(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following Management Discussion and Analysis ("MD&A") is intended to help the reader understand our results of operations and financial condition. This MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to the financial statements.
All references to years in this MD&A represent fiscal years unless otherwise noted. Refer to Note (1) of the notes to consolidated financial statements for information regarding our fiscal year end.
Information regarding our 2017 results of operations, including a year-to-year comparison against 2018, may be found in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our annual report on Form 10-K for the period ended December 29, 2018, which was filed with the Securities and Exchange Commission on February 8, 2019.
Bookings, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $5.99 billion in 2019, which is a decrease of 11% compared to $6.72 billion in 2018, with the decrease primarily reflecting a more selective approach to low-margin, long-term contracts that typically represent large booking values.
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Revenues for 2019 increased 6% to $5.69 billion, compared to $5.37 billion in 2018. The increase in revenue reflects ongoing demand from new and existing clients for Cerner's solutions and tech-enabled services driven by their needs to keep up with regulatory requirements, adapt to changing reimbursement models, and deliver safer and more efficient care.
Net earnings for 2019 decreased 16% to $529 million, compared to $630 million in 2018. Diluted earnings per share decreased 13% to $1.65 in 2019, compared to $1.89 in 2018. The overall decrease in net earnings and diluted earnings per share was primarily a result of increased operating expenses, including expenses incurred in connection with our operational improvement initiatives discussed below, partially offset by increased revenues.
We had cash collections of receivables of $5.79 billion in 2019, compared to $5.49 billion in 2018. Days sales outstanding was 72 days for the 2019 fourth quarter, compared to 74 days for the 2019 third quarter and 79 days for the 2018 fourth quarter. Operating cash flows for 2019 were $1.31 billion, compared to $1.45 billion in 2018.
Operational Improvement Initiatives
We transitioned to a new operating structure in the first quarter of 2019. The Company has been focused on leveraging the impact of this reorganization and identifying additional efficiencies. Currently, we are focused on reducing operating expenses and generating other efficiencies that are expected to provide longer-term operating margin expansion. We are also considering exiting certain low-margin businesses and being more selective as we consider new business opportunities. To assist in these efforts, we have engaged an outside consulting firm to conduct a review of our operations and cost structure. We are focused on ongoing identification of opportunities to operate more efficiently and on achieving the efficiencies without impacting the quality of our solutions and services and commitments to our clients.
In the near term, we expect to incur expenses in connection with these efforts. Such expenses may include, but are not limited to, consultant and other professional services fees, employee separation costs, contract termination costs, and other such related expenses. We recognized $221 million of expenses related to these efforts in 2019, which are included in operating expenses in our consolidated statements of operations and discussed further below. We expect to incur additional expenses in connection with these initiatives in future periods, which may be material.
Health Care Information Technology Market Outlook
We have provided an assessment of the health care information technology market under "Health Care and Health Care IT Industry" in Part I, Item 1 "Business," which is incorporated herein by reference.
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Results of Operations
% of % of (In thousands) 2019 Revenue 2018 Revenue % Change Revenues $ 5,692,598 100 % $ 5,366,325 100 % 6 % Costs of revenue 1,071,041 19 % 937,348 17 % 14 % Margin 4,621,557 81 % 4,428,977 83 % 4 % Operating expenses Sales and client service 2,675,337 47 % 2,493,696 46 % 7 % Software development 737,136 13 % 683,663 13 % 8 % General and administrative 520,598 9 % 389,469 7 % 34 % Amortization of acquisition-related intangibles 87,817 2 % 87,364 2 % 1 % Total operating expenses 4,020,888 71 % 3,654,192 68 % 10 % Total costs and expenses 5,091,929 89 % 4,591,540 86 % 11 % Operating earnings 600,669 11 % 774,785 14 % (22 )% Other income, net 53,843 26,066 Income taxes (125,058 ) (170,792 ) Net earnings $ 529,454 $ 630,059 (16 )%
Revenues & Backlog
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Sales and client service expenses as a percent of revenues were 47% in 2019, compared to 46% in 2018. These expenses increased 7% to $2.68 billion in 2019, from $2.49 billion in 2018. Sales and client service expenses include salaries and benefits of sales, marketing, support, and services personnel, depreciation and other expenses associated with our managed services business, communications expenses, unreimbursed travel expenses, expense for share-based payments, and trade show and advertising costs. The increase in sales and client service expenses was primarily driven by a $72 million increase in personnel expenses, inclusive of higher associate benefits costs; a $16 million increase in bad debt expense related to client receivables; $66 million of charges recognized in 2019 in connection with the termination of certain client contracts prior to the end of their stated terms; and a $30 million charge in connection with a client dispute recognized in 2019. We expect the termination of such client contracts to reduce future revenues by approximately $170 million on an annualized basis. We do not expect a significant impact to future operating earnings, as the terminated contacts related to lower margin business. Refer to Note (12) of the notes to consolidated financial statements for further information regarding the client dispute. The 2018 amount includes a pre-tax charge of $45 million to provide an allowance against certain client receivables with Fujitsu Services Limited ("Fujitsu"), as further discussed in Note (12) of the notes to consolidated financial statements.
Software development expenses as a percent of revenues were 13% in both 2019 and 2018. Expenditures for software development include ongoing development and enhancement of the Cerner Millennium and HealtheIntent platforms, with a focus on supporting key initiatives to enhance physician experience, revenue cycle, population health management, and health network solutions. In addition, 2019 includes costs incurred in connection with our efforts to modernize our platforms, with a focus on development of a software as a service platform. A summary of our total software development expense in 2019 and 2018 is as follows:
For the Years Ended (In thousands) 2019 2018 Software development costs $ 783,593 $ 747,128 Capitalized software costs (270,948 ) (271,787 ) Capitalized costs related to share-based payments (2,923 ) (1,906 ) Amortization of capitalized software costs 227,414 210,228 Total software development expense $ 737,136 $ 683,663
General and administrative expenses as a percent of revenues were 9% in 2019, compared to 7% in 2018. These expenses increased 34% to $521 million in 2019, from $389 million in 2018. General and administrative expenses include salaries and benefits for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, depreciation and amortization, transaction gains or losses on foreign currency, expense for share-based payments, certain organizational restructuring and other expense. The increase in general and administrative expenses is primarily driven by expenses incurred in 2019 in connection with our operational improvement initiatives discussed above; inclusive of $86 million of charges associated with employee separation benefits, as further discussed in Note (1) of the notes to consolidated financial statements. We expect to incur additional expenses in connection with these efforts in future periods, which may be material.
Amortization of acquisition-related intangibles as a percent of revenues was 2% in both 2019 and 2018. These expenses increased 1% to $88 million in 2019, from $87 million in 2018. Amortization of acquisition-related intangibles includes the amortization of customer relationships, acquired technology, trade names, and non-compete agreements recorded in connection with our business acquisitions. The increase in amortization of acquisition-related intangibles includes the impact of intangibles recognized in connection with our acquisition of AbleVets, LLC ("AbleVets") in 2019. Refer to Note (8) of the notes to consolidated financial statements for further information regarding our acquisition of AbleVets.
Other income, net was $54 million in 2019, compared to $26 million in 2018. The 2019 period includes a $16 million gain recognized on the disposition of one of our equity investments and a $14 million unrealized gain recognized on another one of our equity investments. Refer to Note
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Our effective tax rate was 19% in 2019, compared to 21% in 2018. The decrease in the effective tax rate in 2019 is primarily due to increased excess tax benefits recognized as a component of income tax expense due to elevated stock option exercise activity. Refer to Note (14) of the notes to consolidated financial statements for further information regarding our effective tax rate. We do not expect significant changes to our overall effective tax rate in 2020, from what is reported for 2019.
Operations by Segment
The following table presents a summary of our operating segment information for the years ended 2019 and 2018:
% of % of Segment Segment (In thousands) 2019 Revenue 2018 Revenue % Change Domestic Segment Revenues $ 5,038,127 100% $ 4,730,266 100% 7% Costs of revenue 967,035 19% 827,904 18% 17% Operating expenses 2,398,422 48% 2,164,465 46% 11% Total costs and expenses 3,365,457 67% 2,992,369 63% 12% Domestic operating earnings 1,672,670 33% 1,737,897 37% (4)% International Segment Revenues 654,471 100% 636,059 100% 3% Costs of revenue 104,006 16% 109,444 17% (5)% Operating expenses 276,914 42% 321,116 50% (14)% Total costs and expenses 380,920 58% 430,560 68% (12)% International operating earnings 273,551 42% 205,499 32% 33% Other, net (1,345,552 ) (1,168,611 ) 15% Consolidated operating earnings $ 600,669 $ 774,785 (22)%
Costs of revenue as a percent of revenues were 19% in 2019, compared to 18% in 2018. The higher costs of revenue as a percent of revenues was primarily driven by higher third-party costs associated with professional services revenue.
Operating expenses as a percent of revenues were 48% in 2019, compared to 46% in 2018. The higher operating expenses as a percent of revenues was primarily driven by $66 million of charges in connection with client contract terminations and the $30 million charge in connection with a client dispute, both recognized in 2019 and discussed above.
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Costs of revenue as a percent of revenues were 16% in 2019, compared to 17% in 2018. The lower costs of revenue as a percent of revenues was primarily driven by a lower mix of technology resale revenue, which carries a higher cost of revenue.
Operating expenses as a percent of revenues were 42% in 2019, compared to 50% in 2018. The decrease as a percent of revenues is primarily due to a pre-tax charge of $45 million in 2018 to provide an allowance against certain client receivables with Fujitsu, as further discussed in Note (12) of the notes to consolidated financial statements.
The effects of inflation on our business during 2019 and 2018 were not significant.
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Liquidity and Capital Resources
We believe that our present cash position, together with cash generated from operations, short-term investments and, as appropriate, remaining availability under our Credit Agreement and other sources of debt financing, will be sufficient to meet anticipated cash requirements during 2020. The following table summarizes our cash flows in 2019 and 2018:
For the Years Ended (In thousands) 2019 2018 Cash flows from operating activities $ 1,313,099 $ 1,454,009 Cash flows from investing activities (640,408 ) (828,937 ) Cash flows from financing activities (601,380 ) (609,787 ) Effect of exchange rate changes on cash (3,594 ) (12,082 ) Total change in cash and cash equivalents 67,717 3,203 Cash and cash equivalents at beginning of period 374,126 370,923 Cash and cash equivalents at end of period $ 441,843 $ 374,126 Free cash flow (non-GAAP) $ 567,710 $ 733,388 Cash from Operating Activities For the Years Ended (In thousands) 2019 2018 Cash collections from clients $ 5,787,180 $ 5,486,654 Cash paid to employees and suppliers and other (4,348,438 ) (4,032,498 ) Cash paid for interest (25,639 ) (15,707 ) Cash paid for taxes, net of refunds (100,004 ) 15,560 Total cash from operations $ 1,313,099 $ 1,454,009
Cash flows from operations decreased $141 million in 2019 compared to 2018, due primarily to net refunds of taxes in 2018 along with cash payments in 2019 associated with our operational improvement initiatives discussed above. Days sales outstanding was 72 days in the fourth quarter of 2019, compared to 74 days for the third quarter of 2019 and 79 days for the fourth quarter of 2018.
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Cash from Investing Activities For the Years Ended (In thousands) 2019 2018 Capital purchases $ (471,518 ) $ (446,928 ) Capitalized software development costs (273,871 ) (273,693 ) Sales and maturities of investments, net of purchases 215,107 (71,497 ) Purchase of other intangibles (35,587 ) (36,819 ) Acquisition of business, net of cash acquired (74,539 ) - Total cash flows from investing activities $ (640,408 ) $ (828,937 )
Cash flows from investing activities consist primarily of capital spending, investment, and acquisition activities. . . .
Feb 10, 2020
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