Cerner (CERN) Beats Q2 Earnings, Revises '16 Revenue View

Cerner Corp. (NASDAQ:CERN) reported strong second-quarter 2016 earnings. After a miss in the previous quarter, bookings recovered, increasing 9% year over year to $1.40 billion.

However, the company lowered the high end of its guidance for revenues but reiterated the earnings guidance for the full-year of 2016.

Cerner reported adjusted earnings of 54 cents per share (including stock-based compensation), which beat the Zacks Consensus Estimate by a penny and increased 11.5% on a year-over-year basis driven by 8% growth in revenues. Excluding stock-based compensation, earnings were 58 cents, up 11.5% year over year in the quarter.

Meanwhile, revenues of almost $1.22 billion also beat the consensus mark of $1.21 billion and were well within the management’s guided range of $1.175 billion to $1.25 billion.

Revenues in the U.S. increased 8% from the year-ago quarter to $1.073 billion, while non-U.S. revenues grew 9% to $143 million.

Cerner believes the replacement market will remain active due to higher number of hospitals on legacy platforms providing a significant growth prospect for the company. Management also noted that its products continue to seize market share from the clutches of its competitors.

Cerner stated that most of the new electronic health record (EHR) clients selected the Revenue Cycle product as part of their purchase. Several large clients also chose Cerner’s acute Revenue Cycle and ambulatory business office services during the quarter. The company also made several new client additions to the HealtheIntent platform.

Quarter Details

System sales increased 5.7% year over year to $333.1 million, supported by strong growth in software partially offset by a decline in hardware sales.

Total services revenue, including professional and managed services, was up 12% on a year-over-year basis to $604 million. Support and maintenance revenues improved 1% to $257 million.

Bookings were within management’s guided new business bookings range of $1.35 billion to $1.48 billion. In the last quarter, long-term bookings comprised 28% of total bookings. Cerner noted that bookings included 45 large contracts worth over $5 million, of which 28 deals were valued at over $10 million.

Cerner stated that non long-term bookings grew 20% from the year-ago quarter. In the second quarter, 34% of bookings came from outside the company’s core Millennium installed base.

In this regard, management expects the replacement market to remain strong over the next two to three years, which will provide Cerner ample opportunities to win contracts at the cost of its competitors.

Backlog increased 13% from the year-ago quarter to $15 billion.

Gross margin expanded 20 basis points (bps) on a year-over-year basis to 83.1%, primarily driven by favorable business mix and strong services revenues. Notably, system sales margin expanded 150 bps to 68.1% in the quarter.

Adjusted operating expenses (excluding share-based compensation expense, Health Services-related amortization, acquisition-related deferred revenue, and other acquisition-related adjustments) increased 9% to $721 million, driven by personnel expenses related to revenue generating associates.

Sales and client service expense jumped up 13%, general & administrative expense increased 6%, while software development expense declined 2% on a year-over-year basis in the quarter.

Adjusted operating margin (excluding share-based compensation expense, Health Services-related amortization, acquisition-related deferred revenue, and other acquisition-related adjustments) contracted 40 bps to 23.8%, in line with management expectations.

Guidance

For the third-quarter 2016, Cerner forecasts revenues between $1.20 billion and $1.275 billion. The mid-point of the guided range reflects 10% year-over-year growth.

Cerner also projects new business bookings between $1.45 billion and $1.60 billion. At mid-point, this reflects a slight decline on a year-over-year basis.

Adjusted earnings are now expected in the range of 59 cents to 61 cents. At mid-point, this reflects 11% growth on a year-over-year basis.

For full-year 2016, Cerner revised down its revenue guidance at the range of $4.9 billion to $5 billion (previous guided range was $4.9 billion to $5.1 billion), reflecting 12% (down from 13%) improvement over full-year 2015. The decline resulted due to lower hardware revenues in the first-half 2016.

Notably, revenues from support and maintenance are up 5% year to date. Cerner predicts similar mid-single-digit growth for the rest of the year.

Adjusted diluted earnings are still expected in the band of $2.30 to $2.40 per share, representing almost 11% growth over 2015.

Cerner anticipates margin expansion to be limited for full-year 2016. However, the company expects to expand margins by 50 to 100 bps annually after 2016.

Cerner expects capital expenditures to increase in 2016, primarily due to construction of a new campus. However, the company still expects to generate solid free cash flow.

For full-year 2017, management expects a decline in capital expenditures, resulting in stronger free cash flow.

Our Take

We believe Cerner’s strong product portfolio will help it to win customers in the rest of 2016 and beyond. The company has growth opportunities in the revenue cycle management (RCM), Population Health and ambulatory market based on its product strength and enviable track record. Additionally, growing percentage of higher margin software in the business mix is expected to drive margins.

However, the HCIT market is highly competitive, which exerts considerable pressure on both pricing and margins. Moreover, a growing proportion of low-margin services and technology resale may affect margins. Meanwhile, stringent hospital budgets exert further pressure on pricing.

Zacks Rank & Key Picks

Currently, Cerner carries a Zacks Rank #3 (Hold).

Better-ranked stocks in the broader medical sector include AMN Healthcare services (NYSE:AHS) , The Advisory Board (NASDAQ:ABCO) and Streamline Health Solutions (NASDAQ:STRM) . While AMN Healthcare and The Advisory Board sports Zacks Rank #1 (Strong Buy), Streamline has a Zacks Rank #2 (Buy).

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