January 29, 2015 Cerner Corporation Current Recommendation Prior Recommendation SUMMARY DATA NEUTRAL Outperform Date of Last Change 08/01/2012 Current Price (01/28/15) $66.87 Target Price $70.00 52-Week High $68.12 52-Week Low $49.43 One-Year Return (%) 23.72 Beta 0.61 Average Daily Volume (sh) 1,087,121 Shares Outstanding (mil) 341 Market Capitalization ($mil) $22,834 Short Interest Ratio (days) 13.23 Institutional Ownership (%) 82 Insider Ownership (%) 13 Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) 16.0 Earnings Per Share (%) 23.1 Dividend (%) N/A using TTM EPS 45.8 using 2015 Estimate 35.8 using 2016 Estimate 30.1 Zacks Rank *: Short Term 1 3 months outlook * Definition / Disclosure on last page 3 - Hold SUMMARY Risk Level * Type of Stock (CERN-NASDAQ) Cerner reported a mixed third quarter wherein earnings of $0.39 per share were in line with the Zacks Consensus Estimate, but revenues missed the same. However, revenues increased on a year-over-year basis, driven by strong growth across all segments. We are impressed with the company s bookings performance which led to a 21% increase in total backlog. Meanwhile, Cerner is benefiting from the accelerated movement among medical providers to comply with federal EHR requirements. Further, its non- EHR offerings for the untapped HCIT market, such as population health management and care coordination are considered to be future growth drivers. However, the HCIT market is highly competitive, which puts considerable pressure on both pricing and margins. Moreover, a growing proportion of low-margin services and technology resale may further affect margins. Thus, we maintain our Neutral recommendation and set a target price of $70.00. Low, Large-Growth Industry Med Info Sys Zacks Industry Rank * 77 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 680 A 708 A 728 A 795 A 2,911 A 2014 785 A 852 A 840 A 906 E 3,383 E 2015 1,029 E 1,144 E 1,157 E 859 E 4,189 E 2016 4,699 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.31 A $0.32 A $0.33 A $0.36 A $1.32 A 2014 $0.34 A $0.37 A $0.39 A $0.41 E $1.51 E 2015 $0.42 E $0.47 E $0.49 E $0.49 E $1.87 E 2016 $2.22 E Projected EPS Growth - Next 5 Years % 16.8 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Based in North Kansas City, MO, Cerner Corporation (CERN) provides healthcare information technology (HCIT) solutions worldwide. The company designs, develops, markets, installs, hosts and supports software information technology as well as content solutions for healthcare organizations and consumers. It offers software and hardware solutions that give healthcare providers secure access to clinical, administrative and financial data in a short time. Cerner implements the healthcare solutions as stand-alone or enterprise-wide systems. The company organizes information for the specific needs of physicians, nurses, laboratory technicians, pharmacists, and other care providers, as well as for front and back office professionals. Cerner s products are licensed by over 14,000 facilities across the globe, including more than 3,000 hospitals, 4,900 physician practices (covering more than 60,000 physicians), 590 ambulatory facilities (such as laboratories, radiology clinics, ambulatory centers and cardiac facilities), 3,500 extended care facilities, 150 employer sites and 1,790 retail pharmacies. The company reported total revenues of $2.9 billion in 2013, up 9.2% year over year. In the first nine months of 2014, revenues increased 17% year over year to $2.5 billion. Cerner operates under three main segments: System Sales (26.9% of total revenues in the first nine months of 2014) which includes sale of licensed software, software as a service, technology resale (hardware, devices, and sublicensed software), deployment period licensed software upgrade rights, installation fees, transaction processing and subscriptions; Support, maintenance, and Services revenues (70.2%) which includes professional services, excluding installation, and managed services, and Reimbursed travel (2.9%). Considering operating areas, the company reports revenues under two broad segments: Domestic and Global. The Domestic segment (89.1% of revenues in the first nine months of 2014) includes revenues and expenditures associated with business activity in the U.S. while the Global segment (10.9%) includes revenues and expenditures related to business activity in Aruba, Australia, Austria, Brazil, Canada, Cayman Islands, Chile, Egypt, England, France, Germany, Guam, India, Ireland, Israel, Malaysia, Mexico, Qatar, Saudi Arabia, Singapore, Spain, Switzerland and the United Arab Emirates. REASONS TO BUY Cerner is the largest pure-play HCIT company and its wide footprint, large reference-able client base and composite array of solutions make it an ideal candidate for investors seeking an exposure to the HCIT industry. The HITECH Act, which has authorized the Electronic Health Record (EHR) Incentive program or the Meaningful Use program, presents significant opportunities for EHR vendors like Cerner. In order to qualify for the HITECH incentives and other payment reform opportunities, the EHR buying activity of individual hospitals, health systems and integrated delivery networks has increased. Further, as these practices choose to replace older EHR technology, it represents additional prospects in the replacement market. We note that Cerner continues to benefit from the ongoing demand for its core solutions and services driven by the HITECH Act, as reflected by a 19% year-over-year rise in new business bookings revenue in the third quarter of 2014. Cerner continues to be a winner in the market for hospital clinical information technology with a significant presence in the rapidly growing ambulatory clinical IT market. The company is one of only two vendors (the other being Epic) that are reportedly gaining market share in the medium- to large- Equity Research CERN Page 2
hospital space. Cerner's proven execution skills and ability to deliver results to its clients at a predictable cost distinguish it in the marketplace. Furthermore, Cerner benefits from a large number of opportunities to win over projects from legacy vendors who have been unable to keep their promises. Such rebound customers, who are dissatisfied with their previous vendor, generally tend to gravitate toward larger vendors such as Cerner, as they tend to provide more composite services. Cerner follows a strategy of acquiring complementary businesses that enable the company to expand its solutions, device offerings and services, and grow its market and client base. Notably, the addition of InterMedHx in Aug 2014 is expected to provide Cerner with additional capabilities in the market. Moreover, Cerner is currently in the process of acquiring Siemens Health Services, the HCIT business of German industrial conglomerate Siemens AG. The acquisition, which is expected to close in the first quarter of fiscal 2015, will improve the company s scale of business. The acquisition is also expected to prove accretive to Cerner's adjusted earnings per share by more than $0.15 in 2015 and over $0.25 in 2016. Cerner is not simply a player in the domestic HCIT market. Instead, it offers an exposure to worldwide healthcare automation. Its international operations provide a more diversified revenue stream. In the past, the company has won contracts in the U.K. as well as in the Middle East. The company has expanded its HIT solution client base to 24 countries by offering Cerner Millennium to a privatelyowned 674-bed Hospital Israelita Albert Einstein in Brazil. The HIT solution will help improve the quality of patient care and streamline operations in the hospital. Also, Cerner has a presence in the private health care sector of UAE by means of a deal with Dubai-based physician helpline service provider Mobile Doctors (MD 24-7). Cerner s strong balance sheet and cash flow enable it to pursue growth opportunities including accretive acquisitions. The company uses its cash flow to return value to investors in the form of dividends and share repurchases. During the first nine months of 2014, Cerner purchased 4.1 million shares for $217 million. The company still has roughly $100 million available under its current share repurchase program as of Sep 27, 2014. Meanwhile, aggressive share buyback will boost earnings as well as shareholders value over the long run. REASONS TO SELL The lingering global economic weakness presents a substantial risk for Cerner. Unlike the manufacturers of life-saving devices, the demand for the software company s products is closely tied to budgetary processes of clients. As a result, the company may face a decline in system sales due to a drop in customer orders. Cerner's industry is highly regulated by the government. With rapid evolution of product standards and requirements, any change in government regulation may have an adverse impact on Cerner's products. Moreover, as the government EHR program winds down, it is expected to create a significant headwind for Cerner. The market for HCIT solutions, devices and services is intensely competitive, rapidly evolving and subject to rapid technological change. Competition is fierce with well reputed names such as Allscripts Healthcare Solutions, Epic Systems, GE Healthcare Technologies, McKesson Corporation, Quality Systems and others. The intensity of competition may pressure both pricing and margins. Stringent hospital budgets place further pressure on pricing. A growing proportion of low-margin services and technology resale may negatively impact Cerner s gross margin. Software as a Service (SaaS) based models exerts additional pressure on the margin. Equity Research CERN Page 3
RECENT NEWS Third-Quarter Highlights Cerner Corp. posted an 18.2% year-over-year rise in earnings to $0.39 per share in the third quarter of 2014, which was in line with the Zacks Consensus Estimate. Net income came in at $134.9 million, up from $123.6 million recorded in the year-ago quarter. Quarter Details Revenues in the quarter grew 15.4% to $840.1 million but missed the Zacks Consensus Estimate of $852 million. The increase can be attributed to stronger revenues from all the businesses. Revenues from System sales rose 10.7% to $224.3 million, Support, maintenance and services revenues went up 16.6% to $593.1 million, and Reimbursed Travel sales escalated 36.3% to $22.7 million. Bookings revenues grew 19% to an all-time high of $1.1 billion. Cerner s bookings performance led to a 21% increase in total backlog, reaching the figure to $10.2 billion. Total backlog comprised $9.34 billion of contract revenue backlog along with $814.0 million of support and maintenance backlog. Cerner had cash and cash equivalents of $496.5 million as of Sep 27, 2014, substantially higher than $202.3 million as of Dec 28, 2013. Total long-term debt and capital lease obligations declined 11.5% to $146.8 million as of Sep 27, 2014 compared with $165.8 million as of Dec 28, 2013. In the first nine months of the year, cash flow from operating activities improved 12.5% to $623.6 million from $554.4 million in the same period of 2013. Capital expenditure slid 8.3% to $200.4 million compared with $218.4 million in the year-ago period. As a result, free cash flow rose 39.2% to $292.4 million from $210.0 million in the 2013-period. Third quarter days sales outstanding were 67 days, up from 66 days in the comparable quarter of 2013. Outlook For the fourth quarter of 2014, Cerner anticipates revenues between $880 and $915 million. Adjusted earnings are expected between $0.46 and $0.47 per share. The company also expects 2014-fourth quarter new business bookings between $1.15 and $1.25 billion. Cerner also provided full-year 2015 guidance. The company expects adjusted earnings in the range of $2.05 to $2.15 per share, including estimated accretion from the Siemens Health Services acquisition. At the midpoint, this reflects growth of 27% over 2014. Preliminary guidance for combined revenue, until the acquisition is completed, stands at $4.8 $5 billion. Equity Research CERN Page 4
VALUATION Over the last five years, Cerner s shares have traded in a range of 28.9x to 46.5x trailing 12-month earnings. The company s current trailing 12-month earnings multiple is 45.8x, compared with the 76.5x average for the peer group and 18.6x for the S&P 500. Currently, shares of Cerner Corp are trading at 35.8x our 2015 EPS estimate. The stock is also trading at a discount to the peer group, based on forward earnings estimates. The current, which is close to the mean of the historical range, is at a 56.8% discount to the peer group for 2015. Our long-term Neutral recommendation on the stock indicates that it will perform in line with the overall market. Our $70.00 target price, 37.4x 2015 EPS, reflects this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Cerner Corporation (CERN) 35.8 30.1 16.8 31.8 45.8 46.5 28.9 Industry Average 82.8 57.7 16.8 30.8 76.5 154.7 19.9 S&P 500 16.2 15.1 10.7 16.1 18.6 19.4 12.0 Allscripts Healthcare Solutions, Inc.(MDRX) 41.2 29.4 14.4 11.1 88.9 200.3 14.4 athenahealth, Inc. (ATHN) 424.3 251.3 21.0 67.2 285.8 641.0 73.4 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow Cerner Corporation (CERN) P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA 6.5 6.7 3.5 13.8 0.0 0.0 25.6 Industry Average 5.0 5.0 5.0-9.7 0.3 0.8 7.4 S&P 500 5.1 9.8 3.2 24.8 N/A 2.0 N/A Equity Research CERN Page 5
Earnings Surprise and Estimate Revision History Equity Research CERN Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of CERN. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1116 companies covered: Outperform - 15.8%, Neutral - 77.2%, Underperform 6.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research CERN Page 7