||
| Costs of revenue | 698,268 | 17 | % | 793,655 | 19 | % | (12) | % | |||||||||||||||||||||
| Margin | 3,412,495 | 83 | % | 3,456,711 | 81 | % | (1) | % | |||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||||||||
| Sales and client service | 1,907,138 | 46 | % | 2,026,825 | 48 | % | (6) | % | |||||||||||||||||||||
| Software development | 551,101 | 13 | % | 548,934 | 13 | % | — | % | |||||||||||||||||||||
| General and administrative | 391,000 | 10 | % | 398,305 | 9 | % | (2) | % | |||||||||||||||||||||
| Amortization of acquisition-related intangibles | 43,031 | 1 | % | 64,809 | 2 | % | (34) | % | |||||||||||||||||||||
| Total operating expenses | 2,892,270 | 70 | % | 3,038,873 | 71 | % | (5) | % | |||||||||||||||||||||
| Total costs and expenses | 3,590,538 | 87 | % | 3,832,528 | 90 | % | (6) | % | |||||||||||||||||||||
| Gain on sale of businesses | 216,869 | 5 | % | — | — | % | |||||||||||||||||||||||
| Operating earnings | 737,094 | 18 | % | 417,838 | 10 | % | 76 | % | |||||||||||||||||||||
| Other income, net | 78,247 | 44,973 | |||||||||||||||||||||||||||
| Income taxes | (176,758) | (87,688) | |||||||||||||||||||||||||||
| Net earnings | $ | 638,583 | $ | 375,123 | 70 | % | |||||||||||||||||||||||
Revenues
Revenues decreased 3% to $4.11 billion in the first nine months of 2020, as compared to $4.25 billion in the same period of 2019. The decline in revenues is primarily attributable to the following:
•The impact of the ongoing COVID-19 pandemic on our operations during the first nine months of 2020, with the largest impact in the areas of licensed software, technology resale, professional services, and reimbursed travel revenues, as further discussed above.
•The first nine months of 2020 includes a $126 million reduction in revenues due to the termination of certain revenue cycle outsourcing contracts effective in the fourth quarter of 2019.
•The first nine months of 2020 includes a $22 million reduction in revenues due to the sale of certain of our business operations primarily conducted in Germany and Spain, as further discussed in Note (7) of the Notes.
•The first nine months of 2020 includes a $20 million reduction in revenues due to the sale of certain of our revenue cycle outsourcing business operations, as further discussed in Note (7) of the Notes.
These declines are partially offset by increased implementation activity within our federal business, inclusive of ongoing projects with the U.S. Department of Defense and the U.S. Department of Veterans Affairs. In the first nine months of 2020, 17% of our total revenues were attributable to our relationships (as the prime contractor or a subcontractor) with U.S. government agencies, compared to 11% in the same period of 2019. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models.
Costs of Revenue
Costs of revenue as a percent of revenues were 17% in the first nine months of 2020, compared to 19% in the same period of 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel
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revenue, which carries a 100% cost of revenue; a lower mix of technology resale revenue, which carries a higher cost of revenue; and reduced utilization of third-party resources associated with professional services and support and maintenance revenue.
Operating Expenses
Total operating expenses decreased 5% to $2.89 billion in the first nine months of 2020, compared to $3.04 billion in the same period of 2019.
•Sales and client service expenses as a percent of revenues were 46% in the first nine months of 2020, compared to 48% in the same period of 2019. These expenses decreased 6% to $1.91 billion in the first nine months of 2020, from $2.03 billion in the same period of 2019. The decrease in sales and client service expenses was primarily driven by a $35 million reduction in associate travel costs; the first nine months of 2019 included a $60 million charge in connection with the termination of certain revenue cycle outsourcing contracts, discussed above; and the first nine months of 2019 included a $20 million charge in connection with a client dispute. The divestiture transactions, as further discussed in Note (7) of the Notes, also contributed to the reduction in expenses.
•Software development expenses as a percent of revenues were 13% in the first nine months of both 2020 and 2019. Expenditures for software development include ongoing development and enhancement of the Cerner Millennium® and HealtheIntent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle, population health management, and health network solutions. In addition, the first nine months of 2020 includes costs incurred in connection with our efforts to modernize our platforms, with a focus on development of a software as a service platform. A summary of our total software development expense in the first nine months of 2020 and 2019 is as follows:
| Nine Months Ended | |||||||||||
| (In thousands) | 2020 | 2019 | |||||||||
| Software development costs | $ | 592,025 | $ | 591,182 | |||||||
| Capitalized software costs | (219,879) | (209,458) | |||||||||
| Capitalized costs related to share-based payments | (4,831) | (1,826) | |||||||||
| Amortization of capitalized software costs | 183,786 | 169,036 | |||||||||
| Total software development expense | $ | 551,101 | $ | 548,934 | |||||||
•General and administrative expenses as a percent of revenues were 10% in the first nine months of 2020, compared to 9% in the same period of 2019. These expenses decreased 2% to $391 million in the first nine months of 2020, from $398 million in the same period of 2019. The decrease in general and administrative expenses includes the impact of the first nine months of 2019 including a $7 million charge to settle disputes with a former vendor. The divestiture transactions, as further discussed in Note (7) of the Notes, also contributed to the reduction in expenses. In the first nine months of 2020, general and administrative expenses include $118 million of expenses incurred in connection with our operational improvement initiatives, discussed above, compared to $115 million in the same period of 2019. We expect to incur additional expenses in connection with these efforts in future periods, which may be material.
•Amortization of acquisition-related intangibles as a percent of revenues was 1% in the first nine months of 2020, compared to 2% in the same period of 2019. These expenses decreased 34% to $43 million in the first nine months of 2020, from $65 million in the same period in 2019. The decrease in amortization of acquisition-related intangibles is primarily due to the impact of certain intangible assets from the Health Services acquisition in February 2015 becoming fully amortized in the first quarter of 2020. The divestiture transactions, as further discussed in Note (7) of the Notes, also contributed to the reduction in expenses.
Gain on Sale of Businesses
The first nine months of 2020 includes a $217 million gain on sale of businesses. Refer to Note (7) of the Notes for further information regarding divestiture transactions that closed during the first nine months of 2020.
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Non-Operating Items
•Other income, net was $78 million in the first nine months of 2020, compared to $45 million in the same period of 2019. The first nine months of 2020 includes a $76 million gain recognized on the disposition of one of our equity investments. The first nine months of 2019 includes a $9 million unrealized gain recognized on that same equity investment. The first nine months of 2019 also includes a $16 million gain recognized on the disposition of another one of our equity investments. The remaining difference is primarily attributable to increased interest expense in the first nine months of 2020, from the $600 million of revolving credit loans we borrowed under our Credit Agreement in May 2019, and the $300 million of Series 2020-A Notes we issued in March 2020.
•Our effective tax rate was 21.7% for the first nine months of 2020, compared to 18.9% for the same period of 2019. The increase in the effective tax rate in the first nine months of 2020 is primarily due to a decrease in net excess tax benefits recognized as a component of income tax expense in connection with the exercise of stock options and the vesting of restricted share and share unit awards. Also contributing to the increase, are taxes associated with the divestiture transactions that closed in the third quarter of 2020, as further discussed in Note (7) of the Notes. Refer to Note (8) of the Notes for further discussion regarding our effective tax rate.
Operations by Segment
The following table presents a summary of our operating segment information for the first nine months of 2020 and 2019:
| (In thousands) | 2020 | % of Revenue | 2019 | % of Revenue | % Change | ||||||||||||||||||||||||
| Domestic Segment | |||||||||||||||||||||||||||||
| Revenues | $ | 3,645,397 | 100% | $ | 3,762,205 | 100% | (3)% | ||||||||||||||||||||||
| Costs of revenue | 638,284 | 18% | 719,119 | 19% | (11)% | ||||||||||||||||||||||||
| Operating expenses | 1,724,545 | 47% | 1,817,244 | 48% | (5)% | ||||||||||||||||||||||||
| Total costs and expenses | 2,362,829 | 65% | 2,536,363 | 67% | (7)% | ||||||||||||||||||||||||
| Domestic operating earnings | 1,282,568 | 35% | 1,225,842 | 33% | 5% | ||||||||||||||||||||||||
| International Segment | |||||||||||||||||||||||||||||
| Revenues | 465,366 | 100% | 488,161 | 100% | (5)% | ||||||||||||||||||||||||
| Costs of revenue | 59,984 | 13% | 74,536 | 15% | (20)% | ||||||||||||||||||||||||
| Operating expenses | 182,594 | 39% | 209,580 | 43% | (13)% | ||||||||||||||||||||||||
| Total costs and expenses | 242,578 | 52% | 284,116 | 58% | (15)% | ||||||||||||||||||||||||
| International operating earnings | 222,788 | 48% | 204,045 | 42% | 9% | ||||||||||||||||||||||||
| Other costs and expenses, net | (985,131) | (1,012,049) | (3)% | ||||||||||||||||||||||||||
| Gain on sale of businesses | 216,869 | — | |||||||||||||||||||||||||||
| Consolidated operating earnings | $ | 737,094 | $ | 417,838 | 76% | ||||||||||||||||||||||||
Domestic Segment
•Revenues decreased 3% to $3.65 billion in the first nine months of 2020, from $3.76 billion in the same period of 2019. The decline in revenues is primarily attributable to the following:
◦The impact of the ongoing COVID-19 pandemic on our operations during the first nine months of 2020, with the largest impact in the areas of licensed software, technology resale, professional services, and reimbursed travel revenues, as further discussed above.
◦The first nine months of 2020 includes a $126 million reduction in revenues due to the termination of certain revenue cycle outsourcing contracts effective in the fourth quarter of 2019.
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◦The first nine months of 2020 includes a $20 million reduction in revenues due to the sale of certain of our revenue cycle outsourcing business operations, as further discussed in Note (7) of the Notes.
These declines are partially offset by increased implementation activity within our federal business; inclusive of ongoing projects with the U.S. Department of Defense and the U.S. Department of Veterans Affairs. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models.
•Costs of revenue as a percent of revenues were 18% in the first nine months of 2020, compared to 19% in the same period of 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel revenue, which carries a 100% cost of revenue; a lower mix of technology resale revenue, which carries a higher cost of revenue; and reduced utilization of third-party resources associated with professional services and support and maintenance revenue.
•Operating expenses as a percent of revenues were 47% in the first nine months of 2020, compared to 48% in the same period of 2019. These expenses decreased 5% to $1.72 billion in the first nine months of 2020, from $1.82 billion in the same period of 2019. The decrease in operating expenses was primarily driven by a $27 million reduction in associate travel costs; the first nine months of 2019 included a $60 million charge in connection with the termination of certain revenue cycle outsourcing contracts, discussed above; and the first nine months of 2019 included a $20 million charge in connection with a client dispute.
International Segment
•Revenues decreased 5% to $465 million in the first nine months of 2020, from $488 million in the same period of 2019. The decline in revenues is primarily due to a $22 million reduction from the sale of certain of our business operations primarily conducted in Germany and Spain, as further discussed in Note (7) of the Notes. Additionally, we believe the ongoing COVID-19 pandemic has negatively impacted our operations for the first nine months of 2020, as further discussed above. Refer to Note (2) of the Notes for further information regarding revenues disaggregated by our business models.
•Costs of revenue as a percent of revenues were 13% in the first nine months of 2020, compared to 15% in the same period of 2019. The lower costs of revenue as a percent of revenues was primarily driven by lower reimbursed travel revenue, which carries a 100% cost of revenue; a lower mix of technology resale revenue, which carries a higher cost of revenue; and reduced utilization of third-party resources associated with professional services and support and maintenance revenue.
•Operating expenses as a percent of revenues were 39% in the first nine months of 2020, compared to 43% in the same period of 2019. These expenses decreased 13% to $183 million in the first nine months of 2020, from $210 million in the same period of 2019. The decrease in operating expenses is primarily due to the sale of certain of our business operations in Germany and Spain, as further discussed in Note (7) of the Notes.
Other Costs and Expenses, net
These expenses decreased 3% to $985 million in the first nine months of 2020, from $1.01 billion in the same period of 2019. The decrease is primarily due to decreased expenses incurred in the first nine months of 2020 as a result of our operational improvement initiatives, discussed above.
Liquidity and Capital Resources
Our liquidity is influenced by many factors, including the amount and timing of our revenues, our cash collections from our clients and the amount we invest in software development, acquisitions, capital expenditures, and our share repurchase and dividend programs.
Our principal sources of liquidity are our cash, cash equivalents, which primarily consist of money market funds and time deposits with original maturities of less than 90 days, short-term investments, and borrowings under our Credit Agreement and other sources of debt financing. At September 30, 2020, we had cash and cash equivalents of $419 million and short-term investments of $473 million, as compared to cash and cash equivalents of $442 million and short-term investments of $100 million at December 28, 2019.
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We have entered into a Credit Agreement with a syndicate of lenders that provides for an unsecured $1.00 billion revolving credit loan facility, along with a letter of credit facility up to $100 million (which is a sub-facility of the $1.00 billion revolving credit loan facility). We have the ability to increase the maximum capacity to $1.20 billion at any time during the Credit Agreement's term, subject to lender participation and the satisfaction of specified conditions. The Credit Agreement expires in May 2024. As of September 30, 2020, we had outstanding revolving credit loans and letters of credit of $600 million and $30 million, respectively; which reduced our available borrowing capacity to $370 million under the Credit Agreement.
We have also entered into note purchase agreements pursuant to which we may issue and sell unsecured senior promissory notes to those purchasers electing to purchase. See Note (5) of the Notes for further information.
We believe that our present cash position, together with cash generated from operations, short-term investments and, as appropriate, remaining availability under our Credit Agreement and other sources of debt financing, will be sufficient to meet anticipated cash requirements for the next 12 months.
The following table summarizes our cash flows in the first nine months of 2020 and 2019:
| Nine Months Ended | |||||||||||
| (In thousands) | 2020 | 2019 | |||||||||
| Cash flows from operating activities | $ | 924,045 | $ | 875,524 | |||||||
| Cash flows from investing activities | (596,825) | (436,387) | |||||||||
| Cash flows from financing activities | (345,527) | (312,805) | |||||||||
| Effect of exchange rate changes on cash | (4,382) | (4,028) | |||||||||
| Total change in cash and cash equivalents | (22,689) | 122,304 | |||||||||
| Cash and cash equivalents at beginning of period | 441,843 | 374,126 | |||||||||
| Cash and cash equivalents at end of period | $ | 419,154 | $ | 496,430 | |||||||
| Free cash flow (non-GAAP) | $ | 461,282 | $ | 275,652 | |||||||
Cash from Operating Activities
| Nine Months Ended | |||||||||||
| (In thousands) | 2020 | 2019 | |||||||||
| Cash collections from clients | $ | 4,085,527 | $ | 4,233,269 | |||||||
| Cash paid to employees and suppliers and other | (3,051,302) | (3,271,818) | |||||||||
| Cash paid for interest | (31,661) | (20,756) | |||||||||
| Cash paid for taxes, net of refunds | (78,519) | (65,171) | |||||||||
| Total cash from operations | $ | 924,045 | $ | 875,524 | |||||||
Cash flows from operations increased $49 million in the first nine months of 2020 when compared to the same period of 2019, due primarily to an increase in cash impacting earnings. This increase also includes the impact of $56 million of certain federal payroll taxes related to pay cycles in the second and third quarters of 2020, for which we have deferred remittance to the taxing authority as permitted under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). We expect to continue to defer the remittance of such payroll taxes for the remainder of 2020, as permitted by the CARES Act, for which the remittances to the taxing authority are to be paid in equal amounts at the end of 2021 and 2022, respectively. Days sales outstanding was 81 days in the third quarter of 2020 and the second quarter of 2020, compared to 74 days for the third quarter of 2019.
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Cash from Investing Activities
| Nine Months Ended | |||||||||||
| (In thousands) | 2020 | 2019 | |||||||||
| Capital purchases | $ | (238,053) | $ | (388,588) | |||||||
| Capitalized software development costs | (224,710) | (211,284) | |||||||||
| Purchases of investments, net of sales and maturities | (298,069) | 189,279 | |||||||||
| Purchases of other intangibles | (29,698) | (25,794) | |||||||||
| Sale of businesses | 229,471 | — | |||||||||
| Acquisition of businesses, net of cash acquired | (35,766) | — | |||||||||
| Total cash flows from investing activities | $ | (596,825) | $ | (436,387) | |||||||
Cash flows from investing activities consist primarily of capital spending, investment, acquisition, and divestiture activities.
Our capital spending in the first nine months of 2020 was driven by capitalized equipment purchases primarily to support growth in our managed services business, investments in a cloud infrastructure to support cloud-based solutions, building and improvement purchases to support our facilities requirements and capitalized spending to support our ongoing software development initiatives. Capital purchases for the remainder of 2020 are expected to continue to be below 2019 levels, primarily driven by reduced purchases to support our facilities requirements, reflective of the completion of construction on the current phases of our Innovations Campus in the third quarter of 2020.
Short-term investment activity historically consists of the investment of cash generated by our business in excess of what is necessary to fund operations. The 2020 activity includes the investment of proceeds from the sale of certain business operations in the third quarter of 2020, as discussed below. The 2019 activity was impacted by changes made to our investment mix, such that our excess funds were more heavily held in cash and cash equivalents versus short-term and long-term investments.
Investment activity also includes the sale of one of our equity investments in August 2020 for cash proceeds of $90 million. Refer to Note (4) of the Notes for further information regarding this investment.
In the second quarter of 2020, we paid $35 million of purchase price consideration in connection with our acquisition of a consulting company specializing in providing cybersecurity solutions to clients in the healthcare industry. In the first quarter of 2020, we paid $1 million of purchase price consideration in connection with our October 2019 acquisition of AbleVets, LLC, upon finalization of working capital adjustments. We expect to continue seeking and completing strategic business acquisitions, investments, and relationships that are complementary to our business.
On July 1, 2020, we sold certain of our business operations, primarily conducted in Germany and Spain, for cash proceeds of $224 million. We also sold certain of our revenue cycle outsourcing business operations on August 3, 2020. Refer to Note (7) of the Notes for further information regarding these sales. We expect to continue to evaluate and complete divestiture transactions that are strategic to our operational improvement initiatives discussed above.
Cash from Financing Activities
| Nine Months Ended | |||||||||||
| (In thousands) | 2020 | 2019 | |||||||||
| Long-term debt issuance | $ | 300,000 | $ | 600,000 | |||||||
| Repayment of long-term debt | (2,500) | — | |||||||||
| Cash from option exercises (net of taxes paid in connection with shares surrendered by associates) | 180,057 | 173,480 | |||||||||
| Treasury stock purchases | (650,000) | (1,020,542) | |||||||||
| Dividends paid | (166,277) | (57,293) | |||||||||
| Other | (6,807) | (8,450) | |||||||||
| Total cash flows from financing activities | $ | (345,527) | $ | (312,805) | |||||||
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In March 2020, we issued $300 million aggregate principal amount of 2.50% senior unsecured Series 2020-A notes. In May 2019, we borrowed $600 million of revolving credit loans under our Credit Agreement. Refer to Note (5) of the Notes for further information regarding these obligations.
We may incur additional indebtedness in the next 12 months, which will primarily be dependent on cash flows from operations as well as the timing of business acquisition and capital allocation activity. The proceeds from such indebtedness would be deployed in accordance with our capital allocation strategy, which may include share repurchases and dividend payments (as discussed further below), as well as for general corporate purposes, including acquisitions and investments. The terms and availability of any such debt financing may be impacted by economic and financial market conditions, as well as our financial condition and results of operations at the time we seek such financing, and there can be no assurances that we would be able to obtain such financing on terms that will be acceptable or advantageous to us.
Cash inflows from stock option exercises are dependent on a number of factors, including the price of our common stock, grant activity under our stock option and equity plans, and overall market volatility. We expect net cash inflows from stock option exercises to continue throughout 2020 based on the number of exercisable options as of September 30, 2020 and our current stock price.
During the first nine months of 2020 and 2019, we repurchased 9.2 million shares of our common stock for total consideration of $650 million and 14.4 million shares of our common stock for total consideration of $1.0 billion, respectively. As of September 30, 2020, $1.03 billion remains available for repurchase under our share repurchase program. We may continue to repurchase shares under this program in 2020, but such repurchases will be dependent on a number of factors, including the price of our common stock and other cash flow needs. There is no assurance that we will repurchase up to the full amount remaining under the program.
On December 12, 2019, our Board of Directors declared a cash dividend of $0.18 per share on our issued and outstanding common stock, which was paid on January 9, 2020 to shareholders of record as of December 27, 2019. On March 19, 2020, our Board of Directors declared a cash dividend of $0.18 per share on our issued and outstanding common stock, which was paid on April 17, 2020 to shareholders of record as of April 3, 2020. On May 21, 2020, our Board of Directors declared a cash dividend of $0.18 per share on our issued and outstanding common stock, which was paid on July 17, 2020 to shareholders of record as of June 5, 2020. On September 10, 2020, our Board of Directors declared a cash dividend of $0.18 per share on our issued and outstanding common stock, which was paid on October 13, 2020 to shareholders of record as of September 25, 2020. Subject to declaration by our Board of Directors, we expect to continue paying quarterly cash dividends as a part of our current capital allocation strategy. Future dividends will be subject to the determination, declaration and discretion of our Board of Directors and compliance with covenants under our outstanding debt agreements.
The source of funds for such repurchases and dividends may include cash generated from operations, liquidation of investment holdings and other dispositions of assets, and the incurrence of indebtedness. Refer to Note (10) of the Notes for further information regarding our share repurchase and dividend programs.
Free Cash Flow (Non-GAAP)
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| (In thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Cash flows from operating activities (GAAP) | $ | 381,949 | $ | 351,448 | $ | 924,045 | $ | 875,524 | |||||||||||||||
| Capital purchases | (71,757) | (110,714) | (238,053) | (388,588) | |||||||||||||||||||
| Capitalized software development costs | (73,317) | (66,382) | (224,710) | (211,284) | |||||||||||||||||||
| Free cash flow (non-GAAP) | $ | 236,875 | $ | 174,352 | $ | 461,282 | $ | 275,652 | |||||||||||||||
Free cash flow increased $186 million in the first nine months of 2020 compared to the same period in 2019, primarily due to reduced capital expenditures. Free cash flow is a non-GAAP financial measure used by management, along with GAAP results, to analyze our earnings quality and overall cash generation of the business, and for management compensation purposes. We define free cash flow as cash flows from operating activities reduced by capital purchases and capitalized software development costs. The table above sets forth a reconciliation of free cash flow to cash flows from operating activities, which we believe is the GAAP financial measure most directly comparable to free cash flow. The presentation of free cash flow is not meant to be considered in isolation, nor as a substitute for, or superior to, GAAP results, and investors should be aware that non-GAAP measures have inherent limitations and should be read only in conjunction with
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our consolidated financial statements prepared in accordance with GAAP. Free cash flow may also be different from similar non-GAAP financial measures used by other companies and may not be comparable to similarly titled captions of other companies due to potential inconsistencies in the method of calculation. We believe free cash flow is important to enable investors to better understand and evaluate our ongoing operating results and allows for greater transparency in the review and understanding of our overall financial, operational and economic performance, because free cash flow takes into account certain capital expenditures necessary to operate our business.
Forward Looking Statements
All statements contained in this quarterly report on Form 10-Q that do not directly and exclusively relate to historical facts constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements are based on the current beliefs, expectations and assumptions of Cerner's management with respect to future events and are subject to a number of significant risks and uncertainties. It is important to note that Cerner's performance, and actual results, financial condition or business could differ materially from those expressed in such forward-looking statements. The words "will," "believe," "plans," "may," "expect," "expected," "anticipated," "mitigate," "strategy," "continue," "opportunities," "future," "estimate" or "predict" or the negative of these words, variations thereof or similar expressions are intended to identify such forward-looking statements. For example, our forward-looking statements include statements regarding our expectations, opportunities or plans for growth; our operational improvement initiatives and the results expected to be realized from those initiatives; our expectations with respect to realizing revenue from backlog; our anticipated expenses, cash requirements and sources of liquidity; the expected impact of the COVID-19 pandemic on our results of operations, financial condition, business and operations; and our capital allocation strategies and plans. These statements involve a number of risks, uncertainties and other factors that could cause or contribute to actual results differing materially, including without limitation: the possibility of significant costs and reputational harm related to product and services-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities, or those of third parties with whom we have contracted (such as public cloud providers), that could expose us to significant costs and reputational harm; the possibility of increased expenses, exposure to legal claims and regulatory actions and reputational harm associated with a cyberattack or other breach in our IT security or the IT security of third parties on which we rely; our proprietary technology may be subject to claims for infringement or misappropriation of intellectual property rights of others, or may be infringed or misappropriated by others or subject to claims related to open source licenses; material adverse resolution of legal proceedings or other claims or reputational harm stemming from negative publicity related to such claims or legal proceedings; risks associated with our global operations, including without limitation, greater difficulty in collecting accounts receivable; risks associated with fluctuations in foreign currency exchange rates; changes in tax laws, regulations or guidance that could adversely affect our tax position and/or challenges to our tax positions in the U.S. and non-U.S. countries; the uncertainty surrounding the impact of the departure of the United Kingdom from the European Union on our global business; risks associated with the unexpected loss or recruitment and retention of key personnel or the failure to successfully develop and execute succession planning to assure transitions of key associates and their knowledge, relationships and expertise; risks related to our dependence on strategic relationships and third party suppliers, including any impact to the business of such suppliers resulting from the COVID-19 pandemic; risks inherent with business acquisitions or strategic investments and the failure to achieve projected synergies; risks associated with volatility and disruption resulting from global economic or market conditions, including any impact thereon resulting from events such as the COVID-19 pandemic; significant competition and our ability to anticipate or respond quickly to market changes, changing technologies and evolving pricing and deployment methods and to bring competitive new solutions, devices, features and services to market in a timely fashion; managing growth in the new markets in which we offer solutions, health care devices or services; long sales cycles for our solutions and services; risks inherent in contracting with government clients, including without limitation, complying with strict compliance and disclosure obligations, navigating complex procurement rules and processes and defending against bid protests; risks associated with our outstanding and future indebtedness, such as compliance with restrictive covenants, which may limit our flexibility to operate our business; impact of the phase-out of the London Interbank Offered Rate (LIBOR) on the interest rates under our financing agreements and the related interest rate swap related to the outstanding indebtedness under our Credit Agreement; the potential for losses resulting from asset impairment charges; changing political, economic, regulatory and judicial influences, which could impact the purchasing practices and operations of our clients and increase costs to deliver compliant solutions and services; non-compliance with laws, government regulation or certain industry initiatives or failure to deliver solutions or services that enable our clients to comply with laws or regulations applicable to their businesses; variations in our quarterly operating results; potential variations in our sales forecasts compared to actual sales; volatility in the trading price of our common stock and the timing and volume of market activity, including volatility resulting from the COVID-19 pandemic; inability to achieve expected operating efficiencies and sustain or improve operating expense reductions; risks that Cerner's revenue
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growth may be lower than anticipated and/or that the mix of revenue shifts to low margin revenue; risks that our capital allocation strategy will not be fully implemented or enhance long-term shareholder value; risks that Cerner's business may be negatively affected as a result of future proxy fights or the actions of activist shareholders; and the extent to which the COVID-19 pandemic and measures taken in response thereto could adversely affect our financial condition, future bookings and results of operations, including risks associated with the impact of the COVID-19 pandemic on collecting accounts receivable. Additional discussion of these and other risks, uncertainties and factors affecting Cerner's business is contained in our filings with the Securities and Exchange Commission, including those under the caption "Risk Factors" in our latest annual report on Form 10-K and in this quarterly report on Form 10-Q, or in materials incorporated herein or therein by reference. Forward-looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as of the date that they are made. Except as required by law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in our business, results of operations or financial condition over time.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
No material changes.
Item 4. Controls and Procedures
a)Evaluation of Disclosure Controls and Procedures.
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of our disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report on Form 10-Q (the "Evaluation Date"). Based upon that evaluation, our CEO and CFO have concluded that, as of the Evaluation Date, our disclosure controls and procedures were designed, and were effective, to provide reasonable assurance that the information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in SEC rules and forms and is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding required disclosure.
b)Changes in Internal Control over Financial Reporting.
There were no changes in our internal controls over financial reporting during the fiscal quarter ended September 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
c)Limitations on Controls.
Our management can provide no assurance that our disclosure controls and procedures or our internal control over financial reporting can prevent all errors and all fraud under all circumstances. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been or will be detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
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Part II. Other Information
Item 1. Legal Proceedings
From time to time, we are involved in litigation which is incidental to our business. There have been no material developments to the legal proceedings previously reported in our 2019 annual report on Form 10-K (the "Form 10-K"), as supplemented by our quarterly reports on Form 10-Q for the quarters ended March 31, 2020 and June 30, 2020. In our opinion, no litigation to which we are currently a party is likely to have a material adverse effect on our consolidated financial condition, results of operations, or cash flows.
Item 1A. Risk Factors
For information regarding risk factors that could affect our business, results of operations, financial condition or future results, see Part I, "Item 1A. Risk Factors" of the Form 10-K. In addition to the risk factors disclosed therein, we are supplementing those identified in the Form 10-K with the following risk factor, as described below. For further information on our forward-looking statements see Part I, Item 2 of this quarterly report on Form 10-Q.
The extent to which the COVID-19 pandemic and measures taken in response thereto could materially adversely affect our financial condition, future bookings and results of operations will depend on future developments, which are highly uncertain and are difficult to predict. The COVID-19 pandemic and efforts to control its spread have significantly curtailed the movement of people, goods and services worldwide, including in most or all of the regions in which we sell our Solutions and Services and conduct our business operations. It has caused us to modify our business practices (including requiring most of our employees to work remotely and restricting employee travel, developing social distancing plans for our associates and canceling or postponing in person participation in meetings, events and conferences), and we may take further actions as required by government authorities, our clients or as determined to be in the best interests of our employees, clients and business partners. These measures and our clients' focus on the pandemic have also resulted in delays in marketing, selling and implementing our Solutions and Services. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus and our ability to perform critical functions could be harmed.
The magnitude and duration of the disruption and resulting decline in business activity is uncertain. In particular, we have experienced and may continue to experience a negative financial impact due to a number of factors, including without limitation:
•Cerner's efforts and investments in assisting its clients in their response to the pandemic, which includes redirecting development and consulting resources and priorities, and waiving, deferring or reducing fees for COVID-19-related emergency expansions;
•Near-term declines in new business bookings as our clients focus on helping their patients during the crisis, rather than making new or expanded purchasing decisions;
•Longer-term declines in bookings for new Solutions and Services to the extent that the pandemic results in a sustained global or U.S. economic downturn;
•Delays in implementing our Solutions and Services, including delays in the pace of completion of existing projects, such as the MHS Genesis project with the U.S. Department of Defense and the U.S. Department of Veterans Affairs’ Electronic Health Record Modernization project, while client resources are reallocated or dedicated to fighting the COVID-19 pandemic in the United States;
•Supply chain interruptions;
•Financial pressures being put on our clients, which may in turn result in a delay in collections or non-payment from our clients; and
•Financial pressures being put on our strategic investments for which we hold an equity interest increases the risk of asset impairment.
Accordingly, we expect the COVID-19 pandemic to have a negative impact on our revenues and results of operations from our 2020 second quarter and beyond. The size and duration of this impact is difficult to predict and forward-looking estimates provided by the Company are subject to the risks discussed herein.
The extent to which the COVID-19 pandemic will impact our financial condition and results of operations will depend on future developments, which are highly uncertain and difficult to predict, including, but not limited to, the duration and spread of the pandemic, its severity, the actions to contain the virus or treat its impact, its impact on our strategic
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investments, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, we may experience material adverse impacts to our business as a result of the global or U.S. economic impact and any recession that has occurred or may occur in the future. There are no comparable recent events that provide guidance as to the effect the COVID-19 pandemic may have, and, as a result, the ultimate impact of the pandemic on our operations and financial results is highly uncertain and subject to change.
Additionally, concerns over the economic impact of the COVID-19 pandemic have caused extreme volatility in financial and other capital markets which has and may continue to impact our stock price. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described under "Risk Factors" in the Form 10-K, such as those described in our risk factors titled "We depend on strategic relationships and third party suppliers and our revenue and operating earnings could suffer if we fail to manage these relationships properly," "Volatility and disruption resulting from global economic or market conditions could negatively affect our business, results of operations and financial condition", "We operate in intensely competitive and dynamic industries, and our ability to successfully compete and continue to grow our business depends on our ability to anticipate or respond quickly to market changes, changing technologies and evolving pricing and deployment methods and to bring competitive new Solutions and Services and features to market in a timely fashion", "Our success depends upon the recruitment and retention of key personnel”, and those under the heading "Risks Related to our Common Stock."
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Issuer Purchases of Equity Securities
The table below provides information with respect to Common Stock purchases by the Company during the third fiscal quarter of 2020.
| Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (a) | Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (a) | |||||||||||||||||||||||
| Period | ||||||||||||||||||||||||||
| July 1, 2020 - July 31, 2020 | — | $ | — | — | $ | 1,033,733,300 | ||||||||||||||||||||
| August 1, 2020 - August 31, 2020 | — | — | — | 1,033,733,300 | ||||||||||||||||||||||
| September 1, 2020 - September 30, 2020 | — | — | — | 1,033,733,300 | ||||||||||||||||||||||
| Total | — | $ | — | — | ||||||||||||||||||||||
(a) Under our current share repurchase program, which was initially approved by our Board of Directors on May 23, 2017 (and announced May 25, 2017) and most recently amended on December 12, 2019 (as announced on December 13, 2019), the Company is authorized to repurchase up to $3.70 billion of shares of our common stock, excluding transaction costs. The repurchases are to be effectuated in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers. No time limit was set for the completion of the program. During the nine months ended September 30, 2020, we repurchased 9.2 million shares for total consideration of $650 million under the program pursuant to Rule 10b5-1 plans. As of September 30, 2020, $1.03 billion remains available for repurchase under the program. Refer to Note (10) of the Notes for further information regarding our share repurchase program.
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Item 6. Exhibits
| (a) | Exhibits | |||||||
| 10.1 | ||||||||
| 10.2* | ||||||||
| 10.3* | ||||||||
| 31.1 | ||||||||
| 31.2 | ||||||||
| 32.1 | ||||||||
| 32.2 | ||||||||
| 101.INS | Inline XBRL Instance Document - the instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document. | |||||||
| 101.SCH | Inline XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
| 101.LAB | Inline XBRL Taxonomy Extension Labels Linkbase Document | |||||||
| 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |||||||
| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document | |||||||
| 104 | Cover Page Interactive Data File - formatted in Inline XBRL and contained in Exhibit 101. | |||||||
| *Indicates a management contract or compensatory plan or arrangement. | ||||||||
42
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| CERNER CORPORATION | |||||||||||
| Registrant | |||||||||||
| Date: October 29, 2020 | By: | /s/ Marc G. Naughton | |||||||||
| Marc G. Naughton | |||||||||||
| Executive Vice President and Chief | |||||||||||
| Financial Officer (duly authorized | |||||||||||
| officer and principal financial officer) | |||||||||||