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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

  x

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

For the quarterly period ended October 1, 2011

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

There were 169,405,814 shares of Common Stock, $.01 par value, outstanding at October 20, 2011.

 

 

 


Table of Contents

CERNER CORPORATION AND SUBSIDIARIES

INDEX

 

Part I.

  

Financial Information:

  

Item 1.

  

Financial Statements:

  
  

Condensed Consolidated Balance Sheets as of October 1, 2011 (unaudited) and January 1, 2011

     1   
  

Condensed Consolidated Statements of Operations for the three and nine months ended October 1, 2011 and October 2, 2010 (unaudited)

     2   
  

Condensed Consolidated Statements of Cash Flows for the nine months ended October 1, 2011 and October 2, 2010 (unaudited)

     3   
  

Notes to Condensed Consolidated Financial Statements (unaudited)

     4   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     13   

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     26   

Item 4.

  

Controls and Procedures

     26   

Part II.

  

Other Information:

     27   

Item 6.

  

Exhibits

     27   
  

EX-31.1

  
  

EX-31.2

  
  

EX-32.1

  
  

EX-32.2

  
   EX-101 INSTANCE DOCUMENT   
  

EX-101 SCHEMA DOCUMENT

  
  

EX-101 CALCULATION LINKBASE DOCUMENT

  
  

EX-101 LABELS LINKBASE DOCUMENT

  
  

EX-101 PRESENTATION LINKBASE DOCUMENT

  
  

EX-101 DEFINITION LINKBASE DOCUMENT

  

 


Table of Contents

Part I. Financial Information

Item 1. Financial Statements

CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

As of October 1, 2011 (unaudited) and January 1, 2011

 

(In thousands, except share data)                2011                             2010              
  

 

 

 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 231,194      $ 214,511   

Short-term investments

     524,011        356,501   

Receivables, net

     548,048        476,905   

Inventory

     12,286        11,036   

Prepaid expenses and other

     97,033        83,272   

Deferred income taxes

     10,560        3,836   
  

 

 

 

Total current assets

     1,423,132        1,146,061   

Property and equipment, net

     493,594        498,829   

Software development costs, net

     247,037        244,848   

Goodwill

     187,857        161,374   

Intangible assets, net

     55,323        38,468   

Long-term investments

     334,765        264,467   

Other assets

     101,860        68,743   
  

 

 

 

Total assets

   $ 2,843,568      $ 2,422,790   
  

 

 

 

Liabilities and Shareholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 79,345      $ 65,035   

Current installments of long-term debt

     34,560        24,837   

Deferred revenue

     137,924        109,351   

Accrued payroll and tax withholdings

     93,411        86,921   

Other accrued expenses

     32,262        19,788   
  

 

 

 

Total current liabilities

     377,502        305,932   

Long-term debt and other obligations

     99,281        67,923   

Deferred income taxes and other liabilities

     147,518        126,215   

Deferred revenue

     11,913        17,303   
  

 

 

 

Total liabilities

     636,214        517,373   
  

 

 

 

Shareholders’ Equity:

    

Cerner Corporation shareholders’ equity:

    

Common stock, $.01 par value, 250,000,000 shares authorized, 169,388,233 shares issued at October 1, 2011 and 168,058,570 shares issued at January 1, 2011

     1,694        1,681   

Additional paid-in capital

     710,926        616,972   

Retained earnings

     1,506,270        1,290,835   

Accumulated other comprehensive loss, net

     (11,656     (4,191
  

 

 

 

Total Cerner Corporation shareholders’ equity

     2,207,234        1,905,297   

Noncontrolling interest

     120        120   
  

 

 

 

Total shareholders’ equity

     2,207,354        1,905,417   
  

 

 

 

Total liabilities and shareholders’ equity

   $ 2,843,568      $ 2,422,790   
  

 

 

 

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 October 1, 2011 and October 2, 2010

(unaudited)

 

     Three Months Ended          Nine Months Ended  
  

 

 

      

 

 

 
(In thousands, except per share data)            2011                     2010                          2011                     2010          
  

 

 

      

 

 

 

Revenues:

           

System sales

   $ 188,698      $ 133,439         $ 486,222      $ 386,292   

Support, maintenance and services

     371,467        321,289           1,067,791        939,909   

Reimbursed travel

     11,475        7,955           33,514        23,820   
  

 

 

      

 

 

 

Total revenues

     571,640        462,683           1,587,527        1,350,021   
  

 

 

      

 

 

 

Costs and expenses:

           

Cost of system sales

     84,268        57,396           204,254        155,087   

Cost of support, maintenance and services

     24,721        13,797           71,858        46,536   

Cost of reimbursed travel

     11,475        7,955           33,514        23,820   

Sales and client service

     220,177        189,320           631,738        566,943   

Software development (Includes amortization of $20,919 and $59,887 for the three and nine months ended October 1, 2011; and $17,756 and $50,015 for the three and nine months ended October 2, 2010.)

     72,544        67,257           213,478        202,024   

General and administrative

     38,063        32,966           110,621        99,611   
  

 

 

      

 

 

 

Total costs and expenses

     451,248        368,691           1,265,463        1,094,021   
  

 

 

      

 

 

 

Operating earnings

     120,392        93,992           322,064        256,000   

Other income (expense):

           

Interest income, net

     2,770        87           7,621        2,291   

Other income (expense), net

     5        5           45        (566
  

 

 

      

 

 

 

Total other income, net

     2,775        92           7,666        1,725   
  

 

 

      

 

 

 

Earnings before income taxes

     123,167        94,084           329,730        257,725   

Income taxes

     (44,332     (33,212        (114,295     (91,090
  

 

 

      

 

 

 

Net earnings

   $ 78,835      $ 60,872         $ 215,435      $ 166,635   
  

 

 

      

 

 

 

Basic earnings per share

   $ 0.47      $ 0.37         $ 1.28      $ 1.01   

Diluted earnings per share

   $ 0.45      $ 0.36         $ 1.24      $ 0.98   

Basic weighted average shares outstanding

     169,140        165,095           168,343        164,559   

Diluted weighted average shares outstanding

     174,283        170,721           173,656        170,546   

See notes to condensed consolidated financial statements (unaudited).

 

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Table of Contents

CERNER CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the nine months ended October 1, 2011 and October 2, 2010

(unaudited)

 

     Nine Months Ended  
  

 

 

 
(In thousands)                2011                             2010              
  

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net earnings

   $ 215,435      $ 166,635   

Adjustments to reconcile net earnings to net cash provided by operating activities:

    

Depreciation and amortization

     156,841        140,871   

Share-based compensation expense

     20,363        17,050   

Provision for deferred income taxes

     9,246        18,802   

Changes in assets and liabilities (net of businesses acquired):

    

Receivables, net

     (103,829     (2,915

Inventory

     (1,200     3,174   

Prepaid expenses and other

     1,469        16,675   

Accounts payable

     8,026        24,455   

Accrued income taxes

     4,662        (21,393

Deferred revenue

     18,932        (14,780

Other accrued liabilities

     47,860        (13,877
  

 

 

 

Net cash provided by operating activities

     377,805        334,697   
  

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Capital purchases

     (75,602     (75,341

Capitalized software development costs

     (61,827     (61,783

Purchases of investments

     (870,960     (627,904

Maturities of investments

     615,219        379,705   

Purchase of other intangibles

     (8,395     (8,034

Acquisition of businesses, net of cash acquired

     (28,069     (14,486
  

 

 

 

Net cash used in investing activities

     (429,634     (407,843
  

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from sale of future receivables

     —          1,516   

Repayment of long-term debt

     (715     (2,404

Proceeds from excess tax benefits from stock compensation

     34,009        17,884   

Proceeds from exercise of options

     36,463        23,266   

Contingent consideration payments for acquisition of businesses

     (779     —     
  

 

 

 

Net cash provided by financing activities

     68,978        40,262   
  

 

 

 

Effect of exchange rate changes on cash

     (466     2,908   
  

 

 

 

Net increase (decrease) in cash and cash equivalents

     16,683        (29,976

Cash and cash equivalents at beginning of period

     214,511        241,723   
  

 

 

 

Cash and cash equivalents at end of period

   $ 231,194      $ 211,747   
  

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid during the year for:

    

Interest

   $ 3,081      $ 3,483   

Income taxes, net of refund

     62,328        88,238   

Summary of acquisition transactions:

    

Fair value of net tangible assets (liabilities) acquired (assumed)

   $ (8,053   $ 1,069   

Fair value of intangible assets acquired

     18,204        5,076   

Fair value of goodwill

     26,130        11,290   

Less: Fair value of contingent liability payable

     (5,235     (1,725

Less: Fair value of working capital settlement payable

     (939     —     
  

 

 

 

Cash paid for acquisition

     30,107        15,710   

Cash acquired

     (2,038     (1,224
  

 

 

 

Net cash used

   $ 28,069      $ 14,486   
  

 

 

 

See notes to condensed consolidated financial statements (unaudited).

 

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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 (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 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 our opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring accruals) 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 accounting principles generally accepted in the United States (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 2011 and 2010 third quarters ended on October 1, 2011 and October 2, 2010, respectively. All references to years in these notes to condensed consolidated financial statements represent the three or nine months ended of the third fiscal quarter, respectively, unless otherwise noted.

Stock Split

On May 27, 2011, the Board of Directors of the Company approved a two-for-one split of our common stock in the form of a one hundred percent (100%) stock dividend, which was distributed on June 24, 2011 to shareholders of record as of June 15, 2011. In connection with the stock split, 790,000 treasury shares previously reflected in the consolidated balance sheets were utilized to settle a portion of the distribution. All share and per share data have been retroactively adjusted for all periods presented to reflect the stock split including the use of treasury shares, as if the stock split had occurred at the beginning of the earliest period presented.

Under the terms of our outstanding equity awards, the stock split increased the number of shares of our common stock issuable upon exercise or vesting of such awards in proportion to the stock split ratio and caused a proportionate decrease in the exercise price of such awards to the extent they were stock options.

Recently Adopted Accounting Pronouncements

ASU 2009-13. In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2009-13 —Multiple-Deliverable Revenue Arrangements (ASU 2009-13). ASU 2009-13 requires a vendor to allocate revenue to each unit of accounting in many arrangements involving multiple deliverables based on the relative selling price of each deliverable. It also changes the level of evidence of standalone selling price required to separate deliverables by allowing a vendor to make its best estimate of the standalone selling price of deliverables when more objective evidence of selling price is not available.

We adopted ASU 2009-13 for all new and materially modified arrangements on a prospective basis beginning January 2, 2011. We have reviewed the primary accounting literature related to the elements that typically get bundled into our arrangements and determined that the majority of the elements fall in to two different accounting units. One unit is comprised of software and software-related elements which include our licensed software, licensed software support, application services provider, subscriptions, professional services, remote hosting, sublicensed software and sublicensed software support. The second unit of accounting is non-software elements, which include hardware and hardware maintenance.

 

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Table of Contents

The majority of our multiple-element arrangements do not contain both software and non-software deliverables such as hardware and thus are not impacted by the new guidance. For our arrangements that are impacted by ASU 2009-13, we determined fair value based upon vendor-specific objective evidence (VSOE), if it existed, and in instances where VSOE did not exist (primarily for our licensed software), we determined fair value based upon the estimated selling price concept. The application of this concept relies primarily on historical pricing and management guidance for similarly sized arrangements.

The adoption of ASU 2009-13 did not result in a material change in the timing of revenue recognition due to the small number of arrangements executed with both software and non-software deliverables and the existence of VSOE for most of our business models.

ASU 2009-14. In October 2009, the FASB issued ASU 2009-14 —Certain Revenue Arrangements That Include Software Elements (ASU 2009-14). Under ASU 2009-14, tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance in ASC 985-605. We adopted the amendment provisions of ASU 2009-14 on January 2, 2011; the adoption of this standard did not have material impact on the timing of revenue recognition.

Recently Issued Accounting Pronouncements

ASU 2011-05. In June 2011, the FASB issued ASU 2011-05 —Presentation of Comprehensive Income (ASU 2011-05). 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. ASU 2011-05 is effective for us in the first quarter of 2012 and is required to be applied retrospectively. The adoption of this standard is not expected to have a material effect on our consolidated financial statements.

ASU 2011-08. In September 2011, the FASB issued ASU 2011-08 —Testing for Goodwill Impairment (ASU 2011-08). 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 ASC Topic 350. Otherwise, the two-step goodwill impairment test is not required. ASU 2011-08 is effective for us in 2012, with early adoption permitted. The adoption of this standard is not expected to have a material effect on our consolidated financial statements.

 

(2) Acquisitions

On May 23, 2011, we completed the purchase of 100% of the outstanding common shares of Resource Systems, Inc., developer of the CareTracker® point-of-care electronic documentation system primarily used within skilled nursing and assisted living facilities. Cerner believes that there is significant market opportunity for information technology solutions in the long-term care market as the U.S. population ages and life expectancy continues to increase.

 

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Consideration for the acquisition of Resource Systems is expected to total $36.3 million consisting of up-front cash plus additional contingent consideration, which is payable if we achieve certain revenue milestones through the quarters ending June 30, 2012 and December 29, 2012 and bookings milestones through the quarters ending June 30, 2012 and June 29, 2013 from the clients acquired from Resource Systems. We valued the contingent consideration at $5.2 million based on a probability-weighted assessment of potential contingent consideration payment scenarios, which remains unchanged at October 1, 2011. The allocation of the purchase price to the estimated fair values of the identified tangible and intangible assets acquired, net of liabilities assumed, is summarized below:

 

(In thousands)    Allocation Amount  

Tangible assets and liabilities

  

Current assets

   $ 5,249   

Property and equipment

     209   

Current liabilities

     (6,803

Deferred tax liabilities

     (6,708
  

 

 

 

Total net tangible liabilities acquired

     (8,053

Intangible assets

  

Customer relationships

     11,204   

Existing technologies

     6,401   

Non-compete agreements

     599   
  

 

 

 

Total intangible assets acquired

     18,204   

Goodwill

     26,130   
  

 

 

 

Total purchase price

   $ 36,281   
  

 

 

 

The fair values of the acquired intangible assets and the contingent consideration were estimated by applying the income approach. Such estimations required the use of inputs that were unobservable in the market place (Level 3), including a discount rate that we estimated would be used by a market participant in valuing these assets, projections of revenues and cash flows, probability weighting factors and client attrition rates. See Note 3 for further information about the fair value level hierarchy.

The goodwill of $26.1 million arising from the acquisition consists largely of the synergies and economies of scale, including the value of the assembled workforce, expected from combining the operations of Cerner and Resource Systems. All of the goodwill was allocated to our Domestic operating segment and is not expected to be deductible for tax purposes. The other identifiable intangible assets are being amortized over five years. The operating results of Resource Systems were combined with our operating results subsequent to the purchase date of May 23, 2011. Pro-forma results of operations, assuming this acquisition was made at the beginning of the earliest period presented, have not been presented because the effect of this acquisition was not material to our results.

 

(3) 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.

 

   

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.

 

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The following table details our financial assets measured at fair value within the fair value hierarchy:

 

(In thousands)       October 1, 2011     January 1, 2011  
Description  

Balance Sheet

Classification

  Fair Value Measurements Using     Fair Value Measurements Using  
         Level 1               Level 2               Level 3               Level 1               Level 2               Level 3       

 

 

Money market funds

 

Cash equivalents

  $ 58,393      $ —        $ —        $ 44,237      $ —        $ —     

Time deposits

 

Cash equivalents

    —          6,671        —          —          —          —     

Time deposits

 

Short-term investments

    —          57,028        —          —          41,764        —     

Commercial paper

 

Short-term investments

    —          31,750        —          —          44,500        —     

Government and corporate bonds

 

Short-term investments

    —          435,233        —          —          251,787        —     

Auction rate securities

 

Short-term investments

    —          —          —          —          18,450        —     

Government and corporate bonds

 

Long-term investments

    —          334,765        —          —          264,467        —     

We classify our long-term, fixed rate debt as a long-term liability on the balance sheet and estimate the fair value using a Level 3 discounted cash flow analysis based on our current borrowing rates for debt with similar maturities. The fair value of our long-term debt, including current maturities, was approximately $99.0 million at October 1, 2011.

 

(4) Receivables

Receivables consist primarily of accounts receivable and contracts receivable. Accounts receivable represent recorded revenues that have been billed. Contracts receivable represent recorded revenues that are billable by us at future dates under the terms of a contract with a client. Billings and other consideration received on contracts in excess of related revenues recognized are recorded as deferred revenue. Substantially all receivables are derived from sales and related support and maintenance and professional services of our clinical, administrative and financial information systems and solutions to health care providers located throughout the United States and in certain non-U.S. countries.

We perform ongoing credit evaluations of our clients and generally do not require collateral from our clients. We provide an allowance for estimated uncollectible accounts based on specific identification, historical experience and our judgment. Provisions for losses on uncollectible accounts for the first nine months of 2011 and 2010 totaled $8.4 million and $7.5 million, respectively. A summary of net receivables is as follows:

 

(In thousands)    October 1, 2011      January 1, 2011  
  

 

 

 

Gross accounts receivable

   $ 467,315       $ 352,554   

Less: Allowance for doubtful accounts

     22,554         15,550   
  

 

 

 

Accounts receivable, net of allowance

     444,761         337,004   

Contracts receivable

     103,287         139,901   
  

 

 

 

Total receivables, net

   $ 548,048       $ 476,905   
  

 

 

 

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 October 1, 2011, 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 the majority of other long-term assets as of the third quarter ended October 1, 2011. While the ultimate collectability of the receivables pursuant to this process is uncertain, we 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 2011 and 2010, we received total client cash collections of $1.57 billion and $1.40 billion, respectively, of which $53.4 million and $45.8 million were received from third party arrangements with non-recourse payment assignments.

 

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(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 34.7% and 35.3% for the first nine months of 2011 and 2010, respectively. This decrease was primarily due to the research and development tax credit being in effect for the first nine months of 2011 while it was not effective for the first nine months of 2010, a favorable foreign tax audit settlement during the first quarter of 2011 and other discrete items.

During the first quarter of 2010, the Internal Revenue Service commenced its examination of the 2008 and 2009 income tax returns. We do not believe this examination will have a material effect on our financial position, results of operations or liquidity.

We expect that a partial settlement related to this examination will occur within the next twelve months. Related to this settlement, we expect to recognize a decrease of approximately $2 million to $3 million in unrecognized tax benefits.

 

(6) Earnings Per Share

Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in our earnings. A reconciliation of the numerators and the denominators of the basic and diluted per share computations are as follows:

 

     Three Months Ended  
     2011      2010  
In thousands, except per share data)    Earnings
(Numerator)
     Shares
(Denominator)
     Per-Share
Amount
     Earnings
(Numerator)
     Shares
(Denominator)
     Per-Share
Amount
 
  

 

 

    

 

 

 

Basic earnings per share:

                 

Income available to common shareholders

   $ 78,835         169,140       $ 0.47       $ 60,872         165,095       $ 0.37   

Effect of dilutive securities:

                 

Stock options and non-vested restricted stock

     —           5,143            —           5,626      
  

 

 

       

 

 

    

Diluted earnings per share:

                 

Income available to common shareholders including assumed conversions

   $ 78,835         174,283       $ 0.45       $ 60,872         170,721       $ 0.36   
  

 

 

       

 

 

    

Options to purchase 1.4 million shares of common stock at per share prices ranging from $42.84 to $64.68 and $29.11 to $43.35 were outstanding at October 1, 2011 and October 2, 2010, respectively, but were not included in the computation of diluted earnings per share because the options were anti-dilutive.

 

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     Nine Months Ended  
     2011      2010  
     Earnings
(Numerator)
     Shares
(Denominator)
    

Per-Share

Amount

     Earnings
(Numerator)
     Shares
(Denominator)
    

Per-Share

Amount

 
  

 

 

    

 

 

 
(In thousands, except per share data)                                          

Basic earnings per share:

                 

Income available to common shareholders

   $ 215,435         168,343       $ 1.28       $ 166,635         164,559       $ 1.01   

Effect of dilutive securities:

                 

Stock options and non-vested restricted stock

     —           5,313            —           5,987      
  

 

 

       

 

 

    

Diluted earnings per share:

                 

Income available to common shareholders including assumed conversions

   $ 215,435         173,656       $ 1.24       $ 166,635         170,546       $ 0.98   
  

 

 

       

 

 

    

Options to purchase 2.0 million and 1.0 million shares of common stock at per share prices ranging from $38.99 to $64.68 and $29.11 to $43.35 were outstanding at October 1, 2011 and October 2, 2010, respectively, but 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 October 1, 2011 was as follows:

 

     For the Nine Months Ended October 1, 2011  
Options    Number of
Shares
(thousands)
    Weighted-
Average
Exercise Price
    Aggregate
Intrinsic Value
(thousands)
    Weighted-
Average
Remaining
Contractual
Term (years)
 

 

 

Outstanding at beginning of year

     14,753      $ 18.87       

Granted

     1,261        58.24          

Exercised

     (2,630     14.00       

Forfeited and expired

     (481     35.31       
  

 

 

       

Outstanding as of October 1, 2011

     12,903      $         23.09      $      586,136                    6.34   
  

 

 

       

Exercisable as of October 1, 2011

     8,351      $ 14.59      $ 450,338        5.37   

As of October 1, 2011, there was $66.8 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 3.13 years.

Non-vested Shares

Non-vested share activity for the nine months ended October 1, 2011 was as follows:

 

     For the Nine Months Ended October 1, 2011  
Restricted Stock    Number of
Shares
(thousands)
    Weighted-
Average
Grant Date
Fair Value
    Weighted-
Average
Remaining
Contractual
Term (years)
 

 

 

Outstanding at beginning of year

                  222         $          41.12        

Granted

     148        53.25     

Vested

     (38     41.48     

Forfeited

     (90     45.68     
  

 

 

     

Outstanding as of October 1, 2011

     242      $ 46.78                 1.74   
  

 

 

     

As of October 1, 2011, restricted stock outstanding includes 206,800 shares of performance-based non-vested restricted stock. Vesting is contingent upon meeting certain pre-determined performance goals, subject to reduction based on an annual subjective performance assessment related to individual performance and performance goal attainment, as defined in the award agreements. The amount of compensation expense recognized is based on management’s estimate of the most likely outcome and will be reassessed at each reporting date through the final vesting date, which may result in adjustments to compensation cost.

 

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As of October 1, 2011, there was $7.4 million of total unrecognized compensation cost related to non-vested restricted stock granted under all plans. That cost is expected to be recognized over a weighted-average period of 1.74 years.

The following table presents the total compensation expense recognized in the condensed consolidated statements of operations with respect to stock options, non-vested restricted shares and Associate Stock Purchase Plan shares:

 

     Three Months Ended     Nine Months Ended  
(In thousands)                2011                             2010                             2011                             2010              
  

 

 

   

 

 

 

Stock option and non-vested restricted share compensation expense

   $ 7,232      $ 6,244      $ 20,363      $ 17,050   

Associate stock purchase plan expense

     458        424        1,506        1,229   

Amounts capitalized in software development costs, net of amortization

     (175     (118     (425     (376
  

 

 

   

 

 

 

Amounts charged against earnings, before income tax benefit

   $ 7,515      $ 6,550      $ 21,444      $ 17,903   
  

 

 

   

 

 

 

Amount of related income tax benefit recognized in earnings

   $ 2,875      $ 2,440      $ 8,182      $ 6,669   
  

 

 

   

 

 

 

 

(8) Comprehensive Income

Total comprehensive income, which includes net earnings, foreign currency translation adjustments and gains and losses from a hedge of our net investment in the United Kingdom (U.K.), amounted to $55.5 million and $80.7 million for the three months ended October 1, 2011 and October 2, 2010, respectively, and $208.0 and $167.8 million for the nine months ended October 1, 2011 and October 2, 2010, respectively. None of the items within comprehensive income, including net earnings, relate to non-controlling interests.

As of October 1, 2011, we designated all of our Great Britain Pound (GBP) denominated long-term debt as a net investment hedge of our U.K. operations. The objective of the hedge is to reduce our foreign currency exposure in the U.K. subsidiary investment. Changes in the exchange rate between the United States Dollar (USD) and GBP, related to the notional amount of the hedge, are recognized as a component of accumulated other comprehensive income (loss), to the extent the hedge is effective.

The following tables represent the fair value of the net investment hedge included within the Condensed Consolidated Balance Sheets and the related unrealized gain or loss, net of related income tax effects:

 

     Balance Sheet    Fair Value  
(In thousands)    Classification    October 1, 2011     January 1, 2011  
  

 

  

 

 

 

Net investment hedge

   Short-term (S/T) liabilities    $ 14,473      $ 14,488   

Net investment hedge

   Long-term (L/T) liabilities      57,891        57,950   
        

 

 

 

Total net investment hedge

         $ 72,364      $ 72,438   
        

 

 

 
          
     Net Unrealized Gain (Loss)    Net Unrealized Gain (Loss)  
    

For the Three Months Ended

   For the Nine Months Ended  
(In thousands)                2011                            2010                            2011                             2010              
  

 

  

 

 

 

Net investment hedge - S/T

   $(281)    $(361)    $ (9   $ 204   

Net investment hedge - L/T

   251    (1,803)      1,341        1,023   
  

 

  

 

 

 

Total net investment hedge

   $(30)    $(2,164)    $ 1,332      $ 1,227   
  

 

  

 

 

 

We recognize foreign currency transaction gains and losses within the Condensed Consolidated Statements of Operations as a component of general and administrative expenses. We realized a foreign currency gain of $0.6 million and a loss of $0.9 million during the three months ended October 1, 2011 and October 2, 2010, respectively, and a gain of $0.6 million and a loss of $0.3 million during the nine months ended October 1, 2011 and October 2, 2010, respectively.

 

(9) Contingencies

The terms of our software license agreements with our clients generally provide for a limited indemnification of such intellectual property 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

 

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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.

From time to time we are involved in routine litigation incidental to the conduct of our business, including for example, employment disputes and litigation alleging solution defects, intellectual property infringement, violations of law and breaches of contract and warranties. We believe that no such routine litigation currently pending against us, if adversely determined, would have a material adverse effect on our consolidated financial position, results of operations or cash flows.

 

(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 revenues not generated by the operating segments and 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.

 

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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 the operating information for the three and nine months ended October 1, 2011 and October 2, 2010:

 

     Operating Segments  
(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   
  

 

 

    

 

 

    

 

 

   

 

 

 
     Operating Segments  
(In thousands)    Domestic      Global      Other     Total  

Three months ended 2010

          

Revenues

   $ 394,052       $ 68,631       $ —        $ 462,683   
  

 

 

    

 

 

    

 

 

   

 

 

 

Cost of revenues

     64,150         14,998         —          79,148   

Operating expenses

     102,605         29,482         157,456        289,543   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total costs and expenses

     166,755         44,480         157,456        368,691   
  

 

 

    

 

 

    

 

 

   

 

 

 

Operating earnings (loss)

   $ 227,297       $ 24,151       $ (157,456   $ 93,992   
  

 

 

    

 

 

    

 

 

   

 

 

 
     Operating Segments  
(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   
  

 

 

    

 

 

    

 

 

   

 

 

 
     Operating Segments  
(In thousands)    Domestic      Global      Other     Total  

Nine months ended 2010

          

Revenues

   $ 1,130,384       $ 219,637       $ —        $ 1,350,021   
  

 

 

    

 

 

    

 

 

   

 

 

 

Cost of revenues

     189,540         35,903         —          225,443   

Operating expenses

     311,663         93,577         463,338        868,578   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total costs and expenses

     501,203         129,480         463,338        1,094,021   
  

 

 

    

 

 

    

 

 

   

 

 

 

Operating earnings (loss)

   $ 629,181       $ 90,157       $ (463,338   $ 256,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(11) Subsequent Events

On October 6, 2011, we reached an agreement to acquire Clairvia, Incorporated, an organization that has spent more than a decade developing health care workforce management solutions, including Care Value Management™ and Physician Scheduler™. The acquisition closed on October 17, 2011 and is not expected to have a material impact on Cerner’s 2011 financial results.

 

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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 (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 2011 and 2010 third quarters ended on October 1, 2011 and October 2, 2010, respectively. All references to years in the MD&A represent the respective three or nine months ended of the third fiscal quarters, unless otherwise noted.

On May 27, 2011, the Board of Directors of the Company approved a two-for-one split of our common stock in the form of a one hundred percent (100%) stock dividend, which was distributed on June 24, 2011 to shareholders of record as of June 15, 2011. In connection with the stock split, 790,000 treasury shares previously reflected in the consolidated balance sheets were utilized to settle a portion of the distribution. All share and per share data have been retroactively adjusted for all periods presented to reflect the stock split including the use of treasury shares, as if the stock split had occurred at the beginning of the earliest period presented.

Except for the historical information and discussions contained herein, statements contained in this Form 10-Q may constitute “forward looking statements” within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended (the 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: 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 ongoing adverse financial market environment and uncertainty in global economic conditions; changing political, economic and regulatory 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; the authority of our Board of Directors to issue preferred stock and anti-takeover provisions contained in our corporate governance documents; 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 therein by reference. Forward looking statements are not guarantees of future performance or results. 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 the quality, safety and efficiency in the delivery of health care. We implement the health care solutions as stand-alone, combined or enterprise-wide systems. Cerner Millennium® software solutions can be managed by our clients or in our data centers via a managed services model.

 

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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 9,000 facilities around the world, including more than 2,600 hospitals; 3,500 physician practices covering more than 30,000 physicians; 500 ambulatory facilities, such as laboratories, ambulatory centers, cardiac facilities, radiology clinics and surgery centers; 800 home health facilities; 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 who have not yet selected a supplier and by displacing competitors in health care settings that are looking to replace their current health care information technology (HCIT) partners.

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 HealtheTM employer services, Cerner ITWorksSM services, Cerner RevWorksSM services, physician practice solutions and solutions and services for the pharmaceutical market. Finally, we are focused on selling our solutions and services outside the United States. Many non-U.S. markets have a low penetration of HCIT solutions and their governing bodies are in many cases focused on 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 our history of growing revenue, our net earnings have increased at more than 20% compound annual rates over the most recent five-and ten-year periods. We believe we can continue driving strong levels of earnings growth and leverage key areas to create operating margin expansion. The primary areas of opportunity for margin expansion include:

 

   

becoming more efficient at implementing our software by leveraging implementation tools and methodologies we have developed that can reduce the amount of effort required to implement our software;

 

   

leveraging our investments in R&D by entering new markets that do not require significant incremental R&D but can contribute significantly to revenue growth; and

 

   

leveraging our scalable business infrastructure to reduce the rate of increase in general and administrative spending to below our revenue growth rate.

We are also focused on increasing cash flow by growing earnings, reducing the use of working capital and controlling capital expenditures.

The Health Care and Health Care IT Industry

We believe there are several factors that are favorable for the HCIT industry over the next decade, despite some lingering weakness in the global economy. Because HCIT solutions play an important role in health care by improving safety, efficiency and reducing cost, they are often viewed as more strategic than other capital purchases. Most United States health care providers also recognize that they must invest in HCIT to meet regulatory, compliance and government reimbursement requirements and incentive opportunities. In addition, with the Centers for Medicare and Medicaid Services estimating United States health care spending at $2.6 trillion or 17.5 percent of 2010 Gross Domestic Product, we believe the growing cost of our health care system is unsustainable. We further believe the intelligent use of information systems will improve health outcomes and, correspondingly, drive down costs. This belief is supported by a 2005 study by RAND Corp., which estimated that the widespread adoption of HCIT in the United States could cut health care costs by $162 billion annually.

The broad recognition that HCIT is essential to helping control health care costs and improving quality contributed to the inclusion of HCIT incentives in the American Recovery and Reinvestment Act of 2009 (ARRA). The Health Information Technology for Economic and Clinical Health (HITECH) provisions within ARRA include more than $35 billion in incentives for health care organizations to modernize operations through “meaningful use” of HCIT. These incentives are contributing to increased demand for HCIT solutions and services in the United States.

 

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Another element in the United States marketplace is the health care reform legislation that passed in 2010. We believe the legislation, which promises to drive insurance coverage to up to 32 million additional consumers, could have many second order effects on our clients. For example, health care providers may face increased volumes that could create capacity constraints, and they may find it challenging to profitably provide care at the planned reimbursement rates under the expanded coverage models. We also expect additional compliance and reporting challenges for our clients in the areas of pay-for-quality, ICD-10 coding requirements, fraud, abuse and waste measures.

We believe the above factors create strong incentives for providers to maximize efficiency and create the need for additional investments in HCIT solutions and services. Cerner is well positioned to benefit from this expected increase in demand due to our large footprint in United States hospitals and physician practices and our proven ability to deliver value to our clients.

Outside the United States, the economic downturn of the last few years has impacted and could continue to impact our results. However, we believe long-term revenue growth opportunities outside the United States remain significant because other countries are also focused on controlling health care spending while improving the efficiency and quality of care that is delivered, and many of these countries recognize HCIT as an important piece of the solution to these issues.

In summary, while the current economic environment has impacted our business, we believe the fundamental value proposition of HCIT remains strong. The HCIT industry will likely benefit as health care providers and governments continue to recognize that these solutions and services contribute to safer, more efficient health care.

Results Overview

The Company delivered strong levels of bookings, revenues, earnings and cash flows in the third quarter of 2011. New business bookings revenue, which reflects the value of executed contracts for software, hardware, professional services and managed services, was $650.3 million in the third quarter of 2011, which was an increase of 31% compared to $495.7 million in the third quarter of 2010. Revenues for the third quarter of 2011 increased 24% to $571.6 million compared to $462.7 million in the year-ago quarter. The year-over-year increase in revenue reflects improved economic conditions and demand driven by the United States stimulus incentives related to HCIT. As discussed above in “Health Care and Health Care IT Industry”, we believe the HITECH incentives and the nation’s focus on improving the efficiency and quality of health care will create a period of increased HCIT demand in the United States.

Third quarter 2011 net earnings increased 30% to $78.8 million compared to $60.9 million in the third quarter of 2010. Diluted earnings per share increased 25% to $0.45 compared to $0.36 in the third quarter of 2010. Third quarter 2011 and 2010 net earnings and diluted earnings per share reflect the impact of accounting for stock-based compensation using the fair value method to measure and record expense for stock options, pursuant to Accounting Standards Codification (ASC), 718, Stock Compensation. The effect of these expenses reduced the third quarter 2011 net earnings and diluted earnings per share by $4.6 million and $0.03, respectively, and third quarter 2010 net earnings and diluted earnings per share by $4.1 million and $0.02, 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, particularly leveraging R&D investments and controlling selling, general and administrative expenses. Our third quarter 2011 operating margin was 21.1%, which is 80 basis points higher than the year-ago quarter.

We had strong cash collections of receivables of $532.8 million in the third quarter of 2011 compared to $471.8 million in the third quarter of 2010. Days sales outstanding was 87 days in the third quarter of 2011 compared to 88 days in the second quarter of 2011 and 91 days in the third quarter of 2010. Operating cash flows for the third quarter of 2011 were strong at $129.2 million compared to $119.0 million in the third quarter of 2010.

 

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Results of Operations

Three Months Ended October 1, 2011 Compared to Three Months Ended October 2, 2010

The following table presents a summary of the operating information for the third quarters of 2011 and 2010:

 

 

 

 

 
(In thousands)               2011                     % of Revenue                     2010                     % of Revenue             % Change      
 

 

 

 

Revenues

         

System sales

  $ 188,698        33   $ 133,439        29     41

Support and maintenance

    138,573        24     130,199        28     6

Services

    232,894        41     191,090        41     22

Reimbursed travel

    11,475        2     7,955        2     44
 

 

 

 

Total revenues

    571,640        100     462,683        100     24

Costs of revenue

         

Costs of revenue

    120,464        21     79,148        17     52
 

 

 

 

Total margin

    451,176        79     383,535        83     18

Operating expenses

         

Sales and client service

    220,177        38     189,320        41     16

Software development

    72,544        13     67,257        15     8

General and administrative

    38,063        7     32,966        7     15
 

 

 

 

Total operating expenses

    330,784        58     289,543        63     14
 

 

 

 

Total costs and expenses

    451,248        79     368,691        80     22
 

 

 

 

Operating earnings

    120,392        21.1     93,992        20.3     28

Interest income, net

    2,770          87       

Other income, net

    5          5       

Income taxes

    (44,332       (33,212    
 

 

 

 

Net earnings

  $ 78,835        $ 60,872          30
 

 

 

 

Revenues & Backlog

Revenues increased 24% to $571.6 million for the third quarter of 2011 from $462.7 million for the same period in 2010.

 

   

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 41% to $188.7 million for the third quarter of 2011 from $133.4 million for the same period in 2010. The increase in system sales was driven by a very strong increase in technology resale and a strong increase in licensed software and subscriptions.

 

   

Support and maintenance revenues increased 6% to $138.6 million during the third quarter of 2011 from $130.2 million during the same period in 2010. This increase was attributable to continued success at selling Cerner Millennium applications, implementing them at client sites and initiating billing for support and maintenance fees. We expect 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 22% to $232.9 million from $191.1 million for the same period in 2010. 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.

 

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Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 24% in the third quarter of 2011 compared to the same period in 2010. 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:

 

(In thousands)    October 1, 2011      October 2, 2010  
  

 

 

 

Contract backlog

   $ 4,964,942       $ 4,018,475   

Support and maintenance backlog

     691,069         642,436   
  

 

 

 

Total backlog

   $ 5,656,011       $ 4,660,911   
  

 

 

 

Costs of Revenue

Cost of revenues was 21% of total revenues in the third quarter of 2011, compared to 17% in the same period of 2010. The higher cost of revenues as a percent of revenue was primarily driven by a higher mix of technology resale, which carries a higher cost of revenue, and a slightly higher level of third party consulting costs. The cost of revenues includes the cost of reimbursed travel expense, third party consulting services and subscription content, 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. Costs 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 14% to $330.8 million in the third quarter of 2011, compared with $289.5 million for the same period in 2010.

 

   

Sales and client service expenses as a percent of total revenues were 38% in the third quarter of 2011, compared to 41% in the same period of 2010. These expenses increased 16% to $220.2 million in the third quarter of 2011, from $189.3 million in the same period of 2010. 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 was primarily attributable to growth in managed services and professional services.

 

   

Software development expenses as a percent of revenue were 13% in the third quarter of 2011, compared to 15% in the same period of 2010. These expenses increased 8% to $72.5 million in the third quarter of 2011, from $67.3 million in the same period of 2010. Expenditures for software development in the third quarter of 2011 reflect continued development and enhancement of the Cerner Millennium platform and software solutions and investments in new growth initiatives. Although these expenses increased in the third quarter of 2011, 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 2011 and 2010 is as follows:

 

    Three Months Ended  
(In thousands)               2011                             2010              
 

 

 

 

Software development costs

  $ 72,397      $ 70,037   

Capitalized software costs

    (20,368     (20,199

Capitalized costs related to share-based payments

    (404     (337

Amortization of capitalized software costs

    20,919        17,756   
 

 

 

 

Total software development expense

  $ 72,544      $ 67,257   
 

 

 

 

 

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General and administrative expenses as a percent of total revenues were 7% in the third quarter of 2011 and 2010. These expenses increased 15% to $38.1 million in the third quarter of 2011, from $33.0 million for the same period in 2010. 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 driven primarily by corporate personnel costs.

Non-Operating Items

 

   

Net interest income was $2.8 million in the third quarter of 2011, compared to net interest income of $0.1 million in the third quarter of 2010. Interest income increased to $4.1 million in the third quarter of 2011 from $1.8 million for the same period in 2010 due primarily to growth in investments and an increase in investment returns. Interest expense decreased to $1.4 million in the third quarter of 2011 from $1.7 million for the same period in 2010, due to payments on our long-term debt.

 

   

Other income was insignificant for the third quarters of 2011 and 2010.

 

   

Our effective tax rate was 36.0% for the third quarter of 2011 and 35.3% for the third quarter of 2010. This increase was primarily due to a change in the mix of earnings between the U.S. and foreign jurisdictions and other discrete items.

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 Aruba, Australia, Austria, Belgium, Canada, Cayman Islands, Chile, China (Hong Kong), Egypt, England, France, Germany, India, Ireland, Malaysia, 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 2011 and 2010:

 

 

 

 

 
(In thousands)               2011                     % of Revenue                     2010                     % of Revenue                 % Change          
 

 

 

 

Domestic Segment

         

Revenues

  $ 499,497        100   $ 394,052        100     27

Costs of revenue

    109,656        22     64,150        16     71

Operating expenses

    110,775        22     102,605        26     8
 

 

 

 

Total costs and expenses

    220,431        44     166,755        42     32
 

 

 

 

Domestic operating earnings

    279,066        56     227,297        58     23
 

 

 

 

Global Segment

         

Revenues

    72,143        100     68,631        100     5

Costs of revenue

    10,808        15     14,998        22     -28

Operating expenses

    33,412        46     29,482        43     13
 

 

 

 

Total costs and expenses

    44,220        61     44,480        65     -1
 

 

 

 

Global operating earnings

    27,923        39     24,151        35     16
 

 

 

 

Other, net

    (186,597       (157,456       19
 

 

 

 

Consolidated operating earnings

  $ 120,392        $ 93,992          28
 

 

 

 

 

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Domestic Segment

 

   

Revenues increased 27% to $499.5 million in the third quarter of 2011 from $394.1 million in the same period in 2010. This increase was driven by growth across all business models, with particular strength in technology resale and professional services.

 

   

Cost of revenues was 22% of revenues in the third quarter of 2011, compared to 16% of revenues in the same period in 2010. The higher cost of revenues as a percent of revenue was primarily driven by a higher mix of technology resale, which carries a higher cost of revenue, and a slightly higher level of third party consulting costs.

 

   

Operating expenses increased 8% to $110.8 million in the third quarter of 2011, from $102.6 million in the same period in 2010, due primarily to growth in managed services and professional services expenses.

Global Segment

 

   

Revenues increased 5% to $72.1 million in the third quarter of 2011 from $68.6 million in the same period in 2010. Overall, increases in licensed software and managed services revenue were partially offset by declines in professional services and technology resale revenue.

 

   

Cost of revenues was 15% of revenues in the third quarter of 2011, compared with 22% in the same period of 2010. The lower cost of revenues in 2011 was primarily driven by the decline in technology resale, which carries a higher cost of revenue.

 

   

Operating expenses increased 13% to $33.4 million for the third quarter of 2011, from $29.5 million in the same period in 2010, primarily due to an increase in personnel-related expense.

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 19% to $186.6 million in the third quarter of 2011 from $157.5 million in the same period in 2010. This increase was primarily due to growth in professional services, software development, and corporate personnel costs.

 

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Nine Months Ended October 1, 2011 Compared to Nine Months Ended October 2, 2010

The following table presents a summary of the operating information for the first nine months of 2011 and 2010:

 

  

 

 

 
(In thousands)                2011                     % of Revenue                     2010                     % of Revenue             % Change      
  

 

 

 

Revenues

          

System sales

   $ 486,222        31   $ 386,292        29     26

Support and maintenance

     408,580        26     385,304        29     6

Services

     659,211        41     554,605        41     19

Reimbursed travel

     33,514        2     23,820        2     41
  

 

 

 

Total revenues

     1,587,527        100     1,350,021        100     18

Costs of revenue

          

Costs of revenue

     309,626        20     225,443        17     37
  

 

 

 

Total margin

     1,277,901        80     1,124,578        83     14

Operating expenses

          

Sales and client service

     631,738        40     566,943        42     11

Software development

     213,478        13     202,024        15     6

General and administrative

     110,621        7     99,611        7     11
  

 

 

 

Total operating expenses

     955,837        60     868,578        64     10
  

 

 

 

Total costs and expenses

     1,265,463        80     1,094,021        81     16
  

 

 

 

Operating earnings

     322,064        20.3     256,000        19.0     26

Interest income, net

     7,621          2,291       

Other income (expense), net

     45          (566    

Income taxes

     (114,295       (91,090    
  

 

 

 

Net earnings

   $ 215,435        $ 166,635          29
  

 

 

 

Revenues & Backlog

Revenues increased 18% to $1.59 billion for the first nine months of 2011 from $1.35 billion for the same period in 2010.

 

   

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 26% to $486.2 million for the first nine months of 2011 from $386.3 million for the same period in 2010. The increase in system sales was driven by a strong increase in technology resale, subscriptions and licensed software.

 

   

Support and maintenance revenues increased 6% to $408.6 million during the first nine months of 2011 from $385.3 million during the same period in 2010. The increase is attributable to growth in Cerner Millennium applications for which support billing has been initiated.

 

   

Services revenue, which includes professional services, excluding installation, and managed services, increased 19% to $659.2 million from $554.6 million for the same period in 2010. This increase is 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.

 

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Contract backlog, which reflects new business bookings that have not yet been recognized as revenue, increased 24% in the first nine months of 2011 compared to the same period in 2010. This increase was driven by growth in new business bookings during the past four quarters, including continued strong levels of managed services bookings that typically have longer contract terms. A summary of our total backlog follows:

 

$000,000,000 $000,000,000
(In thousands)    October 1, 2011     October 2, 2010  
  

 

 

 

Contract backlog

   $ 4,964,942         $ 4,018,475      

Support and maintenance backlog

     691,069        642,436   
  

 

 

 

Total backlog

   $ 5,656,011      $ 4,660,911   
  

 

 

 

Costs of Revenue

Cost of revenues was 20% of total revenues in the first nine months of 2011, as compared to 17% in the same period of 2010. The higher cost of revenues as a percent of revenue was primarily driven by a higher mix of technology resale, which carries a higher cost of revenue, and a slightly higher level of third party consulting costs. The cost of revenues includes the cost of reimbursed travel expense, third party consulting services and subscription content, 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. Costs 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 10% to $955.8 million in the first nine months of 2011, compared with $868.6 million for the same period in 2010.

 

   

Sales and client service expenses as a percent of total revenues were 40% in the first nine months of 2011, compared to 42% in the same period of 2010. These expenses increased 11% to $631.7 million in the first nine months of 2011, from $566.9 million in the same period of 2010. 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 was primarily attributable to growth in the managed services business and a higher level of professional services expenses, which were slightly offset by a decrease in bad debt expense.

 

   

Software development expense as a percent of total revenues was 13% in the first nine months of 2011, compared to 15% in the same period of 2010. These expenses increased 6% to $213.5 million in the first nine months of 2011, from $202.0 million in the same period of 2010. Expenditures for software development in the first three quarters of 2011 reflect continued development and enhancement of the Cerner Millennium platform and software solutions and investments in new growth initiatives. Although these expenses increased in the first nine months of 2011, 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 first nine months of 2011 and 2010 is as follows:

 

$000,000,000 $000,000,000
     Nine Months Ended  
(In thousands)    2011     2010  
  

 

 

 

Software development costs

   $ 215,418         $ 213,793      

Capitalized software costs

     (60,713     (60,802

Capitalized costs related to share-based payments

     (1,114     (982

Amortization of capitalized software costs

     59,887        50,015   
  

 

 

 

Total software development expense

   $ 213,478      $ 202,024   
  

 

 

 

 

   

General and administrative expenses as a percent of total revenues were 7% in the first nine months of 2011 and 2010. These expenses increased 11% to $110.6 million in the first nine months of 2011, from $99.6 million for the same period in 2010. 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. An increase in corporate personnel costs accounted for the majority of the overall increase in general and administrative expenses.

 

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Non-Operating Items

 

   

Net interest income was $7.6 million in the first nine months of 2011 compared to net interest income of $2.3 million in the first nine months of 2010. Interest income increased to $11.5 million in the first nine months of 2011 from $7.6 million for the same period in 2010, due primarily to growth in investments and an increase in investment returns. Interest expense decreased to $3.9 million in the first nine months of 2011 from $5.3 million for the same period in 2010, due primarily to long-term debt payments made in the fourth quarter of 2010.

 

   

Other income was insignificant in the first nine months of 2011, compared to other expense of $0.6 million for the same period in 2010. Other income and expense in the first nine months of 2010 includes offsetting unrealized gains and losses included in earnings related to our auction rate securities and put-like settlement feature in the net amount of $6.9 million.

 

   

Our effective tax rate was 34.7% for the first nine months of 2011 and 35.3% for the first nine months of 2010. This decrease was primarily due to the research and development tax credit being in effect for the first nine months of 2011 while it was not effective for the first nine months of 2010 and a favorable foreign tax audit settlement during the first quarter.

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 Aruba, Australia, Austria, Belgium, Canada, Cayman Islands, Chile, China (Hong Kong), Egypt, England, France, Germany, India, Ireland, Malaysia, 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 first nine months of 2011 and 2010:

 

 

 

 

 
(In thousands)               2011                     % of Revenue                     2010                     % of Revenue             % Change      
 

 

 

 

Domestic Segment

         

Revenues

  $ 1,370,741        100   $ 1,130,384        100     21

Costs of revenue

    274,994        20     189,540        17     45

Operating expenses

    322,250        24     311,663        28     3
 

 

 

 

Total costs and expenses

    597,244        44     501,203        44     19
 

 

 

 

Domestic operating earnings

    773,497        56     629,181        56     23
 

 

 

 

Global Segment

         

Revenues

    216,786        100     219,637        100     -1

Costs of revenue

    34,632        16     35,903        16     -4

Operating expenses

    94,182        43     93,577        43     1
 

 

 

 

Total costs and expenses

    128,814        59     129,480        59     -1
 

 

 

 

Global operating earnings

    87,972        41     90,157        41     -2
 

 

 

 

Other, net

    (539,405       (463,338       16
 

 

 

 

Consolidated operating earnings

  $ 322,064        $ 256,000          26
 

 

 

 

Domestic Segment

 

   

Revenues increased 21% to $1.37 billion in the first nine months of 2011 from $1.13 billion in the same period in 2010. This increase was driven by growth across all business models, with particular strength in professional services, technology resale and managed services.

 

   

Cost of revenues increased to 20% of revenues in the first nine months of 2011, compared to 17% in the same period in 2010. The higher cost of revenues as a percent of revenue was primarily driven by a higher mix of technology resale, which carries a high cost of revenue, and a slightly higher level of third party consulting costs.

 

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Operating expenses increased 3% to $322.3 million in the first nine months of 2011, from $311.7 million in the same period in 2010, due primarily to growth in managed services and professional services expense, offset by a decrease in bad debt expense.

Global Segment

 

   

Revenues decreased 1% to $216.8 million in the first nine months of 2011 from $219.6 million in the same period in 2010. Overall, declines in technology resale and professional services revenue were partially offset by an increase in managed services, licensed software and support services revenue. The global revenue comparisons were also impacted by a change in certain contract accounting estimates during the first quarter of 2010.

 

   

Cost of revenues was 16% of revenues in the first nine months of 2011 and 2010.

 

   

Operating expenses increased 1% to $94.2 million for the first nine months of 2011, from $93.6 million in the same period in 2010, primarily due to an increase in personnel-related expense.

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 16% to $539.4 million in the first nine months of 2011 from $463.3 million in the same period in 2010. This increase was primarily due to growth in professional services, software development, and corporate personnel costs, slightly offset by lower depreciation expense.

Liquidity and Capital Resources

Our liquidity is influenced by many factors, including the amount and timing of our revenues, our cash collections from our clients and the amounts we invest in software development, acquisitions and capital expenditures.

Our principal sources of liquidity are our cash, cash equivalents, which consist of money market funds and time deposits, and short-term investments. At October 1, 2011, we had cash and cash equivalents of $231.2 million and short-term investments of $524.0 million compared to cash and cash equivalents of $214.5 million and short-term investments of $356.5 million at January 1, 2011. Approximately 17% and 22% of our cash, cash equivalents and short-term investments as of October 1, 2011 and January 1, 2011, respectively, were held outside of the United States.

Additionally, we maintain a $90.0 million, multi-year revolving credit facility, which provides an unsecured revolving line of credit for working capital purposes. Interest is payable at a rate based on prime or LIBOR plus a spread that varies depending on the net worth ratios maintained. The agreement provides certain restrictions on our ability to borrow, incur liens, sell assets and pay dividends and contains certain net worth, current ratio and fixed charge coverage covenants, which as of October 1, 2011, we were in compliance with. The current agreement expires on May 31, 2013. As of October 1, 2011, we had no outstanding borrowings under this agreement; however, we have $9.9 million of outstanding letters of credit, which reduced our available borrowing capacity to $80.1 million.

We believe that our present cash position, together with cash generated from operations, short-term investments and, if necessary, our available lines of credit, will be sufficient to meet anticipated cash requirements during 2011.

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 October 1, 2011, 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 the significant majority of other long-term assets as of the third quarter ended October 1, 2011. While the ultimate collectability of the receivables pursuant to this process is uncertain, we believe that we have valid and equitable grounds for recovery of such amounts and that collection of recorded amounts is probable.

 

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The following table summarizes our cash flows in the first nine months of 2011 and 2010:

 

     Nine Months Ended  
(In thousands)                2011                             2010              
  

 

 

 

Cash flows from operating activities

   $ 377,805      $ 334,697   

Cash flows from investing activities

     (429,634     (407,843

Cash flows from financing activities

     68,978        40,262   

Effect of exchange rate changes on cash

     (466     2,908   
  

 

 

 

Total change in cash and cash equivalents

     16,683        (29,976

Cash and cash equivalents at beginning of period

     214,511        241,723   
  

 

 

 

Cash and cash equivalents at end of period

   $ 231,194      $ 211,747   
  

 

 

 

Free cash flow (non-GAAP)

   $ 240,376      $ 197,573   
  

 

 

 

Cash from Operating Activities

 

     Nine Months Ended  
(In thousands)                2011                             2010              
  

 

 

 

Cash collections from clients

   $ 1,572,917      $ 1,402,553   

Cash paid to employees and suppliers and other

     (1,129,703     (976,135

Cash paid for interest

     (3,081     (3,483

Cash paid for taxes, net of refund

     (62,328     (88,238
  

 

 

 

Total cash from operations

   $ 377,805      $ 334,697   
  

 

 

 

Cash flow from operations increased in the first nine months of 2011 as compared to the same period of 2010 due primarily to the increase in cash impacting earnings, which was partially offset by cash used by working capital. During the first nine months of 2011 and 2010, we received total client cash collections of $1.57 billion and $1.40 billion, respectively, of which 3% in each period were received from third party client financing arrangements and non-recourse payment assignments. Days sales outstanding was 87 days in the third quarter of 2011, 88 days in the second quarter of 2011 and 91 days in the third quarter of 2010. Revenues provided under support and maintenance agreements represent recurring cash flows. Support and maintenance revenues increased 6% in the first nine months of 2011 compared to the first nine months of 2010. We expect these revenues to continue to grow as the base of installed Cerner Millennium systems grows.

Cash from Investing Activities

Cash flows from investing activities consist primarily of cash used in acquisitions, capital spending and our short-term investment activities. Capital spending consists of capitalized equipment purchases primarily to support growth in our CernerWorks managed services business, capitalized building and improvement purchases to support our facilities requirements and capitalized spending to support our ongoing software development initiatives.

In addition, during the second quarter 2011, we completed our acquisition of Resource Systems, Inc. for approximately $28.1 million, net of the cash acquired. During the first quarter 2010, we completed our acquisition of IMC Healthcare, Inc. for approximately $14.5 million, net of the cash acquired.

Cash from Financing Activities

 

     Nine Months Ended  
(In thousands)                2011                             2010              
  

 

 

 

Long-term debt repayments

   $ (715   $ (2,404

Cash from option exercises (including excess tax benefits)

     70,472        41,150   

Other, net

     (779     1,516   
  

 

 

 

Total cash flows from financing activities

   $ 68,978      $ 40,262   
  

 

 

 

Our primary financing obligations are long-term debt repayments. In the fourth quarter of 2009, we commenced payment on the first of seven equal annual installments on our 5.54% Great Britain Pound denominated Note Agreement as well as on the first of four equal annual installments on our 6.42% Series B Senior Notes. Based on current exchange rates, we expect our debt repayments related to these notes to approximate $25 million per year through 2012 and approximately $15 million per year from 2013 through 2015.

 

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Free Cash Flow

 

     Three Months Ended     Nine Months Ended  
(In thousands)                2011                             2010                             2011                             2010              
  

 

 

   

 

 

 

Cash flows from operating activities

   $ 129,177      $ 118,956      $ 377,805      $ 334,697   

Capital purchases

     (23,925     (19,330     (75,602     (75,341

Capitalized software development costs

     (20,772     (20,535     (61,827     (61,783
  

 

 

   

 

 

 

Free cash flow (non-GAAP)

   $ 84,480      $ 79,091      $ 240,376      $ 197,573   
  

 

 

   

 

 

 

Free cash flow increased $42.8 million in the first nine months of 2011 as compared to the same period in 2010, which we believe reflects continued strengthening of our earnings quality. Free cash flow is a non-GAAP financial measure used by management along with GAAP results to analyze our earnings quality and overall cash generation of the business. The presentation of free cash flow is not meant to be considered in isolation, nor as a substitute for, or superior to, GAAP results. Investors should be aware that non-GAAP measures have inherent limitations and should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP. Free cash flow may also be different from similar non-GAAP financial measures used by other companies and may not be comparable to similarly titled captions of other companies due to potential inconsistencies in the method of calculation. We believe free cash flow is important to enable investors to better understand and evaluate our ongoing operating results and allows for greater transparency in the review of our overall financial, operational and economic performance.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

No material changes.

 

Item 4. Controls and Procedures

 

  a)

Evaluation of disclosure controls and procedures. The Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by the Quarterly Report (the Evaluation Date). They have concluded that, as of the Evaluation Date, these disclosure controls and procedures were effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities and would be disclosed on a timely basis. The CEO and CFO have concluded that the Company’s disclosure controls and procedures are designed, and are effective, to give reasonable assurance that the information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the rules and forms of the SEC. They have also concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that are filed or submitted under the Exchange Act are accumulated and communicated to the Company’s management, including the CEO and CFO, to allow timely decisions regarding required disclosure.

 

  b)

There were no changes in the Company’s internal controls over financial reporting during the nine months ended October 1, 2011 that have materially affected, or are reasonably likely to materially affect, its internal controls over financial reporting.

 

  c)

The Company’s management, including its CEO and CFO, has concluded that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at that reasonable assurance level. However, the Company’s management can provide no assurance that our disclosure controls and procedures or our internal control over financial reporting can prevent all errors and all fraud under all circumstances. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been or will be detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

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Part II. Other Information

 

Item 6. Exhibits

 

(a)

Exhibits

31.1    Certification of Neal L. Patterson, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of Marc G. Naughton, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS XBRL Instance Document

101.SCH XBRL Taxonomy Extension Schema Document

101.CAL XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB XBRL Taxonomy Extension Labels Linkbase Document

101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF XBRL Taxonomy Extension Definition Linkbase Document

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   

CERNER CORPORATION

   

Registrant

October 28, 2011

   

By:

 

/s/ Marc G. Naughton

Date

     

Marc G. Naughton

     

Executive Vice President and

     

Chief Financial Officer

     

(duly authorized officer and

principal financial officer)

 

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