Q3 2012 10-Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(X)    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 29, 2012

OR

( )    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number          0-15386             

CERNER CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
 
43-1196944
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification
Number)

2800 Rockcreek Parkway
North Kansas City, Missouri 64117
(816) 201-1024
(Address of Principal Executive Offices, including zip code; registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]     No [  ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X]     No [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]     Accelerated filer [  ]     Non-accelerated filer [  ]     Smaller reporting company [  ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]       No [X]
Indicate the number of shares outstanding of the issuer’s classes of common stock, as of the latest practicable date.
Class
  
Outstanding at October 18, 2012
Common Stock, $0.01 par value per share
  
171,564,145 shares


Table of Contents

CERNER CORPORATION AND SUBSIDIARIES

I N D E X
 
 
 
 
Part I.
Financial Information:
 
 
 
 
Item 1.
Financial Statements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II.
 
 
 
Item 6.



Table of Contents

Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 29, 2012 (unaudited) and December 31, 2011

(In thousands, except share data)
2012
 
2011
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
288,101

 
$
243,146

Short-term investments
750,895

 
531,635

Receivables, net
542,415

 
563,209

Inventory
24,308

 
23,296

Prepaid expenses and other
128,541

 
94,232

Deferred income taxes, net
11,520

 
46,795

Total current assets
1,745,780

 
1,502,313

 
 
 
 
Property and equipment, net
551,663

 
488,996

Software development costs, net
260,876

 
248,750

Goodwill
211,793

 
211,826

Intangible assets, net
66,477

 
75,366

Long-term investments
462,999

 
359,324

Other assets
170,868

 
113,783

 
 
 
 
Total assets
$
3,470,456

 
$
3,000,358

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
134,775

 
$
85,545

Current installments of long-term debt
54,979

 
39,722

Deferred revenue
179,783

 
153,139

Accrued payroll and tax withholdings
108,842

 
109,227

Other accrued expenses
17,628

 
51,087

Total current liabilities
496,007

 
438,720

 
 
 
 
Long-term debt and other obligations
141,678

 
86,821

Deferred income taxes and other liabilities
122,153

 
150,229

Deferred revenue
13,941

 
13,787

Total liabilities
773,779

 
689,557

 
 
 
 
Shareholders’ Equity:
 
 
 
Cerner Corporation shareholders’ equity:
 
 
 
Common stock, $.01 par value, 250,000,000 shares authorized, 171,536,679 shares issued at September 29, 2012 and 169,565,856 shares issued at December 31, 2011
1,715

 
1,696

Additional paid-in capital
818,130

 
723,490

Retained earnings
1,882,886

 
1,597,462

Accumulated other comprehensive loss, net
(6,174
)
 
(11,967
)
Total Cerner Corporation shareholders’ equity
2,696,557

 
2,310,681

 
 
 
 
Noncontrolling interest
120

 
120

Total shareholders’ equity
2,696,677

 
2,310,801

 
 
 
 
Total liabilities and shareholders’ equity
$
3,470,456

 
$
3,000,358


See notes to condensed consolidated financial statements (unaudited).

1

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and nine months ended September 29, 2012 and October 1, 2011
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands, except per share data)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
System sales
$
229,925

 
$
188,698

 
$
651,040

 
$
486,222

Support, maintenance and services
432,281

 
371,467

 
1,262,231

 
1,067,791

Reimbursed travel
14,276

 
11,475

 
41,781

 
33,514

 
 
 
 
 
 
 
 
Total revenues
676,482

 
571,640

 
1,955,052

 
1,587,527

Costs and expenses:
 
 
 
 
 
 
 
Cost of system sales
100,668

 
84,268

 
318,193

 
204,254

Cost of support, maintenance and services
34,634

 
24,721

 
95,112

 
71,858

Cost of reimbursed travel
14,276

 
11,475

 
41,781

 
33,514

Sales and client service
259,141

 
220,177

 
746,090

 
631,738

Software development (Includes amortization of $20,880 and $60,353 for the three and nine months ended September 29, 2012; and $20,919 and $59,887 for the three and nine months ended October 1, 2011)
78,094

 
72,544

 
222,746

 
213,478

General and administrative
41,973

 
38,063

 
119,912

 
110,621

 
 
 
 
 
 
 
 
Total costs and expenses
528,786

 
451,248

 
1,543,834

 
1,265,463

 
 
 
 
 
 
 
 
Operating earnings
147,696

 
120,392

 
411,218

 
322,064

 
 
 
 
 
 
 
 
Other income, net
3,351

 
2,775

 
8,789

 
7,666

 
 
 
 
 
 
 
 
Earnings before income taxes
151,047

 
123,167

 
420,007

 
329,730

Income taxes
(52,160
)
 
(44,332
)
 
(134,583
)
 
(114,295
)
 
 
 
 
 
 
 
 
Net earnings
$
98,887

 
$
78,835

 
$
285,424

 
$
215,435

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.58

 
$
0.47

 
$
1.67

 
$
1.28

Diluted earnings per share
$
0.56

 
$
0.45

 
$
1.63

 
$
1.24

Basic weighted average shares outstanding
171,251

 
169,140

 
170,643

 
168,343

Diluted weighted average shares outstanding
175,870

 
174,283

 
175,517

 
173,656

See notes to condensed consolidated financial statements (unaudited).


2

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three and nine months ended September 29, 2012 and October 1, 2011
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net earnings
$
98,887

 
$
78,835

 
$
285,424

 
$
215,435

Foreign currency translation adjustment and other (net of taxes (benefit) of $(843) and $(1,478) for the three and nine months ended September 29, 2012; and $2,245 and $1,407 for the three and nine months ended October 1, 2011)
6,240

 
(23,358
)
 
5,247

 
(7,465
)
Change in net unrealized holding gain (loss) on available-for-sale investments (net of taxes (benefit) of $321 and $338 for the three and nine months ended September 29, 2012)
518

 

 
546

 

 
 
 
 
 
 
 
 
Comprehensive income
$
105,645

 
$
55,477

 
$
291,217

 
$
207,970

See notes to condensed consolidated financial statements (unaudited).


3

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 29, 2012 and October 1, 2011
(unaudited)
 
 
Nine Months Ended
(In thousands)
2012
 
2011
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net earnings
$
285,424

 
$
215,435

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
162,336

 
156,841

Share-based compensation expense
26,304

 
20,363

Provision for deferred income taxes
20,679

 
9,246

Changes in assets and liabilities (net of businesses acquired):
 
 
 
Receivables, net
(31,102
)
 
(103,829
)
Inventory
(907
)
 
(1,200
)
Prepaid expenses and other
(18,322
)
 
1,469

Accounts payable
30,596

 
8,026

Accrued income taxes
(36,983
)
 
4,662

Deferred revenue
26,333

 
18,932

Other accrued liabilities
63,402

 
47,860

 
 
 
 
Net cash provided by operating activities
527,760

 
377,805

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital purchases
(129,966
)
 
(75,602
)
Capitalized software development costs
(72,506
)
 
(61,827
)
Purchases of investments
(999,697
)
 
(870,960
)
Sales and maturities of investments
663,257

 
615,219

Purchase of other intangibles
(7,212
)
 
(8,395
)
Acquisition of businesses, net of cash acquired

 
(28,069
)
 
 
 
 
Net cash used in investing activities
(546,124
)
 
(429,634
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of long-term debt
(1,772
)
 
(715
)
Proceeds from excess tax benefits from stock compensation
36,431

 
34,009

Proceeds from exercise of options
31,102

 
36,463

Contingent consideration payments for acquisition of business
(3,400
)
 
(779
)
 
 
 
 
Net cash provided by financing activities
62,361


68,978

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
958

 
(466
)
 
 
 
 
Net increase in cash and cash equivalents
44,955

 
16,683

Cash and cash equivalents at beginning of period
243,146

 
214,511

 
 
 
 
Cash and cash equivalents at end of period
$
288,101

 
$
231,194

See notes to condensed consolidated financial statements (unaudited).


4

Table of Contents

CERNER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
(1)
Interim Statement Presentation
The condensed consolidated financial statements included herein have been prepared by Cerner Corporation (we or the Company) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our latest annual report on Form 10-K.
In management’s opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position and the results of operations and cash flows for the periods presented. Our interim results as presented in this Form 10-Q are not necessarily indicative of the operating results for the entire year.
The condensed consolidated financial statements were prepared using GAAP. These principles require us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.
Our third fiscal quarter ends on the Saturday closest to September 30. The 2012 and 2011 third quarters ended on September 29, 2012 and October 1, 2011, respectively. All references to years in these notes to condensed consolidated financial statements represent the respective three or nine months ended on such dates, unless otherwise noted.
Recently Adopted Accounting Pronouncements
Comprehensive Income. On January 1, 2012, we adopted Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2011-05, Presentation of Comprehensive Income. ASU 2011-05 requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in equity. These condensed consolidated financial statements include separate Condensed Consolidated Statements of Comprehensive Income.
Goodwill Impairment. On January 1, 2012, we adopted FASB ASU 2011-08, Testing for Goodwill Impairment. ASU 2011-08 amends existing guidance by giving an entity the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than the carrying amount. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then it is necessary to perform the two-step goodwill impairment test, as currently prescribed by FASB Accounting Standards Codification Topic 350. Otherwise, the two-step goodwill impairment test is not required. The adoption of this standard did not have a material effect on our condensed consolidated financial statements.
 
(2)
Fair Value Measurements
We determine fair value measurements used in our condensed consolidated financial statements based upon the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
 
Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2 – Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.

5

Table of Contents

Level 3 – Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following table details our financial assets measured and recorded at fair value on a recurring basis at September 29, 2012: 
(In thousands)
 

 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
Money market funds
 
Cash equivalents
 
$
64,156

 
$

 
$

Time deposits
 
Cash equivalents
 

 
10,971

 

Time deposits
 
Short-term investments
 

 
86,381

 

Commercial paper
 
Short-term investments
 

 
63,978

 

Government and corporate bonds
 
Short-term investments
 

 
600,536

 

Time deposits
 
Long-term investments
 

 
5,693

 

Government and corporate bonds
 
Long-term investments
 

 
447,306

 


The following table details our financial assets measured, but not recorded, at fair value on a recurring basis at December 31, 2011:
(In thousands)
 
 
 
Fair Value Measurements Using
Description
 
Balance Sheet Classification
 
Level 1
 
Level 2
 
Level 3
Money market funds
 
Cash equivalents
 
$
123,919

 
$

 
$

Time deposits
 
Cash equivalents
 

 
7,358

 

Time deposits
 
Short-term investments
 

 
67,632

 

Commercial paper
 
Short-term investments
 

 
23,250

 

Government and corporate bonds
 
Short-term investments
 

 
440,753

 

Time deposits
 
Long-term investments
 

 
19,579

 

Government and corporate bonds
 
Long-term investments
 

 
337,245

 

We estimate the fair value of our long-term, fixed rate debt using a Level 3 discounted cash flow analysis based on current borrowing rates for debt with similar maturities. The fair value of our long-term debt, including current maturities, at September 29, 2012 and December 31, 2011 was approximately $75.6 million and $72.6 million, respectively. The carrying amount of such fixed-rate debt at September 29, 2012 and December 31, 2011 was $69.8 million and $67.5 million, respectively.
 
(3)
Investments

Cash equivalents consist of short-term marketable securities with original maturities less than 90 days. Short-term investments primarily consist of time deposits, commercial paper, and government and corporate bonds with maturities of less than one year. Long-term investments primarily consist of government and corporate bonds with maturities of less than two years.

Effective April 1, 2012, we began reporting all securities in our investment portfolio as available-for-sale. The change resulted in the transfer of investments with an aggregate carrying amount of $1.0 billion from held-to-maturity to available-for-sale, with gross unrealized gains of $0.7 million and gross unrealized losses of $0.7 million. The unrealized gains and losses, net of the related tax effects, were recorded to accumulated other comprehensive income. The decision to transfer the securities to available-for-sale is intended to provide us with financial flexibility in determining whether to hold our investment securities to maturity. Such change contemplates the possibility that securities may be liquidated prior to maturity as we manage through changing market conditions.

Available-for-sale securities are recorded at fair value with the unrealized gains and losses reflected in accumulated other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis.

We regularly review investment securities for impairment based on both quantitative and qualitative criteria that include the extent to which cost exceeds fair value, the duration of any market decline, and the financial health of and specific prospects for the issuer. Unrealized losses that are other than temporary are recognized in earnings.

6

Table of Contents


Available-for-sale investments at September 29, 2012 were as follows:
(In thousands)
 
Adjusted Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
64,156

 
$

 
$

 
$
64,156

Time deposits
 
10,971

 

 

 
10,971

Total cash equivalents
 
75,127

 

 

 
75,127

 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
86,339

 
44

 
(2
)
 
86,381

Commercial paper
 
64,000

 
18

 
(40
)
 
63,978

Government and corporate bonds
 
599,990

 
617

 
(71
)
 
600,536

Total short-term investments
 
750,329

 
679

 
(113
)
 
750,895

 
 
 
 
 
 
 
 
 
Long-term investments:
 
 
 
 
 
 
 
 
Time deposits
 
5,700

 
2

 
(9
)
 
5,693

Government and corporate bonds
 
446,981

 
426

 
(101
)
 
447,306

Total long-term investments
 
452,681

 
428

 
(110
)
 
452,999

 
 
 
 
 
 
 
 
 
Total available-for-sale investments
 
$
1,278,137

 
$
1,107

 
$
(223
)
 
$
1,279,021


At December 31, 2011, we held cash equivalents, short-term investments and long-term investments of $131.3 million, $531.6 million and $359.3 million, respectively. Investments at December 31, 2011 were classified as held-to-maturity and stated at amortized cost.

We sold available-for-sale investments for proceeds of $8.5 million during the nine months ended September 29, 2012, resulting in an insignificant gain.

(4)
Receivables
A summary of net receivables is as follows:
 
(In thousands)
September 29, 2012
 
December 31, 2011
Gross accounts receivable
$
490,972

 
$
496,706

Less: Allowance for doubtful accounts
34,491

 
24,270

 
 
 
 
Accounts receivable, net of allowance
456,481

 
472,436

 
 
 
 
Contracts receivable
60,888

 
81,776

Current portion of lease receivables
25,046

 
8,997

 
 
 
 
Total receivables, net
$
542,415

 
$
563,209


During the second quarter of 2008, Fujitsu Services Limited’s (Fujitsu) contract as the prime contractor in the National Health Service (NHS) initiative to automate clinical processes and digitize medical records in the Southern region of England was terminated by the NHS. This had the effect of automatically terminating our subcontract for the project. We are in dispute with Fujitsu regarding Fujitsu’s obligation to pay the amounts comprised of accounts receivable and contracts receivable related to that subcontract, and we are working with Fujitsu to resolve these issues based on processes provided for in the contract. Part of that process requires resolution of disputes between Fujitsu and the NHS regarding the contract termination. As of September 29, 2012, it remains unlikely that the matter will be resolved in the next 12 months. Therefore, these receivables have been classified as long-term and represent less than the majority of other long-term assets as of the quarter ended September 29, 2012. While the ultimate collectability of the receivables pursuant to this process is uncertain, we

7

Table of Contents

believe that we have valid and equitable grounds for recovery of such amounts and that collection of recorded amounts is probable.

During the first nine months of 2012 and 2011, we received total client cash collections of $2.0 billion and $1.6 billion, respectively, of which $56.2 million and $53.4 million were received from third party arrangements with non-recourse payment assignments.
 
(5)
Income Taxes

We determine the tax provision for interim periods using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment. We classify interest and penalties associated with unrecognized tax benefits as income tax expense in our Condensed Consolidated Statements of Operations.
Our effective tax rate was 32.0% and 34.7% for the first nine months of 2012 and 2011, respectively. This decrease was primarily due to an increase in net favorable discrete items recorded in 2012 relative to 2011, partially offset by the expiration of the research and development tax credit on December 31, 2011.
We recorded an adjustment to our unrecognized tax benefits during the first quarter of 2012, resulting from the settlement of an ongoing tax audit, which favorably impacted our income tax provision by $12.0 million. In the first quarter of 2012, we also recognized $5.6 million of tax expense as a discrete item in connection with the license of certain intellectual property rights to a wholly owned foreign subsidiary. During the second quarter of 2012, we increased our estimate of a tax deduction available for 2011 and recorded the related benefit as a favorable discrete item, which reduced our effective tax rate.
We do not anticipate recognition of any material unrecognized tax benefits in the next twelve months.
 
(6)
Earnings Per Share

A reconciliation of the numerators and the denominators of the basic and diluted per share computations are as follows:
 
 
 
Three Months Ended
 
 
2012
 
2011
 
 
Earnings
 
Shares
 
Per-Share
 
Earnings
 
Shares
 
Per-Share
(In thousands, except per share data)
 
(Numerator)
 
(Denominator)
 
Amount
 
(Numerator)
 
(Denominator)
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders
 
$
98,887

 
171,251

 
$
0.58

 
$
78,835

 
169,140

 
$
0.47

Effect of dilutive securities:
 
 
 
 
 
 
 
 
 
 
 
 
Stock options and non-vested shares
 

 
4,619

 
 
 

 
5,143

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
 
$
98,887

 
175,870

 
$
0.56

 
$
78,835

 
174,283

 
$
0.45


For the three months ended September 29, 2012 and October 1, 2011, options to purchase 2.8 million and 1.4 million shares, respectively, of common stock at per share prices ranging from $55.24 to $85.96 and $42.84 to $64.68, respectively, were not included in the computation of diluted earnings per share because the options were anti-dilutive.


8

Table of Contents

 
 
Nine Months Ended
 
 
2012
 
2011
 
 
Earnings
 
Shares
 
Per-Share
 
Earnings
 
Shares
 
Per-Share
(In thousands, except per share data)
 
(Numerator)
 
(Denominator)
 
Amount
 
(Numerator)
 
(Denominator)
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders
 
$
285,424

 
170,643

 
$
1.67

 
$
215,435

 
168,343

 
$
1.28

Effect of dilutive securities:
 
 
 
 
 
 
 
 
 
 
 
 
Stock options and non-vested shares
 

 
4,874

 
 
 

 
5,313

 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to common shareholders including assumed conversions
 
$
285,424

 
175,517

 
$
1.63

 
$
215,435

 
173,656

 
$
1.24


For the nine months ended September 29, 2012 and October 1, 2011, options to purchase 2.1 million and 2.0 million shares, respectively, of common stock at per share prices ranging from $55.24 to $85.96 and $38.99 to $64.68, respectively, were not included in the computation of diluted earnings per share because the options were anti-dilutive.

(7)
Share-Based Compensation
Stock Options
Options activity for the nine months ended September 29, 2012 was as follows:
 
(In thousands, except per share data)
Number of Shares
 
Weighted-Average Exercise Price
 
Aggregate Intrinsic 
Value
 
Weighted-Average Remaining Contractual Term (Yrs)
Options
Outstanding at beginning of year
12,909

 
$
23.78

 
 
 
 
Granted
1,751

 
81.32

 
 
 
 
Exercised
(1,911
)
 
16.68

 
 
 
 
Forfeited and expired
(228
)
 
48.23

 
 
 
 
Outstanding as of September 29, 2012
12,521

 
$
32.47

 
$
569,674

 
6.36
 
 
 
 
 
 
 
 
Exercisable as of September 29, 2012
7,613

 
$
16.86

 
$
460,814

 
5.10

We valued options granted in 2012 under the Cerner Corporation 2011 Omnibus Equity Incentive Plan using the following weighted average assumptions: 
Expected volatility (%)
 
34.8

Expected term (yrs)
 
9.1

Risk-free rate (%)
 
2.1

Fair value per option
 
$
37.3

As of September 29, 2012, there was $102.0 million of total unrecognized compensation cost related to stock options granted under all plans. That cost is expected to be recognized over a weighted-average period of 3.30 years.







9

Table of Contents

Non-vested Shares
Non-vested share activity for the nine months ended September 29, 2012 was as follows: 
(In thousands, except per share data)
Number of Shares
 
Weighted-Average
Grant Date Fair Value
Restricted Stock
Outstanding at beginning of year
254

 
$
47.75

Granted
78

 
76.30

Vested
(48
)
 
50.85

Forfeited

 

Outstanding as of September 29, 2012
284

 
$
55.14

As of September 29, 2012, there was $8.6 million of total unrecognized compensation cost related to non-vested share awards granted under all plans. That cost is expected to be recognized over a weighted-average period of 1.36 years.
The following table presents the total compensation expense recognized in the Condensed Consolidated Statements of Operations with respect to stock options, non-vested shares and our Associate Stock Purchase Plan: 

 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
 
Stock option and non-vested share compensation expense
 
$
9,721

 
$
7,232

 
$
26,304

 
$
20,363

Associate stock purchase plan expense
 
719

 
458

 
2,064

 
1,506

Amounts capitalized in software development costs, net of amortization
 
(218
)
 
(175
)
 
(600
)
 
(425
)
 
 
 
 
 
 
 
 
 
Amounts charged against earnings, before income tax benefit
 
$
10,222

 
$
7,515

 
$
27,768

 
$
21,444

 
 
 
 
 
 
 
 
 
Amount of related income tax benefit recognized in earnings
 
$
3,910

 
$
2,875

 
$
10,621

 
$
8,182

 
(8)
Hedging Activities
The following table represents the fair value of our net investment hedge included within the Condensed Consolidated Balance Sheets:
(In thousands)
 
 
Fair Value
Derivatives Designated
Balance Sheet Classification
 
September 29, 2012
 
December 31, 2011
 
 
 
 
 
 
Net investment hedge
Short-term liabilities
 
$
15,007

 
$
14,421

Net investment hedge
Long-term liabilities
 
45,020

 
43,262

 
 
 
 
 
 
Total net investment hedge
 
$
60,027

 
$
57,683

 
The following table represents the related unrealized gain or loss, net of related income tax effects, on the net investment hedge recognized in comprehensive income: 

(In thousands)
Net Unrealized Gain (Loss)
 
Net Unrealized Gain (Loss)
 
For the Three Months Ended
 
For the Nine Months Ended
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net investment hedge - S/T
$
(262
)
 
$
281

 
$
(362
)
 
$
9

Net investment hedge - L/T
(786
)
 
(251
)
 
(1,085
)
 
(1,341
)
 
 
 
 
 
 
 
 
Total net investment hedge
$
(1,048
)
 
$
30

 
$
(1,447
)
 
$
(1,332
)


10

Table of Contents

(9)
Contingencies
The terms of our software license agreements with our clients generally provide for a limited indemnification of such clients against losses, expenses and liabilities arising from third party claims based on alleged infringement by our solutions of an intellectual property right of such third party. The terms of such indemnification often limit the scope of and remedies for such indemnification obligations and generally include a right to replace or modify an infringing solution. To date, we have not had to reimburse any of our clients for any losses related to these indemnification provisions pertaining to third party intellectual property infringement claims. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the terms of the corresponding agreements with our clients, we cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions.
 
(10)
Segment Reporting

We have two operating segments, Domestic and Global. Revenues are derived primarily from the sale of clinical, financial and administrative information systems and solutions. The cost of revenues includes the cost of third party consulting services, computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Operating expenses incurred by the geographic business segments consist of sales and client service expenses including salaries of sales and client service personnel, communications expenses and unreimbursed travel expenses. Performance of the segments is assessed at the operating earnings level and, therefore, the segment operations have been presented as such. “Other” includes expenses that have not been allocated to the operating segments, such as software development, marketing, general and administrative, share-based compensation expense and depreciation. We manage our operating segments to the operating earnings level. Items such as interest, income taxes, capital expenditures and total assets are managed at the consolidated level and thus are not included in our operating segment disclosures.

Accounting policies for each of the reportable segments are the same as those used on a consolidated basis. The following table presents a summary of our operating segments and other expense for the three and nine months ended September 29, 2012 and October 1, 2011:
 
(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
Three Months Ended 2012
 
 
 
 
 
 
 
Revenues
$
591,327

 
$
85,155

 
$

 
$
676,482

 
 
 
 
 
 
 
 
Cost of revenues
131,663

 
17,915

 

 
149,578

Operating expenses
131,787

 
32,794

 
214,627

 
379,208

Total costs and expenses
263,450

 
50,709


214,627

 
528,786

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
327,877

 
$
34,446

 
$
(214,627
)
 
$
147,696

 
 
 
 
 
 
 
 
(In thousands)
Domestic
 
Global
 
Other
 
Total
Three Months Ended 2011
 
 
 
 
 
 
 
Revenues
$
499,497

 
$
72,143

 
$

 
$
571,640

 
 
 
 
 
 
 
 
Cost of revenues
109,656

 
10,808

 

 
120,464

Operating expenses
110,775

 
33,412

 
186,597

 
330,784

Total costs and expenses
220,431

 
44,220

 
186,597

 
451,248

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
279,066

 
$
27,923

 
$
(186,597
)
 
$
120,392



11

Table of Contents

(In thousands)
Domestic
 
Global    
 
Other    
 
Total    
Nine Months Ended 2012
 
 
 
 
 
 
 
Revenues
$
1,707,259

 
$
247,793

 
$

 
$
1,955,052

 
 
 
 
 
 
 
 
Cost of revenues
403,618

 
51,468

 

 
455,086

Operating expenses
372,668

 
97,616

 
618,464

 
1,088,748

Total costs and expenses
776,286

 
149,084

 
618,464

 
1,543,834

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
930,973

 
$
98,709

 
$
(618,464
)
 
$
411,218

 
 
 
 
 
 
 
 
(In thousands)
Domestic
 
Global
 
Other
 
Total
Nine Months Ended 2011
 
 
 
 
 
 
 
Revenues
$
1,370,741

 
$
216,786

 
$

 
$
1,587,527

 
 
 
 
 
 
 
 
Cost of revenues
274,994

 
34,632

 

 
309,626

Operating expenses
322,250

 
94,182

 
539,405

 
955,837

Total costs and expenses
597,244

 
128,814

 
539,405

 
1,265,463

 
 
 
 
 
 
 
 
Operating earnings (loss)
$
773,497

 
$
87,972

 
$
(539,405
)
 
$
322,064



12

Table of Contents

(11)
Related Party Transactions

During 2009, as part of our long-term space planning analysis, we determined that we would require additional office space for associates to accommodate our anticipated growth. We evaluated various sites in the Kansas City metropolitan area and negotiated with several different governmental entities regarding available incentives. Upon completion of this review, we decided to proceed with an office development in Wyandotte County, Kansas, which is part of the “Village West” development. In order to maximize available incentives, we agreed to pursue the Village West office development in conjunction with the development of an 18,000 seat, multi-sport stadium and related recreational athletic complex.

The Village West stadium complex was developed by Kansas Unified Development, LLC (the “Developer”), an entity controlled by Neal Patterson, Chairman of the Board of Directors, Chief Executive Officer and President of Cerner Corporation, and Clifford Illig, Vice Chairman of the Board of Directors of Cerner Corporation. Sporting Kansas City (“Sporting KC”) is the principal tenant of the stadium complex. OnGoal LLC (“OnGoal”), the owner of the Sporting KC professional soccer club, is also controlled by Messrs. Patterson and Illig.

The total construction and development cost of the office complex has initially been estimated to be approximately $160.0 million. The Company currently believes it will receive incentives totaling approximately $80.0 million from the Developer, the Unified Government of Wyandotte County/Kansas City, Kansas (the “Unified Government”) and the Kansas Department of Commerce. Incentives from the Kansas Department of Commerce will include cash grants, tax exemptions and tax credits. The value of some of these incentives may ultimately increase or decrease depending upon the final capital invested and the number of new jobs created. We currently expect our net investment in the Village West office complex, after applying expected government incentives and payments from the Developer, to be approximately $80.0 million.

In connection with the Village West office complex development and the related incentives, we have entered into three agreements:

Land Transfer and Specific Venture Agreement (the “Land Transfer Agreement”) dated January 19, 2010 with the Unified Government and the Developer,
Workforce Services Training Agreement (the “Workforce Agreement”) dated January 20, 2010 with the Kansas Department of Commerce, as amended by the First Amendment to Workforce Services Training Agreement dated June 7, 2011, and
Interparty Agreement dated January 19, 2010 with OnGoal and the Developer.

Pursuant to the Land Transfer Agreement, we acquired the land from the Unified Government with certain contingencies upon which the office complex is being constructed. The purchase price, equal to the site’s fair market value, is being paid by the Developer. In the second quarter of 2012, vertical construction began on the Village West office development. In connection with the commencement of vertical construction, contingencies were resolved and we recorded land contributed to the Company from the Unified Government at its appraisal value.

Pursuant to the Workforce Agreement, as amended, we agreed to establish positions for 4,500 employees with an average annual wage of at least $31.00 per hour. In consideration of this commitment, we have elected to receive up to $48.5 million from the Kansas Department of Commerce for project investment costs and employee training (the “IMPACT Award”). We can specify the date when the IMPACT Award will be distributed by the Kansas Department of Commerce, which must be by December 31, 2015. The State of Kansas has issued bonds in order to fund these incentives to us and has incurred costs of issuance and debt service obligations. We may be obligated to repay the Kansas Department of Commerce under the following circumstances:

If we do not request distribution of all or part of the IMPACT Award, we must pay $64.9 million (which represents the Impact Award amount plus the state’s estimated issuance costs)(the “Gross Funded Amount”) less an amount equal to any IMPACT Award amount not received,
If we fail to establish new jobs for at least 4,275 full time employees at the Village West office complex prior to December 31, 2017, we will repay an amount equal to $48.0 million multiplied by the shortfall of total new jobs created by us, which is 4,500 less the number of jobs created as of December 31, 2017, divided by 4,500 (the “MPI Repayment Amount”), and
If we have not generated aggregate Kansas state tax withholdings from wages earned by new jobs at the Village West office complex of at least the Gross Funded Amount within 10 years after receiving the IMPACT Award, then

13

Table of Contents

we will repay the difference (the “Withholding Tax Repayment Amount”).

The MPI Repayment Amount is not due until 10 years after we first receive the IMPACT Award. Our total repayment obligations under the Workforce Agreement will not exceed the Gross Funded Amount less the aggregate Kansas state tax withholdings from wages earned by new jobs at the Village West complex during the 10-year period after the IMPACT Award is received.

The Interparty Agreement provides that the Developer and OnGoal will be responsible for the repayment of any issuance costs plus the MPI Repayment Amount owed by us under the Workforce Agreement. The Developer and OnGoal will also indemnify and hold us harmless from and against any and all losses, costs, expenses, penalties and damages arising as a result of: a) the Developer’s failure to pay any sum that it has agreed to pay, or b) the Developer’s breach of any agreement with us which creates an obligation on our part for which the Developer has agreed to be responsible.

The Interparty Agreement further provides that the Developer or OnGoal will pay us a success fee of $4.0 million if the terms and conditions of the Workforce Agreement are satisfied so that no MPI Repayment Amounts or issuance costs are due by the Developer under the Workforce Agreement.

Pursuant to the Multi-Sport Stadium Specific Venture Agreement, the Developer, recognizing that the Unified Government relied on our jobs creation goals in its decision to provide incentives for the stadium complex, agreed to make ten annual “Office Payment Installments” to the Unified Government, each in the amount of approximately $3.0 million, commencing in 2017. The Office Payment Installments are intended to supplement the purchase prices paid to the Unified Government by the Developer for the stadium site and the office site. The Office Payment Installments may be reduced if the Developer meets certain conditions and if we commence construction of the office complex and meet the job creation goals.

We believe that the amount of government incentives that the Developer and OnGoal received, as well as the government incentives received by us, were materially increased due to the fact that we agreed to build our office complex in close proximity to the stadium complex. The independent members of our Board of Directors, acting as a committee, reviewed and unanimously approved the decision to proceed with the development of the Village West office complex in 2009. The independent Directors received advice from outside legal counsel, retained a consultant with real estate expertise regarding the transaction and were briefed on the structure of the various expansion options by members of management (other than Messrs. Patterson and Illig) at six separate meetings.

We entered into a Construction Coordinator Agreement dated January 20, 2012, as amended by Amendment No. 1 to the Construction Coordinator Agreement dated May 31, 2012, with GRAND Construction, LLC (“Coordinator”), a limited liability company owned in part by an entity controlled by Messers. Patterson and Illig, to coordinate, supervise, schedule and assist with managing the development, design and construction of the Cerner Kansas campus phase 1 and 2 buildings and site at the Village West development. Under the agreement, we will pay Coordinator 2% of the total cost of the project (as specified in the agreement). Based on management’s projected scope of services, it is anticipated that the fees will be approximately $3.2 million, and paid over two years. The independent members of the Company’s Board of Directors, acting as a committee, reviewed and unanimously approved the Construction Coordinator Agreement dated January 20, 2012.

Additionally, in June 2012, the Company entered into an agreement with Coordinator for a separate project to make improvements to a parking facility for future use by one of our office campuses. The project is complete, and we paid Coordinator $0.3 million.


14

Table of Contents

Item 2. 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 the results of operations and financial condition of Cerner Corporation and subsidiaries (Cerner, the Company, we, us or our). This MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes to the financial statements (Notes) found above.
Our third fiscal quarter ends on the Saturday closest to September 30. The 2012 and 2011 third quarters ended on September 29, 2012 and October 1, 2011, respectively. All references to years in this MD&A represent the respective three or nine months ended on such dates, unless otherwise noted.
Except for the historical information and discussions contained herein, statements contained in this quarterly report on Form 10-Q may constitute “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements can often be identified by the use of forward-looking terminology, such as "could," "should," “will,” "intended," "continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast," “plan,” “guidance” or “estimate” or the negative of these words, variations thereof or similar expressions. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including without limitation: the possibility of product-related liabilities; potential claims for system errors and warranties; the possibility of interruption at our data centers or client support facilities; our proprietary technology may be subject to claims for infringement or misappropriation of intellectual property rights of others, or may be infringed or misappropriated by others; risks associated with our non-U.S. operations; risks associated with our ability to effectively hedge exposure to fluctuations in foreign currency exchange rates; the potential for tax legislation initiatives that could adversely affect our tax position and/or challenges to our tax positions in the United States and non-U.S. countries; risks associated with our recruitment and retention of key personnel; risks related to our reliance on third party suppliers; risks inherent with business acquisitions; the potential for losses resulting from asset impairment charges; risks associated with the uncertainty in global economic conditions; changing political, economic, regulatory and judicial influences; government regulation; significant competition and market changes; variations in our quarterly operating results; potential inconsistencies in our sales forecasts compared to actual sales; volatility in the trading price of our common stock and the timing and volume of market activity; the authority of our Board of Directors to issue preferred stock and anti-takeover provisions contained in our corporate governance documents; material adverse resolution of legal proceedings; and, other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials incorporated herein or therein by reference. Forward looking statements are not guarantees of future performance or results. The reader should not place undue reliance on forward-looking statements since the statements speak only as to the date they are made. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.
Management Overview
Our revenues are primarily derived by selling, implementing and supporting software solutions, clinical content, hardware, health care devices and services that give health care providers secure access to clinical, administrative and financial data in real time, allowing them to improve quality, safety and efficiency in the delivery of health care.
Our fundamental strategy centers on creating organic growth by investing in research and development (R&D) to create solutions and services for the health care industry. This strategy has driven strong growth over the long-term, as reflected in five- and ten-year compound annual revenue growth rates of 10% or more. This growth has also created an important strategic footprint in health care, with Cerner® solutions licensed by approximately 9,300 facilities around the world, including more than 2,650 hospitals; 3,750 physician practices; 40,000 physicians; 500 ambulatory facilities, such as laboratories, ambulatory centers, cardiac facilities, radiology clinics and surgery centers; 800 home health facilities; 40 employer sites and 1,600 retail pharmacies. Selling additional solutions back into this client base is an important element of our future revenue growth. We are also focused on driving growth through market share expansion by strategically aligning with health care providers that have not yet selected a supplier and by displacing competitors in health care settings that are planning to replace their current supplier.
We expect to drive growth through new initiatives and services that reflect our ongoing ability to innovate and expand our reach into health care. Examples of these include our CareAware® health care device architecture and devices, Cerner HealtheSM employer services, Cerner ITWorksSM services, Cerner RevWorksSM services, and solutions on our Healthe IntentSM platform. Finally, we believe there is significant opportunity for growth outside of the United States, with many non-U.S. markets focused on health care information technology (HCIT) as part of their strategy to improve the quality and lower the cost of health care. Beyond our strategy for driving revenue growth, we are also focused on earnings growth. Similar to

15

Table of Contents

our history of growing revenue, our net earnings have increased at compound annual rates of more than 20% over the most recent five- and ten-year periods. We expect to drive continued earnings growth through ongoing revenue growth coupled with margin expansion, which we expect to achieve through efficiencies in our implementation and operational processes and by leveraging R&D investments and controlling general and administrative expenses.
We are also focused on continuing to deliver strong levels of cash flow, which we expect to do by continuing to grow earnings and prudently managing capital expenditures.
Results Overview
The Company delivered strong levels of bookings, revenues, earnings and cash flows in the third quarter of 2012.
New business bookings, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $769.9 million in the third quarter of 2012, which was an increase of 18% compared to $650.3 million in the third quarter of 2011. Revenues for the third quarter of 2012 increased 18% to $676.5 million compared to $571.6 million in the year-ago quarter. The year-over-year increase in revenue reflects ongoing demand related to “meaningful use” incentives that we believe are increasing the focus of health care providers on improving the efficiency and quality of health care through the use of information technology and related services. In addition, demand for DeviceWorks and Cerner ITWorks solutions is contributing to growth.
Third quarter 2012 net earnings increased 25% to $98.9 million compared to $78.8 million in the third quarter of 2011. Diluted earnings per share increased 24% to $0.56 compared to $0.45 in the third quarter of 2011. Third quarter 2012 and 2011 net earnings and diluted earnings per share reflect the impact of stock-based compensation expense. The effect of these expenses reduced the third quarter 2012 net earnings and diluted earnings per share by $6.3 million and $0.04, respectively, and third quarter 2011 net earnings and diluted earnings per share by $4.6 million and $0.03, respectively.
The growth in net earnings and diluted earnings per share was driven primarily by strong revenue growth and continued progress with our margin expansion initiatives, including driving efficiencies in our services businesses, leveraging R&D investments and controlling selling, general and administrative expenses. Our third quarter 2012 operating margin was 21.8%, which is 70 basis points higher than the year-ago quarter.

We had strong cash collections of receivables of $661.7 million in the third quarter of 2012 compared to $532.8 million in the third quarter of 2011. Days sales outstanding was 73 days in the third quarter of 2012 compared to 71 days in the second quarter of 2012 and 87 days in the third quarter of 2011. Operating cash flows for the third quarter of 2012 were strong at $182.2 million compared to $129.2 million in the third quarter of 2011.


16

Table of Contents

Results of Operations
Three Months Ended September 29, 2012 Compared to Three Months Ended October 1, 2011
The following table presents a summary of the operating information for the third quarters of 2012 and 2011:
 
(In thousands)
2012
% of
Revenue
 
2011
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
229,925

34
%
 
$
188,698

 
33
%
 
22
%
Support and maintenance
154,333

23
%
 
138,573

 
24
%
 
11
%
Services
277,948

41
%
 
232,894

 
41
%
 
19
%
Reimbursed travel
14,276

2
%
 
11,475

 
2
%
 
24
%
 
 
 
 
 
 
 
 
 
Total revenues
676,482

100
%
 
571,640

 
100
%
 
18
%
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
Costs of revenue
149,578

22
%
 
120,464

 
21
%
 
24
%
 
 
 
 
 
 
 
 
 
Total margin
526,904

78
%
 
451,176

 
79
%
 
17
%
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Sales and client service
259,141

38
%
 
220,177

 
38
%
 
18
%
Software development
78,094

12
%
 
72,544

 
13
%
 
8
%
General and administrative
41,973

6
%
 
38,063

 
7
%
 
10
%
 
 
 
 
 
 
 
 
 
Total operating expenses
379,208

56
%
 
330,784

 
58
%
 
15
%
 
 
 
 
 
 
 
 
 
Total costs and expenses
528,786

78
%
 
451,248

 
79
%
 
17
%
 
 
 
 
 
 
 
 
 
Operating earnings
147,696

22
%
 
120,392

 
21
%
 
23
%
 
 
 
 
 
 
 
 
 
Other income, net
3,351

 
 
2,775

 
 
 
 
Income taxes
(52,160
)
 
 
(44,332
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
98,887

 
 
$
78,835

 
 
 
25
%
Revenues & Backlog
Revenues increased 18% to $676.5 million for the third quarter of 2012 from $571.6 million for the same period in 2011.
 
System sales, which include revenues from the 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, increased 22% to $229.9 million for the third quarter of 2012 from $188.7 million for the same period in 2011. The increase in system sales was driven by strong growth in licensed software and solid growth in subscriptions and technology resale.
Support and maintenance revenues increased 11% to $154.3 million during the third quarter of 2012 from $138.6 million during the same period in 2011. This increase was attributable to continued success at selling Cerner Millennium® applications and implementing them at client sites. We expect that support and maintenance revenues will continue to grow as the base of installed Cerner Millennium systems grows.
Services revenue, which includes professional services, excluding installation, and managed services, increased 19% to $277.9 million from $232.9 million for the same period in 2011. This increase was driven by growth in CernerWorksSM managed services as a result of continued demand for our hosting services and an increase in professional services due to increased implementation activities and growth in Cerner ITWorks services.
Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, at September 29, 2012 increased 22% when compared to October 1, 2011. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services and Cerner ITWorks services bookings that typically have longer contract terms. A summary of our total backlog follows:

17

Table of Contents

(In thousands)
September 29, 2012
 
October 1, 2011
 
 
 
 
Contract backlog
$
6,061,500

 
$
4,964,942

Support and maintenance backlog
723,687

 
691,069

 
 
 
 
Total backlog
$
6,785,187

 
$
5,656,011

Costs of Revenue
Cost of revenues was 22% of total revenues in the third quarter of 2012, compared to 21% in the same period of 2011.
Cost of revenues includes the cost of reimbursed travel expense, sales commissions, third party consulting services and subscription content and computer hardware, devices and sublicensed software purchased from manufacturers for delivery to clients. It also includes the cost of hardware maintenance and sublicensed software support subcontracted to the manufacturers. Such costs, as a percent of revenues, typically have varied as the mix of revenue (software, hardware, devices, maintenance, support, services and reimbursed travel) carrying different margin rates changes from period to period. Cost of revenues does not include the costs of our client service personnel who are responsible for delivering our service offerings. Such costs are included in sales and client service expense.
Operating Expenses
Total operating expenses increased 15% to $379.2 million in the third quarter of 2012, compared with $330.8 million for the same period in 2011.
 
Sales and client service expenses as a percent of total revenues were 38% in the third quarters of 2012 and 2011. These expenses increased 18% to $259.1 million in the third quarter of 2012 from $220.2 million in the same period of 2011. Sales and client service expenses include salaries of sales and client service personnel, depreciation and other expenses associated with our CernerWorks managed service business, communications expenses, unreimbursed travel expenses, expense for share-based payments, sales and marketing salaries and trade show and advertising costs. The increase in sales and client service expense was primarily driven by an increase in personnel costs to support our overall revenue growth.
Software development expenses as a percent of revenue were 12% in the third quarter of 2012, compared to 13% in the same period of 2011. Expenditures for software development reflect ongoing development and enhancement of the Cerner Millennium platform, including investments in the next evolution of Cerner Millennium, Millennium+™, which leverages the cloud and enables greater mobility. The reduction as a percentage of revenue reflects our ongoing efforts to control spending relative to revenue growth. Because of the strong platform we have built, we are able to continue advancing our solutions and investing in new solutions without large increases in spending. A summary of our total software development expense in the third quarters of 2012 and 2011 is as follows:
 
Three Months Ended
(In thousands)
2012
 
2011
 
 
 
 
Software development costs
$
82,873

 
$
72,397

Capitalized software costs
(25,126
)
 
(20,368
)
Capitalized costs related to share-based payments
(533
)
 
(404
)
Amortization of capitalized software costs
20,880

 
20,919

 
 
 
 
Total software development expense
$
78,094

 
$
72,544

 
General and administrative expenses as a percent of total revenues were 6% in the third quarter of 2012, compared to 7% in the same period of 2011. These expenses increased 10% to $42.0 million in the third quarter of 2012 from $38.1 million for the same period in 2011. General and administrative expenses include salaries for corporate, financial and administrative staffs, utilities, communications expenses, professional fees, transaction gains or losses on foreign currency and expense for share-based payments. The increase in general and administrative expenses was primarily driven by an increase in corporate personnel costs, as we have increased such personnel to support our overall revenue growth.




18

Table of Contents

Non-Operating Items
 
Interest income increased to $4.4 million in the third quarter of 2012 from $4.1 million for the same period in 2011. Interest expense was $1.0 million for the third quarter of 2012 compared to $1.4 million for the same period in 2011.
Our effective tax rate was 34.5% for the third quarter of 2012 and 36.0% for the third quarter of 2011. This decrease was primarily due to differences in the mix of earnings between U.S. and foreign operations, partially offset by the expiration of the research and development tax credit on December 31, 2011.
Operations by Segment
We have two operating segments: Domestic and Global. The Domestic segment includes revenue contributions and expenditures associated with business activity in the United States. The Global segment includes revenue contributions and expenditures linked to business activity in Argentina, Aruba, Australia, Austria, Canada, Cayman Islands, Chile, China (Hong Kong), Egypt, England, France, Germany, Guam, India, Ireland, Italy, Japan, Malaysia, Mexico, Morocco, Puerto Rico, Qatar, Saudi Arabia, Singapore, Spain, Sweden, Switzerland and the United Arab Emirates.

The following table presents a summary of the operating information for the third quarters of 2012 and 2011:
 
(In thousands)
2012
 
% of Revenue
 
2011
 
% of Revenue
 
% Change  
 
 
 
 
 
 
 
 
 
 
Domestic Segment
 
 
 
 
 
 
 
 
 
Revenues
$
591,327

 
100%
 
$
499,497

 
100%
 
18%
Costs of revenue
131,663

 
22%
 
109,656

 
22%
 
20%
Operating expenses
131,787

 
22%
 
110,775

 
22%
 
19%
Total costs and expenses
263,450

 
45%
 
220,431

 
44%
 
20%
 
 
 
 
 
 
 
 
 
 
Domestic operating earnings
327,877

 
55%

279,066

 
56%
 
17%
 
 
 
 
 
 
 
 
 
 
Global Segment
 
 
 
 
 
 
 
 
 
Revenues
85,155

 
100%
 
72,143

 
100%
 
18%
Costs of revenue
17,915

 
21%
 
10,808

 
15%
 
66%
Operating expenses
32,794

 
39%
 
33,412

 
46%
 
(2)%
Total costs and expenses
50,709

 
60%
 
44,220

 
61%
 
15%
 
 
 
 
 
 
 
 
 
 
Global operating earnings
34,446

 
40%
 
27,923

 
39%
 
23%
 
 
 
 
 
 
 
 
 
 
Other, net
(214,627
)
 
 
 
(186,597
)
 
 
 
15%
 
 
 
 
 
 
 
 
 
 
Consolidated operating earnings
$
147,696

 
 
 
$
120,392

 
 
 
23%
Domestic Segment
Revenues increased 18% to $591.3 million in the third quarter of 2012 from $499.5 million in the same period in 2011. This increase was driven by growth in all business models, with strong growth in professional services and licensed software.
Cost of revenues was 22% of revenues in the third quarters of 2012 and 2011. The mix of sales in the third quarter of 2012 was consistent with the same period in 2011.
Operating expenses increased 19% to $131.8 million in the third quarter of 2012 from $110.8 million in the same period in 2011, due primarily to growth in managed services and professional services expenses.

Global Segment
Revenues increased 18% to $85.2 million in the third quarter of 2012 from $72.1 million in the same period in 2011. This increase was primarily driven by growth in support and maintenance, licensed software and managed services, which was partially offset by a decrease in technology resale.
Cost of revenues was 21% of revenues in the third quarter of 2012, compared with 15% in the same period of 2011. The increase in cost of revenues as a percent of revenue was primarily driven by higher use of third party services.
Operating expenses were relatively flat at $32.8 million for the third quarter of 2012, compared to $33.4 million for

19

Table of Contents

the same period in 2011.

Other, net
Operating results not attributed to an operating segment include expenses, such as centralized professional services costs, software development, marketing, general and administrative, stock-based compensation, depreciation and amortization. These expenses increased 15% to $214.6 million in the third quarter of 2012 from $186.6 million in the same period in 2011. This increase was primarily due to growth in corporate and development personnel costs.

Nine Months Ended September 29, 2012 Compared to Nine Months Ended October 1, 2011
The following table presents a summary of the operating information for the first nine months of 2012 and 2011:
(In thousands)
2012
% of
Revenue
 
2011
 
% of
Revenue
 
% Change  
Revenues
 
 
 
 
 
 
 
 
System sales
$
651,040

33
%
 
$
486,222

 
31
%
 
34
%
Support and maintenance
450,584

23
%
 
408,580

 
26
%
 
10
%
Services
811,647

42
%
 
659,211

 
41
%
 
23
%
Reimbursed travel
41,781

2
%
 
33,514

 
2
%
 
25
%
 
 
 
 
 
 
 
 
 
Total revenues
1,955,052

100
%
 
1,587,527

 
100
%
 
23
%
 
 
 
 
 
 
 
 
 
Costs of revenue
 
 
 
 
 
 
 
 
Costs of revenue
455,086

23
%
 
309,626

 
20
%
 
47
%
 
 
 
 
 
 
 
 
 
Total margin
1,499,966

77
%
 
1,277,901

 
80
%
 
17
%
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Sales and client service
746,090

38
%
 
631,738

 
40
%
 
18
%
Software development
222,746

11
%
 
213,478

 
13
%
 
4
%
General and administrative
119,912

6
%
 
110,621

 
7
%
 
8
%
 
 
 
 
 
 
 
 
 
Total operating expenses
1,088,748

56
%
 
955,837

 
60
%
 
14
%
 
 
 
 
 
 
 
 
 
Total costs and expenses
1,543,834

79
%
 
1,265,463

 
80
%
 
22
%
 
 
 
 
 
 
 
 
 
Operating earnings
411,218

21
%
 
322,064

 
20
%
 
28
%
 
 
 
 
 
 
 
 
 
Other income, net
8,789

 
 
7,666

 
 
 
 
Income taxes
(134,583
)
 
 
(114,295
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings
$
285,424

 
 
$
215,435

 
 
 
32
%
Revenues
Revenues increased 23% to $2.0 billion for the first nine months of 2012 from $1.6 billion for the same period in 2011.
 
System sales increased 34% to $651.0 million for the first nine months of 2012 from $486.2 million for the same period in 2011. The increase in system sales was driven by very strong growth in technology resale and strong growth in licensed software and subscriptions.
Support and maintenance revenues increased 10% to $450.6 million during the first nine months of 2012 from $408.6 million during the same period in 2011. This increase was attributable to continued success at selling Cerner Millennium applications and implementing them at client sites. We expect that support and maintenance revenues will continue to grow as the base of installed Cerner Millennium systems grows.
Services revenue increased 23% to $811.6 million from $659.2 million for the same period in 2011. This increase was driven by growth in CernerWorks managed services as a result of continued demand for our hosting services and an increase in professional services due to increased implementation activities and growth in Cerner ITWorks services.


20

Table of Contents

Costs of Revenue
Cost of revenues was 23% of total revenues in the first nine months of 2012, compared to 20% in the same period of 2011. The higher cost of revenues as a percent of revenue was driven by a higher mix of technology resale, which carries a higher cost of revenue.