Cerner Corporation
Q4 2017 Earnings Call Transcript

Published: 7 Feb 2018

[Operator:]

Welcome to Cerner Corporation's Fourth Quarter 2017 Conference Call. Today's date is February 6, 2018, and this call is being recorded. The company has asked me to remind you that various remarks made here today constitute forward-looking statements including, without limitation, those regarding projections of future revenues or earnings, operating margins, operating and capital expenses, bookings, taxes, solution development and future business outlook, including new markets or prospects for the company's solutions and services. Actual results may differ materially from those indicated by forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements may be found under Item 1A in Cerner's Form 10-K, together with the company's other filings. A reconciliation of non-GAAP financial measures discussed in this earnings call can be found in the company's earnings release, which was furnished to the SEC today and posted on the Investors section of cerner.com. Cerner assumes no obligation to update any forward-looking statements or information except as required by law. At this time, I'd like to turn the call over to Marc Naughton, Chief Financial Officer of Cerner Corporation.

[Marc Naughton:]

Thank you, Kevin. Good afternoon, everyone, and welcome to the call. I'll start with a review of our numbers. Zane Burke, our President, will follow me with the results, highlights and marketplace observations. Our Chief Operating Officer, Mike Nill, will provide operational highlights. And then our new Chairman and CEO, Brent Shafer, will provide closing comments. Turning to our results, for the most part, Q4 was a solid finish to 2017 with record bookings, revenue in our guidance range, strong cash flow and earnings slightly below our expectations. Our bookings in Q4 were $2.329 billion, an all-time high and up 62% from the $1.437 billion in Q4 of 2016. Bookings came in more than $300 million above the high end of our guidance range due to several large deals that Zane will discuss. Full year bookings were $6.325 billion, which is up 16% over $5.446 billion in 2016. We indicated at the beginning of the year that the large and complex nature of the opportunities in our pipeline set us up for the potential for large quarterly swings in bookings. This did play out and, except for Q3, the volatility was reflected in upside relative to our guidance with the end result being a very strong year of bookings. Our revenue backlog ended the year at $17.545 billion, which is up 10% from $15.927 billion a year ago. Revenue in the quarter was $1.314 billion, which is up 4% over Q4 of 2016. The revenue composition for Q4 was $363 million in system sales, $262 million in support and maintenance, $661 million in services and $28 million in reimbursed travel. For the full year, total revenue grew 7% over 2016 to $5.142 billion, which is in the range we provided at the beginning of the year. System sales revenue for the quarter was up 3% compared to Q4 of 2016 driven primarily by growth in licensed software. Our system sales margin percent of 65.5% was down year-over-year and sequentially due mostly to lower margins on technology resale related to a higher mix of device resale and lower subscription margins related to the mix of subscriptions having higher third-party costs. For the full year, system sales revenue grew 7% and margin increased 6% from 2016. Moving to services, total services revenue, including professional and managed services, was up 6% from a tough comparable in Q4 of 2016 when services grew 18%. Full year services revenue was up 9% over 2016 reflecting good execution by our service organizations. Support and maintenance revenue increased 3% for both the quarter and the full year, which is in line with expectations. Looking at revenue by geographic segment, domestic revenue increased 4% over the year ago quarter to $1.154 billion and non-U.S. revenue of $160 million increased 10%. For the full year, domestic revenue grew 8% and non-U.S. revenue grew 3%. As a preview to the annual update of our detailed business model that we'll provide at our investment community meeting on March 7 at HIMSS, I'd like to provide you with the total revenue and growth by business model for the full year 2017. Licensed software increased 11% to $612 million. Technology resale was flat at $274 million. Subscriptions increased 6% to $469 million. Professional services revenue grew 10% to $1.592 billion. Managed services increased 7% to $1.047 billion. Support and maintenance was up 3% to $1.047 billion and reimbursed travel was $101 million, which is up 15%. Note that a portion of the strength in licensed software and the lower growth in subscriptions is related to a shift in how we sold some of our content during 2017. This shift in approach meant more content was sold as a license. The higher license revenue in 2017 creates a tough comparable for licensed software in 2018 and lowers the run rate of subscriptions. Moving to gross margin. Our gross margin for Q4 was 82.6%, which is down from 84.1% in Q3 and basically flat compared to a year ago. The sequential decline is largely due to a lower mix of services as a percent of total revenue compared to Q3 and the lower technology resale margins I previously mentioned. Full year gross margin of 83.4% is down slightly from 83.8% in 2016. Now I will discuss spending, operating margin and net earnings. For these items, we provide both GAAP and adjusted or non-GAAP results. The 2017 and/or 2016 adjusted results exclude share-based compensation expense, share-based compensation permanent tax items, acquisition-related adjustments, tax reform impact and voluntary separation plan expense, all as detailed and reconciled to GAAP in our earnings release. Looking at operating spending, our fourth quarter GAAP operating expenses of $866 million were up 4% compared to $831 million in the year-ago period. Full-year GAAP operating expenses were $3.328 billion, up 7% from $3.106 billion in 2016. Adjusted operating expenses were $815 million, which is up 9% compared to Q4 2016. This growth was primarily driven by an increase in personnel expense related to revenue-generating associates and non-cash items. Looking at the line items, sales and client service expenses increased 9%. Software development increased 11% driven by non-cash items as we had $1 million less capitalized software and $9 million more amortization than Q4 of 2016. G&A expense was up 2%. Amortization of acquisition-related intangibles decreased 5% year-over-year. For the full year, adjusted operating expenses were up 9% to $3.138 billion. Moving to operating margins, our Q4 GAAP operating margin was 16.7% compared to 16.9% in the year-ago period. Full year GAAP operating margin was 18.7% compared to 19.0% in the year-ago period. Our adjusted operating margin was 20.5% in Q4, which is down from 23.3% in the year-ago period due to the previously discussed technology resale margins, revenue mix and non-cash expenses. In addition, as I mentioned last quarter, we did have higher operating expense in Q4 tied to upfront investments on some large projects that won't contribute to revenue until this year. The lower Q4 margins contributed to a lower full year adjusted operating margin of 22.4%, which is down from 23.6% last year. Another factor impacting our margins all year was our net software capitalization, which ended the year about $20 million lower than we had originally anticipated as we capitalized less software than expected while increasing amortization as planned. So it had a larger than expected negative impact on our margins and earnings this year. The lack of margin expansion in 2017 is consistent with our original guidance, although the decline is slightly more than expected due to the reasons I discussed. Going forward, we still see an opportunity to resume expanding margins but we do face headwinds in the near term that I discussed throughout 2017. These include the following

[Zane M. Burke:]

Thanks, Marc. Good afternoon, everyone. Today I'll provide color on our results and make some marketplace observations. I'll start with bookings. As Marc discussed, we significantly over-attained our bookings target, which led to a record level of bookings for Q4 and for the year. This quarter included closing key deals that had pushed from Q3 as well as success at closing other large details forecasted in Q4. Multiple large transactions contributed to the strength of our bookings. In fact, we signed six contracts that were greater than $75 million in Q4. These included the expanded relationship with the Adventist Health, which was announced early this month; another large ITWorks contract at an academic health system on the East Coast; an expansion of services and solutions, including population health, with a major children's hospital; and two different IDNs expanding solutions, services and sites; and an expanded global relationship. Looking at bookings mix, as you'd expect with the strength of our Works business, the percent of bookings coming from long-term contracts was higher than normal in Q4 at 46%. Even with this mix, we still had strong growth in the non-long-term bookings of 28%. For the year, the percent of long-term was 35% compared to 30% last year. From a competitive standpoint, we had a good quarter and year. This quarter, 22% of our bookings were from outside our core Millennium installed base. While this was lower than most quarters, it is still strong when you consider the volume of Works business which was all back into the base and drove most of our over-attainment. Overall, we maintained our greater than 50% win rate this year and continued to have success against our primary competitor in an environment where prospects are focused on return on investment. In the ambulatory market, we had another very good quarter and year. For the year, ambulatory bookings grew 15%, and we had 27 displacements of our primary ambulatory competitors. In the smaller hospital market, we continue to do well with our CommunityWorks offering. Our CommunityWorks bookings grew more than 30% for the year driven by the addition of 29 new clients and higher average deal sizes compared to past years as we've been able to move upmarket with this offering. We now have more than 180 CommunityWorks clients across 39 states. We also had a good year in revenue cycle, with 15% revenue growth and over 50% bookings growth. This was driven by inclusion of revenue cycle in almost all new EHR deals as well as increasing penetration of revenue cycle in our base. For the year, we had 25 displacements of various competitors' revenue cycle systems. The year also included record services bookings driven by the Cerner RevWorks expansion at Adventist Health. In population health, we continue to make good progress at adding clients to the HealtheIntent platform and ended the year with 144 unique clients. For the year, population health bookings grew 42% and revenue grew 20%. We have been able to continue growing in an environment that includes uncertainty regarding when the broader shift from fee-for-service to value-based care will occur because of our platform's ability to help clients optimize fee-for-service models while also preparing them to the shift to value-based payments. A noteworthy population health win in Q4 was signing with our first commercial health plan. This plan will use HealtheIntent to enhance their service to more than 300,000 Medicaid and Medicare Advantage lives. They are using HealtheIntent solutions to support their growing risk-based arrangements and give their providers a single source of truth for risk metrics and clinical information. A key differentiator in the selection process was HealtheIntent's ability to aggregate a wide range of clinical and claims data from multiple sources and turn it into actionable information. Moving to our business outside the U.S., we had a good quarter with 10% revenue growth. The 3% growth for the full year that Marc mentioned reflects a soft first half of your being offset by a good second half. Looking at bookings, our non-U.S. bookings were an all-time high in 2017. The record bookings combined with a strong pipeline position us well for good revenue growth going forward. Next, I'd like to provide an update on our federal business. Last quarter, I indicated we are live at our four sites that comprised the Initial Operating Capability, or IOC, program for the Department of Defense MHS GENESIS project. We also mentioned that the next step is a review process that identifies where the system can be optimized. Some media coverage suggested this exercise represents a setback in the project, but this is a planned exercise. The next milestone is a full deployment decision which is expected the summer, and we remain on track to begin full deployment later this year. Note that IOC sites represent the first successful deployment of a commercial, off-the-shelf comprehensive EHR solution in the federal space. Additionally, the project has led to a HIMSS Level 6 designation with all four sites using functionality they didn't have prior to implementing Cerner, such as advanced clinical decision support, proactive care management, structured messaging, business and clinical intelligence and the capability to share data with the community-based EHR. MHS GENESIS is also driving patient engagement as patients can now access the portal from multiple devices. I'd also like to provide an update on our opportunity with the Department of Veteran Affairs. As Marc mentioned, our contract did not sign in Q4 as we expected. The delay was primarily related to the VA's decision to conduct an external validation process to ensure their interoperability requirements can be met. We welcome this review as we're confident in our interoperability capabilities and believe it's good to have the requirements clearly defined. We also like that the VA is focused on pushing for interoperability across the industry, something we have long supported, as you know. This delay does not change the magnitude or importance of the overall opportunity, and we believe the contract will sign soon. We look forward to providing more details at that time. With that, I'll turn the call over to Mike.

[Michael R. Nill:]

Thanks, Zane. Good afternoon, everyone. Since we have more content than normal on our call today, I'm just going to make a few brief comments about our Works businesses and then turn the call over to Brent. I'll start by discussing the expanded relationship with Adventist Health that Zane mentioned. This included significant expansion of our RevWorks relationship with Cerner and an initial ITWorks relationship. We will soon be taking over day-to-day management of their revenue cycle and clinical applications IT staff and will ultimately manage all applications that involve a patient, including clinical EHR, revenue cycle, CareAware and HealtheIntent. We will also build on the foundational work of our Value Creation Office that was established to optimize clinical and operational performance levels across their enterprise. I believe this will create a more aligned and embedded relationship where we can be more effective at addressing the challenges of today while also innovating so we are in a position to excel in the future. Looking more broadly at our ITWorks and revenue cycle businesses, the strength in our fourth quarter led to both achieving record levels of bookings for the year. I believe this could be the beginning of a ramp in our Works businesses as both ITWorks and RevWorks align directly with our clients' needs to get more of their existing spend in the current challenging operating environment to providers. With that, I'll turn the call over to Brent.

[Brent Shafer:]

Thanks a lot, Mike. The team has done a great job of covering the results. I'd just like to make a few comments before we go to Q&A. First of all, I'm very excited to join Cerner at a time where there is so much impact we can have together. I spent my career in healthcare and I've always been aware of Cerner's successes and Neal Patterson's role. In my view, he was without peer in terms of his passion and the way he shaped the development of the health IT industry. Together with the other founders and the team they built, they created a remarkable company. For someone like me who's worked in healthcare and has seen so much of the unaddressed need, it's impossible not to be excited about Cerner's position in the market. The investments in platforms and services have been well timed, and as you know, in the U.S. and globally, healthcare spending continues to rise, consumer expectations of technology are at an all-time high, and the payment models are shifting toward paying for value. Together with our clients, we have a huge opportunity to impact cost, quality and satisfaction in healthcare. In the short time I've been on board, I've been extremely impressed with the talent of Cerner's leadership team. I did have the opportunity to spend a significant amount of time with the team leading up to my official start date last week, including a number of one-on-ones with key senior leaders and the opportunity to meet most of the top 100 executives in Cerner. I've had the opportunity to meet with leaders of our client organization and the chance to sit in on the first quarter's progress reviews. I plan to spend the first 100 days diving deeper and talking with as many clients as possible. As a leadership team, we'll be focusing – working together to review three-year priorities for investments, refining our strategies and identifying opportunities to optimize our business so we can keep our strong forward momentum and achieve our goals for innovation and profitable growth. Cerner is incredibly well positioned and I'm optimistic about our future. I look forward to meeting many of you next month at HIMSS. And with that, let me turn the call back over to the moderator so we can begin Q&A. Thank you.

[Operator:]

Our first question comes from Charles Rhyee with Cowen.

[Charles Rhyee:]

Yeah. Hey, thanks for taking the question. Brent, maybe I can start with you, just as you come on board, and obviously, you've only had a limited time kind of surveying things, but maybe you could share for us sort of your thoughts of where you think the market is going overall, where healthcare technology is going and the sort of the role, obviously, Cerner has a leading position there, but – so where you think things can go from here.

[Brent Shafer:]

Well, thanks. I appreciate the question and it's been very short, so I'll make my observation brief as well. But I think given what's happening with consolidation and chronic conditions and the need to deliver value, Cerner's positioning is really fantastic. I think we're in a great place. And I see that, much of what Zane covered in his discussion, there's a lot of opportunity for us in the marketplace to expand into – globally and domestically and to go deeper in our key client relationships. And I think it's a critical time for us as well in healthcare. And with the position we have with the work that's been done here in the fourth quarter and the year, I'm very optimistic about the opportunity it holds.

[Charles Rhyee:]

Great. And, Zane, maybe if I can follow up, it sounds like RevWorks, a lot of good growth here, but one announcement obviously came out a little while back Intermountain going with a competitor on sort of a 10-year deal. Can you talk about that since you do have a strong relationship with the organization in other areas?

[Zane M. Burke:]

Sure. As you know, Intermountain is a great partner of Cerner's, and we are aligned with them on a multitude of elements. This was a arrangement they've had a longstanding relationship with that particular organization and, in fact, our investors in that organization. And so that was an anticipated element of how that – for that relationship moving forward. I think there's plenty of other opportunities for us to think about how to continue to move the cost curve and bring our scale along with Intermountain as we move forward. So I think you could look forward to more items in that space, but that's an area that we were very well apprised of.

[Charles Rhyee:]

Were you able to gain things out of that? Because if I remember, you were – when you guys announced that several years back, you were talking about developing things for the RevWorks platform, even if they made that decision, were you able to still gain knowledge and capabilities from that? And I'll stop there. Thanks.

[Zane M. Burke:]

Yeah, so absolutely, so from a solution perspective, they're utilizing our full solution set, all our rev cycle solutions, and we are continuing to develop the software side of this. This really reflects the outsourcing and services component which they already had a relationship existing previously, and then they expanded that relationship and that was part of what we anticipated. We will continue to drive software innovation on the revenue cycle side as we move forward.

[Charles Rhyee:]

Okay. Thank you.

[Operator:]

Our next question comes from Ross Muken with Evercore.

[Ross Muken:]

Good afternoon, guys. So, just on the cost side and the investments, obviously, we've seen sort of some chunkiness in the bookings and obviously had some great success on the ITWorks side, and we're still sort of waiting I guess on VA. How hard is it, given the mosaic and maybe some of the lumpiness on the bookings front, to kind of plan for or forecast the cost needs, because I'm guessing some of this is people and ramp ahead of the revenue come-through. So just help us think through that, and then in that transition into 2019, what is the real element that sort of ramps down in terms of cost? Is it really just these software cap lines or is it some of the people side as well?

[Marc Naughton:]

Yeah. This is Marc. The investment component, you are correct that there are elements of these large projects that we are starting that we have ramped up ahead of time to be prepared. We are spending time both from a project readiness, from a services side, to an IP side preparing for some of these large contracts. And we've made the decision that we were going to ramp up ahead so that we were prepared and we can deliver. So there is an expense impact to that, but we made that decision and we expect that near-term impact to be relatively brief as we go – those contracts get signed, begin to drive revenue and begin offsetting the costs, which we've invested in ahead of time. So, I think as we look – so you're exactly right. We made that decision. Lumpy bookings, very big transactions obviously can make a difference and – but we'll err on the side in this case when we have these large opportunities of ensuring we deliver even if it's a near-term impact on the income statement. I think, as you look to 2019, I think certainly the things that are hitting us as part of the increases this year from relative to the non-cash expenses, relative to some of the investments in these projects that we've made, relative to some of the R&D, I think all of that growth moderates when we get to 2019, and that's why we see 2018 really as an investment year. I mean, we're very fortunate that the federal government gave us a fairly significant amount of capital to invest in the business, and we're actually doing that in 2018 with the expectation that, as we get to 2019, we should be set up for growth again.

[Ross Muken:]

That's helpful. And maybe on the market just in terms of rev cycle, it feels like we're kind of hitting inflection. I think you kind of called it out. I mean, it seems like a business that should have maybe come sooner, and the benefits are obvious. So, what's actually transpiring at the provider level that's making them sort of more open to some of those more substantial transactions? And what's sort of the impetus? And is it sort of unusual to see so many occur maybe at one time?

[Zane M. Burke:]

Ross, this is Zane. I think there's multiple things going on, but the biggest of which is, when you look at this space, there's a significant amount of cost in the administration of the claim. And it is incredibly labor-intensive. And that labor tends to be a maturing labor workforce, a less educated workforce, that is the right spot for the tech-enabled services organization to help solve problems for our clients. And so, I think what you're seeing here is really a timing of clients that are trying to get their cost structure in order and get to a high performance on collections and on those pieces, and we can offer a scale to that. And I think the focus going from the meaningful use environment kind of exclusively to here are some other things that we can work on also plays into that revenue cycle focus as well, because it allows some of the attention to go on to some solutions that have been there for 30-plus years, and now they need to get onto the current applications. And then as you're thinking about getting onto current applications, how do I think about what my workflows ought to look like on a go-forward basis versus how have we done it for the past 30 years. So there's kind of a multiple effect there, and I do think we are on the front side of a very strong buying wave in that space. And I really like our position.

[Ross Muken:]

Thanks, guys. Very helpful.

[Marc Naughton:]

Thanks, Ross.

[Operator:]

Our next question comes from Lisa Gill with JPMorgan.

[Lisa C. Gill:]

Thanks very much. Marc, can I just start first with a question around tax? So it looks like you're raising numbers by about $0.05 for tax, but talking about really spending the incremental. Can we talk about what the actual tax benefit is? Is it something that's closer to what we projected maybe $0.15 to $0.20? How do I think about what the actual tax is and how that potentially impacts 2019 as you talk about some of these investments rolling off in 2019?

[Marc Naughton:]

Yeah, Lisa. We would look at the number to be kind of between $0.20 and $0.24, so delivering $0.05 of that to the bottom line means that we're basically taking $0.19 of that and putting it towards investments. And especially in this year when those investments are things like large projects, pre-work, the 600 people that I'm putting into basically a Works business center in Kansas City to help drive that business, as the last question talked about the opportunities that we see in that space. So that is the impact relative to what – if we hadn't invested any of that, you would've seen between $0.20 and $0.24. And if we – based on what we are investing, we're taking about $0.19 or $0.17 or so of that and putting it back into the business.

[Lisa C. Gill:]

And so, as we think about the future periods, my expectation would be that you would recognize some of that in earnings once these investments are done?

[Marc Naughton:]

Clearly, as we start getting return on those investments, the tax rate is going to stay the same. The benefit from that is going to be an annual recurring item, but today, it's helping us play forward a little bit on those investments. And then, absolutely, that's why I look at 2019 as say we should start getting returns on those investments starting in 2019 and I'm still driving the same tax benefit. So, yes.

[Lisa C. Gill:]

That's perfect. And then my second question just was around the VA. I understand you'll sign it soon, talk about it when it's done, but do you have anything currently in the guidance for 2018 as it pertains to VA?

[Marc Naughton:]

Yeah. I think as we look at our 2018 plan, we certainly have, as we did before, we had elements of the VA in there. We have revised those elements and we certainly have some of that in the revised 2018 plan certainly with a lesser impact than we did originally. Obviously, I can't provide any more color than that on kind of what that amount is. We're still pending obviously signature of the contract. And once we get more information and have more facts, we'll be able to kind of share a little bit more detail. But at this point, it is included but certainly at a lesser amount than we originally – after a Q4 signing was in our projections.

[Lisa C. Gill:]

Great. Thank you for the comments.

[Marc Naughton:]

Sure.

[Operator:]

Our next question comes from Sean Wieland with Piper Jaffray.

[Sean W. Wieland:]

Hi. Thanks. So just to follow up on Lisa's question, because I'm a little confused and I'm not trying to play got you here, but the transcript from last quarter says our guidance does not assume a significant booking for the VA contract. And in this quarter, you're saying plan had assumed work would start in Q4. So I'm just trying to reconcile those two statements.

[Marc Naughton:]

Yeah. When we're talking about bookings in Q4, were we thinking there was going to be a $300 million, $400 million coming through from the VA? We absolutely didn't think that. Did we think there was going to be an initial task order or set of task orders that would be in lesser amount to allow us to get working, would allow us to start driving revenue from that, yeah, that was our expectation. Certainly, our expectation was that by the time we kicked off this year, we have that workforce in place, they would all be working on the project, and we would kind of be up and running kind of on a – certainly the initial phase kind of running full speed. So that's – we certainly in Q4 didn't expect a big number, but we did expect to get something out of that.

[Zane M. Burke:]

And I would just add we would've anticipated additional task orders coming in 2018 because of the Q4 signing, which obviously all those pieces would have fallen out. So 2018 would've had a significant impact. So the timing is significant here.

[Sean W. Wieland:]

So, if the fax machine started buzzing in your office right now with that order, would that drive an upward revision to guidance at this point?

[Marc Naughton:]

Well, if it was only up to a fax machine, but I think the reality is – the good news, Sean, is it's very public, right, you're going to know when it gets signed. You're going to know when the task orders get issued. So it'll be very visible to you when those things happen and you'll have actually a pretty good sense of the magnitude of what's happened. And once that happens, then we can kind of give you some guidance as to when that flows into revenue in our income statement. But until we get to that point, and we're being appropriately in our mind circumspect, and certainly, when we have a – when we get an updated view, we certainly will adjust our estimates relative to that updated view.

[Sean W. Wieland:]

Okay. So there is an adjustment when the deal is signed?

[Marc Naughton:]

If it varies from what we already have in our plan, then there could be an adjustment. What we will do is certainly update our plan for what happens, and if that results in a change to our estimates, we'll certainly provide that. Keep in mind, I did say that there is an element of VA in the 2018 numbers, so it's not like it's – the number is zero, so – but depending on what happens, depending on what task orders get signed, that can vary from our plan, and we will certainly adjust estimates as appropriate if necessary based on that change.

[Sean W. Wieland:]

Okay. Thank you.

[Marc Naughton:]

Sure.

[Operator:]

Our next question comes from George Hill with RBC.

[George Hill:]

Hey. Good afternoon, guys, and thanks for taking the question. I guess, Marc, I want to kind of focus in again on this investment. And I guess, if I heard you right, it sounded like part of the investment was for Works deals that are coming on and part is for the VA. I guess, first, I just want to make sure I heard that right. And then the second part is kind of, how do we think about visibility and operating leverage as we go from 2018 to 2019? And I guess what I'm trying to figure out is what portion of the expenses related to future expected revenue? Are we already recognizing such that we understand the profitability of this revenue when it rolls on? Kind of how far out ahead of the revenue recognition, and if there's any way you can tell us, order of magnitude, ROE with the incursion of the expenses versus the expected revenue?

[Marc Naughton:]

Yes. I think the incursion of the expenses ahead of revenue, I think 2018, the revenue streams will turn on relative to a significant portion of that investment certainly on the project side of the house so that, by the time – and that's why, in 2019, by the time we hit 2019, we should be making money on all of those resources that are now basically a pre-existing investment. I think the 600-person investment that we're making in Kansas City for our Works offering, that will begin to – that will help us drive business in 2017 and should be contributing to delivering the 2018 because, in many of those Works businesses, centralization is the key to driving efficiencies. And by creating that centralized location in Kansas City, to begin doing that work right away rather than waiting for it to occur over a five-year period of time, we're trying to accelerate that efficiency and our ability to centralize into one or two locations something – activities that might be occurring at 10 to 15 of places today. (46

[George Hill:]

Okay. So, if we just use the 600 number that you used then, I guess, I would ask how many of those people have you already sold through on Works deals and how many of those people are capacity for deals that haven't been sold yet?

[Marc Naughton:]

Well, most of those people are – and keep in mind, on the Works deal, we rebadged the existing workforce. So for the most part, those 600 people aren't rebadged, they are new Cerner associates, and therefore, they are cost today. As we sign new business and are able to start putting them on projects and using them to facilitate existing projects, that's when we'll start getting the pull-through from them. I do expect most of that to kind of occur in 2018 setting us up for 2019, but there is an impact as we kind of roll through 2018.

[George Hill:]

Okay. All right. I'll hop back in the queue. Thanks.

[Marc Naughton:]

Sure.

[Operator:]

Our next question comes from Matthew Gillmor with Robert Baird.

[Matthew D. Gillmor:]

Hey. Thanks for the question. Maybe following up on some of the margin comments, I think you've talked in the past about 50 bps to 100 bps of expansion in a normal year and I know you've got these investments for 2018 in the non-cash items. But as you think about getting leverage off of that, is that still a good number to think about in 2019? Or does some of the revenue mix items you've also discussed impact that range in a normal year?

[Marc Naughton:]

Yes, no, I think obviously a great question. The business we've always talked about 50 bps to 100 bps being what we think should be able to be driven. I think it's certainly one of the things – and part of the investments we're making is to help drive the efficiencies and drive those – the margins in the businesses and get those projects started on a quick pace so that we can start driving the revenue from those projects quickly and the margins related to that. It is going to be dependent somewhat on the mix because, if the Works businesses takes off and goes absolutely crazy and software basically is flat or slightly up, then that mix is going to at least impact near-term margins. I think our goal – and that'd be a great high-class problem if we're growing the top line of that business really quickly so that it was actually impacting our margins in that way. Our goal and our target is those Works businesses over time we continue driving efficiencies and enhancing those margins. So, if I can basically, without growing margins, bring in a bunch of top line revenue and then start increasing those margins, those 50 basis point to 100 basis point increases that we talk about should be attainable. But I think you make a very good point that it is going to dependent on risk and we'll continue to try to provide our view of the mix of the business. That's why we give you the business model view that we'll talk about at HIMSS more in detail to let you kind of see what the mix of the business is and how it's impacting the margins.

[Matthew D. Gillmor:]

Okay. And then on the revenue performance, Marc, you've talked about and you've given some numbers around the portion of revenues from backlog and bookings on an annual basis. Can you just give us a sense for how that came in for 2017? And did you see any better or worse conversion out of backlog versus bookings versus what you thought?

[Marc Naughton:]

Yes. I mean, 2017 was just almost exactly on what we were expecting from backlog. So it was actually – felt really good, I think we delivered what we thought we would deliver from that revenue side. As we look at our 2018 plan as we went into 2017, we were looking about kind of somewhere around 82% of our revenue coming in from backlog for the year. As we go into 2018, we're at that same 82%. So I think we're still on a bigger revenue number, we're still driving a significant amount of that coming from our backlog, and I think that's probably 26% of our total backlog that we'll look to trigger in 2018. So it's a very similar look. The one thing that, as you look at that number, it actually is maybe even a little better than the 82% we had in 2017 merely because the revenue standard does take some of your backlog away from you and this basically takes it out of some of those future periods. The rough standard (51

[Matthew D. Gillmor:]

Okay. Thanks, Marc.

[Marc Naughton:]

Sure.

[Operator:]

Our next question comes from Stephanie Davis with Citi. Stephanie, if your phone line is muted, could you please unmute the phone line? Again, Stephanie Davis, your line is open. You can ask your question.

[Stephanie J. Davis:]

Hey. This is Stephanie Davis on. Thank you for taking my question. I just wanted to hear a little bit more about the commercial health plan win on pop health. Is this a bit of a one-off or how should we think about the expansion into this end market?

[Zane M. Burke:]

This is Zane. This is a part of the market that we have turned our attention to in pretty good order and I would anticipate we'll see – I mean, we're competing today on a number of those scenarios and we're competing very well. This particular win was a multistate environment and we have a couple of those that look very similar to that in our pipeline and progressing well. So, our view is really HealtheIntent is an incredibly powerful tool that we can utilize in many ways and it's whether it's in our provider clients, payer clients and I think some non-traditional places where access to healthcare data, creating longitudinal health care records, taking the data from multiple systems, normalizing that data and creating actionable items back into the workflow, there's a lot of applicability in a lot of marketplace for that. And I feel very good about the market position that we've put ourselves into and I think there's only going to be growth in the addressable market for that toolset as we move forward.

[Stephanie J. Davis:]

All right. That makes sense. And then one follow-up for that. Could you – just given the recent traction you're seeing in pop health and RCM bookings and if some of them would be (53

[Marc Naughton:]

Well, clearly, we talked a little bit about the target that we've traditionally had of trying to grow margins 50%, 100% – or 50 basis points, 100 basis points annually. And I think you make a good point as was made before that the more that – more of those businesses – that growth is predicted somewhat on the mix of business. And the more we have of the Works type businesses, those can be somewhat lower margins on the services component. The more we have from the pop health business which tends to be higher margins because of the software and the tool and cloud nature of the tool brings us up to where those increases and margin can be greater. So, as we look at our mix and we look to grow both the Works business and our pop health business, kind of on our 2025 view, we end up with the Works businesses are strong contributor, but almost about the same size you see pop health. And on that scenario, you should see us be able to expand margins as we go forward.

[Stephanie J. Davis:]

All right. That makes sense on a mix standpoint. Thank you so much, guys.

[Marc Naughton:]

Thanks.

[Operator:]

Our next question comes from Robert Jones with Goldman Sachs.

[Robert Patrick Jones:]

Great. Thanks for the questions. Just wanted to go back to overall market demand. Marc, I think you described the EHR market as mature, which isn't necessarily new news, but we have seen some soft updates from some of your ambulatory peers recently. So just curious maybe if you could share what you're seeing out there from an RFP standpoint, has your win rate trended up or down? And if we maybe put this in the context of Cerner system sales, are you expecting growth as we look across 2018?

[Zane M. Burke:]

Robert, I'll take the first crack. And if Marc wants to do any cleanup, he can. I'll look at it and say, we are seeing very strong activity in community hospital marketplace, the small hospital marketplace, those are for all-in EHR systems, clinical, revenue cycle, administrative, ambulatory, in those spaces. And actually, those remain at near record, actually at record highs in terms of numbers. The size of those deals are smaller. But we also have some very large items like the federal government and state and local opportunities. So we're actually seeing demand at kind of that record pace side of that, but much of that is we have the lumpiness on some of the bigger items. And then much of our activity is a little bit smaller deal sizes. So we still see good market opportunity in over 2,000 sites that are not on a currently marketed EHR solution, and that is really reflective of a little less than half of the marketplace in the U.S., total – needed to buy (56

[Marc Naughton:]

Yeah, this is Marc. Relative to system sales, I think our 2018 plan would assume that we are growing system sales. So, the components of that, even in a mature market, you have different impact on – obviously had a stronger year this year in traditional license, but even the things we sell on a cloud basis or an ASP basis had significant growth. So I think as we see that our SaaS business continue to take off, that's always going to go in there. And my expectation for growth in system sales basically assumes that tech resales basically is flat. It doesn't contribute to any of that growth. So that growth is coming primarily from the other elements of system sales, which are primarily software delivered in some form, either SaaS or through normalizing this (57

[Robert Patrick Jones:]

Okay, no, that's really helpful. And then I guess one quick follow-up on Adventist, congrats on the contract expansion there. I was hoping maybe you could just give us some sense of the scope of the expanded relationship and then maybe any context around how much this particular expansion contributed to the really nice bookings in the quarter.

[Zane M. Burke:]

Well, this is Zane. I'll comment as it relates to what the scope of it is, and then I'll let Marc decline your second part of your comment. The scope of this is a full revenue cycle outsourcing. So it's a full rebadging of all the personnel for Adventist Health. And previously, we were doing some work with Adventist around the RevWorks side of this and outsourcing, but this is actually a full rebadging. So, on the rev cycle side, it's all in with Cerner Corporation. In addition to that, they also did a portion of their IT shop and outsourced part of that and created ITWorks business as well. So kind of a full all-in on the revenue cycle and then a big step in around the ITWorks side, but there's more to be had there. And that's reflective probably more broadly of what we're doing from our Value Creation Office and really how we're partnered with Adventist around driving value overall. And so it's a true trading partnership and relationship in terms of the trust to what we're doing and the value they're receiving that they are so heavily invested now with us, both on the full outsourcing revenue cycle side and the partial ITWorks outsourcing side.

[Marc Naughton:]

Yeah. As far as quantifying team, (59

[Robert Patrick Jones:]

Great. Thanks for all that.

[Marc Naughton:]

Sure.

[Operator:]

Our next question comes from Mohan Naidu with Oppenheimer.

[Mohan Naidu:]

Thanks for taking my questions. Marc, a quick clarification around the numbers, and I think on the system sales side you noted shift in some sales. I think you said content from subscription to license. Can you elaborate on that a little bit?

[Marc Naughton:]

Yes, I think it was just – as we look at the performance that we had in 2017, we had a strong, certainly strong license. As we went into 2017, the sale of our content, we actually changed a little bit on how we sold some of that content. We can – so it was structured as a license, which put more of that revenue into the license, less of it into the subscriptions. Once we go into 2018, that change won't be in place. So I think, as we go forward and look at 2018, we're just kind of making the point that big growth on licensed software, less growth on subscriptions. Those probably reverse a little bit so that there would be some growth on the license side and maybe a little bit more growth on subscriptions as we come into next year. But overall, both ways are just ways of selling intangible properties. So, as long as we're – when we look at and we kind of combine those two, but as you guys look at them, they might be – you'll hear, see two different numbers, and we talked about license sales being a separate number. So just want to make sure you understood that that number was up this year. It's not going to grow as much next year. Subscriptions wasn't up as much and that likely grows more next year.

[Mohan Naidu:]

Got it. I'll keep it to that. Thank you very much.

[Marc Naughton:]

Sure. How about we take one more question?

[Operator:]

Our next question comes from Jamie Stockton with Wells Fargo.

[Jamie Stockton:]

Thanks for squeezing me in. I guess, just, Marc, with the margin headwinds that we're certainly seeing in 2018, what are your thoughts about getting a lot more aggressive on the buyback front? Your balance sheet's clean. You guys are generating good free cash flow. Could we see maybe that used as a lever to improve the trajectory of earnings if we see these margin headwinds?

[Marc Naughton:]

Well, certainly, margin headwinds are something that we're focusing on addressing in and of themselves from a business standpoint because I think these investments have got to drive more increased margins in the future. And that's why we're making them or we wouldn't make them. As I said my comments, the board had approved – the latest approval was for $500 million of stock repurchase authorization. I think we spent about $70 million of that. So we still have that available. I think we've – last year, the year before, we were very aggressive, bought back a lot. Last year, a little less. I think, right now, we still are focused on buyback enough to offset any dilution that we have relative to options and other stock-based compensation. But I think, given our free cash flow, we're certainly investing a lot. But even with that investment we're going to make from a capital standpoint, we still expect to grow free cash flow. We'll continue to look at ways to invest our capital. We'll continue to look at opportunities from an acquisition standpoint, although, as we've talked, there's just not that much out there that that interesting of size that would be something we'd be looking at. So, given that those options are less likely, the way we use our capital would be to do stock repurchases.

[Jamie Stockton:]

All right. Thanks.

[Marc Naughton:]

I appreciate everybody's time today. We thank you for being with us and we hope you have a good day. Thank you. Bye-bye.

[Operator:]

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.