Cerner Corporation (CERN) on Q2 2021 Results - Earnings Call Transcript
Operator: Welcome to Cerner Corporation’s Second Quarter 2021 Conference Call. Today’s date is July 30, 2021 and this call is being recorded. I’d now like to turn the call over to your host, Allan Kells, Senior Vice President, Investor Relations.
Allan Kells: Thank you. Good morning, everyone, and thank you for joining us. On the call with me today are Brent Shafer, Chairman and CEO; Mark Erceg, our Chief Financial Officer; Don Trigg, our President; and Travis Dalton, our Chief Client and Services Officer.
Brent Shafer: Allan, thanks very much, and good morning, everyone. On our last call we talked about our sharpen focus and increase sense of urgency to deliver value to our clients and shareholders. And as Mark will discuss, this increase focus and urgency helped us deliver very solid results in the second quarter. All key metrics reflected good progress on our transformation initiatives and a strengthening market presence. And based on this progress, we have increased our earnings outlook for the year again. What pleases me most is that as we undergo our transformation, we’re maintaining an unwavering focus on client success, which is truly our Northstar. Our key initiatives, which include product rationalization, driving operating efficiencies and continuing to refine our operating structure, all revolve around creating client value through accelerated innovation. And we expect these same efforts to also drive sustainable and profitable growth that should create value for our shareholders. I’d like to share some examples of progress we’re making. Through improved focus and structure in our client organization, Travis and his team have grown our sales funnel, and improved sales and client relationship management, resulted in 24 new client footprints so far this year, while reducing client attrition. They have also improved our overall Net Promoter Score by 5 points and have delivered 49 major client go-lives.
Mark Erceg: Thanks, Brent. Good morning, everyone. Today I will cover our second quarter results and provide a guidance update. Overall, we are pleased with our second quarter results. Bookings were up 2% versus year ago to $1.36 billion, which brings year-to-date bookings growth to 7%. Importantly, we believe this represents a positive inflection point since total bookings were down during fiscal 2019 and fiscal 2020. The higher rate of bookings added to our revenue backlog, which ended the second quarter at $13.2 billion, which is up 1% up sequentially and down slightly versus year ago due primarily to divestitures. Revenue of $1.46 billion was up 10% over the year-ago quarter, which was admittedly heavily impacted by COVID. The increase in revenue was driven in large part due to strong growth in Federal services. In addition, it is worth noting that virtually all of the growth we experienced during the second quarter was organic, with $45 million of incremental revenue from the Kantar Health acquisition being largely offset by $39 million of divested revenue. Gross margin was down 200 basis points from a year ago at 82.1%, primarily due to the mix of revenue in the quarter. Specifically, higher levels of lower margin technology resale, third-party services and reimbursed travel. Adjusted operating margin, however, expanded 220 basis points from 18.4% to 20.6%, driven primarily by tight expense control and a negatively impacted year ago margin due to COVID. Now to build on this progress, we took bold actions across our largest spend pools during the second quarter. For example, we incurred $54 million of employee separation costs due to a sizable reduction in force related to productivity improvements we recently implemented. We also incurred a charge of $68 million to reduce the properties line on our balance sheet to fair value in connection with the sale of one property and the designation of two other properties as held for sale. Since the start of the year, we have sold 260,000 square feet of office space and have earmarked an additional 750,000 square feet of space for future sale. Lastly, we recorded a charge of $48 million to reduce the carrying amount of certain capitalized software development costs to estimated net realizable value as part of our comprehensive product portfolio rationalization work, which is designed to improve over time the return on our nearly $800 million annual R&D investment. Each of these actions and their related charges are captured in our reconciliation of GAAP to non-GAAP results. These actions are also consistent with our previously communicated efforts to operate more efficiently, drive more value for clients and better position Cerner for sustainable long-term profitable growth.
Operator: Our first question comes from Elizabeth Anderson with Evercore.
Elizabeth Anderson: Hi, guys. Thanks so much for the question. I guess I have a question about the overall demand environment. One, can you talk about sort of how hospitals are engaging as -- at this point and where we are with COVID? And two, can you talk about their competence in the topline in the back half of the year? What are you seeing in different sectors? What’s resonating with clients? That would be helpful? Thank you.
Brent Shafer: Yeah. We ask, Don and then Travis to comment on that.
Don Trigg: Good morning, Elizabeth. So, one, I think as you’ve seen from some of the investor-owned provider organizations that have reported out, and I think, they track with our conversations with CEOs in the market. I think volume levels are returning to pre-COVID levels and so people are feeling good about core aspects of the business on the provider side and how it’s recovering from the disruption last year. I think, at the same time, sort of watching with a wary eyes the Delta variant plays forward and certainly disrupt certain hotspots. So I think broadly volumes feel good. There’s a lot of areas I think that have momentum and focus, some of which Brent’s articulated in his script. I think a lot of interest in real time, hospital strategies in part because of the workforce disruption that they’re dealing with, with their providers, strong and ongoing interest in consumer strategies. They’ve had to think through now what that is going to look like in a post-pandemic new normal. And then, I think, interestingly, a lot of conversations and active conversations about value-based care, and how they want to think about a business model going forward, particularly as it relates to areas such as Medicare Advantage. So it’s an interesting landscape. I think people feeling good and the main about how they’ve recovered in the first half. And asking, I think, some questions about where they want to take the business to create real opportunities for us.
Brent Shafer: Good. Travis, do you want to add to that?
Travis Dalton: Yeah. Thanks. Thanks, Brent. Thanks, Don. I -- yeah, I think, our ability to be confident in the topline, the work we’re doing is directly related to our ability to meet our clients’ needs. Brent had noted some of those in the script. Don reiterated that. My goal and our focus really is on improving our funnel health. So we’re focused on sufficiency of the funnel velocity through our sales process and growth of that funnel. I think we’ve been -- we’ve got improved process, discipline and inspection inside of our business and our forecast processes. And so we’re really working to underpin our plans and our forecast with tools, automation and discipline, and that will give us greater confidence as we move in visibility to the topline forward. I think, Don’s spot on, I mean, we’re seeing in our U.S. client base, the first half was some challenges in our Federal business, although I’m confident in that business holistically moving forward. But we were able to perform well in our U.S. client business and globally. And so we see good opportunities and a large expansion and extension base inside of our U.S. client, we’re focused on that. We see great opportunities to campaign around client value with our strategic growth businesses and products. I think there’s buying opportunity and community works that we expect to go and be aggressive and win. And then our Federal business and global business has been very robust this year, as we’ve had great wins in Middle East, U.K. and other parts of the globe and Canada. So I’m confident in the second half of the year. I think we’ve accurately reflected the nature of the Federal business and been transparent about that. And so, I think, it’s underpinned well and resilient and will continue to move forward.
Elizabeth Anderson: Got it. And then maybe just as a follow-up, as you are going to think about in terms of the pacing of the gross margin line in the back half of the year between the third quarter and fourth quarter?
Brent Shafer: I think what I would say is that, I expect to see those relatively comparable in the both third quarter and fourth quarter.
Elizabeth Anderson: Okay. Thank you.
Mark Erceg: And one thing to note on gross margin is, Kantar uses a fair amount of third-party services and about 80% of the revenue services. So that’s just a location on the P&L issue. So it’s really their overall upper teens margin at the operating margin, but does the loop at the gross margin level just a little bit?
Elizabeth Anderson: Got it. That’s helpful. Thanks.
Operator: Our next question comes from Sandy Draper with Truist Securities.
Sandy Draper: Thanks very much. Just wanted to see if I could get a little bit more color on that the comment that you brought up about looking at potential M&A, strategic and financial. One, I guess, do you have specific financial targets that you’re willing to share, whether it’s ROIC, revenue contribution, earnings accretion, anything along those lines? And then, I would assume strategically they would be primarily focused on the new strategic growth areas, but just any other commentary maybe from, Don, or whoever else on that line would be great? Thanks so much.
Brent Shafer: Yeah. As far as the criteria, I think, we articulated four in the first earnings call. We said that for us to action something it would have to enhance our competitive position in the marketplace, first and foremost. Second, would have to exceed our cost of capital. Third, it would need to be accretive over time. And then, fourth, we’d have to clearly create shareholder value. As far as like where we might be looking currently I would refer to Don at this point.
Don Trigg: Yeah. Good morning, Sandy. So what I think if you just think about the core enterprise business, I think we like aspects of that space of, areas like cyber and cybersecurity are areas where we’ve seen traction inside both our data strategies and some of our third-party partner strategies in that space. I think once you move outside the four walls, we -- as I said earlier, I think, there’s a lot of traction and trend around provider network and what it looks like to make those operate in an integrated fashion for fee-for-service and fee-for-value. So that’s an area we like quite a bit. And then, I think, the Kantar, post close integration work has given the team, a very good view of what the opportunity set looks like in the data space. And that’s an area where I think we’ll look to take a hard look at how inorganic acquisition can help us go faster.
Sandy Draper: Great. Thanks.
Operator: Our next question comes from Donald Hooker with KeyBanc.
Donald Hooker: Hello. Sorry about that, because I was on mute. Good morning. Yeah. Just want to maybe hear maybe a little bit more on the VA, as we think about maybe next year. Is the hope -- can you can you maybe just elaborate on all the moving parts of the VA? It seems like you lost some revenue due to the pause and deployments, but it sounded like there’s some other stuff you’re doing that maybe offset that and can be -- what do you think about next year, are we going to get back to a normal cadence? Can you just elaborate your thoughts there?
Brent Shafer: Travis, why don’t you take that one?
Travis Dalton: Yeah. Absolutely. Happy to take it. Thanks for the question. Always appreciate the opportunity to discuss the business. I think about our federal business holistically. It is encompassed by DVA and other opportunity. As Brent noted, we’re very pleased with the DoD space. I mean, that Wave Carson go-live was probably the single largest go-live that we’ve ever had in my 20 years that I’ve seen in the industry. And so we’re moving forward very well with DoD, which bodes well for us as it relates to our VA business as well. For those that, can recall and I was on the journey, we -- after our Fairchild go-live with DoD, we were in a similar position to we are -- to what we are in VA. And we took about 12 months to work on a lot of the similar things we’re working on at VA. And so, as Brent noted in his opening remarks, the strategic assessment wasn’t a surprise to us. We support it. We both need to be ready to move forward collectively. And as the administration came in, and the Secretary, the Deputy Secretary who we spoken to and expressed mutual support had come in, we’re really going to be focused on governance, training, site readiness, change management. To your question directly, I think, on the second half we expect to continue to do value-add work. We’ve got opportunities and we’ve got backlog service work that we’re doing. We’ve got readiness assessments that we’ll be doing. We’ll be doing technical and solution, configuration and deployment. So we’ll all be very productive work in support of going forward in 2022. We’ve noted the wave impact to the right. I’ll also note that the VA contracted a 10-year IDIQ contract. The revenue opportunities and the other opportunities aren’t lost. Those are deferred into out years. I expect it will exit this year with a good plan with better alignment at the agency level, with governance collectively and it will start to move into wave activity and go-live activity in 2022. And then I really think we’ll start to get industrial strength and pick up in 2023, 2024 and beyond similar to like we did on the DoD business.
Donald Hooker: Okay. And I’ll just have one follow up on -- thank you for that. That’s good clarity. And then would you -- would -- you may not know the answer to this. But just your any thoughts you have would be interesting, just do you think there will be a catch up, maybe they’ve sort of delayed some of the deployments where we could get maybe kind of a more of a bolus in some future period, because maybe they want to keep the overall timetables stable. What do you think about that?
Travis Dalton: Yeah. I think our goal is to finish the program on time and on budget on the 10-year basis, as we’ve noted, collectively. I think that, as I noted, 2022 we will continue -- we will see continued increased activity and I -- we are hoping our goal would be as similar to DoD is to speed up activity and be able to do more than we originally planned in out years. When and exactly how that comes together. I can’t say today. But that is our expectation. That is our goal in the middle of the program.
Donald Hooker: Great. Thank you. Thank you so much.
Travis Dalton: Thank you.
Operator: Our next question comes from El Samuel with JP Morgan.
El Samuel: Hi, guys. Thanks for taking the question. Mark, I was wondering if you could maybe quantify some of the expense reduction actions that you took in the quarter for the model. And then also, is there anything else that you think that there’s left to do on any low hanging fruit? Thanks.
Mark Erceg: Yeah. Appreciate the question. So we talked about three principal items. One was the $48 million charge for the capitalized R&D and this is related to the optimization work we’re doing on the portfolio itself, where there’s a lot of redundant products and features, and we’re finding ways to drive that into a more normalized state. That probably has about $8 million to $9 million of annual savings associated with it. On the property side, we talked about the $68 million adjustment there to bring the one property that we’re marketing largely in line with fair value based on the assessments that we’ve had done in the appraisals that we received. That’s probably going to save us about $10 million annually between depreciation and operating costs. At this point, we plan to action roughly 50% of our total owned office space, we had about 6.5 million square feet before the actions we took. And as I cited, we sold 600 -- 260,000 square feet of space and we now have another 750,000 square feet that is being marketed for sale. And then on the reduction in force, we talked about $34 million charge. That covered a little bit north of 500 people. We also eliminated about 300 open positions. And normally what you see in something like that is that the annualized savings is roughly equal to the amount of the severance costs themselves. So maybe call that an additional 50. So between those three items, that’s about $70 million of annualized savings that we’ve been able to capture.
El Samuel: That’s really helpful color. Thanks so much. And then, I guess, as you think about costs, streamlining the cost structure going forward. Is it still fair to think about low-double digits is the target for bottomline growth or do you think that you can achieve something higher on mid single-digit revenue growth? Thanks.
Mark Erceg: No. I think that’s probably right. When you look at it all in and you look at what we’re doing with respect to the balance sheet, right, where we should be able to increase our dividend payout ratio a little bit each year, where we should be able to continue to buy back shares at attractive prices, and where we should be able to monetize that mid single-digit revenue growth by expanding margins towards our goal of being in the mid-20s by fiscal 2024. Yeah, I think that low double-digit EPS progression is just about right.
El Samuel: That’s great. Thanks very much.
Mark Erceg: Thank you.
Operator: Our next question comes from Charles Rhyee with Cowen.
Charles Rhyee: Yeah. Thanks for taking the question. Maybe just thinking about, I think, the summer is the start of the enforcement of interoperability rules across the industry. Can you talk about sort of the readiness for your clients and what does that -- what kind of extra services are they looking from you guys to help them comply with all the new rules coming through? And then, secondly, particularly, as it relates to your data business, can you talk about how -- what kind of opportunities this has created for you, particularly as you integrate Kantar into the business and maybe just a little bit more around that area? Thanks.
Travis Dalton: Yeah. It’s a -- that is a fantastic question. So, one, I think, we have been making some material investments around 21st Century Cures and what it looks like for our end-to-end product set to be fully compliant with it. I think clients are early in terms of really thinking through magnitude and impact of those changes, which are not just technical in nature, but as your question implies, also has big implications for them in terms of how they think about Master Data Management across their enterprise assets and their provider network. So I think we’re early in that conversation with our clients and they’re kind of thinking around it. I think it sets up a ton of business opportunities for us. So, first and foremost, it’s a good example of where the relevance of our technology assets to a regulatory action make us center front and center in terms of how clients need to think about their strategies and approach. So we’re right in the middle of that conversation and we’re relevant to it by definition. It then sets up some of those growth opportunity dialogues that I described earlier, had has them thinking about cyber and how they want to think about security risks associated with data management, it has some thinking about near real time data strategies for how they tackle things like capacity management workforce. And importantly, it has been thinking about the role of data, not just in terms of transforming their hospital operations, but also larger commercial opportunities for provider organizations in that space. So it’s a great example of where if we can be smart around regulatory landscape, understand it better than early-stage companies or big tech companies who want to get into this vertical and then have the right conversations with our clients. It can be a huge tailwind for us from a book revenue and revenue perspective over the next 36 months.
Charles Rhyee: That’s helpful. And just a follow up there…
Travis Dalton: Yeah.
Charles Rhyee: And you kind of alluded to it is that, with these changes, it does kind of open up the vertical to other players who have not traditionally been in healthcare, let’s say, new startups and big tech where they don’t have to have that -- the integration part is made a lot easier, I guess. What does the competitive landscape look like right now and do you find that your clients are coming to you first before looking out or is it that you are hearing lots of different new competitors coming in and pitching existing clients to talk about services they can now start to provide? What does that landscape look like today?
Travis Dalton: Well, look, there’s a lot of noise. I agree with you there. But I think we’re set up to have this conversation with our clients. Well, they look to us for strategic clarity around how they ought to be thinking about it. And our systems, as I said earlier, are central to what their operational strategy needs to look like. At the end of the day, particularly as you see a trend outside the hospital in the provider network space, they’re looking for integration. Is there someone who has the size and scale capabilities to integrate and make that provider network operate effectively against their contract strategies and were set up incredibly well to do that, not only with the EMR assets, but also with CareAware, and with more importantly, healthy intent. So that’s where this market is going to move away from hundreds and hundreds of points solution, buying decisions to looking to who is someone who I can count on to drive integration. And importantly, that really understands the provider workflow integration opportunities, both within the standards that exist today, but also the integration that needs to occur to actually profitably manage a patient for fee-for-service or take first dollar risk in an area like MA.
Charles Rhyee: Okay. That’s helpful. Thanks a lot.
Travis Dalton: Yeah. Thank you.
Operator: Our next question comes from Kevin Caliendo with UBS.
Adam Noble: Great. Thanks for the question. This is actually Adam Noble in for Kevin. I was curious if you could comment on the recent announcement by Amazon of general availability for HealthLake and whether in your view that complements what you’re offering and looking to develop with Amazon or whether that more competes with you. And just beyond that, if you can just give us an update on the re-platforming efforts with onto AWS and where those stand at this point?
Travis Dalton: Yeah. Thanks, Adam. Great question. So, as Brent framed up in his remarks, we now not only have publicly cloud enabled healthy intent, but we’ve also now had a second successful platform move with CareAware, which drives not only our device integration strategies, but also is core to our sort of growth strategies in that space around real time hospitals. So I think that has been really good technical learning for us in terms of what path to modernization looks like. It’s also surfaced some really important non-technical capabilities that we need to build out in terms of how we think about contract management and other parts of what it looks like to go work through that strategy across our client base. So I would say the progress there has been positive, including some important milestones in the first half of this year. In terms of Amazon and AWS sort of strategies around the healthcare vertical, again, as I said earlier, there’s a long history of big cap entry and big cap exit from healthcare. There’s an inherent complexity at the intersection of healthcare and IT. I see market interest in areas that we’re focused on is very validating of the growth opportunity that exists. And what we need to be able to do is be smart around where we can competitively differentiate from a fire based strategy for data aggregation. That’s interesting. But in our case, where we have deep competency around the very dirty data in healthcare and what it looks like to normalize that data around Master Data Management, and have a level of clarity around it that you could imagine is being pushed into the provider workflow and being leveraged as part of a care process. Those are very different things.
Adam Noble: Got it. That’s super helpful. And if I can just sneak one more question in, there’s been a rush of companies that have come to the public market over the past year in the tech enabled primary care space. And so I’m just wondering if that’s a market and service you think would be attractive to you guys, given your health system relationships and technology assets? And I guess more broadly than that you -- can you envision Cerner getting more deeply into care delivery over time as you explore additional growth opportunities?
Travis Dalton: So I think, you’re right, that has absolutely been a trend. Again, what are the strategies going to look like outside the four walls of the hospital and how are these provider networks going to get built out on a market-by-market basis. I think we’re incredibly well positioned to be the technical foundation of those strategies to help with systems level thinking and design and activation. We have strategies today where we partner with players like Lumeris, where they’re signing up for performance risk around managing lives and we use that as a way to refine our own thinking. To Mark’s point around where and how we want to play to drive the right level of profitable growth around our provider network strategy. So I think that’s how we’re moving our way into it. What’s the technology and services strategy needs to look like to support it and is it attractive for us to start to think about taking performance risk around provider networks. I think when you deliver a lot of value, you start thinking about how you can benefit and profitably take advantage of it.
Adam Noble: Great. Thanks for the questions.
Brent Shafer: Thank you.
Operator: Our next question comes from Sean Dodge with RBC Capital Markets.
Sean Dodge: Thanks. Yeah. Good morning. Mark maybe just to clarify one of your earlier comments around like the cost action. The cost saving you mentioned coming from the facility rationalizations. I think you said $10 million. Is that just tied to the 260,000 square feet you’ve already sold or does that include what should be realized once you sell the 750,000 square feet you currently have for sale?
Mark Erceg: Yeah. We expect that to be the annualized savings when we affect the sale of the additional properties being marketed for sale.
Sean Dodge: Okay. So that’s all in. And then maybe seen on the cost sections, Brent, maybe if you could talk a little bit more about what’s happening across the R&D organizations. You’re spending $800 million annually there. It sounds like there’s been a lot of work to rationalize lower ROI projects and reinvest that higher one. I guess you see an opportunity to reduce your R&D budget at some point or do you think you’re spending the right amount and you just maybe kind of focus a little bit better on kind of more of the optimal projects?
Brent Shafer: I think it’s a great question. I think it’s one that we’re going to continue to work through and process a little bit, right? We know we’ve been spending $800 million a year in the R&D area. We talked about the fact that, our product portfolio at this point is very dispersed. We took 25,000 features. We combine those into the new 400 different products that were assembled into 82 different product groups and those top 25 product groups accounted for 85% plus of our revenue. We also talked about the fact that one of the opportunities we have is to dramatically enhance our management reporting systems and that’s one of the things that we’ve been spending a lot of time doing so that we can really allocate that $800 million specifically to projects. And one of the things I’m really excited about that we’ve been able to bring forward here in just the last few weeks, frankly, is we now have an internal system that lets us look at every single one of our scrum teams, 641 of them to be exact and we can now know exactly what those scrum teams are doing each and every week. There’s clear milestones and markers for the work that needs to be delivered and we can literally penetrate that the very, very granular level now, which was a capability we didn’t previously have. So I think the answer is probably going to likely be, yes, in the sense that we are going to be able to do a whole lot more with that money, and if in fact, that’s true, we might be able to do it with a little less. We’ve been spending roughly 14% of sales on R&D each and every year. That’s a very large number. But we’ll see as it plays itself out. The great thing is, is that we’re getting a lot of visibility in line of sight. Don and his team is leading a very new comprehensive review of that product set. And then, Jerome, with the work he’s doing on the digital factor, he is going to make the dollars we are spending a whole lot more efficient. It’s just as a matter of course. So I’m very excited about what’s happening in that whole area.
Don Trigg: I did add the whole issue of time to market. You talked about velocity and time to market. That is a huge win for us. Because as we’ve gotten larger and with the scale, these are better processes, better ways of managing, it’ll help tremendously. We are just working through the development cycle.
Sean Dodge: Okay. That’s great. Thanks again.
Brent Shafer: Thank you.
Operator: Our next question comes from Jeff Garro with Piper Sandler.
Jeff Garro: Yeah. Good morning and thanks for taking the questions. Maybe I will continue on the innovation front. It seemed like there were fewer remarks in the script on the strategic growth areas, although, Don, definitely mentioned some of those here in the Q&A. But would like an update on how those areas are progressing and being addressed operationally.
Don Trigg: Hi, Jeff. So, yeah, absolutely did speak to a couple of those earlier. I think, we’re still very excited in the core enterprise space around some of the things, frankly, we’re doing around the core offer in areas like front end access management and engage in access with kind of a patient centric lens around the revenue cycle space, a lot of traction and trend there from a -- with Travis’ team in the market. So excited about that. Certainly excited about what we’re doing in the RTHS space. And consumer more broadly has been a very strong space for us, not only native capabilities, but also partner capabilities inside our consumer framework and a ton of traction and trend around unified communications. So some really nice momentum, I think, around enterprise capabilities and enterprise capabilities that extend out into the provider network space. As we get over onto the continuum side and we start thinking about the provider network landscape, we’re seeing a lot of traction and trend around behavioral health. A huge successful outcome there with longtime partner UHS in the second quarter that we’re very excited about, really gives us a chance to build out end-to-end venue capabilities from a BH perspective, an area that as you know has a lot of COVID related tailwinds, I’ll say, but obviously, the complexity and crisis of behavioral health and mental health coming out of COVID. So really like that area. And then look both the organic update as we think about the data space and data strategies around intelligence, but also some of the inorganic activity that we alluded to, both today as it relates to the integration of Kantar, but also how we think about putting the balance sheet to work in the future. So we’re happy with the progress in this space. We see some nice traction in the first half of the year round areas where we’ve made bets and now we needed to go further faster for scale impact over the next two, four, six quarters.
Brent Shafer: Yeah. Maybe just to pick up on that, your question about the operational view, I think, one of the things we went on set up the group, it’s set up a bit to give a fair amount of autonomy, allowing speed, development and a bit of a skunk works approach to go. I think as we’ve benefited from having Jerome join us CTO level, we’ve found that I think some of the standard tools and processes also can help us with velocity consistency working across that portfolio. So we are applying those same concepts through those groups and we see benefit, I think, that will help us ultimately with speed to market and consistency development.
Don Trigg: Yeah. Absolutely. We talk a lot about at the business group level about entrepreneurial scale. So when we have market strategies that are non-provider in their orientations. So when we’re in selling to life sciences and pharma illustrative way through Kantar, we imagine the level of autonomy around the operating model that allows them to move at pace and operate in a very different market with a very different buyer type. But we’re also thinking about scale attributes and what it looks like to leverage some of the benefits of things like the investment that that Jerome and Keith Jones are making in the digital factory. And so that gives us scale attributes across all the platforms. And at the same time, allows us to be efficient in terms of how we think it cost to sale inside the enterprise space, but also to operate with a little bit more autonomy and flexibility in areas that are very different than our core provider market.
Jeff Garro: Excellent. I appreciate all the comments there. One more for me on customer retention, any customer leaving seems to make it into the press, but you’ve cited stronger retention today. So I was hoping you could tell us what’s working to improve retention and then any update you could give us on your intent to improve competitive dynamics against your primary competitor? Thanks.
Brent Shafer: Maybe, Travis, I’ll let you comment. I -- this has been a multiyear effort to really put in place focused metrics, focused teams around client retention and it’s been a lot of work done there. But, Travis, let me ask you to comment.
Travis Dalton: Yeah. Happy too. I think that was the first question I got my first earnings call, what are you going to do different. So we’re -- I’m going to talk about what’s improved. I’ve talked in the past. And these are matters of discipline and a matter of focus. I think that we’re doing more in terms of how we’re aligning to our clients. So we’ve mentioned earlier some of the actions we taken. Those actions really, in my view, were to improve our client alignment. So we’ve flattened out our client organization. We’ve tried to eliminate the number of touch points to our clients to really be more strategic with how we engage with them. We think that’s important not only to on a value retention level, but also to expand strategies that, Don team, I have noted prior. So, better client alignment. Our end-to-end delivery commitments are crucial. We not only sell in the client organization, but we deliver on our promises. And so we’re really focused on how do we take our managed services, consulting and support businesses, and deliver to our clients on an end-to-end basis to where we not just get to go-live. But we actually get there by meeting our commitments with good data insights along the entirety of that path. And so, an end-to-end focus on delivery is also crucial for us as we continue to meet and keep high commitments. And then we have a set of, I think, great tools and capabilities that we weren’t getting to our clients, I think, in the most efficient manner. So we’ve got data driven insights, we have a treasure trove of data through our Lights On Network and we’re working closely in to develop comprehensive programming at a client level. So specific clients strategic planning based on their needs and their value needs and then bringing the right tools and tool sets market enabled to those clients. And we’ve done a lot of targeted work around blueprint activity in the clinical space, around configuration evaluation, around upgrades and uplifts. It’s all of those things collectively together that improve the client experience. And I think we -- we are in the -- we’re heading in the right direction. That work is never done. There’s always work to do to proceed in that area. But I like how we’re thinking about it in a holistic manner and I like how we’re more strategic I think in our approach with clients individually. But we’ve got a ways to go. And to the second half your question, I think, back to the earlier question for -- I like how we’re competing. I like our focus. I think that winning in the market is driving value for our clients. And we know our client’s needs. I think we’ve got better market insights, working closely with our marketing organization. I think that we’re improving the way that we think about sales enablement. And so as we work on our IP infrastructure, as we sharpen our product focus, we’re also working on how do we generate demand and lead. But also how do we get to market more quickly, as Brent noted, with velocity. And so the work that we’ve been doing the last three years, frankly, is starting to come to fruition and we’ve seen really good progress, as Don noted, with real time health system, I think will campaign around remote patient monitoring, referral management, key areas that are outside the traditional kind of EMR space, that will really allow us to add more value, which makes us more productive with our clients and more competitive. And I will end -- I will just say our win rate is very good. I’m very happy with how we competed in the community works on new footprints, our global footprint outstanding, our teams are really competing well there. So, good progress, lots to do. We’re in a highly competitive environment. We’ve got a tough competitor, but we welcome the competition that makes us better and we are seeking to get better and win every day.
Jeff Garro: Great. Thanks, again.
Operator: Our next question comes from Steve Halper with Cantor.
Steve Halper: Hi. When we think about the $70 million of savings that the cost actions are going to take, is it safe to assume that some portion of that will be redeployed or will that, at some point, impact -- the whole amount impact the profitability of the company?
Mark Erceg: I mean, we’re constantly looking to recycle and redirect dollars towards areas within the company that we think we can drive organic revenue growth through. But I would contend that, in this particular case, much of this will likely go to the bottomline, right? We talked about the fact that during the year of COVID, we really didn’t make a lot of margin progress. But we still have set our sights on that mid-2020s by fiscal 2024. And so we have a little bit of ways to go and so this will help us in that regard, most specifically.
Steve Halper: Right. And then, if that’s the case, how long of a time period, right, do you -- should that hit the income statement? I’m assuming, if -- most of its going to hit the income statement, is it all going to hit in 2022 or you’ll get to that in 2023?
Mark Erceg: No. Great question. So what I would say is that the, reduction in force, that we effected has been completed at this point in time. So, as you think about our third quarter, fourth quarter run rates, that should be reflective. As you think about the charge we took on the capitalized R&D that rolls forward immediately in effect, because that amortization isn’t there to flow through the P&L. And then on the property side, I appreciated the clarifying question earlier, we did sell a campus earlier, that didn’t have a huge amount of carrying value associated with it yet and so once we find ourselves in a position to actually affect the sale, then you’ll start to see the benefit of that $10 million largely roll through. So that one’s a little bit more time determinant.
Steve Halper: Very helpful. Thank you.
Operator: Our next question comes from Eric Percher with Nephron Research.
Eric Percher: Thank you. Mark, the progress on cost is increasingly clear, especially after the commentary this morning. I’d welcome your thoughts on the process for evaluating mid- to long-term revenue growth opportunities. And have your thoughts evolved in early 2021 or is this kind of a process that’s ongoing and is there a moment, traditionally it was around TAMs. But I know you also have the CHC conference coming up, where we might look to you for evolve thoughts on revenue growth?
Mark Erceg: No. I appreciate that. You made a comment about the margin progression and the cost takeout and I know we had it in the prepared remarks, but it might just bear repeating here. In Q2, our gross margin was down 200 basis points year-over-year, right? But despite the fact that gross margin compressed by 200 basis points, our adjusted operating margin was actually up by 220, right? That’s a 400-basis-point reversal in effect. Now, only 30 basis points of that came from divestitures, right? So a lot of this was just hard work being done by the team, broadly speaking. As we think about the revenue plot going forward. One of the things that we’re doing is we are also, like I said, strengthening our major reporting capabilities to allow us to have a better understanding of the different growth vectors that we have organically. So we right now are building out, what I call, 16 fully allocated business group P&Ls within the company, which we never had before. We are going to be able to have 16 businesses that we have, General Managers effectively in charge of with full accountability with multifunctional resource teams that we can use for our planning processes. And right now we are going through that process to build out our three-year plan. We have a December due date with the Board, whereby we’re going to share our fiscal 2022, 2023 and 2024 plans at a level that we’ve never built them up before, right, with full involvement across the whole entire broad based leadership team, so that we have clear revenue bridges and everything else that goes along with it. So I think thus taking that step to get to these 16 internal fully allocated P&Ls for the business groups will be a big enabler for us as we think about where do we want to really drive point of impact across the business itself. And that will then inform, I think, also our strategic M&A process, because once we have a better understanding of what we can really expect internally, we have a better line of sight into what we might need to enhance our capabilities with respect to. So more to come on out.
Eric Percher: That’s very helpful.
Mark Erceg: But, certainly we need time to build out that next three-year plan at a very great detail level. I’m committed to doing that.
Eric Percher: Very helpful. Thank you.
Operator: Our next question comes from George Hill with Deutsche Bank.
George Hill: Hey. Good morning, guys, and thanks for taking the question. Mark, two quick ones for you, I think you said that there were 24 new sites live in the quarter? I would first ask is that a gross number or a net number? And maybe talk a little bit more about what’s going on with the footprint and attrition given the declining maintenance revenue line? And number two, have you guys quantified a COVID impact for 2021, what -- whether it’s either a headwind or a tailwind? And should we think of the $3.25 numbers the way you are jumping off point for 20 -- for the way you jumping off point 2021 or 2022 estimates? Thanks,
Mark Erceg: Travis, I think, that first part was directed towards you.
Travis Dalton: Yeah. Thanks, Mark. Appreciate the question. Yeah. 24 new clients footprints in the first half of the year. I also would be remiss if I didn’t note, we also had 51 extensions and 120 expansion. So we had a whole bunch of clients that made commitments to us on a go-forward basis based on our work together. That was a gross number to the 24 new. I think we can meet or exceed that in addition to the second half of the year. We’ve got good opportunities, as I’ve noted, going forward. The attrition -- in terms of attrition, I’d say, we’ve made vast improvements over where we’ve been over the last several years. I can’t say specifically where we’re at, but our net gains have been double-digit in terms of our net on that. And it’s also obviously been revenue positive for us on net versus -- attrition versus gain for the first half of the year. That’s a good positive turn and trend for us. The last three years or four years, as many of you know, were tough for us and we had some downward momentum on that. But I feel like we’re starting to turn that back towards a positive. And so I like -- I made notes earlier around our competitiveness and now I like how we’re focused and competing. And so I think that that bears that out our first half performance and we have to continue that, we have to continue to improve in highly competitive environment.
Mark Erceg: Yeah. With respect to your second question on the $3.25, I guess, what I’d say is this, at this point, this is the new normal, so to speak, and the $3.25 I think is a pretty good baseline to use for our forward projections. I don’t think you’re going to hear us talk a lot about year-over-year differentials driven by COVID impacts, knock on wood, and as we start talking about the 22 plans and everything that comes thereafter. Certainly, we were heavily impacted in the prior year. We have been making adjustments to that with our workforce as it relates to flexible working arrangements. We’ve obviously been adjusting our properties and our footprint as it relates to that as well to take that into account. But I think, at this point, we’re going to say $3.25 is a pretty clean base to build on.
George Hill: Helpful. Thank you
Operator: Our next question comes from Dave Windley with Jefferies.
Dave Windley: Hi. Good morning. Thanks for taking my questions. I wanted to just drill in on the data-as-a-service business with, one, are you getting -- are your -- in terms of your revenue models there, are you getting paid basically for the data you’re providing and maybe some analytics on top of that or do you also have revenue opportunity for, I am thinking about the life sciences space mostly, but like for bringing trials to your community provider clients and/or identifying patients for -- specifically identifying patients for trials to your life sciences clients. I’m just interested in the revenue -- a little more detail around the revenue model.
Mark Erceg: Yeah. Thanks, Dave. So, just to level set, you’ve got the fairly small release of information business that sits inside kind of how we define the data-as-a-service business. But as you said that, the lion’s share of the revenue is sitting over around the strategies associated with life sciences and pharma. So we have a set of provider organizations that participate in our Learning Health Network. So we’re targeting 80 participants by the end of the year. We’re well on path based on first half performance, including six new clients in Q2, who have said, hey, we want to participate in research related economics. That drives a couple of different kind of business model opportunities for us. One, we have some partner economics that that sit in that strategy related to our partnership and investment with Elligo. So they have to do some work often. If you’re not IUH or you’re not banner with the U of A asset or you’re not MedStar with Georgetown. Those midsize provider organizations have to do some work around site readiness. And what it looks like to be educated for how to participate, document and deal with audit related realities of what it looks like to participate in a clinical trial. So we have some small economics associated with that. And then, yes, we’re creating trial opportunities with our Kantar business, where we’re going in and engaging with life sciences and pharma, those top 25 players and bringing those opportunities back to those Learning Health Network members and we’re sharing in those -- we’re actually sharing in those economics around that research activity. And then, finally, Kantar, obviously, has a standalone set of businesses that predate their integration into Cerner, that include, as Allan alluded to strategic consulting work that are the final components of business model.
Dave Windley: Very helpful. Thank you. Back to the core business, when you think about replacement market at this point, and hopefully, closer to the end of the pandemic than the beginning, do you assess that replacement decisions have legitimately been pushed to the right and is that opening up now? I’m just kind of curious what you’re now seeing percolate?
Brent Shafer: Yeah. Well, Travis did a really nice job kind of framing up net new footprint activity, extensions, and then importantly, expansion. So every time we’re going in to have a term driven conversation with a client, it affords us a chance to talk about expansion of capabilities around things like RTHS and CareAware, and probably, most importantly, capability sets that we have in the provider network space associated with healthy intent. So there’s an appetite to want to have those conversations period. They also always feature in any sort of a dialogue around renewal with a client. And I think, to Mark’s point, and to Travis’ point, I think we’re pushing hard to get better discipline in terms of how we have that conversation and make sure that we’re maximizing the value of those futures. And also have clear paths to actually deploy and deliver value around them as part of that extension conversation.
Travis Dalton: And Dave…
Dave Windley: Thank you.
Travis Dalton: …since we are on the topic of data-as-a-service and Kantar, I’m going to do my friend and colleague, Allan, a favor and answer a question for you all that, otherwise you’ll probably get individually from each of you. We said that we were using $350 million of cash to close on Kantar, and previously, we talked about $375 million. There’s a difference between those two points and times that we’re going to end up with $14 million of cash acquired as part of the transaction and there’s two smaller international markets that haven’t yet closed due to some regulatory process work that we’re going through. So that bridges the $375 million we previously spoke with versus the $350 million net that I tell you today.
Dave Windley: Helpful. Thank you.
Operator: Our next question comes from Stephanie Davis with SVB Leerink.
Stephanie Davis: Thank you, guys, for taking my question. Mark, as a lot of folks have mentioned the bright spot in the quarter but how quickly you hit the ground running on the cost takeout side, but quick one that forms the strategy. Given the maintain EPS guidance on software revenues, how should we think about the op -- like the op margin expansion opportunity and a more normalized topline growth year? Like if you didn’t have VA headwinds, where would we have ended up?
Mark Erceg: Well, I think, what we had said was we’ve asked about a 0.5 point of our revenue in the first earnings release as related to the VA assessment. And now subsequently, we probably added another 0.5 point to that. So I think, at this point, it would be fair to say there’d be almost another 0.4 point of revenue growth. At this point, we’ve simply said that the full year will be mid-single digits, if you add it on another 0.4 point…
Stephanie Davis: On the op margin side, now expect that…
Mark Erceg: I guess, what I would say -- yeah. Yeah. I guess what I’d say is, an extra point of revenue is, call it, $60 million. And you guys know kind of what the pass-through rates generally look like and so that would be the way I would model that for you.
Stephanie Davis: All right. Helpful. And then on the strategy side, Don, I think, you mentioned, cybersecurity earlier on the call. So what is your strategy for competing against the large tech companies have already made some early moves in the cybersecurity healthcare space? And given the lack of scale healthcare specific cybersecurity companies, is it safe to assume that this is going to generally be a build over a buy decision?
Don Trigg: Yeah. That is awesome question, Stephanie. So, I mean, one just observationally you’re making a great point. Isn’t it interesting that we don’t have any $1 billion plus scale impact cyber businesses specific to healthcare?
Stephanie Davis: Why?
Don Trigg: It’s really interesting and do you think we’re going to continue to see significant tailwinds there around breach activity? Absolutely and when you think about hybrid environments with a combination of on-prem and cloud, the opportunity set to manage those environments is very high. So really interesting space. The second thing I would say is, we’ve done some really good work, I think, methodologically to take the NIST framework and really, say, what would it look like to look at this space from a systems level and really try to think about what the holistic opportunity looks like. And then, finally, a lot of what we’re doing in that space, modestly today from a topline perspective is down market. It’s with our smaller and mid size hospital clients, where we’re going in and providing those as a service capabilities. And really, I think using it as an opportunity to say, what would it look like to do this up market for larger clients inside our client community. And then, importantly, how do you also think about it of provider network and all the technology heterogeneity and complexity of what it looks like to do this with a combination of owned and affiliated facility footprints. So this is a -- this is an interesting space. Our competency in it is growing both in terms of what the business opportunity looks like. But also, candidly, in terms of some of the public sector work that Travis is driving in terms of what it looks like to fulfill the needs of the DoD, the VA and really imagine what it would be like to do it at scale. So I like the space and we’re thinking a lot about it and we see organic opportunities to drive a bigger business there.
Stephanie Davis: Do you think the large health systems are ready to actually look at cybersecurity as something important for their core strategy?
Don Trigg: I think so. I think it tends to be at the, I’ll say, at NPR levels greater than $2 million. This is really the big opportunity on a 90-day basis for the CIO and the CSO to get in front of senior leaders to be visible to the Board. So they care a lot about it. We know how to sell to that buyer type, and so, yes, our level of conversations around it are increasing. That’s a little bit of a different point than you’re implicitly making, which is how are they ready for it, now they’re looking for a strategy and they’re looking for capability sets.
Brent Shafer: Good.
Stephanie Davis: Hey. Very helpful. Thank you, guys.
Brent Shafer: Thank you. Well, listen, thank you all for your time and energy today. Appreciate it. Let me just take this opportunity to thank the leadership team for all the hard work over the last 90 days, a lot of great progress and great team really gaining traction together. So -- and I also shout out to associates worldwide for all the great work. You take care and we’ll close now. Thanks.
Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.
